Hoping for investments to go up in smoke

By Alice Ross
Published: November 8 2008 02:00

Retail investors are for the first time able to gain access to the fast-growing carbon futures market, with the launch of a new product.
ETF Securities has launched an exchange traded commodity that tracks the price of carbon allowances in the European market.
Carbon trading was introduced in the EU in 2005 as a way of encouraging energy companies to reduce their emissions. Companies are allocated a certain number of allowances and are able to sell those they do not need.
There are two main schemes: the European scheme, which uses EU allowance (EUA) credits, and the UN scheme under the Kyoto protocol, which uses carbon emission reduction credits, or CERs.
Until recently, the two schemes had very limited trading with each other - but in the past month the market has opened up.
As yet, retail investors have not piled into the carbon credit market. In part, this is because of the perceived complexity. "No one in the advice industry really understands carbon trading," says Mark Hoskin at Holden & Partners, the ethical financial planners.
The pricing of carbon credits is dependent on various factors. First, there is the political risk - as the whole scheme is entirely dependent on government support.
"Carbon assets are a construct of the political process and their pricing is impacted by changes in that political process," notes James Thompson, chief financial officer at EcoSecurities, a global carbon credit trader.
The price differential between coal and gas is another concern. Oil price rises often cause natural gas to rise, making coal a cheaper option for energy companies and thereby increasing demand for EUAs.
The lack of retail products is also a factor. Before now, private investors could only gain indirect access to the carbon trading market. One way is to invest in companies that are acting as a gobetween for developing world projects and western energy companies.
The UN system of credits, or CERs, operates by giving credits to companies in developing countries that are engaged in emission offsetting activities. They can then sell these to developed companies in the west.
EcoSecurities, for example, helps companies in China and India to get registered with the UN in return for their carbon credits, which it trades on the stock market.
Hoskin also puts his clients into Trading Emissions, an Aim-listed stock that invests in carbon credits.
And Deutsche Bank Group offers the DWS CO 2 Opportunities fund, which invests in structured products with exposure to carbon credits. However, Hoskin says investors should be aware that because this fund is not registered in the UK, it is not eligible for capital gains tax relief.
The ETFS product offers a more direct way for private investors to become involved in the carbon market. It is Europe's first carbon ETC and will track the ICE ECX EUA Futures Contract, the carbon emissions futures contract.
The outlook for the carbon futures market is mixed. On the one hand, the system of trading emissions allowances is expected to grow worldwide. Barack Obama, the US president-elect, has given his support to a cap and trade system. Last month, the UK's climate change bill proposed resetting the targets to cut emissions by 2050 from 60 per cent of 1990 levels to 80 per cent.
And governments have an interest in ensuring the carbon price is strong, says Hoskin, as they need it to act as an incentive for companies to change their businesses.
Drax, the power generator that is heavily dependent on coal, reported a 45 per cent fall in profits in the first half of this year thanks in part to more expensive carbon emissions permits.
Yet the price of carbon credits has crashed this year along with the wider stock market.
ECX CFI Futures Contracts fell from a peak of €29.33 on July 1 to €17.40 on October 28.
Others fear that a recession in Europe may lower the price of carbon futures, as companies will slow production, causing emissions to fall, meaning there will be less demand for extra credits.
"In the near term, it's quite possible more and more industrial companies who have as many certificates as they need will see their output drop and won't need any more," says Alessandro Vitelli, director of strategy at IDEACarbon, the carbon analysts.
But he does not expect the price to collapse completely, as happened in the first phase of the EUA system from 2005 to 2007, when too many credits were allocated to companies.
IDEACarbon predicts the floor for EUA contracts is about €15. Currently, the price is around €18. Vitelli expects the market to reach this floor between now and mid-2009.
But, he says, the longer- term pressure on prices going up remains stable. "Everyone is working towards the 2020 target of a 20 per cent reduction in emissions. That assumes a lot of investment going into low carbon emissions." Consequently, he believes the price will climb again to between €29 and €30 after 2009.
"We're closer to what we think is the floor price than what we think is the ceiling price for sure," says Vitelli. "If a private investor wants to get into the market and ride it for a while, then getting in at €16/17 would be a good idea."
Copyright The Financial Times Limited 2008