This may be the year when carbon trading enters center stage. Growing interest in emissions trading is emerging not just in Europe, but also in the United States and globally. This still young market could see a shake-up as experienced exchange operators, such as Climate Exchange plc and Nord Pool, are challenged by a host of newcomers.

Today, NYMEX Holdings, in partnership with several investment banks and brokers, launched carbon derivatives trading on a new “Green Exchange” in New York. This is the first real challenge to U.S.-based Chicago Climate Exchange, owned by Climate Exchange plc, and is bound to spark new interest in potential growth for the U.S. carbon market. Last month, New Carbon Finance, a research firm, predicted that the U.S. carbon market could be valued at $1 trillion by 2020 if Congress passes a federal “cap-and-trade” system after the next presidential election.

Emissions trading markets allow polluting companies in countries regulated by the Kyoto Protocol to pay others to cut greenhouse gas (GHG) emissions on their behalf to meet emissions reduction targets. Companies in unregulated markets can also make voluntary commitments to reduce their emissions and trade on exchanges such as the Chicago Climate Exchange.

As pressure mounts for negotiators to agree on a post-2012 successor agreement to the Kyoto Protocol, exchange operators and banks are quickly seizing new opportunities. The value of global carbon markets grew by 80 percent from 2006 to 2007, reaching $60 billion in 2007, according to consulting group Point Carbon. This market is expected to continue to grow rapidly, and extend from Europe to the United States.

Several factors are driving this trend. For one, the likely presidential nominees in each party are backers of cap-and-trade legislation. After Sen. John McCain emerged as the Republican candidate for president on the Feb. 5 “Super Tuesday” primary, the price of carbon dioxide traded on the Chicago Climate Exchange jumped from $2.70 for $4.50 per ton. Like his Democratic counterpart, Sens. Clinton and Obama, McCain has pledged to make passage of climate change legislation a hallmark of his presidency. In addition, this bolsters the chance that the United States will be an active participant in the “Bali Roadmap” for a new global climate agreement, and open the door to new carbon trading markets at home and abroad.

Europe vs. the United States
Even without an international post-2012 agreement, Europe is committed to moving ahead on its own. In January, the European Commission announced its proposal for emissions reduction targets to 2020 as well as an update to the European Union Emissions Trading Scheme (EU-ETS). Given that carbon prices for the first phase of trading (2005-2007) collapsed in 2006 due to an oversupply of emissions allowances to affected entities, Europe is now focused on tightening targets, reducing the free allocation of permits and expanding coverage to new industries, including airlines, in the next round (2008 2012), which coincides with the first binding limits under the Kyoto Protocol. The Commission’s proposal still needs approval from national governments and the European Parliament, and extensive debate is likely to continue.

Meanwhile, as the United States awaits adoption of its own federal climate legislation, the focus is on voluntary markets, including the Chicago Climate Exchange and a market in Renewable Energy Certificates (RECs) that is meant to spur alternative energy investment. Twenty-seven states plus the District of Columbia have Renewable Portfolio Standards in place that drive the REC market. Additionally, 10 states in the Northeast and Mid-Atlantic region have agreed to a cap-and-trade program to control power generation emissions starting in 2009 under the Regional Greenhouse Gas Initiative (RGGI). And finally, the Chicago Climate Exchange also announced plans in May 2007 to launch the California Climate Exchange, which will support that state’s mandatory reductions under the California Global Warming Solutions Act, or AB32. At the same time, several states, including participants from Canada and Mexico, have moved towards standardized corporate emissions reporting through The Climate Registry, a non-profit agency that aims to provide transparency in emissions accounting.

This range of trading options has created a wide variance in carbon prices. A ton of carbon dioxide traded voluntarily on the Chicago Climate Exchange now trades for just over $5, for example, while an equivalent contract on the European Climate Exchange, also managed by parent company Climate Exchange plc, fetches around $35. The main reason for the disparity is that the European trades count toward emissions reductions under the Kyoto Protocol, whereas the U.S. trades do not.

But this all could change after this fall’s national elections, and several U.S. banks are already preparing for the future. As one the world’s two largest GHG emitters (along with China), the United States is expected to quickly surpass Europe in carbon trades as its key industries become regulated. Banks are eager to step in as intermediaries, and many are buying up carbon credits to sell to industry and national governments later on. Morgan Stanley, for one, has announced plans to commit approximately $3 billion over the next five years to buying carbon credits and developing emissions reduction projects. Several other U.S. and international banks are also building carbon credit portfolios and offering brokerage services for clients, including Barclays plc, Citigroup, Credit Suisse, Deutsche Bank, Merrill Lynch and Morgan Stanley.