What Exactly Is Energy Trading? An Interesting Field For Energy Risk Professionals.

Energy Trading Technology

Energy Trading Technology

I’m sure every Energy Risk Professional has at one point or another asked himself/herself whether energy trading wouldn’t be a good challenge to get involved in. I certainly have many times and have dabbled in trading more than once ūüėČ A large part of the energy risk professional curriculum prepares us quite nicely for trading and financial risk management in the field.

Here I put together three brief videos that give an overview about what’s going on today in energy trading. Feel free to take them as a starting point to inform yourself about the subject of trading commodities and equities in the energy sector. Enjoy!

Sunguard: “Risk management a skill in demand for energy trading.”

Overview of Energy Trading at Shell: What does it take to trade energy at Shell? “Live 100 years and not get bored.”

Shell: “Reponsiblity is encouraged every hour of the day.”

The Kyoto Protocol In A Nutshell

CO2 Reduction

CO2 Reduction

The Kyoto Protocol is a somewhat dry topic in the curriculum for the Energy Risk Professional exam. It is still important to understand the basics of the Protocol, the different carbon trading units, joint implementation (JI), and the clean development mechanism (CDM). This article will give a brief overview of all.

The Kyoto Protocol is an international treaty outlining and regulating the efforts of its 37 member countries to reduce their greenhouse gas (GHG) emissions by 2012. It is legally binding and was entered into force on 16 February 2005. The Kyoto Protocol is linked to the United Nations Framework Convention on Climate Change (UNFCCC). The major feature of the protocol is that it sets binding targets for its 37 industrialized countries and the European community for reducing greenhouse gas emissions: These should be reduced an average of 5% against 1990 levels over the 5-year period 2008-2012. Each country and its industries are assigned certain targets based on historical emission data that they agreed to meet by the end of the 5-year period. The United States, Japan and Australia (among others) are not member countries of the Kyoto Protocol, but are implementing their own measures to reduce greenhouse gases with less regulations and accountability.

Below a graphic of current Kyoto Protocol member countries:

Kyoto Protocol member countries

The Kyoto Protocol, like the UNFCCC, is also designed to assist countries in adapting to the adverse effects of climate change. It facilitates the development of techniques that can help increase resilience to the impacts of climate change. The Adaptation Fund was established to finance adaptation projects and programmes in developing countries that are Parties to the Kyoto Protocol.

Under the Kyoto Protocol, the following emissions are considered greenhouse gases (GHG): Carbon dioxide (CO2), Methane (CH4), Nitrous oxide (N2O), Hydrofluorocarbons (HFCs), Perfluorocarbons (PFCs), and Sulphur hexafluoride (SF6). It is important to note that Hydrogen Sulfide (H2S) is not considered a GHG. Countries must meet their targets primarily through national measures, such as more efficient combustion or reduction of emissions in general through use of cleaner fuel. However, the Kyoto Protocol offers them an additional means of meeting their targets by way of three market-based mechanisms:

  1. Emissions trading, known as ‚Äúthe carbon market”
  2. The Clean development mechanism (CDM), which involves investment in sustainable development projects that reduce emissions in developing countries.
  3. Joint implementation (JI), which enables industrialized countries to carry out joint implementation projects with other developed countries.

These mechanisms help stimulate green investment and enable parties to meet their emission targets in a cost-effective way. In order to account for progress and make trade possible, there are three standardized instrument units used, each equal to 1t of CO2:

  1. A removal unit (RMU) of GHGs on the basis of land use, land-use change and forestry (LULUCF) activities such as reforestation.
  2. An emission reduction unit (ERU) generated by a joint implementation (JI) project in another country.
  3. A certified emission reduction (CER) generated from a clean development mechanism (CDM) project activity in a developing country.

Transfers and acquisitions of these units are tracked and recorded through the registry systems under the Kyoto Protocol. An international transaction log ensures secure transfer of emission reduction units between countries.

The heart of the Kyoto Protocol is the Clean Development Mechanism (CDM). It allows a country to implement emission-reduction projects in developing  countries. Such projects can earn certified emission reduction (CER) credits that can be re-sold in the carbon market. A CDM project must provide emission reductions that are additional to what would otherwise have occurred. The projects must qualify through a rigorous and public registration and issuance process.

The CDM is the first global, environmental investment and credit scheme of its kind, providing a standardized emissions offset instrument, CERs. A CDM project activity might involve a rural  electrification project using solar panels or the installation of more energy-efficient boilers. The mechanism stimulates sustainable development and emission reductions, while giving industrialized countries some flexibility in how they meet their emission reduction or limitation targets.

Joint implementation (JI) allows a country to earn emission reduction units (ERUs) from an emission-reduction or emission removal project in another country, which offers parties a flexible and cost-efficient means of fulfilling a part of their Kyoto commitments, while the host party benefits from foreign investment and technology transfer.

As with all international treaties, the Kyoto Protocol is not all fun and games. Unfortunately, there are quite severe challenges that are not easy to solve:

  1. Verification. Many countries were late in setting up verification procedures and technologies, slowing CDM implementation.
  2. Controlling sale of “hot air”. The baseline year is 1990, which coincides with the fall of communism. All formerly communist countries are far below their baseline targets, so Kyoto designers feared downward pressure on emissions credits. The 1990 figure is meaningless for those countries, so their baseline under the NAP¬†was set close to their current emissions targets.
  3. Quality and price of carbon credits. Large spread between CERs and EUAs (‚ā¨ 11-30), largely due to uncertainty with CERs and associated transaction cost. Convergence is expected, as both credits can be applied to¬†the same¬†goal.
  4. Enforcing compliance. Penalty for noncompliance set at ‚ā¨40 per metric¬†ton CO2 above the cap in phase one (2005-07)¬†and ‚ā¨100 in phase two (2008-12).
  5. Integrating various trading platforms.
  6. CDM bottleneck. Lack of personnel, piecemeal approach. Number of new protocols delaying projects in the pipeline.

For the Protocol to be successful, it is important that the efforts of its member countries can be tracked credibly, and that the targets are enforced in an effective way.

Did you enjoy this post? Please leave a comment in the ERP group on Facebook, and check out these related posts also: