Earth, Wind, and Fire

New markets are emerging to help companies cope with climate change risks.

To say that Jack MacDonald’s company sells hot air would be wrong. In fact, EcoSecurities, where MacDonald is CFO, sells the absence of hot air.

The Dublin-based, London-listed firm is one of many companies which develop projects to cut greenhouse gases in China, India and other developing countries, generating emission-reduction credits that companies in Europe can use to offset their obligations under the EU’s CO2 cap-and-trade scheme. The trade in developing-world credits will be worth €4.6 billion ($6.1 billion) this year, double the total two years ago, according to consultancy Point Carbon.

In February, the Intergovernmental Panel on Climate Change, a group of scientists and government officials gathered by the UN, issued the fourth of a series of much-anticipated reports on global warming. The panel concluded that human activity is exacerbating climate change, leading to more frequent heat waves, heavy precipitation and severe tropical cyclones. In response, a host of new markets are emerging for financial instruments to help companies offset their emissions, bolster operations against increasingly capricious weather, or simply burnish their green credentials. What follows is CFO Europe‘s forecast of the key developments for climate-conscious finance chiefs.

Kyoto Flexible Mechanisms

The EU’s mandatory CO2 trading scheme, covering some 6,000 companies in the heaviest polluting industries, accounts for 60 percent of the volume, and 80 percent of the value, of global emissions trading. Most of the remaining trade is in credits generated by the “flexible mechanisms” of the Kyoto protocol, which are expected to increase in the coming years. (See chart below.)

Under the EU’s system, a portion of a company’s emissions allowance, generally between 10 percent and 20 percent, can be covered by UN-certified credits generated by projects that reduce pollution in the developing world, under a program known as the Clean Development Mechanism (CDM). Because achieving reductions in emissions in countries such as China and India is usually cheaper and easier than in western Europe, companies are expected to maximize their use of developing-world credits in the future in those parts of the world.

Analysts at JPMorgan recently estimated that companies will experience an annual credit shortfall of 150 million to 220 million between 2008 and 2012. (Each credit covers the emission of one ton of CO2.) The analysts reckon that around half of this shortfall can be met by using Kyoto credits.

Last year, prices for CDM credits ranged from around €6 to €17 per ton, according to Point Carbon. Energy companies and other large emitters often manage projects directly, securing credits at the low end of the price range, but also bearing the risks of project failure, registration delays and the like.

Insurers now offer “credit-delivery guarantees,” policies covering many of the risks inherent with CDM projects, which usually take one to three years from launch to certification by the UN.

EcoSecurities and other firms of its kind represent the growing influence of specialist carbon financiers in the CDM market. (Others include AgCert, Camco, CantorCO2e and Climate Change Capital.) These speculative investors seek the arbitrage opportunity of generating cheap credits in poor countries to sell to the developed world, primarily Europe, where the benchmark price for domestic CO2 credits in 2008 and beyond currently trades at around €15. More than €1.2 billion has been raised by private carbon funds to date, according to Sonia Labatt and Rodney White in Carbon Finance (John Wiley, 2007).


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