Tuesday, June 16, 2009

To Market, To Market

To market, to market to buy a fat pig.
Home again, home again, dancing a jig.

Mother Goose

Common thinking with regard to carbon emissions is that caps will be more effective if emitters have the chance to buy allowances until they can implement the technologies necessary to reduce emissions. As the same time innovators stand a better chance of commercializing new environmentally friendly products and services if they can monetize the technology through the sale of carbon credits. Of course, the so-called credits are earned through the reduction of carbon emissions in the course of implementation or installation. This is the trade portion of proposed environmental legislation now before the U.S. Congress.

There are already clearing house and exchanges set up around the world to accommodate emitters and innovators alike. The first to spring up after the Kyoto Protocol was signed in 2005, was the European Union Emission Trading Scheme.

Some individual states in the U.S. have trading programs, such as the Emissions Reduction Market System in Chicago. Other states have banded together such as in the Regional Greenhouse Gas Initiative started in January 2009 in the Northeast and including the State of New York. In Early 2007, seven U.S. states and four Canadian provinces formed the Western Climate Initiative, another regional greenhouse gas emissions trading system.

Enterprise has also been at play. The Chicago Climate Exchange sprang up in late 2007, for corporations to voluntarily limit emissions and earn offsets. The Exchange has come a long way in the past couple of years and is now provides quotes on the home page of its website. It has also created the Chicago Climate Futures Exchange that offers standardized futures and options on emissions allowances. Volume in May 2009, was five million carbon “financial instruments” compared to 72,500 instruments in the same month five years earlier. The exchange traded just 31,100 instruments in December 2003, the first month of trading on the exchange.

The Chicago Climate Exchange has been instrumental in establishing China’s first carbon credit trading platform, the Tianjin Climate Exchange. The Tianjin exchange is co-sponsored by the China National Petroleum Corporation.

None of these exchanges are household names and there is very little uniformity in their approaches to carbon credit trading. Indeed, they cannot even agree on the terminology - one says offset, the other says credit. We expect that to clear up eventually, especially as exchanges cooperate more fully with a centralized regulator or data keeper. The Climate Registry is already implementing record keeping on carbon credits that will bring consistency to trading.

The World Bank says carbon trading has been on the increase in the last few years. The World Bank measured of the world carbon market at $64 billion in 2007, the last year for which they published a value. That was almost double the value of $30 billion in 2006 and nearly six times the $11 billion value in 2005.

We expect these exchanges to grow and consolidate. All are privately held at this point, limiting participation by minority investors. Based on what appears to be a strong likelihood that cap and trade will be adopted worldwide, we expect to see a consolidator use a public offering to access capital.

Next post: a few ideas on how to play the cap and trade trend through the building market for monitoring and verification products and services.

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.

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