Pardon the pun, but the topic of climate change is hot, hot, hot.

Not a day goes by without it being dissected and discussed by pundits, reporters, activists or simply interested persons on the street - all in the agreement that something must be done. And so, they looked to COP15, the 15th United Nations Climate Change Conference in Copenhagen, as hopes ran high that environmentalism might triumph over politics; that all countries might be united in stopping the world from overheating.

The world watched in anticipation for what was supposed to have been a climatic happily ever after to a long-drawn, weary tale. Instead, they got a loud thud of an anti-climax in the form of the Copenhagen Accord, a non-binding statement urging for deeper emissions reductions but lacking real powers to police action.

The results of the meeting have been generally reported as 'disappointing', said Tom James, an author and practitioner with 20 years of experience in energy, emissions and commodity markets. No legally enforceable agreement has come from the meeting, although there is still hope that some framework can be drawn up at the Mexico meeting in one year's time.

This is a man who firmly believes that the markets can make a dent in global warming, despite criticisms that carbon trading has proven ineffective in reducing emissions. He explained: Market mechanisms are the right approach to financially encourage steady change from fossil fuels to alternative energy sources.  The alternative is for governments worldwide to ban the burning of hydrocarbons and finance with taxpayers' money - trillions of dollars - to pay for the conversion of whole industries and economies to clean renewable energy.

However, other immediate concerns were weighing in. Having just bailed out the global banking sector from a crisis, most countries are not in a position nor are taxpayers willing to find the extra cash from higher taxation to pay this additional bill. Therefore I expect emissions markets will continue to evolve over the next five to 10 years and market-based mechanisms will flourish to slowly wean our economies off hydrocarbons over to alternatives, said James, who is also chair professor of LNG business at India's University of Petroleum and Energy Studies.

Making cents of Kyoto

James, who spoke at SMU's International Trading Institute (ITT) Guest Lecture Series recently, outlined why energy trading works, and discussed how the policies of key countries have impact on the future of a global emissions market.

The Kyoto Protocol was adopted on December 11, 1997 and entered into force on February 16, 2005 with 184 countries ratifying it. America was both conspicuously and controversially absent. The highlight of Kyoto was to set legally binding targets for 37 industrialised countries and the European community to reduce six greenhouse emissions, primarily carbon dioxide.

Targets are in the range of 5 to 8% against 1990 levels, over the five year period between 2008 and 2012. Participating countries have to meet their reduction goals by 2012 or face harsher cutbacks in the next phase. We wait with bated breath the tally of figures, but we won't know till 2013 or 2014 who the bad boys of emissions are, said James.

Under the agreement, countries must meet their targets primarily through national measures. However, they can also tap on three market-based mechanisms: Emissions trading; Joint Implementation (JI); and Clean Development Mechanism (CDM) projects.

Emissions trading schemes reduce the cost of the cutbacks to the economy, by allowing industries to make the cutbacks where they can most cost effectively happen.  Politicians like emissions trading schemes as they can save jobs, reduce the reduction cost burden to the economy on the whole, whilst achieving the desired cut backs they have committed their countries to achieve, he explained.

All emissions trading systems (also known as cap-and-trade schemes) have some form of tradeable permits, called an allowance or credit equivalent to a set volume of emissions.

Emitters have to hold permits for all their emissions - dubbed by James as licenses to pollute - and a measurement and enforcement system ensures that emitters have permits for these emissions. The number of permits available is pegged to the target set by the regulating body, and is less than the amount usually emitted. This leads to a shortfall of available emissions credits and emitters have two choices: reduce emissions, or buy permits from another party to cover all of their emissions.

Thin air billions

Emitters can also earn credits by taking part in JI or CDM projects. JI allows a participating country in the Kyoto Protocol to earn Emission Reduction Units when it implements an emission-reduction or emission removal project in another participating country. CDM allows a participating country to earn Certified Reduction Units when it implements an emission reduction project in developing countries.

Both JI and CDM create a supply of emission reduction instruments, while emissions trading allow these instruments to be sold on international markets. This led to the creation of carbon markets in several countries, including the largest multi-country, multi-sector European Union Greenhouse Emissions Trading Scheme (EU ETS) which began in 2005. 

Emissions became a commodity... tradable around the world, creating a physical market worth billions which literally came out of thin air, James noted - wryly, pun intended.

The numbers have been convincing: the London Energy Brokers' Association, which represents London-based energy brokers dealing in UK and European markets, announced that over-the-counter carbon volumes grew 82% in the first five months of 2009, compared to the same period in 2008.

The call for a global market

Calls to further the global cap-and-trade system and emission market are growing. The EU's Executive Commission, for one, has set an ambitious goal of achieving a global carbon market by 2020.

James believes a global cap will stop the carbon emissions musical chairs. The key thing is that we see developed countries exporting manufacturing to developing countries. With that comes the exporting of emissions from one country to another, so we must have a global emissions market and regulation, otherwise, we will have a limited effect on global emissions reductions.

This global cap-and-trade idea, however, has been dismissed by many to be far-fetched as it entails complex negotiations to link up markets, but more importantly, it involves an agreement on the basic yet critical issue of reductions targets. It is not too difficult to imagine that a wide disparity in reduction levels will render it impossible to arrive at a common global price.

Another thorn in the flesh is the upcoming US Senate energy bill that is expected to be debated in early 2010, particularly Section 765, which asks Should the US slap carbon tariffs on imports from countries that don't curb their own greenhouse gases? This sentence has raised much alarm and annoyed trading partners, in particular, China - a major exporter to the US and world's largest emitter of greenhouse gases.

What if a global market fails to materialise?

Even if talks at Copenhagen and beyond fail to create a global carbon market, the trading of carbon is set to continue.

The EU ETS has already confirmed that it will continue, and it will accept Kyoto-linked credits (CERs) generated up to 2012 into the scheme until 2020. So there is an exit for CERs generated before the current Kyoto expires. The EU scheme will continue unabated. If Kyoto was not to be extended beyond end of 2012, individual countries would still continue with their plans, James noted.

But in case the point was missed, James pointed out that several prominent political leaders, including US President Barack Obama, were elected on their green mandate - and so, they are expected to deliver legislation to control and reduce emissions.  In July 2009, the G8 announced at a forum on Energy and Climate in Italy that they have agreed to halve carbon emissions by 2050 and to restrict the rise in temperature to 2 degrees Celsius.

Potential legislation in the US will further this cause. So far, the country looks set to go ahead with its own domestic federal emissions scheme, and the Congress has already approved a bill encompassing a federal cap and trade scheme - similar to that of Europe. As part of the bill, US firms will be allowed to buy foreign credits like those generated by the CDM mechanism.

What this means is that a large carbon market will be created, with links to CER credits, across major economies like America, Europe and Japan. And hopefully, with this market, the heat will start to somewhat dissipate.