Responsible Investor

What does Bali mean for institutional investors?

Agreement on a ‘roadmap’ for a post-Kyoto climate agreement gives carbon trading a longer perspective. How should institutional investors react?

The horse-trading over reduction of global greenhouse gases during the Bali conference to find a ‘roadmap’ successor to the Kyoto Agreement underlines the difficulty in predicting the future direction and efficacy of carbon trading markets. Both are important to institutional investors increasingly pressured on one side over their response to global warming and coveted on the other by investment banks and a new wave of carbon trading firms keen to get long-term investors on board as clients. A report issued this month by The London Accord, the largest ever private-sector investment research project into climate change and backed by some of the biggest global financial services groups, said institutional investors should now be putting money into carbon markets if they believe in their long-term prospects. The project says market activity and government measures – dependent on Bali and subsequent global climate meeting outcomes ahead of the Copenhagen conference in 2009 – could produce medium to long-term carbon prices in the range of €30 to €40 per tonne of CO2. This is a significant predicted rise from the €20 per tonne that most analysts believe will remain the approximate short-term value of a tonne of carbon from the beginning of 2008 in the second phase of reductions under Kyoto that run until

2012. Privately, many investors believe €40 per tonne is about the minimum price at which carbon would begin to have an meaningful impact on company financials and prompt serious emissions reductions; a failing which has been levelled at carbon markets to date. The concerns carry weight: carbon trading is, after all, a synthetic market created to reduce greenhouse gases.
Confidence in carbon trading is growing following the disastrous debut of the EU emissions trading system and its over-allocation of credits and subsequent price collapse. The London Accord said investment portfolios could be constructed that produce attractive financial and ‘carbon returns’ at €30-40 per tonne levels. It said much of the future capital for climate change solutions will come from pension funds and asset managers who rely on analysis by the financial services sector for their investment decisions. One strategy will likely be carbon trading.
To recap, the CO2 emissions market is based on the Kyoto agreement. This aimed to reduce by 2012 the emissions of greenhouse gases to 5% under 1990-levels.
Under the European Emission Trading Scheme (ETS), the first compulsory market in the world, European countries distributed emission rights (EUAs), initially for free, among the highest polluters. The credits have since

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