What Is Carbon? Energy Risk Management Series ERM 01


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Risk Manage Carbon, the newest entrant in the energy trading segment. The Carbon Industry today is under risk of rebooting and remodeling. The Billion Dollar Cap and Trade industry that had a volatile 5 years of existence, may now become non-existent and replaced by Cap and Tax, as a new Bill is being introduced in the US Senate.
In our series on Energy Risk Management, we suggest methods on how to account for carbon and spread out the risks.

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What Is Carbon? Energy Risk Management Series ERM 01

  1. 1. What is Carbon ? Energy Risk Management Series ERM 01 Energy Risk Management Series ERM 01
  2. 2. What is Carbon ? <ul><li>It is not a good </li></ul>
  3. 3. What is Carbon ? <ul><li>It is not a Service </li></ul>
  4. 4. What is Carbon <ul><li>Is it an </li></ul><ul><li>“ off balance sheet entry ?” </li></ul>
  5. 5. What is Carbon Straight into the income statement. From Where?
  6. 6. Carbon: from where? <ul><li>Carbon comes from the Chimney </li></ul>
  7. 7. Carbon: from where? It is the proverbial hot air from our stacks, or the emissions
  8. 8. What is Carbon <ul><li>Carbon permits are a subsidy to the energy industry </li></ul>
  9. 9. Carbon: why ? <ul><li>As per Kyoto pact there are half a dozen GHG emissions that need to be tackled and mitigated. They are Carbon C02, Methane CH4, Nitrous Oxides N20 and CFC HCFC, namely Fluorocarbons etc. </li></ul>
  10. 10. Carbon: why ? <ul><li>Carbon is chief cause of Global warming as per studies done by IPCC at UNFCCC </li></ul>
  11. 11. Kyoto Protocol <ul><li>37 Industrial nations who produce 80% of the Global emissions have agreed in Kyto in 1997 to lower GHG emissions by minimum 5 % before 2012. US has not ratified the pact. </li></ul>
  12. 12. Kyoto Protocol <ul><li>Implemented largely in the European Union, the emission control under the EU Emission Trading Scheme has been based on the theory that emissions can be capped if Carbon is traded like a marketable commodity. </li></ul>
  13. 13. The EU ETS <ul><li>The EU ETS 1 was developed to usher in a cap and trade market in 2005, for Carbon trading. </li></ul>
  14. 14. The EU ETS permits <ul><ul><li>Under the EU ETS1 each member state of the EU could on basis of existing industry capacity issue carbon permits licensing energy producers to emit Co2. </li></ul></ul>
  15. 15. Carbon Trading <ul><li>Those who did not use their full quota of permits could sell them, while those who needed more would have to buy the permits either from EU ETS auctions or </li></ul><ul><li>off the market. </li></ul>
  16. 16. EU ETS energy subsidy is to all <ul><li>T he EU ETS has no benchmarking procedure, which means that free carbon permits, were issued to all units and were not related to an industry’s emission efficiency. </li></ul>
  17. 17. General Energy Subsidy <ul><li>The CDM under the Kyoto pact also does not make it mandatory to invest the proceeds of carbon sales into renewable energy, so it is not a specific subsidy against capital expenditure for any environmental gains, but a general subsidy. </li></ul>
  18. 18. Carbon as a energy subsidy <ul><li>Proceeds from its </li></ul><ul><li>Carbon sales can </li></ul><ul><li>be at best entered </li></ul><ul><li>in the books as </li></ul><ul><li>‘ income from other </li></ul><ul><li>sources.’ like any </li></ul><ul><li>other subsidy. </li></ul>
  19. 19. Treating Carbon as a subsidy <ul><li>Wait a minute……. </li></ul><ul><li>Carbon a subsidy? </li></ul><ul><li>Then why is it not under the WTO. </li></ul>
  20. 20. Carbon subsidy under WTO <ul><li>As a general subsidy, Carbon sales proceeds become a protectionist tarrif for Europe’s emitters. </li></ul>
  21. 21. Carbon subsidy tariffs <ul><li>Why has Europe’s largest steel plants, profiting billions from carbon credits not been slapped with Carbon equalizing duties or antidumping tariffs. </li></ul><ul><li>Why? ….only time will tell !!! </li></ul>
  22. 22. Risk Managing Carbon <ul><li>Risk Managing Carbon is not easy </li></ul>
  23. 23. For it is both a grant as well as a cost <ul><li>For most of the time it is a free issue and a subsidy. </li></ul><ul><li>But at some of the times it could be a cost. </li></ul>
  24. 24. Free and auctioned permits <ul><li>93 % of Carbon permits in UK in 2008 have been free issues. </li></ul><ul><li>Only 7% (4 million) Carbon permits were auctioned at GBP 54 million. </li></ul>
  25. 25. Carbon Pricing <ul><li>The 4 million permits issued under EU ETS2 had a cost price, and need a different treatment in accounting. </li></ul>
  26. 26. Carbon pricing in 2008 <ul><li>Let us say that 1 million Carbon units were bought under auction by a European steel maker under EU ETS 2 and this Carbon permit was accounted as a fuel surcharge for the year ended 2008 worth at its cost price which was GBP13.6 million </li></ul>
  27. 27. Carbon pricing in 1 st Quarter 2009 <ul><li>I f the Carbon allowances were sold in the summer of 2009, by the steel major, they would have fetched 28 million Pounds, generating an additional non-operating profit of GBP 14.4 million </li></ul>
  28. 28. Carbon pricing in 3 rd Quarter 2009 <ul><li>If the Carbon allowances were sold in the autumn of 2009, by the steel major, they would have fetched 8 million Pounds, generating a net loss of GBP5.6 million </li></ul>
  29. 29. Carbon valuation <ul><li>Due to its nature of price volatility, free carbon permits must be entered in the income statement only after realization. </li></ul><ul><li>Under the EU ETS 1 scheme millions of legitimate Carbon allowances were not realized, for there no buyers in the market </li></ul>
  30. 30. Carbon market is volatile <ul><li>Like in EU ETS 2 Carbon prices in EU ETS 1 had crashed below par within 6 months of its issue and volumes were manipulated by EU to keep it above the floor prices. Hence free issue carbon may be entered in the books only after sales are realized. </li></ul>
  31. 31. So Risk Managing Carbon is a duel hazard <ul><li>The free Carbon permits are neither good, nor services and can be only treated as a general subsidy or other income. </li></ul><ul><li>The auctioned permits too are subject to price volatility and is often below the issue price at the auctions. </li></ul>
  32. 32. Carbon through auctions <ul><li>Carbon purchased through auctions must be carefully evaluated. Purchase only if it cannot be deferred. Value at cost in the Books of account as a fuel surcharge. </li></ul><ul><li>Integrating it as a part of fuel cost and spreading it over time is a fail safe technique, to account for Carbon. Since the allowances of 1 million carbon bought would be normally for use over a period of 6 months or a year 1 year, it is wiser to allocate the carbon cost over the entire fuel cost during that extended period of operation. </li></ul>
  33. 33. Buy carbon off markets <ul><li>From the trends available for EU ETS 1 and EU ETS 2 it is highly unlikely that Carbon prices will rise, especially now, due to the arrival of carbon offsets in the market </li></ul><ul><li>The Risk manager would advise staying away from the auctions, and purchase off markets only, against plant demand, at this stage. </li></ul>
  34. 34. Environmental utility <ul><li>The EU ETS has been amended twice but still only 45% the total C02 emissions are measurable today under the Kyoto pact and a only 3 % mitigated in the UK, the best operating EU model. </li></ul>
  35. 35. Effectiveness of EU ETS
  36. 36. How mitigation was done <ul><li>Emission reduction was done at the plant level by additional oil and gas support to conventional coal fired units, which is the easiest way to reduce coal consumption and consequently carbon emissions </li></ul>
  37. 37. Mitigation leads to price hikes <ul><li>This resulted in speculative positions in oil by the commodity traders, resulting in futures of Brent Oil spurting and creating a global price spiral. </li></ul><ul><li>Pollution permits burn European consumers </li></ul><ul><li>Did EU ETS &quot;Cap and Trade&quot; Cause Energy Prices to Skyrocket? </li></ul>
  38. 38. Effect of Cap and Trade on Oil Price rise (ORB) since Kyoto
  39. 39. Difficulty in cap and trade enforcement <ul><li>High increase in frauds including VAT frauds since enforcement of cap and trade in Europe </li></ul><ul><li>Europol says 90% Cap and Trade transactions are fraudulent in some EU states, as VAT fraud crosses Euro 5 Bn. </li></ul>
  40. 40. Asia refuses to bite <ul><li>Biggest blow to Cap and Trade ETS was received at Copenhagen meet when Asia and the developing world refused to accede to Europe’s mitigation methods. </li></ul><ul><li>The US quickly broke ranks to join the BASIC nations to frame a new deal, that put Carbon trading in the backseat and EU negotiators on the back foot. </li></ul>
  41. 41. Bill in US to kill Cap & Trade US Senator Graham (R-S.C.), backed Senators Kerry (D-Mass) and Liebermann(I-Conn) who are proposing a new bill to do away with CAP and Trade in its present form, shortly.
  42. 42. Global acceptability <ul><li>So Risk managing Carbon has only one option. To include it as a income only after realization. </li></ul><ul><li>Any other treatment including the effort of securitization will be prone </li></ul><ul><li>to hazard, as less than 20 % of the Global economy has accepted it. </li></ul><ul><li>  </li></ul>
  43. 43. Carbon is high Risk <ul><li>As we have seen carbon is either a subsidy or a cost and not a commodity. </li></ul><ul><li>It is a fact that though it was traded in the commodity markets as a good, it could never establish a benchmark price because it had no intrinsic value. </li></ul><ul><li>It was a non-commodity in a commodity market, hence susceptible to high risk volatility. </li></ul>
  44. 44. Europe can’t sustain the carbon burden alone <ul><li>It is highly unlikely that Europe will be able to convince other nations to follow the Cap & Trade Carbon economy. </li></ul><ul><li>In all probability, they may abandon it in favor of a Carbon Tax before the end of this year, bringing an abrupt end to the $100 billion carbon trade industry. </li></ul>
  45. 45. Exit Carbon strategy <ul><li>Industries who have free carbon permits should not add it to their stocks or income statement unless proceeds have been realized. </li></ul><ul><li>Those who have bought permits through auctions may spread it over their annual fuel bills. </li></ul>
  46. 46. Big Banks exposure to carbon allowances is risk prone <ul><li>Banks which are active in Carbon trade, would possible be tested for exposure : </li></ul><ul><li>Barclays Capital </li></ul><ul><li>Deutsche Bank </li></ul><ul><li>J P Morgan </li></ul><ul><li>Morgan Stanley </li></ul><ul><li>Orbeo </li></ul><ul><li>BNP Paribus </li></ul>
  47. 47. Our references Ecology to Economics Our goal is to help promote clean, safe and better practices in economy and ecology worldwide. Balanced, efficient and a little more sustainable. Amazon Kindle Blog : Ecothrust http://bit.ly/7XwAG or http://bit.ly/ecothrust RSS feed for Technorati http://technorati.com/people/Ecothrust/index.xml
  48. 48. Our acknowledgements <ul><li>Thanks to our Creative Director Katerina Voutsara for Art & Video presentation. </li></ul><ul><li>For any questions on the presentation please send your queries to the Author Sandip Sen </li></ul><ul><li>at sen.sandip@gmail.com </li></ul>
  49. 49. Other Presentations by us Climate Change Positive Solutions Series CE-01 http://bit.ly/4kzzIz Climate Change Positive Solutions Series CE-01 http://www.slideshare.net/SandipSen/cop15bullshitting-15-years-on-climate-change http://tinyurl.com/luzxss Climate Change Positive Solutions Series CE-82 http://bit.ly/XUrUd
  50. 50. Other presentations by us Business Risk management Series http://bit.ly/6Es2z6 Business Risk Case Studies Ba31 http://www.slideshare.net/SandipSen/business-risk-case-study-ba31
  51. 51. Other Presentations by Us Business Risk Case Study – Ba 33 http://www.slideshare.net/SandipSen/business-risk-case-study-ba33 Business Risk Case Studies Ba32 http://tinyurl.com/lnkv9h
  52. 52. COP 15 Failure Analysis <ul><li>PART 1 DISTRUST http://bit.ly/5TNFhd </li></ul><ul><li>PART 2 EQUITY http://bit.ly/6dtoYm </li></ul><ul><li>PART 3a TRANSPARENCY Base model http://bit.ly/5oX8GL </li></ul><ul><li>PART 3b TRANSPARENCY assessment </li></ul><ul><li>http://bit.ly/66UBTe </li></ul>