Background

The global carbon market has two major submarkets: a regulated market, also known as the “Kyoto market”, and an unregulated market, generally referred to as the “voluntary market (VM)”. The regulated market comprises the EU ETS (European Union Emissions Trading Scheme) as well as the CDM (Clean Development Mechanism) and JI (Joint Implementation) Kyoto Protocol mechanisms.

The VM is a market where countries, entities or people that have no regulatory obligations to reduce greenhouse gas emissions, either reduce their emissions and/or purchase offsets voluntarily. This is done with two main intentions: a) to contribute to the cause of mitigating climate change, mainly by offsetting their carbon footprint; or b) as pre-compliance. In this latter case, companies purchase emission reductions prior to an expected regulated market, usually expecting that these “early action” purchases will count towards their regulatory obligations if a cap-and-trade system comes into place. They are hedging a future risk of having to buy a number of offsets when prices will potentially be higher or when there will not be enough availability to purchase offsets; so, although they do it voluntarily now, they are practically doing it as pre-compliance.

The VM is generally divided in two: exchanges (e.g., the Chicago Climate Exchange (CCX)) and the over the counter (OTC) market1. The following table provides an overview of the volumes and market values in the VM as a whole and vis-à-vis the Kyoto market. Our expectations are that the VM should at a minimum triple in 2008 as compared to 2006-2007.

In 2006, the VM consisted mostly of forestry projects and projects involving industrial gases. By the following year, energy efficiency, methane capture and renewable energy projects were dominant. We expect that in 2008, under a pre-compliance market, industrial gases will once again play an important role.

The main motivation of voluntary buyers in 2006 and 2007 was “social responsibility / public relations” – i.e., companies wanting to look “green”, as it relates to their shareholders, and to show that they are concerned with and committed to the environment. These shall probably remain the main motivations in the coming times, but we also note a major shift in the US market as it moves towards a pre-compliance market, where hedging against the consequences of potential, imminent carbon legislation is becoming an increasingly powerful motivator.

Prices have been highly volatile, especially over the past six months. Thus, the price on CCX (which can be considered representative of this market) averaged US$ 3.4 per tonne CO2e over the past year, but over that same time period ranged between about half of that (US$ 1.85 some five months ago) to about double (US$ 7.4 recently). In other words, we are dealing with a pretty erratic market. The recent price increase was due in part to speculation regarding the implementation of a federal cap-and-trade system in the USA, kicking off in 2012 or 2013, and companies are therefore buying credits in the VM as a form of pre-compliance. Prices in the VM might either continue at their current levels, increase if there are signs that the aforementioned US legislation shall be more stringent than currently expected, or drop if there are signals from US Congress that early action might be more limited and/or harder to pass than expected. In summary, today at least, we are looking at a market that is not only extremely volatile, but also highly unpredictable!

If we analyze prices from the standpoint of underlying motivations (keeping in mind that the transactions that have taken place were few in number and small in size), we note that the highest price was paid for emission reductions coming from an African project whereas the lowest corresponded to a US project… though both projects are equivalent from the point of view of greenhouse gas mitigation. This suggests buyers are responding emotionally, e.g., by supporting development in Africa, which has been highly underrepresented in emission reductions markets worldwide.

MGM's views on the VM

Fabian Gaioli, Head of MGM’s CDM Development Team, has been insisting for years already that precisely because it is a voluntary market, standards here should be even higher than those in regulated markets. He points out that whoever buys on the VM is doing so basically because he wants to; buyers therefore want top standards and are probably willing to pay higher prices, provided these reflect higher quality.

Emission reductions from certain projects do indeed command higher prices (e.g., Gold Standard projects), though this reflects primarily perceived quality in terms of sustainability and not necessarily in terms of contribution to climate change mitigation. Thus, small renewable energy projects command higher prices than chemical projects, which make a larger contribution to mitigation of climate change but do not provide the perceived social benefits associated with sustainable development. Photographs of renewable energy projects look better in annual reports than do those of chemical plants – another reason why some Voluntary Emission Reduction (VER) buyers prefer “charismatic” projects to industrial projects. Overall, however, VER prices are significantly below those of regulated markets: about half those of CERs (at best), or one fourth those of EUAs.

Quality is a major issue in the voluntary markets. These markets were initially seen by some market players pretty much as “landfills” where emission reduction projects that did not live up to Kyoto standards could be dumped, implying that voluntary markets could accept non-additional projects, as long as emission reductions occurred. This naturally gave rise to much confusion and - often justified - criticism. The issue of quality became critical this year, with a lot of negative press related to project quality in general and, in particular, to the so-called “carbon cowboys” who were selling projects that were not additional and/or even selling the same reductions several times over.

What does “quality” refer to in VM projects? There are several standards that can be followed, including: CDM Standard, VCS 2007 (Voluntary Carbon Standard 2007), Gold Standard, VER+ Standard, and VOS (Voluntary Offset Standard); of these, perhaps the VCS 2007 standard shall become the dominant model.

We at MGM believe that, in the absence of a regulator that could determine whether the project is or is not acceptable, we need to keep the highest standards in the development of voluntary projects, just as we have done from the start with regards to Kyoto projects. We are therefore using the highest standards - i.e., CDM standards - to develop voluntary projects, because we are as concerned with quality as the market should be, and therefore expect to keep our top quality credentials in the nascent VM.

MGM has traded 625,000 tonnes of offsets on the CCX and 1 million tonnes OTC. We keep learning and gaining experience about developing and commercializing VERs, just as we are still learning about the Kyoto market, even though we have over 100 CDM and JI projects under our belt.

Current issues to be solved in the VM

MGM's commitment

MGM’s main corporate objective is to reduce greenhouse gas emissions by helping industries around the world achieve this goal. That is a step in the right direction, but more can and should be done – to start off with, each and every one of us should look for ways of becoming “carbon neutral”. With this in mind, MGM has committed to “double offset” all company emissions, worldwide: for every tonne of CO2 caused by MGM activities, we shall retire two tonnes of CO2 –because climate change is real, but if we all work together we can find reasonable ways of mitigating its effects.

1 Source: “Forging a frontier. State of the Voluntary Carbon Markets 2008”, joint report by Ecosystem Marketplace and New Carbon Finance. MGM was one of the sponsors of this report.
2 GWP (Global Warming Potential): The concept of a global warming potential (GWP) was developed to compare the ability of each greenhouse gas to trap heat in the atmosphere relative to another gas. The definition of a GWP for a particular greenhouse gas is the ratio of heat trapped by one unit mass of the greenhouse gas to that of one unit mass of CO2 over a specified time period. (US EPA)