Is emissions trading the way of the future? If so, Climate Exchange could be a winner.
Emissions trading is a simple idea: it's a 'cap and trade' system, where countries and businesses are allowed to emit a specified amount of greenhouse gases, and they then buy and sell these allowances depending on their actual requirements.
So if an organization cuts back its carbon output it can sell some of its allowance and make money from becoming more green.
Simple in theory, but in practice the value of these allowances is very hard to quantify; over the past year, the price of CO2 credits has ranged from over €30 per tonne to under €1 per tonne. It's a scary business.
Rather than being directly exposed to such a volatile price, Climate Exchange
(LSE: CLE)
earns its revenue from the volume of credits traded. The company owns the European Climate Exchange (ECX), which claims to handle 80% of Europe's exchange-traded carbon emissions, and the Chicago Climate Exchange (CCX), which is "North America's only legally binding rules-based greenhouse gas emissions allowance trading system".
So far, so good. LondonStock Exchange
(LSE: LSE)
has done very nicely from providing the trading platform for shares, and this is a similar business.
The valuation of Climate Exchange depends on how this emissions trading market develops over the coming years. Currently, volumes are booming. Results for 2006, announced this morning, included:
- average daily volumes on CCX increased by 610%
- average daily volumes on ECX increased by 233%
- revenue more than tripled, to £4.8m
- operating loss of £4.7m
On those figures, the market capitalisation of £461m may look a bit steep (even allowing for the £13.6m in the bank), but a few years of this sort of growth could justify it.
Is this really the embryonic stage of a new global industry? Europe's Emissions Trading Scheme (ETS) is the only mandatory trading system, so there is clearly scope for other regions to follow suit. The second phase of the ETS runs from 2008 to 2012, and it will be interesting to see if tightened allowances reduce the volatility of credit prices.
While there is no consensus that 'cap and trade' is the right way to manage emissions, it appears that the EU is committed to using it as a tool to achieve its 2020 targets. There are moves to introduce mandatory measures in other countries, but according to Climate Exchange: "Our view is that mandatory markets will not occur before 2010 in the U.S. and 2013 in India and China. We enjoy first mover advantage and are currently engaged in membership recruitment and trading on a global basis."
Despite America not signing up to the Kyoto Protocol, expect the environment to be a bigger factor in the 2008 presidential race. Some academics have even suggested introducing personal carbon trading.
It's also reasonable to expect that such moves would attract other players into the market, but having an established business already does put Climate Exchange in a strong position.
Predicting how this will play out is very difficult, which is probably why the company's share price has doubled, then halved, then doubled again, in the past three months. Climate Exchange is a highly speculative investment, but if legislation follows the current trend it could be very lucrative.
The share price was up 15p to 1115p this morning.
