Selling the blue sky
8 September 2010
NEW YORK - There are any number of ways to make money trading, though some prefer the term gambling.
That's because the financial world is full of innovation these days - even in the wake of the Great Recession - which primarily means inventing new instruments to trade. One can still trade the mortgage-backed securities that helped derail the global economy or corporate debt repackaged as bonds. Enron helped pioneer the trade in "physical" electricity, actual power available for purchase on the grid and only physical in the sense that the infrastructure to transport it is more visible than an odorless, colorless greenhouse gas. Both are now lucrative markets, but certainly electricity, despite its physics, is more stable.
So why would David Nussbaum, an unassuming middle-aged trader from New Jersey, switch from this steady market to one that doesn't even really exist yet in this country or, more frequently, is completely voluntary? "People thought I was nuts," Nussbaum said. "I'm not a tree hugger, but this is something above and beyond just a financial transaction. It's reducing the world's carbon emissions."
Nussbaum has a chocolate bar on his desk wrapped in a fake $1,000,000 bill. It's a payment from his boss at Evolution Markets for closing a deal that he didn't think could be done. And all the Blackberries, Etrali super-phones, laptops and monitors - a constant stream of communication and information - pale in significance to the most important trait a carbon broker can have: The ability to "smell BS" as Hochschild put it, even more important than speaking any of the multiplicity of languages carbon is traded in today.
"Agreeing on price, quantity and delivery is only half the battle," Nussbaum said. "The devil is in the details of these trades." This market is uniquely dependent for its very existence on governments - and in the United States, the government appears divided on how to proceed. Different bills linger in the House of Representatives and Senate - with little chance of passage - while the EPA plods forward with regulations to cut CO2 emissions. The EPA "doesn't know what's going to happen on cap and trade. The President doesn't even know," observed Lenny Hochschild, Nussbaum's partner in carbon at Evolution. "The hardest part is being reliant on a political process which doesn't appear to be incented towards what is good for America. The single biggest problem is regulatory uncertainty." In other words, nobody knows what the rules of the game will ultimately be.
As goes the United States, so goes the global market. Nussbaum has a cartoon on his desk that neatly summarizes the problem. A bespectacled, gaunt U.N. negotiator says "Avoiding climate change requires cooperation from everybody." His translator says: "We're screwed."
Or, as one broker who declined to be identified said: "It'd be nice to be in a market that's not created by a government."
Yet, the very complexity of the rules created by governments - whether the Clean Development Mechanism enshrined by the Kyoto Protocol, the fuel emission analyses in California's climate change law, or the arcane necessities of the 40-year-old Clean Air Act and its potential to impact on U.S. emitters of greenhouse gases - keep the brokers in business. No one can figure out what the rules are.
Of course, that creates problems too, not least the incessant hand-holding, whether that be in the form of cursing out a trader at a financial firm or loudly lamenting the stupidity of a would-be participant to said participant - a situation common to all commodity markets, at least judging by the occasional bombast from the coal or weather desks. "This is so asinine, it's ridiculous," one broker barked into the phone to a client, who is failing to complete a deal because of a missing fee.
Miscalculations can be costly. Betting on carbon regulation may have seemed like a sure thing in the 1990s as scientific and, seemingly, political consensus grew around the need to regulate greenhouse gas emissions. Yet, more than a decade of inaction - and the collapse of international negotiations as well as domestic efforts to cap carbon - has proven the perils of the business. Richard Sandor, founder of the Chicago Climate Exchange, a voluntary trading regime for CO2, and a founding father of carbon markets, sold out for $600 million this year. Brokerage CantorCO2e closed its U.K. carbon desk in July, consolidating those operations in the United States and effectively ending its physical presence in the world's most active carbon market, in Europe. "Carbon is a relatively small part of what we do in terms of revenue," said CantorCO2e CEO Josh Margolis. "Diversity is our friend."
And the U.N.'s Clean Development Mechanism market itself may come to an end in 2013 - bringing to a close the $20.6 billion trade - without a new set of commitments by the global community on how to extend the Kyoto Protocol's provisions, according to the U.N.
Whims of government
A closer look at the primary U.S. effort - the Regional Greenhouse Gas Initiative of 11 Northeastern states - may clarify. Regular auctions to sell the right to pollute, or allowances, have netted nearly $676 million for the states and emissions have dropped to roughly 120 million metric tons of CO2 - 34 percent below the cap for 2009, according to a report from Environment Northeast. The price of an allowance is under $2, hardly a massive economic burden on either electric utilities or electricity users.
Yet, there have been problems. Politicians, such as the governor of New York, have raided RGGI auction funds - supposed to be spent on energy efficiency improvements and rebates to electricity users - to remedy budget shortfalls. And the bulk of the emissions drop is not a consequence of a price on carbon or the cap - as theory would hope - but rather a byproduct of the mild winter in 2009 paired with a collapse in the U.S. economy - both of which reduce the demand for electricity and therefore the amount of CO2 pumped out to create it.
The great-granddaddy of all emission markets - the U.S. Environmental Protection Agency's Acid Rain Program - shows how vulnerable such a trade can be to the whims of government. Thanks to regulatory reforms begun under the Bush administration beginning in 2005, that market has collapsed - with allowances that once traded for $1,550 per ton in 2005 now trading for just $10.
In the end, the only thing that matters is whether any carbon market actually reduces emissions of greenhouse gases. The answer so far: Not yet. The European emissions trading scheme, the largest in the world, "has reduced emissions by just 2 percent compared to the projected levels without ETS," according to a 2010 report from the U.S. Climate Task Force. "Moreover, if the effects of the 2008-2009 financial meltdown and recession are taken into account, the data show that the ETS has had little if any independent effect on European [greenhouse gas] emissions."
And that brings up a question cap-and-trade's critics love to ask: If it can't reduce emissions, what is a carbon market really for?
Story © David Biello. All rights reserved.
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