The carbon market is still in its infancy but as private sector investors are discovering this niche as uncorrelated performance driver, the dynamic is shaping up. The Kyoto Protocol set the framework for the “Kyoto mechanism” under which emission targets should be met primarily through national measures. Emissions from greenhouse gases are to be reduced by 5.2 percent based on 1990 levels until 2012. This can be achieved by capping total annual emissions and through trading emission permits, where the market assigns a monetary value to any shortfall.
Nationally allocated credits can be exchanged between businesses or bought and sold in international markets at the prevailing market price. The agreed “caps” or quotas on the maximum amount of greenhouse gases from industrialised countries can be met using market-based mechanisms, namely Emission Trading Schemes (ETS), Joint Implementation (JI) and the Clean Development Mechanism (CDM). These schemes trade and settle internationally under the supervision of the UNFCCC allowing emission certificates to be transferred between countries.

It was not until 2005 when the Kyoto mechanism was adopted for CO2 trading by all EU countries under its Trading Scheme (EU ETS) that the carbon market really took off. With the European Commission acting as its validating authority through national registries, what followed in its first three years of operation (phase 1) was a manifestation of the public interest, growing the carbon markets from a trading volume of approximately $8bn in 2005 to $118bn in 2008. The carbon market is currently dominated by the EU ETS which accounts for roughly 70 percent of all trading volume. Whilst a considerable portion of future growth is estimated to come from increasing liquidity in the CDM, a US climate and security act could potentially create a market three times the size of the EU ETS, propelling the global carbon emissions market to $500bn by 2012 and $3.5trn by 2020.

Carbon is more than a new commodity − it is an independent asset class and will be part of every strategic asset allocation.

The landscape is already changing as active carbon management is required on an enterprise level. Although the market is expanding rapidly, global regulation remains premature and the framework is still developing. A multinational company operating in several jurisdictions can be exposed to price differences due to variations between regulatory environments and market inefficiencies.

Investors should investigate how carbon issues impact their investment portfolio and reflect this in the investment policy and risk management. To balance risk with reward, the solution will involve finance, technology and engineering as investments are evolving from simply buying carbon assets to taking equity positions in the underlying projects and benefiting from the revenue stream.

Asset class
Carbon investments as an asset class pose a tempting opportunity for sophisticated investors as it has both, a very low correlation to traditional asset classes and offers diversification. As a growth market, it currently also offers plenty of inefficiencies as well as the liquidity to support a long/short trading strategy. The maturity of the carbon derivatives market now even allows for the creation of portable alpha strategies. Whilst there are numerous ways to invest in the market, the use of private funds as a collective investment vehicle is emerging as the method of choice enabling the investor to share risk, diversify and rely on professional management. Despite the global economic crisis, carbon fund assets under management grew by 25 percent last year. The carbon market offers an attractive risk/reward proposition due to a lack of transparency, fragmentation and volatility. Investing in the market presents opportunities to outperform by exploiting pricing inefficiencies of carbon emission permits, carbon-related projects and cleantech investments.

AtlasCapital Financial Services relies on years of experience as one of the dominant market players on the BlueNext Exchange. It offers a variety of services in the environmental markets from advisory and trading, to structuring and project investment.

For more information tel: +357 25 50 10 00; email: dejongd@ACFS.eu; www.ACFS.eu