A great opportunity in carbon credits

It takes something special to make enemies of the USA, China and forty other countries around the world. But the EU has managed to do just that.

I'm talking about new plans by the EU to overhaul it's carbon credit scheme. I'm sure you've heard of it, and know that this is one of the main mechanisms by which we are trying to save the planet. The concept is quite simple.

Businesses that reduce their level of carbon emissions by, for instance, generating power from wind turbines or capturing and recycling noxious emissions, get carbon credits.

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Dirty businesses like coal-fired power stations or cement works are obliged to buy carbon credits off the good guys. This transfer of wealth rewards 'clean' businesses and penalizes 'dirty' ones. It incentivises the reduction of carbon emissions, and the evidence suggests that it works.

In fact I think there are a number of very exciting penny shares in this field. Especially now that the sector has been almost completely written off.

The devastating collapse in carbon pricing

The EU's carbon trading scheme is in disarray. Just before Christmas a letter from the EU Corporate Leaders Group on Climate Change (Patron, Prince Charles) warned that without some action, it could be in serious jeopardy. The problem is that the price of a carbon credit has fallen so far that it is no longer disincentivising pollution.

The traded value of carbon credits halved in the second half of 2011. This reflects flaws in its initial design. The recession is hitting the output of the polluters, who therefore need fewer carbon credits. With their demand falling, the price of carbon credits has fallen as well but one reason why this could be about the change is the same as that which has provoked the wrath of the rest of the world.

The EU has decided that aeroplanes emit dangerous carbon and they should pay the penalty. They must give a full report on their emissions and buy carbon credits when these emissions are above a prescribed level. To make matters for the airlines worse and I rather like this aspect of the scheme the emissions of the entire journey will be measured, not just those made when in EU air space.

The EU has effectively levied a global airline tax

This has gone down like a lead balloon. China's four leading airlines have said that they will refuse to pay and China has dropped dark hints about future orders for Europe's Airbus. The Indian government will formally protest at the forthcoming India-EU summit in New Delhi next month. The US and Canada have lodged a petition, while Hillary Clinton has warned that unless the EU suspends the scheme and negotiates with other governments on how to limit airlines' CO2 emissions on a global basis, the US "will be compelled to take appropriate action" whatever that means.

Summing it up, Sanat Kaul, chairman of the International Foundation for Aviation and Development (so not biased, then) says that "Europe is marginalised on the issue, as the whole world is against the decision."

The whole world, that is, except me. Because I think it sounds rather a good idea.

A great opportunity in carbon credits

But I also think that it will help to redress the imbalance in the carbon credit market, something that is already of concern to the EU. Just before Christmas, in a move that went unnoticed by UK investors, EU politicians backed a proposal that would prop up carbon prices by withholding 1.4 billion permits from the third phase of its Emissions Trading Scheme. This immediately sent prices some 20% higher, and I believe should mark the bottom for carbon credit prices. Although the EU trading scheme accounts for about 97% of global traded emissions today, its dominance is set to be challenged by prospective new schemes in Australia, the USA and China.

So whether or not airlines are penalised, carbon trading is here to stay. It's set to become a global rather than an EU phenomenon. I think the stock market offers one great way to play this theme, and it is through a penny share that I have been following for some time. To read all about it, just get a copy of this month's Red Hot Penny Shares.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth.

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Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by MoneyWeek Ltd.