Markets can help slow down global warming

http://www.financialexpress.com/news/markets-can-help-slow-down-global-warming/347097/0

V Shunmugam

Posted: Monday, Aug 11, 2008 at 0033 hrs IST

Updated: Monday, Aug 11, 2008 at 0033 hrs IST

Unlike the markets for other technologies where the value of technology arises from the resource/cost savings it can contribute only, the market for clean technology is driven by yet another factor, which is the return on savings on greenhouse gas (GHG) emissions to which it can contribute. However, the earnings from GHG savings measured in terms of certified emission reductions (CERs) issued by the United Nations Framework Convention on Climate Change (UNFCCC) emanate from a market that has been created with a scientifically felt need in mind. A tangible economic justification is yet to be done.

In an ever-changing world, the long-term valuation of clean technology would have to be measured by both the savings and returns to emissions reductions that it can contribute to. However, the returns on CERs that clean technology buyers may look for have so far been highly volatile as the regulator (UNFCCC) had left the choice of deciding rules of the game to the buyers themselves in the long-term interest. In addition, the buyers are concentrated in non-Annexure I countries whose IPR protection regime is not yet proven. It contributes to an additional risk when it comes to transferring the technology.

And in such a case, the long-term potential of clean technology becomes blurred. It could lead to evaluation of the technology based on medium-term cost savings that it can contribute to. As a result, most technologies that could contribute larger emission controls stay only within the confines of design rooms, much to the disillusionment of the objective behind creation of the markets for emissions reduction. So, it is necessary that we have markets that not only decide returns on the existing technology but also provide a fair valuation on it. Additionally, this would also bring in sustainability to these markets by providing adequate signals to the policymakers on how to sustainably develop this market regime.

The emission markets today face two sets of risks that are closely related to each other. The origin of these risks lies in the policy regime that directs these markets and their own supply and demand. While it would take time for these markets to structurally mature before the policy regime stabilises, there are several other factors that would contribute to the price risk that exists in these markets for CERs. Most of these risk factors could ideally be mitigated by the implementers of CDM projects in India through strategies in the physical markets or by hedging it on the respective commodities that may contribute to price risks in CERs or in the CER futures such as the one recently introduced by MCX. Such risks include the risk related to prices of natural gas, crude oil and power from other sources that may lead to large emitters such as power generators or the transportation sector to switch their consumption in order to remain competitive. It would lead to demand volatility in buyers’ markets (Annexure I countries) leading to price volatility.

As the implementation of CDM projects might involve additional costs on technology or other accompanying inputs, its success would revolve around the savings in costs it could generate and the potential revenue it could earn out of additional business opportunity the implementation would entail or the revenue accruing from the CERs. Most of the CDM projects implemented in India largely rely upon the revenues from CERs rather than the other two factors. And in such a situation, there is a dire need for markets that could give long-term price signals, taking into account the demand (managed from the policy side and the fundamentals) and the supply factors (affected by fundamentals). In short, this needs vibrant futures markets that are indulged in green trading. Green trading would include trading on emission reductions, renewable energy and energy efficiency that are interrelated. It would help in generating market-based incentives to meet the goals of deployment of new, cleaner technology to meet rising demand for energy, which is the major culprit behind the process of climate change that has attracted the attention of the world through IPCC’s path-breaking techno-economic research report.

After the failure in achieving the process of slowing down the climate change through commands and controls and fiscal instruments, it has widely been accepted that markets would remain the ultimate saviours as evidenced through the wider acceptance of the Kyoto Protocol. However, with the rules of the game left to the players in the market, the EU-ETS trading mechanism as it existed two years ago was much unsettled compared with the current conditions due to the policy risk arising out of allocating allowances. It took almost about three years for the EU-ETS markets to come to a position where they are now. Though the stability of the current CER prices in the EU-ETS markets falls short of the players’ expectations, it might have given a fair understanding of the markets to the players in the physical markets. If not for the futures exchanges such as the European Climate Exchange (ECX) and others such as EEX and Nordpool, and the transparency created by them, this understanding and policy stabilisation would not have happened in largely opaque markets.

If we were to achieve the objective of creating efficient markets to mitigate the process of climate change through the CDM mechanism and ultimately through development and transfer of clean technology, the opportunities for participation in the markets should be extended for Indian participants as has been the effort of MCX through the launch of CER and CFI contracts on its platform. In addition, the technology developers shall hedge their interests if their implementers fail to do the same. Efficient futures markets could not only facilitate technology development but also help CDM developers get the best of technology valuation during transfer negotiations.

The writer is chief economist, Multi-Commodity Exchange of India. These are his personal views