From Altriusm to Alternative Investment: The “Three Pillars” of a carbon markets institution
Mar 18th, 2010 | Filed under: Institutional Investing, Today's Post
Among the television ads that book-ended this year’s U.S. Super Bowl extravaganza, Audi’s Green Car commercial truly stood out, not for the beautiful car or the amazing scenery but for its apt, modern-day take on the no-littering, no-polluting, no composting, no carbon-foot printing world we all now try, as much as we can, to live in.
Some iconic snapshots: A man pulled out of his home by a squad team for not composting a rind; another man arrested for choosing plastic over paper; a cop pulling over two other cops for using Styrofoam cups; and last but not least, an Audi A3 clean diesel driver allowed to pass an “eco” road blockade for not fouling up the air with noxious fumes – all to the tune of a song entitled “The Green Police.”
It was a deprecating take on what in the developed world at least has become a fairly all-encompassing issue: collective guilt over trying to follow – and keep up with – the ever-changing rules of keeping “green.”
The investing world has certainly been no different. In fact, in many cases, the “going green” mantra has become a mandate among pensions, endowments and other institutional investors, whose constituents are mandating money be allocated to clean-technology investments – through specific types of firms, fund managers or both.
Trouble is, and continues to be, that finding such investments and managers is easier said than done. A recent paper (click at the top of the page to download the complete version) published by Janelle Knox-Hayes with Oxford University’s Centre for the Environment, focuses on carbon emissions markets emerging as governance mechanisms to reduce greenhouse gas emissions and mitigate climate change – not only at the hands of regulators but also at the hands of private organizations.
In essence, the paper analyzes how organizations develop the three pillars of the carbon market institution: regulative, normative and cultural-cognitive constructs. Since organizations build the institutional pillars of the carbon market network, the strength of the institution cannot be determined by regulation alone.
The paper also draws on inherent issues prevalent in these emerging carbon credit markets: namely the debate over whether a “credit” is a physical piece of property, and if so how it is valued, traded and eventually cashed in.
The premise of carbon trading is fairly simple: polluters – companies, governments and people – purchase credits in various markets to offset the environmental damage they inflict, and “clean” firms and people sell excess credits they stockpile for being good environmental citizens.
An on-the-ground example might be an electric utility firm, where users pay a few cents extra for every kilowatt of power they use, which then goes to paying for stuff that reduces future CO2 emissions like a new gas-fired power station, which wouldn’t have been economically viable if not for the extra capital, and for the carbon credits it will also generate that can be sold.
It is a market that in theory at least is growing by leaps and bounds. A report published last year by PricewaterhouseCoopers entitled, “Capitalizing on a Climate of Change” noted the market has surged in the past five years, jumping to more than $120 billion from just $1 billion in 2004.
Still, the reality, according to Knox-Hayes and others, is that trading carbon credits in the context of a traditional marketplace is far more complex: carbon markets themselves aren’t necessarily designed to govern behaviors which emit greenhouse gas emissions.
Further, from a trading perspective, carbon credits provide the right to emit, but the credits themselves do not become a property right until they are traded, either over the counter (matching buyer to seller) through contract, or through an exchange in partnership with a registry.
In most cases, the property right, what many lawyers refer to as ownership title, is established using legal certificates that house carbon reductions that can then be traded or sold through Emissions Reduction Purchase Agreements (ERPAs), but these can take months to negotiate and settle.
The International Emissions Trading Association (IETA) has developed a Master Agreement to trade EU allowances, which can be traded more quickly, though some exchanges still require traders to provide a statement of sole claim to ownership. For instance, for offsets that were produced through a chain of companies, each company must sign a letter that they do not claim the right of the emission reduction.
All of which is to say that, despite the ever-growing recognition of going “green”, and despite the growing interest and mandates that investors, particularly on the institutional side, are facing, carbon trading as a viable way to both invest money and help the environment is still at a nascent stage – even with estimates showing the growth potential as huge (see chart below).
Indeed, as Knox-Hayes points out, while countries and regulatory bodies can and certainly have built carbon-trading markets, it is still up to private firms and players that participate in these markets to ensure they function – kind of like having the traders, computers and telephones at the Chicago Board Options Exchange.
Perhaps Audi’s ad for next year’s Super Bowl will be a spoof on a COE pit-trader trying to sell enough carbon credits to buy a car.
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