SNAP ANALYSIS: CME triggers greenrush for carbon benchmark

London, (Quantum Commodity Intelligence) - On Monday CME Group joined rival exchange SGX and price reporting agencies in seeking to offer a risk-management tool for the burgeoning nature-based carbon offset market.

Through the launch of its N-GEO, the exchange hopes to help clients "manage climate risk, add price discovery and proactively pursue ESG initiatives."

It presumably hopes to make some money from trading fees too.

The market for carbon offsets has been around for two decades and so far has focussed on the carbon element of the credit, meaning projects such as renewable energy, energy efficiency and schemes to cut industrial emissions have been the most attractive.

They were also some of the most profitable as they could easily prove that they cut a tonne of carbon by showing quantitative displacement, and, as such, get registered with the UN to allow governments to use them to meet targets under the Kyoto Protocol.

However, growing corporate sustainability targets and the need to show some community benefit from the investment means demand for nature-based carbon credits - such as those that award offsets for planting new trees and not cutting down existing ones - is expected to grow exponentially.

That's despite the fact these credits have historically struggled to unequivocally prove a tonne of carbon was permanently removed or saved.

As such, they were at the back of the queue in being registered by the UN for nations to use to meet emission targets under the Kyoto Protocol.

But earlier this month, the world's biggest oil price benchmark provider - S&P Global Platts - said it would launch a nature-based carbon offset reference price to "help bring additional transparency" to the marketplace, and, presumably to become the main price reference for credits.

In doing so, it joined fellow price reporting agency Oil Price Information Service (OPIS) in offering price assessments for nature-based carbon offsets, which launched its own product in January.

And just last month, SGX said it too was working on a contract to tackle the problem of "thin liquidity and credits of questionable quality" in the market.

It's not altruism though, the traded value of the global offset market is supposed to be worth $200 billion by the middle of the century.

Carney

CME's launch has effectively triggered the starting gun on a race to become the global price benchmark for all carbon offsets - a benchmark that the former governor of the Bank of England said earlier this year was necessary to trigger finance flows to more and more emission reduction projects.

Through his chairmanship of the privately-backed Taskforce on Scaling the Voluntary Carbon Market, Mark Carney said that a large-scale voluntary carbon market is critical to reaching the goals of the Paris Agreement to curb global warming and limit an increase in temperatures to 1.5C.

And while that has encouraged financial services companies to fill the void of price discovery, it has made those involved in the markets for many years wary of short-term profiteering.

Aside from airlines and some regional schemes, there is currently no international mandatory market for carbon offsets after the expiration of the Kyoto Protocol in 2012 effectively killed the UN scheme - the Clean Development Mechanism.

The less-robust, but more inclusive, Paris Agreement, which succeeded Kyoto from 2020, allows countries to meet emission reduction pledges by taking part in international carbon markets, but it has still to formalise how that would work.

As such there are no universally-accepted rules on how to measure the prevention of emitting a tonne of carbon dioxide, removing it from the atmosphere or how to issue a carbon credit to prove either, participants say.

Carbon-free oil

Yet while many retailers have sought to green their images by buying so-called nature-based credits, so have energy companies.

Oil and gas companies and trading houses have started to market crude oil, gas and refined products as "carbon-free" - effectively selling oil and products in a package with voluntary carbon credits that they claim offsets the climate cost of producing, transporting and burning the fuel.

Some companies do it at cost or even at a loss, while for most deals the cost of the credit is disguised, with some companies sourcing the credits in bulk or developing projects themselves at very low cost and making handsome profits on selling cargoes of fuel that green groups say caused the problem in the first place.

"No one is going to tell you what they paid for the offset," said one carbon market participant who has been in the industry for two decades and has clients in the energy sector.

He added buyers should be careful about what they receive as some credits are "legacy" offsets where emission reductions would have been made "a long time ago" versus the expectation that the reductions would be made more recently.

He added that the cost of credits can vary from $0.50/mt to $7/mt depending on "methodology, geographic region, size of deal and the vintage (year in which the reduction took place)."

"People think there is just one price - there isn't. But if these... (contracts and assessments) can persuade the market that there is agreement on price around a certain type, a certain vintage at a specific value, then that can maybe be used as a reference point," he said.

Maximum profit

One thing is for sure though, the current opacity in the market isn't pleasing everyone.

Louis Redshaw, a private consultant that had previously pioneered carbon trade at Barclays Capital in the early 2000s, said Monday that he had seen markups of more than 1,500% or more in some deals for credits - profits he said were exorbitant and destroyed trust.

His solution was to encourage developers to set a maximum profit take per credit, adding his company would not charge any more than 15% above the cost of each credit.

"If a company or individual is prepared to make what essentially amounts to a charitable contribution to try to save the planet by buying carbon offsets, then their contribution should, in the majority, accrue to the project or project investor," Redshaw wrote in industry newsletter Carbon Pulse.

That won't matter to CME, Platts, SGX or whoever wins the global benchmark for carbon.

They plan to make money on the liquidity of trade and volatility of price, not the profitability of projects.