What is the environmental benefit of these carbon points? What is the benefit for market participants? Is there a way for institutions and individuals to invest in it or speculate on it?
Carbon points are those official or unofficial certificates that are issued in some countries as tools to control the number of carbon emissions for companies that have industries that pollute the environment. On the mandatory markets are pollution monitoring certificates, which are measured in metric tons of carbon dioxide, or other greenhouse gases, i.e. those that cause an increase in global warming. They are like licenses that allow their holder to pollute a certain level, and here we mean carbon points traded in mandatory carbon markets, which are awarded by state authorities to polluters. Mandatory carbon markets work in the way of emission limits and points being issued and subsequently traded on the market.
Does carbon trading have a future?
The launch of Saudi Arabia's voluntary carbon trading market raises questions about the utility of the idea of trading what are known as carbon credit certificates, or what might be called carbon points. What is the environmental benefit of these carbon points? What is the benefit for market participants? Is there a way for institutions and individuals to invest in it or speculate on it?
The largest market for this type of point is the European Union ETS market, which was launched in 2005 and is used by more than ten thousand plants in Europe. The price of one point this year ranged from $60 to $96, meaning that with this amount, the buyer is allowed to pollute the environment by one ton of carbon dioxide more than the permitted limit. An entity that purchases carbon points does so when its emissions are above the permitted limit, so the process becomes a sort of tax on the polluter. Carbon point sellers, on the other hand, are companies that have a surplus of points due to their ability to control their emissions, and thus sell the points to those who are short of them. One of the most important companies that benefit from the carbon licensing mechanism is the Tesla Electric Vehicle Company. Its share of environmental pollution is much less than the permissible limit because it produces electric cars, and in the last five years, the company has earned more than six from these points a billion dollars.
There is a futures market for mandatory points on the London Stock Exchange, where participants hedge or speculate on these points as futures contracts, just as oil contracts are traded. As for the market that launched in the Kingdom last week, it's not specific to Mandatory Points, although nothing is stopping them from circulating Mandatory Points. It's more about voluntary points, so what are voluntary points?
After the success of the market with mandatory points and the clarification of its benefits in environmental protection, there was a need to find other markets not only for the circulation of tons of carbon dioxide but also to include any other gases harmful to the environment, so that individuals and companies interested in the field of the environment could participate on the market by investing in environmental projects that contribute to the reduction or elimination of emissions.
The idea is that there are investment companies that have environmentally friendly projects and want to raise the necessary funds for these projects, for example, projects related to increasing the level of vegetation cover in the country or projects to eliminate harmful emissions by internal retention or reuse. In areas that allow their use. How do these entities get money to implement those environmentally friendly projects? One way is to capture carbon points and sell them on a financial market, such as the one established by the Public Investment Fund and the Saudi Tadawul Group.
Who will buy these points? And why would he buy it?
Voluntary buyers in the market are entities with social responsibility or government obligations that want to reduce their pollution and buy carbon points from environmental entrepreneurs, who in turn use the money to support their projects. Buyers can be individuals and institutions with a sense of environmental protection, so their participation is non-profit, and it can be for-profit through investment and speculation in these points. How is it?
One carbon point equals one ton of harmful gases, mostly carbon dioxide, and its price is subject to market forces of supply and demand and is subject to daily price fluctuations, just like any traded financial instrument. The number of points traded on the market depends on the number of environmental projects offered and the extent to which large companies need to support these projects, which are self-motivated or the result of internal or external pressures. The number of points also depends on the size of the industrial activity in the country. The more industrial activities there are, the more severe the pollution and the greater the need to buy points to make up for the lack of credits in these activities. For example, a sharp decline in carbon spot prices occurred in Europe as a result of the 2008 financial crisis and economic recession.
There are many differences between a mandatory market, such as the European market, and a voluntary market, such as the one launched last week in the Kingdom, including that voluntary carbon points are not accepted in mandatory markets because they do not meet legislative requirements, but it is possible the opposite, i.e. trading with mandatory points on the voluntary market. The volume of trades in the voluntary market is also much smaller than in the mandatory market, with trading reaching more than $850 billion in 2021, compared to just $2 billion in the voluntary market. The average price of one point is also much lower in the voluntary market, where the average price of a carbon point increased as a global average from $2.50 in 2020 to $4 in 2021, while the price of a mandatory point in Europe is trading around $70. The problem with voluntary markets in general is that there is no global price for the points traded on them, given the number and variety of projects, their different specifications, the quality of control over them, and the extent of their commitment. Despite this, there are efforts by the Chicago Derivatives Market to come up with a global index for the voluntary market. This is because the market launched three types of futures contracts last year, including international GEO emission point contracts, which are characterized by being reliable and approved points, and there are carbon point contracts related to nature and forests, and the third type is contract technology, namely any environmental projects that are not in the area of industrial emissions. Nor in nature and forestry, but in any of the complementary technical or financial fields.
And finally, these are high-risk markets. Participation in them can take place through mandatory European London Market Points contracts, the Chicago Voluntary Points Market, or through exchange-traded funds such as Reshares, which hold futures contracts for this purpose. During this year, there has been a drop in the price of carbon points in all forms, in some cases by as much as 50 percent, and problems related to mandatory markets in that their prices are determined by caps set by legislators. For the number of emissions and not due to natural supply and demand in the markets as assumed in voluntary markets.
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