Carbon markets: Boom or bust?

Emissions trading stands at a crossroads -- a future as a US$2 trillion market if the United States bolsters it, or as a modest sideline to energy and commodities trade if a new climate treaty is not agreed.

Some players have bet on the growth of the $126 billion global carbon market after 2012 but regulatory uncertainty will be drawn out for another year as a deadline for a binding treaty on greenhouse gas emissions was pushed back to 2010 this week.

That uncertainty about the future form of emissions trading after the Kyoto Protocol expires in 2012 could put off new entrants and discourage banks, brokers, funds and commodity traders from expanding their operations.

"It looks like carbon trading will remain a small backwater in commodities markets," said David Metcalfe, chief executive of UK-based research group Verdantix.

"With fewer participants coming into the market because of remaining uncertainty, there will be less trading parties, less liquidity and less commission."

The global market is touted to reach $2 trillion by 2020 if nations agree to a new climate pact curbing greenhouse gas emissions and the United States introduces its own federal cap-and-trade scheme.

However, negotiators will not meet a December deadline for agreeing on a binding climate pact in Copenhagen.

In the United States, Senate Democrats are trying to pass climate legislation in the early spring of 2010, Senator John Kerry said on Monday.

But some senators do not back the bill in its current form.

Some banks have already closed their carbon trading desks or reduced staff due to financial difficulties and tumbling carbon prices resulting from the global economic slowdown.

"Desks are watching. They may stay open but lower their participation slightly. Players will be back when something on the table is new," said Emmanuel Fages, analyst at Societe Generale/orbeo.

DIVERSIFY OR DIE

Prices for carbon permits, called EU Allowances (EUAs), under the EU's Emissions Trading Scheme (EU ETS) have fallen by half since last summer. Once famously volatile, they have barely moved out of a 12-15.50 euro range in the past six months.

Without a climate deal, prices are not expected to move significantly in 2010 and analysts forecast average EUA prices anywhere between 12 and 35 euros in 2012.

"As a financial, unless you are doing lots of flow business there is more of a limit to how much you can keep yourself busy in current conditions," an emissions trader said.

With uncertainty over carbon offset regulation set to last at least another year, investors in the U.N.'s Clean Development Mechanism are also increasingly nervous.

As a result, some players are also seeking business in forestry credits or expanding into other commodities, or both.

"There is still a market to 2012 but we have diversified into metals, oil, agriculture commodities and are looking at power and gas in preparation for a watered-down climate agreement," said Eric Boonman, head of environmental markets origination at Fortis Bank Netherlands.

Many players have bet on the emergence of a U.S. emissions trading scheme. Oil trading companies like Gunvor and Mercuria have beefed up their desks in anticipation of a multi-million dollar market.

Compliance players in the EU ETS, such as utilites, have more certainty than most. They have been actively hedging, preparing for the scheme's third phase (2013-2020), when they start paying for carbon permits currently received for free.

E.ON AG's carbon allowance trading volume from January to September grew to 383 million, from 92 million in the same period last year, it said in a trading report last week.

RWE AG's cash outflow early this year to cover 2008 emissions amounted to 1 billion euros, it said in a statement last week.