Environmental Markets Archives


February 15, 2017

The Republican-Proposed Carbon Tax

by Noah Kaufman

A group of prominent conservative Republicans—including former Secretary of State James Baker III, former Treasury Secretary Hank Paulson, former Secretary of State George Shultz and former Walmart Chairman Rob Walton—met with key members of the Trump administration on Wednesday about their proposal to tax carbon dioxide emissions and return the proceeds to the American people. Such an economy-wide tax on carbon dioxide could enable the United States to achieve its international emissions targets with better economic outcomes than under a purely regulatory approach.

Attributes of the Republican Carbon Tax Proposal

While the details on the plan from the newly formed Carbon Leadership Coalition (CLC) are considerably less specific than a legislative proposal, this is a well-thought-out and ambitious plan that makes a good-faith effort at addressing many of the difficult choices on the path to enacting a carbon tax. Consider the following attributes:

  • Significantly reduces emissions. The group proposes a tax that would start at $40 per ton of carbon dioxide emissions from fossil fuels and increase over time. A paper released by CLC provides a useful summary of recent modeling efforts on the effects of a carbon tax on emissions. It concludes that the CLC proposal (including the effects of rolling back some regulations) would reduce greenhouse gas emissions roughly 28 percent below 2005 levels by 2025, the upper end of the United States’ commitment under the Paris Agreement on climate change. It also implicitly recognizes concerns of the environmental community by calling for a rate that is high enough to provide greater emissions reductions than regulations already in place. WRI research shows that models tend to underestimate the emissions reductions from a carbon tax, so it seems likely that the United States would achieve its 2025 emissions target under this proposal.

  • Benefits for poor and middle classes. As WRI research has shown, a carbon tax’s effects on household finances are most heavily dependent on how the revenue is used. According to the CLC proposal, all tax proceeds would be returned to the American people on an equal basis via quarterly dividend checks. CLC chose this approach because of its transparency and because the longevity of the policy would be “secured by the popularity of dividends.” In addition, this tax-and-dividend approach would be highly beneficial to poor and middle-class households, who would receive far more in dividends than they would spend on the tax. (Of course, these households—and all households—would also benefit from cleaner air and reduced risks of climate change.) High-income households, on the other hand, would be better off if the revenue were used in other ways, such as to lower other taxes.

  • Addresses concerns about U.S. competitiveness and international action. A core pillar of the CLC proposal is a “border carbon adjustment.” Exports to countries without comparable policies would receive rebates for carbon taxes paid, while imports from such countries would face fees contingent on the carbon content of their products. The border carbon adjustment would protect the competitiveness of energy-intensive companies and those that are subject to foreign competition. It would also encourage all U.S. trading partners to adopt similarly stringent policies, which is necessary to achieve meaningful global progress on climate change.

  • Cost-effectively reduces emissions. As economists will tell you, putting a price on emissions is the most cost-effective way to reduce them because it encourages producers and consumers to seek out the lowest-cost opportunities to reduce their emissions. Economic models show that for decarbonizing the U.S. economy, economic outcomes are far better with a carbon tax as the centerpiece of policy efforts as compared to a strictly regulatory approach.

  • Offers potential for bipartisan support. Transforming to a low-carbon economy is an objective that Democrats widely support, but it will require new and comprehensive legislation that attracts Republican support as well. Prominent Republicans are supportive of the CLC proposal because it embraces both free markets and limited government with its plan to eliminate regulations that are no longer necessary with the existence of the carbon tax (“Less Government, Less Pollution,” as CLC puts it).

More Details Eventually Needed

The CLC proposal will need to gain support from policymakers currently in office for it to become proposed legislation. If it does, important details will need to be filled in. Examples include:

  • Details of the regulatory reform. The CLC plan involves replacing much of EPA’s regulatory authority over carbon dioxide emissions. Environmental groups are likely to push for mechanisms to ensure that the emissions reductions needed to meet climate goals are sufficiently certain; the Environmental Defense Fund recently described options for combining such “Environmental Integrity Mechanisms” with a carbon tax. In addition, the policy should avoid eliminating regulations that are not duplicative with a carbon tax. For example, WRI research has explained why supporting the research, development and deployment of the next generation of low-carbon technologies will lead to more cost-effective decarbonization in the long-run.

  • Support for coal communities. While the near-term effects of a carbon tax on the vast majority of American households and businesses would be small, communities of coal industry workers (and others whose livelihoods are tied to a high-carbon economy) are already struggling. In order to avoid making the situation worse, certain policy measures must be in place to help rebuild these economies. Whether by allocating tax revenues to economic development in these communities (just a small sliver of the tax revenue could provide enormous help) or though separate legislation, support for workers in the fossil fuel industry should be a key consideration in designing our country’s decarbonization strategy.

There is strong support for carbon taxes among the American public and in the business community, including more than two-thirds of all Americans and more than half of Republicans. Nearly 40 countries and more than 20 sub-national jurisdictions are now pricing carbon.

Despite this support, political gridlock and the powerful corporate opposition have obstructed policy action at the U.S. federal level. Overcoming these entrenched interests will require courageous politicians. This proposal deserves serious attention from the Trump administration and policymakers on both sides of the aisle.

Noah Kaufman is an economist for the U.S. Climate Initiative  at the World Resources Institute.  The focus of his work is on carbon pricing and other market-based climate change solutions.

July 26, 2016

GlyEco Expands Antifreeze Recycling Footprint

by Debra Fiakas CFA

Glyeco recycles waste glycol into reusable antifreeze, windshield wiper fluid and air conditioning coolants for the automotive and industrial markets.   The used coolant and antifreeze liquids are frequently contaminated with water, dirt, metals and oils.  The company uses a proprietary technology at the foundation of its recycling system to eliminate contaminants.  The company focuses mainly on ethylene glycol in its six processing plants.

Last month chemical recycler GlyEco, Inc. (GLYE:  OTC/QB) acquired Brian’s On-Site Recycling, a provider of antifreeze and air conditioning coolant disposal services in the Tampa, Florida area.  The deal extends Glyeco’s market share and geographic footprint.  The company also gains expertise through the members of Brian’s management team who have agreed to join Glyeco to advance the Glyeco brand in Florida.  Terms of the transaction were not disclosed and Glyeco is keeping mum on the revenue and earnings contribution expected from Brian’s
Image result for glycol imageStill the idea of recycling a hazardous chemical is beguiling.  Ethylene glycol and propylene glycol are the preferred raw materials used for water-based antifreeze due to a mix of favorable properties:  high boiling point, low freezing point and thermal conductivity.  Glycol is typically made from natural gas or crude oil  -  non-renewable and polluting sources.    Glycol does breakdown in water, but it can deplete oxygen levels and kill fish and other aquatic life.  While propylene glycol is more or less non-toxic, it can be extremely corrosive when exposed to air.  On the other hand, ethylene glycol is decidedly poisonous.

The company is still struggling to get the business going.  In the twelve months ending March 2016, Glyeco reported $7.5 million in total sales.  Unfortunately, the antifreeze recycling business is not profitable.  The net loss in that period was $12.3 million or $0.16 per share.  The company had to use $1.3 million in cash to support operations.  With a cash kitty of $3.8 million at the end of March 2016, there is something of a cushion for the company until the business gains sufficient scale to generate profits.  The acquisition of Brian’s should contribute to that end.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

November 06, 2012

Has Shale Gas Reduced Carbon Emissions?

Jim Hansen

Last week, I wrote that the U.S. is on course to set a new export record of coal. A few days later the EIA made similar projections and estimate that exports will reach 125 million tons for 2012.

EIA coal exports on course for record 2012-10-23

One side effect of the success of U.S. coal exports is the degree to which may they have cancelled out the carbon emissions reduction experienced in the U.S. as shale gas displaced coal in the power generation sector. This question of displacement was addressed in a study just released by researchers at the University of Manchester.

The Study’s lead author Dr. John Broderick had this comment on how the coal to gas switching is being broadly viewed. “Research papers and newspaper column inches have focused on the relative emissions from coal and gas. However, it is the total quantity of CO2 from the energy system that matters to the climate.”

“The calculations presented in this report suggest that more than half of the emissions avoided in the US power sector may have been exported as coal. In total, this export is equivalent to 340 MtCO2 emissions elsewhere in the world, i.e. 52% of the 650 MtCO2 of potential emissions avoided within the US.” [Link is to full 29 page report pdf]

It is easy to forget that oil is not the only energy resource with global interactions. Changes in nuclear power use in Japan and the linkage of LNG prices to an oil benchmark impacted the price of seaborne LNG putting pressure on European power generators to expand their use of coal. Add this to the drop in the price of North American thermal coal to levels that made it more competitive in foreign markets and the movement of this carbon intensive fuel shifted off shore.

The issues of climate and energy are bonded at the hip. If either side in the debate over climate and energy forget that relationship the outcome will be unsatisfactory for everyone. One sided solutions are destine to fail the test of time.

Jim Hansen is an investment advisor at Ravenna Capital Management based in Seattle, Washington. He has spoken at the ASPO-USA national conference as well given other public and academic presentations. His weekly report The Master Resource Report is available online.

October 10, 2012

Emissions Standards Driving Algae Aviation Fuel Sourcing...or not

by Debra Fiakas CFA

Algae in the River Wate photo via BigStock

My post “Algae Takes Flight” featured Algae-Tec (ALGXY:  OTC/PK),  Lufthansa’s new biofuel partner.  Algae-Tec has agreed to operate an algae-based biofuel plant in Europe to supply Lufthansa with jet fuel.  Lufthansa is footing the capital costs of the plant, which is to be located in Europe near a carbon source.  Algae thrive on carbon so industrial plants and power plants using fossil fuels make the best neighbors.  Lufthansa has agreed to purchase a minimum of 50% of the algae-based biofuel Algae-Tec can produce.

Australia-based Algae-Tec is not Lufthansa’s first biofuel source.  The same week it inked the deal with Algae-Tec, Lufthansa also entered into a memorandum of understanding with synthetic fuel developer Solena Fuels Corporation.  Solena has already decided on a location at the PCK Industry Park in Schwedt/Oder, Germany.  The plant will use municipal waste to produce bio synthetic paraffinic kerosene, which Solena calls Bio-SPK.

Lufthansa is eager to adopt biofuels in order to comply with the European Union’s emissions trading system (ETS), which added aviation to the mix of industries that must reduce carbon emissions in the EU region.  Airlines had until March 2012 to reach compliance to the EU standards.  In the future, airlines that do not comply could face fines of US$128 per ton of carbon dioxide emissions.  Non-compliance could lead to a ban from European airports.  It is not surprise that According to the U.S. Energy Information Administration, worldwide over 5,000 barrels of jet fuel are used each year, resulting in as much as 635 million tons of carbon dioxide emissions.

Lufthansa burns at least nine million tons of jet fuel each year.  The airline has had some difficulty in sourcing renewable fuels that could reduce it carbon footprint.  In July 2011, Lufthansa began using Neste Oil's (NEF: Berlin) NExBTL renewable aviation fuel in an Airbus A321 aircraft.  Flights between Hamburg and Frankfurt were run in both directions four times a day.  One of the engines of the aircraft operated using a blend of 50% NExBTL renewable aviation fuel and 50% fossil fuel.  However, in January 2012, Lufthansa announced it would be discontinuing flights using renewable jetfuel because it had not been successful in securing long-term sources of biofuel. In all, Lufthansa completed 1,187 biofuel flights between Hamburg and Frankfurt that relied on biofuel.  Lufthansa claimed CO2 emissions were reduced by 1,471 tons.

It would seem that meeting aviation emissions standards in Europe would be a source of significant demand for renewable fuels.  However, it might be premature to expect anything more than modest shifts in fuel sourcing.  After considerable pushback from China and India airlines, the European Union has been considering a rollback of emissions standards.  Members of the U.S. Senate met in August 2012 with representatives from twenty countries to draft a resolution against the EU’s fines.  The group was unable to reach agreement, but the meeting made clear that U.S. leadership is more concerned about profits than environmental sustainability.

In the meantime, several biofuel companies have been cozying up to the aviation industry.  Amyris (AMRS: Nasdaq)is working with Brazil’s Azul Airlines.  Solazyme (SZYM: Nasdaq) has been mentioned as in cooperation with both United and Quantas airlines.  Honeywell’s UOP (HON:  NYSE) is working with India’s Kingfisher Airline, United Airlines, British Airways, France Airways and Spain’s Iberia.  U.S. carriers alone used at least 16.4 million gallons of aviation fuel in 2011 (U.S. Bureau of Transportation Statistics).  At least a third of that is used in international flights.  It presents a very large market opportunity for the biofuel producer that can deliver renewable fuel.  Unless, of course, politicians get in the way.

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

June 25, 2011

Is Energy Sourcing the Gateway Drug to Energy Efficiency?

Tom Konrad CFA

I recently interviewed Richard Domaleski, CEO of World Energy Solutions (NASD:XWES).  World Energy is a comprehensive energy management services firm whose core offering is extremely price competitive energy sourcing (that is, finding an energy provider to supply all of a client's energy needs at the lowest possible cost.) 
world energy logo.png
They achieve competitive sourcing using an electronic energy exchange designed to achieve much better price discovery in what is traditionally a very opaque market.  According to Domaleski, a recent KEMA study showed that only 7% of large commercial, industrial, and government customers are sourcing their energy online; the rest are using traditional brokered or paper-driven deals.  World Energy currently has about 5% of the market, leaving plenty of room for growth.  Among their current customers are the General Services Administration (the Federal Government's procurement arm), several state governments, General Dynamics Land Systems, and Brown University, to name a few. 

They also partner with Energy Service Companies (ESCOs).  ESCOs sign energy customers up to a "Performance Contract" under which the ESCO is paid a fixed fee in order to deliver a defined set of energy services (lighting and temperature levels, for example), and the ESCO makes energy efficiency improvements using their own capital to reduce energy use while still delivering the defined energy services.  The lower energy use quickly repays the ESCO's out of pocket capital cost, leading to lower (and stable) energy bills for the customer, and a healthy profit for the ESCO.

Domaleski says that 143 such ESCOs and other procurement companies now use World Energy's procurement platform to source their energy.  When I asked for names, he cited non-disclosure agreements but was able to say that one prominent one was SAIC (NYSE:SAI).  Yet adoption of World Energy's platform is not universal.  One prominent ESCO they pitched but did not convince is the leading pure-play publicly traded ESCO: Ameresco (NYSE:AMRC).

Is it Green?

Getting electricity and natural gas at lower prices may be a compelling proposition for World Energy's customers, but environmentally concerned investors should think twice before calling it green.  A lower price for energy is more likely to discourage than encourage energy conservation, and hence lead to higher, not lower energy emissions.  Energy sourcing may or may not include the sourcing of green power or Renewable Energy Credits (RECs.)  A REC is a way of accounting for all the green or environmental attributes of a MW of electricity.

World Energy draws a distinction between "physical green power" and RECs, with the former being produced from renewable sources on the same ISO as the customer, and the RECs often produced somewhere else in the world.  I don't think this is a very useful distinction, since the actual power produced is often not the same as the power consumed due to both proximity and timing issues.  A simple example of why this is so can be seen in the case of a supermarket that signs up for 100% locally produced wind power.  While a nearby wind farm will indeed be producing the same number of kWh as the supermarket consumes, the supermarket keeps its lights on and continues to run its refrigeration even when the wind is not blowing at the local farm.  In this sense, "physical green power" is just normal electricity with bundled RECs.

What really makes a REC (or "physical green power") green is additionality.  If the price of the REC is enough to ensure that a wind farm that would not otherwise have been built is indeed built, then the REC is additional.  World Energy's ability to extract the lowest possible price for RECs may work to undermine the additionality of those RECs.  After all, which is more likely to increase the chances of a wind or solar farm being built: a $10 REC, or a $20 REC?

Low Price as a Gateway Drug

Yet it's hard to see saving money as a bad thing, and I find World Energy's numerous ESCO partners very encouraging.  If World Energy's procurement platform enables ESCOs to offer potential customers performance contracts at lower prices, more such customers will sign up, and receive the energy efficiency improvements that are the ESCOs' bread and butter.

World Energy also offers energy efficiency improvements to their direct customers as well as helping those customers capture the utility incentives available for energy efficiency and Demand Response programs.  Demand Response companies like Comverge (NASD:COMV) and EnerNOC (NASD:ENOC) may use World Energy's demand response exchange, but also compete with them to sign up customers directly.  As with ESCOs, World Energy does not say which Demand Response providers use their exchange, but they did say that they have 20 leading providers signed up.

One of the most significant barriers to energy efficiency is simply the complexity of options on offer.  Although the internal rate of return on efficiency investments is very high, the absolute number of dollars available from energy efficiency is seldom enough to sell a facilities manager. Facilities managers seldom have an incentive or expertise to save energy, although this is improving as companies become more energy aware and make changes to employee incentives to fit the new goals.  Yet it is still generally difficult to get most facilities managers to give energy the attention it needs in order to capture the available energy savings.  Lower energy prices, on the other hand, are easy to grasp and communicate to higher-ups.  If World Energy and ESCOs working with them can offer a facilities manager a one-stop shop for both lower energy prices and additional energy savings, they'll be much more willing to take action, even with weak internal incentives.  One step World Energy has recently taken to make this decision much easier is their  strategic investment in Retroficiency a company whose technology will allow World Energy to conduct virtual energy audits for clients based on the detailed energy usage data they are already collecting.  This will allow facilities managers to easily identify the particular buildings in their portfolios most likely to benefit from more detailed energy audits and retrofits.

Other Businesses

World Energy also runs other trading platforms, most notably the platform for trading carbon credits under the Regional Greenhouse Gas Initiative (RGGI).  With New Jersey pulling out of the ten-state RGGI climate initiative, I thought it would be interesting to get Domaleski's perspective, but he was unable to comment due to a confidentiality agreement with RGGI.  This exchange is part of their Green green product line, which accounts for approximately 5% of World Energy's business and includes other environmental commodity trading as well as RGGI.

At the urging of a utility, World Energy has also recently launched a wholesale energy exchange.  This exchange enables utility and municipal customers to find the best price for power from World Energy's 500 suppliers.  This must be a useful service, because in the four years since the exchange was launched, they have signed up 70 large customers.  The company's Wholesale division accounts for roughly 15% of revenues.


The move to internet based energy sourcing seems like an inevitability, and World Energy has a powerful first mover advantage.  While online procurement of energy may not be green in and of itself, the savings on offer serve to get building managers in the door.  If World Energy or its ESCO partners can then include significant energy efficiency and green power in the mix, we have the formula for a significant shift towards a more energy efficient economy.

Walmart CFLs.jpgIn this sense, World Energy may be a lot like Wal-Mart.  Customers come in the door for low prices, but then find it easy to buy energy efficient products as well.


DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.  

December 19, 2009

World Energy Solutions (XWES) and Ram Power (RPG.TO) Appear Promising

From Small Fries to Big Shots? Part 1 of 2

by Bill Paul

Feel like rolling the dice on some small alternative energy stocks that appear to have big-time potential?

Just remember: sometimes you roll snake eyes.

First up: World Energy Solutions Inc. (Symbol: XWES), which currently trades on NASDAQ for $3 and change per share.

Worcester, MA-based World Energy Solutions operates online exchanges for energy and green commodities, including the one administered by Regional Greenhouse Gas Initiative Inc. (RGGI), the regulatory scheme under which 10 Northeastern and Middle Atlantic states "cap" their power plants' emissions by requiring plant owners to buy permits for the gasses they emit.

World Energy Solutions is a poster child for how to run a cap-and-trade system. "RGGI auctions continue to run like clockwork," RGGI's chairman recently said, adding, "RGGI is showing that cap-and-trade works."

With Europe and Asia already well on the way to having full-blown cap-and-trade systems, it would seem only a matter of time before World Energy Solutions attracts far wider investor interest (and just maybe a corporate suitor). While the company is still in the red, last month it reported that third-quarter and nine-month losses had narrowed significantly from a year ago, on increased revenue.

Next up: geothermal power developer Ram Power Corp., which trades on the Toronto Stock Exchange under the symbol RPG (RPG.TO, RAMPF.PK). Nevada-based Ram shares also currently sell for $3 and change, although just two months ago they were selling for under $1. But then the World Bank's International Finance Corp. proposed to arrange $216 million in debt financing for the company's 72 megawatt geothermal project in Nicaragua, now due to come online in 2011.

Ram Power's chairman clearly believes this is the start of something big for his firm. Chris Thompson said this past week that "Ram Power's mission (is) to be the premier provider of geothermal energy in Central America. We see this region, especially Nicaragua, as an area where our company can develop stable, long-term energy supply relationships."

Unlike World Energy Solutions, Ram's third quarter and nine month losses widened - significantly so - from year-earlier results, though that clearly hasn't hampered its recent stock activity. The company has other geothermal interests in Nevada, California and Canada.

(Next Week: Two more small fries whose prospects appear promising.)


DISCLAIMER: This is a news article.  Please read terms and policy.

Bill Paul is Managing Editor of EnergyTechStocks.com.

September 24, 2009

Climate Change & Corporate Disclosure: Should Investors Care?

Charles Morand

On Monday morning, I received an e-copy of a new research note by BofA Merrill Lynch arguing that disclosure by publicly-listed companies on the issue of climate change was becoming increasingly "important". The note claimed: "[w]e believe smart investors and companies [...] will recognize the edge they can gain by understanding low carbon trends." I couldn't agree more with that statement.

It was no coincidence that on that same day the Carbon Disclosure Project (CDP), a non-profit UK-based organization that surveys public companies each year on the state of their climate change awareness, was releasing its latest report at event organized by BofA/ML in NYC.

I am fairly familiar with the CDP, having worked on one of the reports in 2006. In a nutshell, the CDP sends companies a questionnaire covering various topics such as greenhouse gas (GHG) emissions, programs to manage the identified risks of climate change, etc. (you can view a copy of the latest questionnaire here). The responses are then aggregated and made into a publicly-available report.

The CDP purportedly sends the questionnaire on behalf of institutional investors who are asked to sign on to the initiative but have no other obligation. The CDP currently claims to represent 475 institutional investors worth a collective $55 trillion. Not bad!

Putting Your Money Where Your Signature Is?

Despite their best efforts, initiatives like the CDP or the US-based CERES are mostly inconsequential when it comes to where investment dollars ultimately flow. Investors are asked to sign on but are not required to take any further action, such as committing a percentage of assets under management to low-carbon technologies or avoiding investments in companies with poor disclosure or that deny the existence of climate change altogether.

Case in point, the latest Global Trends in Sustainable Energy Investment report found that, in 2008, worldwide investments in "sustainable energy" totaled $155 billion. That's about 0.28% of the $55 trillion in assets under management represented by CDP signatories. A mere 1% commitment annually, or $550 billion for 2008, would substantially accelerate the de-carbonization of our energy supply, probably shrinking the time lines;we're currently looking at in several industries to years rather than decades.  

And that's ok. By-and-large, investors are investors and activists are activists. In certain cases, investors can be activists, either from the left side of the political spectrum with socially-responsible funds or from the right side with products like the Congressional Effect Fund. But overall, most sensible people want investors to be investors.

That's because the function that investors serve by being investors rather than activists is a critical one in a capitalist system - they force discipline and performance on firms and their management teams. By having to compete for capital with other firms in other sectors, clean energy companies have an incentive to crank out better technologies at a lower cost, and that process will have positive implications for all of society in the long run.

The problem with the CDP is that it's really an activist organization parading as an investor group. If the Sierra Club were to go around and ask Fortune 500 companies if they wanted to be hailed as environmental leaders in a glossy new report with absolutely no strings attached, I bet you anything they would get 475 signatures in a matter of days. And so it goes for CDP signatories - institutional investors the world over get to claim that climate change keeps them up at night while not having to deploy a single dime or alter their asset allocation strategies.

Approaching Climate Change Like An Investor

Someone approaching climate change like an investor - that is, as a potential source of investment outperformance (long) or underperformance (short or avoided) - isn't likely to care for activist campaigns aimed at forcing large corporates to disclose information on the matter; in fact, they may prefer less public disclosure to more.

That is because one of the greatest asset an investor can have is an informational advantage. In the case of climate change, those of us who believe that it's real and who think they can put money to work on that basis have a pretty good idea where to look and what to look for - we don't need the SEC to mandate disclosure. Those who think it's one giant hoax couldn't care less - they don't need the SEC to get involved, either. Yet this is where such campaigns are going, according to the BofA/ML report.

I like to think of climate change as an investment theme in terms of three main areas: (1) Physical, (2) Business, and (3) Regulatory. All three areas present investment risks and opportunities.

Opportunity Risk
Physical DESCRIPTION: Companies that stand to gain  from strengthening or repairing the physical infrastructure because of an increased incidence of extreme weather events or a changing climate. Examples include electric grid service companies such as CVTech Group (CVTPF.PK), Quanta Services Inc (PWR) and MasTec Inc. (MTZ)

: Medium-term   
DESCRIPTION: Companies that stand to be negatively impacted by more frequent and more powerful extreme weather events, or by a changing climate. Examples include ski resort operators, sea-side resort operators and property & casualty insurers.  

: Long-term
Business DESCRIPTION: Companies that provide technologies and solutions to help reduce the carbon footprint of various industries, be it power generation, transportation or the real estate industry. Renewable energy and energy efficiency are two obvious examples.

: Immediate     
DESCRIPTION: Companies that make products that increase humanity's carbon footprint and that could fall out of favor with consumers on that basis. Examples include car makers with a large strategic and product focus on SUVs and other needlessly large vehicles.

: Medium-term
Regulatory DESCRIPTION: Firms that have direct positive exposure to the regulatory the responses to climate change enacted by governments. Examples include firms that operate exchanges or auction/trading platforms for carbon emission credits such as Climate Exchange PLC (CXCHY.PK)  and World Energy (XWES).

: Near-term
DESCRIPTION: Companies that are in the  regulatory line of fire for carbon emissions. Coal-intensive power utilities are a good example, as are other energy-intensive industries that might have a limited ability to pass costs on to consumers because of high demand elasticity or fierce competition.

: Near-term 

This categorization provides a high-level framework for thinking about what may be in store for investors as far as climate change goes. However, with the exception of Business/Opportunity and Regulatory/Opportunity, the investment case is not necessarily clear-cut and requires some thinking.

For instance, oil would seem like a perfect candidate for the Business/Risk category were it not for another major and more powerful price driver: peak oil. As for Regulatory/Risk, the European experience thus far has shown how open a cap-and-trade system is to political manipulation, and firms there have been able to withstand the regulatory shock more because of achievements on the lobbying side than on the operational side. That is why I have stressed in the past that understanding emissions trading was more about understanding the rules and the politics than about understanding the commodity.

Nevertheless, these trends are worth following for people who: 1) like investing and 2) think that climate change is not the greatest hoax ever perpetrated on the American people. For instance, CVTech Group (CVTPF.PK), a small Canadian electrical network services company, reported that in fiscal 2008 around 58% of its annual revenue increase (C$23.0 MM) was due unscheduled electricity infrastructure repairs as a result of hurricanes in Texas, Louisiana, North Carolina and South Carolina. In the annual report, management noted: "Since 2005, an increase in the occurrence of hurricanes has resulted in growing demand for our services in these states."


I have nothing against the concept of activist organizations going after corporations with various demands, be they influenced by left- or right-wing thinking; after all, we live in a free, open society and it's everyone's right to do so within the confines of the law.

What I don't like quite as much is hypocrisy and greenwashing. As far as I go, if an institutional investor truly believes that climate change can be a worthwhile investment theme, they should put a couple of analysts on it and figure out how to put money to work. If they don't believe that it is, then they should just go on doing what they do best: manage money.

What they shouldn't do is pretend to see an investment risk or opportunity where they really don't just to appease a handful of vocal stakeholders. Lobbying to get the SEC to force disclosure on climate change is nothing more than window dressing; investors who think this is real already know where to look and what to look for and - surprise, surprise - it's not rocket science!


August 17, 2009

Biochar's Likely Market Impacts

Biochar is still mostly a research and cottage industry, yet it has the potential to impact returns for a broad range of investors.

Biochar, or amending soil with biomass-derived carbon, shows great potential to improve the productivity of soils, as well as to increase the utilization of fertilizers by plants, while sequestering carbon to reduce the drivers of climate change.  On August 10, I went to the 2009 North American Biochar Conference to look at the potential for investors. 

Before I went, I took a look at the publicly traded companies involved in biochar.  I did not learn of  any new public companies at the conference, but I have nevertheless become increasingly convinced that biochar has a large role to play in moving to a sustainable economy, not just for energy, but for agriculture.

While the biochar industry is still too early stage for most stock market investors, understanding the economics of biochar will give investors insight into the effects the broad use of biochar will have on the overall economy, and their other investments.  Many types of public companies are likely to be impacted.  Some industries likely to be affected are  

  • Agricultural and forestry companies, which may benefit from increased yields and an additional market for their products,
  • Advanced biofuel companies which may have to compete with biochar companies for feedstock, as well as for a place in low carbon fuel standards with a biofuel with a much lower carbon footprint, 
  • Any participants in environmental markets for carbon offsets, since biochar is likely to be a source of carbon credits.

Carbon Sequestration

Long-term carbon sequestration in the soil is the headline benefit of biochar.  Depending on how the biochar is made, it may stay in the soil for thousands of years.  Biochar has both volatile and fixed or "recalcitrant" carbon fractions.  The volatile fraction decays relatively rapidly, over a few years or decades, while the recalcitrant fraction stays in the soil for centuries or millennia.  The relative fractions depend on the feedstock and how the char is made, but debate continues about the best conditions and feedstocks for a high recalcitrant fraction, which can be the vast majority of the char.

As a potentially vast source of carbon offsets, biochar has the potential to reshape offset markets for carbon dioxide.  Although biochar is not currently accepted as an offset in any climate trading regime, many expect that it will soon qualify.  Peter Weisberg, an Offset Project Analyst at The Climate Trust not only expects that biochar will qualify as carbon sequestration, but says that The Climate Trust is interested in purchasing offsets from biochar projects.

If biochar does qualify for carbon finance, it will place downward pressure on the price of carbon offsets... to a point.  As anyone who has grilled a hamburger knows, char can also be burned to produce useful heat.  Anyone who buries char gives up the use of that energy.  I asked a couple experts what they thought might be the value of the forgone energy.  David Laird, a Research Soil Scientist at the US Department of Agriculture thinks the break even point would be about $10/ton of CO2, or about $30-$40/ton of carbon.  Dr. Joel Swisher,  Chief Technology Officer at carbon-offset provider Camco International, thinks the number is somewhere between $10 and $20 per ton of CO2, or about $50/ton carbon.

While these prices are higher than offsets currently trade on most exchanges, they also assume that the only benefit of incorporating biochar into the soil is the carbon sequestration aspect.  That is not the case.

Improved Soil

In all but the most optimal growing conditions, biochar increases plant productivity.   Although the mechanisms are not completely understood, most studies show that biochar allows plants to more effectively use Nitrogen and Phosphorus, as well as other nutrients that either occur naturally in the soil, or are added with either organic or inorganic fertilizers.  It also aids water retention.

The effects of this are significant increases in plant growth, especially in poorer soils or with limited fertilizer or water; heavily fertilized and higher quality soils show lesser effects.  In poor conditions, some studies have seen boosts to plant productivity by as much as 40%, although 15-25% is a more normal range, to judge by the studies presented at the conference.

This improved soil fertility has several benefits, each of which could serve as an added enticement for farmers to use char.  Because plants can use the available nutrients more effectively, a farmer should be able to use less fertilizer and still achieve a high rate of growth from his plants.  Not only does this save the farmer money, but because less fertilizer is used, and a greater fraction of it is taken up by plants, there is less resulting pollution in the form of fertilizer runoff and nitrous oxide formation. Nitrous oxide is a potent greenhouse gas and also depletes the ozone layer.

The cost savings from reduced fertilizer use, lowered irrigation costs from improved water retention, as well as any reduced costs of meeting environmental regulations may all have value to farmers which might induce them to sell biochar based offsets at prices below that dictated purely by the cost of the energy forgone.  

These reduced costs for farmers, as well as the potential new revenue streams from offsets and increased crop productivity add weight to my previous conclusion that investing in farms and other sources of biomass feedstocks is one of the best ways to benefit from bio-energy (biofuels, as well as biomass based electricity and biomass cofiring.)

Other Commodities

Increased plant productivity with bichar may eventually increase the supply of available biomass for bio-energy applications and food.  This may benefit the economics of any biofuel technology, but I expect the gains to only be marginal, since most biofuels are commodity businesses, and an increase in feedstock supply may increase volume, but is unlikely to improve long term margins.

Reduced fertilizer use might also be expected to reduce prices in fertilizer markets, but to the extent that fertilizer is made from commodities such as natural gas (which have a wide variety of other uses,) the effect on fertilizer prices can also be expected to be marginal.

Renewable Energy

The whole story, however, is not just the char.  During pyrolysis, a whole range of volatile organic compounds are emitted from the biomass feedstock, and these can be used to 

  1. Produce bio-oil, which can be upgraded into liquid fuel.  The company Dynamotive (DYMTF.OB) is working to commercialize this process, as I discussed in my investing in biochar article.
  2. Fuel a generator to produce electricity.
  3. Produce heat for some other process.

The choice between these options depends on a range of factors, most importantly scale and if there is a local need for heat.  

Some biomass feedstocks, such as poultry litter are available in massive quantities in a single location.  This allows the use of a larger scale plant, and hence will most likely lend itself to the production of higher value energy which requires more processing, such as bio-oil based liquid fuel.  Hence, if a liquid fuel production process is widely adopted, it may not only help the company which commercializes it, but it may also produce significant added value and clean up a pollution problem for producers of concentrated biowaste, such as poultry producer Tyson Foods (TSN).

The specific type of biomass also affects the use of the volatile organics.  Some sorts of biomass, such as corn stover, contain large amounts of silica or other impurities which can cause buildup in electric generators and add to maintenance costs.  In such cases it may make more sense to produce bio-oil or heat, rather than electricity.

Heat can be produced by directly burning the volatile organics, or recovered in a combined heat and power operation when generating electricity. Generating heat is the simplest process, and hence will lend itself most readily to distributed biochar facilities.  The catch is that, in order to capture the economic value, there has to be a local use for the heat.

One practical variation is the use of specially designed efficient cookstoves in the third world.  These are optimized to both improve cooking efficiency, indoor air quality, and biochar production.  Biochar advocates hope this approach could impact developing nations in a number of significant ways including improved health of woman and children, improved nutrition from the garden amendment, and decrease the need for biomass in cooking due to improved cook stove efficiency.

Even if the heat is not used, however, it is important to flare the gasses released when creating biochar, since volatile organics are pollutants in their own right.


Biochar, although a simple technology, is still at a very early stage of commercial development.  Nevertheless, stock market investors would be wise to be aware of the broad ranging effects the industry might have on carbon trading, biofuel, fertilizer, and agricultural markets.  Even these industries may not be a complete list: There is ongoing research into using biochar for remediation of mine tailings.  Backyard gardeners may also be able to improve their productivity and reduce fertilizer use by incorporating biochar into their soil.  

It is important to note that not all biochars are created equal.  Most biochars are slightly basic, and will produce greater benefits in acidic soils.  It's worth knowing the properties of what you plan to be putting in your soil before you incorporate it.  It's also worth noting that biochar has its greatest effects when combined with small to moderate amounts of conventional or organic fertilizers, since biochar is not a fertilizer in and of itself, but rather helps plants make better use of the nutrients in fertilizer.

Mantria sells a commercial biochar called EternaGreen from a biochar plant in Tennessee, with a distribution center in Georgia. I hope this is just the first of many, so most of us will be able to use biochar without having to worry about the carbon footprint of shipping.  Or, rather than waiting, we can make (probably lower quality/less recalcitrant) biochar ourselves.


DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.


July 22, 2009

Carbon ETFs/ETNs: Playing Copenhagen

Charles Morand

At $126 billion transacted in 2008, up from $11 billion in 2005, the global carbon market is the fastest growing commodities market in the world and, provided that an agreement is reached at the COP15 conference in Copenhagen and that the US adopts a cap-and-trade program, this growth could go on for several more years.

Yet this is a market that remains comparatively unknown for a number of reasons, not the least of which is the fact that the rules surrounding it are very complex. Unlike other commodities, to successfully invest directly in carbon assets one must have a complete understanding of various layers of rules and regulations, starting at the top with broad public policy objectives all the way down to the minutiae of how carbon assets can be traded.    

 In early May, I wrote an article discussing how US investors could invest in emissions trading. In that article, I mostly ignored the iPath Global Carbon ETN (GRN) and the AirShares EU Allowances Fund (ASO) - the two ETF/ETNs that track European carbon prices - because the article focused on US carbon emissions and neither has exposure to US emissions markets such as the RGGI or the CCX.

These two products, launched in the past year, provide investors with direct exposure to carbon contracts. In a way, they are a much more direct means of expressing one's view on the carbon market than going through the back door by owning an exchange such as Climate Exchange PLC (CXCHY.PK) or a trading platform like World Energy (XWES).

Although I first discussed GRN and ASO in early January, I never researched either of them in any detail. Yesterday, I looked into how they had been performing in 2009. The graph below shows their performance over the past six months.

What accounts for GRN's seeming outperformance (I haven't checked for statistical significance) is the composition of the underlying portfolio of carbon assets. The following table provides a summary of the main carbon assets traded around the world (for a larger table, you can download the Barclays Capital report from which I took it and scroll to page 4).

Currently, the most liquid and active carbon markets are for the EU ETS' EUAs and secondary CERs (see table above). I will not cover the rules of the EU ETS in this article, but you can find a detailed overview of the program here. In 2008, out of a total of about $126 billion transacted on international carbon markets, EUAs accounted for $92 billion and secondary CERs $26 billion - together, they made up roughly 94% of transacted value.

EUAs must be surrendered to governments by regulated companies each year in an amount equivalent to the company's emissions. CERs can also be used toward meeting regulatory requirements, although their use is capped at 13.5% of total  permit requirements in the EU ETS (this varies by country). CERs thus tend to trade at a discount to EUAs even though the marginal cost of abatement might be lower in the emerging economies where they are generated.


Although they both hold carbon futures contracts transacted on the European Climate Exchange, GRN and ASO are set-up very differently.

ASO, according to information available on its website, holds a basket of EUA futures of different vintages - that is, of different compliance years - that is rolled over annually. You can view the current portfolio here. ASO holds the futures until  shortly before the EUAs come due in December of each year, at which time it sells them and uses the proceeds to invest "in futures contracts expiring in December of the next five subsequent years [...]" Since ASO is not a regulated entity under the EU ETS, there is no sense in the fund taking physical delivery of the EUAs.

GRN, on the other hand, holds a basket of EUA (~79%) and CER (~21%) futures. The weights are determined annually by a committee and the index is re-weighted in November of each year. The other major - and, arguably, more important - difference with ASO is the fact that GRN holds only current year contracts. When it is re-weighted each November, the futures for period T (current year) are thus entirely replaced with futures for period T+1.  

GRN is heavily leveraged to near-term market developments, whereas ASO takes a longer-term view.


Because ASO looks five years out, a strong agreement in Copenhagen  in December would be favorable for the fund, as the EU has indicated that it would raise its greenhouse gas reduction target from 20% below 1990 level by 2020 to 30% below 1990 by 2020 if such an agreement were reached. The 2013 futures then held by ASO following the annual roll would most likely experience a pop.

Additionally, if the US were to join the carbon trading club by the end of the year, the long-term picture would brighten substantially, which again might favor ASO.

Besides these macro events, I don't currently have a view on which security is superior as I haven't done sufficient analysis of the EU ETS yet. This is something I intend to do in the next few weeks and months, as I think interest in this commodity will grow substantially in the lead-up to Copenhagen.

DISCLOSURE: None            


UPDATE (JULY 28, 2009): A reader alerted me to this: http://www.indexuniverse.com/sections/newsinfocus/6256-xshares-to-close-carbon-etf-.html - ASO has now been withdrawn. Not especially surprising in my opinion.

May 03, 2009

Trading Places: Will America's Carbon Market Outsize Europe's?

Charles Morand

In early January, I said the following on the likelihood that the Obama Administration would move on carbon regulations in the near-term: "The next 12 to 18 months are unlikely to produce much in the way of vigorous environmental action on the part of government (barring subsidies for alternative energy related to the stimulus package), especially if it means additional costs on industry." Clearly, I had underestimated the power of another fundamental rule of politics - besides "don't anger the rust belt states that gave you your presidency by burdening their industries with avoidable costs in the midst of an economic downturn" - that says that if you're going to go big public policy-wise, do it in the first few months of your term in office so that four years on voters have forgiven you.

This is the approach Henry A. Waxman and Edward J. Markey decided to take when they introduced their mammoth American Clean Energy and Security Act of 2009 in late March (you can find the full 648 pager here or a 5-page summary here - the excellent WSJ Environmental Capital also wrote an interesting series of posts on the proposed climate bill). While there definitely are components of clean energy and energy security to this bill, it is fair to say that the most significant measure proposed is the introduction of a cap-and-trade system to control greenhouse gas (GHG) emissions. Here are some key quotes from the summary document [emphasis added]:

The draft establishes a market-based program for reducing global warming pollution from electric utilities, oil companies, large industrial sources, and other covered entities that collectively are responsible for 85% of U.S. global warming emissions. Under this program, covered entities must have tradable federal permits, called “allowances,” for each ton of pollution emitted into the atmosphere. Entities that emit less than 25,000 tons per year of CO2 equivalent are not covered by this program. The program reduces the number of available allowances issued each year to ensure that aggregate emissions from the covered entities are reduced by 3% below 2005 levels in 2012, 20% below 2005 levels in 2020, 42% below 2005 levels in 2030, and 83% below 2005 levels in 2050.

The draft allows covered entities to increase their emissions above their allowances if they can obtain “offsetting” reductions at lower cost from other sources. The total quantity of offsets allowed in any year cannot exceed 2 billion tons, split evenly between domestic and international offsets. Covered entities using offsets must submit five tons of offset credits for every four tons of emissions being offset.

The draft directs EPA to create a “strategic reserve” of about 2.5 billion allowances by setting aside a small number of allowances authorized to be issued each year thereby creating a cushion in case prices rise faster than expected. The draft directs EPA to make allowances from the reserve available through an auction when allowance prices rise to unexpectedly high levels.

The draft provides for strict oversight and regulation of the new markets for carbon allowances and offsets. It ensures market transparency and liquidity and establishes strict penalties for fraud and manipulation. The Federal Energy Regulatory Commission is charged with regulating the cash market in emission allowances and offsets. The President is directed to delegate regulatory responsibility for the derivatives market to an appropriate agency (or agencies), based on the advice of an interagency working group.

To ensure that U.S. manufacturers are not put at a disadvantage relative to overseas competitors, the draft authorizes companies in certain industrial sectors to receive “rebates” to compensate for additional costs incurred under the program. Sectors that use large amounts of energy, and produce commodities that are traded globally, would be eligible for the rebates. If the President finds that the rebate provisions do not sufficiently correct competitive imbalances, the President is directed to establish a “border adjustment” program. Under that program, foreign manufacturers and importers would be required to pay for and hold special allowances to “cover” the carbon contained in U.S.-bound products. (Unclear this would withstand a WTO (China) or NAFTA (Canadian Oil Sands) challenge).


The bill therefore proposes an enforceable cap on GHG emissions effective as early as 2012, or during the current presidential term. Although the 2012 target may not seem especially daunting (-3% over a 2005 baseline), any reduction at all is no easy task. As shown in the table below, drawn from the EPA's 2009 U.S. Greenhouse Gas Inventory Report, total US emissions of GHG have grown at an average of around 1% per year since 1990 (figures are in millions of metric tons of CO2e). Click on the table for a more comprehensive table in PDF.

A 3% reduction over 2005 equates to roughly 180 million metric tons of CO2e (using the net emissions figure - 5,986 mmt). Assuming a metric ton of carbon trades between $10-$15, this would be worth between $1.8 billion and $2.7 billion. To put this into perspective, 180 million metric tons of CO2 is the equivalent of about 9.5% of total US transportation-based CO2 emissions for 2007 (1,887 mmt), or approximately 21% of total CO2 emissions coming from industrial sources (845 mmt) (see the PDF table for these figures). The latter number is actually more relevant as most of transportation would not be included in the program (sources <25,000 tons per year are excluded). It is not a stretch to say that cutting a fifth of US industrial emissions over three years is no easy task, although this recession will undoubtedly take care of some of that.    

This bill thus has the potential to generate some real - albeit small - carbon emissions trading in the US within about 3 years. For people with an interest in carbon markets, this is significant. And although carbon offsets - investing in projects that prevent GHG being emitted to generate tradable allowances - can only be used with a ratio of 4-to-1 to government-issued allowances, you can expect some significant interest in this area as well (for those not familiar with the offsets market, Bloomberg Markets Magazine ran an interesting story on the leading US player in this space, Blue Source LLC). That means money flowing into areas such livestock methane capture at the farm level, landfill gas capture, ecosystem restoration (i.e. tree planting), etc. 

Beyond 2005, the targets are high enough to incent substantial investments in carbon reduction measures, as well as sustain strong trading volumes in carbon markets. Assuming such a system is launched in 2010, the objective would be to reduce emissions at an arithmetic average of ~2% (assuming 2010 emissions are roughly equal to 2005 because of the economic crisis) per annum by 2020 vs. an arithmetic average growth rate of just under 1% per annum since 1990. Again, to put this into perspective, a 20% reduction over 2005 net emissions (5,986 mmt) equals 1,197 million metric tons, and the total CO2 emissions for the US transportation sector in 2007 stood at 1,887 million metric tons.  

Does this mean the US is about to unseat Europe as the new global emissions trading hotspot? Not quite: according to a World Bank report, in 2007, some 2,061 million metric tons of CO2e were transacted on European emissions markets for a total value of $50.1 billion. An interesting factoid about the European market is that 80% of transaction volumes occurred over-the-counter in 2007.        

Why Only Get Excited About Emissions Trading Now?       

Why, you ask, write about this now, over a month after the draft bill was released? Because last week something happened that materially raised the likelihood that this bill could become law in something close to its current form: Senator Arlen Specter of Pennsylvania crossed the aisle. Coupled with the growing likelihood that Al Franken will prevail in Minnesota, this means that before too long the Democrats could have a filibuster-proof majority in the Senate.

Of course, certain barriers remain, including convincing Blue Dog Democrats. But overall the chances of seeing carbon trading in the US in the next couple of years has increased dramatically. The thorny issue of how to allocate allowances to industry - giving them away vs. auctioning them - was conveniently left out of the bill, no-doubt to serve as a bargaining chip as final details are hammered out.  

How Do I Play US Carbon Markets?  

That's a question I've addressed on a number of occasions on this blog in the past two years, and luckily the range of options has been expanding over time.

On the equity side, World Energy (XWES) just got a whole lot more exciting last week when it migrated from the Pink Sheets to the NASDAQ. This is a company I noticed a couple of years ago but to which I only ever paid scant attention because the prospect for substantial environmental commodities trading seemed distant in the US. In a nutshell, World Energy provides a platform for electronic trading and auctions for various commodities like electricity, nat gas, renewable energy certificates and, most importantly, carbon credits. Electricity and gas account for most of the business right now. 

Things got really interesting for World Energy when it was selected to run CO2 emissions allowance auctions for the RGGI, the first and only regulated carbon market in the US. This is a good development for the company in my view. However, the recent pop in the share's price from a buck something on the Pink Sheets to $6.60 on the NASDAQ as at Friday close has less to do with fundamentals than it does with a reverse stock split at the end of March

I had a quick glance at the 2008 10-K. Revenue has grown by around 290% since 2004 and now stands at $12.5 million. Gross margin has shrunk considerably over that period from 82% in 2004 to 63% in '08. Operating margin has also deteriorated, going from 3% to -55%. However, this is a marked improvement over 2007 when operating margin was -89%. World Energy earned -$0.08 per share in 2008 vs. -$0.11 in 2007.

Balance sheet-wise, the company has a current ratio of 1.20, down from 2.36 in 2007. This drop is due in large part to cash burn, as the cash ratio went from 1.8 in 2007 to 0.46 in 2008. World Energy has no short or long-term debt besides around $3,700 in capital leases. The company has an undrawn credit facility worth $3 million.

Dramatic margin compressions and high cash burn are normal occurrences in rapidly-growing companies. At this time of year in 2006, this wouldn't have particularly worried me. However, at the current burn rate (cash went firm $7 million at the end of 2007 to $1.7 million at the end of 2008), World Energy will most likely have to raise equity sooner rather than later, which could be problematic in the current market environment and result in significant dilution. I would thus wait a little longer before touching this stock, at least until Q1 results are released and the company's cash position can be ascertained.

Another way to play emissions trading through the stock market is through Climate Exchange PLC (CXCHY.PK), the owner of the Chicago and European climate exchanges. This company is the global leader in running carbon exchanges and its primary listing is on the LSE AIM. However, for US investors, the fact that the stock trades only on the Pink Sheets Grey Market (scroll down to the end, just before the skull-and-bones!) makes this a more complicated proposition.

Nevertheless, Climate Exchange is fast-becoming a serious play on carbon trading and financials are improving - revenue grew from £13.8 million (~$21 mm) in 2007 to £22.8 (~$34 mm) million in 2008 while operating margin went from -64% to -12% over the same period. The company has a current ratio of over 4 with ample cash reserves (cash ratio of 3.19). Revenue is growing fast, profitability is within sight and there are no pressing liquidity needs.

Two exchange traded products that actually track carbon credit prices, the iPath Global Carbon ETN (GRN) and AirShares EU Allowances Fund (ASO), are also now available to US investors. In both cases, however, there is a very strong European emissions component, and the timeline for integrating US emission allowances into these products is uncertain. While both could experience a temporary bounce if a climate bill passes, they remain an overall lousy play on US emissions trading due to the lack of exposure to US emissions (duh...)

Lastly - and this is definitely more long-term in nature - there is a very real possibility that natural gas could be a big winner as this would strengthen a trend toward its growing prevalence in US power generationon. This may be an interesting angle for those who like nat gas right now anyways and may be thinking a few years out as well. The main play here would be the US Natural Gas ETF (UNG). Somewhat paradoxically, then, a strong climate bill might provide a catalyst toward a more gas-centric long-term energy policy.

Update (May 6, 2009): In the original entry, I stated that the company had $3.7 million in capital leases. I had mis-read the actual figure which is $3,700.

Disclosure: Charles Morand does not hold a position in any of the securities discussed in this article.

January 07, 2009

Some Tidbits From The World Of Emissions Trading

To be sure, the near-term prospects for carbon emissions trading are bleak. Continued decline in industrial production across the world's major manufacturing economies will inevitably lower carbon emissions. The clearest indicator of this, short of directly measuring emissions, is a sharp decline in the price of various fossil energy commodities (i.e. oil, natural gas and coal) on the back of falling demand.

Another important factor for carbon emissions trading is that the commodity in play - the regulatory right to emit a unit of carbon dioxide equivalent (CO2e) - derives its legitimacy entirely from a regulatory scheme rather than from an economic need. Placing faith in carbon markets therefore means placing faith in politicians. The next 12 to 18 months are unlikely to produce much in the way of vigorous environmental action on the part of government (barring subsidies for alternative energy related to the stimulus package), especially if it means additional costs on industry.

These headwinds didn't prevent XShares Advisors from launching a new carbon emissions ETF, the AirShares EU Carbon Allowances Fund (ASO). ASO is an interesting product - it's a commodity pool that holds long positions in emission allowances under the European Emissions Trading Scheme.

ASO is the second product of its kind (sort of...). Last June, Barclays launched the iPath Global Carbon ETN (GRN), an exchange traded note that tracks what it calls "carbon-related credit plans". For now, GRN tracks the EU ETS as well as the Clean Development Mechanism (CDM), conferring it an emerging market angle that ASO lacks.

These two securities now allow individual investors to play carbon trading more directly, but beware; the world of carbon markets is highly complex and unless you're crystal clear on the rules on how these permits are allocated by regulators and traded by market participants, you could be in for some nasty surprises. For instance, for the first phase of the EU ETS (2005 to 2007), European governments over-allocated permits, leading a price collapse when people figured out the market was net long.

Besides these securities, investors can also play carbon trading indirectly by taking equity positions in firms running carbon exchanges, including Climate Exchange plc (CXCHY.PK) or World Energy (XWE.TO). We will continue to seek out and list securities that allow investors to play various environmental markets, so be sure to check our Environmental Markets section regularly.

In closing, although I do believe that in the long run emissions trading will likely become the preferred regulatory route to curtail carbon emissions in many jurisdictions, the next 12 to 24 months could spell more downside for the sector as the perfect storm continues to hit. I will provide an update on these and other securities when I see the outlook brightening.

DISCLOSURE: Charles Morand does not have a position in any of the securities discussed above.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

December 10, 2008

Avoiding a Carbon-Price Backlash

by Tom Konrad, Ph.D.

Economics and Greenery, a Belated Rapprochement

It is truly a triumph of economic ways of thinking that many of environmental activists are championing market-based approaches to tackling climate change.   Those people who are not for cap-and-trade on global warming gas emissions promote the even more economically rigorous carbon tax.  The most common defense against criticisms of subsidies for renewable energy is to retort that the fossil fuel industry benefits from much large subsidies.  Not only do fossil fuels get generous subsidies in direct and indirect payments, but they seldom pay anything like the indirect costs of the environmental harm they cause.

The simple and obvious conclusion that many environmentalists have drawn (and which I subscribed to only a few years ago), is that if we can just get the price signals right, people will start using renewable energy and stop building coal plants, and we'll be able to live on this planet without destroying it for a few more centuries.

Classical Economics' Dirty Secret

H.L. Mencken said, "For every human problem, there is a neat, simple solution; and it is always wrong."  

Greens putting their faith in market orthodoxy are also likely to be unpleasantly surprised.  The problem is that the classical economic dictum that if you raise the price of something, people will use less, and if you lower the price, people will use more, often fails outside the classroom.  Humans often act against their economic self interest, often because doing so requires much less effort than not.  

At the recent Energy Star Summit, I was speaking to an Energy Star employee whose job is to help people make more energy efficient choices.  Even though he has the resources at his fingertips on a daily basis, he still has not made many of these cost effective changes in his own home.  If he isn't making changes he knows are cost effective, it's no surprise that most people are doing even less, because most have the added step of lack of information about just what they should be doing and how to do it.

As an aside, I picked up a copy of Homeowner's Handbook to Energy Efficiency after a chat with one of the authors, Chris Dorsi, at the Summit.  Like the Energy Star employee, I'm immersed in energy day in and day out, but while I have a theoretical understanding of the comparative advantages of electricity transmission and utility scale storage, that does not mean that I know how to install a Water Heater Blanket, or how much I will save by doing so.  This book gives a clear and concise description of how, and some idea of expected payback.

Other examples of price signals failing to move energy markets abound.  

  • Todd Litman, of the Victoria Transport Policy Institute, an economist and advocate of sustainable transportation policies, says that pricing schemes designed to get people out of cars are only effective when there are acceptable or appealing other transit options to get people to their destinations.  If my commute by car to work goes up in price from $2 to $20, I'm only going to consider taking transit if transit is available and it will get me there reasonably comfortably.  If my only option is a bus which I have to walk a mile to at either end, and the trip takes an hour longer than it would in my car, I'll just pay the $20.  I'll also be mad at the people who I see as causing me the extra expense.
  • The water heater blanket I referenced above costs about $20, and it will pay for itself in a year in a home with an older water heater. 

Most energy efficiency improvements are manifestations of market failures. After all, classical economics demands that no investment be available which have very low risk and which return more than their cost of funds.  Yet all of us have countless examples of such investments we can make, and the main "risk" to the return on an energy efficiency improvement are that energy prices fall, and the savings fall with them.  The correlation of energy efficiency returns with a risk factor (energy prices) actually makes energy efficiency improvement more, not less attractive from the perspective of portfolio theory.  Risk aversion would lead individuals to invest more, not less, in energy efficiency.

How Not to Cause a Backlash

If price signals are not enough, what is?  On carbon pricing, I brought you ten insights last year, which I can sum up by saying that it's not enough to just get the price right, you also have to make sure that the person paying the price has other acceptable choices.  It does little good to tax the emissions of a newly build coal plant, since the plant owner will simply pay the tax and pass it on to his customers because his recent large investment would have to be abandoned otherwise.  If the coal plant owner is a regulated utility, this will not even hurt profits, because the full cost of carbon will be passed on to the consumers.

The key to getting price signals right is exactly what Todd Litman recommends above for transit pricing.  That is, in addition to a price signal, the payer also needs acceptable options which can be adopted by a casual consumer, without requiring significant sacrifices of time, effort, or comfort.  This means that the information to make good energy decisions has to be readily available, and that reliable contractors or how-to books, be available at reasonable prices and without requiring extensive research on the part of the individual.  

In terms of economics, this can be seen as increasing the price-elasticity of demand.  Price-elasticity of demand measures how much demand is able to fall for any given increase in price.  If price elasticity is low, then demand does not fall, and consumers are likely to lash out, and demand that "someone" bring prices down, regardless of whether that someone has the ability to do so.  Last summer, we saw this phenomenon in outrage at oil speculators, Big Oil, and calls for "Drill, Baby, Drill."

In the example of a carbon tax (or cap and trade) above, consumers need easy access to programs to help reduce their usage of more-expensive electricity, either through efficiency or renewable energy, or the result will again be a backlash against the carbon pricing scheme. People don't like to see their bills go up.  If they have an easy way to lower them, they will, but if lowing their bills is hard, they'll find it much easier to get angry, and will put more effort into making the tax go away than into lowering their usage.

The economic crisis and a new administration have given us an opportunity to capture the benefits of clean energy.  The Economist recently wrote why they thought a Green stimulus package would be a bad idea. The package they outlined, which was heave on subsidies for the most expensive forms of renewable energy, would have been a bad idea.  Fortunately, the package which the President-Elect recently outlined is heavy on energy efficiency and electricity infrastructure, much like the response to the crisis I hoped for in early October.  

The energy efficiency programs in the stimulus not only will be good for the economy, but they will also help cushion the blow when we finally have a country-wide cap-and-trade for carbon emissions.  Giving people the tools they need to reduce their energy bills will give consumers an opportunity to respond to the new price signals productively, rather than with anger.  

We're lucky to finally have leaders who opt for the more complex solution which has a chance of being right, rather than the neat, simple solution, which is always wrong.  But we can't assume that once we get the price right everything will follow.  Getting the price right is just the beginning; helping people adjust to the new prices will be a long, uphill battle.  If we're not prepared, we may find that we've lost ground, not gained it.

November 18, 2008

What's In Store For Emissions Trading Stocks Under An Obama Administration?

All the recent talk about Barack Obama creating a "Climate Czar" position in his administration begs the following question: will Obama dare to implement a nation-wide cap-and-trade system for greenhouse gases (GHGs) in the midst of an economic collapse? While the recent pullback in energy prices will certainly provide some cost relief to energy-intensive industries, which were getting squeezed by rising energy prices, this pullback pales in comparison to the challenges they face in other areas of their businesses right now, and slapping them with complex and potentially-costly new regulation could create significant political backlash. What's more, continued softness in industrial output should take care of at least some emissions in 2009, lessening the political imperative to act now. So the question is: what's in store for US emissions trading regulation and emissions trading stocks?

In May, I wondered whether the Climate Exchange plc story was overdone. Climate Exchange plc (CXCHF.PK) is the company that runs the Chicago and European climate exchanges. Another Massachusetts-based but Toronto-listed play on carbon emissions trading is World Energy Solutions (XWE.TO), the company that runs the auction platform for the RGGI's carbon dioxide emissions allowances. How have these two stocks done in the past six months? Not extraordinarily well, according to the chart below (the beige line is the S&P 500 - apologies for the unclear legend).

Does this fall from grace represent a great buying opportunity, especially for Climate Exchange plc (it would benefit most from federal-level regulation), or is the sector doomed for the foreseeable future because a new president would never dare to regulated GHGs in this context? Obama, as recently as yesterday, was still hinting that he indented to move full swing ahead with his climate plann. But subsidizing clean technologies and imposing hard emissions caps are two very different things, and they have vastly different political implications.

To be continued...

DISCLOSURE: Charles Morand does not have a position in any of the securities listed here.

August 31, 2008

Climate Change Will Hurt The Poor Most But the Solutions Don't Have To

The International Center for Appropriate and Sustainable Technology (iCAST) helps communities use local resources to solve their own problems.  I've been a fan of iCAST's approach of teaching people how to fish (or, in this case, how to apply sustainable technologies) rather than giving away fish since I first encountered them at a conference in 2006.  Last week, they took advantage of some of their own local resources (namely the fact that the DNC was in Denver) to organize a luncheon with a panel of nationally recognized speakers, any one of whom would have been enough to draw a crowd alone, and asked them to speak about how coping with Climate Change will impact the poor.

The speakers were Daniel Esty, co-author of Green to Gold, the bestselling book on how companies turn environmental innovation into profit opportunities, Aimée Christensen, a consultant to organizations addressing the issues of climate change including the Clinton Global Initiative and Richard Branson, and Jim Lyons, VP of Policy and Communication at Oxfam America.  The talk was moderated by Vijay Vaitheeswaran, award winning correspondent for The Economist, and author of Power to the People, and Zoom.

Should Investors Worry About the Poor?

Stereotypically, business and investors do not care about the plight on the poor.  Like most stereotypes, it only has to be true if we choose to live down to it.  Many argue that socially responsible investing can lead to superior returns, and have studies to support this conclusion, but the mutual fund track record shows mixed results.  I personally ascribe underperformance of socially responsible mutual funds to high fees and unsuccessful active management.  Moral responsibility does not absolve the investor from the need of doing good research, but my anecdotal experience leads me to the belief that at least among individual investors, many act as if moral investing is a substitute for due diligence.  Addressing Climate Change need not come at the cost of profit (Walmart came to energy efficiency from the profit motive, not an environmental ethic, as Ms. Christensen pointed out.)

That said, it's an equal fallacy to assume that financial due diligence absolves us of moral obligation.  I'm not here to tell you what your moral obligations are, but for many it will probably include making sure that the most vulnerable people do not bear the bulk of the cost of decarbonizing our energy supply.  On a more cynical note, it's a lot easier for people to accept large profits if more people are helped than harmed in the process of making them.  I attended the luncheon with the hope that I would gain some ideas on specific types of companies which are both addressing both the problem of Climate Change and of poverty.  

Climate Change and the Poor

The good news is that there is considerable potential for leapfrogging, with off grid or microgirds powered by solar or wind often being the cheapest way to bring electricity to remote locations which never had it before.  The bad news is that although such projects often bring tremendous benefits to the people in need, and carbon emissions are reduced as electric light displaces oil lamps or candles, the small scale of such projects and the limited financial resources of their users mean that such projects can seldom be completely self-financing.

Yet the rural poor are not the only ones who will benefit from switching to renewable sources of energy.  Since these projects bring reductions in carbon dioxide and other pollutants, a carbon trading system could help to bridge the gap between need and ability to pay. According to Ms. Christensen, current carbon prices are still too low to bridge the gap, in large part due to uncertainty in the quality of offsets on offer.  If the buyer is uncertain that the project producing the offsets purchased would have happened without the sale of offsets, he will be less willing to pay as much for each offset.  This is the much discussed problem of additionality.

Another problem is moral hazard.  In an unregulated environment where there are buyers of carbon offsets, a company will have an incentive to plan a new factory using less efficient processes, or even intentionally emit more of a potent greenhouse gas such as HFC-23, than they might on purely economic grounds, in order to receive a payment to later upgrade the factory to use the more efficient process they might have used anyway.  

Raising the Price of Carbon, and Enabling the Poor to Sell

There are many efforts underway to improve and certify the quality of carbon offsets on the market.  Organizations such as Green-e certify offsets to high standards, and allow retailers to place their logo on certified offsets and Renewable Energy Credits, but the very proliferation of such efforts speaks to the difficulty of the combined certifying additionally without providing perverse incentives.  

A much better solution would be global carbon emissions regulation.  By providing a mandatory cap (even a rising one) for all countries, the total number of offsets sold would be limited to the amount by which emissions were below that cap.  This would provide certainty of additionality, and also remove the perverse incentive to emit more in order to receive later payments to cut emissions.

The prospects for a truly global treaty to reduce greenhouse gas emissions, referred to by Mr. Esty as "Kyoto II", are mixed. He believes that China would be willing to sign up to a truly global agreement (although they would definitely negotiate hard to get a relatively forgiving emissions quota,) but that India does not yet feel the necessary urgency which would induce it to join such a regime.  Given the size and growth of these two emerging economies' emissions, both would be necessary signers to persuade smaller emerging economies to join.

A global treaty, by both creating demand for carbon offsets, and by providing more certainty as to the quality of those offsets, would go a long way towards increasing prices and making combined poverty reduction/carbon reduction projects economically viable.  It's my hope that the benefits of self-sustaining poverty reduction schemes run by for-profit businesses, and made economic by carbon offsets could be enough to induce large, poor, but rapidly industrializing countries like India and China to join a global carbon regulatory treaty.

Climate Change and Poverty Reducing Investments

Until we have strong, global carbon markets, we should look for investments which help bring them about.  North American investors can now buy an American Depository Receipt for Climate Exchange PLC (CXCHY.PK) the parent of the Chicago Climate Exchange (CCX).  However, the carbon contracts traded by CCX have been frequently criticized on the basis of lack of additionality.  On the other hand, the CCX already allows different sorts of offsets to be traded, and the offsets most criticized for additionality are those for the carbon sequestered by low till farming, since there are documented instances of farmers who already follow this helpful practice being paid for what they had already been doing.  An even more serious criticism of no-till farming is that the science behind the measurement of carbon sequestration is in doubt.  If our priority is solving Climate Change, the additionality and certainty of carbon sequesteration is of great concern, but if we are pursuing the dual goals of poverty reduction and carbon sequestration, then the lack of additionality is a minor concern, since there is always uncertainty in what is truly "additional."  After all, even if a farmer had been practicing no-till for years and only now is receiving payments, those payments may be enough to keep him in business and keep his land from being plowed by a less progressive farmer.  

But how will Climate Exchange PLC fare when a global carbon trading system is finally established?  The signs do not seem good.  At the moment, CCX's advantage in the carbon market seems to be that they both define the contract and provide a platform for trading it.  If governments step in to define carbon contracts by regulatory fiat, CCX will only have the advantage of incumbency, something of dubious value when the trading is in a new contract. 

A better investment would be a company which is alredy in the business of developing high-quality carbon offsets, that is, starting projects which reduce greenhouse gas emissions, and would not have happened without offset payments.  Such companies would likely be able to focus their efforts on developing contracts which could be sold into any well thought out regulatory regime. One I did find was Veolia Environmental Services (NYSE:VE), which sells offsets from landfill gas projects.  This is admittedly a small part of their business, yet their other businesses, focused on water, waste, energy efficiency, and transit are all sectors likely to do well as we confront the reality of Climate Change, and also sectors of concern to the world's poor.


DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance.  Please take the time to read the full disclaimer here.

June 05, 2008

A New Player In The North American Emissions Trading Sector

Over the past two weeks, a couple of announcements were made that went mostly unnoticed despite their importance to the North American carbon marketplace.

Firstly, on May 30, the Montreal Exchange, a derivatives exchange, announced that it was launching an emissions trading market for CO2. The Montreal Exchange is now a unit of the TSX Group (TSXPF.PK or X.TO), the firm that runs all of Canada's exchanges.

The second announcement came last week, when the premiers of Quebec and Ontario, Canada's two largest provinces and the heart of its industrial base, announced that they were moving ahead with a cap-and-trade scheme to cut their greenhouse gas emissions. Together, these two jurisdictions form North America's fourth largest economy, so needless to say this is a market with some potential.

Now once this scheme gets underway - and it's unclear when that will be - the TSX group through the Montreal Exchange will be the platform of choice for the exchange-based portion of the market. While that's unlikely to be a material event for the company initially, the potential size of that market in Canada alone is nothing to frown at, and this could prove a lucrative niche in the future as Alberta continues to expand production in the dirty oil sands.

May 19, 2008

Carbon Offsets Work – Will the Mainstream Media Ever Get It?

The carbon markets are an area of keen interest for me personally and professionally, so it is always frustrating that the mainstream media largely refuses to learn the details.

In general, layman and media who don’t understand the details of the carbon markets attack carbon offsets in two areas, first, questioning whether the credits are for a project that would have occurred anyway (a concept known in carbon as “additionality”), and second questioning whether there are checks and balances to ensure the environmental standards are adhered to and the abatement actually happens (in carbon known as the validation and verification processes). The frustrating part for anyone in the industry is that the entire of the carbon credit process set up under Kyoto is all about ensuring the answers to those two questions. Leading certification firms and carbon project developers have been dealing with the details behind those questions for years.

The biggest weakness of the carbon offset process to date has been that the high level of oversight and protection, while working, has led to higher costs and fewer projects getting done, rather than too many. Bottom line, the carbon markets ARE working, and are pouring billions of dollars into fighting global warming, just like the NOx and SOx trading markets helped reduce air pollution faster and cheaper than anyone expected. Now it's time to figure out how to make them REALLY scale.

I caught up with a friend of mine, Marc Stuart, to give us a little teach in about the real story in carbon offsets, what matters, what does not, what works, and what still needs to be tweaked. Marc should know, he’s one of the founders of EcoSecurities plc (ECGUF.PK or ECO.L), one of the first, and still the leader in generating and monetizing carbon credits. Marc, thanks for joining us, we appreciate the time and the teach in.

1. Even for those who don't know much about carbon offsets, many people have heard about the concept of additionality, and almost everyone intuitively understands it at some level. But it is devilishly complicated in practice. I've always described it to people as "beyond business as usual". Can you explain additionality and give us some insight into the details?

Additionality is the core concept of the project-based emissions market. In a nutshell, it means that a developer cannot receive credits for a project that represents “business as usual” (BAU) practices. A classic and often cited example is that industrial forest companies should not be able to get credits simply for replanting the trees that they harvest from their plantations each year, since that is already part of their business model. A utility changing out a 30 year old, fully depreciated turbine would not be able to claim the efficiency benefits, though a utility that swapped out something only five years old might be able to under certain circumstances.

Additionality is easy to definitively prove in cases where there is zero normal economic reason to make an investment, such as reducing HFC-23 from the refrigeration plants or N2O from fertilizer plants. Such projects easily pass a “financial additionality” test, since it’s clear that as a cost without a benefit, they wouldn’t have been economically feasible under a BAU scenario. It gets far more complex though, with assets that contribute to both normal economic outputs and the development of carbon credits, in particular in renewables and energy efficiency. Sometimes these projects are profitable without carbon finance, but there may be other barriers preventing their execution that make them additional.

The UN has developed a very structured and rigorous process that projects must undergo to prove additionality. It is essentially a regulatory process with multiple levels of oversight, in which a body called the Executive Board to the UN’s Clean Development Mechanism (The CDM is the international system for creating carbon offsets called CERs) ultimately makes a binary decision about whether a project is eligible to participate or not. Anchored in the middle of that oversight is an audit process run by independent, licensed auditors, the largest of which is actually a multi-national nonprofit called Det Norske Veritas (DNV). However, many projects don’t even make it to that decision point before they are dropped in the process.

2. One of the benefits of carbon offsets often touted by those who support them is the idea that they provide compliance flexibility and liquidity in the early years of a compliance cap and trade system. What are your thoughts on how that works?

The simple reality is that many assets that emit carbon have a long lifetimes and that legitimate investment decisions have been taken in the past that rightfully did not take into account the negative impact of carbon emissions. For an easy example, think about somebody who is a couple of years into a six-year auto loan on a gas guzzler—can policy just force that person to immediately switch to a hybrid, especially since the used car market for his guzzler has now completely disappeared? Even if society says yes, how long would it take for the auto industry to ramp up its production of hybrids? Now look at infrastructure—for example, most power plants and heavy industry facilities have lifetimes of thirty years plus. Even if we were economically and politically able to affect a radical changeover, simply put, the physical capacity for building out new technology is limited, even in a highly accelerated scenario. So, like it or not, GHG emissions from the industrial world are going to take quite a while to stabilize and reduce.

The point of offsets is that, in fairly carbon efficient places like California or Japan, availability of low cost reductions within a cap-and-trade system is quite limited, meaning there is an incentive to look beyond the cap for other, credible, quantifiable, emissions reductions. Reductions in GHGs that are uncapped (either by sector, activity, or geography), such as are found in the CDM, are thus a logical way to achieve real GHG reductions and accelerate dissemination of low carbon technologies. In effect, the past helps subsidize changeover to the future as buyers of emission rights subsidize other, cheaper, GHG mitigation activities. As caps get more restrictive over time, capital changeover occurs. Offsets allow this to occur in an orderly and cost-effective manner.

3. There have been a number of studies questioning whether offsets are just "hot air" and whether carbon offset projects actually achieve real emission reductions. What is your response to these accusations?

As noted in the first question, the CDM in particular is a market that is completely regulated by an international body of experts supported by extensive bureaucracy to ensure that real emission reductions and sustainable development are occurring. The first and foremost requirement of that body is to rule on whether each individual project is additional. Each project is reviewed by qualified Operational Entity, the Executive Board Registration and Issuance Team, the UNFCCC CDM Secretariat and the CDM Executive Board itself. Plus, there are multiple occasions for external observers to make specific comments, which are given significant weight. So, while there is always the chance something could get through, there are a lot of checks and balances in the system to prevent that.

That said, determining an individual emission baseline for a project – the metric against which emission reductions are measured – is a challenging process. The system adjusts to those challenges by trying to be as conservative as possible. In other words, I would argue that in most CDM projects, there are fewer emission reductions being credited than are actually occurring. It is impossible for a hypothetical baseline to be absolutely exact, but it is eminently possible to be conservative. Is it inconceivable that the opposite occasionally occurs and that more emission reductions are credited to a project than are real? We’ve never seen it in the more than 117 projects we’ve registered with the CDM, but I suppose it’s possible.

4. What about the voluntary carbon market in the US, where there have been accusations that many projects would have happened anyway? How is this voluntary market different from what EcoSecurities does under the Clean Development Mechanism?

The voluntary market has had more of a “wild west” reputation compared to the compliance market. In some ways, that is deserved, but in some ways it is unfair. For a number of years, the voluntary market was the only outlet for project developers in places like the United States and in sectors like avoided deforestation that were not recognized by the CDM. However, because there were virtually no barriers to entry and no functional regulation other than what providers would voluntarily undertake, it was difficult for consumers and companies to differentiate between legitimate providers and charlatans. For EcoSecurities, while the voluntary market has been a very small part of our overall efforts, we always qualified projects according to vetted additionality standards such as the CDM and the California Climate Action Registry, and always used independent accredited auditors. With the emergence of stand-alone systems like the Voluntary Carbon Standard (Editors note: Marc Stuart sits on the board of the VCS), and the growing demand for offsets from the corporate sector, I believe the “wild west” frontier is drawing to a close. [Editors note: Other voluntary carbon standards we watch closely include Green-e Climate, put out by the people who certify most of the renewable energy credits (RECs) in the US]

It is also important to note that while the voluntary market has recorded very explosive growth, it is still a very small fraction of the regulatory market, comprising a few tens of millions of dollars of transactions, versus the potential tens of billions of dollars of value embedded in the highly regulated and supervised CDM. The fact that many observers still equate the occasional problems in the fringes of the voluntary market (which are increasingly history) with the real benefits being created in the Kyoto compliance market is a misperception we’d like to correct.

5. What about these projects we've heard about in China, where the sale of carbon credits generated from HFC-23 capture is far more valuable than production of the refrigerant gas that leads to its creation in the first place? How is this being addressed in the CDM and how can future systems ensure that there are not perverse incentives created like this?

HFC-23 projects are the epitome of what is often referred to as “low hanging fruit.” In this case, most of the fruit might have actually been sitting on the ground. While there is no doubt in anybody’s mind that the market drove the mitigation of HFC-23 globally, the extreme disparity between the costs of reducing those gases and the market value those reductions commanded invariably led to questions whether there were more socially efficient ways to have reduced those emissions. In all likelihood, there were. But to catalyze an overall market like this, it is probably important to get some easy wins at the outset to create broader investment interest and this certainly accomplished that. Moreover, Kyoto created a mechanism for engaging these kinds of activities. It would have sent a much worse signal to the market to have changed the rules in the middle of the game. The CDM has subsequently adjusted the rules to make sure that no one can put new factories in place simply for the purposes of mitigating their emissions. I don’t see too many other situations like HFCs in the future, simply because there are no other gases where the disparity of mitigation costs and market value is so severe.

6. Given that the majority of CDM projects currently under development are located in China and India, how can we ensure that these countries eventually take on the binding targets we will need to reach the scientifically determined reductions in GHGs? Doesn't the CDM simple create an incentive for these countries to avoid binding targets as long as possible?

It is clearly in the world’s interest to get as much of the global economy into a low carbon trajectory as quickly as possible. However, it is politically unrealistic to expect these countries—whose emissions per capita are between one fifth and one tenth the per capita of the United States—to make an equivalent commitment at this juncture, particularly considering that they are in the midst of an aggressive development trajectory. The CDM provides a way for ongoing engagement with these countries, developing the basic architecture of a lower carbon economy. And there is no doubt that China’s emissions in 2012, 2015 or 2020 will be measurably lower than they otherwise would have been, simply because of the current accomplishments of the CDM. Over time, the use of project based mechanisms will contribute to accelerating the development and dissemination of low carbon technologies, which will make those negotiations for binding caps from all major economies far more tenable.

7. It is widely believed that to address the climate crisis on the scale necessary to avert dangerous global warming, significant infrastructural and paradigm shifts must occur at an unprecedented scale. Some people are concerned that offsets provide a disincentive for making these shifts, since companies can just offset their emissions instead of making the changes themselves. Is this something you saw under the EU ETS at all, and if so, how can it be addressed in a US system?

Virtually all of the macroeconomic analysis that has been done of Phase I of the ETS shows that there were real emission reductions undertaken within the system, despite the fact that many companies were also actively seeking CDM CERs. Clearly the fact that both Kyoto and the EU ETS system place quantifiable limits on the use of CDM and Joint Implementation (JI) credits guarantees that emission reductions will also be made in-country as well, so pure “outsourcing” of emissions compliance is not possible. This also appears to be the model being pursued in most US legislation.

8. Many have complained that the CDM system is too administratively complex, unpredictable, and that the transaction costs of the system are so significant that they could almost negate any possible benefits. What lessons can be learned about structuring an offset system in a simpler, but still environmentally rigorous way? What steps is the CDM EB taking to address these issues?

The CDM treads a very fine line between ensuring environmental integrity of the offsets that it certifies and the need to have some kind of efficient process within an enormous global regulatory enterprise. To date, one has to think that they have gotten it about right, as business has complained about inefficiency and environmentalists have complained about environmental integrity. However, it is becoming increasingly clear that the project by project approval approach is creating logistical challenges as the system graduates from managing dozens, to hundreds, to now, quite literally, thousands of projects in all corners of the world. Ironically, it is the success of the CDM in terms of its very broad uptake by carbon entrepreneurs that is causing problems for the current model.

We believe the benefits of the CDM can be maintained by moving many project types into a more standardized approach, whereby emission reduction coefficients are determined “top-down” by a regulatory body, as opposed to being undertaken individually for every project by project proponents. For example, there are dozens of highly similar wind energy projects in China that all have microscopically different emission baselines. A conservative top down baseline set by the regulator (in this case, the CDM Executive Board) would enable projects to get qualified by the system in an efficient manner with far less bureaucratic overhang. This is how California’s Climate Action Reserve deals with project based reductions and we think that it could work well for many sectors.

9. Is there any difference between a renewable energy certificate (REC) and a carbon offset? Does EcoSecurities support the concept of selling RECs to offset carbon emissions?

While renewable energy clearly helps lower the carbon intensity of the electrical grid, there are a great number of other incentives for development of renewables in the US, including significant Production Tax Credits, and in most states, RECs or Green Tags. For EcoSecurities, this makes it extremely problematic to claim that these assets are additional, despite their obvious benefits to the global environment and decarbonization of the economy. Acknowledging this, EcoSecurities—along with many other companies—has steered clear of developing REC projects for VERs in the voluntary market. There are other firms that have chosen other approaches, which again highlights the need for standardized approaches like the VCS. That said, we are very active in helping create carbon value for RE projects throughout the developing world via the CDM, where incentives such as RECs are almost universally non-existent.

10. There has been a lot of concern about "carbon market millionaires" profiting from selling offsets, and that the only "greening" going on is in the lining of peoples' pockets. As a carbon market millionaire yourself, what do you think about this concern?

Capital markets exist to reward innovation and punish underperformance. EcoSecurities has existed for more than 11 years and the founders – of which I am one – have devoted more than 15 years to building up various aspects of the carbon market. For many of those years, as we watched friends and colleagues flourish in other markets like internet and biotech, our decision to stay in this seemed fairly quixotic. But we understood enough of the science of climate change to recognize that a fundamental policy response had to be forthcoming, or we would be heading to a global catastrophe. Now those policies have come into focus and the overriding recognition is that society will need to mobilize trillions of dollars of capital to decarbonize the global economy. As part of the proverbial “bleeding edge” for many years, we were ironically well positioned to take advantage when early movers in the capital markets recognized the capabilities and brand that we had built up over a decade. As for whether that is the only greening – well, I can tell you that given the very conservative and difficult aspects of qualifying projects for the CDM, I am 100% certain that our activities contribute solidly to that decarbonization trajectory and that real emission reductions have occurred all over the world because of our efforts.

11) What lessons have you learned personally about the market as a cofounder of the leading CDM project developer in the world? You must have some interesting lessons learned for the US as you are probably unique amongst your competitors in having been based here in the US for over 10 years.

Thanks for the compliment but actually, I’m not that unique. I started in the market in the early 1990’s when the US was the epicenter of a future carbon trading regime, and Europe and Japan looked at it with suspicion and distaste. Quite a number of us from that era did not give up, but instead spent a fair bit of time since then getting our US passports stamped regularly to search the world for projects. It’s nice to see that we may finally be getting back to where we thought we would be a decade ago—with the US as a driving force for innovation in decarbonizing the world’s economy (coincidentally in a recent report produced by the UNFCCC, the US along with Germany, the UK and France provided over 70% of the clean technology currently being utilized in CDM projects). The US is in a perfect position to learn from the both the successes and mistakes within the first Kyoto iteration and I am looking forward to being part of that next stage as well.

12) What do you say to popular press who don't seem to believe that Kyoto works?

Honestly, you haven’t seen what I have seen. I’ve traveled all over the world and seen the results of Kyoto, where “carbon entrepreneurs” – ranging from divisions within multinationals to garage inventors on their own—are seeking ways to cost effectively reduce GHG emissions. That simply would not have happened without the market signal that Kyoto created. The fact that the CDM has registered more than 1000 projects and has a backlog of several times that – despite the incredible bureaucratic requirements – shows an uptake several magnitudes beyond what anybody predicted when Kyoto was negotiated. When the managing director of a West African oil refinery is proudly detailing to you the steps he’ll be ordering his engineers to take to help save some 250,000 tonnes of CO2 emissions to the atmosphere, that’s when you realize that you’ve tapped into something significant. And having had the same basic conversation in Mumbai, Jakarta, Sao Paulo and Beijing, you realize that people really want to do something, but that you need a little push from a market. That said, we are still in the first tentative moments of what is probably a century long issue and there are doubtless many improvements that can and will be made. But we have undoubtedly proven that the basic premise works.

Thanks Marc. A pleasure to chat as always. Keep up the good fight.

Neal Dikeman is a founding partner at Jane Capital Partners LLC, a boutique merchant bank advising strategic investors and startups in cleantech. He is founding contributor of Cleantech Blog, a Contributing Editor to Alt Energy Stocks, Chairman of Cleantech.org, and a blogger for CNET's Greentech blog. He is also the founder of Carbonflow, a provider of software solutions for the carbon markets.

May 15, 2008

US Presidential Election & Carbon Markets: Is The Climate Exchange Story Overdone?

An interesting piece yesterday in POLITICO on how carbon prices on the Chicago Climate Exchange (CCX) have been trending up in recent months, mostly since it's become clear that all three remaining presidential hopefuls will likely regulate CO2 emissions at the federal level.

In fact, as per the chart above, prices for the right to emit a metric ton of CO2 have been on a tear, recovering from a pretty significant slump in the preceding months. Last week, the World Bank Carbon Finance Unit released its annual update on the state of global carbon market (PDF document), and, as expected, that market continued to grow appreciably.

But is the latest hype around the CCX contracts justified? After all, should there be federally-mandated carbon caps, no one yet knows what the rules will be and what will count as a valid carbon credit. The CCX currently has its own rules for certifying a tradable emission reduction, and it's unclear whether these reductions will be worth anything at all in the eyes of US environmental regulators. For instance, the RGGI, the first regulated carbon market in the US, engaged a small firm called World Energy (XWE.TO) to write the auction software that will be used for the trades.

A safer play would therefore be to buy the exchange because ANY contract can be traded on it, so revenue would spike with volumes. It appears as though the marketplace has picked up on that one as well, pushing up the price of Climate Exchange (CXCHF.PK), the CCX' parent company, by upwards of 90% in the last three months. Mind you, this increase is probably due in large part to the fact that Climate Exchange's 2007 annual figures (PDF document) looked strong, with a 1,164% increase in revenue on 2006 and a loss per share of GBP0.0953, up from a loss per share of GBP0.3168 in '06. However, the current stock price certainly includes a significant future growth premium, and a good chunk of that premium is linked to CCX's positioning in US carbon markets.

But is this a reasonable bet? A few months ago, NYMEX, a much bigger rival, announced the creation of The Green Exchange to directly compete in the environmental commodities space. The Green Exchange is currently awaiting regulatory approval to introduce a carbon contract for the RGGI. Regulation-driven carbon trading will dwarf the voluntary market, which is CCX' current stronghold in the US (it is the leader in the regulated market in Europe).

The main question now is: will there be enough room in the US carbon market to accommodate multiple players, or will a dominant exchange outcompete everyone else? Can a pure-play carbon exchange survive in an era of increasing exchange consolidation? There is a lot of growth currently built in Climate Exchange's share price...is it too much?

DISCLOSURE: The author does not have a position in any of the stocks discussed in this article

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

December 14, 2007

Climate Legislation: Who wins? Who loses?

Most Americans now agree that something needs to be done to reduce our greenhouse gas emissions. Hopefully most Americans now appreciate that this is not a small, but even more so, not a simple problem. I am a big believer that the playing field for our low carbon future should start level, and the market should be structured to allow our major power and energy companies a chance to lead the way, instead of simply dishing out punishment for our combined historical choices.

Carrots and sticks work well together, but sticks alone are not going to solve our global carbon problem. I think it is also important to ensure that our carbon legislation does not result in a higher cost to consumers in middle America, just because the MidWest happens to have been historically coal fired, than the cost to those of us living on the coasts. Jim Rogers of Duke Energy puts this much more eloquently than I do.

Duke Energy (NYSE:DUK), one of the largest power companies in the US, has been a long supporter of energy efficiency, and known for being forward looking when it comes to a low carbon future, smart metering, and advanced energy technologies, despite having a generation fleet that is 70% coal fired. Cleantech Blog is delighted to welcome Jim Rogers, CEO of Duke Energy, to give us his thoughts on the devil in the details from their perspective. It is heartening to see a major power company take on the carbon issue full force, and like Duke has done, push energy efficiency in a big way.

- Neal Dikeman, Cleantechblog.com

By Jim Rogers
Chairman, President and CEO of Duke Energy

As we debate our differences on how to address the challenge of global climate change, surely we can agree on the end-goal – a secure, sustainable and affordable supply of energy now, and for future generations.

Most Americans also agree that we must act now – and begin building a bridge to an energy-efficient, low-carbon economy.

As the third-largest coal consumer in the United States, and one of the largest greenhouse-gas emitters, Duke Energy has a responsibility to be part of the solution. That means looking at not only how climate change affects our business today, but also the implications for the future.

We support federal legislation to address global climate change by putting a cap-and-trade system in place. The U.S. Senate is in the process of vetting a cap-and-trade bill introduced by Senators Lieberman and Warner in October. This bill is well-intended, contains some good points and appears to have bipartisan support.

But on closer examination, questions arise. Who really stands to gain, and who stands to lose? What are the real costs to average Americans?

You would expect the bridge to a low-carbon economy to have a cost, just as you might pay a toll to cross any bridge. But should some of us have to pay twice? With the Lieberman/Warner approach, that’s exactly what would happen.

Lieberman/Warner proposes to auction a large number of emissions allowances to the highest bidder. In effect, an auction becomes a carbon tax, levied on consumers in the 25 states that depend on coal for electric power – primarily the Midwest, the Great Plains and the Southeast.

Electric power customers in those regions would have to pay for the auctioned allowances up front, and then pay again later to upgrade power plants, or build new ones, as carbon-control technologies become available.

A better approach is to allocate allowances at no cost to generators who emit greenhouse gases – and reduce the number of allowances over time, while new carbon-control technologies are being developed and put in place.

Some say that an auction is the only way to take action to reduce emissions, but history tells us otherwise. Allowances were not auctioned under the 1990 Clean Air Act Amendments; nearly 97 percent of them were allocated at no cost. Since then, new technologies to reduce sulfur dioxide and nitrogen oxide emissions have been developed and implemented. Those environmental controls have reduced emissions by more than 40 percent since 1990, and they continue to decrease, without dramatic rate hikes. In fact, the nation’s average electric rates have declined.

In contrast, some estimates put the Lieberman/Warner bill’s cost to the average family at more than $1,000 per year, while emissions traders would stand to profit greatly from a volatile market for carbon allowances. According to Bloomberg, the Lieberman/Warner bill would create a potential $300 billion annual carbon-trading market by 2020.

So the question comes down to this – are we interested in protecting consumers or enriching emissions traders?

Customers who live in the Midwest, the Great Plains and the Southeast did not choose to get a large portion of their electricity from coal – it was a matter of economics, geography and geology. They should not be punished for decisions made decades ago, in good faith, using the best and lowest-cost technology of the time, with regulatory approval – and long before anyone knew about the impact of carbon emissions on climate change.

And before we dismiss coal as a viable energy source for the future, consider this: The U.S. is sitting on more than 250 years of coal reserves, more than any other nation in the world. This rich natural resource has untapped potential for ensuring our country’s energy security. The challenge is primarily technological – to find smarter and cleaner ways to use it, such as carbon capture and storage. Until those technologies are available, we must continue to use our existing coal resources and protect the interests of consumers who rely on coal.

The goal for carbon legislation should not be to punish utilities for building coal plants to keep the lights on in the past. It should be to create the incentives to put new clean technologies in place for the future – not just clean coal, but also nuclear and renewable energy, natural gas and the “fifth fuel” – energy efficiency.

Under the Lieberman/Warner approach, electric power customers in half of our states will carry a disproportionate share of the burden. We need to pass climate legislation that is fair to all consumers and protects the economic interests of all states and regions. Our climate is at stake, and so is our economy. By allocating most allowances, following the precedent set by the successful Clean Air Act, we believe both can be protected.

Jim Rogers is the CEO of Duke Energy, writing as a guest columnist on Cleantech Blog. AltEnergyStocks.com wishes to thank Jim Rogers and Neil Dikeman at Cleantech Blog for letting us republish this piece.

December 13, 2007

Competition In Environmental Markets Heats Up

Close followers of the environmental finance space have known it for a while; Climate Exchange (CXCHF.PK or CLE.L) is sitting on a potential gold mine. The market for environmental commodities, but especially carbon emissions, is slated to grow significantly over the next 5 to 7 years. It was therefore only a matter of time before competition sprung up, both from small players trying to leverage their technological platforms and from the big guys.

The big guys came out swinging this week, with NYMEX announcing a partnership with JP Morgan and Morgan Stanley, among others, to set up a platform to trade various environmental contracts, including European carbon credits. The partnership, called The Green Exchange, will also look to cooperate with the brokers who currently drive most of the volume in the EU ETS (around 70% of European carbon trades are conducted OTC). NYMEX officials had hinted at this a few months ago, so there is no big surprise here. The surprise really lays with the scale of the partnership, and I think it's now fair to say that this may not bode well for Climate Exchange.

The timing of this announcement is also interesting. At a time when certain world leaders are doing all that they can to emasculate multi-lateral efforts to tackle global warming, big finance just sent a powerful reminder that this is no negative sum game, and that a growing tranche of the business community could profit from a well-designed program to cut greenhouse gas emissions. Hopefully our leaders heed the call.

December 02, 2007

Ten Insights into Carbon Policy and Its Implications

On November 27, I attended the National Renewable Energy Laboratory's (NREL) Fifth Energy Analysis Forum, hosted by NREL's Strategic Energy Analysis & Applications Center.  The forum focused on carbon policy design, the implications for Renewable Energy and Energy Efficiency.  As a stock analyst focused on that sector, I am extremely lucky to have NREL as a local resource: the quality and the level of the experts at NREL and the ones they bring in is probably not matched anywhere in the country, and conferences like these provide priceless insights into what these Energy Analysts are thinking.  

Why should investors care what analyst think about the best form of carbon regulation, when it will be the politicians who eventually implement it?  Because these are the very experts politicians will call on when designing their legislation.  While interest groups will also undoubtedly have a large say in regulation, they are unlikely to come up with new ideas which help shape future regulation.  The new ideas will come from the 50 or so analysts that gathered in Lakewood last Tuesday, and the regulations based on these ideas will be critical to the business plans of the companies we invest in.

This is a link to my notes.  I will likely find many investment ideas there, only some of which will make it into articles.  For those with the time and interest, I expect they will be a valuable resource.  For the other 99% of readers, here are ten interesting, intriguing, or just plain surprising ideas that pop out for me.

From Howard Gruenspecht, Deputy Administrator: Energy Information Administration

INSIGHT #1: "Clean Coal" is a Solution to a Political Problem

Integrated Gasification Combined Cycle with Carbon Capture and Sequestration (IGCC w/ CCS or "Clean Coal") is popular with legislators because it is a solution to a political problem, not because the technology is ready or because analysts expect it to be the most economical solution. Nuclear power is likely to be cheaper, and it is an existing technology. 

INSIGHT #2: Electricity Generation may be a Better Use of Biomass than Liquid Fuels

If the goal is to reduce net carbon emissions, burning biomass for electricity (either by cofiring in coal power plants, or in dedicated biomass generation stations) is more effective than using the same biomass to produce liquid fuels, such as cellulosic ethanol.  TK note: I believe that many investors in companies developing methods to produce cellulosic ethanol are underestimating the competition for available feedstock from biomass based electricity generation.

From Joe Kruger, Policy Director National Commission on Energy Policy

INSIGHT #3: Electricity Generators May Get Windfall Profits

Allocation of Emission Credits is likely to create windfall profits for existing generators except in carefully designed auctions.

From Eric Smith, EPA Climate Economics Branch.

INSIGHT #4: EPA May Have to Regulate More than Tailpipes

Because of the Massachusetts vs. EPA lawsuit, the EPA must now regulate Greenhouse Gas (GHG) emissions from automobile tailpipes.  The EPA is now studying GHG, and if the EPA concludes that GHG represent an endangerment to the public, the EPA will be forced to regulate GHG emissions from many more sources than just vehicles.

From Rich Cowart, Regulatory Assistance Project

INSIGHT #5: It's Better to Allocate Credits to Electricity Distributors than Producers

Greenhouse Gasses need not be regulated at power generators, and other approaches may lead to more efficient reductions.  Mr. Cowart was introduced as "Father of the Load-based Cap," in which GHG emissions are distributed to power distributors on behalf of their customers.  Carbon regulation can occur anywhere from the mine/wellhead when a fossil fuel is first taken from the ground, to the final consumer.  Where this regulation takes place matters because different actors have different abilities to change the way power is consumed.  Mr. Cowart argues effectively that for the electricity and natural gas sectors, energy distribution companies are best placed to work with consumers to reduce overall energy use.

BONUS INSIGHT (my own): China Can Build Coal Plants, But We Can Cap Their Emissions

Worries about the number of coal plants built in China and other developing countries might be best dealt with by applying carbon regulation at the mine mouth.  China is now a net coal importer.  Given that, the rest of the world does not need China's acquiescence to regulate carbon emissions: the coal exporters of the world could form an Organization of Coal Exporting Countries (OCEC), which would effectively be able to limit the total amount of coal burned around the globe.  The United States, which I have previously called the "Saudi Arabia of Coal," could play the role of the swing producer, much as Saudi Arabia has traditionally played in OPEC.

From Karl S. Michael, NYSERDA 

From Karl S. Michael, NYSERDA 

INSIGHT #6: Reggie Never Asked, "Where are GHGs best Regulated?"

The Northeast Regional Greenhouse Gas Initiative (RGGI, or "Reggie") will be an emissions cap on power plants because the question was never asked: are power plants the right place to regulate Greenhouse Gasses?  Future climate regulations should ask this question up front.

Todd Litman, Victoria Transport Policy Institute.  I've long been a fan of Todd Litman.  Among other things, his comprehensive economic analysis was very influential in providing the ideas for my recent articles Investing in Mode-shifting, and my current love affair with commuter rail stocks.

INSIGHT #7: A Carectomy is Better than a Better Car

Regulations designed to solve a single problem often end up making others much worse.  For instance, an increase in CAFE standards will make vehicles more efficient, lowering fuel costs.  Driving will rise somewhat because it is less expensive, but this will only reduce the fuel savings by a small amount.  However, the increased distances driven will increase accidents, congestion, parking costs, road costs, and other indirect costs to society, and these costs are likely to swamp the savings from better fuel economy.  Society would be better served by policies which reduce driving, rather than increase it.

INSIGHT #8: Put the Car back into "A La Carte."

The current pricing system for driving is like the "all you can eat buffet."  It encourages people to over-consume (drive too much) because the marginal cost of driving (fuel and maintenance) is only a small fraction of the average cost of driving, which consists mainly of fixed costs such as vehicle ownership and parking costs.   Since most of the costs to society of driving are correlated to the number of miles driven (road safety, road maintenance, pollution), this leads to much higher costs to society for increased driving than to the individual.  The all-you-can-eat pricing model is also unfair to the poor, because it makes it impossible for many to drive at all, when an a-la-carte pricing model would allow them to drive small amounts for essential trips.

Mark Meliana, NREL Hydrogen Technologies Program, speaking of California's Low Carbon Fuel Standard (LCFS), on which he worked until recently being hired by NREL.

INSIGHT #9: Some Fuels are Better than Others

The California LCFS incorporates "Drive Train Efficiency" for different fuels, which reflects the quality of the energy in various transportation fuels.  A Btu of electricity is worth a lot more than a Btu of gasoline, because electric motors are inherently more efficient (by a factor of 5) than gasoline engines.  This is completely independent of vehicle aerodynamics, and drive train design, factors which will also effect efficiency.  Diesel engines are inherently 1.28 times as efficient (on a Btu basis) than gasoline engines, while hydrogen is 2.13x as efficient, and electric motors are 5 times as efficient as gasoline engines.  This is why an electric vehicle powered by electricity from a coal plant is still much less carbon intensive than a gasoline powered vehicle.  These numbers are the inverse of the factor "eta" in the LCFS.

John Sheehan, Live Fuels (formerly of NRELs Biofuels division.)  Incidentally, I had the opportunity to hear John speak (PDF 100 KB, (Powerpoint 4.5 MB) over a year ago while he was still at NREL.  At that time, he was constrained in expressing his opinion about conventional biofuels... this time he didn't pull any punches.

INSIGHT #10: Water is the 800 Pound Gorilla

Narrowly defined incentives in biofuel policy are likely to lead to more boondoggles as we have seen in the domestic corn ethanol and biodiesel industries (see notes for specifics.) Water use is "the 800 pound gorilla" we need to be talking about when considering which biofuels we can sustainably produce.

Final Thoughts: For analysts, it's clear that a narrow focus, be it in biofuels, transportation policy, or allocation of GHG allowances, will lead to more perverse effects.  For investors, we need to be aware that the perverse effects of bad policy will eventually fail to sustain an unsustainable model, as investors have recently learned about corn ethanol. On the other hand, shorter term investors may be able to profit handsomely from regulatory windfalls, a trend we have also seen in corn ethanol.

Will likely policies which will be designed to encourage IGCC and a focus on cheaper driving rather than more efficient transport in the future follow this same pattern?  They may, and it is likely to lead to substantial costs to society and investors who jump on the trends at the wrong time.   

In contrast, good policies will allow investors to do well by doing good, and profit as companies solve societal problems, rather than reaping transient rewards at the taxpayer's expense.  These good policies include load-based rather than generation based carbon caps, which will allow energy efficiency companies to more easily reduce consumers' electric bills and make profits for their shareholders.   Likewise, transport policies which provide viable alternatives to driving and incentives to use those alternatives will allow investors in alternative transit to profit while reducing commuting costs, traffic fatalities, congestion, pollution, and greenhouse gas emissions.

We all like making money in the market.  Good energy analysts, like the ones at this forum, are working to provide us the opportunity not only to make money, but to solve societal and environmental problems at the same time. For that, we're all lucky to have them.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

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 TheStreet.com 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. AltEnergyStocks.com 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 America...it's only a matter of time

Just a quick follow-up on my carbon trading post a few days ago. Thanks to GreenBiz.com 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 GreenBiz.com 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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