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How Would Banks Play Carbon Markets?

Posted in Energy & Commodities, Financial Markets by teslik on May 17, 2010

Just heard an interesting discussion on Reuters Insider—a very good new source for analysis on markets and finance (and I’m not just saying that because RGE has partnered with them)—on how the financial sector is preparing to play markets for carbon if a climate change bill passes. The conversation featured Trevor Sikorski, who is the head of environmental markets research at Barclays Capital. A few takeaways:

  • At least in the beginning, when the carbon market will be dominated by electric utilities (the market would launch for utilities in 2013, then would expand to manufacturers in 2016), banks will play their biggest role either providing liquidity as market-makers, or helping companies hedge against swings in carbon credit prices and thereby manage risk.
  • At this point, competition to trade carbon credits would be dominated by two exchanges: the ICE (Intercontinental Exchange) and The Green Exchange, which is part of NYMEX.
  • In terms of pricing, the climate legislation currently bubbling in Congress sets a price floor at $12/ton of carbon emissions and a price cap at $25/ton. At least in the beginning, Sikorski says, Barclays is expecting prices at the bottom end of that band.

It’s not 100% clear that all banks would get access to this market—or even, necessarily, that any would. The drafters of the proposed legislation, Sens. Lieberman and Kerry, have suggested that the U.S. Treasury would determine whether market-makers will be needed, and if so would decide which banks would play the role. It does seem likely that the market would require some participation from the financial sector in order to guarantee liquidity—yet even if banks are given a seat at the table, the government might well clip their profits. Treasury says it will see to it that any market-makers involved in carbon markets will be limited to a “reasonable rate of economic return.”

Longer-term, I’m curious how the financial sector will interact with this (potentially rapidly expanding) market, and particularly the degree to which speculators will get involved. Will we see carbon ETFs, for instance, or significant hedge fund activity? And if so, what would the practical effects be on utilities or manufacturers looking to hedge themselves?

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