Carbon trading – a look into the fast-developing Asian markets

With the acceleration of the energy transition, the buzz around carbon trading markets has either been ignited, or in some cases like the EU, is witnessing a renaissance of sorts. As governments have declared their commitments to carbon neutrality targets and binding policies at national and global levels – such as the Paris Agreement – come into greater effect, the impetus on stakeholders within global supply chains to decarbonise has never been greater. For commodity traders, this presents a fair few opportunities.

What is carbon trading?

Unlike most commodities, carbon is not a physical product which can be traded. Instead, businesses will look to tackle their own emissions reductions targets through the trading of carbon credits. Typically, one carbon credit equates to one ton of carbon dioxide. These credits can be bought and sold to offset the amount of CO2 a company is emitting.

Carbon trading is seen as an effective market-based instrument used to incentivise businesses to meet emissions reductions targets. There are two markets under which carbon trading is conducted: Compliance and Voluntary markets. Compliance markets are regulated schemes where a state or regional authority has mandated companies to trade carbon credits. Under this scheme, companies have designated ‘carbon allowances’ that are then bought and sold in the marketplace.

Voluntary markets operate outside a regulated scheme and allow companies to buy and sell carbon offsets on a voluntary basis. It operates almost on a pure origination basis and for a carbon-reduction project to generate credits, it needs to meet criteria set by independent standards such as Gold Standard or VCS (Verified Carbon Standard). Therefore, the quality of such projects matter. As one senior leader in the industry described to me, “there is a difference between incinerating rubbish vs. a reforestation project”. These credits are then ‘retired’ once submitted through a registry and they’ve made their contribution towards the company’s climate commitments. While momentum is gathering for voluntary markets, it is still relatively nascent, with much room for development.

A brief history and current markets…

The most established emissions trading market is in Europe where the EU Emissions Trading Scheme was established in the mid-2000s. As of today, it still stands as the largest ETS in the world and it compels over 11,000 power plants, factories and airlines within Europe to operate within what is known as a ‘cap and trade’ scheme. Allowances are auctioned off or allocated for free, which can then be traded in the market. Under this scheme, if businesses are unable to stay within their designated allowance, they can compensate by buying allowances from firms which are below their annual cap, with the price set by demand. While the EU ETS is the most mature market – which many countries have subsequently used as a case study for their own schemes – it has come with its fair share of teething issues over the years. It has previously been criticised for not providing strong enough incentives, causing the market to essentially flatline as prices remained too low and permits oversupplied the market. However, in recent weeks we have seen it gather momentum as the price of carbon reached 50 EUR/mt for the first time this month – a positive sign for the market that has already spurred greater commercial interest.

Here in the Asia-Pacific region, we have established regulated emissions trading schemes in countries such as Korea and New Zealand. However, most of the region remains relatively underdeveloped. China is on track to open its national ETS in June, which will instantly make it the largest carbon trading market in the world. The voluntary market is where much of the action is currently taking place and while corporates are still familiarising themselves in this space, exploring technologies, costs and their own abatement curves, there is undoubtedly huge potential in the region. A recent report written by Conversation International, DBS Bank, Temasek and NUS declared that with about 15% of the world’s tropical forests, South-East Asia’s carbon stores will offer the highest rate of return in the world. Singapore have also just announced plans to headquarter a new global carbon exchange. Although overall demand for carbon credits is still relatively low in the region, this a clear indication that we’re likely to see a robust carbon market develop soon.

Again, much work needs to be done in terms of ensuring that the quality and integrity of credits generated in APAC are high. If a business is looking to offset their own carbon liabilities, these projects and the credits extracted from them need to be bulletproof. As environmental products teams are starting out, they will likely buy credits from the secondary market to create a portfolio to play around with. However this can pose risks when it comes to quality. Companies with long-term ambitions in this space are investing into upstream projects to ensure they have exclusive rights and greater control over the quality of these credits. As the price of carbon rises, the initial CAPEX spent on these projects will be minimal in the long term once the projects can consistently produce carbon certificates.

So what does this mean for commodity trading?

The creation of these markets not only enable businesses to meet their own carbon liabilities, but it creates opportunities for arbitrage and a liquid trading environment. Over the last quarter we have seen leading trading houses establish carbon desks. For example, Trafigura and Vitol recently announced that their carbon trading soared by over 60% in 2020. The pace of the carbon movement has generated huge momentum for any commodity trading business – energy, agricultural and metals – to build teams.

As one can imagine, the scramble for talent is immense. Individuals with emissions and environmental products backgrounds in Asia are sparse and those whom I have spoken with in the region have been approached in the last quarter like never before. Our US and European based colleagues have confirmed the same and most individuals are grabbing the opportunity to speak with several businesses concurrently. Carbon traders and originators know their stock is high and we are already seeing some businesses renegotiate contracts with their existing carbon teams (or whatever may be left of them) to ensure retention. What complicates matters further for businesses looking to bring on board strong talent is the stark reality that the talent pool is shallow – particularly in Asia. Carbon emissions trading is nowhere near developed to the level of Europe, resulting in vastly undersupplied talent in the region. BP and Shell have (or had) the two most established environmental products/low carbon trading set-ups in the region but have been left in a precarious position as they’ve watched their teams deplete rapidly over the last 1-2 months.

Talent is scarce, where can businesses look?

Although the two majors’ teams are a shell of their former selves (excuse the pun), they will likely have the luxury of being able to pull internal talent from other parts of the globe. Many of their traders already came from their European Gas and Power teams. There will also be plenty of strong individuals within these businesses putting their hand up to jump on the carbon train no doubt.

For companies who do not possess such luxuries, they have two options: move fast and pay a premium for talent or get creative and look into individuals with less product experience. Gas, power and renewables would naturally be the first place to look. It is likely these traders have had exposure to emissions markets already and many carbon traders today find their roots there.

There are also those in the region who come from a strong environmental products background but have since shifted into other products. The collapses of the market over the last decade or so caused them to look for greener pastures, but several I have spoken to have already indicated interest to move back given the traction the carbon markets are gaining.

In Asia, there are a small handful within the LNG space. The voluntary markets today are also described as very similar to what LNG was 10 years ago. However, it will not be easy to pull these individuals out. LNG is going to play a major part in our energy transition (see my previous blog) and some would argue it’s a more stable and predictable market. With the increasing prominence of carbon neutral deals in the LNG market, these individuals will likely want to leverage their skill set within their current roles. Therein lies the conundrum – this combination of experience will likely become increasingly desirable and individuals may be reluctant to take a punt on a pure carbon trading role, especially if they were put off by the market once before.

Other products I have been suggested to look into for talent include biofuels – another space we have seen a rapid increase in interest. Coal traders may even be an option! Several have seen the writing on the wall and have already begun the transition into environmental products within their own organisations. Carbon trading and origination ‘isn’t rocket science’ according to those in the field, and any trader worth their mettle will tell you they’re commodity agnostic anyway.

Whether Singapore/Asia is the best location to develop these teams remain to be seen. As mentioned, the talent pool is relatively small and the market is itself still lags behind Europe by a few years, which is where we still see most of the demand coming from. That being said, pace is gathering in Asia and will undoubtedly grow. It could make geographical sense to have teams based in Singapore given its proximity to many of the projects and growing demand in the region. Businesses could look into hiring strong external talent from Europe and base them in Singapore.

The bottom line is: if businesses are serious about setting up carbon trading and origination teams in Asia, they’ll need to move fast and expect to pay a premium. Or they may have to get creative and hire those with less product experience. Either way, it’s evident from the businesses we work with across all commodity sectors that the carbon movement is well and truly underway and we can expect to see more growth in Asian markets sooner rather than later.

Anyone interested in exploring carbon trading opportunities, please do not hesitate to reach out to me or my colleagues Jon Funnell in Europe or Ross Gregory in the US.

This article is part of a report from Proco Commodities – ‘The Journey to Carbon Zero’. The download the report, click here.