Green finance special section
EXCITEMENT ABOUT THE market for greenhouse gases is rising even faster than global temperatures. Investment banks that are already active in the market are doubling their teams, while those that aren’t are quickly trying to build them. But although there is a compelling need for some banks to be present in the market to serve existing clients, and the opportunities are attractive, so far most of the real money is being made by other types of participants.
The non-financial technicalities of emission reduction projects, which generate tradable certified emission reduction certificates (CERs), and the lack of regulatory clarity in what is essentially a market created by regulation, is encouraging more and more banks, especially those late to the game, to seek equity stakes or partnerships as a means of gaining expertise.
The market for greenhouse gases has directly created three main areas of business opportunity: the financing and development of carbon offsetting projects; the trading and risk management of emissions allowances and CERs; and speculative investing. Of these, the biggest money-spinner to date has been the first. Banks, however, have largely been missing out on the action, which instead has gone to the corporates that own the projects and to the market’s pioneering consulting firms, which are increasingly morphing into what look like funds themselves.
"It’s the guys with the equity that are making the real money," says Steve Drummond, managing director of CantorCO2e, a leading developer of carbon offset projects and CER brokerage, "and those in the main are the local companies that are investing in emission reduction projects. There are institutions in London putting equity into these projects but that’s a small percentage of the overall activity – mostly they are contracting to buy credits, which enables local investors to raise funding. This is the CDM in action."
 |
"Cap-and-trade schemes are the most efficient solution because people can make money out of it"
Louis Redshaw, Barclays Capital |
Companies in countries with no emission reduction obligations under the Kyoto Protocol can earn CERs through projects that reduce their greenhouse gas emissions and sell them on to those companies and governments in other countries that do have obligations, under the protocol’s Clean Development Mechanism (CDM) or Joint Implementation scheme. The economics of such projects vary enormously depending on the technical nature of the project but in some cases can be highly lucrative. Some of the most attractive early projects, which focused on eliminating the particularly potent greenhouse gases, such as HFCs and nitrous oxide, which have a warming effect hundreds of times greater than carbon dioxide, required investments of just a few euros per tonne of gas emitted to yield tens of millions of CERs, which today trade at a value of about €13.
French chemicals company Rhodia, for example, is expected to earn between €468 million and €2.2 billion over five years from a project to abate nitrous oxide emissions at two polyamide factories in Brazil and Korea that will generate about 100 million tonnes of CERs, according to estimates from Morgan Stanley.
In general, however, bankers and CDM developers are extremely coy about discussing the returns they are getting from their projects and say little beyond "at least double digits".
Carbon funds, which operate by buying forward streams of CERs from abatement projects but do not generally invest in the equity of projects, are also looking at impressive returns on their investments. The European Carbon Fund, set up by Fortis and Caisses d’Epargne and managed by Natixis Environnement & Infrastructures is so far looking at a 70% return over the past two years. The original €142 million fund, which now holds 5 million tonnes of issued CERs and 20 million tonnes-worth in forward contracts, is almost fully invested and the European Carbon Fund is about to launch a second fund with a target size of €300 million to €500 million.
Carbon funds aim to make money by buying the forward CER streams of abatement projects at a discount and then selling them on later when the price of CERs rises. The funds are able to buy these primary CERs cheaply because they offer cash upfront for a project’s CER output with no guarantee on the volume of CERs that will ultimately be delivered.
Having seen the money being made at these carbon funds, however, a growing number of companies, particularly in India, have started to look at developing and registering abatement projects themselves in the hope of selling issued CERs on the spot market in order to obtain a better price. But this is not the only trend that could eat into the returns of future projects.
Although the carbon abatement industry is just a few years old, there is a growing recognition in the market that most of the low-hanging fruit, the most accessible and profitable projects, have already been picked.
"The low-hanging fruit might be almost exhausted but there is still a lot of emissions reduction potential out there, it just requires a greater level of upfront investment to be made," says Jerome Malka, managing director of Orbeo, an emissions trading and CDM project joint venture between Société Générale and Rhodia. "The average volume of CERs per project is getting smaller and smaller because people are waiting for clarification about the validity of CERs post-Kyoto before they start committing money to expensive long-term projects. Until then, the cost of producing credits is likely to increase, as will the resources that those looking to source CERs will have to commit because it takes just as much time to negotiate a small transaction as a large one."
The carbon myth?
Uncertainty about the market beyond the Kyoto Protocol’s 2012 life span is also hampering the development of carbon credits as a source of financing deals. A long-term forward purchase of CERs from a creditworthy buyer can be used by a company investing in an abatement project as a source of financing that reduces their cost of funding because most often the bank offering the financing is also the buyer of the credits.