Get it while it's hot

Too many South African businesses are still not taking the issue of carbon, and by association climate change, seriously. But it is a serious matter, and South Africa has some unique advantages and disadvantages in the management of the carbon issue.

But first, the science stuff. The carbon issue is the offspring of climate change, in particular the phenomenon of global warming (the earth getting hotter). Global warming is associated with high levels of “greenhouse” gases (GHGs) in the atmosphere. These gases (carbon dioxide, methane and others) trap the sun’s heat in the manner of a greenhouse, with the obvious effect of making the planet hotter. The obvious solution is to reduce the amount of GHGs in the atmosphere.

But why worry about global warming? Because predictions of the extra heat’s long-term impact are dire: studies have warned about ocean levels rising, killer heat waves, an increased numbers of droughts, floods, hurricanes and tsunamis, and widespread crop failures.

Such predictions caught the ears of the world’s powerful people, and the result was a series of global summits about how best to fix the mess we’ve made, which culminated in the Kyoto Protocol.

The Kyoto Protocol is the world’s best attempt at a response to climate change, and a pretty meagre attempt at that, despite the gargantuan efforts of the negotiators. Notably, the world’s number 1 polluter, the US, did not sign Kyoto. The key Kyoto agreements came into effect on February 16 this year.

The main thrust of the protocol is that industrialised nations (called Annex 1 countries) must reduce their carbon emissions by 5% compared to 1990 emission levels. That generally means a more-than 5% reduction on current levels, because levels have crept up since 1990.

Each country gets a target emissions level, and must strive to reach it. In the European Union, companies are given quotas for the maximum tonnage of carbon they can emit, with a view to falling within the emission target for the country overall.

If a company emits less than its quota, it can sell the unneeded quota tonnes to companies emitting more than their quota. In this way, the overall emissions are reduced, and those companies that can easily reduce emissions are encouraged to do so because they can sell their excess tonnes.

These intra-company trades and local reductions, however, may not be enough to reduce emissions to the target level. Therefore Annex 1 countries can partner with non-Annex 1 countries (developing countries) on projects, called Clean Development Mechanisms (CDMs), to reduce emissions in the developing country, earning credits in the industrialised partner.

In other words, if a project in, say, Gabon removes a tonne of carbon from the atmosphere, the project’s European partner can offset the credit certificate for that tonne against its quota. The carbon removed in Gabon is represented by a Certified Emission Reduction certificate. The certificate is fungible – that is, it can be exchanged for a European Union certified carbon tonne. So the EU partner would exchange its CER for an EU carbon quota tonne. This all works because non-Annex 1 countries, including SA, have no emissions targets, so they can afford to sell their carbon tonnes.
South Africa’s unique position

SA has some unique characteristics that make it an interesting case study in the world of carbon trading. For a start, in absolute terms South Africa is the fourteenth-biggest carbon emitter globally – higher than China and France. The reason for our large carbon footprint is simple: coal. South African electricity is reliant on low-grade coal, which we have in abundance. Unfortunately, the energy yield per tonne of our low-grade coal is quite modest, so we have to burn a lot to provide sufficient power. This means local industries that use Eskom power, which is all of them, have a large carbon footprint.

That puts the country in a precarious position. The US refused to sign Kyoto because the treaty failed to set targets for major developing country emitters (Brazil, China and South Africa). So it is likely that in the next round of carbon negotiations these three countries will get targets. And that would mean emissions caps for South African companies.

Worryingly, SA is ill prepared for the carbon age. There are no local CDMs currently underway. Or rather, there are several projects in the planning stages, but none likely to deliver any carbon units within the next few years.

There are, however, some hopeful signs. For example, the JSE is home to the world’s first listed tradable carbon instrument.

Asset management company Sterling Waterford listed the carbon credit note (CCN) on the JSE earlier this year. The CCN is a tradable derivative, a fully underwritten obligation to deliver a carbon credit (a CDM registered Certified Emission Reduction) to the purchaser, at a date in the future, in this case four years. Private investors bought the rights to the CERs and they can sell them upon delivery at, hopefully, a profit. Alternatively, they can trade the notes ahead of delivery.

Sterling Waterford marketing manager David Allardice said that listing the note was a major achievement, involving complicated negotiations with the Reserve Bank, the JSE and other parties. Because there are no ripe CDMs in SA, the CCN had to be linked to projects in other developing countries. They were also insured, to ensure that the carbon would indeed be delivered.

Since listing, the notes have seldom been traded.

“Most of our investors have held onto their notes, so there has been very little trade. We are very happy with the notes’ performance. They have retained their value, despite currency fluctuations,” said Allardice.

He explained that many European investors, especially institutional investors, have expressed an interest in the notes.

“There has been a lot of interest from European investors. I think right now they are still sizing up the JSE as a market, deciding whether or not they would be safe investing in it. They are definitely interested in the concept of the note. This is something that they need [carbon tonnes], and it is available here at a much lower price. Of course they’re interested,” he said.

Sterling Waterford will be going on a European road show later this year, to sell the concept of its carbon notes to EU investors.

Allardice agreed that South Africa is unprepared for the impact of carbon on the world economy. Increasingly, it is becoming a major issue for global investment houses. Carbon liabilities will soon have to be reported on the balance sheet of organisations, and investors want to know what organisations are doing to manage their carbon liabilities.

Said Allardice, “Institutional investors in SA need to start asking tough questions about carbon. Many local companies are listed in the EU, and they have to start addressing the carbon issue. The local press also needs to start explaining the issues.”

Felicity Duncan

Posted: Tue, 26 Jul 2005 12:27 | © Moneyweb Holdings Limited, 1997-2005

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