Institutional Investor's Alpha Magazine - April 2008 - (Page 76)

Carbon Trading research is available, “a lot of this analysis is conducted as a thumb in the air due to the lack of reliable information.” Clearly, the carbon market is no place for the timid. A risk-loving hedge fund, on the other hand, could ﬁnd a rich source of alpha in carbon trading. Richard Sandor, a Chicago economist and entrepreneur who came to be known as the father of ﬁnancial futures for his proposal 30 years ago to package and trade ﬁnancial instruments, has created a platform that lets investors trade carbon contracts, options and futures. Sandor is chairman and CEO of the Chicago Climate Exchange, which he founded in 2003 as the world’s ﬁrst pollution credit exchange. He is also chairman of the London-based Climate Exchange, the company that now owns the Chicago exchange and its sister European Climate Exchange. Hedge funds are already “signiﬁcant players” in the Chicago exchange, Sandor says, though he declined to say how many participate. He is quick to promote the market as an undervalued opportunity. “I am as excited about this as an asset class as I was about ﬁnancial futures in 1975,” he says. “This portends to be the largest single commodity in the world.” Most of the action has been in Europe, however, and the biggest problem facing the Chicago exchange is the absence of a cap-and-trade policy in the U.S. Credits traded on the Chicago exchange are purely voluntary, which means buyers are purchasing a promise from a company that it will limit its carbon emissions to a certain level over a certain period of time. U.S. companies that are already reducing carbon emissions are either trying to get ahead of what they see as inevitable regulation or to gain an advantage with consumers in promoting their green bona fides. Without a federal law to force compliance and regulate credits, the value of U.S. credits remains highly speculative. Voluntary and mandatory systems differ profoundly in their impact on carbon credit prices. In Europe contracts backed by the force of national and international rules sold for $25 to $30 per ton of carbon in late January, for instance. A comparative voluntary contract on the Chicago Climate Exchange could be had for $2.15. Sandor says a U.S. cap-and-trade policy would drive up prices, an assertion supported by the effect of the presidential debate over carbon emissions. As the race narrowed during the winter to McCain, Clinton and Obama, carbon credits on the CCE more than doubled in price, hitting $4.50 in March, and demonstrated one of the fundamental drivers of the carbon market: politics. “It is not a true ﬁnancial market,” explains Peter Fusaro, co-founder of New York–based Energy Hedge Fund Center, which advises hedge funds and others on investment opportunities in climate change. “It is a hybrid market.” Fusaro notes that viable carbon trading requires two parts: “You need a government policy framework and a capital market. It is not like trading pork bellies.” Pork belly contracts, which represent a promise to produce a speciﬁc amount of pork at a speciﬁc date Photo by Gabriela Hasbun for Alpha Josh Margolis, co-CEO of market maker CantorCO2e, says it’s possible both to help clients make money and to promote environmentalism. Barack Obama call for reducing U.S. greenhouse gas emissions by 80 percent from 1990 levels by 2050 and would auction off carbon credit permits rather than grant them, as some policymakers have suggested. Doubts about such programs creep in because the market is so immature. There are disagreements about how to value carbon credits, how to be certain of their validity and how much faith to put in the governments that issue the credits. For instance, is a solar panel worth more or less than a gas-ﬁred heating system? “You can’t look at this as just any other product,” says Josh Margolis, co-CEO of San Francisco–based CantorCO2e, the carbon trading operation of broker-dealer Cantor Fitzgerald. “The regulations are in ﬂux. The reasons to buy are changing with light speed. The number of people participating is growing. You are likely going to ﬁnd yourself stumbling into a fantastic transaction or scratching your head and saying, ‘How did I lose my shirt?’” Some who have approached the carbon market as a standard trading opportunity have had a rude shock. In an October 2007 report, “The Carbon Emission Trading Market,” Celent, a financial services consulting firm in Boston, concluded that the main characteristic of the carbon market is uncertainty, even in Europe. “Trading in the carbon emission market today is like trading in the equity market without industry research and company annual reports,” the report concluded. It noted that although some 76 • INSTITUTIONAL INVESTOR’S ALPHA • APRIL 2008

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - April 2008

Institutional Investor's Alpha Magazine - April 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Here to Eternity The Good Guys: Voice of Hope Cover Story: The Kings of Cash Where the Money Is Into the Light Interview: Proceeding with Caution Strategies: A Convenient Truth Alpha Bytes: Village Voice Unhedged: Commentary: No Time for Complacency

Institutional Investor's Alpha Magazine - April 2008

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