The Carbon Market

Carbon dioxide is no longer free, as it once was. It now comes with a price.

It used to be that no one worried about CO₂–it was just a gas that had no real use. But as more light was shone on this once useless gas, new theories and opportunities began to emerge.

Once it was realized that CO₂ is a heat-trapping or greenhouse gas (GHG), the entire game changed. There were calls for emissions reductions and in late 1997 a treaty was created by the United Nations (UN) assigning mandatory emission limitations to all signatory nations.

As of today, a total of 169 countries, with the notable absence of the U.S. and Australia, have ratified the agreement. In that time, CO₂ has evolved into a precious commodity, expanding its value not only as a GHG, but also in other applications such as advanced recovery techniques for aging oil wells.

Under the Kyoto agreement (and even alongside it) a number of carbon reduction and trading schemes have been established, leading to what the New York Times says "will be the world’s biggest commodity market, and it could become the world’s biggest market over all."

With predictions like that, and the billions of dollars that have already been poured into this sector, I thought it was high time to get on the inside of what will surely be a juggernaut of an industry.

So last week I went to the U.S. Carbon Finance Forum in New York City. The theme of the conference was "Preparing for carbon regulation and trading in the U.S.," and what I learned there is already proving to be invaluable.

Clearing the Fog

First off, it cleared up some gray areas concerning what exactly constitutes a legally binding carbon reduction scheme. To date, there are three such arrangements in the world.

Under the Kyoto Protocol, there are two main trading devices. The first, the Clean Development Mechanism (CDM), allows Kyoto countries to offset their emissions by investing in clean technologies in developing countries or purchasing the resultant Certificates of Emission Reduction (CERs) from such projects. The second, called Joint Implementation (JI), allows industrialized countries to do essentially the same thing, only in other industrialized countries.

The other government-backed trading program was adopted by the European Council in 2003 and is called the European Emission Trading Scheme (EU ETS).

In 2006, 1.1 billion CERs (each worth one metric ton of CO₂) were channeled through the EU ETS at a value of $24.3 billion.

The last carbon trading pact is the voluntary scheme implemented here in the U.S. through the Chicago Climate Exchange (CCX). This market, I learned, is still relatively small, but will triple its 2006 value by the end of this year. It is also not federally regulated, so there is more inherent risk.

Now, with that out of the way, let’s talk about the possibilities for profit that can be found in the emerging global carbon market.

Institutions

First and foremost, this is a big boy’s game. The sudden surge of capital in the carbon market can be attributed to a flood of investment from large institutional firms.

They invest billions and billions of dollars in what has now become known as Project Finance, or projects that are used to generate CERs. These projects can vary widely in type, from wind farms in the developing world to energy efficiency programs in downtown London. But in the end, either the U.N. or the verification arm of the EU ETS must certify all projects.

Then, once the CERs are reaped from a project, they are sold to companies or countries that need to meet their legally binding targets.

Operations like this have become commonplace for big banks, hedge funds and brokerage firms all over the world. In fact, many of those institutions now have dedicated carbon departments and have assigned positions like Vice President of Carbon Markets or Senior Investment Officer for Carbon Finance–both of which were titles I saw at the conference.

And power players in the financial realm aren’t just looking to finance carbon reduction projects, they’re also offering consulting and risk mitigation strategies.

Earlier I told you that carbon is no longer free. And what power generation companies are realizing now is that carbon has a price even before they generate emissions. That means corporations that generate emissions in any form now have to account for the price of carbon in their business models.

And big banks are now calculating this new business risk before granting loans or underwriting IPOs.

But even though the generation and trading of carbon credits and the mitigation of carbon-associated risk is primarily dominated by large institutional firms, the profit potential for individual investors is still exponential.

Individual Investors

This is because the large funds that have been set up to finance emissions reductions projects are continually looking for new projects to invest in–now more than ever.

Under the Clean Development Mechanism (CDM), large investment firms first went after the low-hanging fruit. They went into China, India, and other developing countries and cleaned up the dirtiest operations they could find. When the CDM was in its infancy, these projects turned out to yield huge returns.

In fact, just 3% of the registered CDM carbon reduction projects accounted for 55% of total carbon reductions. Currently, there are 222 projects registered under the CDM. These projects are preventing 65 million metric tons of carbon from entering the atmosphere every year. But the current demand for CERs is as high as 500 million metric tons. You can see why more projects are needed.

And although the U.S. hasn’t ratified Kyoto, it is primarily our technology that is driving these projects, especially as the carbon fruit gets harder and harder to pick. The main markets for carbon reduction projects are as follows:

• Energy Efficiency
• Methane Capture/Waste-to-Energy
• Carbon Capture
• Power Plant Revamping
• Fuel Switching
• Demand-side management

These are all sectors in which the U.S. excels, and from which it is possible to reap massive profits. And with the recent market selloff, there are some good bargains out there.

Covanta Holding Corp. (NYSE: CVA) is one of them. Involved in waste-to-energy, renewable projects, and landfill gas projects, this company could soon become a CER Mecca. Another no-brainer play in waste-to-energy conversion is Waste Management (NYSE: WMI).

But, as I learned at the conference, the most promising opportunities for emissions-related profit will be in the realms of energy efficiency and demand-side management. That means instead of finding new ways to produce energy, we simply find ways not to use it.

A company that has been white hot in this sector is Echelon Corporation (NASDAQ: ELON). This company went gangbusters in the past six months as it announced deal after deal–including one to help McDonald’s use less power.

The Green Chip Stocks portfolio includes a similar company.

And there are plenty more opportunities. Soon, carbon will become a full blown commodity. Its emissions will be regulated all over the world and companies will have to divulge their carbon footprints as public information. A thriving carbon market will be commonplace.

Companies that Green Chip has been following for years, especially in the renewables market, will begin to take additional profits from the sale of carbon credits. It will be a great time to be in this sector.

To take full advantage of the coming carbon boom, you must be a member of Green Chip Stocks. To take advantage of our discounted price, click here .

In the meantime I’ll be working on a detailed carbon report that will analyze a multitude of ways to profit from reducing carbon emissions. It will be available to Green Chip members as soon as it’s done.

Until next time,

Nick