Carbon Trading May Dwarf That of Crude Oil

If carbon cap-and-trade becomes a reality, get ready for a potential multi-trillion dollar commodities market that could sprout up quickly, but not without growing pains.

Carbon Tax
Carbon Tax

“I’m estimating carbon markets could be worth $2 trillion in transaction value – money changing hands – within five years of trading (starting),” says Bart Chilton, a Commodity Futures Trading Commission (CFTC) commissioner, who's also chairman of its energy and environmental markets advisory committee. “That would make it the largest physically traded commodity in the US, surpassing even oil.”

Chilton's estimate is based on futures activity in commodities. “It’s a fairly reasonable to estimate 10 times the expected cash market,” he says, pointing to a multimillion dollar voluntary carbon market in the US in 2008.

That could mean a carbon emissions market of 60 to 180 million contracts. By comparison, 135 million contracts of light sweet crude oil, 39 million contracts of natural gas and 53 million of all metals were traded on the Nymex in 2008.

“It’s very exciting, the opportunities are really unbounded,” he says. “We’re going to see innovation and really fast and furious growth. The potential for this market is truly impressive.”

US carbon markets are just getting started.

The World Bank estimates the value of global carbon markets jumped from $110 million in 2002 to $126 billion in 2008, while a recent report by New Carbon Finance and Ecosystems Marketplace shows 123 million tons of carbon credits worth $705 million were traded here in 2008.

While that’s more than double that of 2007’s 65 million tons and $331 million, it’s still a drop in the bucket compared to the world’s largest carbon market, the European Union Emission Trading Scheme (EU ETS). Launched in 2005 to provide a market for EU member compliance with the Kyoto agreement, it handles about 2.1 billion tons in the European carbon market.

Europe's is a compliance market, where market participants—power plants, big industrial users and so on—are compelled to law to have the necessary carbon credits to cover their operations.

In the U.S., some small compliance markets exist, but the most active market is the voluntary market, where companies choose to buy or sell carbon credits to get ahead of regulation or to fulfill their own corporate social responsibility goals.

The Carbon Challenge - A CNBC Special Report - See Complete Coverage
The Carbon Challenge - A CNBC Special Report - See Complete Coverage

The OTC market once dominated this voluntary carbon trading, but as tracking and trading infrastructure has grown, the Chicago Climate Exchange (CCX) took off. In 2008, it handled more transactions than the OTC for the first time ever, according to the New Carbon Finance report.

The exchange offers a voluntary but legally binding platform to trade carbon emissions and counts such companies as chemical manufacturers Potash Corp. and FMC Corp. and energy provider DTE Energyamong its members.

On the other side, compliance markets require participants to reduce emissions by auctioning and granting them allowances and allowing them to buy credits as needed. To date, only one such market exists in the U.S.; the northeast’s Regional Greenhouse Gas Initiative (RGGI), where member states—Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island and Vermont -- regulate emissions from electricity plants over 25 megawatts..

The regional organization closed its fifth quarterly carbon allowance auction in early September and has auctioned more than 110 million allowances worth $366.5 million since its launch in 2008.

Other nascent regional compliance markets include two launched in 2007: the Western Climate Initiative—a group of US and Mexican states as well as Canadian provinces—and the Midwestern Greenhouse Gas Reduction Accord, whose members are primarily US states. Neither has yet to hold an auction.

A US Market?

At this point, all eyes are on Washington, where a possible federal carbon cap-and-trade system may come out of the American Clean Energy and Security Act of 2009, sponsored by Reps. Henry Waxman (D-Calif.) and Edward Markey (D-Mass.), which passed the House of Representatives this spring. Sens. Barbara Boxer (D-Calif.) and John Kerry (D-Mass.) are expected to introduce their version of the bill Wednesday..

If Washington creates a national market, it will most likely absorb these existing ones.

“As the compliance markets expand, there will be a reduced role for voluntary markets,” says Jared Snyder, assistant commissioner for air resources, climate change and energy for the New York State Department of Environmental Conservation (NYDEC), and whose state is a RGGI member. “There may be niches for them,” he adds, but to achieve the planned reductions “we’ll need to be (regulated) in every sector.”

But that doesn’t mean the work to date has been in vain. Today’s voluntary and compliance markets helped build key infrastructure for future growth, including the development of carbon credit tracking registries, as well as trading and auction platforms.

And since these markets require third-party verification of carbon credit creation and consumption to work effectively, criteria for this evaluation has been fine-tuned. Now, more than 96% of carbon credits are verified by an independent third party to provide transparency and trust.


Some experts believe this means there could still be room for both national voluntary and compliance markets operating in tandem, with the voluntary markets handing industrial sectors uncovered by a federal cap-and-trade scheme.

“With cap-and-trade expanding globally, the voluntary markets are starting to play a crucial role in capacity building as companies start to prepare for emission caps,” said Milo Sjardin, head of North America for New Carbon Finance and co-author of its report. “Demand ensures that the voluntary markets also have a unique role to play alongside compliance markets.”

“We’re hoping for a strong federal program that builds on the work in the RGGI states,” says NYDEC Commissioner Pete Grannis, also chairman of RGGI’s board of directors. “We’ve put a value on carbon and proved the value of auction allowances. The states would still be strong partners.”

Even if the US fails to adopt the legislation this year, other political forces will drive the debate and help shape policy.

The world's two carbon emitters—the US and China—meet for bilateral talks in November and United Nations international climate change talks (billed as the successor to those in Kyoto, Japan in 1997) take place in Copenhagen in December.

“I don’t think we’re going to see a large multinational agreement,” says Lenny Hochschild, managing director at emission brokerage Evolution Markets. “I’m more interested in seeing what happens between China and the US.”

NYDEC’s Grannis has greater expectations for Copenhagen.

“With [President] Obama, we’ll go as an actor and not as people sitting on the sidelines like for the last decade,” he said.