The Growing Carbon Market

Stephen DeAngelis

June 26, 2007

Environmental issues are increasingly taking center stage in a number of fora — from Al Gore’s appearance at the Oscars to discussions among leaders of the world’s wealthiest nations at the recent G8 summit. Even large corporations are jumping on the green bandwagon and are trying to reduce their carbon footprint. One of the most interesting developments on the environmental scene, however, is taking place on the trading floor and it involves carbon credits — or as a recent article in The Economist puts it “Trading thin air” [2 June 2007]. The air being traded may be thin, but it’s also smelly.

“Every year the average sow and her piglets produce 9.2 tonnes of carbon-dioxide equivalent through the methane emissions from their effluent. In the past, that has been a problem both for the environment and for pig-farmers. In developing countries the pig-effluent collects in open lagoons which smell bad and get infested with flies. Sometimes it flows straight into nearby water systems.”

To give you some idea of how many pigs are out there producing methane, over 100 million pigs a year are killed for food each year in the United States alone. And, of course, even more live pigs remain to carry on the business. That’s a lot of effluent! Large pig farms (i.e., farms containing approximately 100,000 animals or more) generate the equivalent waste of a city of a quarter-million people, but have no wastewater treatment system. As The Economist article indicates, one of the main issues is the football field-size lagoons typically used by pig farms to capture all this waste. The extent of this problem was first revealed to most American citizens In October of 1999, when Hurricane Floyd swept through North Carolina. Flooding caused by that storm overwhelmed North Carolina pig farm effluent lagoons and spread their contents (pig feces and urine) across vast tracts of land and into many waterways. What to do with all that waste remains a challenge. The Economist notes, however, that challenges facing one group often represent an opportunity for another.

“Now this problem has become an opportunity. Bunge, an agricultural-commodities business based in America, builds lined and enclosed pools to collect the effluent and captures the methane that it emits. The farmer can use the gas to generate electricity. By preventing methane from escaping into the atmosphere, Bunge creates a credit which it can sell on the carbon market. The farmer gets to keep 20-30% of the value. Bunge has 40 such projects operating in Brazil and is planning to expand into Mexico, Guatemala, Peru and the Philippines.”

The focus of this article’s is not that waste from pigs (or cows or chickens or turkeys for that matter) is a problem, but that the carbon market has proven to be innovative — not as innovative as it could be, but innovative nonetheless.

“The carbon market is truly innovative. Although it works like any commodity market, what is being bought and sold does not exist. The trade is not actually in carbon, but in not-carbon: in certificates establishing that so many tonnes of carbon dioxide (or the equivalent in other greenhouse gases) have not been emitted by the seller and may therefore be emitted by the buyer. The purpose of setting up the market was, first, to establish a price for carbon and, second, to encourage efficient emissions reductions by allowing companies which would find it expensive to cut emissions to buy credits more cheaply. It has had some success on both counts—some would argue too much on the second.”

The European Emissions-Trading Scheme (ETS) currently establishes the price of carbon credits. As with other commodities, the greater the demand the higher the price. Demand for carbon credits is driven up by driving down allowances that regulate “dirty” industries. As noted above, the hope is that the price of credits will be high enough to encourage industries to reduce emissions (and thus help meet established allowances) but not so high that nobody buys them (because they remain a source of income in the developing world). Once carbon credits are established as a source of steady income, the desired goal is to encourage developing nations to build environmentally friendly industries that are profitable on their own and clean enough to ensure that they can still sell carbon credits to boost profitability. Harvesting animal waste is one great example. To really work, of course, everybody needs to sign up to this system and that is not currently the case.

“The supply of carbon credits comes principally from two sources. The first is the allowances given to companies in the five dirty industries covered by the ETS (electricity, oil, metals, building materials and paper). The second source of carbon dioxide lies outside Europe. The European Commission linked the ETS to the ‘clean-development mechanism’ (CDM) set up under the Kyoto protocol. This provides for emissions reductions in developing countries—such as those on the Latin American pig farms—to be certified by the UN. Such ‘certified emissions reductions’ (CER) can then be sold. The demand for carbon credits comes mostly from within the ETS, from polluters who need certificates allowing them to emit carbon. There is some demand from Japan, which has a voluntary scheme, and from companies and individuals elsewhere in the world who want to offset their emissions for moral reasons, or to make themselves look good. The trade is now sizeable. Some €22.5 billion-worth ($30.4 billion) of allowances were traded last year, according to Point Carbon, a data-provider, representing 1.6 billion tonnes of CO2—a huge increase on the €9.4 billion traded in 2005. Europe’s ETS made up about 80% of the total value. Developing-country CERs accounted for about €4 billion of last year’s trade: 562m tonnes of CO2.”

The Bush administration, as most people know, refused to sign the Kyoto protocol, but it does favor voluntary participation in the carbon credits scheme. Money invested in carbon credits is generally used to generate more credits.

“The money has gone mostly into projects in developing countries to produce CERs. Bunge’s Brazilian pig-farmers are making CERs out of their animals’ effluent. But the bulk of the investment has gone into greenhouse-gas capture in China.”

The article laments the fact that buying carbon credits remains cheaper than investing in emission reductions for most businesses, although it provides a few examples of companies that have found novel ways to reduce emissions.

“The carbon price has delivered some of the innovation that it was supposed to generate. Shell, for instance, is pumping CO2 from a refinery in the Botlek area of the Netherlands into 500 greenhouses producing fruit and vegetables, thus avoiding emissions of 170,000 tonnes of CO2 a year and saving the greenhouse owners from having to burn 95m cubic metres of gas to produce the CO2 they need. Alcan, an aluminium company, is planning to use the heat from one of its smelters to increase the efficiency of its power-generation plant at Lynemouth in Northumberland in Britain. Wyn Jones, managing director of Alcan’s British smelting and power-generation operations, says this will save 150,000 tonnes of CO2 a year (€3m if the price of CO2 is around €20 a tonne, as Alcan expects) and 60,000 tonnes of coal (£2.1m, or $4.2m, at around £35 a tonne). He is not sure how much the project will cost, but is reckoning on a payback period of around five years.”

Environmentalists have always insisted that consumers don’t pay a fair price for manufactured goods because environmental costs have never been factored in. As a result, they argue, the environment has been subsidizing consumption. Carbon credits are a step towards undoing that subsidy and encouraging a little more consideration for the environment.