What is Carbon ?What is Carbon ?

Energy Risk Management Energy Risk Management Series Series ERM 01ERM 01

Energy Risk Management Series Energy Risk Management Series ERM 01ERM 01

What is Carbon ?What is Carbon ?

It is not a goodIt is not a good

WhatWhat is Carbon ? is Carbon ?

It is not a ServiceIt is not a Service

What is CarbonWhat is Carbon

Is it an Is it an

“ “off balance sheet entry ?”off balance sheet entry ?”

What is CarbonWhat is Carbon

Straight into the income statement. From Where?

Carbon: from Carbon: from where?where?

Carbon Carbon comes comes from the from the ChimneyChimney

Carbon: from Carbon: from where?where?

It is the proverbial hot air from our stacks, or the emissions

What is CarbonWhat is Carbon Carbon permits are a subsidy to Carbon permits are a subsidy to

the energy industry the energy industry

Carbon: why ?Carbon: why ? As per Kyoto pact there are As per Kyoto pact there are

half a dozen GHG emissions half a dozen GHG emissions that need to be tackled and that need to be tackled and mitigated. They are Carbon mitigated. They are Carbon C02, Methane CH4, Nitrous C02, Methane CH4, Nitrous Oxides N20 and CFC HCFC, Oxides N20 and CFC HCFC, namely Fluorocarbons etc.namely Fluorocarbons etc.

Carbon: why ?Carbon: why ?

Carbon is chief cause of Carbon is chief cause of Global warming as per studies Global warming as per studies done by IPCC at UNFCCCdone by IPCC at UNFCCC

Kyoto Protocol Kyoto Protocol 37 Industrial nations who produce 80% 37 Industrial nations who produce 80%

of the Global emissions have agreed in of the Global emissions have agreed in Kyto in 1997 to lower GHG emissions Kyto in 1997 to lower GHG emissions by minimum 5 % before 2012. US has by minimum 5 % before 2012. US has not ratified the pact. not ratified the pact.

Kyoto ProtocolKyoto ProtocolImplemented largely in the Implemented largely in the

European Union, the emission European Union, the emission control under the EU Emission control under the EU Emission Trading Scheme has been Trading Scheme has been based on the theory that based on the theory that emissions can be capped if emissions can be capped if Carbon is traded like a Carbon is traded like a marketable commodity.marketable commodity.

The EU ETSThe EU ETS The EU ETS 1 was developed The EU ETS 1 was developed

to usher in a cap and trade to usher in a cap and trade market in 2005, for Carbon market in 2005, for Carbon trading. trading.

The EU ETS The EU ETS permitspermits

Under the EU ETS1 each member Under the EU ETS1 each member state of the EU could on basis of state of the EU could on basis of existing industry capacity issue existing industry capacity issue carbon permits licensing energy carbon permits licensing energy producers to emit Co2. producers to emit Co2.

Carbon TradingCarbon Trading

Those who did not use their Those who did not use their full quota of permits could sell full quota of permits could sell them, while those who needed them, while those who needed more would have to buy the more would have to buy the permits either from EU ETS permits either from EU ETS auctions or auctions or

off the market. off the market.

EU ETS energy subsidy EU ETS energy subsidy is to all is to all

TThe EU ETS has no he EU ETS has no benchmarking procedure, benchmarking procedure, which means that free carbon which means that free carbon permits, were issued to all permits, were issued to all units and were not related to units and were not related to an industry’s emission an industry’s emission efficiency.efficiency.

General Energy General Energy Subsidy Subsidy

The CDM under the Kyoto pact also does not The CDM under the Kyoto pact also does not make it mandatory to invest the proceeds make it mandatory to invest the proceeds of carbon sales into renewable energy, so it of carbon sales into renewable energy, so it is not a specific subsidy against capital is not a specific subsidy against capital expenditure for any environmental gains, expenditure for any environmental gains, but a general subsidy.but a general subsidy.

Carbon as a energy Carbon as a energy subsidysubsidy

Proceeds from itsProceeds from its

Carbon sales canCarbon sales can

be at best entered be at best entered

in the books as in the books as

‘‘income from other income from other

sources.’ like any sources.’ like any

other subsidy.other subsidy.

Treating Carbon as a Treating Carbon as a subsidysubsidy

Wait a minute……. Wait a minute……. Carbon a subsidy?Carbon a subsidy?

Then why is it not under the Then why is it not under the WTO.WTO.

Carbon subsidy under WTOCarbon subsidy under WTO

As a general subsidy, Carbon sales As a general subsidy, Carbon sales proceeds become a protectionist proceeds become a protectionist tarrif for Europe’s emitters.tarrif for Europe’s emitters.

Carbon subsidy tariffs Carbon subsidy tariffs

Why has Europe’s largest steel Why has Europe’s largest steel plants, profiting billions from plants, profiting billions from carbon credits not been carbon credits not been slapped with Carbon equalizing slapped with Carbon equalizing duties or antidumping tariffs.duties or antidumping tariffs.

Why? ….only time will tell !!!Why? ….only time will tell !!!

Risk Managing Carbon Risk Managing Carbon

Risk Managing Carbon is not Risk Managing Carbon is not easyeasy

For it is both a grant For it is both a grant as well as a cost as well as a cost For most of the time it is a free For most of the time it is a free

issue and a subsidy.issue and a subsidy. But at some of the times it could But at some of the times it could

be a cost.be a cost.

Free and auctioned permitsFree and auctioned permits

93 % of Carbon permits in UK in 93 % of Carbon permits in UK in 2008 have been free issues.2008 have been free issues.

Only 7% (4 million) Carbon Only 7% (4 million) Carbon permits were auctioned at GBP 54 permits were auctioned at GBP 54 million.million.

Carbon PricingCarbon Pricing

The 4 million permits issued under The 4 million permits issued under EU ETS2 had a cost price, and need a EU ETS2 had a cost price, and need a different treatment in accounting.different treatment in accounting.

Carbon pricing in 2008Carbon pricing in 2008

Let us say that 1 million Carbon Let us say that 1 million Carbon units were bought under auction units were bought under auction by a European steel maker under by a European steel maker under EU ETS 2 and this Carbon permit EU ETS 2 and this Carbon permit was accounted as a fuel was accounted as a fuel surcharge for the year ended surcharge for the year ended 2008 worth at its cost price 2008 worth at its cost price which was GBP13.6 millionwhich was GBP13.6 million

Carbon pricing in 1Carbon pricing in 1stst Quarter 2009 Quarter 2009

IIf the Carbon allowances were sold f the Carbon allowances were sold in the summer of 2009, by the in the summer of 2009, by the steel major, they would have steel major, they would have fetched 28 million Pounds, fetched 28 million Pounds, generating an additional non-generating an additional non-operating profit of GBP 14.4 operating profit of GBP 14.4 million million

Carbon pricing in 3Carbon pricing in 3rdrd Quarter 2009Quarter 2009

If the Carbon allowances were sold If the Carbon allowances were sold in the autumn of 2009, by the in the autumn of 2009, by the steel major, they would have steel major, they would have fetched 8 million Pounds, fetched 8 million Pounds, generating a net loss of GBP5.6 generating a net loss of GBP5.6 million million

Carbon valuationCarbon valuation

Due to its nature of price Due to its nature of price volatility, free carbon permits volatility, free carbon permits must be entered in the income must be entered in the income statement only after realization.statement only after realization.

Under the EU ETS 1 scheme Under the EU ETS 1 scheme millions of legitimate Carbon millions of legitimate Carbon allowances were not realized, for allowances were not realized, for there no buyers in the market there no buyers in the market

Carbon market is Carbon market is volatilevolatile

Like in EU ETS 2 Carbon prices in EU ETS 1 had Like in EU ETS 2 Carbon prices in EU ETS 1 had crashed below par within 6 months of its issue and crashed below par within 6 months of its issue and volumes were manipulated by EU to keep it above volumes were manipulated by EU to keep it above the floor prices. Hence free issue carbon may be the floor prices. Hence free issue carbon may be entered in the books only after sales are realized.entered in the books only after sales are realized.

So Risk Managing So Risk Managing Carbon is a duel Carbon is a duel hazardhazard The free Carbon permits are The free Carbon permits are

neither good, nor services and neither good, nor services and can be only treated as a general can be only treated as a general subsidy or other income.subsidy or other income.

The auctioned permits too are The auctioned permits too are subject to price volatility and is subject to price volatility and is often below the issue price at the often below the issue price at the auctions.auctions.

Carbon through Carbon through auctionsauctions

Carbon purchased through auctions must be carefully Carbon purchased through auctions must be carefully evaluated. Purchase only if it cannot be deferred. Value evaluated. Purchase only if it cannot be deferred. Value at cost in the Books of account as a fuel surcharge.at cost in the Books of account as a fuel surcharge.

Integrating it as a part of fuel cost and spreading it over Integrating it as a part of fuel cost and spreading it over time is a fail safe technique, to account for Carbon. time is a fail safe technique, to account for Carbon. Since the allowances of 1 million carbon bought would Since the allowances of 1 million carbon bought would be normally for use over a period of 6 months or a be normally for use over a period of 6 months or a year 1 year, it is wiser to allocate the carbon cost over year 1 year, it is wiser to allocate the carbon cost over the entire fuel cost during that extended period of the entire fuel cost during that extended period of operation. operation.

Buy carbon off Buy carbon off marketsmarkets

From the trends available for EU ETS 1 From the trends available for EU ETS 1 and EU ETS 2 it is highly unlikely that and EU ETS 2 it is highly unlikely that Carbon prices will rise, especially now, Carbon prices will rise, especially now, due to the arrival of carbon offsets in due to the arrival of carbon offsets in the market the market

The Risk manager would advise staying The Risk manager would advise staying away from the auctions, and purchase away from the auctions, and purchase off markets only, against plant demand, off markets only, against plant demand, at this stage.at this stage.

Environmental utilityEnvironmental utility

The EU ETS has been amended The EU ETS has been amended twice but still only 45% the total twice but still only 45% the total C02 emissions are measurable C02 emissions are measurable today under the Kyoto pact and a today under the Kyoto pact and a only 3 % mitigated in the UK, the only 3 % mitigated in the UK, the best operating EU model.best operating EU model.

Effectiveness of EU Effectiveness of EU ETSETS

How mitigation was How mitigation was donedone Emission reduction was done at Emission reduction was done at

the plant level by additional oil the plant level by additional oil and gas support to conventional and gas support to conventional coal fired units, which is the coal fired units, which is the easiest way to reduce coal easiest way to reduce coal consumption and consequently consumption and consequently carbon emissionscarbon emissions

Mitigation leads to price Mitigation leads to price hikeshikes

This resulted in speculative positions This resulted in speculative positions in oil by the commodity traders, in oil by the commodity traders, resulting in futures of Brent Oil resulting in futures of Brent Oil spurting and creating a global price spurting and creating a global price spiral.spiral.

Pollution permits burn European consumers

Did EU ETS "Cap and Trade" Cause Energy Prices to Skyrocket?

Effect of Cap and Trade on Effect of Cap and Trade on Oil Price rise (ORB) since Oil Price rise (ORB) since Kyoto Kyoto

Difficulty in cap and Difficulty in cap and trade enforcementtrade enforcement

High increase in frauds including VAT High increase in frauds including VAT frauds since enforcement of cap and frauds since enforcement of cap and trade in Europetrade in Europe

Europol says 90% Cap and Trade says 90% Cap and Trade transactions are fraudulent in some EU transactions are fraudulent in some EU states, as VAT fraud crosses Euro 5 Bn.states, as VAT fraud crosses Euro 5 Bn.

Asia refuses to biteAsia refuses to bite

Biggest blow to Cap and Trade ETS was Biggest blow to Cap and Trade ETS was received at Copenhagen meet when Asia received at Copenhagen meet when Asia and the developing world refused to and the developing world refused to accede to Europe’s mitigation methods.accede to Europe’s mitigation methods.

The US quickly broke ranks to join the The US quickly broke ranks to join the BASIC nations to frame a new deal, that BASIC nations to frame a new deal, that put Carbon trading in the backseat and EU put Carbon trading in the backseat and EU negotiators on the back foot.negotiators on the back foot.

Bill in US to kill Cap & Bill in US to kill Cap & TradeTrade

US Senator Graham (R-S.C.), backed Senators Kerry (D-Mass) and Liebermann(I-Conn) who are proposing a new bill to do away with CAP and Trade in its present form, shortly.

Global acceptabilityGlobal acceptability

So Risk managing Carbon has only one So Risk managing Carbon has only one option. To include it as a income only option. To include it as a income only after realization.after realization.

Any other treatment including the Any other treatment including the effort of securitization will be prone effort of securitization will be prone

to hazard, as less than 20 % of the to hazard, as less than 20 % of the Global economy has accepted it.Global economy has accepted it.

  

Carbon is high RiskCarbon is high Risk

As we have seen carbon is either a As we have seen carbon is either a subsidy or a cost and not a commodity.subsidy or a cost and not a commodity.

It is a fact that though it was traded in It is a fact that though it was traded in the commodity markets as a good, it the commodity markets as a good, it could never establish a benchmark could never establish a benchmark price because it had no intrinsic value.price because it had no intrinsic value.

It was a non-commodity in a commodity It was a non-commodity in a commodity market, hence susceptible to high risk market, hence susceptible to high risk volatility.volatility.

Europe can’t sustain the Europe can’t sustain the carbon burden alonecarbon burden alone

It is highly unlikely that Europe will be able It is highly unlikely that Europe will be able to convince other nations to follow the Cap & to convince other nations to follow the Cap & Trade Carbon economy. Trade Carbon economy.

In all probability, they may abandon it in In all probability, they may abandon it in favor of a Carbon Tax before the end of this favor of a Carbon Tax before the end of this year, bringing an abrupt end to the $100 year, bringing an abrupt end to the $100 billion carbon trade industry.billion carbon trade industry.

Exit Carbon strategyExit Carbon strategy

Industries who have free carbon Industries who have free carbon permits should not add it to their permits should not add it to their stocks or income statement unless stocks or income statement unless proceeds have been realized.proceeds have been realized.

Those who have bought permits Those who have bought permits through auctions may spread it through auctions may spread it over their annual fuel bills.over their annual fuel bills.

Big Banks exposure to Big Banks exposure to carbon allowances is risk carbon allowances is risk proneprone Banks which are active in Carbon trade, Banks which are active in Carbon trade,

would possible be tested for exposure :would possible be tested for exposure :

Barclays CapitalBarclays Capital Deutsche BankDeutsche Bank J P MorganJ P Morgan Morgan StanleyMorgan Stanley OrbeoOrbeo BNP ParibusBNP Paribus

Our referencesOur references

Ecology to Economics

Our goal is to help promote clean, safe and better practices in economy and ecology worldwide. Balanced, efficient and a little more sustainable.

Amazon Kindle Blog : Ecothrusthttp://bit.ly/7XwAG or http://bit.ly/ecothrust RSS feed for Technoratihttp://technorati.com/people/Ecothrust/index.xml

Our acknowledgementsOur acknowledgements

Thanks to our Creative Director Katerina Thanks to our Creative Director Katerina Voutsara for Art & Video presentation.Voutsara for Art & Video presentation.

For any questions on the presentation For any questions on the presentation please send your queries to the Author please send your queries to the Author Sandip SenSandip Sen

at sen.sandip@gmail.comat sen.sandip@gmail.com

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