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been rationed and companies that manage to drive down emissions can sell their surplus credits to those that don’t.
Gavin Tait, head of emissions trading at ABN Amro, said that going into phase two, EU companies were net 6% short of permits, meaning they will have to trade or cut: “We are looking at much tighter supply.”
On a purely investment basis, institutions should at least be aware of the impact of carbon prices on large emitters in their portfolios, which look likely to include airline companies as they are included in the EU programme from 2011.
This constriction of credits may go some way to actually reducing carbon emissions, but still leaves question marks over whether the baseline calculation for the ‘cap’ underpinning the trade of carbon credits is at the right level, or even whether the levels agreed under Kyoto are meaningful, based as they are on climate science from 1990, which falls far short of current global warming predictions. The value of EUAs will almost certainly be reassessed against these criteria over time.
The second important leg to emissions trading is the Clean Development Mechanism (CDM) whereby credits are earned by developers originating carbon abatement and development projects in emerging countries. Under the CDM – one of the many acronyms rapidly becoming the jargon of carbon trading – developers working, for example, to make power plants in developing countries cleaner can sell the resultant credits, or Certified Emissions Reductions (CERs) to European companies. The UN has approved approximately 800 such projects so far and it is predicted that there could be about 1600

CERs approved by 2012. Criticisms have been aired about the CDM. One is that the UN verification body for such projects is under resourced. Another is that many CDM schemes are being set up in China where a cut in emissions is cheaper to achieve. Ironically, China is also predicted to overtake the US as the biggest contributor of greenhouse gases. One investment banker said some of the projects coming out of China were already “on the dodgy side.” Thorough and transparent verification will be key to ensure that the CDM does not fall prey to graft.
The second phase of Kyoto is also likely to see more focus on C02 reduction, rather than the so-called “low-hanging fruit” of reductions in Nitrogen Dioxide and Trifluromethane (HFC23), both of which are more dangerous than C02, less prolific and significantly more lucrative in terms of credits, which has led to a spate of early abatement projects. A report released in July by Morgan Stanley said: “If non-CO2 gases are taken out of the portfolio, the effect of the CDM as a catalyst of low carbon climate change resilient economic development is much less clear.” A recent report by the World Wildlife Fund (WWF) report, also suggested that 20% of emissions reductions certified under the initiative may have been passed without CDM financing, meaning they do not properly meet the ‘additionality’ criteria laid down by the UN that such projects should bring genuine new CO2 reductions. The combination of lucrative financial returns on sometimes opaque projects in developing countries will likely lead to more such criticisms and significant business risk.
The third leg of carbon markets is the VER, standing for Voluntary Emissions Reductions or carbon credits

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