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The greatest risk embedded in carbon credits isn’t that governments won’t agree on long-term reduction targets, but that they won’t have the backbone to enforce those targets once agreed on. Now two founding members of the London Accord have proposed a hedging instrument that forces government to put their money where their mouths are.
Potential climate change investors have one big doubt: are governments committed to de-carbonizing the economy? Developers of low carbon projects (such as wind farms or solar companies) face two major problems turning ideas into reality. The first is showing attractive returns. The second is raising capital. Most low carbon projects will provide attractive returns only if government policies lead to lower emissions, higher fossil fuel prices and higher carbon prices. Uncertainty about government commitments creates risks which developers, and their investors, are not keen to bear.
Governments claim they are committed, but history raises doubts. Lack of confidence in government commitment impairs investment. Lack of confidence also leads to low prices for carbon. For example, the EU ETS market Phase 1 (2005 to 2007) carbon price crashed in 2007 when it became apparent that EU governments had jointly issued far too many permits to emit, i.e. clearly they weren’t committed to reductions. Despite numerous white papers, there is little confidence that the UK government will meet its carbon emission reduction targets. Further, the worsening economic environment leads governments to talk about ‘temporary’ easing of carbon reduction commitments at the same time as easing demand lowers carbon prices.
The uncertainty about government commitment manifests itself in three specific risks
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