Creating a “Wall Street” for Carbon

Climate Forests Investments Jan 1, 2001
Careesa Gee

Are recent partnerships between emission exchanges in Europe signs of a growing trend towards consolidation in the carbon market? The Ecosystem Marketplace takes a look at how some of the major players are staking out ground in a field full of competition. In a small room of Amsterdam's modern, glass-walled World Trade Centre located just beyond the edges of the city's charming canal rings, Peter Koster is checking to see if the carbon exchange has yet hit the million tonne mark for the day. "Last Monday," he says, referring to July 11, 2005, "we traded 1.2 million. It took us a month to pass the first million tonnes traded after we started in April 2005." As the director of the European Carbon Exchange (ECX), Koster oversees one of the largest exchange players to emerge onto the European carbon trading scene since the EU ETS was launched in January of 2005. On September 23, 2005, the ECX celebrated its 38 millionth ton of carbon dioxide traded. Since the launch of the EU ETS, carbon emissions trading has increased exponentially, despite the rapidly rising price for a ton of carbon. One sign of this increase has been the seemingly monthly creation of carbon exchanges on the continent. "Bilateral trading used to account for 90 to 95 per cent of the total value of trading," explains Koster. "Now, 50 per cent is done through exchanges, and 75 per cent of this is through the ECX." The ECX, which trades emissions futures on the International Petroleum Exchange (IPE) platform, is a full subsidiary of the Chicago Climate Exchange. Its Carbon Financial Instruments (CFIs) contracts are based on allowances issued under the EU ETS, and include a series of futures contracts that allow users to lock-in prices for delivery at a set date in the future. Since it uses the IPE trading platform, ECX is positioned to capture the emissions trading of IPE members, which include major oil and gas companies such as BP and Shell, and major financial institutions such as Goldman Sachs, Morgan Stanley, and Merrill Lynch. Currently, there are 80 companies that can either trade emissions contracts directly or through one of the Clearing Members on the IPE, and about 4500 traders active on the ECX. The use of the IPE platform means that emission trades through the ECX are done through the London Clearing mechanism, which has a default fund of seven million sterling, and whose members include all the triple A banks. Further cementing its position as one of the pre-eminent global carbon exchanges, the ECX recently completed a partnership arrangement with PowerNext, a French-based electricity exchange that trades in the emissions spot market. Powernext has 50 members, and launched the first European continuous CO2 spot market in June. The delivery versus payment function will be done by Caisse Des Depots, a founding partner of Powernext Carbon with Powernext and Euronext. The cooperative agreement between ECX and PowerNext means that members of both exchanges can trade through an integrated platform, and have access to a broader variety of carbon trading tools. The joint technology initiative enables the market to access all contracts on the same screens, and the choice of trading in either futures or spot contracts. In a press release announcing the agreement, Jean-Francois Conil-Lacoste, CEO of Powernext, stated that the "agreement promotes concentration of liquidity and creates a platform to become the leading pan European market in the fight against climate change."

Other Exchanges

The first exchange in the world to offer trading and clearing of European Union Allowances (EUAs) was the Oslo-based Nord Pool, which is, by volume, Europe's biggest electricity exchange. Opened in February, the first trade saw Statoil ASA sell the right to emit 5 000 tonnes of CO2 to France's EDF Trading. There are now 59 members that can trade CO2 allowances, both forward and spot contracts, through a continuous trading system. The counterparty for all exchange trades is Nord Pool Clearing, which guarantees both the cash settlement to the seller and the physical delivery to the buyer of the contracts. This clearing service is also offered for Over the Counter transactions known as OTC trades. "By opening this marketplace, we're facilitating more efficient trading of EUAs across national boundaries and industrial sectors," said Nord Pool president and CEO Torger Lien in a release at the initial launch of the market. "Efficient trading is an important requirement if the EU is to succeed with its model for meeting the obligations enshrined in the Kyoto protocol." Another major exchange is the European Energy Exchange (EEX) in Leipzig, Germany. The EEX is continental Europe's largest energy exchange by volume and participants, and was the result of a merger between the Leipzig Power Exchange (LPX) and the European Energy Exchange of Frankfurt in 2002. It has the advantage of being situated in a country with about 25 percent of the total EU ETS emissions allowances, making it the largest domestic market for emissions trading. It has 126 participants from 15 European countries that were able to start trading CO2 allowances in March. In early August, the EEX began offering continuous trading for C02 allowances, to provide an option to its initial auction model, where single hour and block bids can be placed both for purchase and sale. The exchange also offers OTC clearing and, as of October 2005, EEX says all is ready for the launch a European Futures Market. "European Carbon Futures" announced the exchange on September 26, 2005, "will enable price hedging for the EU Allowances trading up to the year 2012." Another Amsterdam-based exchange is New Values, which operates three trading platforms: Climex, used for the online trading of CO2 emissions, CertiChange, used to trade Certificates of Origin, and EEeXchange, which buys and sells Nitrogen Oxides (NOx) emission rights. CertiChange is used primarily by Dutch companies, and the EEeXchange is used soley by Dutch companies as NOx is a regional environmental problem. Through an anonymous online trading system, Climex processes all transactions and covers the settlement risks. Climex recently formed a partnership with both SENDECO2, a Spanish-based exchange, and Asia Carbon International B.V., which is also based in the Netherlands. Tames Rietdijk, the Chief Technology Officer, says these partnerships are one way of attracting more liquidity, which he, too, believes will be the key to survival. "I think it will be a combination of product offerings, geographic spread, and number of partners that will influence the liquidity that exchanges will generate," Rietdijk says, with regards to which factors will dominate the competition between the exchanges. As a result, one of True Value's goals is to actively seek partnerships that give them greater geographical spread, which would work to increase both members and trading, since some countries (such as Germany) tend to have more surpluses, while others (such as Italy) have more deficits and are bigger buyers. Given this fact, the partnership with the Barcelona-based SENDECO2, the first Spanish trading platform for CO2 allowances, should prove beneficial, as it brings together Northern and Southern European participants. Unlike the ECX, Climex trades in spot emissions, a decision that was linked to the fact that their membership base is largely smaller industry and commercial companies that are not currently trading on the major power exchanges. At the time of Climex's launch in February, Axel Posthumus, CEO of New Values explained this strategy, saying that "Climex will offer secure trading opportunities at low cost for all players in the market. We will attract liquidity to the platform by providing a solution to aggregate the volume of small and medium size companies. Companies that trade smaller volumes and do not very actively engage in the market currently face a high market entry barrier. Together with our partners in Germany, the Netherlands and the UK we are able to access these companies on a personal level." To help develop the market, Climex also offers workshops, trading simulations, and online forums with market experts. Climex's second partnership with Asia Carbon is an interesting development, as it moves CO2 trading from its current focus on EU ETS allowances to combining this with Clean Development Mechanism (CDM) projects and the Certified Emissions Reductions (CERs) they generate (reductions that can be used to meet the compliance requiremens of the Kyoto Protocol). Regarding this second partnership, Posthumus noted that it "intends to connect the EU ETS market with the global CDM market and intends to provide additional CERs for European institutions. For market players this means that the market becomes more liquid and therefore more trustworthy." Asia Carbon works with developers in China, India, Vietnam, and Indonesia on CDM projects, which can be registered under the Kyoto Protocol to earn companies credits to help meet their emissions targets. However, since it won't be until at least 2008 that CERs can be validated and become fungible, the exchange will be set up more as a forward market, and act a 'matchmaking service' between buyers and sellers.

The Future of the Exchanges

The price of CO2 emissions has already risen dramatically since the launch of the EU ETS–between January and July the price per ton in Euros increased from just over 6 euros to 20.50 euros. According to the ECX, the market this year could reach $5 billion. This increase is partly attributable to the weather this summer in countries such as Spain and Italy, where high temperatures lead to increased energy demand, at the same time that the rising price of oil and gas drove energy companies to switch to coal, all of which resulted in heavier emissions. Since this could lead to emissions over their caps, many energy companies have had to buy carbon credits, pushing the price up. Both the ECX and Climex expect that trading in emissions will increase when the second phase of the EU ETS commences in 2008–at that point, it will be decided what other sectors will be added to the scheme, as well as what other types of emissions could be traded. Under the EU ETS, current allowances have been given out for a combined total of emissions around 2.2 billion tons of CO2 each year until 2007, to 12,000 "heavy polluters" in sectors such as power, paper, glass, packaging, refining, ceramics, cement, steel, and some chemicals. In the second phase, which goes from 2008 to 2012, it looks likely that the aviation sector could be added (on September 27, 2005, the European Commission officially endorsed this idea) along with the ability to trade sulphur dioxide and nitrates, which is sure to fuel an increase in emissions trading. But will this trading still be done on the same exchanges? With many of the key players now moving to expand geographically, provide new services, and offer more products, Koster predicted that the exchanges will either grow, merge, or die off. Explaining that the preferences of traders would likely be one of the key determining factors, Koster said "liquidity attracts liquidity, because traders don't want to be squeezed where they can't trade out." Noting that it would also be better for both buyers and sellers to have fewer markets to trade in (because of the increased price transparency), Koster said that, in his opinion, this would mean greater consolidation of emissions trading. "There is no need for six exchanges from a market perspective," says Koster. "The market loves competition, but hates fragmented liquidity. At the end of the day, there will be one or two exchanges." "The market will decide where it wants to trade," he predicted. He clearly hopes the ECX will be one the market's main choices. But in this he is not alone: other exchanges harbour the same hopes for themselves. Only time–and liquidity–will tell. To download a MicroSoft Word document of the exchanges mentioned in this article, click here. Careesa Gee works in sustainable development out of Amsterdam, Hong Kong, and Canada. She can be reached at First posted: September 28, 2005