Copenhagen will set the agenda for carbon trading

AFTER months of preparation, wrangling and hype, the world’s leaders have finally descended on Copenhagen for the UN Climate Change Summit, where they will attempt to thrash out a successor to the 1992 Kyoto Treaty. The stakes could not be higher. The Kyoto agreement expires at the end of 2012 and it has done little to reduce or even stabilise the amount of carbon dioxide emitted into the Earth’s atmosphere – carbon emissions are now 20 per cent higher than they were in 1992 and the UN claims that temperatures by the end of the century could be as much as 1.1C-6.4C higher than they are now.

Although a subject of intense debate, it is generally agreed by policymakers and economists that a cap and trade system is more effective at incentivising firms to reduce their carbon emissions than a tax on emissions. Cap and trade should in theory establish a market price that is high enough for polluting firms to take into account the damage that they are inflicting and develop cleaner technologies or reduce their emissions appropriately.

The European Union’s Emissions Trading System (ETS), established in 2005, has so far been the only large-scale attempt to set a carbon price. And it has been relatively successful – not only are trading volumes continuing to grow at double-digit pace, but a study last year by MIT indicated the scheme had probably been responsible for a cut in emissions of about 2-5 per cent over its first three years. Where a market has been created, derivatives follow. Contracts for difference (CFDs) traders are able to trade carbon emissions with the major providers such as IG Markets, CMC Markets and GFT. The CFD contract is based on the near-month ICE ECX futures contract, which sets a price for EU carbon emissions allowances (EUA).

They are effectively a play on slightly dirty global industrial expansion, says Tim Hughes, head of sales at IG Markets. The impact of the global recession saw the price of carbon emissions slump to just €8 ($11.88) a tonne from €30 at the start of 2008 as recession-hit manufacturers cut back on production, and consequently emissions fell. But since the start of June, the carbon emissions market has been stuck in a range between €12 and €16, as market participants held fire ahead of the Copenhagen summit.

The market has traded sideways as it became increasingly uncertain what Copenhagen will achieve. It had been optimistically hoped that a global consensus to stabilise carbon emissions would be reached at Copenhagen. This is now looking unlikely. America has failed to pass legislation on climate change, India is refusing to commit to any reductions at all and China – now the world’s largest emitter of carbon dioxide – has so far only given vague promises to cut emissions rather than any hard figures.

But if policymakers agree on an international system, then Hughes says this would be a boost for the carbon emissions price because global industry would need to reduce its emissions, making allowances more valuable. New Energy Finance, a consultancy, reckons that the carbon price needs to increase to $38, or €25.57, a tonne to make investing in onshore wind energy a viable unsubsidised project. It would not be worthwhile for a company to invest in offshore wind until the price for a tonne of carbon hits $136 (€91.55), $196 (€131.97) for solar cells.

If you think that Copenhagen will at least pave the way towards a global agreement on emissions reduction then you may want to go long at the current cheap price of emissions. On the other hand, sceptics may feel that the uncertainty will continue and carbon futures will keep trading at current levels.