Carbon Derivatives Market in India Essay examples
Energy security, resource conservation, reduction of pollution and protection of natural habitats has got governments all around the world interested in carbon trading. Investor interest in the emerging global carbon credit market has created apt conditions for risk management products, ranging from insurance to derivatives. The carbon trading market allows polluting companies to pay others to cut carbon emissions on their behalf so as to meet the reduction targets set by Kyoto Protocol. A high volume of trading in the carbon derivatives market helps price discovery and liquidity, and in this way helps to set a clear price signal which helps businesses to plan investments.
India has …show more content…
Need for Carbon Derivatives
For companies investing in greenhouse gas reduction projects, it is essential to know what the future price of the emissions will be. For example, let a Company X invests in a greenhouse reduction project to reduce 100,000 t of CO2 in 5 years with an investment of $100 million. Now, if after 5 years the average market price is $500 per ton, then the company has made losses on this investment. Had this company known the future price beforehand, it would have made a rational decision of discontinuing this project and looking for a more favourable investment opportunity.
To eliminate this risk of future emissions price fluctuations, company X needs to hedge the risk using derivatives. It can short a futures contract with another market participant in order to receive a pre-determined price at end of five years. Thus the price volatility risk can be eliminated.
This market allows emissions reduction project developers, who generate credits under the Clean Development Mechanism (CDM) of the Kyoto Protocol, to hedge against price risk. So if a firm reduces