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Carbon ETFs

Connecting the Carbon Dots

Written by Nick Hodge
Posted December 19, 2008

Pee-Wee Herman used to sing, "Connect the dots... laa la laa la laa," as he leapt into the magic screen.

No, I haven't been hanging out with Pee-Wee in movie theaters. But his advice on connecting the dots is applicable in the context of financial and political realms... and the trends and investment ideas that emerge. 

Since the election in November, a series of dots have been emerging that indicate it's time to take a serious look at recently-established carbon ETFs and ETNs.

Connecting the Carbon Dots

In naming his climate change and energy team last week, Mr. Obama nominated Lisa Jackson to head the Environmental Protection Agency.

In her previous position, Jackson led the New Jersey Department of Environmental Protection, where she is credited with helping put New Jersey in a leadership role on the issue of climate change and with encouraging the state to adopt a moratorium on building new coal plants.

She also championed the reduction of emissions. And, in 2007, New Jersey became the third state, behind California and Hawaii, to pass a law that mandates steep emissions cuts over the next four decades.

New Jersey, under Jackson's direction, also helped establish the Regional Greenhouse Gas Initiative (RGGI), the first mandatory, market-based CO2 emissions reduction program in the United States.

A "market-based" program means it is possible to profit from reducing emissions.

And I suspect, under her leadership, the EPA will push through a similar measure that covers the entire country. You may know it as a cap-and-trade system.

Her new boss is certainly on board. The 'agenda' section of his website has the following three things to say about changing our carbon habits:

  • Reduce our Greenhouse Gas Emissions 80 Percent by 2050

  • Implement an economy-wide cap-and-trade program to reduce greenhouse gas emissions 80 percent by 2050

  • Make the U.S. a Leader on Climate Change.

Obama has already said he'll consider asking the EPA to regulate emissions under the Clean Air Act, which is something they should've been doing already, but Bush declined to do so after saying that such a plan would turn the EPA into the "de facto regulator of the economy."

In response, Jackson sent a forceful letter to the EPA saying that "the past eight years have demonstrated a shocking, yet consistent, irresponsibility on the part of the federal government to engage in any meaningful way... in implementing sustainable solutions to reduce emissions."

I think the policies she intends to carry out in her new position are clear.

Are you going to take advantage?

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Profiting from Capping Carbon

The first thing you'll want to do in preparation of a nationwide cap on carbon emissions is limit your exposure to companies that have significant carbon risk.

You see, the moment a limit is put on the amount of CO2 American companies can spew into the air, carbon becomes a liability in earnest, even though it already is in some ways.

That big utility in the south that generates electricity primarily from coal-fired plants? Probably not a good investment anymore.

I wouldn't go as far as saying that coal companies are an unwise investment. I think companies like Peabody and Chesapeake have bright futures as electricity demand increases.

It'll be the companies burning the coal that'll have immediate negative impacts. Of course, we'll have to wait and see how the policy takes shape before how all companies involved will be affected.

But one thing is for sure. According to New Carbon Finance, the preeminent carbon industry analysts, a $1 trillion carbon trading market will exist in the U.S. by 2020 if emissions are capped and and traded—that's more than twice the size of the European Union's Emissions Trading Scheme (EUETS).

New Carbon Finance also concluded that a U.S. cap-and-trade program would lead to:

  • A carbon price of $40 per ton as soon as 2015, which will result in a rise in consumer energy prices in real terms of roughly 20% for electricity, 12% for gasoline and 10% for natural gas — as well as impacts on other prices as higher energy and transportation costs filter through the economy; and

  • Major U.S. investments in renewable energy, energy efficiency, and greenhouse gas mitigation projects and technologies.

That means investment in renewable energy will abound, and you'll want to come along for the ride because energy prices are also predicted to rise.

For now though, let's just focus on recently-created market mechanisms focused on profiting directly from a carbon-constrained economy.

A Carbon Trading ETF

I'm talking about the less-than-a-week-old carbon ETF called the AirShares EU Carbon Allowances Fund (NYSE: ASO).

According to its website:

AirShares EU Carbon Allowances Fund (NYSE Arca: ASO) is a commodity pool that seeks to provide investors with investment results generally corresponding, before payment of ASO's expenses and liabilities, to the performance of a basket of exchange-traded futures contracts for European Union Allowances (EUAs).

Those allowances have been on a downtrend of late, sliding with the broader economy from 30 euros per EUA to below 15 euros per EUA, with the broader economy.

But the recovery of the global economy, coupled with a firm carbon cap from the U.S., and the negotiation of a successor to the Kyoto protocol, will send the price of carbon emissions soaring again in the coming years.

Getting in now, at the birth of the fund and the bottom of the carbon market, will ensure sustained growth for years to come.

A Carbon ETN

The iPath Global Carbon ETN (NYSE: GRN) tracks the prices (82% and 18%, respectively) of the European Union Allowances (EUAs) and the Certified Emission Reductions (CERs) of the Kyoto Protocol via the Barclays Capital Global Carbon Index Return.

According to its website:

The Barclays Capital Global Carbon Index Total ReturnTM (BGCITR) is designed to measure the performance of the most liquid carbon-related credit plans and is designed to be an industry benchmark for carbon investors. Each carbon-related credit plan included in the BGCITR is represented by the most liquid instrument available in the marketplace. The BGCITR expects to incorporate new carbon-related credit plans as they develop around the world. The BGCITR currently includes two carbon-related credit plans: European Union Emission Trading Scheme or EU ETS Phase II and Kyoto Protocol's Clean Development Mechanism.

Similar to the AirShares ETF, this note will offer nice returns as demand for carbon credits grows, for all the reasons mentioned in this article.

Of course, the carbon ETF and carbon ETN aren't the only ways to profit from the emergence of stringent emission standards.

Investing in individual companies that specialize in reducing emissions in a number of ways, from forestation to heat recovery, can also generate nice profits.

I recommend those types of companies to readers of my Alternative Energy Speculator, in addition to profiting from all the other sectors the cleantech world has to offer.

Join me, and thousands of other readers, as we play this coming boom for all it's worth.

Call it like you see it,

nick hodge

Nick

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