Market Trends: The Carbon-Supply Connection

The energy markets are mercurial, ever shifting.

Not a bold statement, but it’s true. More importantly, it means that companies need to keep a close eye on what’s happening today and have a clear view of what’s on the horizon. Staying a step ahead provides opportunities to improve the bottom line. And, just as important, minimize risk.

To that end, one development that’s starting to have a major impact on the energy markets is a different-but-related market: carbon.

The recent COP21 summit signaled a major change — the desire of almost every nation to pursue a path of global carbon reduction and sustainability. Today, carbon markets are structured so that companies can attain their sustainability goals and this is redefining the economics of energy supply.

Officially, COP21’s stated goal was to balance carbon emissions by the latter half of the century. While carbon goals often target 2030, 2050 or beyond, they are pursued by making changes today. And that has led to the emergence of carbon markets. Nearly half of the world’s population lives in jurisdictions with active carbon markets, which means that climate action and carbon reduction has moved beyond the realm of politics and science, and into the economics of supply and demand.

For example, coal has traditionally proven to be a cost-effective means of generating electric power; however, it also emits a great deal of carbon compared to alternative sources. In an area where a carbon market exists, the price of carbon may be high enough to make consuming other sources of energy more cost effective. It may be beneficial to convert to a fully renewable option like wind or solar, or it could mean a switch to a less carbon-intensive option such as natural gas, which generally requires only half the carbon permits of comparable coal generation.

Depending on the framework of the particular market, a heavy user of coal not only has to pay more to acquire carbon permits, they may also have to purchase them from the excess permits allotted to their renewable-focused competitor. Thus, carbon permits don’t only mean added costs for carbon emissions. They can also represent a revenue opportunity for those ahead of the renewable curve.

Importantly, carbon permits have no inherent “supply”, so the relevant governing body can alter the supply of permits and thus alter the real-world energy supply. This means that with carbon targets in place for countries around the world, it is not a question of if carbon markets will impact the supply of energy, but when. The short answer: it’s already happening.

From the original framework of the 1997 United Nations’ Kyoto Protocol, a number of global carbon markets have emerged and adapted to meet the environmental challenges of the 21st century. While carbon markets are still in their infancy, they occupy an increasingly larger space in the global marketplace. By the beginning of 2015 the world boasted 17 separate emissions trading systems (ETS) which covered 35 countries, 13 states and provinces, and a number of major cities throughout the world. Even more impressively, areas participating in an ETS in 2015 accounted for more than 40 percent of the overall global gross domestic product (GDP). At current projections, that number is set to grow to nearly 50 percent of the world’s GDP over the next year.

Until recently, Europe largely overshadowed other parts of the world when it came to carbon markets; however, carbon markets continue to grow around the world. Today, these markets have become an important component of economies that would have seemed unlikely adopters not long ago.

China, the world’s leading emerging market and heaviest user of coal, is in the process of converting the existing carbon markets of its largest cities into a nationwide framework. In crude-rich Kazakhstan, carbon markets are viewed as a way to prepare the country’s delicate economy for a future that may demand less of its oil.

Furthermore, cities, states and nations with quite different backgrounds are finding common ground on carbon trading, as Brazil, Russia, Thailand, and others all look to adopt policies.

In the United States, one of the potential impacts of the Clean Power Plan (CPP) is the expansion of carbon markets. This could mean the expansion of the Regional Greenhouse Gas Initiative (RGGI) which operates as a multi-state carbon market in the Northeastern U.S. For states considering joining this coalition, the impacts of carbon markets and RGGI, in particular, are already apparent. In 2012, RGGI states reduced the emission of greenhouse gases by 40%from 2005 levels, even as the economy of those states expanded by 7%.

Broadly speaking, the ongoing expansion of carbon markets means looking at the traditional supply and demand picture of energy commodities is no longer sufficient. Carbon markets are specifically designed to reshape the market’s balance and change the supply of energy. For those that refuse to adapt, this may translate into considerably higher costs.

This is just one of six key trends affecting the way companies purchase and use energy in 2016.

For a complete look, download the “6 for 2016: Global Energy Market Trends” whitepaper.

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