Friday, May 04, 2007

Carbon Credit Line

Mother Nature appears to be calling mankind’s line of credit. Cancellation notices are cropping up all over the world. German activists are in a last ditch effort to save that country’s single remaining glacier. Greenland hunters are looking into new career opportunities because the dwindling ice fields are no longer producing enough fish and game to support hunter families. The list could go on and on of significant environmental changes as a consequence of an increase in planet temperatures.

So mankind has set up its own credit line of sorts - carbon credits. Carbon credits place a monetary value on polluting the air. One credit is the equivalent of one ton of CO2 emissions. Generating credits results in assets while generating pollution uses up credits or creates a debt. Very clever, but how does an investor play this new credit line game?

First, there needs to be an exchange. In the case of carbon credits, there are two: the
Chicago Climate Exchange and European Climate Exchange. Only verified credits can be traded on these exchanges and there are authorized entities to visit the generating operation. None are public so far, so there is no public markets play at this level.

Once approved, a generator can sell carbon credits to entities which are in a deficit. Microgy, Inc. a subsidiary of
Environmental Power Corp. (EPG: AMEX), which was first profiled in the November 2006 issue of our Small Cap SEARCH newsletter, is an approved generator in the U.S. The Italy subsidiary of Fuel Tech, Inc. (FTEK: Nasdaq), which is in the coverage universe of Crystal Equity Research, also generates carbon credits for trading on the European Exchange. Industrial producers of cement or steel are examples of those operations that would be in the market for a carbon credit. That list is quite lengthy.

At first glance it might appear that the carbon credit scheme is not much more than a shell game. After all, in order to cool down the planet, the polluters still have to physically reduce carbon emissions and alternative energy must be produced in meaningful quantities to replace fossil fuel. It is important to view carbon credits as lubrication for the process. A substitution of non-polluting fuel for fossil fuel has a price tag and requires considerable capital investment. A substitution of non-polluting fuel for fossil fuel has a price tag and requires considerable capital investment. By monetizing carbon emissions it facilitates analysis by investors of the both the costs of carbon pollution and the non-polluting value of renewable energy.

The list of possible investments among carbon credit generators is short but growing. The real cost of industrial operations is probably not fully appreciated and therefore the true profitability of certain high-polluting industries is probably overstated. We expect the topic to gain prominence in analyst commentary as investors demand more accountability to pollution generation. Imagine the discussion if public companies were required to show carbon assets and liabilities on their balance sheet. We expect that is a long time in coming. But we do see some early discussion of credit generation as more companies see it as a way to wring more value about of their processes.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. Crystal Equity Research has a Buy rating on FTEK and EPG is profiled with a favorable viewpoint in Small Cap SEARCH.

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