INSIGHTS FROM AMPHORA
Carbon and ESG set for dramatic impact to the energy industry
The world of commodities and commodity trading is moving very swiftly in many ways but one area that will have dramatic impacts is ESG and carbon. Now, of course, carbon credits and allowances are back in vogue. In the EU ETS, carbon allowances are reaching extremely high prices at around 65Eur/Tonne and allowances under the post BREXIT UK system of allowances have recently reached 76GBP/Tonne. The higher and volatile carbon prices probably reflect increased fossil fuel generation by utilities as natural gas prices soar and renewables output is insufficient and unpredictable. As the cost of allowances to offset emissions rises, it will feed into the cost of electric power.
The purpose of a carbon cap and trade market is to effectively establish a price for carbon as well as reduce emissions by reducing the number of available allowances over time. The EU ETS is perhaps the best known such market along with its UK post-BREXIT equivalent. From 2021, to increase the pace of emissions cuts, the overall number of emission allowances in the EU ETS will decline at an annual rate of 2.2% from 2021 onwards, compared to 1.74% currently. Other features of the EU ETS exist to aid in an overall reduction of emissions for phase 4 of the scheme (to 2030).
The problem is that such cap-and-trade markets are regional, allowances and instruments of various types exist in all these markets and there is no single price for carbon. There may be more than 60 such regional markets in fact with a variety of rules, instruments, and schema. Furthermore, as the noose around the neck of CO2 emissions tightens, other aspects of CO2 will be applied into these schemes. For example, the EU’s 'Fit for 55’ policy package includes a proposal to expand the ETS to cover CO2 emissions from the shipping industry for the first time. The current proposal would mean that all ships over 5000 gross tonnes calling at EU ports would need to pay for their CO2 emissions regardless of flag. The measures would be eased in from 2023 and be fully in place by 2026. At current carbon prices, it is estimated that this will make marine fuel oil between 20-30% more expensive.
Furthermore, a plethora of other requirements may emerge ranging from audits to carbon footprint tracking and reporting that will add complexity, costs, and risks across the board. With COP-26 currently taking place, there may be other considerations, changes, and emerging rules to consider as well but we already know, for example, that counterparty ESG policy will impact credit risk and a company’s own policies will impact its credit as well as access to trade finance and other capital. Market risk and exposures will include carbon meaning emissions will need to be offset and the cost of allowances hedged. These transactions will all need to be tracked and reported in many ways, not least of which may be carbon footprint reporting on invoices for a specific transaction. Sourcing, movement, processing and so on will also require more work and due diligence from an ESG perspective. Much of this will need to be included in PnL reporting to ensure that the costs and exposures impacts on profitability are well known. Things are going to get even more complicated.
Currently, there does not appear to be a CTRM or ETRM solution on the market now that can cater for all carbon markets and instruments. Many firms still use legacy solutions from the very early days of the EU ETS or similar or rely on spreadsheet tools. Some solutions may allow the capture of the allowance positions but do not help in managing the lifecycle of the instrument (registry, vintage, retirement and so on). All of which are vital in managing credits from a lifecycle, exposure and PnL perspective and to further complicate matters those credits could be linked to a multitude of different regional repositories.
Amphora is aware of all of this and is talking to customers and the market about the likely needs in this area. Meanwhile, we are engaging on a new project, Harmony, that focuses on registry inventory and primary project management, as well as ensuring that our Clarity project is fully informed of any additional needs arising from these requirements. If you would like to discuss this with us, please do contact us.
Amphora is a unique provider in today's commodities marketplace. We offer CTRM and Shipping services under one roof, allowing clients to go to market quicker and for a significantly lower cost.
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