Could the rise in CO2 levels play havoc with global food supplies?

Goldman recently published a report discussing global carbon emissions (see discussion on cap & trade issues). Apparently the amount of carbon in the atmosphere now is the highest in over 400,000 years (chart below). Researchers use small air bubbles trapped in the antarctic ice sheets over time to determine historical carbon (CO2) levels.

X-axis = number of years ago (source: GS)

It is difficult to determine what impact this is having on global weather patterns, but between last July being the hottest month on record (since record-keeping started in 1895), and Hurricane Sandy veering inland due to irregular jet stream patters, people are beginning to take this more seriously.

In particular the impact on global food supply is a concern because the loss in yield during "bad" years is not recovered during periods of favorable weather (see chart below - this pattern resembles the P&L of a short options portfolio). It means that if what happened this past summer becomes a more frequent occurrence, the impact on global food supplies could be devastating.

Historical corn yields (source: GS)

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Carbon emissions in 2040's US projected to be below 2005; cap & trade programs ineffective as emissions shift to emerging markets

One of the reasons for the failure of the so-called cap & trade program in the US (other than political), has to do with the fact that carbon emissions have declined on their own - without any caps. And why would a company pay for an emissions "allowance" if it can stay under the cap without it. Of course politically it made no sense to force companies to pay at the time when they were emitting materially less carbon on their own. Furthermore, there was no incentive for investors to hold these contracts because each year the long-term projections for carbon emissions in the US have declined. Carbon emissions in 2040 US are now projected by the EIA to be below that of 2005.

Source: EIA

The sharp declines first took place during the financial crisis, as companies simply produced less and therefore emitted less. Two major factors driving lower emission projections have to do with slower economic growth and increasing usage of natural gas. Other factors are at play as well.

EIA: - From 2009 to 2013, key changes in the AEO include:

1. "Downward revisions in the economic growth outlook, which dampens energy demand growth
2. Lower transportation sector consumption of conventional fuels based on updated fuel economy standards, increased penetration of alternative fuels, and more modest growth in light-duty vehicle miles traveled
3. Generally higher energy prices, with the notable exception of natural gas, where recent and projected prices reflect the development of shale gas resources
4. Slower growth in electricity demand and increased use of low-carbon fuels for generation
5. Increased use of natural gas"

And once cap & trade became known as a "tax scheme", while some idiotic media stories linked it to Goldman, it was all over for the program. The experimental "voluntary" program called CCX (Chicago Climate Exchange) died in 09, as Obama's proposed legislation was killed in Congress (rejected with 219-212 vote in the House.) The CCX contract and the trading volume effectively went to zero (see discussion).

Source: ICE

Even in Europe, where cap & trade has been in place for some time, carbon allowance contracts aren't doing much better. Europe's economic growth prospects are worse than those of the US, resulting in lower emissions. The ECX CER unit now trades below €1.

One lot of one thousand (1,000) Certified Emission Reduction units (CER) (price in euros; source: barchart.com, ICE)

There has been talk of bringing the program back and some projects in North America (Québec and California for example) have been implemented on a small scale (these are mostly symbolic in nature.) It is certainly positive that the US and Europe emit far less carbon than expected. But the saddest part of this story however is in the bigger picture. Both the US and Europe have effectively "exported" a great deal of their carbon-heavy industries to emerging nations, particularly to China. However countries like China are actually far less "carbon efficient" than factories in the developed world. Making a gadget in China pumps much more carbon into the atmosphere than producing the same gadget in Europe. Therefore global emissions increased even as the developed world cut them. And unfortunately carbon is one of those global pollutants - it makes no difference where it is produced, the impact is world-wide. Which means that even if the US had a full fledged cap and trade program, the impact on total carbon in the atmosphere would not be dramatically different without the commitment from emerging markets nations.

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The Chicago Climate Exchange and the "cap and trade" market in the US

Here is a quick follow-up on the 2009 post called Death of market. It discussed the collapse of the voluntary carbon emissions credits market on the US based Chicago Climate Exchange (CCX), as the proposed "cap and trade" legislation got derailed.

In 2010 the UK parent of CCX called Climate Exchange Plc (CLE) was sold to ICE.

Futures Mag: Under the agreement, CLE shareholders would receive £7.5 ($11.26) for each share of CLE at the closing of the scheme (sale), valuing CLE at £395 (approximately $593 million). According to a release, the acquisition represents a premium of 56.9% from the April 29 closing price of CLE.

The deal expands the competition between ICE and CME Group, which is part of the Green Exchange joint venture. The Green Exchange trades on the CME Globex and Clearport platforms and clears through CME Group's clearinghouse.

In a statement, Climate Exchange Chairman Richard Sandor said, “We believe that a combination with ICE makes strategic sense and look forward to addressing continued opportunities together.”

Apparently these "opportunities" were quite limited. Even though carbon trading is still somewhat active in Europe, the US carbon futures exchange is shutting down. It was a great idea by Richard Sandor to create a market based solution to a global problem, but in the US it makes little sense politically. Republicans are not too keen to tax corporations in order to "address" global warming, while some Democrats and many environmentalists are not too happy with market based solutions.  Both have an incentive to kill the program.

Unfortunately the project is ending on a sour note. The futures arm of CCX had sold a number of exchange seats which are now worthless. In order to recoup some funds, the owners are suing Richard Sandor, claiming fraud. The claim states that Sandor promised to keep the number of seats fixed, and the seats were transferable and could be leased. None of those promises were kept according to the claim.

Crain's (Dec 15th): Traders at the Chicago Climate Futures Exchange, which plans to shut down early next year, are suing founder Richard Sandor and other exchange officials, alleging a fraud that impaired the value of their trading privileges. ...

The suit, filed in Cook County Circuit Court on Wednesday by two dozen individuals and trading firms, claims that they were told that only 250 trading privileges would be sold at the short-lived exchange and that their seats could be resold or leased when 250 were purchased. Mr. Sandor and other defendants made false representations, it alleges, because the exchange never intended to limit sales to only 250 seats or to allow them to be transferred or leased.

There is some good news on the carbon trading front in the US however. Seems California is getting into the game of carbon trading.

Businessweek: California air regulators approved the final design for what will become the country’s first economy-wide program to regulate greenhouse gas emissions.

The Air Resources Board approved 252 pages of rules governing how the state will cut carbon emissions from power generators, oil refineries and industrial plants roughly 15 percent by 2020. The plan will now be reviewed by the state Office of Administrative Law.

It's hard to see how California could make much of an impact on global carbon emissions with China and India pumping enormous amounts of CO2 into the atmosphere to support their growth, but one's got to respect them for trying.

SoberLook.com

Cap-and-trade contract pricing revisited

Let's discuss another great comment on Seeking Alpha, this time in reference to the Sober Look post called The collapse of the CCX carbon emissions contract

Here is the comment in full from Aaron Joseph:

The author ignores the fact that prices collapsed before Waxman Markey was even in the news. Take a look at the author's 2nd chart - when the bill actually passed in June of this year, CCX prices were already trading at all time lows.

No, Waxman Markey did not kill the CCX contract; prices collapsed with natural gas (as well oil, stocks, and other markets) in late 2008 and early 2009. Now, as markets, particularly stocks, have rebounded, the CCX remains depressed. Waxman Markey probably isn't helping, but other U.S. carbon markets like the Regional Greenhouse Gas Initiative have seen the value of their voluntary offset contracts hold up. The story behind the path of CCX contracts is not nearly as simple as the argument given in this piece.

Let's clarify a couple of items Aaron Joseph discusses:

1. He is indeed correct on the Waxman Markey timing issue. However long before the bill was proposed, the market participants were well aware that as the financial crisis hit hard, Congress will have no appetite for any bill that would cause the US industry to cough up funds for carbon allowances. At least not in the near future. The market thus responded, dumping the CCX contract. As the details of the bill became clear, and more importantly the opposition to cap-and-trade as a concept straightened, any chance of CCX contact recovery became less likely. Thus federal level legislation (or lack thereof) is indeed the key cause of the CCX contract pricing problem.

2. With regard to RGGI, it is actually a mandatory program implemented by some states. From www.rggi.org:

"RGGI is the first mandatory, market-based CO2 emissions reduction program in the United States.

The states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, and Vermont are signatory states to the RGGI agreement. These ten states have capped CO2 emissions from the power sector, and will require a 10 percent reduction in these emissions by 2018."

If participants are forced into this program by their respective state governments, it will certainly improve the allowance pricing relative to the CCX contract. That's exactly the point here.

RGGI also has bidders who are in fact not required to participate, and do so on a voluntary basis. They are called "non-compliance entities" and are usually environmental charities and some environmentally-minded individuals. But all the large bids (>5 MM tons) are usually put in by the "compliance entities", those who are required to do so by the states. And they effectively set a floor on the allowance pricing. Here is the breakdown by the type of bidder from the most recent RGGI auction:



Even with the state requirement, the clearing prices were quite low: $3.23 for the 2009 emissions and $2.06 for 2012, vs. EUR 14.50 in Europe (where cap-and-trade is federally mandated). Without a strong and immediate federal cap-and-trade bill, this market is facing an uphill battle.

The collapse of the CCX carbon emissions contract

This may be a surprise for some, but "cap and trade" has been in place in the US for years. The trading is done via a firm called the Chicago Climate Exchange (CCX), a creation of Richard Sandor (the inventor of the CBOT bond futures). The contracts traded represent 100 metric tons of carbon emissions each (see contract specs) There is one catch with this cap & trade program though: the member firms' participation is voluntary. From CCX:

CCX emitting Members make a voluntary but legally binding commitment to meet annual GHG emission reduction targets. Those who reduce below the targets have surplus allowances to sell or bank; those who emit above the targets comply by purchasing CCX Carbon Financial Instrument® (CFI®) contracts.

So why would firms participate on a voluntary basis? A couple of reasons. One is they would like to be perceived as good citizens, the other is they wanted to get ready for the real cap & trade. With full expectations that Democrats in the office would implement this type of program, many firms joined voluntarily to get ahead of their competitors and learn the process.

But when the long awaited legislation finally showed up, it wasn't exactly what everyone expected. Under the so called Waxman-Markey American Clean Energy and Security Act of 2009, companies would be required to have “allowances” for all the greenhouse gases (carbon) they emit. Between 2012 and 2026 about 90 percent of the allowances would be given away for free. The chart below from the Heritage Foundation (which by the way really wants this bill to go away) shows what percentage of the emission allowances would be free.



So here is the question. Why would you pay for a carbon credit (an allowance) if the government will give it to you for free, even if Waxman-Markey passes? If it doesn't pass, there is no cap on emissions at all and a carbon credit becomes worthless. Either way in the immediate future there is little value in the CCX allowance contract:



The allowance contract used to trade like a commodity, somewhat linked to US natural gas (natural gas is seen as a cleaner burning fuel). It spiked in 08 when energy and other commodities hit records. People felt that if Obama was going to win, cap & trade was just around the corner. But the recession hit hard and Congress was loathe to inflict addition pain on the hard hit US industry by imposing a costly program - the timing was very wrong. So they watered down the bill, in effect killing the CCX contract. This program will come back some time in the future - it has to eventually, given the impact of emissions on global climate. But for now CCX will struggle to stay profitable, trading a nearly worthless emissions allowance (it's hard to generate volume when there is little speculator interest).