the Carbon Markets in 2009 haven been overshadoved by two major events, the unexpectedly severe financial crisis, and the impending climate change talks in Copenhagen in December of the last year. Me and Martin Schulte, Asset Management S.A. of First Climate, give you an overview of the ups and downs the market experienced and the issues that will continue to shape supply and demand in 2009 and beyond.
As regular readers of our own market reports will have noted, the carbon credit market has faced a tough year with many challenges and difficulties. Following a phase of almost uninterrupted price increases for carbon credits
until the summer of last year, we saw prices falling sharply until March last year; no doubt the crash of Lehman Brothers added extra momentum.
The decline in prices hit the market all the harder for being unexpected. Until then carbon credit had been regarded as largely uncorrelated with ohter asset classes. Now a high correlation to macroeconomic developments became evident. In the last quarter of 2008 and the first quarter of this year, this price development, as previosly reported, led to a substantial crisis of the market for primary credits: sellers were unwilling to sell at the low prices, and the remaining buyers had lost much of their risk appetite.
At the same time, many buyers were forced to withdraw from the market. After the market hit bottom in spring 2009, prices recovered somewhat, though they have yet to reach the price level of the summer of 2008. It still seems impossible to foresee all the consequences of this, the most scathing economic crisis since the 1930s.
Increased demand for risk premiums
One consequence of the crisis, however, is that the demand for risk premiums has generally risen in the markets. This is reflected in the reduced valuations of stocklisted companies as well as in the increased return demands for credit risk bearing bonds. Surprisingly, this is a behavior pattern not yet seen in the primary market for climate protection projects. Many project promoters are holding the price risk for their carbon credits
unhedged until their issuance or have unrealistic expectations regarding the risk appetite of buyers, which can be seen in the demand for unsecured project finance participation.
At the same, the pressure of competition can once again be felt among buyers. Especially purchase programs of Annex I countries, but also some late starters among the European energy utilities are obviously prepared to pay very high prices in the primary market. This competitive pressure also shows that a large number of buyers seems not to believe in a longlasting global economic crisis and is convinced that there will be an undersupply of emission
Analyses by reputable organizations, published in the first half of 2009 raise fears of an over-supply of carbon credits
within the European Emissions Trading Scheme. Indeed, expectations regarding the level of emissions in the EU-ETS have decreased due to the economic contraction, in turn, depressing the demand for credits.
This has to be seen in tandem, however, with a continued rise in the rejections of projects by the CDM executive board due to the tightening of eligibility criteria for projects. The limited capabilities of accredited organizations to validate and verify projects are leading to delays in the issuance of certificates. Finally, while many registered projects have underperformed, the average size of new projects is shrinking.
The reduced number of certificates coupled with a recovering economy should, in our view, prevent another price dive as experienced in March 2009. The EU ETS allows for banking of allowances and CERs beyond 2012 (end of the current trading period) and other countries are making their mid-term emission
reduction commitments until 2020.
Thus, what really matters beyond 2012 are the market fundamentals until 2020. In our view, an international agreement in Copenhagen, which would keep the CER as the international carbon currency of choice would keep its prices at healthy levels. However, a failure in Copenhagen and a possible scattering of the market into various commodity types would exert downward pressure on international carbon prices.
Believing to have covered their requirements and allowances, many compliance buyers had to substantially adjust their project portfolios to ensure a realistic valuation of assets, given risk discounts on the expected volume of certificates. These discounts are the result of delays and defaults in the registration of projects on the one hand and of excessive original volume expectations of project developers on the other hand.
The performance of investment vehicles invested in the market reflects the volume adjustments and price decay of the recent monts. A recovery of these vehicles has begun in the last few weeks.
The major challenges
It is important to remember that the basic framework hasn`t changed: Scientifically, it is proven that the rise in global average temperatures is a consequence of the prevalent consumption behavior, and that it has and will continue to have grave effects on flora and fauna and the basis of human life on earth. It is similarly undisputed that a drastic reduction in the current levels of greenhouse gases is necessary in order to halt this temperature rise. The climate crisis represents a central challenge to humanity for the next decades. Whatever criticisms the marketbased mechanisms of the Kyoto Protocol may face and even if on its own they cannot halt the rise in GHG emissions - their effectiveness is commonly acknowledged. The import of project-based emission
reduction certificates represents an important and economic solution to the problem of complying with ever tightening emissions limits. First Climate is convinced that both emissions trading and projectbased mechanisms have a future beyond 2012.
There is, however, a second challenge, which the world and especially countries such as China, India and Brazil, where both population and prosperity are growing, face: They have to meet a rapidly growing demand for energy with energy sources that are not permanently reliant on fossil fuels. But industrialized and emergent nations have to cover their increasing energy demands with new, preferably renewable energy sources as well. All this requires huge investment in the infrastructure required for the generation and distribution of energy. At the moment, this infrastructure is limited and faces a continuosly growing demand, which by tendency may well lead to at least stable, often probably growing margins for energy providers. This trend creates opportunities in the shape of investment participation in promising sustainable energy infrastructure projects. Attractive and sustainable returns can thus be generated through the climatefriendly generation of energy. However, with more political uncertainty reigning the carbon market the forward sale of carbon credits
serves as an attractive hedge against market developments but also political decisions.
With kind regards
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