Carbon market instruments, trading strategy analysis and company strategy to leverage them

Abstract

Global warming and climate change are the biggest threat to mandkind today. Inorder to mitigate the risk of global warming, the United Nations formed a global organization known as the UNFCCC (United Nations Framework Convention on Climate Change). To mainstream emission reduction initiatives, the UNFCCC decided to monetize emission reductions and develop a market for them. The entire functioning of the market based system was finalized as part of the landmark Kyoto protocol passed in 1997. This lead to the formation of the multi billion dollar carbon market. The market is expected to reach more than 3 trillion dollars by 2020 as per a recent World Bank estimate. However this market has many internal flaws. These flaws lead to acute information asymmetry and many times the basic motive of emission reduction is generally lost. One important concern from the Indian point of view is the inability of small rural projects to get the benefit from carbon credits due to high upfront costs. Similarly the wave of global warming across the globe has lead to many companies wanting to become carbon neutral. Since companies can’t reduce their emissions below a particular level they have to purchase carbon credits. The concept of carbon equity which helps small projects monetize their emission reductions can be the ideal source for Indian companies to purchase low cost emission reductions with a high social impact. The concept involves having the small project as part of the organizational boundary of a company estimating its carbon footprint. Thus the emission reductions from the project accrue to the company. These emission reductions can be monetized as ISO 14064 credits. Inorder to further hedge its risks, the company can provide a part of the initial capital of the project and take carbon equity in the project. Thus this provides the company with a long term cost effective source of emission reductions.Carbon equity if transformed to practice can lead to large scale rural development projects in India like biogas, solar lanterns, small hydro amongst others. Many companies including Infosys, Wipro, HSBC, ITC etc. have invested crores of money in their quest for carbon neutrality. The carbon equity concept can help in the proper channelization of these funds to small rural energy projects in India.