C is the chemical element symbol for Carbon.  Carbon is number 6 in the Periodic Table of the Elements and is the fourth most common element in the Universe behind Hydrogen, Helium and Oxygen.  Carbon is a fundamental component of many organic compounds and has a common presence in all known forms of life.  Wikipedia can tell you everything you need to know about Carbon…well, almost everything…

Carbon is at the centre of the Global Warming crisis being, as it is, a fuel in the production of CarbonDioxide (CO2). Methane gas (CH4) in the presence of Oxygen will readily combust to produce water (H2O) and CO2. CO2 is the primary suspect in the observed rise in the Earth’s temperature over the last 2 centuries.  Humans’ hunger for energy production has made CO2 emissions a villainous side-effect of economic development.  This ‘negative externality’ (a situation where the costs of the polluting effects of CO2 generation are felt by others but not tagged to, nor compensated by, the polluter) is a major policy focus for most governments.  One solution, a direct application of the Coase Theorem that this blog has discussed previously, is to assign property rights to Carbon and to have these credits trade freely in Carbon markets.

Carbon markets work to control the quantity of Carbon used in the production of energy.  A coal-fired power station, for instance, might make a profit of $5 per tonne of Carbon burned.  If the power station is allocated credit to consume one tonne of Carbon, a savvy operator will first check whether it can sell the credit for more than $5.  Some Carbon credits sell for $8 in the market so this producer is better off selling the Carbon credit for $8 and shutting down the plant instead of earning $5 profit.  The purchaser of the credit for $8 must be a more efficient energy producer than the coal-fired plant since they are able to make a profit even after paying $8 for the right to use  1 tonne of Carbon. This is a market solution to a real world externality.

Being the fourth most common chemical element in the Universe, one would think that Carbon (C from now on) would be pretty generic with C-credits trading at a single price.  Gold, silver, copper, lead, zinc and so forth are chemical elements just-like C and they trade at the same price. Arbitrage ensures that any discrepancy between Gold in London and Gold in New York is quickly equalised. Despite being the 6th element on the periodic table, it appears that all C is NOT made alike…

Last Friday saw the launch of China’s official C-credit market.  The online exchange quotes markets in 3 kinds of C-credit based on its intended use.  The C-credit for one tonne of C in Beijing-area power generation opened at USD8.20 per tonne.  This compares with European C-credits for power generation that closed on Friday at USD62.78.  The other two kinds of C-credit in China are for different locations in China.  These C-credits traded at roughly USD6 and USD4 per tonne of C.  Whereas arbitrage equates the price of Gold in London and New York, no such force appears to exist to drive a C-credit in Beijing towards the price of a C-credit in Guangdong let alone arbitrage pressuring Chinese C-credits toward those in Europe.

While C is a generic substance, C-credits are clearly not.  In the regulated markets, C-credits are allocated by the government to various industries according to a formula.  Usage beyond the allocated quota must be acquired in the open market with the demand for credits dictated by production costs.  The supply and demand for C-credits-tagged-to-power-production ultimately determines price.

To add complication to what should be a simple market for a generic commodity, the regulated market has been joined by a ‘voluntary’ market for C-credits.  This attracts C-consumers and C-producers who have a social objective to either limit or offset their C-footprint.  C-consumers such as airlines, agriculture and so forth may purchase C-credits from C-producers such as forest plantations, agriculture and some aquaculture activities to put back the C that they consume.  A tonne of coal is roughly the same as a tonne of wood so coal consumers can replace their carbon consumption by growing a tree.  But the voluntary markets, too, have different issuers of C-credits that trade at different prices.  Indonesian C-credits generated from rubber plantations trade more cheaply than similarly sourced C-credits from Malaysia.  The ‘provenance’ of a C-credit from a starving tribe in Africa may dictate a higher price than from a massive sun-farm in California or Australia by virtue of its social value.  The market for C has gotten confused by a host of different factors unrelated to Global Warming…

I worry that the design of C-credits is holding back the wholesale reduction in CO2 that could be achieved if a tonne of C produced by anyone was treated as the same by everyone.  If I am making millions of dollars by growing strawberries in a carbon dioxide rich tent in Korea why shouldn’t I be rewarded with a $20 per tonne rebate just as the Brazilian Indians are being rewarded for refraining from clearing the rainforests?  C-investors are to blame here.  It seems that the current crop of investors are confusing their obligations to C-creation with other social causes, all of which are fair concerns, but which effectively constrain the market’s ability to focus on C specifically without being held back by the other attributes of its sourcing. C created by saving the Amazon rainforest is apparently more noble than that absorbed by Korean strawberries.

Philanthropists and profit motivated investors alike should simplify their demands. C is a generic commodity so push for a market that treats all C the same.  There is every reason that a tonne of C produced in Indonesia can satisfy the footprint created by a trans-atlantic flight from NY to London.  The price of Indonesian C will rise and the price of airline C will fall, thereby effectively arbitraging the disparate price for what is, in the end, one of the most generic commodities imagineable.