Carbon capitalists warming to climate battle using derivatives

Source: The Economic Times

Across Uganda, thousands of women warm supper over new, $8 orange-painted stoves. The clay-and-metal pots burn about two-thirds the charcoal of
the open-fire cooking typical of East Africa, where forests are being chopped down in the struggle to feed the region’s 125 million people.

Four thousand miles away, at the Charles Hurst Land Rover dealership in southwest London, a Range Rover Vogue sells for £90,000 pounds. A blue windshield sticker proclaims that the gasoline-powered truck’s first 45,000 miles (72,421 km) will be carbon neutral.

That’s because Land Rover, official purveyor of 4x4s to Queen Elizabeth II, is helping Ugandans cut their greenhouse gas emissions with those new stoves.

These two worlds came together in the offices of Blythe Masters at JPMorgan Chase & Co. Masters, 40, oversees the New York bank’s environmental businesses as the firm’s global head of commodities. JPMorgan brokered a deal in 2007 for Land Rover to buy carbon credits from ClimateCare, an Oxford, England-based group that develops energy-efficiency projects around the world. Land Rover, now owned by Mumbai-based Tata Motors, is using the credits to offset some of the CO2 emissions produced by its vehicles.

For Wall Street, these kinds of voluntary carbon deals are just a dress rehearsal for the day when the US develops a mandatory trading program for greenhouse gas emissions. JPMorgan, Goldman Sachs Group Inc. and Morgan Stanley will be watching closely as 192 nations gather in Copenhagen next week to try to forge a new climate-change treaty that would, for the first time, include the US and China.

US CAP AND TRADE

Those two economies are the biggest emitters of CO2, the most ubiquitous of the gases found to cause global warming. The Kyoto Protocol, whose emissions targets will expire in 2012, spawned a carbon-trading system in Europe that the banks hope will be replicated in the US.

The US Senate is debating a clean-energy bill that would introduce cap and trade for US emissions. A similar bill passed the House of Representatives in June. The plan would transform US industry by forcing the biggest companies , such as utilities, oil and gas drillers and cement makers, to calculate the amounts of carbon dioxide and other greenhouse gases they emit and then pay for them.

Estimates of the potential size of the US cap-and-trade market range from $300 billion to $2 trillion.

BANKS MOVING IN

Banks intend to become the intermediaries in this fledgling market. Although US carbon legislation may not pass for a year or more, Wall Street has already spent hundreds of millions of dollars hiring lobbyists and making deals with companies that can supply them with “carbon offsets” to sell to clients.

JPMorgan, for instance, purchased ClimateCare in early 2008 for an undisclosed sum. This month, it paid $210 million for Eco-Securities Group, the biggest developer of projects used to generate credits offsetting government-regulated carbon emissions. Financial institutions have also been investing in alternative energy, such as wind and solar power, and lending to clean-technology entrepreneurs.

The banks are preparing to do with carbon what they’ve done before: design and market derivatives contracts that will help client companies hedge their price risk over the long term. They’re also ready to sell carbonrelated financial products to outside investors.

Masters says banks must be allowed to lead the way if a mandatory carbon-trading system is going to help save the planet at the lowest possible cost. And derivatives related to carbon must be part of the mix, she says.

Derivatives are securities whose value is derived from the value of an underlying commodity — in this case, CO2 and other greenhouse gases.

‘HEAVY INVOLVEMENT’

“This requires a massive redirection of capital,” Masters says. “You can’t have a successful climate policy without the heavy, heavy involvement of financial institutions.”

As a young London banker in the early 1990s, Masters was part of JPMorgan’s team developing ideas for transferring risk to third parties. She went on to manage credit risk for JPMorgan’s investment bank.

Among the credit derivatives that grew from the bank’s early efforts was the credit-default swap. A CDS is a contract that functions like insurance by protecting debt holders against default. In 2008, after U.S. home prices plunged, the cost of protection against subprime-mortgage bond defaults jumped. Insurer American International Group Inc., which had sold billions in CDSs, was forced into government ownership, roiling markets and helping trigger the worst global recession since the 1930s.

LAWMAKERS LEERY

Now, that story — and the entire role the banks played in the credit crisis — has become central to the US carbon debate. Washington lawmakers are leery of handing Wall Street anything new to trade because the bitter taste of the credit debacle lingers. And their focus is on derivatives. Along with CDSs, the most-notorious derivatives are the collateralized-debt obligations they often insured. CDOs are bundles of subprime mortgages and other debt that were sliced into tranches and sold to investors.