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On Growing Green, Going Green, and Getting Green: Ups and Downs on the Chicago Climate Exchange
Suz-Anne Kinney : September 2, 2008
The Chicago Climate Exchange (CCX), the first voluntary carbon trading platform in the United States, started operating in 2003. Since the market’s inception, prices for carbon credits have fluctuated wildly, moving from $1.70 per metric ton of C02 in November 2007 to a high of $7.40 per ton in May of 2008. What accounts for this volatility? As with all markets, the supply and demand fundamentals are influenced by a variety of factors. With the CCX, the tale of influence includes the lack of transparency, market interventions by the exchange, electoral politics, legislation, and financial speculation.
The most important factor affecting prices on a voluntary carbon market is transparency. Buyers want to know that the offsets they purchase represent actual reductions in greenhouse gas emissions. On the CCX, this transparency can be tricky. Two types of credits are traded on the CCX: allowance-based credits and offset credits. When a member organization reduces its emissions beyond its targets, it can then sell “surplus” reductions as allowance-based credits to other member organizations. An offset credit represents a project taken on by a non-trading member of the exchange that either reduces or captures emissions; the integrity of these projects is verified through a third party.
Forestry credits fall into the latter category since they capture and store carbon emissions. CCX currently accepts three types of forestry projects: 1) afforestation credits are given for planting trees on land previously unforested (with 15-year no-cut commitment), 2) managed timber credits are given for timberland with American Tree Farm Certification (again with a 15-year no-cut commitment), and 3) long-lived wood credits are given for certain product classes after harvest, as wood used to frame houses and craft furniture continues to sequester carbon.
The issue with transparency for the CCX is that the actual allowance- and project-based credits are not traded on the exchange. Instead, once allowances or projects are registered at the exchange and verified, carbon financial instruments (CFIs) are issued. These CFIs are backed by, but not tied directly to, specific allowances or projects. While each CFI represents 100 tons of CO2 equivalent, there is no way to identify whether you have an allowance backed credit, a no-till soil project offset, or a managed timber project offset. In a recent survey, buyers of carbon credits indicated that the most important factor in their credit buying decisions was quality—a combination of demonstrable emissions reductions or sequestration and third party certification. For those concerned with quality, CFIs may not be that attractive.
Buyers also reported an interest in “co-benefits” when they buy carbon credits; these “ co-benefits” range from social and environmental to the economic and business benefits that occur as a result of offset projects and in addition to reducing or capturing emissions. Let’s look at an example. Home Depot is a company that relies on forests for significant portions of its inventory. If Home Depot wants to offset its carbon emissions by purchasing CFIs, it might want to purchase CFIs backed by forestry-based offsets. By strategically offsetting its own emissions with forestry credits, Home Depot would get the additional benefit of having a positive influence on its future supply lines. Today, however, since the CCX does not allow for this type of transparency, companies looking for co-benefits must either take a chance or look elsewhere for their offsets.
Other factors affecting prices on the CCX are market intervention by the CCX, politics, legislation, and speculation by financial institutions. A tracking of the price through the nine-month period beginning November 2007 and ending in August 2008 will illuminate these additional factors.
In November of 2007, CFIs traded at $1.70 per ton. Not surprisingly, investors began to get anxious and put pressure on the CCX to stabilize the market. Jurgen Meyer, who works for the Dutch aggregator and CCX member, Carbon-TF, says this pressure led the exchange to exclude new Europe-based offset projects, claiming that participants in the market did not want credits from European markets. As a result of the exclusion of these projects, supply of project-based credits constricted and prices began rising. By late January, prices had recovered to $2.30 per ton.
February saw additional elevation, as prices climbed to $4.50 per ton. Why? On Super Tuesday (February 5), CFIs traded at $2.75 per ton. Once the primary results were in, the field was narrowed to three candidates, all of whom favored a cap-and-trade system. Richard Sandor, chief executive and founder of the CCX, speaking of the effect of electoral politics on the market, said: “t’s a raging bull market and volumes are moving up exponentially.” Demand did increase—t rading volume spiked to 10 million tons in February, up from 1.3 million tons in January.
The fact that the remaining presidential candidates supported mandatory cap-and-trade legislation was a boon not only to the market, but to speculators as well. The theory from their perspective is this: if the U.S. carbon market becomes mandatory, CFIs (purchased for $2.00-$4.00 per ton) would be good for regulatory compliance and would be tradable on a mandatory market (a ton of C02 reduction on the mandatory EU market is currently trading at US$39.00). Speculators, excited by the prospect of converting dimes into dollars, continued to stoke demand. CFI prices in March closed at 5.85 per ton, in April at $6.40, and in May at $7.40. Volumes remained high, ranging from 7-10 million tons.
Then, on June 6, the Lieberman-Warner Climate Security Act of 2008, a mandatory cap-and-trade system, was killed on the Senate floor. Interestingly, this bill was drawing fire on both sides, with both environmental and business concerns opposing it. That day, CFI prices fell from $7.35 to $5.55. Later in June, the supply side of the equation also experienced a shock. Meyer explains it this way: elevated prices in May led to short sellers being squeezed; as a result, the CCX felt pressure to loosen the market. Almost at once, the volume of registered offset credits on the CCX increased by 50 percent. This influx of project-based credits brought supply and demand back in line, and prices dropped another $0.70, to $4.85 per ton. By July 10, prices had fallen to $3.90 per ton. By the end of July, volumes retreated to under 5 million tons. By August 27, CFIs closed the day at $3.60 per ton.
This new price more closely reflects reality, and it may mean that speculators have figured out that CCX credits will likely not be tradable under a mandatory cap-and-trade system, as the standards for transparency that are required in mandatory systems are more stringent. Andrew Ertel, CEO of Evolution Markets, said this about the wisdom of this speculation: “ After McCain won the [Republican] nomination there was a speculative run-up in Chicago pricing. People thought [CFIs] would be good for regulatory compliance [under a mandatory cap-and-trade system]. That’s nonsense. They won’t be fungible.” Where there are markets, however, there will always be speculators, and we will continue to see a combination of transparency issues, politics, legislation, market intervention by the exchange and speculation driving the ups and downs of supply and demand and therefore price on the CCX.
For those interested in registering forestry-based offset credits on the CCX, there are a few issues to consider. The tougher standards of a mandatory system may increase the cost of managing and verifying offset projects, but it could also increase returns. On the voluntary market, F2M estimates the return on long-lived wood credits total somewhere in the neighborhood of $5-$7 per acre. The Texas Forest Service estimates that a 30-year plan that starts with afforestation credits, moves to managed timber credits after a thinning at Year 15, and then ends in Year 30 with long-lived wood credits at harvest can add $15-$20 per acre per year to a timberland owner’s revenue stream. Under a mandatory system, these numbers could be significantly higher (as evidenced by the going rate of a credit on the EU carbon market).
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