Carbonflow CEO, Neal Dikeman developed the Carbon Trading Game, “to teach people how to better understand the nuances of Carbon Trading. The Carbon Trading Game, according to Richard Barber, CTO of Carbonflow is “a really good introduction to Carbon Trading - it is somewhat different to what you think it is going to be like. People run-away from coal-fired power stations very fast”. Mr Dikeman said that, “an interesting finding is that, price volatility by either the emitters or traders does not effect whether the Cap is met. If the Cap is an enforceable cap abatement of carbon dioxide (CO2) tends to happen whether people make profits or the price of carbon is high or not - ERGO the ENVIRONMENT WINS!

The Carbon Trading Game may well be the game that people need to play in order to understand how Carbon Trading actually works. This is particularly so as there is a debate going on in the U.S press about whether the Carbon Trading mechanisms, (New York Times March 1st 2009) should be maintained in the revised Kyoto Protocol to be reviewed in Copenhagen December 2009 by all nations of the world including the United States. The U.S is starting to criticize the market mechanisms, which were included in the original Kyoto Protocol at the behest of Bill Clinton in 1997. These markets mechanisms, which include CDM can be improved with software solutions like Carbonflow particularly suited to resolving issues like additionality and time to market, but not only. It would be unfortunate if the potential of  CDM was canceled out just as it is coming up to speed, simply because of a lack of awareness on the part of key U.S negotiators about solutions. It seems many do not understand how the Carbon Markets work.

Mr Dikeman says that, “the aim of the Game is to model how effectively the Cap and Trade Carbon Game can be at forcing and driving low carbon infrastructure change. It also shows how small changes in system design can have wide impacts on the cost of abating carbon, the price of carbon and who are the winners and losers. The Game shows the impact of uncertainties in carbon policies and markets have on the early changes in price and emitter behavior.

The rules are quite simple and only apply to the power sector. Other sectors could be added, however for the purposes of education the power sector is used, which happens to correspond to the current system in the North-East of the U.S, the Regional Greenhouse Gas Initiative (RGGI) and to the EU-Emissions Trading Scheme (EU-ETS).

THE RULES OF THE CARBON TRADING GAME

It is a 4 round game with an expanding cap in the power sector. The cap starts small and expands throughout the game.  Each round represents a commitment period 2012, 2017, 2022, 2027 of Kyoto Mark 1 and 11, where we auction more carbon permits per unit of power because the cap is expanding. Each round the number of credits auctioned is fewer 75%, 50%, 25%, 25%.

In the first round we allocate enough permits ahead of the auction to ensure an oversupply to run power plant and produce power. Each round we also auction off a random set of power plants coal, nuclear, gas, wind and hydro with different capacity factors. We auction of different fuels to run the power plants and then we auction of the carbon credits.

For example: One coal-fired power station and one supply of coal and two units of carbon credits is required to run the plant and produce electricity. In this model we were auctioning off the power plants using a 2nd price auction, which is one where, “the highest bid wins but pays the 2nd highest bid”. The next thing is to auction of the fuel using a dutch auction, where everybody bids the number of fuel units and price per unit. Everyone who wins pays the price they bid for settled in order of highest to lowest bid.

We have played multiple games of the Carbonflow Carbon Trading Game with Executives from Designated Operational Entities (DOE) like DNV and SGS, the auditors of the current carbon trading industry.

CONCLUSION and INSIGHTS OF THE CARBON TRADING GAME

1. Carbon prices tend to be higher in early rounds and stay flat or fade as commitment periods go on.

2. In the after-market, where players buy and sell fuel between themselves so they can run their plants, if you don’t have enough fuel and carbon credits you can’t run your coal or gas plant.  In this after-market we found that prices for fuel and carbon became highly inter-linked and have a large impact on the value of power plants and the mix of power production.

3. Also as might be expected high capacity renewable plants and low carbon power plants such as nuclear and wind are able to be sold for substantially higher prices than coal or gas plants with high emission factors and attendant fuel risks like not having enough fuel to run plants or the low emission factor and low capacity wind plants.

4. The most interesting thing is that the simulations confirm that the farther one goes into the commitment period the more inter-linked the fuel commodities and carbon markets become and the higher the discount to justify coal plant investment, even though coal fuel is in oversupply by the end of the game. This is an indication that coal and gas plants tend to be retired in favor of hydro-electricity, wind and nuclear plants. In the fuel markets the differential on a per KWH basis between low carbon commodities like nuclear and gas fuel tends to rise drastically and unpredictably higher than high carbon fuels like coal.

5. Under this simulation we assumed that fuel was always adequate to supply plants into the market. It does not appear to be clear. The price changes are driven by financial traders taking commodity bets and physical traders seeking to secure forward supply.

6. Price volatility by either the emitters or traders does not effect whether the cap is met. If the Cap is an enforceable cap abatement of carbon dioxide (CO2) tends to happen whether people make profits or the price of carbon is high or not - ERGO the ENVIRONMENT WINS!

7. The other conclusion is that Cap and Trade does push out the high emitting coal and lower emitting natural gas plants. The price per ton of carbon in most of our games varied between $20 to $80 dollars per ton per round.

CARBON OFFSET SIMULATION

We did simulate the impact of offsets like energy efficiency, which seem to provide emitters with the opportunity of making profits outside the cap and has a slightly moderating downward pressure on prices for carbon. In the early days it is a limited effect with virtually no impact towards the end of the game as the cap is reached.

HOARDING CREDITS and TRADING STRATEGIES

Trading strategies and hoarding of credits due to uncertainty in early rounds seem to outweigh the impact of the oversupply of allocation of offsets in the early rounds thus keeping prices down.

By later rounds the market expectation is that offset emitter energy efficiency and free allocation would mean emitters escape paying a price of carbon and abatement doesn’t occur. However, we find that the opposite is true, traders making a market for carbon and emitters buying to secure future carbon supply act in a way that supports the price of carbon because inventory of carbon stays high. As the game goes on carbon inventories are exhausted, low carbon fuel prices rise and the value of low carbon plants rise and high carbon fuel prices fall as companies more rapidly than expected shift to a lower carbon market.

Trading strategies are highly profitable as the industry grows and pure commodity trading strategies tend to do badly. The only obvious losing strategy is straight coal but that does not become apparent until later rounds and the last point is the winning strategy tends to be won by those that invest heavily on low carbon strategies as soon as possible.

In Conclusion, this is a fanatastic game to bring everyone up to speed on the mechanics of carbon trading and it has the benefit of showing actual human behaviuor, which can only be factored in when people are in the position of actually buying power plants and seeing what they would do when faced with a cap and a requirement to buy fuel and carbon credits to run their plants.