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June 20, 2012updated 29 Jan 2016 4:31pm

Carbon Credits: Investment Must-Have or Boiler-Room Scam?

By Christopher Silvester

There’s more to carbon credits than just hot air, but prospective investors should handle them with care if they don’t want to get their fingers burnt, says Christopher Silvester
one of the many to have signed up to receive information from a financial information website in recent years, chances are you will have received emails drawing your attention to the burgeoning investment market in carbon credits. Indeed, you may have been bombarded with such missives. You may have been called by a broker — well, actually a salesman who works for a broker, often with a less than sure grasp of grammatical expression. Welcome to the voluntary market for carbon credits, now being aggressively marketed as a must-have element in the portfolio of any sophisticated investor.

Now this may not bother HNWs or UHNWs, who presumably have wealth managers to caution them against dodgy investment strategies, but, as we know from the Madoff affair and other instances of financial skulduggery, even those who are blessed with enormous wealth and count themselves among the canniest are still capable of being separated from their wealth by resourceful tricksters.

Companies offering carbon credits to investors have been proliferating with abandon, and the Financial Services Authority has declared that carbon credits are the latest boiler-room scam. ‘You could lose money on your investment by not being able to sell, or at least get a competitive rate, when trading a small volume of carbon credits,’ it warns. The FSA issued its first warning to consumers in August 2011 and has since added several carbon credit firms to its blacklist of unauthorised traders. This is not to say that these companies are fraudulent, but that investors through such companies do not enjoy similar safeguards to investors in more regulated sectors.

Since the Kyoto Protocol was signed by 190 nations, polluting companies are able to earn credits by reducing their carbon footprints or to invest in carbon-reducing projects. Credits such as EUAs (European Union allowances) and CERs (certified emission reductions), which are earned through a CDM (clean development mechanism) project, are traded in what is known as the compliance market. There is also a voluntary market in which VERs (voluntary emissions reductions) are traded over the counter by specialised brokers. These VERs are graded and the FSA’s decision whether to designate a carbon credit broker as authorised depends on whether it offers credits that are VCS (verified carbon standard) or gold standard (meaning that the clean energy project will have a positive effect on the local community). These are the only brokers a wise investor should have anything to do with.

Richard Clark, senior consultant with MH Carbon (an FSA-authorised trader), cites as an example a paper mill in Russia that used its waste to generate electricity through a biomass project: ‘The project was assessed and given VCS status, and the credits were awarded. Canny investors were able to buy these credits at a price as low as £3.01 and within the year had exited to a strategic partner at £4.04, making a smooth 34 per cent profit. The brokerage will charge a fee for its service — normally to the tune of 1-2 per cent on the entry and exit — but no other charges, VAT or stamp duty should apply.’

ANOTHER APPROACH FOR an investor would be to buy shares in a company that earns carbon credits and sells them into the market. One such is Energy Edge Technologies Corporation (EEDG), a US company specialising in energy cost reduction for industrial, institutional and commercial facilities. In April EEDG announced that it was about to reap huge dividends by selling approximately 110,000 tons of reduced CO2 emissions on the carbon credits market through US broker Green Giant Venture Fund.

However, Camco International, a developer of low-carbon and clean technology projects in North America, Europe, Asia and Africa, which is listed on London’s AIM, announced on 22 May that it had made a loss of €29.2 million in 2011, compared with a 2010 profit of €10.1 million. The company’s carbon portfolio had been hit by record low carbon prices — the market for carbon credits lost two-thirds of its value in 2011 owing to a glut of supply.

‘In the medium to long term we continue to believe that as action is taken by regulators and governments, market inefficiencies will be corrected,’ said chief executive Scott McGregor. Already Camco has adjusted its business model to new market circumstances. Instead of a fixed average buy price, it now earns a percentage of market price for credits it delivers, purchases or resells.
A RELATIVELY SAFE way to gain exposure to the carbon credits market is through an ETF. However, there is only one vehicle available, actually an exchange-traded note (ETN) — the iPath Global Carbon ETN, which seeks to follow the price and yield performance of the Barclays Capital Global Carbon Total Return Index. Another way to access the market, although it carries all the risks associated with such products, is through contracts for difference. Copenhagen-based broker Saxo Bank has launched a CFD product based on future carbon emission values. The minimum contract size is for 25 metric tons and the price of emissions has ranged between €8 and €30 per ton in the past couple of years.

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Some commentators believe that carbon credit derivatives, such as futures and options, are bound to lead to manipulation of the fair value price of carbon credits — another instance of tail-wagging-dog syndrome.

Back in February 2010, Daily Telegraph commentator Jeremy Warner predicted that the carbon market would be ‘another gigantic asset bubble — if indeed the non-production of carbon can be described as an asset’. So far his prediction has been wide of the mark. Thomson Reuters Point Carbon predicts that the global CO2 market will grow by 13 per cent in 2012, taking trading from 8.4 billion tons in 2011 to 9.5 billion. Within that, the voluntary market is expected to trade 400 million tons of CO2. Looking towards the future, there is every possibility that airlines will be brought into the emissions trading scheme. If that happens it will mean greater trading liquidity, which bodes well for the market as a whole.

Yet for the short to medium term the picture remains one of volatility and tentative growth. Since the eurozone is the biggest purchaser of carbon credits, the recession there means that polluting companies will need to buy fewer carbon credits to offset their footprints. While many investors will wish to steer clear of the market completely, even those who are interested in adding carbon credits to a diversified portfolio, whether for ethical or acquisitive reasons, should hang fire and wait until the market matures.
Illustration by Russ Tudor
Read more by Christopher Silvester

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