By Susanna Twidale and Shadia Nasralla
LONDON (Reuters) - An expected dash by big corporations for offsets to meet their climate targets has prompted financial exchanges to launch carbon futures contracts to capitalise on what could be a multi-billion dollar market.
It's a step change. Carbon offsets, generated by emissions reduction projects, such as tree planting or shifts to less polluting fuels, have struggled for years to gain credibility, but as climate action has become urgent, their market is expected to grow to as much as $50 billion by 2030.
Among the major corporations that say they expect to use them to compensate for any emissions they cannot cut from their operations and products are Unilever, EasyJet, Royal Dutch Shell and BP, which all have climate targets.
Singapore-based digital exchange AirCarbon told Reuters it planned to launch an offset futures contract by the second quarter.
"The entire concept behind carbon trading and offsets is to employ the profit motive in order to push decisions towards climate change mitigating activities. (We ensure) that you find the most efficiently priced offsets," William Pazos, co-founder of AirCarbon, said.
The futures market would allow companies to buy a simple credit, effectively a promise to reduce a tonne of emissions but not specifying where that would take place, in contrast to the existing market that offers direct access to particular offset projects.
Advocates, such as AirCarbon, say the resulting liquidity and transparency are positive.
Critics, including some environmental groups and some project developers, say making the market bigger may just make it cheaper for emitters without providing any guarantee it will support the projects most effective in reducing emissions.
"There is a risk in a ... switch from something which has a large proportion of over-the-counter buyers at least taking some interest in what they are buying and its quality to large wholesale transactions that aren’t so easily unpacked," said Owen Hewlett, chief technical officer at Gold Standard, one of the biggest carbon offset registries.
SMALL AND OPAQUE
Carbon offset credits are currently traded in small, bilateral and typically project-specific deals.
An emitter can buy a credit awarded to a forestry or clean cooking stove project for a tonne of carbon dioxide emissions the project has prevented.
The buyer uses these credits to offset past or future emissions and the credit is "retired", or removed from the system.
The retail price of an offset can vary from 50 cents for a renewable energy project in Asia to $15 for a clean cook stoves project in Africa to $50 for a plastic recycling project in eastern Europe. (Graphic: Carbon offset wholesale prices: https://fingfx.thomsonreuters.com/gfx/ce/rlgvdexlgpo/WholesaleOffsetPrices.png)
(Graphic: Carbon offset retail prices: https://fingfx.thomsonreuters.com/gfx/ce/ygdvzenwdpw/OffsetPricingB2C.png)
These voluntary deals are distinct from compliance cap-and-trade markets, such as the European Union's Emissions Trading System, based on lawmakers setting a carbon budget and allocating a finite number of allowances, which can be traded by emitters or market players.
The underlying principle echoes the carbon offset market in that those that have emitted too much carbon can buy pollution permits from those with allowances to spare.
As demand to limit carbon emissions grows, carbon prices in the EU ETS have soared to a record high of over 40 euros a tonne this year.
In the off-exchange, bilateral market for carbon offsets, some say they are struggling to navigate the proliferation of standard setters, registries, verifiers and criteria.
"The market today is very small. It’s difficult to be confident that the product you are investing in is credible," said Bill Winters, CEO of Standard Chartered bank and Chair of a private sector task force seeking to create a multi-billion dollar offset market in the coming months. (Graphic: How small is the voluntary carbon offset market?: https://graphics.reuters.com/CLIMATE-CHANGE/OIL-CARBONCREDITS/oakvexkkmpr/chart.png)
This year in theory should mark the coming of age of carbon markets as decades of U.N. talks on tackling climate change reach a decisive stage.
Delegates at the United Nations climate conference in November in Glasgow, Scotland, are expected to work on designing a market to channel money into offset and emissions removal projects to prevent global temperatures from rising more than 1.5 degrees Celsius (2.7 degrees Fahrenheit) above the preindustrial average.
Some players, such as AirCarbon, are eager to launch their financial products sooner.
Global exchange CME, home of the main U.S. crude oil benchmark contract, will launch an offset futures contract in March.
"It is a brand new market for many players," Peter Keavey, Global Head of Energy at CME Group, told Reuters. "We can help provide standardised pricing benchmarks and improve price discovery in the voluntary offset market. That's our goal."
Ahead of the talks later this year on market design, both CME and AirCarbon plan to use standards set under the aviation CORSIA offset scheme, which many environmental campaigners have said are not rigorous enough as they allow the aviation sector to use most types of project to reach its emissions targets.
They say they fear a repeat of problems that beset the offset market of the Kyoto Protocol, the Clean Development Mechanism (CDM).
The market under Kyoto, a precursor of the Paris climate deal, was flooded with cheap credits from industrial gas projects, mainly from Asia. That led to price crashes and made it harder for other projects to attract funding. (Graphic: Spot price of Certified Emission Reductions: https://fingfx.thomsonreuters.com/gfx/ce/yzdpxwqokvx/Pasted%20image%201613645738271.png)
"CORSIA allows a lot of project types and does not have particularly stringent criteria, such as forestry projects with permanence issues and old CDM (Kyoto) credits with little environmental benefit," Gilles Dufrasne, policy officer at the non-governmental organisation Carbon Market Watch, said.
The International Civil Aviation Organization (ICAO), which developed the scheme, said in an email CORSIA only allows CDM units issued from 2016, meaning the majority of CDM credits are not eligible.
The email also said the permanence of emissions reductions for forestry credits was guaranteed by an insurance mechanism.
Some project developers, brokers and environmental groups also question the wisdom of decoupling carbon units from their underlying project.
They say combining emissions-focused projects with those that might prioritise other issues, such as community engagement, education or biodiversity, could lead to a race to the bottom in terms of price.
This might make it harder for more capital intensive projects to attract buyers.
More broadly, green groups are concerned companies may place too much emphasis on offsets which, if priced too cheaply, could lead them to focus less on cutting their own emissions.
There are no rules on how many tonnes of carbon a company is allowed to offset a year.
Emitters, such as Royal Dutch Shell, BP and Unilever and project developers, say the first priority must be to reduce emissions.
"We have always acknowledged that offsetting can only be an interim solution while zero-emissions technology is developed," EasyJet said in an email.
The private sector task force, chaired by Winters and promoted by former central banker Mark Carney, wants to encourage a range of participants, such as bankers and trading houses, as well as emitters to join the market to boost liquidity.
"Markets work best when they are efficient, and that efficiency comes from greater rather than smaller liquidity. So it’s important to have as many participants as possible, from all different types of background," said Abyd Karmali, Managing Director, Climate Finance at Bank of America, who is also a member of the private sector task force.
Others question the role of speculative trading in a climate context.
"There might be a place for a bunch of traders flipping margins on some futures contracts, but at the end of the day I don’t see how the volume of trading going through (exchanges) has any positive impact on climate change," said Wayne Sharpe, CEO and founder of ecommerce site Carbon TradeXchange.
(Reporting By Susanna Twidale and Shadia Nasralla; Editing by Katy Daigle, Veronica Brown and Barbara Lewis)