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Ed Wijaranakula, Ph.D.
Chief Investment Strategist, Infotix
Systems, Inc. - December
17,
2008
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The
six major greenhouse gases (GHG), emitted from processes such as the fermentation of organic matter,
known as agricultural GHG, and fossil fuel combustion, are
methane
(CH4),
nitrous
oxide (N20),
hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sulphur hexofluoride (SF6)
and carbon dioxide (CO2).
The
Kyoto protocol mandates that by the year 2012, the
emission of greenhouse gases are collectively reduced to
5.2% below
the emission levels in the year 1990.
The concept of carbon
credit or carbon emission reduction credit trading is to
allow companies to sell their excess carbon
emissions in the form of credits to commercial and
individual companies that are unable to reduce their
carbon emission footprint to meet their greenhouse gas
emission limitations.
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According to London,
UK-based New Carbon
Finance, the world’s carbon
markets could reach the $116 billion mark by the end of 2008.
The growth is expected to accelerate to 2012, when it
should reach $550 billion. If the US introduces a federal
cap-and-trade scheme, the carbon market could turn over $3
trillion per year by 2020.
Carbon Commodities -
The two dominant tradable carbon commodities in the Global
Carbon Exchange are EU
Allowances (EUA) and Certified Emission Reduction (CER).
An EUA unit allows a holder, or company, the right to
emit one metric ton of CO2.
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Under the
European Union Emissions
Trading Scheme (EU ETS), given EU Allowances are issued to companies
in certain industries which are required to participate
in the scheme. If the companies produce less than their
given allowance, they can sell the EUA surplus in a carbon
trading exchange, such as the
European Climate Exchange (ECX). Companies that emit
more carbon than their allowances need to purchase carbon credits to offset the excess emissions and avoid
EUA penalties.
The CERs are emission reduction
credits that are earned from Clean Development
Mechanism (CDM) projects and verified by the Department
of Energy (DOE) under the Kyoto Protocol.
In this cap-and-trade scheme, companies from
industrialized countries invest in projects that reduce
GHG emissions in developing countries as an alternative
to more expensive emission reduction in their own
countries. According to the World Bank "State
and Trends of the
Carbon Market 2007" report, EUAs made up 78% of the
value of the carbon credits traded on the open market.
Other tradable emission
reductions are Emission Reduction Units (ERU) and
Verified Emission Reductions (VER). The ERUs are generated
from emission reductions from Joint Implementation (JI)
projects defined in Article 6 of the Kyoto Protocol. The
VERs,
also known as voluntary offsetting of greenhouse gas
emissions, allow companies to offset emissions of
greenhouse gases produced in one location by helping
fund emission reduction projects that occur elsewhere.
The VERs are verified by an independent third party auditor
but
are not otherwise approved under the Kyoto Protocol.
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Trading Platform -
The Chicago Climate Exchange (CCX),
which was launched in 2003, operates North
America’s only cap-and-trade system for all six
greenhouse gases. The carbon commodity futures and
options traded on the CCX platform, are Carbon Financial Instrument
(CFI) contracts, each of which represents
100 metric tons of carbon dioxide equivalent (CO2e)
units. The CFI contracts are
comprised of Exchange Allowances (similar to EUAs)
and Exchange Offsets (similar to CERs). Exchange Allowances are issued to emitting
members in accordance with their
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emission baseline and the CCX
Emission Reduction Schedule. Exchange Offsets are generated by qualifying offset
projects which must undergo third party verification by a CCX approved verifier.
Emission reductions made in
North America
are verified through the independent third party
Financial Industry Regulatory Authority (FINRA,
formerly NASD). In addition, the Chicago Climate Futures Exchange
(CCFE), a derivatives exchange of the CCX, also offers
Regional Greenhouse Gas Initiative (RGGI) futures
and options contracts on RGGI CO2
allowances. The RGGI, which is made up of ten participating
Northeastern and Mid-Atlantic states, develops and maintains
a system to report data and to track CO2
allowances for the power industry sector. Under
a cap-and-trade scheme, RGGI sells emission
allowances by auctioning off CO2
allowances permits as well as RGGI futures
and options contracts.
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About the Author: Dr. Ed Wijaranakula is presently the
Chief Investment Strategist at Infotix Systems, Inc. Prior to Infotix Systems, he has worked with
Intel, Hewlett-Packard, Micron, Motorola and Texas Instruments and has held senior as well
as managerial positions in semiconductor manufacturing companies. He has published over 80
technical papers and holds more than 12 U.S. and foreign patents. Dr.
Wijaranakula's portfolio does not hold any positions in any of the
financial products mentioned in the article.
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