Carbon finance comes of age
The cap-and-trade market for emissions - coming soon to America - is creating huge new opportunities for business.
(Fortune Magazine) -- If all goes according to plan, the business of buying and selling rights to pollute the atmosphere with carbon dioxide and other greenhouse gases - carbon trading, as it is known - will curb global warming and save the world. That is its only purpose. Along the way, a lot of people will get rich.
Last year traders bought and sold about $60 billion worth of emissions allowances, mostly in Europe and Japan, where governments regulate greenhouse gases. If, as expected, regulation comes to the U.S., this country's carbon-trading market is expected to be worth $1 trillion annually by 2020. That's why investment banks, utilities, industrials, and hedge funds - among them GE (GE, Fortune 500), Goldman Sachs (GS, Fortune 500), J.P. Morgan Chase (JPNV.L), and AES (AES) - are rushing into the business of carbon finance. To succeed they will have to master what is surely the most bizarre, complicated, and controversial new industry of the 21st century. We'll try to break it down, beginning with a couple of things any Fortune reader can understand: a pile of pig manure and a private jet.
Daniel Co and his family raise about 10,000 pigs on a farm called Uni-Rich Agro Industrial in the province of Tarlac in the Philippines. Until recently pig manure was shoveled into concrete ponds, where it decomposed, emitting methane, a potent greenhouse gas, and a putrid smell. Daniel Co knew that he could install biogas technology to seal the ponds, trap the gas, and produce electricity, but he didn't want to spend the $200,000 or so it would cost until he heard that pig farms could collect money from Europe for capturing methane: He would be paid not to pollute.
The Uni-Rich farm is a very small player in a very big global experiment that was set in motion when the Kyoto Protocol was ratified in 2005. Thirty-six industrial countries (but not the U.S.) have agreed to reduce greenhouse gas emissions over time; they can do so, in part, by financing "clean development" projects in the developing world. This has led to a global scramble for cheap ways to reduce emissions, like Daniel Co's biogas project; the invention of a new tradable commodity, called a Certified Emissions Reduction, or CER; the development of competing markets to buy and sell CERs; and the rise of an army of regulators to oversee the entire business.
Daniel Co got involved when he was approached by EcoSecurities, an Irish company that has developed more carbon-mitigation projects than any other firm. Its experts calculated that trapping his farm's methane would generate 2,929 CERs a year. A CER is created when the equivalent of one ton of carbon dioxide is prevented from entering the atmosphere. (Because methane creates more global warming than carbon dioxide, trapping one ton of methane generates 21 CERs.) CERs are sometimes called carbon credits.
EcoSecurities offered to pay Uni-Rich $4 per credit, or $12,000 a year, every year, until Kyoto expires in 2012, and to handle all the paperwork at the UN, which registered the project late in 2006. Uni-Rich then installed the methane digesters.
Now, thanks to the magic of carbon finance, Daniel Co and his family treasure their pig waste. They use it to produce electricity, which has reduced their utility bills by about $48,000 a year. They collect their $12,000 a year in carbon revenues. EcoSecurities, in turn, will sell the credits for about $18 each, or $54,000 a year, to a big French bank called Caisse des Dépôts. Caisse des Dépôts can hold onto the CERs as an investment, betting that their value will rise, or sell them to a client, most probably a European power generator or industrial firm that needs credits to meet its regulatory obligations.
Pig farmers are not alone in bringing home the bacon. Methane can be captured from chicken farms in India, landfills in Mexico, and coal mines in Thailand. Industrial gases can be destroyed at refrigerant and fertilizer plants in China. Carbon dioxide emissions can be avoided by building dams in Guatemala and wind farms in Mongolia. These are among the 4,000 clean development projects in the UN pipeline, and together they add up to real money.
What's more, everyone in the business thinks this is just a beginning. Virtually every new clean energy project in China is seeking carbon credits. As carbon finance evolves, it's possible that big emitters in the U.S. and Europe will pay landowners in Brazil and Indonesia to refrain from cutting down trees (nice work if you can get it). There's even talk of generating carbon credits from the use of energy-saving light bulbs in China, or efficient wood-burning stoves in Africa, or pills to influence the digestive systems of cattle so they emit fewer methane-producing burps or farts. Seriously.
And the jet planes? While carbon emissions by airlines aren't yet regulated, the European division of NetJets, a company owned by Warren Buffett's Berkshire Hathaway (BRK.A), decided last year to become carbon neutral. It turned to EcoSecurities and now buys carbon credits from pig-farming neighbors of Daniel Co.