A New Derivatives Market?

Remember that pesky Kyoto agreement? The one that is supposed to save our environment, in part through creating a credit points system to reduce greenhouse emissions? Now, I always found Kyoto’s idea of gas emissions credits inherently faulty since, as it looks to me, you’d be basically stealing from Paul to pay Peter. But, that little conundrum is another story for another time.

Ottawa is finally admitting it needs to join the club and create both the regulatory framework and the technological platform to facilitate trading in greenhouse gas credits. The trading platform responsibility landed with the Montreal Exchange, which is Canada’s main derivatives exchange. On the regulatory side, Ottawa is expected to release the timeline, as well as to establish the credit system itself, within the next few weeks.

As usual, environmentalists worry about the Canadian government succumbing to its usual meek approach to international initiatives. For example, there is already a government-administered technology investment fund available to excessive polluters. All that impacted companies have to do is to pay into the fund to have their “sins” instantly “forgiven,” so to speak. In other words, why buy pollution credits, prices of which are subject to unpredictable market forces, when you can simply dump your money into a fund and keep on polluting. (I know, I simplify things, but that’s what it usually boils down to.)

Although Stephen Harper’s government has said that credits trading will be limited to Canada only, officials at the Montreal Exchange said that an effective trading system is likely to hatch regardless of the regulatory restrictions. If companies can purchase credits in the U.S., for example, there are indications Ottawa is likely to allow credit trading U.S. partners just to keep the good thing going.

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Canadian provinces have already jumped on the bandwagon. British Columbia plans to reduce its greenhouse emissions by 33% within the next decade or so. Ontario is also working hard on developing emission targets and a compliance plan. The release of both plans is expected sometime in May.

Now, an interesting situation could be developing in Alberta. The province’s oil and energy industries are the largest polluters in the country. Alberta’s officials are, naturally, interested in keeping credits trading limited to Canada only. If international trading is allowed, Alberta could see billions of dollars go to credit sellers elsewhere.

In any event, somehow a new and exciting marketplace is shaping up in Canada. Greenhouse gas emission credits are soon expected to trade in derivatives format on the Montreal Exchange, and if the government does not cripple the market size too much (making it Canada only), and provided provincial and federal regulations avoid head-on collisions, we could have an efficient and cost effective marketplace to trade new kind of derivatives. So, once things become clearer, I’ll revisit the issue with concrete ideas how readers of Profit Confidential could turn a profit.