AT A GLANCE
- As more organizations commit to becoming carbon neutral, more are turning to carbon pricing tools to hedge positions.
- Since its launch in 2021, CME Group has traded more than 200,000 carbon offset futures contracts, representing 200 million tonnes of carbon offsets.
Putting a price on carbon is the biggest challenge in efforts to halt the rise in global greenhouse gas emissions.
Because in order to impose the cost of emitting another ton of carbon dioxide, a whole ecosystem of functioning and verifiable markets is required, which includes a range of instruments such as carbon offsets.
The good news is that carbon markets are becoming an indispensable tool in the fight against climate change. According to the Carbon Pricing Leadership Coalition, carbon pricing tools now cover over 20% of global greenhouse gas emissions and will generate $53 billion in revenue by the end of 2021. This corresponds to an increase in sales of 17% compared to the previous year.
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The hard news is that the task of reducing emissions is not easy. In total, the world emits 50 billion tons of CO2 into the atmosphere every year, a 40% increase in emissions since 1990, according to Our World in Data.
Shrinking carbon footprint through offsets
Companies, often working to reduce their own emissions, are increasingly turning to carbon offsets, which can be verified through established registries, to reduce their carbon footprint.
A carbon offset credit is a transferable tool that has been certified by independent bodies or governments, and each credit represents a reduction of one tonne of carbon dioxide or its equivalent greenhouse gas.
To be effective, the credits must represent an environmentally sound project that contributes to climate change mitigation – such as B. preserving a forest that should be cut down or building a clean energy project to avoid burning fossil fuels. After purchasing a credit, a company can “retire” it to claim a reduction in its own greenhouse gas reduction targets.
Read more about global carbon offset futures
Some of the offsetting efforts, particularly those that are not independently verified, can be criticized as greenwashing. Corporations are also increasingly aware of the damage that companies incur in such cases.
“If you’re using an offset that’s not particularly credible, and that’s something that’s emerging,” noted David Kane, partner at Baringa, a UK-based consultancy, “then there’s going to be reputational damage, and the risk of reputational damage is huge and has a high impact.”
Once verified, one of the biggest challenges in carbon offsetting is pricing the credits, and this is where the spot and futures markets come in. CME Group launched the Global Emissions Offset (GEO) futures contract in 2021 with the goal of making it a global benchmark. Giving customers a way to manage risk and help with pricing.
Market growth in its infancy?
Interest in the GEO futures contract — each representing 1,000 offsets — has surged this year, according to Jessica Masters, director of energy products at CME Group.
The emissions contract market is establishing itself, “but ultimately I think there is still a lot of room for improvement. Obviously this market is still young.”
CME Group followed the GEO contract with the launch of Nature-based GEO Futures (N-GEO) in 2021 and Core GEO Futures (C-GEO) in 2022. All three products have shown growth in trading volume this year .
The total traded volume of the three contracts combined recently reached over 200,000, equivalent to 200 million tons of carbon offsets. In July of this year, trading hit a record with an average of 1,200 lots traded daily per month. The exchange set an all-day record in mid-June when over 5,100 offset futures were traded. Open interest, the number of outstanding contracts, surpassed 18,000 in the later months of 2022.
About 100 different companies have traded offsetting futures contracts, but significantly, more than half of those companies started trading the contracts this year, according to CME Group data.
“We’re seeing more and more people entering the carbon markets, and all the major commodity traders have carbon desks set up, are setting up carbon desks, or at least are analyzing where to put their chips,” Baringa’s Kane said.
As a sign of growing maturity, carbon markets are also attracting speculators who help grease the wheels of a growing market. “They play an important role and help create a liquid market,” Masters said.
However, another challenge for the broader market is the different standards for the different companies looking at carbon offsetting.
“Everyone’s going to calculate their carbon exposure a little differently, and that’s a bit of a challenge,” Kane said. “There aren’t necessarily industry standards by which people can say, ‘This is how I calculate my carbon exposure.’ So it becomes more difficult when it comes to netting and potential proprietary trading around this position.”
price compensation
Pricing is key for market-based offsets. Companies involved in carbon markets need to know if they are making money on their investment. And that only happens through price discovery and benchmark setting — which are critical in any commodity market, from crude oil to corn.
“There would be a lot more reluctance to enter the market if you had no idea if what you were doing was financially sound,” Masters said. “And a benchmark gives transparency and empowers people to make strategic business decisions.”
Kane agrees, saying that any increase in liquidity “will result in price discovery, benchmark pricing and the ability to have both secure, credible offsets and the ability to hedge your issuance position or take directional views in the market.”
Ultimately, he says, any effective carbon offset market must help organizations achieve their carbon neutral goals.
“Ultimately, all of this must make a real difference in reducing emissions. This will be one of the biggest challenges these companies will have to face in the coming years.”
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