Meanwhile, traders are trying to prove that the current carbon market works.
In the first nine months of 2007, the EU ETS has seen total trade of around 760 million allowances, called EUAs. Full-year 2006 trading's total was 827 million allowances. This does not account for certified emissions reductions, or CERs, from approved projects, trading in which has been growing rapidly from a very low base.
Today, emissions traders in Europe are watching the relative prices of EUAs and CERs, looking for the cheapest compliance options, and encouraging reluctant industrial companies to optimize their compliance strategies. Financial companies -- banks, hedge funds and purpose-built investment fundsare leading traders, while utilities are the largest "natural" players, buying allowances and offsets to cover the CO2 emitted through power generation.
Phase 1 of the EU ETSand to a certain extent Phase 2 as wellended up giving non-power generating industrial companies as many allowances as they needed, in an effort to avoid penalizing industrial sectors in international competition. In some cases, these companies were given sizeable surpluses of EU Allowances which they turned into healthy revenue streams, selling to EUA-starved utilities.
Phase 2 promises to be generally tighter in terms of EUA supply, but industrial companies will again find themselves a key source of liquidity.
EU ETS rules allow companies to provide an average 10% of their total allocation of emissions allowances in the form of CERs from Clean Development Mechanism projects.
Industrial companies which are to be allocated almost 100% of their requirements will therefore be able to swap up to 10% of their EUAs for CERs, releasing EUAs into the market which can then be bought by utilities, who once again will face the lion's share of the reduction burden.
And while the private sector is leading the way in terms of trading activity, governments are no slouches. Most EU governments have launched carbon purchasing funds of one type or another as they try to balance the effort being made by the "trading" and "non-trading" sectors of their economies. "Trading" sectors are covered by the EU ETS but the commercial, domestic and agricultural sectors must also generate carbon savings.
By the time 2012 comes around, we may see emissions trading spread to a far greater proportion of the economy. Much of this research is being carried out in the UK, where the government is planning to launch emissions trading for large non-industrial concerns, such as supermarkets or commercial developments. The Royal Society is even trialing a personal carbon account, whereby individuals account for the carbon content of their activities.
It's clear from these developments that the market is maintaining its central role in fighting climate change. Bringing emissions trading to developing countries and to the US can only reinforce that role.
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