Carbon finance comes of age (p. 3)

Instead, they are getting paid to clean up their act. That is just as it should be, says Pedro Moura Costa, a 44-year-old forester who has been working on carbon mitigation since the early 1990s. Moura Costa is the co-founder of EcoSecurities, the company that bought credits from Daniel Co and has contracts to buy credits from another 500 clean development projects around the world. These projects, he argues, give poor countries access to technology they could not otherwise afford. Industrial economies save money because the market finds them low-cost ways to reduce emissions. What's more, because carbon dioxide is a global pollutant, it doesn't matter whether emissions are cut in Bonn, Bombay, or Baltimore.

EcoSecurities' first UN-registered project captures methane from a landfill in Brazil, Moura Costa's home country. "That never would have happened in my lifetime," he says. "It's a splendid manifestation of the benefits of carbon trading."

EcoSecurities went public on London's AIM market in 2005, and its stock has gyrated ever since. The company, which has about 300 employees in 30 offices, says its projects will produce a portfolio of about 171 million tons of credits between now and 2012; at today's prices for CERs, they would generate more than $3 billion in revenues. But because of regulatory and other uncertainties, EcoSecurities has a market capitalization of just $170 million. The company recorded revenues of $11.3 million and losses of $70.6 million last year.

The posse of carbon cowboys continues to grow. London-based Climate Change Capital has raised more than $1 billion to invest in carbon reductions; it's got 19 people hunting for pollution in China alone. Natsource, an asset manager based in New York, raised an investment pool of about $800 million from European and Japanese industrial companies that need credits to offset their emissions. Miami-based MGM International, a leader in the Latin American market, is 38%-owned by Morgan Stanley; its first project married a Japanese utility that needed credits with a Nestlé plant in Chile that makes ice cream and dulce de leche, and switched its fuel from coal to natural gas.

There has never been a better time to own a polluting factory, landfill, coal mine, or chicken or pig farm in the developing world. Best of all is to own a plant that emits industrial gases like nitrous oxide, PFCs, or HFCs that are the most potent - and therefore the most valuable - of the regulated greenhouse gases. Consider HFC23, a refrigerant gas that traps heat effectively, whether in a vending machine or the earth's atmosphere. Because emitting one ton of HFC23 is the atmospheric equivalent of emitting 11,700 tons of carbon dioxide, trapping a single ton of HFC23 generates 11,700 CERs. The result is that factories in China that install equipment to destroy HFCs, which is standard in much of the West, generate millions of credits and windfall profits - as much as $6 billion of credits for making about $150 million in pollution-control investments, according to Michael Wara, a lecturer at Stanford Law School who exposed the problem last year. Chinese refrigerant companies, he says, have become carbon-credit factories that only incidentally sell refrigerants. "That's a major distortion of the market," Wara says. Moura Costa disagrees: "A market is supposed to be driven by profit." The Chinese government, he notes, has imposed a 65% tax on the payments for industrial-gas credits, money that is steered into renewable energy projects - which are also eligible for credits.

You'll never guess who else covets carbon revenues: Petro China, the world's biggest oil company, and the oil sheiks of the Persian Gulf. The Chinese oil giant plans to install about $46 million worth of pollution control equipment to destroy nitrous oxide at a petrochemical factory. It will generate the equivalent of about 10 million carbon credits worth roughly $150 million a year at today's prices. Natsource and Goldman Sachs are underwriting that deal. As for the Gulf states, Moura Costa says Dubai is "very interested" in carbon credits. So is Masdar, the clean energy city being built in Abu Dhabi, which is developing solar and wind energy. "They have a whole division dedicated to creating carbon credits," he says.

The problem with this is not so much that the rich are getting richer. The worry is that a flood of cheap credits into the market will reduce or eliminate incentives to invest in clean energy projects - renewables, nuclear power, or coal-gasification technology - in the West. Beyond that, there is the vexing problem known as "additionality," about which carbon geeks can argue for hours. The UN is supposed to analyze every project and judge whether it is "additional," meaning that it would not have happened without the stream of carbon revenues. Might Daniel Co, for example, who was getting complaints from neighbors about the smell of his pig manure, have installed biogas equipment on his own? On a larger scale, China's central government has declared its intention to invest in solar and wind power. Still, it expects Western subsidies in the form of carbon credits. "How do you tell the dam that China was going to build anyway from the dam that would not have been built were it not for this extra cash from carbon offsets?" asks Wara. The UN can't administer truth serum to the Chinese.

It's easy to get bogged down in the details of carbon finance and lose sight of its overarching goal - to get the world's big economies to stop using fossil fuels or, barring that, figure out ways to clean them up. The leading bill in Congress to regulate greenhouse gases, which is sponsored by Sens. John Warner (R-Virginia) and Joseph Lieberman (I-Connecticut), calls for a 70% reduction of emissions from 2005 levels by 2050. Presidential candidates Hillary Clinton, Barack Obama, and John McCain all favor caps in that ballpark. So does the U.S. Climate Action Partnership, a broad coalition of big companies like GE, GM, and DuPont, and advocacy groups like Environmental Defense and the Natural Resources Defense Council. California and a group of Northeastern states have also passed laws to regulate carbon. If enacted, a federal cap would set off a radical disruption of the economy.

That will create opportunities for investors like MissionPoint Capital Partners, a private equity firm based in South Norwalk, Conn. "Our focus is the transition to a low-carbon economy," says Jesse Fink, who co-founded MissionPoint. "That's all we do." Using their own funds, Fink and his co-founders, Mark Schwartz and Mark Cirilli, were the first outside investors in EcoSecurities, owning 20% of the company before the IPO. Before that they invested in half-a-dozen clean development projects, including a landfill-gas deal in Brazil and an industrial-gas project in China. "There was very little capital comfortable taking those risks, at that time," Cirilli says. All the investments made money.

NEXT: Carbon finance comes of age (p. 4)

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