Last Friday, I spoke with Neil Eckert, CEO of London-based Climate Exchange plc (LSE: CLE, OTC Pink Sheets: CXCHY; http://climateexchangeplc.com), which is not only the pioneer in emissions trading and other clean-tech issues such as water extraction rights trading, but is, practically speaking, the only global exchange with a meaningful stake in this fast-growing area. Climate Exchange plc has two direct subsidiaries, the Dublin-based European Climate Exchange (ECX) and the Chicago-based Chicago Climate Exchange (CCX). Through these there are several other subs and joint ventures that spread their influence throughout North America, Australia, China and India, as well as the US and Europe. They also operate the Insurance Futures Exchange (IFEX), which concentrates on hurricane risk, and potentially on other natural disasters such as earthquakes.
CLE was picked by Gabelli Asset Management as one of its top recommendations for 2009 in a webcast on December 4, 2008 (http://www.wsw.com/webcast/gabelli25/). In a recent report, major institutional holders included Invesco Asset Management (29.85%), Harbert Management (17.42%), BlackRock (8.37%), Fortis, Moore Capital, and others. Lehman Brothers had a stake that was apparently sold off on the open market and is now history. Insiders including directors own 20.55%.
Most trading exchanges around the world are significantly off their year-ago highs in terms of valuations, and in terms of trading volumes in many cases. At CLE revenues are up in triple-digit percentages consistently, and expectations are for a doubling of emissions trading this month over February 2008 – in spite of the economic doom-and-gloom that obliterates the sun around us like a Dickensian London black fog.
Valuations of trading exchanges have been hit hard across the board: at NYSE Euronext, Nasdaq OMX and the LSE, valuations Friday were between 65% and 80% lower than a year ago. CLE shares closed Friday in London at 465.25 vs a 52-week high of 2,117.00, in spite of strongly improved results as of the last report, which covered 6 months ended June 30 2008. CLE reported plenty of cash on hand for the first 6 months of 2008, with ECX volumes up 150%, CCX volumes up 286%, and CCFE (Chicago Climate Futures Exchange, a sub of CCX) up 214%.
Neil joined Climate Exchange from Brit Insurance (LSE: BRE, http://www.britinsurance.com) , where he served as CEO, and where I first had the pleasure of meeting him. He remains a director of Brit Insurance, as well as of Atlanta-based EBIX Inc (Nasdaq: EBIX, http://www.ebix.com), the Isle of Man Assurance Company, privately held US-based Environmental Credit Corp (http://www.envcc.com), and London-based Ri3k (http://www.ri3k.com). He also serves as chairman of AIM-listed Trading Emissions plc (http://www.tradingemissionsplc.com) and Design Technology & Innovation Ltd.
Expansion of Cap-and-Trade Programs
The first cap-and-trade program (for a primer on cap-and-trade: http://www.americanprogress.org/issues/2008/01/capandtrade101.html/) was launched in 1995 in North America to help reduce SO2 emissions, a culprit in various environmental problems, most publicly acid rain. According to Eckert, cap-and-trade programs have expanded significantly since then. “The first programs,” Eckert said, “were directed at reducing sulfur dioxide emissions, and SOX is still the largest category. Since then NOX, or oxides of nitrogen, a prime component of urban smog, have been added, and more recently RGGIs, which are Regional Greenhouse Gas Initiative futures and options have begun to trade, and are really roaring. RGGIs are the carbon footprint-related futures that are most in the public awareness regarding climate change. In addition, we are beginning to trade some water extraction futures and options.
“Too much water is being extracted from the Great Lakes, for instance. Water extraction limits are being set among users, and to the extent that users can get by with lower extraction rates than they are allocated, they can monetize those extraction rights on the Chicago Climate Exchange, which is our subsidiary. During the last year a fairly large lake near Atlanta, Georgia, almost completely dried up due to over-extraction of water for municipal use.” He said that they may be trading water quality soon in Asia, essentially a cap-and-trade program for pollutants that go into the water, but that is not in place yet.
$1.6 Trillion Market
We asked about the global spread of emissions abatement trading, and the expansion of CLE into new geographies. “We do now have operations and joint ventures in Canada, Australia, China and India. Between those areas we will be dealing with a larger portion of the world’s carbon and other emissions, but there are clearly other areas to be addressed, most notably, I suppose, Japan and Russia. The Middle East may be significant, but at present their emissions are not as substantial as one might think.
“If you think about the size of the market, depending on where you look, there are about 40 billion tons of CO2 going into the atmosphere each year. The abatement cost – the cost to keep that from going into the atmosphere – is about $30 to $40 per ton. Notionally, that means the market we are addressing is presently at $1.6 trillion per annum, and probably growing.
“Emissions trading in Europe has huge volumes, and they are growing very quickly and very steadily. Open interest yesterday <Feb 19> was over 400 million tons. To some extent those are compliance trades, that is, they are done to comply with regulations regarding emissions or other environmental issues, but there are a lot of trades that relate to the underlying properties of the fuels that we use.
“Natural gas is a relatively clean fuel, for instance – and coal is less clean. Electric utilities tend to prefer natural gas when it is economical to use, for the reason that emissions are less costly to either hedge or clean up when there are fewer of them. But in a situation where, for example, Russia cuts off the supply of natural gas to Europe, the utilities quickly revert to coal, which means that they have to hedge their compliance issues quickly and sometimes in a very volatile market.
Who Is/Should Be Trading?
In discussing the types of people who are now trading emissions futures and options, Eckert said, “RGGIs are a new style of futures contracts, and the first traders are those we call ‘naturals,’ eg, people with underlying exposures, such as utilities in the case I just mentioned with Russian gas and increased coal use. As those types of contracts begin to gain traction and volume, you then tend to get some speculators, and finally you get larger and more stable audiences of options traders.”
Eckert said that counter-party risk is on the decline, and CLE partners with Intercontinental Exchange (ICE), which now clears about 60% of trades through ICEclear (their London-based electronic clearing house), which means for those trades there is no counter-party risk at all. The remaining 40% are a combination of back-room and counter-party trades at present, but ICEclear instantaneous no-worry electronic clearing is taking market share very quickly.
When asked about competitors, Eckert said that in Europe they have 8 direct competitors, but CLE does 95% of the futures and options. One of the competitors is newcomer Paris-based Bluenext (http://www.bluenext.eu), which just came into being about 14 months ago, and is a joint sub of NYSE Euronext and Caisse des Depots. Another might have been NYMEX (http://www.nymex.com), which is now a subsidiary of the Chicago Mercantile Exchange; NYMEX announced an RGGI trading program in July 2008, but we believe that NYMEX volumes are not yet significant.
We asked Neil what lies ahead for CLE. “We need to get our existing products trading more, and add liquidity for investors,” he said. He indicated that as the size of contracts grows, more US traders will be interested. “Right now, we are meeting companies, going to conferences, doing lots of sales presentations.” When asked to name sectors who ought to be trading, he listed utilities, oil & gas companies, refiners, mining, paper & pulp operations, cement producers, and companies that make aluminum, glass and steel. He said that although in the US, oil & gas companies have lagged behind for the most part, the European and UK “big oils” are trading RGGI contracts now. He believes the majors will all come around, as will governments and regulators worldwide.
“When all is said and done,” Eckert said, “air and water are more important than money.”
<Note: We have no business dealings with Climate Exchange or its affiliates, nor do we own shares in Climate Exchange or any other entity associated with Mr Eckert. JA>