up a cap-and-trade system and the United States appears to be moving slowly toward adopting a cap-and-trade system. Right now the carbontrading market is about $30 billion, but some industry leaders expect theindustry to grow to $1 trillion within a decade according to an article in theNew York Times.1
C
TRADING EUROPEAN CO2 ALLOWANCESThe largest market for trading CO2 at present is at the European ClimateExchange (ECX) futures market. The European Climate Exchange wasfounded in January 2005 and is currently handling about 80 percent of theworld’s exchange-traded CO2 futures volume.2 Since the European ClimateExchange doesn’t have an electronic trading network of its own, the trading is actually done on the Intercontinental Exchange’s ICE Futures network. ICE Futures is Europe’s leading energy exchange for futures andoptions and the world’s largest electronic energy futures exchange.3 Intercontinental Exchange, Inc. is a publicly traded company (Nasdaq: ICE)with a market cap of about $10 billion.297
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The European Climate Exchange’s CO2 futures contract is called aCarbon Financial Instrument or CFI. The underlying instrument is theEuropean Union Allowance (EUA), which is an allowance to emit 1 metricton of CO2 . The CFI futures contract represents 1,000 EUAs and is quotedin terms of euros per metric ton of CO2 emissions. Thus if the CFI futurescontract were trading at 20 euros per metric ton of C02 , the nominal valueof the futures contract would be €20,000 (20 euros times 1,000 EUAs). If thefutures contract were to rise by €0.10 to €20.10 /ton CO2, then the futurescontract would rise in value by 100 euros to €20,100.The growing popularity of the European Climate Exchange CFI futurescontract can be seen from the fact that the average daily volume has doubled in the past year to the current level near 3,500 contracts per day (seeFigure 17.1).Further evidence of the growing popularity of trading CFI futures is thegrowing level of open interest (see Figure 17.2). Open interest is the totalnumber of futures contracts that have been bought and sold and are stilloutstanding. The sharp dip in open interest seen around December 2006occurred when the December 2006 futures contracts expired.Table 17.1 shows a table provided by the exchange of the settlementprices as of July 13, 2007. Each row represents a different futures expiration month. For example, the first line, which is for December 2007 showsthe data related to the CFI futures contract that expires in December 2007.4,0003,5003,0002,5002,0001,5001,0005000May-05
Aug-05
Nov-05
Feb-06
May-06
Aug-06
Nov-06
Feb-07
May-07
FIGURE 17.1 ECX EFI CO2 Futures—Average Daily Volume in Contracts (60-dayaverage)Source: European Climate Exchange, “ECX CFI Futures Contracts: Historic Data 2007,”http://www.europeanclimateexchange.com/uploads/documents/ECXCFIFuturesContract-HistoricData-12July2007.xls.
Settle
0
000000000
Exchangefor Swaps(EFS)
0
000000000
BlockTrades
4,030
25000317724743344104
EFP
7,366 5,585
€0.13500375€0.1300€0.1300€0.1300€19.79 4,795 3,202€20.13 1,766 1710€20.50 248248€20.885750€21.2800
Volume Settle Volume
125,400
45,758002050,80619,2935,7251,4582,340
OpenInterest
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Source: European Climate Exchange, http://www.europeanclimateexchange.com/.
2,492
Low
Total
High
00001,8441644163434
Last
Exchange forPhysicals(EFP)
Previous Business Day
January 12, 2008
Dec-07 €0.14 €0.14 €0.13 €0.13 €0.13Jan-08 €0.00 €0.00 €0.00 €0.00 €0.00Feb-08 €0.00 €0.00 €0.00 €0.00 €0.00Mar-08 €0.00 €0.00 €0.00 €0.00 €0.00Dec-08 €20.50 €19.85 €20.00 €19.25 €19.89Dec-09 €20.35 €20.21 €20.21 €19.76 €20.21Dec-10 €20.22 €20.20 €20.63 €20.20 €20.63Dec-11 €21.20 €21.20 €21.02 €20.45 €21.02Dec-12 €20.80 €20.90 €21.40 €20.78 €21.40
Month Open
Data current at: 13/07/2007 17:00:33 GMT
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TABLE 17.1 Table of ECX CFI CO2 Futures Settlement Prices
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There are several notable items on this table. First, the most activelytraded futures contract in the complex on that day was the December 2008futures contract, as seen by the volume figures shown in the third columnfrom the right. The other futures months for 2008 had yet to start trading.Second, the December futures contracts are the benchmark contracts forany given year as seen by the fact that only December contracts are trading for 2009 and beyond. Fourth, trading volume in the December 2007 contract had dried up but the contract still had very high open interest of 45,758contracts, representing more than one-third of the total open interest.Looking at the settlement prices for the contracts, the December 2007futures contract closed at €0.13 per ton on that particular day, whereasthe December 2008 contract closed at €19.89 per ton. The December 2007contract was trading at such a low level because the EU Registries issuedtoo many allowances for the 2005 through 2007 compliance period, whicheventually made them practically worthless. However, the National Registry sharply decreased the number of allowances for the 2008 through 2012compliance period, which accounts for the higher prices for the December 2008 futures contracts and beyond, which were trading in the €20 to€21 area.
CAUSES OF PRICE MOVEMENTSThe price of the CFI futures contract tracks closely with the cash pricefor the European Union Allowance (EUA) itself. The difference is that thefutures price tries to anticipate what the price of an EUA will be in thefuture.The price of an EUA and its futures contract usually vary quite a bit asseen in Figure 17.3. The biggest factor affecting the price of an EUA is thetotal number of allowances issued by the EU Environment Commission.The greater the number of allowances issued (i.e., the more CO2 emissionsthat are allowed), the lower is the value of each EUA.As mentioned earlier, in October 2001, when the European cap-andtrade system got started, the EU Environment Commission allowed themember states to issue too many allowances.4 One outcome of that decision was that the price of allowances fell sharply. Another outcome of thatdecision was that the European Union found it difficult to meet their goal ofan average 8 percent reduction in CO2 emissions because they had allowedtoo many emissions.In early 2007, regulators began to look forward to the next compliance period and sharply reduced the number of allowances for the secondcompliance period of January 1, 2008, to December 31, 2012. As a result,
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140,000120,000100,00080,00060,00040,00020,0000May-05
Aug-05
Nov-05
Feb-06
May-06
Aug-06
Nov-06
Feb-07
May-07
FIGURE 17.2 European Climate Exchange CFI CO2 Futures – Open Interest (in #of contracts)Source: European Climate Exchange, “ECX CFI Futures Contracts: Historic Data 2007,”http://www.europeanclimateexchange.com/uploads/documents/ECXCFIFuturesContract-HistoricData-12July2007.xls.
the futures price of the EUA went up into the €20 range.5 Then, in July2007, the EU backtracked a bit and increased the number of allowances forIreland and Latvia, which depressed prices somewhat.Another factor affecting the price of an EUA is the relative price of fuelused by power utilities. In 2005, for example, there was a sharp increase inthe price of natural gas and that forced many power utilities to increasepower generation from their coal-fired plants and reduce generation fromtheir natural gas plants. The increased burning of coal increased greenhouse gas emissions and caused the price of emission allowances to rallyabove €30 in April 2006.
€ 35
Euros per metic ton CO2
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€ 25
€ 20
€ 15
€ 10Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
FIGURE 17.3 ECX ECI CO2 – Futures Prices (Dec-08 Contract)Source: European Climate Exchange, www.europeanclimateexchange.com.
Jul-07
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Another factor affecting the price of an EUA is the world cap-and-tradesituation. Prices rose in June 2007 after President Bush proposed a newround of international talks to curb greenhouse emissions. This gave validity to the cap-and-trade systems now operating in many countries. Thereis also anticipation that sooner or later, the United States will have to begin a cap-and-trade system and that will create an even bigger market forallowances.6Another market factor is whether the European Union will decide toexpand its existing Emission Trading System to include transportation. Ifthat happens, there will be many more allowances available from a wholenew group of companies. The effect on EUA prices could be either bullishor bearish depending on whether there is an easy or tight supply of thenew allowances, but the expansion of the system in any case would sharplyincrease volume and open interest.7
EUROPEAN CAP-AND-TRADE CO2 EMISSIONSBACKGROUND EXPLANATIONThe European Union, as part of its agreement to the Kyoto Protocol, committed to reducing its CO2 emissions by 8 percent. In 2001, the EU set upa National Allocation Plan that set an emission cap for each member state.Then each member state in turn put an emission cap on each major individual company. The cap for each company was set at a level of emission thatwas lower than the baseline figure calculated from the company’s normallevel of emissions. The caps covered about 12,000 companies representingover half of all the CO2 emitted in the EU. All this activity is administeredthe by the EU Environment Commission and a registry office in each member state.8Under the cap-and-trade system being used by the European Union,the EU Environment Commission issues allowances (or permits) for eachcompany to emit an amount of CO2 gas equal to its cap. Each EuropeanUnion Allowance (EUA) permits the holder to emit one metric ton of CO2during the compliance period. A total of about 2.2 billion EUAs were issued to the 12,000 companies for the first compliance period of February16, 2005, to December 31, 2007. At the end of the compliance period, eachcompany must surrender the number of EUAs equal to its total emissionsfor the period. If a company’s total emissions for the period are less thanits cap, then the company has extra EUAs to sell. On the other hand, if thecompany’s emissions for the period exceed its cap and the company therefore doesn’t have enough EUAs to equal its actual emissions, then it mustbuy the allowances from a company that has extra ones. If a company by
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the compliance date doesn’t have enough EUAs to equal its total emissions,then the company incurs a penalty of €40 (rising to €100 later on) per metric ton. Under the Kyoto Protocol, a second five-year compliance periodwill begin on January 1, 2008, and end on December 31, 2012.9The trading part of the EU’s cap-and-trade system is called the European Union Emissions Trading Scheme. It started on January 1, 2005,and allowed for trading the European Union Allowances (EUAs). EachEUA equals the right to emit one metric ton of CO2 . Companies can buyand sell EUAs among themselves or they can buy or sell them in the cashmarket (also called the spot or over-the-counter market) at the prevailingmarket price. The cash market for the European Union is composed ofthose companies that are authorized by the EU Environment Commissionto trade EUAs.The EUA futures market is far bigger than the cash market, comprisingabout 95 percent of the total nominal trading volume in CO2 emissions.10Each futures or options contract is for 1,000 European Union Allowances(EUA) and these contracts can be bought and sold by anyone for investment or hedging purposes.
CHICAGO CLIMATE EXCHANGEThe United States does not yet have a CO2 cap-and-trade system so thereare no mandatory U.S. allowances to trade. There is a voluntary CO2 allowance system administered by the Chicago Climate Exchange, but thereis no derivatives trading on those voluntary allowances as yet becausethe market is too thin. However, the Chicago Climate Exchange, whichis a sister company of the European Climate Exchange, will be in a primeposition to start trading futures on mandatory U.S. emissions allowancesif and when the United States government adopts a cap-and-trade systemfor CO2 emissions.Both the Chicago Climate Exchange and the European Climate exchange are owned by the Climate Exchange Plc (London: CLE LN), whichis a publicly traded company listed in London. The company’s market capas of July 2007 was £700 million. The company was founded in 2003 by Dr.Richard Sandor, a well-known and visionary figure in the Chicago futuresmarkets.While CO2 trading has yet to come to the United States in a significantway, there are nevertheless futures trading opportunities at the ChicagoClimate Exchange. The Chicago Climate Futures Exchange (CCFX), whicha subsidiary of the Chicago Climate Exchange, handles trading of U.S.futures and options contracts on sulfur dioxide emission allowances
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(Sulfur Financial Instrument-SFI) and nitrous dioxide emission allowances(Nitrogen Financial Instrument-NFI). The market has expanded to a valueof about $2 billion annually.11The first large-scale cap-and-trade program in the United States was introduced in the early 1990s as a result of the Clean Air Act Amendments of1990. Title 1 of the Amendment set a goal of reducing annual sulfur dioxide(SO2 ) emissions by 10 million tons below 1980 levels by the year 1995. Italso mandated the reduction of annual nitrous dioxide (NO2 ) emissions by2 million tons by the year 2000. This program was called the Acid Rain Program. The program started with an EPA auction of emission allowancesthat was held at the Chicago Board of Trade in 1993. Phase I affected445 coal-burning utility electricity generating plants. The program was expanded in Phase II to include about 2,000 plants. The sulfur-cap-and-tradeprogram was very successful and SO2 emissions by 1995 had been reducedby almost 40 percent below the target level.12The EPA now allocates emission allowances to participating companies each year. The EPA administers the trading of allowances through itsAllowance Management System. The EPA also keeps some allowances inreserve and these are auctioned off each March through the Chicago Boardof Trade.13Figure 17.4 shows the price history of the Chicago Climate FuturesExchange’s Sulfur Financial Instrument (SFI) futures contract price going$1,800
$1,600
$1,400
$1,200
$1,000
$800
$600
$400Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
FIGURE 17.4 Chicago Climate Futures Exchange: Sulfur Financial Instrument(SFI) Futures Price (nearest futures price in dollars per U.S. EPA SO2 allowance)Source: Chicago Climate Futures Exchange, “Chicago Climate Futures Exchange Market Data,” http://www.ccfe.com/mktdata ccfe/index.jsf.
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back to early 2005. The price is quoted in terms of dollars per U.S. EPA SO2Emissions Allowance. Each futures contract represents 25 U.S. EPA SO2Emissions Allowances, meaning that the nominal value of the contract canbe calculated by multiplying the price of the contract by 25. Details on theterms of the contract can be found at the Chicago Climate Exchange’s Website (www.ccfe.com).14
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C H A P T E R 18
InvestmentConclusions
s this book has discussed, clean energy involves an incredibly widevariety of completely different solutions and technologies, each withits own investment opportunities and risks. Perhaps the most interesting thing about clean energy is that there is no silver bullet that provides the complete answer to the world’s energy problems. Instead, thereare likely to be a wide variety of solutions that will be successful.The world is at a juncture where there needs to be a transition fromfossil fuels to cleaner forms of energy. The demand for new and cleanerforms of energy comes not only from environmental considerations, butalso from the sheer amount of new energy generation that will be neededto satisfy the world’s fast-growing energy needs. We have the technology,we have the capital, and we are gathering the will.Fossil fuels helped the world economy get to where it is today, but nowit is time to move on to fuels and technologies that can sustain the earth forcenturies to come. This transition will cause dislocations in certain legacyindustries, but it will also create incredible opportunities for completelynew industries. Investors still have plenty of opportunity to get in at theearly stages of this transition, which has only just begun. The bulk of themoney in this sector has yet to be made.The following is a summary of some of the investment conclusionsoffered by this book:
A
r The world will need 57 percent more energy over the next two decades.Much of this new demand will come from China, India, and the rest ofthe developing world.307
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r Fossil fuels do not offer a realistic solution for meeting this huge demand. This is because fossil fuels carry serious negative attributes suchas pollution, greenhouse gas emissions, and vulnerability to supply disruptions and prices spikes. Moreover, the United States’ dependenceon foreign oil makes it vulnerable from a political, military, and economic standpoint. Energy security is a critical goal. Every country inthe world could benefit from generating energy from within its ownborders.r World policymakers and the public at large are becoming more convinced that global warming is a serious problem. Government measures to curb the use of fossil fuels are likely to grow. All aroundthe world, support for clean energy solutions and power efficiency islikely to increase. In the United States, action on clean energy at thestate and local level is causing increased pressure for action at the federal level. A post-Kyoto CO2 cap-and-trade system that includes theUnited States, China, India, and the developing world would providea huge, additional boost for clean energy solutions that would last fordecades.r The target market for clean energy can be measured in terms of trillions of dollars, first with clean energy used as a supplement and eventually even as a replacement for fossil fuels. With its low starting base,the clean energy industry can easily grow at double-digit annual ratesfor decades.r Some clean energy solutions are already commercially viable anddon’t need government support to thrive. These solutions includepower efficiency products and services, smart meters, power backupand storage products, geothermal power, biomass, biogas, andhybrid vehicles. Other solutions such as wind and solar power needfurther cost reductions, but progress is being made because of technological breakthroughs and the huge amount of capital that is flowing into those areas. Fuel cells are already in commercial salesfor some applications such as power backup and motive power,although much more work needs to be done for other fuel cell applications such as transportation and utility/commercial/residential power.r Solar power has massive potential because both thermal and photovoltaic solar power can be used to generate power at the utility-scalelevel. Solar photovoltaic power can also be used at the residential andcommercial building level as a distributed source of power to protectusers from rising electricity prices. Solar power is already competitive with retail electricity prices in parts of the developed world andwill become increasingly competitive in coming years due to the hugeamount of resources that are being dedicated to cutting manufacturingand balance of system costs.
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r Wind power is already a very popular power generation solution worldwide. The wind industry is currently plagued by production capacityshortages and cannot keep up with current demand. However, the industry is addressing component shortages and is quickly ramping upproduction capacity. Wind power economics will continue to improvedue to improvements in technology. Wind power will become competitive with fossil fuel power generation ex-subsidies even more quicklyif a CO2 emission cost is added to fossil fuel power generation costs.r Fuel cells have disappointed investors in the past due to their slow development. However, the fuel cell industry is making steady progressand is attracting interest from the world’s large industrial companies.Fuel cells are likely to become commercially successful slowly andperhaps only in certain markets. Yet fuel cells represent such an attractive zero-emission power generation solution that further developmentwill likely bring them eventually to full fruition.r Geothermal power is already cost-competitive with fossil fuel powergeneration without subsidies and presents a highly attractive powergeneration solution in appropriate geological locations. Geothermalpower runs 24 hours and day and contributes to a utility’s base loadgeneration portfolio.r Power efficiency and smart grid solutions are in high demand rightnow and will only increase in popularity going forward as the worldstruggles to deal with the huge increase in demand for power and withoutdated transmission and distribution systems. Power efficiency solutions make imminent economic sense right now and present excellentinvestment opportunities.r Regarding the transportation area, the internal combustion engine islikely to be slowly phased out in coming decades because of pollutionand greenhouse gas emissions. The world will literally choke if thereare 2 billion vehicles with internal combustion engines on the world’sroads by 2050, as some experts forecast. Gasoline-electric hybrid vehicles and eventually plug-in hybrids are likely to be much more popularthan most observers currently expect. Battery technology is advancing rapidly and pure electric vehicles are likely to dominate the roadsin coming decades since electric power is cheap and widely available.Fuel cell vehicles may provide a solution for fleets but may never beadopted on a mass scale because of the problems and cost of hydrogenproduction and delivery and because of eventual low-cost competitionfrom electric vehicles.r In the biofuels industry, the companies that are likely to be successfulin the medium term are those that have (1) the R&D capability to maketechnological breakthroughs in cellulosic ethanol; and (2) the globalpresence for feedstock acquisition and biofuel production/distribution.
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Investing in U.S.-based pure-play ethanol producers is mostly a beton the corn-ethanol price spread, with the attendant uncertainties andrisks. There is also the risk that biofuels may only be a temporary solution until the eventual phase-out of the internal combustion engine.r Technological superiority, scale, and the ability to drive costs lowerare the key attributes of the clean energy companies that will bethe most successful in coming years. In choosing individual stocks inthe clean energy sector, investors should focus on companies that havethe potential for major technological breakthroughs and the ability toquickly commercialize those technologies on a mass scale and drivecosts lower.r In order to participate in the sector, investors can buy stocks of companies that focus on clean energy. A safer strategy is to diversify risk bybuying a green exchange-traded fund or mutual fund. Investors shouldconsider green ETFs and mutual funds that are global in nature sincemany of the world’s clean energy companies are outside the U.S.r While there will certainly be some bumps along with the way, the cleanenergy sector has all the earmarks of proving to be one of the best investment trends ever due to the sheer size of the task in moving fromthe legacy fossil fuels of the Industrial Age to the new and clean technologies that are necessary to move into a sustainable future in comingdecades.
M01
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APPENDIX
InformationResources
P
lease see this book’s companion Web site at www.ProfitingFromCleanEnergy.com for an updated resource list and for automaticclick-through links to these sites.
U.S. ENERGY STATISTICSr Annual Energy Outlook 2007 with Projections to 2030, U.S. Department of Energy, Office of Energy Information Administration, February 2007, annual publication, www.eia.doe.gov/oiaf/aeo/.r Monthly Energy Review, U.S. Department of Energy, Office of EnergyInformation Administration, monthly publication, www.eia.doe.gov/mer/.r Electric Power Monthly, U.S. Department of Energy, Office of EnergyInformation Administration, monthly publication, www.eia.doe.gov/cneaf/electricity/epm/.r Short-Term Energy Outlook, U.S. Department of Energy, Office of Energy Information Administration, monthly publication, www.eia.doe.gov/emeu/steo/pub/contents.html.
GLOBAL ENERGY STATISTICSr International Energy Outlook 2007, U.S. Department of Energy, annualpublication, www.eia.doe.gov/oiaf/ieo/.311
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APPENDIX
r Key World Energy Statistics, 2006 Edition, International EnergyAgency, www.iea.org/Textbase/stats/index.asp.
r World Energy Investment Outlook, 2003 Insights, International EnergyAgency, http://www.iea.org/Textbase/work/2003/beijing/6WEIO.pdf.
r World Energy Outlook, International Energy Agency, www.worldenergyoutlook.org.
r BP Statistical Review of World Energy 2007, BP, www.bp.com/statisticalreview/.
RENEWABLE ENERGY DATAr Renewable and Alternative Fuels U.S. Data, U.S. Department of Energy, Office of Energy Information Administration, www.eia.doe.gov/fuelrenewable.html.r Renewable Energy Annual, U.S. Department of Energy, Office ofEnergy Information Administration, Updated 2006 with preliminary data for 2004, www.eia.doe.gov/cneaf/solar.renewables/page/readata/rea sum.html.r Renewables, Global Status Report, 2006 Update, Renewable EnergyPolicy Network for the 21st Century, www.ren21.net.
RENEWABLE ENERGY AND CLIMATE CHANGEPLANS AND REPORTSr Recommendations to the Nation on Reducing U.S. Oil Dependence, Energy Security Leadership Council, December 2006, www.secureenergy.org/reports.php.r U.S. Climate Change Technology Program, Strategic Plan, U.S.Climate Change Technology Program