MARKETS:

After explosive growth, global carbon markets stall and begin to shrink

UNITED NATIONS -- After five years of rapid growth, the global carbon market has stalled.

From an estimated market value of about $15 billion in 2005, the practice of trading in greenhouse gas emissions allowances and carbon emission offsets credits has enjoyed rapid growth, exploding tenfold to reach a record value of close to $144 billion in 2009. Emissions trading doubled in 2008 alone.

But new data released yesterday in Barcelona, Spain, by the World Bank confirm what many in the industry have long suspected: The carbon markets are beginning to contract.

The World Bank and other sources now say emissions trading activity fell by about $2 billion in 2010, to just under $142 billion. The value of trades in the European Union's Emissions Trading System held steady, but activity in the U.N.-administered Clean Development Mechanism (CDM) shrank by 48 percent in value over the previous year.

Trading in the controversial Assigned Amount Units (AAU) handed to Eastern European governments as part of the Kyoto Protocol treaty also slid. And the World Bank's report echoes the pessimism surrounding the Regional Greenhouse Gas Initiative (RGGI) in the northeastern United States: Gains to market value made in 2009 were completely erased in 2010, with further contraction expected after that cap-and-trade system's second-largest member, New Jersey, announced its withdrawal last week.

World Bank researchers didn't bother to paint a rosy picture to cap-and-trade enthusiasts now gathered in Spain for the annual Carbon Expo.

"The global carbon market stagnated even as the global economy stabilized and began a tentative recovery in 2010," authors say at the start of their latest "State and Trends of the Carbon Market 2011" report. "The year may be remembered most for the political opportunities that arose, yet were ultimately failed to materialize."

Politics, apathy and fraud contribute

The World Bank cites a host of reasons for the decline in interest and activity.

Cap-and-trade legislation failed not only in the United States, they point out, but also in Japan and Australia as political interest in legally mandated carbon markets was hit badly. Weak commitment to carbon trading was also evident in South Korea, where, despite the passage of a cap-and-trade system in its legislature, lawmakers later decided to postpone the launch of an emissions trading scheme to 2015.

The year also saw the carbon market's reputation take a beating. A rash of fraudulent activity and outright theft of emissions allowances from various national registries disrupted spot trading activity for an extended period and shook confidence in cap and trade as a solution to the climate change problem.

But mainly the carbon markets are becoming a victim of waning government and public interest in cap and trade, coupled with the failure of governments to agree on a replacement to the Kyoto Protocol, which will effectively come to an end in December 2012 if nations don't sign onto another commitment period.

As a result, the European Union remains the only significant host to carbon trading. Estimates suggest that the Emissions Trading System, which E.U. governments set up to comply with the Kyoto pact, accounts for almost 97 percent of the global carbon market. That takes into account trades, E.U. allowances and the CDM offset credits known as Certified Emission Reductions (CERs) that can be bought in lieu of allowances.

The U.N.-run Clean Development Mechanism, whereby rich nations can offset their emissions by financing greenhouse gas mitigation projects in the developing world, seems to face the most immediate threat.

The value of primary trading in CERs has been trending downward for three years in a row, but the trend seems to be accelerating. That market fell by 48 percent last year, the World Bank reports, to a total market value of $1.5 billion. The primary CER market had been valued at $7.4 billion in 2007.

Secondary trading in the CER offset credits grew in value slightly last year, to $18.3 billion. But that's still 30 percent lower than its recorded value of $26.3 billion in 2008.

CDM experts say that investment in new emissions offsetting projects is stagnating. Administrators at the program's main office in Bonn, Germany, are receiving fewer and fewer requests for new registrations, even as they are now dealing with a rush of requests from currently registered projects for fresh issuances of CERs.

European market prepares to slog on

Many in the market fear that the CDM will cease to exist come January 2013 and are thus rushing to get as much from their initial investment as possible. But the World Bank report spells out another reason for the CDM's woes -- demand for CER credits and for the Emission Reduction Units generated by its sister organization, the Joint Implementation mechanism, is weak.

Confirming what other market analysts have said, the World Bank says the CDM is well stocked with existing projects to meet demand for CERs into the foreseeable future, leaving little real reason for the private sector to add new projects to the pipeline. Almost all CER demand will come from European governments in the years to come, the bank predicts, and those governments will have access to all the CERs they need, even after the European Union outlawed trading in credits gotten from adipic acid and industrial gas destruction projects from 2013 onward.

"Beyond 2012, although the potential demand for emission reductions could reach 3 billion tons or more, the only substantial and unconditional demand to date comes from Europe, estimated at 1.7 billion tons," report authors say. "The supply available between 2013 and 2020, through existing projects, is seen as sufficient to fill that demand, leaving little incentive for project developers to invest further and create a future supply of emission reductions."

Carbon market proponents at the bank hope that regional schemes, like California's proposed carbon market and possible systems in Canadian provinces, could help revive emissions trading's fortunes. E.U. members have so far committed to keeping their cap-and-trade system alive to 2020. And RGGI is scheduled to go on to 2018, though consultants hired by RGGI operators warn that reforms must be made to revive that market, where ultra-weak allowance prices have pulled trading activity in RGGI allowances to almost nothing in the United States.

Analysts continue to predict problems for the CDM in the years to come. In a recent interview, CDM Executive Board Chairman Martin Hession said he and his colleagues continue to operate on the assumption that the CDM will last beyond 2012, though he acknowledged that the future of the program is in doubt and beyond the Executive Board's control.

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