Institutional Investor's Alpha Magazine - April 2008 - (Page 77)

for a speciﬁc price, are precisely the opposite of carbon contracts: a promise not to produce a speciﬁc amount of carbon over a set time period. But although this fundamental difference is important, the mechanics of both markets are essentially the same, which is what makes carbon trading a potentially attractive alternative for investors already schooled in commodities. Fusaro says that worldwide about 50 hedge funds trade pollution credits, including futures contracts, mostly in Europe. Not all of the pollution-credit trading in the U.S. involves carbon contracts. Some is in credits generated by established government programs for reducing other emissions, like sulfur dioxide from coal-ﬁred power plants, though these are minuscule markets compared with the potential for carbon trading. Any number of business sectors can take part in carbon trading. Although the biggest players will surely include the likes of coal-ﬁ red power plants and steel mills, smaller outﬁts aren’t excluded. A company like United Parcel Service might earn credits by running moreefficient or more biofuel-driven trucks. A law firm might earn credits by using energy-efﬁcient lights and less air conditioning. The U.S. puts about 6 billion tons of carbon into the atmosphere each year. If the nation ultimately decides to regulate it all under a cap-and-trade system, and if contracts reach $30 to $50 a ton as some — including Fusaro — predict, the value of the domestic market could reach $3 trillion. “That is what is exciting people,” Fusaro says. What should investors do today? Should hedge funds, with their relatively greater appetite for risk, be dabbling in carbon trading schemes already? Or should they wait until trading platforms, exchanges and rules become more established? With volumes that are still barely a dribble compared with those of other commodities markets, are there enough buyers and sellers yet to make speculating in carbon contracts feasible? Climate Change Capital’s experience suggests that hedge funds interested in arbitrage or rapid-ﬁ re trading should wait for the carbon market to age. In 2005 the ﬁrm launched one of the ﬁrst carbon trading hedge funds, set up to take advantage of new carbon emission rules being crafted by the European Union. The idea was to acquire carbon credits generated by companies that kept their pollution within certain limits, then sell those credits to companies that wanted to exceed them. Climate Change Capital raised $130 million, but it quickly became apparent to Hughes and others in the ﬁrm that carbon trading would not be easy. To generate credits, companies had to undertake projects that reduced emissions — for example, add solar panels or switch from a coal-powered generator to one powered by natural gas. Climate Change Capital found that not enough contracts were in circulation or there were not enough buyers to make speculating on contracts worthwhile. Instead, the firm found immediate opportunities in projects that would generate future credits — a longer-term proposition than those favored by restive hedge fund investors eager for short-term proﬁts. After 18 months, Climate Change Capital folded its carbon hedge fund and opened the Climate Change Capital Carbon Funds, a family of private equity funds suited to long-term investing. “There have been a few hedge funds able to take on longer liabilities and that have been trading in the market,” says Hughes, a former energ y risk a nd insura nce managing director with Marsh, a division of the Marsh & McLennan Cos., a New York– based insurance and management consulting company that has developed a rare expertise in sustainable energy development and climate change policies. Hughes says that despite recent nibbles by hedge funds, “the — NANCY KING, MANAGING majority of pure-play carbon DIRECTOR, MORGAN STANLEY funds would not be of a hedge fund structure today. As markets get more-liquid and more volume is traded, then more hedge funds will start to emerge.” What has already emerged is a core group of causeoriented policy wonks who have migrated to the investment world. It was not surprising that when Cantor Fitzgerald decided to expand into the carbon business, it put its central ofﬁce in San Francisco, known for both its entrepreneurial zeal and its environmentalism. CantorCO2e’s Margolis is a typical carbon market player, many of whom are veterans of governmentsponsored environmental initiatives. A Duke University graduate with a degree in public policy, he has helped craft regulations and pollution-credit trading systems around the world. Although Margolis helped districts in the San Joaquin Valley to unify air pollution control rules and offered advice on emissions banking and trading to industry trade groups based there, the region remains blanketed in some of the nation’s worst-polluted air. At CantorCO2e, Margolis says he plays two roles: helping clients make money and promoting environmentalism. “Every single person [at CantorCO2e] came to it because they know the environment is at risk and they believe the market can be used as a tool to help solve the problem,” Margolis says. “They ﬁrst and foremost believe in it. Yes, there is a proﬁt motive. But the cool thing is, you can do well by doing well.” A similar activism drives the “green” hedge funds that are popping up and dabbling in the carbon market and elsewhere. Fusaro says there are about 20 such funds — three of which exceed $1 billion in assets under management (the rest are much smaller) — devoted to environmentally progressive investments. But he says a few “Carbon most likely will be a factor, not only in trading, but in how companies will be evaluated.” APRIL 2008 • INSTITUTIONAL INVESTOR’S ALPHA • 77

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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