Making Money Out Of Thin Air

Who would have thought that polluting the atmosphere could be a money-spinner?

Well it can if you trade permits that allow you to emit greenhouse gases. Through the European Union Emission Trading Scheme or EUETS, companies can buy and sell the rights to produce greenhouse gases. The idea behind the scheme is to stem pollution by putting a realistic price on harmful emissions. It is hoped that by penalising polluters they will pump less damaging gases into the atmosphere.

The scheme started on 1 January 2005 when all 25 EU countries agreed to bring down their greenhouse gas emissions. Under the scheme, polluting businesses are allocated carbon permits that cap the amount of greenhouse gases they are allowed to produce. Additionally, those businesses that can reduce harmful emissions can offer to sell any unused allocations to less efficient companies.

Through the scheme, a known polluter such as the coal-fired electricity generator Drax Group (LSE: DRX) has to choose the least costly route to reduce its carbon emissions. It can either buy extra permits through the open market or find better ways to cut carbon dioxide emissions. Whichever route it chooses the desired carbon reductions should theoretically be met at the lowest cost possible to society.

The scheme also allows eco-friendly companies generate carbon credits that they can sell to polluters which need to buy more permits. Recently, Ecoenergy International (LSE: ECG) brokered a deal to buy a million tonnes of carbon permits for the European market from a Brazilian landfill gas company Biogas Ambiental. The deal will help Biogas Ambiental finance projects to capture methane, which is a potent greenhouse gas, from its landfills.

AgCert International (LSE: AGC) is another business actively involved in cutting down methane production. It maintains and operates animal waste systems called biodigesters located at livestock farms. By harnessing the methane produced, AgCert can generate millions of carbon permits that it can subsequently sell through the market. Other companies involved in the carbon market include EcoSecurities (LSE: ECO), Camco (LSE: CAO), Climate Exchange (LSE: CLE) and Trading Emissions (LSE: TRE).

In theory, EUETS can help limit the amount of harmful industrial gases by making it more costly to pollute. However, critics argue that emission trading does not reduce pollution but merely shifts the problem from one company to another. And in some cases, it may just move the problem from one part of the world to another!

As I see it, success of the carbon scheme hinges on the value of the permits. When the scheme first started, permits were trading for around €20 per tonne of carbon dioxide. But prices rose steadily to about €30 a tonne as demand for permits increased. Unfortunately, dealing in something as nebulous as carbon emission can be fraught with danger. For instance, permit prices recently crashed 50% when it was discovered that some European companies, notably those in France and Belgium, reported better environmental compliance.

So how much are carbon permits actually worth?

Problem is, no one really knows. Low permit prices means that heavy polluters have been able to reduce emissions to such an extent that they don't need to buy additional permits -- that is great news for mankind. But it's terrible news for companies with large carbon portfolios when they see their paper assets go up in smoke!