Calibrating Canada’s marketsNovember 16, 2012
Canada is rich in natural capital – those environmental goods and services which underpin our well-being and economic prosperity. In fact, based on that particular metric, Canada is one of the richest countries in the world. But, like all countries, the importance of that natural capital is not reflected in its economic system.
The good news, based on a recent survey carried out by Sustainable Prosperity, a green economy think-tank, is that this is beginning to change, albeit slowly. Markets are starting to develop in Canada that place a financial value on natural capital. These environmental markets can deliver cost-effective solutions to many environmental challenges facing the country, and give investors the necessary vehicle for investing in natural capital.
Sustainable Prosperity’s survey shows that there are thriving markets for air quality, water quality and quantity, and habitat conservation in Canada. We estimate the current size of environmental markets in Canada to be between C$462 million–752 million (US$453 million–739 million) annually, distributed across 57 distinct markets.
Sustainable Prosperity identified all air, water and habitat markets in Canada operating in 2011, and estimated the total value of these markets, using whichever of the three methods below was applicable:
- Information from programme reports, market participants and programme personnel on expenditures for environmental payments. Where contacts provided a range of estimated prices, these were used to calculate the high and low value ranges;
- Aggregating volume and price information listed for individual trades and projects funded; and,
- Pricing schedules and contribution ratios provided by the market registry or regulator.
Where data for 2011 was not available, the survey includes the most recent available year.
Much of the difference between the high and low estimates is due to uncertainty about spending on compensatory mitigation for damage to fish habitats, and the range of estimated prices in the markets for tradable hunting rights and carbon credits.
What we know from experience in other jurisdictions is that financial institutions involved in environmental markets naturally tend to favour the relative certainty of those driven by compliance, such as mandatory carbon markets. Compliance-driven markets account for 26% of Canadian environmental markets by number (15 of the 57), and 31% by low value estimate and 57% by high estimate, as shown in table 1. But, while they are important, they are far from the whole story. As the table also demonstrates, government-mediated and voluntary markets are also each worth at least C$100 million annually.
When considering the markets by type – air, water or habitat – as in table 2, it’s clear that habitat markets are the largest. So, while air markets tend to get the most attention, habitat The value of Canadian environmental markets by type (C$)markets are far larger, both in terms of number (39) and value. These are markets to secure habitats against development, such as through conservation easements, or to offset losses in habitat and biodiversity resulting from specific projects.
Despite their significant size in terms of dollars, it is clear why investors haven’t taken much of an interest in most Canadian environmental markets to date. First, although on aggregate they may add up to a lot of money, most of the individual markets are small and underdeveloped in terms of their infrastructure and scope. This fragmentation makes investing at any kind of scale difficult.
Moreover, in almost half of these markets, especially in water and habitat markets, government is the main buyer. This likely reflects policy uncertainty or lack of market maturity. In addition, the structure of many Canadian environmental markets prohibits or hampers trading. For some, this is due to practicalities involving the interchangeability of credits or the absence of market infrastructure and price information.
There is clearly scope in some Canadian environmental markets to enhance liquidity and/or the availability of pricing information. There is an opportunity to increase private sector involvement in these markets to help them grow, but this requires policies that enable their involvement while providing appropriate regulatory oversight.
An example of where government policy has set the right framework for investment is Québec’s pending cap-and-trade system, set to begin operations early next year. The government of Québec expects credit auctions to raise some C$300 million annually until 2020, which would make it the largest single environmental market in Canada for years to come. Approximately 80 major industrial and electricity sector emitters will be regulated starting in 2013, with fuels from the transportation and building sectors to be added in 2015. The Québec carbon market will be linked to that of California through the Western Climate Initiative.
Investors should identify opportunities to participate in existing and emerging markets as lenders, financiers, and insurers, as well as lend their expertise to helping build market infrastructure. The key roles for the financial sector are as a ‘market-maker’ – facilitating the purchases and sales of credits – and adviser for their clients.
For financial service providers to get more involved in these markets, their clients need to get more involved. More companies need to think more deeply about environmental risks, dependencies, and opportunities, and how involvement in environmental markets can help them secure access to ecosystem goods and services. Further, investors need to develop models to understand the new revenue streams that market-based environmental instruments can create.
Policy-makers set the frameworks in which investment decisions are made, but the financial sector is the only part of the economy capable of providing the kind of capital that would be necessary to scale up existing investments beyond their current small size. Finance and investment only flow if they can earn attractive risk-adjusted returns, which is why a regulatory framework that provides transparency, longevity and certainty to lower policy risk is so important.
The ideal policy environment provides a policy structure that is clear and easy to navigate (transparency), which matches the investment time horizon (longevity), and enables the financial sector to generate predictable revenues to support a reasonable rate of return (certainty).
Environmental markets are just one of many tools that can be used to protect the environment. When well designed, with appropriate institutional and regulatory structures, they can produce good outcomes for both the environment and the economy.
However, in Canada these markets have been underutilised and many of those that exist are immature. Investors, companies, policy-makers and researchers all have a role to play in maximizing the benefit that Canada can get out of environmental markets. If we do it right, our environment – and our wallets – will thank us.
By: Environmental Finance