Carbon market exchanges ripe for consolidation

LONDON (Reuters) - A cut-throat battle is emerging to dominate trade in permits to emit greenhouse gases, which could grow to rival the $3 trillion oil trade, with dominant exchanges eventually expected in Europe, the U.S. and Asia.

Emissions exchanges are the hubs of a growing, $60 billion carbon market, where companies buy and sell permits to emit harmful greenhouse gases like carbon dioxide, and are expected to consolidate as a global market emerges, analysts say.

London will remain the world's carbon trading capital in 2012, when the Kyoto Protocol's first commitment period ends, according to a Reuters survey of emissions traders and analysts.

There are currently more than 10 exchanges worldwide trading carbon emissions, and with several more expected to launch futures or spot contracts this year, traders say the market is fragmented and expect consolidation by 2012.

"Inevitably some will fall by the wayside and others will get taken out," said Jim Benson, an emissions trader at BP (BP.L). "I think (by 2012) there is likely to be one dominant exchange in the U.S. and one in Europe."

So which exchanges will dominate?

European Climate Exchange (CLIE.L), the largest emissions exchange in the world, will continue to maintain its dominance in Europe with partner IntercontinentalExchange (ICE) (ICE.N). The ECX currently transacts around 85 percent of European exchange-traded volume.

Newcomer the Green Exchange, launched earlier this year by the world's largest energy futures market, New York-based NYMEX NMX.N, is favored to capture the lion's share of U.S. carbon trading volumes.

"We'll have NYMEX in New York, ECX/ICE in London, and maybe something in Asia," Laurent Segalen, a managing director at Lehman Brothers LEH.N, told Reuters.

CAPITAL TRANSFER?

London has been the global carbon capital since 2005, the first year of the European Union's flagship emissions trading scheme, and the vast majority polled don't see other financial centers like New York or Tokyo challenging it soon.

"We have the brokers, the traders and the main exchange is already right here," said Louis Redshaw, head of environmental markets for London-based Barclays Capital (BARC.L). "We've also got the lawyers, accountants."

Several rival exchanges in other EU countries have tried to seize London and ECX's crown by launching their own emissions trading, but so far none have been successful.

European power exchanges including Germany's EEX and Norway's Nord Pool have launched EU Allowance (EUA) futures, though trading volumes remain comparatively small.

"It's not looking good in terms of global dominance (for the smaller exchanges). They might survive but I'm not sure they'll increase their current market share," added Segalen.

JUST LIKE OIL

As more and more countries pass federal cap-and-trade legislation, a key requirement in the development of emissions trading, the rapidly expanding carbon market may adopt similar characteristics to the oil market, traders said.

Global trade in carbon emissions could hit $2 trillion by 2020, according to Guy Turner of carbon markets analysts New Carbon Finance, while Reuters estimates puts the present value of global oil markets at around $3 trillion.

The world's two main oil contracts, WTI and Brent crude, also trade on exchanges owned by NYMEX and ICE respectively.

Several traders said carbon trading could eventually move from its current 10-hour day to becoming a 24-hour market like oil, with trading rooms overlapping and passing orderbooks across time zones, though this may not happen by 2012.

"Right now there isn't enough demand from the U.S. and Asia to drive a 24-hour market, but that can change quickly, especially as we follow the U.S. legislative process," said Garth Edward, Citigroup's head of environmental products (C.N).

CARBON, CONNECTED

Although most exchanges already list fungible contracts, traders said the introduction of federal cap-and-trade legislation in the U.S., which would force a limit on industrial emissions, is the key ingredient now required for the emergence of a global carbon market.

There is a growing view that a federal cap-and-trade scheme will emerge in the U.S. from around 2012, according to Imtiaz Ahmad, an executive director at Morgan Stanley (MS.N), as all three presidential hopefuls have said they favor the market-based solution as a prime weapon to fight climate change.

Emissions exchanges in the U.S., Canada, Europe, Japan, Australia and New Zealand will be the prime candidates for linking under a global scheme, traders said.

"All the OECD (Organisation for Economic Co-operation and Development) countries could be linked by a trading scheme by 2013," said Barclays' Redshaw.

With U.S. and European carbon trading hubs taking shape, the picture in Asia remains less clear as developing nations like China and India refuse to accept binding emissions targets under a successor agreement to Kyoto.

"We haven't seen any major (Asian exchanges) yet, but they'll possibly be in Mumbai, Hong Kong or Singapore," said Abyd Karmali, head of carbon emissions at Merrill Lynch MER.N.

To vote on where you think the world's carbon capital will be in 2012, log on to www.reutersinteractive.com

(Reporting by Michael Szabo and Chris Wills; Editing by James Jukwey)