Generally cap and trade models have been adopted globally. A cap and trade model entails setting a desired cap on the amount of GHG emissions. The trading of emission credits or allowances then occurs between over and under emitting firms. Gradually the emission credits or allowances are reduced in order to reach the targeted cap. The international carbon market grew from $US10 billion in 2005 to $US30 billion in 2006, according to The World Bank’s ‘State and Trends of the Carbon Market’ report from May 2007. The European Union Emissions Trading Scheme (EU ETS) accounted for the majority of these funds in 2006 ($US24 billion). There is a well-developed secondary market for carbon in Europe which is essential for a successful program as this increases liquidity.
Spot and futures contracts also trade on the over-the-counter market as well as exchanges such as the European Climate Exchange and Powernext. Already there are a small number of investment firms who are looking to profit from this market. This can either be via the more liquid futures markets, or more niche hedge fund type strategies which involve a manager sourcing ‘cheap’ credits, usually from emerging markets countries, and selling them into Europe, the most regulated developed market.
While there is a huge amount of hype regarding carbon trading and its benefits, it is possible that it will not have any real impact on driving investments relating to climate change and will not impact sectors to the degree currently supposed. The European experience to date indicates that achieving the outcome intended is difficult and relies hugely on effective regulation and policy making. An unnamed finance company CEO recently stated: “carbon trading could be the financial scam of the 21st century.” This is obviously not the general consensus, but is a real risk and worth considering before entering into investments of this nature.
Equity earnings growth is highly leveraged to GDP growth. However, GDP growth is not the only determinant of equity growth. There are a multitude of social and financial factors in particular which influence equity growth and these can differ by sectors and countries quite significantly. However, it is fair to conclude that a decline in GDP growth as generally predicted from a climate change perspective is not a positive for equities in aggregate.
Australia will need to adapt to higher costs generally. The higher costs will be primarily the result of increased energy costs and higher basic food prices. Despite this, global demand for commodities is projected to continue to rise dramatically over the coming years. This will be driven partly by developing countries, partly by the need to repair and build new infrastructure to cope with the changing environment and partly by the drive for innovation in certain sectors.