Making a Market for Pollution
By David Biello for the Daily Climate
NEW YORK - When convincing someone to trade in a commodity that cannot be seen or touched, it's best to hold their hand – even if only by telephone. Standing while talking helps, too, at least for broker Lenny Hochschild, who specializes in convincing everyone from agribusiness to electric utilities to buy and sell in a market that doesn't exist yet – a U.S. market for the right to emit carbon dioxide, the most ubiquitous greenhouse gas changing the global climate.
This is possibly the newest market in the world, a would-be global attempt to create a trade in the greenhouse gas emissions from any nation's fleet of cars, household refrigerators, electric power plants, factories, even farms. It's an attempt to peel back the smothering blanket of global warming by giving people a financial incentive to reduce emissions under an economic concept known as cap and trade.
The carbon desk Hochschild occupies is in the middle of five long rows of tables, buried under computer monitors, laptops and thick books of market arcana, that make up the trading floor at Evolution Markets, an "environmental" brokerage in White Plains, N.Y.
Hochschild got his trading start in more physical commodities: metals, specifically the so-called "base metals," such as copper. Of course, copper is the primary metal used around the world to move electricity and that's a route Hochschild followed as well, moving into energy products and, then, in 2003, starting to trade renewable energy credits – another government run market in chits that show a given electric utility has produced or bought a sufficient amount of electricity from renewable resources, such as the sun or wind, to meet a mandate.
The trading of any commodity – whether wheat, pork bellies or renewable energy credits – is essentially the same, but it helps to have an understanding of the reality behind the abstract: the color-coded blinking numbers on a broker's multiple computer screens that reflect current prices in a spread of different regional carbon markets, like the European Carbon Exchange. As a result, many emissions brokers are former traders of the commodities important to the industries that emit CO2 – whether metals or coal, oil, and natural gas. After all, the use of those commodities gives rise to the carbon commodity – an emissions allowance – in the same way that burning coal releases CO2.
With allowances limited by the government, a free resource – the air – suddenly becomes scarce. With scarcity comes value and value means money.
But Hochschild didn't move to the carbon market to save the world. "It's a market that's growing," he said. "It's a market that's doing what needs to be done and allows me to earn a decent living." In fact, the low volume, high margin market is responsible for 25 percent of Evolution's global revenue, according to spokesman Evan Ard.
The effort to create a national market for such CO2 emissions received a serious blow when the U.S. Senate abandoned the effort to pass a climate bill this summer. But worldwide markets are growing, and brokerage houses see potential despite the domestic setback: Worldwide, emissions trading was a $144 billion market in 2009, according to the World Bank, and 2010 figures to be even higher. Regional markets are spreading, notably on the West and East coasts of the United States. Europe's cap-and-trade system, the largest emissions trading scheme in the world and a pillar of the European Union's climate policy, has been up and running since 2005.
To be a broker like Hochschild is to collect a commission – and to convince two companies or, really, two people to exchange something in return for a fee. In Evolution's case they collect at least 3.5 percent of any deal, plus various fees. But what are the parties actually trading? In the case of the carbon market, it's the right to pollute the atmosphere with greenhouse gases.
Here's how it works: first the government sets a cap – or an overall limit on the amount of greenhouse gas pollution permitted. Then the government awards or sells permits to emit said pollution. Those companies that can reduce emissions below the assigned amount can then sell the excess to other companies struggling to meet the cap – this is the trade portion of the name.
The result is an overall emissions decline with the lowest overall economic impact, at least in theory, though some economists and other experts argue that such trade in greenhouse gases amounts to "voodoo economics" – the benefits of the trading never trickle down to the actual pollution control.
But the concept has worked for emissions of other air pollutants, such as the sulfur dioxide from coal-fired power plants behind acid rain. The amount of sulfur dioxide falling on northeastern forests from Midwestern power plants has declined since the 1990s when that market was introduced. The acid rain cap-and-trade market "worked cheaper and faster than the naysayers predicted," Hochschild noted. With the total number of such allowances limited by the government, a free resource – the air – suddenly became scarce. With scarcity comes value and value means money.
Today brokers at carbon desks in London, Beijing, Tokyo and New York drum up business in Indonesia, Russia, Brazil and even the Democratic Republic of Congo. Many expect this worldwide emissions market to be worth trillions of dollars some day. Much of today's value is driven by the Kyoto Protocol, which set up a global market for greenhouse gas emissions but is set to expire in 2012, with no prospects of successor treaty in sight.
And that brings up the fragility of today's emissions markets,.
One domestic cap-and-trade market, organized by the Chicago Climate Exchange, is voluntary. Launched in 2003, it relies on companies such as Cargill, DuPont, Intel, Ford and Monsanto to make legally binding but voluntary commitments to meet emissions targets either by reducing emissions from their factories or by purchasing permits from other members of the exchange who have exceeded their targets.
That system is now in doubt, Jeff Sprecher, chief executive of the CCX's new parent company, Intercontinental Exchange, told investors during an August conference call. "It remains to be seen in an uncertain U.S. regulatory environment whether companies are going to want to continue to walk down their carbon footprint and whether they're going to continue to get credit for it from Congress and how the Environmental Protection Agency ... will give them credit for the work they're voluntarily doing."
The U.S. market, Sprecher added, is a "loss-making business as it exists today," which may be why ICE is reputed to be laying off much of the staff who run the CCX business.
But Intercontinental Exchange also runs Europe's main carbon emissions trading platforms, and that's a growth business even with no prospects of a global deal to cap emissions on the horizon, Sprecher said.
On just one day in mid-May, 6.5 million metric tons of CO2 allowances traded on the European Carbon Exchange – or more than $150 million worth at a price of nearly EU$16 per ton just for the countries in the European Union; it has grown 26 percent for the year through July, according to the Intercontinental Exchange.
The E.U. is not the only region to have such a trade: Regional carbon markets have proliferated, ranging from an 11-state market in the northeastern United States known as the Regional Greenhouse Gas Initiative, or RGGI (pronounced "Reggie" by aficionados), to the would-be global market for avoiding greenhouse gas emissions as the developing world develops under the terms of the Kyoto Protocol, the so-called CDM, or Clean Development Mechanism (which lacks a cutely pronounced acronym, among other problems).
Lost? Hochschild, sitting now, says you're not alone. "There are more acronyms in this business than anything else."
Thanks to U.S. intransigence, there is an international flavor to the carbon market. And that means Hochschild's day starts early, with phone calls to Europe or Asia, segueing as the day progresses into activity in Brazil or the United States. Education is how carbon brokers drum up business. "They've never heard of carbon offsets or cap and trade, or if they have, they've heard it's a tax," Hochschild said of his U.S. prospects. The hand-holding starts with educating potential sellers and buyers. "Seventy percent is free consulting and 30 percent is actual deal flow," he adds.
"But without the consulting, no flow."
Evolution cannot survive on carbon alone, of course. In addition to trading greenhouse gases, Evolution helps broker deals for biofuels, natural gas, the uranium fuel for nuclear reactors, renewable energy credits, air pollution permits for sulfur dioxide and nitrogen oxides, even insurance against bad weather. But it is coal that has kept the lights on for the last 10 years. Whether it's physical shipments of the fossil fuel or the buying and selling of the permits for the pollution that burning it causes – Evolution's first trade was a sulfur dioxide allowance between Enron and Dynegy in February of 2000 – the brokerage makes its living on coal.
Of course, coal is also responsible for nearly 30 percent of U.S. emissions of carbon dioxide, and 20 percent globally. Efforts to halt the global warming caused by carbon dioxide have focused on trading metric tons of the odorless, colorless greenhouse gas globally since at least the 1990s. Evolution has specialized in the nascent trade since 2001 and has posted some early successes, such as the first trade designed to ensure compliance with the emission cuts embedded in the Kyoto Protocol – a transfer of a reduction in emissions in Slovakia to help offset emissions in Japan.
It sees no reason to step back now.
"We were in this market from the very beginning, before it was even a market," Evolution's Ard said. Now "the carbon desk has enough volume coming through to sustain that business."
Photos courtesy Evolution Markets.
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