Carbon Market is No Safe Haven Yet
Date: 10-Oct-08
Country: UK
Author: Nina Chestney
Cap and trade schemes place a limit on industry emissions of heat-trapping gases like carbon dioxide, introducing a growing global trade in carbon permits worth US$64 billion last year.
Those limits are legally binding, and so underpin long-term demand for these new commodities and inject price certainty which looks attractive during a global stocks sell-off.
But the market's relative novelty and complex regulatory framework are deterring a wave of investment for now.
"The market is uncorrelated with equities. That may make it a safe haven, but people are not rushing into it because the technical barrier is too high," said Frederic Brodach, portfolio management director of Dexia Carbon Fund Managers.
The European Union's emissions trading scheme launched in 2005 is the hub of a global carbon market which also includes carbon offsets traded between rich and poor countries.
"The carbon market is just as risky as the turmoil going on in equities. It's new, people don't fully understand it, and there's a lot of political risk," said Trevor Sikorski, carbon analyst at Barclays Capital.
Political risks include uncertainty over carbon caps after 2012, under a new global treaty slated for agreement next year, but now bogged down in squabbles over cost, responsibility for global warming and a US election.
In addition, the new market is over-elaborate or even obtuse to some, and has spawned its own lexicon of jargon and acronyms.
"We have to go through a lot of effort to explain the regulatory framework and technicalities to experienced bankers," Brodach said.
WEATHER
Carbon emissions permits including EU allowances (EUAs) and Kyoto-based certified emissions reductions (CERs) have been hit by the general markets slide, showing some link with equities.
That is because a global slowdown would cut industrial output, and thereby carbon emissions, hitting EUA, CER demand.
EUAs have tracked the MSCI index of global equities over the past month with a correlation of 0.98, near a perfect score of 1. CERs have shown far less stocks correlation in the past four weeks, scoring 0.56.
But other factors also impact carbon demand, for example a cold winter would drive up emissions, and no amount of EU recession is expected to wipe out EUA demand.
That leads many analysts to expect the present EUA-equities link to be short-lived, returning to the 0.005 correlation shown over the past 12 months.
"What ultimately supports the EUA and CER market is compliance buying," said Christian Baum, at the derivatives exchange, Eurex.
However, the market is too small at present to absorb fleeing capital and if anything may become less liquid, albeit briefly, after the collapse of Lehman Brothers and the closure of Swiss investment bank UBS' commodities business.
But some commentators are bullish about the market's potential in the long term.
"In a couple of months' time, if the market has stabilised, I'm sure you will find more people interested in getting back into carbon products," said Shane Spurway, head of carbon banking at Fortis Global Markets Asia.
"Carbon is a commodity of the future. You have to invest in something and this commodity's value is expected to have a longer term increase," said Andrei Marcu, senior emissions trading adviser to law firm Bennett Jones.
(Additional reporting by David Fogarty in Singapore and Gerard Wynn in London; editing by James Jukwey)