Street Clears the Air

Carbon trading takes off.
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Going green could bring a lot of green to investors and investment banks.

Fast-emerging opportunities to trade carbon dioxide -- the gas linked to global warming -- are moving it into the limelight.

And Wall Street firms better known for making a bundle trading traditional commodities such as natural gas and oil are seeing an opportunity to make money from efforts to clean up the environment.

Morgan Stanley

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announced last week that it is committing $3 billion over five years to expand its existing carbon and emissions trading business, including private equity investments in projects related to emissions reduction.

In September,

Goldman Sachs

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purchased a 10% stake in the Chicago Climate Exchange -- a three-year-old electronic commodities exchange that focuses exclusively on trading greenhouse-gas emission allowances in the U.S.

Carbon trading is catching on in the U.S. and especially in Europe as a way for countries and companies to comply with strict guidelines for reducing so-called greenhouse gases such as carbon dioxide.

The concept is an outgrowth of the Kyoto Protocol, an international treaty designed to reduce the risk of global warming.

The U.S. does not follow the treaty, which President Bush rejected soon after he took office in 2001. Bush said the measure was too punitive on polluters and the mandates to reduce carbon emissions would hurt the economy.

The process entails the buying and selling of "allowances,'' the amount of carbon dioxide emissions companies are allowed to emit under the Kyoto treaty.

Companies that emit less pollution can sell their excess allowances to other companies, which pollute too much and can't reduce their emissions to acceptable levels.

By buying up the excess allowances, a polluting company can avoid being hit with a fine or a sanction.

But the goal is that the pollution limits eventually will force all companies to reduce carbon dioxide emissions.

"There is definitely building momentum in corporations and in general for increased action on global warming," says William Marcus, the head of business development at Calyon Financial, a Chicago-based global futures brokerage.

U.S. companies, he says, are "putting into place their own internal practices, trading and educational programs in preparation for the day of mandated limits."

To be sure, the business of carbon trading is still in its infancy.

So far this year, more than 9.3 million metric tons of carbon dioxide equivalent, or 93,000 contracts, have been traded, the Chicago Climate Exchange says.

That's minuscule compared with the daily record set earlier this month on the New York Mercantile Exchange, during which 411,265 energy futures contracts were traded.

And carbon trading also has experienced some growing pains.

Earlier this year, the price for carbon fell in Europe after a panel questioned the effectiveness of the European Union's emission trading scheme. The panel said the number of carbon permits issued by countries to clean-burning businesses exceeded the demand from polluters.

"It's a new market,'' says Richard Sandor, the chairman and CEO of the Chicago Climate Exchange, which has 225 members. "The volume and turnover is significantly less than in Europe, but the breadth of members is significantly wider."

The big commitment by Morgan Stanley to carbon trading is an indication that Wall Street increasingly sees it as an area for real growth.

Simply put, investors and investment banks have recognized the potential to make profits through carbon trading.

Still, for now, carbon trading is really a European affair because of the Bush administration's stance on the Kyoto treaty.

That could change down the road with a new administration, one that takes a more favorable view toward combating global warming.

"The commitment by Morgan Stanley just shows how serious this market is," says Andrew Ertel, the president and CEO of Evolution Markets, which specializes in structured transactions, consulting and advisory services for the environmental credit markets.

Ertel says, "It touches almost every aspect of their business one way or another," such as speculative trading, private equity investments and project financing. "But there is a double perspective -- not only are you making money, but you're actually doing good for the planet."

Ertel's firm does brokerage work for Morgan Stanley.

Investors and hedge funds also might find carbon trading appealing if they are "looking to invest in products with no correlation to the broader securities market as a hedge" in their portfolios, says Ron Geffner, an attorney at Sadis and Goldberg, who represents hedge funds.

The U.S. also does not have federal legislation requiring companies to cap the amount of carbon emissions per company.

Rather, just a handful of states have pushed forward greenhouse gas-reduction initiatives, including several in the Northeast under the Regional Greenhouse Gas Initiative, as well as California.

While federal legislation eventually will be necessary, it is unlikely that there will be stepped-up pressure on President Bush to enter into the Kyoto treaty even if there is a change in control in the House or Senate, Ertel says.