Can the market for hot air rise?

When the Kyoto Protocol came into force in 2005, it created a multi-billion euro market in hot air.

The protocol set up three market mechanisms, (see below) which are growing rapidly. According to World Bank figures, the carbon market was worth €23 billion ($30bn) in 2006, three times what it had been in 2005. Of this total, the European Union’s Emissions Trading Scheme (ETS) was worth €19bn, while the so-called project-based activities, the Clean Development Mechanism (CDM) and Joint Implementation (JI), were together worth €3.8bn. Individuals and companies making their own arrangements to offset carbon consumption have led to the emergence of a voluntary market in carbon that was worth €80 million in 2006.

Analysts predict that the market will keep on growing. Karan Capoor, a senior finance specialist at the World Bank and co-author of its report ‘State and Trends in the Carbon Market 2007’, expects that final figures for 2007 will show that the market has doubled in value to around $50-60bn (€34-41bn). "It is a very attractive, good-sized market," he says, that has "the potential for exponential growth every year". Although Capoor says that it is "unwise to depend on the market for everything and that it cannot be expected to solve all problems" relating to global warming, he thinks a significant feat of the market has been to get people involved in action to counter global warming. "It’s amazing to see the levels of excitement. It gets people in the game and shows them it is not all doom and gloom. A good achievement of the market is that it takes it [global warming] away from the sphere of ‘the world is over.’"

But healthy growth in the future depends on the resolve of governments to enter into long-term commitments to curb global carbon emissions. If leaders fail to agree on a mandate to start talks on a post-2012 deal at Bali, the market for carbon could be left floundering in uncertainty. Some schemes, such as CDM projects, require several years to start working and need certainty about the direction of the price of carbon. In September this year, Yvo de Boer, the executive secretary of the United Nations Framework Convention on Climate Change (UNFCCC) said that if Bali led to a long-term agreement on climate change then that "could allow the expansion of existing [carbon] market mechanisms to a market of $100 billion [€68bn] per year".

The early experimental phase of the carbon market has not been without problems. CDM projects have been slow to take off, with hardly any money invested in projects to protect forests. According to a UNFCCC report on carbon markets, there were only three "afforestation and reforestation projects" among the 1,468 CDM projects in the pipeline at the end of 2006. Meanwhile, the ETS has had serious teething troubles. Under phase I (2005-07) too many permits were issued, causing the price of carbon to plummet and undermining the whole premise of the scheme. During 2006, emissions grew despite the existence of the ETS.

Nonetheless, as the world’s biggest carbon trading scheme, the ETS is well placed to become the nucleus of a global carbon-trading system. In October, officials from the European Commission met their counterparts from California and Chicago to discuss making links between their different emissions-trading schemes. A European official involved in the talks says that the Commission is having "very active" bi-partisan talks about linking the ETS to different American carbon-trading schemes. The EU aspires to link all existing carbon-trading schemes after 2012.

However, that the EU has the biggest carbon market "is an irony of history", observes the official. When the Kyoto Protocol was first mooted, the US pushing for a cap-and-trade scheme, while the EU was lukewarm about markets. But the US refused to ratify the Kyoto Protocol, leaving Europe to take advantage of the emerging carbon market. To add insult to injury, the EU also studied the American emissions trading market for sulphur before it set up its CO2 emissions trading scheme.

"The US has missed out to some extent on the opportunity, although they will catch up and I’m sure they will catch up quickly," says Kapoor at the World Bank. The race to lead the carbon market should become even more interesting after the Bali meeting.

Carbon market jargon

• Clean Development Mechanism (CDM): designed to help developing countries achieve sustainable development, the CDM allows rich countries to finance projects for reducing greenhouse gas emissions in poor countries, as an alternative to undertaking more difficult emissions reductions themselves.

• Joint Implementation (JI): allows countries with a commitment under the Kyoto Protocol to invest in another developed country to reduce net emissions. Emission reductions achieved under the JI are called emission reduction credits (ERU). One ERU equals one tonne of CO2 reduced.

• Emissions Trading Scheme (ETS): launched on 1 January 2005, large polluters trade allowances to emit carbon to keep below caps on emissions set by the European Union.

When the Kyoto Protocol came into force in 2005, it created a multi-billion euro market in hot air.