As Carbon Markets Mature, Opportunities and Risk Abound

Who typically are CantorCO2e's clients, and what services do you provide?

Our role is to help clients understand, create, register, price, and transact environmental products. We also assist clients to evaluate, plan, secure financing for, develop, and participate in the actual projects and technologies that underlay the credits-i.e. the dairy that covers lagoons and captures, cleans, and uses gas to generate electricity; the forest land owner that can sequester carbon through enhanced management; the alloy manufacturer who can eliminate the use of SF6.

Most of our clients are end users. That is they have compliance-current and future-obligations. Or they are transacting the credits to offset their own footprints. Others are traders. That is, they participate in these markets in order to meet financial objectives. Given the choice between transacting equities, currencies, treasuries, and other financial instruments, these folks have decided to make it their business to buy, sell, lease and option environmental credits which range in price from less than $1 to more than $1 million per discrete credit.

In assessing risk for your clients, how uncertain is that future in terms of what protocols-Climate Registry, the EPA, and the RGGI-will be used to price carbon? Are you taking leadership as a firm and helping to rationalize and harmonize whatever protocols are being put forward?

Yes, The uncertainties are huge. Despite the House's passage of the Waxman-Markey bill, we don't know if a unified energy/climate change bill will emerge from Senate subcommittees, be passed by the full Senate, get conference, or be signed by the president. And we don't know if the U.S. program will be compatible with that which emerges from Copenhagen. Clearly there is a great deal of uncertainty regarding which protocols will be used. Despite the desire for simplicity and immediate answers, there is much that we don't know about what will emerge.

But against this backdrop we can make some good predictions. It's a fair bet that we are heading into a carbon constrained future, one that will demand 17-40 percent reduction by 2020 and 80-90 percent reduction in emissions by 2050. And this is after we have already secured significant gains through aggressive energy efficiency, stack, and tailpipe pollution reduction programs. It's a virtual certainty that getting there will involve the participation of every government, business, and household.

It's likely that a cap and trade program, along with a basket of even more aggressive command and control programs, will be deployed. Judging by recent activity, it is clear that industries facing compliance obligations and traders anticipating a $2 trillion market are anxious to participate. And, as we have for nearly 18 years, CantorCO2e will be in board rooms, regulatory workshops, and the markets to assist our clients-business and government.

What does CantorCO2e believe will come out of the black box of the federal legislation process? What would work best for the carbon marketplace?

I believe that we will have a robust, multi-sectoral command and control and cap and trade program. It will target those that have the ability and the responsibility to address the problem.

From a cap and trade perspective, what would work best is simple program that is broad in scope and narrow in focus. What will eventually emerge may be something very different. We will see a climate law in late 2009 or 2010 that is the product of a multitude of deals cut in the House, the Senate, the president, and all those who make it a living to lobby on behalf of their clients.

Once the president signs the law, it will be left to the likes of Lisa Jackson at the EPA and state air agency heads (such as Mary Nichols) to write implementing regulations. Here is where the process will slow, get a little murky, and involve many other programs.

Notwithstanding these challenges, businesses are transacting now. They are making educated guesses as to the prudence of buying credits that come from projects and which credits and projects may or may not meet yet to be defined criteria. Some are carefully building carbon reduction portfolios. Others seem to be looking to go a long without exercising a great deal of caution. We can be pretty sure that there will be more risk-takers than winners.

Some have asserted that carbon is an accounting issue. Where do the big four accounting firms fit into the carbon pricing and cap and trade from your perspective at Cantor?

From my perspective, I see one carbon spreadsheet in the sky. Each company, utility, natural resource extraction firm, and product user has a responsibility for what goes into the spreadsheet. Once responsibilities have been allocated we can start focusing on the costs and feasibility of solving the problem. Then the market will search and find sources with dramatically different marginal cost curves. And, that's when it gets interesting. Once the externalities have been internalized and properly accounted for-once firms know what they must mitigate and appreciate the financial consequences of not doing so-that is when we will see the development of a robust emissions trading program. And that is when we, at CantorCO2e, will be able to do our part by making the world a better place one trade at a time.

Given the failures in the financial markets of late, who can the public trust to oversee the marketplace? What are the weaknesses in the measurements that might impede the progress and robustness of the marketplace you are defining?

The public should be looking to the scientists first, then the politicians. The scientists see smoke and are yelling "Fire!" The politicians need to react with deliberate speed and efficiency to effect a program that secures the needed reductions with requisite speed and equity. If the governments fail to act, the public ought to demand that their elected leaders tell them why the scientists are wrong. In effect, they should demand to know why the chosen strategy is to pull the battery out of the smoke detector.

As we listen to today's cap and trade debates I am concerned that those who oppose the idea of spending time and money on addressing climate change are pouring their efforts into criticizing cap and trade. The vehemence of the opposition to cap and trade suggests that more effort needs to be expended on helping the public to see and understand the climate change threat and the need for immediate action

You mentioned Lisa Jackson and Mary Nichols. Who exactly is in charge of making the rules for how we measure greenhouse gases, and why are they in charge?

Mary and Lisa's role, the role of the government, is to define the targets and the rules of engagement, monitor for compliance, and enforce against those who fail comply.

Wasn't the government doing that before the crash that we are now living through?

So let's learn from this crash. To ensure that we achieve the desired results, we need people in place that have lived through, participated in, and have the scars from earlier market failures. Those who know that environmental markets are a powerful tool that can be used to accomplish social good but also understand that, left unattended, such markets can produce adverse results. Those who know that market participants will behave better if they are motivated by carrots and fearful of sticks.

What lessons have been learned from Europe and London in terms of cap and trade? How are you advising your clients on how the U.S. will learn from those lessons to do it better?

Let's focus on just a few lessons. We have plenty of lessons to learn from both the European example as well as here at home. In the U.S., we have used cap and trade programs over the last 40 years to reduce or manage SO2, NOx, VOC, PM10, wastewater, wetlands, lead in gasoline, fisheries, and airline gates. These programs have succeeded to varying degrees, and they share design elements that would be well worth heeding now. A cap is critical. So too are emission reduction obligations by source and significant noncompliance penalties. Monitoring and enforcement is critical. And multiyear allocations (not auctions) are imperative. For it is only when sources have such allocations can they make planning decisions with ten and twenty year horizons and turn waste streams into profit streams. And we have learned to be leery of those who promise that these programs will deliver gain with no pain. While environmental improvement goals can be achieved, there will be winners and losers. Those who adapt and properly account for carbon will make smart decisions and likely thrive.

How do you measure and govern this at a global level? How do we know your trading partners have measurements we can trust and enforcement we can rely on?

Let me be clear. I believe that we ought not to be in pursuit of a single global program. We will never see a program that subjects U.S. sources to sanctions imposed by some world body. Rather, we should strive for a patchwork of programs that, in unison, will allow the U.S. and other nations to achieve the global objective.

As the Senate deliberates the energy bill and we move toward the U.N. meeting in Copenhagen in December, what are you and your clients looking for as indices of where the markets are going? What level of certainty are we likely to have going into 2010?

We are looking for clarity relative to responsibilities and obligations. With that clarity will come action. Billions of dollars will be invested when the government defines what reductions are required, who is required to participate, by when the goals must be achieved, and, most importantly from a market perspective, the financial consequence of noncompliance. As the world's diplomats meet, pontificate, and ponder, they should bear in mind that there is one party that is not going to negotiate-the climate, the earth's carrying capacity. Hopefully we will figure this out and do it quickly. We are racing climate change feedback loops that could, the scientists tell us, overwhelm any global mitigation actions. If we fail at this task, if we cannot figure out how to be responsible members of the global commons then we should do two things. First, we should look our kids in the eye and explain why we failed them. Second, we should move to higher ground.

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At the time we are doing this interview, the carbon prices are relatively low. As a broker, where do you find the most robust markets?

We see robust markets in the US and abroad, with pre-compliance greenhouse gas reductions as well as criteria pollutant credits. And we see fantastic opportunities (and great risks) for those that are willing to transact in multiple geographies and across discrete markets.

Of course, right now, the deepest and most liquid markets are in the European Union. But the greatest opportunity may be in front of those looking to transact for US companies. Consider credit pricing. In the US credits are selling for between $1 and $15+ per tonne carbon dioxide equivalent. People are buying product that may or may not be useable in a compliance program. An on-going survey of our clients tells us that we may expect to see prices ranging from $12 starting in 2012 and rising to $60 by 2040. Economists have projected that prices of between $150-$200 per ton may be needed if a carbon tax is employed. And we are clearing transactions of criteria pollutants (i.e., Los Angeles area particulate matter) at prices exceeding $1,000,000 per credit. Given those prices and prognostications you can see that there is quite a difference between what you can transact now and what may in fact emerge as the market price in a compliance regime. You can see why people are willing to take a risk and build a quality carbon portfolio in order to participate in this market before the ink dries.

I thought currency traders took risks but you've just described a market with even greater risk-that's amazing.

It's a risky business. It reminds you of the ancient Chinese curse, "May you live in interesting times," or, "where there's chaos, there's opportunity." We do live in interesting and chaotic times where there is a plethora of risk and opportunity. The challenge is to weigh the risks of acting before the ink is dry or waiting until the opportunities have been snapped up by others. CantorCO2e's role is to help our clients to make and implement smart decisions in these risky times.

The footprint from a supply chain is a hot topic at the moment. Some estimates indicate that over 50 percent of a typical organization's footprint comes from the supply chain. What role are you playing with respect to emissions from supply chains?

Yes, we are seeing clients calculate both their footprints as well as the ripples that extend to the raw materials and component parts that come in as well as those associated with the use of their products. We are helping companies define their emissions internal to the products they produce, the processes they use to produce those emissions, the incoming raw materials, and the outgoing products being used by the customers of those companies. We are then defining how those emissions can be reduced and then offset.

Where are we in that timeline of the politicians and regulators understanding their role and the science behind it?

The timelines are short. And getting shorter. A fair number of Nobel laureate scientists tell us that we have exceeded the carrying capacity sometime before the turn of the century. And they tell us our problems are worsening owing, in part, to a feedback loop where consequences of climate change beget more consequences. To avoid disaster we have been told of the need halt the growth of greenhouse gases in the next few years.

Chances seem to be decent that our elected officials will negotiate their way to comprehensive bill in 2009 or 2010. We should be reminded that these deals are cut by well meaning industrial, political, NGO, and governmental interests from across the ideological spectrum. The rejoinder that we hear from the scientists is that the only party that seems to be missing is that which doesn't negotiate...the ecosystem.