Carbon Finance Archives


July 04, 2007

Beware The Vagaries Of Government

I just came across this article on potential problems with the emerging trade in carbon credits. The piece is not technical and I wouldn't say that it is particularly well-researched, but it does raise a key point - as the market for carbon emissions grows, the need for standardization and collaboration between governments and regulators will become ever more pressing. This could create problems.

The carbon market is unique in that the commodity traded derives its value primarily from its ability to meet the requirements set by an environmental regulator. There is also a market for voluntary offsets to emissions, but this market is small and unlikely to ever represent a significant piece of the total carbon trading pie (the World Bank estimates (PDF document) that the EU ETS, the only regulations-based emissions trading market in the world, accounted for 99% of total market value in 2006).

The problem with this is that governments have a long history of messing things up when they get involved in any industry. For instance, in Europe, the market for phase one emission allowances took a massive hit after it became clear that EU governments had over-allocated emissions to shield their national industries from the full effects of strict emissions caps. Besides effectively neutralizing the economic incentive to innovate and reduce emissions, this seriously shook the market's confidence in the ability of governments to uphold the necessary conditions for an effective and efficient carbon market to develop.

As the hype around emissions trading and global carbon markets engulfs you, be sure to always keep in the back of your mind the fact that one of the largest risks this market faces is governments and their regulatory agencies. Like any market, it won't take much of a faux pas for investor confidence to be severely shook and for millions or even billions of dollars in market value to be wiped out overnight. This would be bad for the market and the environment.

June 13, 2007

Linking Emissions Trading Systems

For those interested in the topic of emissions trading, a new piece was just published by the International Emissions Trading Association on the topic of 'linking' different emissions trading regimes (PDF document).

Linking entails allowing emission credits from one scheme to be rendered tradable in another. For example, European credits would be valid and tradable in California, and vice-versa. Beyond allowing the carbon market to become more efficient and liquid, linking could also present a range of arbitrage opportunities.

For all of you environmental markets fiends out there, I would definitely recommend this paper. It's short (13 pages) and gives a good overview of where things are currently at with emissions trading and the possibilities associated with linking.

May 25, 2007

Dead Wrong On Climate Exchange

In a May 8 post I opined that, although I believed that recent developments on the climate change file in the US would bode well for Climate Exchange plc (CXCHF.PK), I thought that the stock was overpriced and had had too great a run for its own good over the past 3 months. I therefore predicted that the next move the stock would make would be to the downside. Climate Exchange was trading at around $28 then, and today it is trading in the neighborhood of $36.

I continue to believe that this stock is going way too far, way to fast for what the fundamentals are telling us, no matter how much growth is forecasted to occur over the next couple of years. Nevertheless, a majority of market participants currently disagree with me, and that, in effect, makes me "wrong".

In the context of this, I thus thought I would share with you a series of emails I received shortly after I wrote the post by a regular reader who also happens to be following Climate Exchange very closely. I got the author's permission to publish these but he will remain anonymous. Enjoy!

Email 1:


I read your latest post about the world of carbon....I wanted to bring to your attention a counter argument to consider about CLE....While you are correct to say that the chart looks extended, and that the valuation looks extreme considering the paltry cash flow number, you may be overlooking one very critical factor right now.

There is deal mania right now in the world of exchange combinations....ICE and the Chicago Merc have been battling to buy Chicago Board of Trade, with Merc coming back with a very strong counteroffer this past week. The exchanges are all looking for growth opportunities at this time.

Carbon trading represents the current "new new thing" on Wall Street. Volume in the EU trading scheme is exploding, with new participants joining the party. In fact, Citigroup announced last month the formation of a European carbon trading team, and they further pledged to spend $50 billion in conservation/environmental initiatives over the next decade.

CLE represents a pure play on the growth of carbon trading in the EU. Meanwhile, CCX and CCFE (Chicago Climate Futures Exchange) are the clear marketplace leaders in the US in GHG trading....CCFE is THE exchange for SO2 trading, and their recently-listed NOx contract is off to a good start....CO2 trading on CCX is still slowly developing, but the prospects look good. Last year's total volume traded was 10mm tons. Through mid-May, CCX has traded nearly 9mm tons. At this pace, CCX should trade roughly 25mm tons for 2007. While CCX volume is dwarfed by ECX, we all know that the US is a much larger potential CO2 marketplace if/when mandatory GHG trading regulations get enacted.

So, ECX volume should continue to grow very strongly over the next several years, allowing CLE stock price to grow into its current valuation. In the meantime, the company's fortunes will skyrocket if/when US legislation comes into play. Also, don't forget that the company has several joint venture arrangements with foreign exchanges such as the Montreal and Mumbai ones to develop carbon trading platforms.

So, the growth potential for CLE is quite abundant....And, growth is what investors (both stock market investors and corporate players) seek.

Final thought for you to consider....ICE does the clearing of ECX trades, for which it receives approximately 28% of the revenues...So, while ICE may not have an equity investment in CLE, it truly does benefit from the growth at ECX. I believe they have a similar arrangement with CCX for clearing.

So, you might be right that CLE stock is a bit overvalued. If the overall market landscape should experience a hiccup, CLE stock could have quite a fall....However, the underlying fundamentals of carbon trading are clearly bullish....CLE is the purest equity play on that theme.

Don't be surprised in the next 18 months if CLE gets mentioned in the M&A world as a potential buyout candidate....ICE bought the NY Board of Trade (a stodgy old exchange focused on coffee, sugar, etc.) for approximately $1 bn last year. The growth prospects for carbon trading has to dwarf those of coffee and sugar. ECX and CCX are already electronic marketplaces with no legacy costs to have to bear in order to convert them to electronic trading....ECX and CCX are both cyber markets today. No costly real estate or maintenance expenses...

Just my two cents on an early Saturday morning.

Email 2:


One more thing to consider about CCX right now.

NYMEX made a splashy anncmt this past week how they want to introduce CO2 trading. Frankly, it shines the spotlight on the potential for growth in that sector here in the states. However, NYMEX cannot possibly hope to compete credibly with CCX at this time.

If Congress and President Bush signed mandatory GHG legislation today, it would be 3 years before a program could be implemented and be ready for trading. That leaves the voluntary market as the only proxy to trade CO2 at the moment. If such momentum develops to want to trade voluntary CO2, CCX already has the contract in place.

NYMEX cannot hope to create a voluntary contract because CCX will not license its CASH contract to NYMEX. NYMEX will be forced to create its own voluntary CASH market in order to trade CO2....CCX has spent nearly 4 years creating the rules, regulations, and auditing process to establish the market we see today....Because any scheme that NYMEX introduces will have to be voluntary (remember, no mandatory law), they will have to convince the large and growing members of CCX to abandon their successful market to come join theirs....I don't think this is likely. It is a large undertaking to design and implement the rules and regs to establish the framework of a voluntary market. Moreover, CCX had the foresight to have their market be regulated by the NASD to alleviate concerns about the integrity of the market. Frankly, I think CCX represents an unimpeachable gold standard for the trading of voluntary CO2. Very little concern about the "carbon cowboy" issue that has recently wracked the voluntary market after the big FT series of articles several weeks ago.

My conclusion.....The more that NYMEX highlights its desire to trade carbon, the more likely it is that smart investors are going to consider the competititve moat that CCX has firmly established in this arena. If voluntary CO2 trading markets begin to expand, CCX is poised to capture most, if not all, of that volume, in my view.

One more thought....CCX recently has seen very strong growth in its membership ranks. Specifically, the class of members called "liquidity providers" has grown very nicely. I take special note that Lehman Brothers recently joined as a "liquidity provider"....Liquidity providers are those companies that join in order to trade the market...They make no commitment to lower their CO2 footprint in the way that regular members do when they join.

My point is that Lehman is the first bulge bracket firm to join CCX as a liquidity provider....Goldman already owns 10+% of CLE. Wall Street is beginning to discover CLE and its family of exchanges.

Bottom line....CLE has a very bright future, despite the possibility for some volatile short-term trading ahead.

May 11, 2007

NYMEX To Get Involved In Emissions Trading

A senior NYMEX official told reporters Wednesday that the exchange was considering getting into the business of carbon emissions trading.

Given the actual, but especially the potential, size of this market, it makes sense that established bourses would take a good hard look at it.

This will probably not be seen as very good news by the folks at Climate Exchange plc [OTC:CXCHF.PK]. Of course, until NYMEX actually unveils anything substantial, this will remain nothing but chatter.

May 08, 2007

Some Emissions Trading News

A lot has happened in the world of carbon finance and emissions trading since we last wrote about this topic, so I felt this might be good time to provide a quick update.

(A) The World Bank Carbon Finance Unit recently released its State and Trends of
the Carbon Market 2007
(PDF document), a periodic assessment of the scale and characteristics of the global market for carbon dioxide emissions.

The Bank found a large increase in the volumes traded (131%) and dollar value (177%) of the global carbon market in 2006 over 2005. Unsurprisingly, the EU ETS continued to account for the bulk of the market's value and volumes.

For a quick summary of the report, see this recent article by Environmental Finance. One of the brokers interviewed in the article argues that the Bank's estimates have a downward bias of up to 25% because of the opacity surrounding certain trades.

Needless to say, these are impressive numbers, especially given how low carbon prices have been in the EU ETS over the past year. I don't want to get into a long discussion here, but suffices to say that those are encouraging numbers. Keep in mind, however, that the bulk (typically upwards of 70%) of volumes are traded in OTC markets rather than on exchanges.

(B) On April 17, the magazine Carbon Finance reported that S&P was to begin rating carbon funds.

As carbon emissions trading grows, you can expect such funds to grow in number and value, and this should be seen as a leading indicator of that future growth.

(C) On April 23, UBS announced that it was launching the world's first global warming index.

The FT article to which I link above notes:

"Retail and institutional investors will also be able to buy exposure to, or short sell, the index in much the same way they would with the FTSE or Dow Jones stock indices. If temperatures rise, so will the value of the index."

Our regular readers may also remember that we reported on UBS' launch of a carbon emissions index a few months ago.

(D) Finally, Climate Exchange plc, a company we've discussed on several occasions in the past, released its 2006 financial results on April 19 (thanks to Mike Temple for the heads up).

Operating revenue growth was impressive, standing at GBP 4.1 million for the year, up from GBP 0.8 million in 2005. Nevertheless, the company is still not profitable and the share price (for the ADR) [OTC:CXCHF.PK] is up over 100% in just 3 months. There's currently a lot of future growth (and speculation) priced into this stock and my sense is that it with the next market correction, it will pull back in a pretty significant way.

While I am kicking myself for not snapping this one up at when it was trading at around $12 in early February, I am confident that it will eventually pull back enough to become attractive again. For the time being, however, I find it a tad pricey and I wouldn't be surprised if when this stock breaks the holding pattern its been in for a few weeks it is with a break to the downside.

March 22, 2007

US Exchanges And Environmental Investing

An interesting bit of follow-up on my article last week about exchanges and environmental markets. Both the NYMEX [NYSE:NMX] and the Chicago Climate Exchange (CCX) [OTC:CXCHF.PK] have partnered up, in the past 2 weeks, with specialty cleantech and alt energy index makers to launch derivatives products.

On March 14, Chicago Climate Futures Exchange (CCFE), a wholly owned subsidiary of the CCX, and WilderShares LLC, announced (PDF document) a licensing agreement to launch a futures market based on the WilderHill Clean Energy Index [AMEX:^ECO]. The ECO is also the underlying index for the Powershares WilderHill Clean Energy Portfolio ETF [NYMEX:PBW].

The CCFE-ECO Index futures, as they will be known, are the CCX' first foray outside of the world of emissions trading and into the realm of cleantech investing. If you were wondering where a pure-play environmental exchange would ever diversify, you got your answer.

Then, on March 20, NYMEX concluded an agreement with Ardour Global Indexes, LLC "to introduce alternative energy index futures and options contracts." The contract will be based on the Ardour Global Index (AGI) series, of which I counted 6 on Ardour's website (priced either in USD or in EUR).

To be sure, listing derivatives based on alt energy and cleantech is different from seeking exposure to pure environmental markets as I defined them last week. Nevertheless, this is all parts and parcels of the same broad movement. Once solid cash markets for environmental commodities are in place, the relationship between environmental markets and cleantech/alt energy stocks/indexes will become clearer, and a larger array of options will becoming available for investors to hedge their bets or exploit inefficiencies.

So let me reiterate what I said at the end of last week's article: keep an eye on how exchanges are positioning themselves with regards to environmentally-driven markets, as these markets will present very attractive growth opportunities in years ahead.

P.S. The Climate Exchange ADR [OTC:CXCHF.PK] has rebounded somewhat since last week - it closed at 16.25 today up from around 12.50 last Thursday.

DISCLOSURE: I do not hold a position in any of the stocks discussed in this article.

March 20, 2007

Carbon Emissions ETF

Today, while reading an article on cleantech ETFs by The Motley Fool, I found out that XShares Advisors LLC and the Chicago Climate Exchange were working on a carbon emissions-based ETF (PDF document).

There is not a lot of info available on what exactly this ETF will track. We reported back in November that UBS had launched an index based on European carbon prices. As noted by Richard Kang at around the same time, this index is well-suited for something like an ETF.

If any of our readers have any further insight on this, don't hesitate to share it with the rest of us.

March 15, 2007

Environmental Markets: The Next Frontier in Environmental Investing?

The term environmental markets remains foreign to most investors (and environmentalists!), even though these markets represent, in my view, a very compelling investment story. Although we've discussed trading in carbon emissions in the past, I thought I would expand a bit and talk about environmental markets in general, and about good ways to play them.

What's An Environmental Market?

Environmental markets exist at the confluence of two movements:

(a) A growing desire on the part of national and regional governments in several countries to both limit environmentally-damaging behavior and to promote the growth of alternative energy sources

(b) A realization by policy-makers that economists were indeed right - if you let the market sort it out on its own you will most likely end up with a more efficient outcome than if you try to tell it what to do

Environmental markets serve one of two purposes.

First, scarcity for an undesirable environmental commodity is created via regulation (e.g. a cap on emissions of a pollutant) and market participants must determine, among themselves, who needs that commodity most and what is a fair price to pay for it. A token example, and one which we've discussed here on several occasions, is trading in greenhouse gas emissions, also called carbon trading.

Second, the production and/or use of an environmentally-desirable commodity is mandated by government, and market participants are allowed to trade certificates worth a certain number of units of that commodity. The best example in this case is the use of Renewable Energy Certificate (REC) programs in several US states to promote renewable energy. RECs certify that a certain amount of green power has been produced and pumped into the grid, and a company under obligation to use renewable energy can buy RECs to meet that obligation instead of producing the clean power directly.

To be sure, environmental markets are, by and large, far from mature. The European Emissions Trading Scheme (ETS), the largest and most liquid environmental market in the world, continues to be dominated by brokers. Latest estimates place the share of OTC markets at around 71% of total traded volumes for the ETS, while exchanges get the remainder. With regards to RECs, there are issues with their transferability between jurisdictions.

But environmental markets are at most a few years old, and never in their history have there been as many policies and regulations in place to favor their expansion. As issues of scale, liquidity and jurisdictional transferability are worked out, I am certain that we will see the rise of healthy cash markets for a number of positive and negative environmental commodities, further bolstered by advances in electronic trading.

Who's Playing Environmental Markets?

What initially got me thinking of writing this post was a press release by a Massachusetts-based, Toronto-listed company called World Energy Solutions [TSE:XWE] announcing that a solar REC trade had been completed through its trading platform. In its own words, "World Energy is an energy brokerage company that has developed the World Energy Exchange online auction platforms, through which a diverse set of energy buyers and sellers can trade energy, financial instruments and renewable energy credits [...]" Basically, it's an exchange.

Then, out of curiosity, I decided to check, after hearing that it had made an unsolicited bid for the Chicago Board of Trade, whether IntercontinentalExchange [NYSE:ICE] offered any environmental products. Turns out it does: it recently launched an ETS-based futures contract in collaboration with the European Climate Exchange, the outfit responsible for about 75% of volumes in the European exchange-traded carbon market.

And then I remembered that, about a month ago, the Montreal Exchange, the exchange responsible for derivatives in Canada, had announced a Canadian energy-focused strategic partnership (PDF document) with NYMEX. Canada has become, by most accounts, a global energy heavyweight. The Montreal Exchange also recently set up the Montreal Climate Exchange (PDF document) in collaboration with the Chicago Climate Exchange. Part of the NYMEX partnership entails opening offices in Alberta, not only home to Canada's famous oil sands but also the largest single source of its infamous greenhouse gases. A recent research note (PDF document) by CIBC World Market conservatively estimates the value of a potential Canadian carbon market at around C$12 billion (circa US$10.2 billion) - not a bad niche to be in.

Finally, I would be remiss if I did not also mention Climate Exchange plc, a little outfit we've discussed on several occasions in the past. Climate Exchange [LSE:CLE or OTC:CXCHF.PK] owns both the European Climate Exchange and Chicago Climate Exchange, and is about 19% owned by Goldman Sachs. Of all of the companies discussed above, this is the only environmental trading pure-play.

So What's Point of All This..?

Environmental markets are currently in their infancy, but there are a number of macro drivers at play that should see them emerge as healthy industries in their own right. Over the next decade, they will become larger in size and value, more liquid, increasingly exchange-based, and, because of their nature, many of them could be international before too long (e.g. the carbon market).

But environmental markets are, by and large, playgrounds for institutional actors. Most retail investors, if they want a piece of that pie, will likely have to look at the intermediaries that allow environmental trades to take place - namely exchanges. As an asset class, exchanges have done extremely well over the past few years, and it would be worth keeping an eye on how they position themselves with regards to environmental markets, as these markets should offer good growth potential.

DISCLOSURE: I do not have positions in any of the securities discussed in this article.

March 02, 2007

Wall Street And Climate Change Get Cosier And Cosier...

A couple of interesting news from Wall Street this week in the realm of carbon finance.

Firstly, on Tuesday, JP Morgan announced the launch of what is, as far as I can tell, the first ever bond index with a special climate change risk overlay. In the interest of disclosure, I was tangentially involved with this project. While this overlay probably won't have much of an impact in the very near term, it will be interesting to see what happens once constituent firms are all subjected to some form of greenhouse gas regulation.

Second, on Thursday, Lehman Brothers announced the appointment of company veteran Theodore Roosevelt IV "to head a new effort to address the challenges of global warming." I bet a great deal of his activities will be focused on figuring out ways to address the opportunities of global warming too.

Have a good weekend!

February 04, 2007

ADR For Climate Exchange plc

One of our readers made a useful comment on our last post about Goldman Sachs and Climate Exchange plc. I thought some of you who are unlikely to go back to that post might be interested:

"Hey this article on the Climate Exchange was great information. But you should tell your readers that there is an ADR trading OTC here in the states - CXCHF. Get it while the gettin is good. How long 'til GS takes this to the big board?"

Thanks for this heads up, cascadehigh.

UPDATE: Following this post, I got the following note from another reader:

"I have not been able to track down any financial info on this company. It trades on the pink sheets, which is immediate reason for caution. It's a very interesting prospect, but where can I find any info on this company?"

This is a very good point, and one worth discussing. Climate Exchange plc [LSE:CLE or OTC:CXCHF.PK] is an interesting beast because, although carbon trading and the CCX and ECX have been in the news plenty of late, there is very little publicly available info on the holding company itself.

Climate Exchange's primary listing is on the LSE's AIM. You can purchase, for GBP10, a Company Profile on CLE.L from the LSE. You can also buy a report on the company by Reuters for $20 here.

If you are looking for free investment-relevant info on CLE.L, I would recommend the following: (a) ADVFN's section on CLE.L; (b) the CCX' news section; the ECX' news section; and Hemscott's section on CLE.L (you have to register to access the information, but that is free of charge).

One of the most interesting "intangibles" about this company is that Dr. Richard L. Sandor, AKA the "Father of Financial Futures", is its chairman.

DISCLOSURE: I don't have a position in either CLE.L or the ADR.

January 17, 2007

Hedging Your Climate Risks

Whether you agree it's because of human activity or not (and, for the record, I do), there's no doubt that the weather has been a little wacky over the past few years, driving a range of events that have had very real repercussions on businesses and the economy. Hurricane Katrina is one obvious example, but there have also been other, more subtle cases.

Many ski resort operators in North America, for instance, were beginning to believe that winter would never arrive on the eastern side of the continent. In the west, we're now being told that cold weather may have jeopardized a large part of California's orange crop.

Several businesses, from golf courses to gas utilities, can be materially impacted by the vagaries of the weather. If you do believe that climate change is indeed an anthropogenic phenomenon, and thus that we're only beginning to feel its impacts, you also probably believe that businesses will increasingly need to find ways to hedge their exposure to weater-related risks.

That is where Weather Bill comes in. The new company, which was discussed in a Red Herring article yesterday and profiled on CNBC's Closing Bell tonight (video), offers weather hedging contracts for businesses. In a nutshell, if you get hurt by bad weather (e.g. too much rain over your golf course = lower revenues), this triggers a payout and you are compensated for some of your loss. If the sun shines (over your golf course), you loose all of your money.

Insurance majors have been in the business of offering similar products for a while. Various forms of weather risk-hedging mechanisms allowing firms to tap straight into the liquidity of financial markets have also emerged over the past few years. So-called cat bonds are a good example. What Weather Bill will add to this space, as far as I can tell, is accessibility for smaller players who don't necessarily have the means and/or the saavy to effectively play the weather markets, as they are called.

There isn't really an immediate investment angle here, but I thought our readers would enjoy the heads up on some of the business opportunities that are arising in response to climate change.

To conclude this post, Jim Jubak over at wrote an interesting article entitled "Turn a Profit From Global-Warming Stocks". The title says it all! Have a read.

Digg This

January 11, 2007

Investing in Climate Change

This post was supposed to be about coal-to-liquids (CTL), but I came across interesting info yesterday after opening a former colleague’s mail that I thought would make for a more interesting post. The CTL piece will thus have to wait a bit.

What was in the package was a hard copy of the January/February 2007 edition of CNBC European Business. This edition is dedicated to climate change, but, more importantly, to how some firms are positioning themselves to benefit from the markets that will be created as a result of regulatory and other actions to tackle greenhouse gas emissions.

Of all of the climate change-related pieces in this edition, I would recommend 2 in particular: “The Green Klondike?, discussing London’s Alternative Investment Market (AIM) and its prominence as a center of alt energy activity, and “The Top 50 Low-carbon Pioneers?, which lists 50 firms that could see some upside from efforts to reduce greenhouse gas emissions.


The visibility of London’s AIM increased significantly post-Sarbanes-Oxley, as many small firms chose to list there instead of the NASDAQ due looser listing requirements and lower costs. It also helped that London was Europe’s principal financial center, with a savvy investor class and plenty of liquidity.

What most people within the alt energy community also know is that the AIM has become, over the past 3 years, a powerhouse of clean tech and alt energy financing. For those interested, New Energy Finance recently released a research note (PDF document) detailing how alt energy companies listed on the AIM have fared so far.

AIM and Investing in Climate Change

Besides being a locus of clean tech activity generally, the AIM also sits at the confluence of 2 converging movements: (a) European efforts to tackle change via market-based means such as emissions trading and (b) growing investor interest in all things alt energy and clean tech. The AIM is therefore becoming a meeting point for firms with solutions to climate change and investors with a strong interest in seeing the solutions these firms have to offer succeed.

The second article that I mentioned initially lists 50 companies that CNBC identifies as having positive exposure to climate change (i.e. that are positioned to benefit as regulations to reduce greenhouse gas emissions are enacted and/or tightened). Of the 50, there are a number of large-cap companies for which, I believe, climate change really won’t be a make or break issue…at least in the foreseeable future. There are also a number of alt energy companies that don’t have a specific focus on climate change per se.

I thus decided to go over the list and pull out, for you, 4 AIM-listed firms with a clear strategic focus on climate change and carbon finance, or emissions trading in carbon credits. These companies can be considered carbon finance pure-plays, and are likely at the fore of a movement likely to grow significantly in the next decade. The companies are:

Climate Exchange plc [LSE:CLE]: Owns the European Climate Exchange, responsible for 80% of exchange-traded volumes of carbon dioxide in Europe, as well as the Chicago Climate Exchange, the only carbon dioxide emissions trading platform currently functioning in the US. Goldman Sachs has a 10% stake in Climate Exchange.

Ecosecurities [LSE:ECO]: Ecosecurities sources, develops and trades carbon dioxide credits. The company finances deals that generate emissions credits, mostly in emerging markets, which can then be sold to mostly developed market companies to meet their compliance obligations.

Camco International [LSE:CAO]: Camco advises companies on how to originate carbon credits in emerging and transiotion economies, with a particular focus on the Russian and Chinese markets as well as Africa and the CEE.

Low Carbon Accelerator [LSE:LCA]: LCA is a private equity fund dedicated to businesses that reduce carbon emissions. Its biggest investor is ABM Amro. No chart.

There are a number of other interesting companies on the list of 50, including good plays on the wind, solar, biofuels and fuel cell markets. The alt energy and clean tech sectors will see some upside related efforts to solve climate change, although climate change is not necessarily the primary driver in this space. The 4 securities listed above have business models that are truly focused on greenhouse gas reduction and emissions trading, and the expertise they are developing will no doubt be worth a lot of money one day, especially as emissions trading extends to North America.

December 13, 2006

EDF Sets Up Carbon Fund

The French electric utility EDF [CAC:EDF] announced today that it is setting up a €300 million ($396 million) carbon fund to help meet its regulatory requirements under the EU ETS, Europe’s regulatory framework to control CO2 emissions.

Carbon funds allow companies to make investments that create CO2 emissions reductions in emerging markets, such as upgrades to industrial operations or renewable energy projects, and use the credits generated thus to meet regulatory requirements in their home jurisdictions. This is a good way to concurrently reduce compliance costs at home and foster environmentally-friendly investments in emerging economies. I have discussed recent development in this mechanism of the Kyoto protocol, called the Clean Development Mechanism, in a previous post.

Carbon Funds are nothing new – the World Bank has been running carbon funds for some time now. What is interesting is that a growing numbers of companies and financial institutions are going at it without the support of governments and the World Bank, indicating a certain level of maturing in that market.

As discussed in a previous post on carbon finance, certain players in the North American financial services industry, most notably Goldman Sachs [NYSE:GS] and Morgan Stanley [NYSE:MS], have begun positioning themselves in anticipation of climate change regulations on this side of the pond. Opportunities tied to emissions trading exist in a number of areas such as brokerage, investment banking, information provision and strategic consulting.

November 22, 2006

Update on the Global Carbon Market

The World Bank Carbon Finance Unit recently released its Q3 2006 update for the global market for CO2 emissions (the carbon market). The document, entitled “State and Trends of the Carbon Market 2006? (PDF file), contains some pretty interesting information that makes it difficult not to be bullish on the future of emissions trading.

Here are some numbers. At the end of Q3 2006, the total value of the market stood at $21.5 billion, up 94% on the whole of 2005 ($11.1 billion). Unsurprisingly, Europe, with its Emissions Trading Scheme, continues to account for the bulk (~99%) of the so-called “allowances? market (I’ll come back to this in a minute). Growth on the Chicago Climate Exchange is also pretty healthy, although the absolute numbers are nothing to write home about just yet. The value of the market currently stands at $27.2 million, up from $2.83 million for the whole of 2005 – I’ll let you do the math. Trading on the CCX has so far been entirely voluntary, but the Democrats’ recent victory takes regulation-driven trading one step closer. Federally-imposed CO2 caps with trading would push the value of the US emissions market far above that of Europe’s. Even without action on climate change at the federal level, the World Bank identifies California’s AB 32 and the RGGI (PDF file) as two of the three most significant global regulatory developments to watch out for in the next few years.

The global carbon market is currently broken down into 2 sub-markets: (a) the “allowances? market (~89% of total market value at Q3’06) and (b) the “project-based? market (the remaining 11%). In a nutshell, the “allowances? market is created when emitters in a jurisdiction where CO2 emissions are capped trade rights to emit on exchanges like the CCX or in OTC markets. The “project-based? market exists because the Kyoto protocol allows entities (e.g. emitters, project developers, financial institutions, etc.) to invest in projects in emerging economies that generate CO2 emissions reductions there, convert those reductions into “allowances?, and then bring the “allowances? back to jurisdictions where emissions are regulated to be sold in CO2 markets. By the World Bank's own admission, reliable data on the project-based market is relatively hard to come by as there is often a strategic angle to such investments, leading companies to be pretty secretive about them. That market is currently worth about $2.4 billion, 60% of which is attributable to investments in China.

Now the interesting thing to note about the project-based market is that while its size is not growing as rapidly as that of the carbon market as a whole, the sophistication of market players is increasing. For instance, while entities on the supply side used to be primarily concerned with generating and selling CO2 allowances, there is now evidence that the spectrum of activities they engage in is widening to include more traditional activities like debt, equipment sales, other commodity sales, etc. The World Bank notes that pure play CO2 sellers are loosing ground to more diversified entities that seek to create income streams from the range of options available to them, partly to hedge against the volatility of CO2 prices. On the flipside of this, don’t be surprised if conventional project financiers in emerging markets begin integrating “carbon income? in their valuation models and DCF analyses for certain categories of projects. This has the potential to create the right incentive, at the margin, to make it economical to go with the cleaner but more expensive technological option.

The other interesting trend highlighted in the report is the increased involvement of investor-owned insurance companies in these markets to help shield against the wealth of risks that exist both in carbon markets and in investing in emerging economies. Leading players named by the report include Swiss Re, Munich Re, AIG and Allianz, among others. (DISCLOSURE: We do not own, or otherwise have financial interests in, any of these companies)

Now I know this may not sound like anything to get too excited about at this point, but investors in the US really should have their sight set on this stuff. Besides the state-based initiatives I’ve discussed before, federally-imposed caps on CO2 emissions look increasingly likely. will continue to follow developments in the emissions trading space for our readers, as we believe significant opportunities should arise in the next few years.

Note: If you are not familiar with the terms 'carbon markets' and 'emissions trading' or would like to know more, I suggest reading or looking over the following: An Overview of Carbon Markets and Emissions Trading, Carbon Credit - The Next Big Thing, and Kyoto, Carbon Credits, and a Big Market for Cleantech .

November 06, 2006

UBS Launches CO2 Emissions Index

UBS (NYSE:UBS) announced on Friday the launch of the UBS World Emissions Index (UBS-WEMI) – the world’s first index based on global carbon markets. At the moment, only the two exchanges linked to the EU Emissions Trading Scheme (ETS) , the Nordic Power Exchange (Nordpool) and the European Climate Exchange (ECX), qualify for WEMI. The index is composed of future contracts on CO2 weighted between the two trading platforms as follows: ECX, 72.11% and Nordpool, 27.89%. The weights are allocated based upon the liquidity of the underlying exchanges as well as their respective share in the European carbon market. The index is calculated in USD, EUR and CHF and the following three indices are published daily: (a) price, (b) excess return, and (c) total return.

The admissibility of a given carbon trading platform to WEMI rests, beyond liquidity and open interest considerations, on links to a formal emissions reduction scheme containing an allowances program and financial penalties for non-compliance. UBS will thus be looking to expand the index as more such programs are implemented, notably in the north east and California.

Now the interesting thing about WEMI is that it will provide the first ever benchmark for derivatives referencing carbon markets. Although the word “world? is a bit of a misnomer (the conditions required by WEMI for inclusion only currently exist in Europe and won’t exist anywhere else, barring a major surprise, until RGGI goes into effect in 2009), this initiative provides an interesting first look at the spectrum of possibilities that will arise once more jurisdictions jump on the carbon trading bandwagon. Such indices will provide excellent bases for financial engineers to unleash their creativity in constructing structured products around global carbon markets. UBS already offers two products based on its index – one priced in USD and the other in CHF.

November 02, 2006

Climate change, carbon trading and's only a matter of time

Just a quick follow-up on my carbon trading post a few days ago. Thanks to for the heads up on the results of a survey that were released during MIT's seventh annual Carbon Sequestration Initiative Forum. The results show that climate change now tops the list of environmental concerns for Americans. I don't want to reveal too much here since this is a story, but it suffices to say that this provides yet more ammunition to the political backers of a framework to reduce greenhouses gases in America. Momentum is building and there will definitely be some loosers but there will also be some big winners. More on this later.

Just to wrap up this morning's post, I came across a good piece on the RGGI and California's AB32 on Evolution Markets' website today. At the very bottom of their homepage, there is a link to a piece is entitled (warning, PDF) Bicoastal Carbon Trading: California and RGGI Markets Mapped Out. Evolution Markets provides a range of services related to energy and environmental markets (DISCLOSURE: I am not affiliated with them and do not have any finanical interest in them).

October 29, 2006

Carbon Finance…The Next Bonanza

Few investors outside of Europe have ever heard of the term carbon finance. What some investors might have heard, however, is that Goldman Sachs took, on September 20, 2006, a 10.1% stake in a little outfit known as Climate Exchange plc (LSE:CLE) for approximately $23 million. Admittedly, by Goldman Sachs standards, that’s peanuts. Not to be outdone, Morgan Stanley unveiled a plan on Thursday October 26 to invest a whopping $3 billion in global carbon markets over the next few years…now that’s the kind of money that gets folks talking at the water cooler, especially when it’s in something they’ve never heard of.

What is carbon trading and how does it work?

Emissions trading is an innovative concept that was first used in the US to reduce emissions of the acid rain-forming gases NOx and SO2. It entails placing a cap on the total emissions of a given pollutant within an imaginary ‘bubble’ (e.g. an industrial district, a city, a state, or, in the case of carbon dioxide (CO2), the whole planet), and allowing emitters of that pollutant to sort out, among themselves, who should emit how much of that limit based on factors such as the nature of their industries, the efficiency of their operations, periodic requirements for higher commercial output, etc.

Lets look at an example. Imagine an industrial district with 3 plants operating in it. Local regulators determine that a maximum of 5 units of pollutant X can go into the atmosphere for any one year. Plant A purchases emissions rights for 3 units, Plant B for 1 and Plant C for 1. Plant A later decides to invest in a new technology and only emits 2 units per year as a result. At the same time, Plant B receives a big order and must scale up production, causing it to increase its output of pollutant X to 2 units. Plant A sells its spare unit to Plant B, and nothing changes for Plant C – there are still no more than 5 units of pollutant X going into the atmosphere, but the allocation of those 5 units has changed. The environmentally-optimal emission level thus never gets exceeded but the market, rather than regulators, decide on the most efficient way to divide up that limit among participating entities.

The Global Carbon Market

An interesting thing about CO2 and other greenhouse gases (GHGs) is that they are global pollutants, meaning that the end result of their presence in the atmosphere in large quantities will be the same whether they came from a Chinese power plant or an American SUV. This spells great possibilities for coordination between national regulatory bodies and the eventual setting up of a global marketplace for CO2 emissions rights.

The market for CO2 emissions currently exists in 2 forms: (a) in jurisdictions where there are legislative frameworks with formal targets in place to control GHGs, such as in the EU, carbon markets, as they are called, form the cornerstone of regulatory implementation, and (b) in areas where there are no regulations but certain market players adopt voluntary emissions targets, such as in the US, carbon trading is one tool used to meet those targets. The actual exchanges used to carry out carbon trades are known as climate exchanges, although many trades also occur in OTC markets.

In the EU, the Emissions Trading Scheme (ETS) came into force on January 1, 2005. That year, the first one during which selected facilities were subjected enforceable regulatory limits, the value of the market reached $8.2 billion. By half-year 2006, carbon finance information provider Point Carbon reported that the ETS’ value already stood at $12.5 billion. Point Carbon estimates that the global carbon market, including both the ETS and voluntary initiatives such as the Chicago Climate Exchange (CCX), will be worth upwards of $27 billion by the end of 2006, up from around $12 billion in 2005 and $377 million in 2004. Now the ETS will continue to account for the bulk of this until other jurisdictions adopt mandatory GHG targets, and that’s where it gets interesting.

Most folks outside of environmental or political punditry circles probably didn’t pay too much attention to the signing into law of Assembly Bill 32 in California just a few weeks back. AB 32 will impose firm caps on GHG emissions in that state, the 6th largest economy in the world, starting in 2012, and will in all likelihood rely on carbon trading to achieve its targets. The Regional Greenhouse Gas Initiative (RGGI) is another interesting development that has been in the works for some time. RGGI will cap GHG emissions from power producers in Northeastern and Mid-Atlantic states and establish a trading system starting in 2009. Even more interesting is the growing number of commentators that now predict federally-imposed GHG emissions targets sometime in the near- to medium-term.

Seeing as the US (a) accounts for about 25% of global GHG emissions and (b) houses the most liquid financial markets in the world, we could be talking about some pretty big money here. A recent Financial Times article estimates that, should consensus be attained on a plan to fight global climate change between the largest emitting jurisdictions, expenditures could top $1,000 billion within 5 years. Seen under this light, those recent announcements by Morgan Stanley and Goldman Sachs look increasingly less like a means to placate environmentalists and earn a little goodwill, and increasingly more like pretty sound strategic positioning to cash in on a pretty significant business opportunity.

How Do I Play This?

Admittedly, this is mostly institutional stuff and that’s probably where a lot of the action will be. But retail investors can definitely get a piece of the pie, too. One good way to play this is to be on the lookout for companies with promising technologies that are sure to get big uptake under the right regulatory scenario. Citigroup Investment Research, in collaboration with the World Resource Institute, a highly respected DC-based environmental think-thank, released this study a few months ago discussing 12 large-cap companies they believe are well positioned to cash in.

The most significant potential upside probably rests, however, with small-cap clean tech pure plays discussed daily on of blogs such as this one. There is an increasing amount of those companies out there, both publicly-listed or at various stages of the VC funding process, and, if you pick wisely, have sufficient nerve and the right amount of patience, you will probably do pretty well. For the more cautious folks out there, a growing number of large industrial concerns like GE, DuPont, Siemens, BP, etc are looking at this and investing big money in R&D to position themselves and their technologies.

But today I want to discuss a pretty unique way to play the climate bonanza: buying directly into climate exchanges. Climate Exchange plc (disclosure: I don’t own it, but am definitely looking at it), the company in which Goldman took a 10.1% stake back in September, has had a pretty nice run since the entry into force of the ETS (see 3 charts below). The company owns both the European Climate Exchange (ECX), the entity with the biggest share of the European exchange-traded carbon market (~80% of volume), and the Chicago Climate Exchange, the only outfit with a functioning carbon trading platform in the US. Volumes traded on both exchanges are growing, fast.

In the 8 months ended 31 August 2006, CCX traded approximately 8 million metric tonnes of carbon in comparison with 0.53 million metric tonnes traded over the same period in 2005. ECX saw trading volumes of 257 million tonnes in the first eight months of 2006 compared with volumes traded from April 2005 (commencement of trading) to December of 95 million tonnes. Now that’s all nice and well. But imagine what would happen to the stock of the only (so far) owner of a carbon trading platform in the US if the Feds were to announce a climate change plan. Even without that, AB 32 and the RGGI should provide plenty of volume in the next few years even before they enter into force, as targeted companies will surely want to hone their carbon trading skills before they’re faced with enforceable targets.

Closing Thoughts on Carbon Finance

To those who kick and scream every time they hear the words climate change or Kyoto, keep these two things in mind. First, there is far more scientific consensus on this then Fox News would have you believe - GHG's will one day be regulated . Second, it’s not all downside. You need to see this as Goldman is seeing this - as a big opportunity.

Is there going to be a massive transfer of wealth away from inefficient and dirty companies towards cunning investors who understand carbon trading? That remains to be seen but I, and some big institutions, strongly believe that to be the case. I see a great opportunity in carbon finance for those who can navigate the waters ahead.

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