Carbon funds upbeat on post-2012 market

Published: 09 Feb 2010 11:27 AM EST

North American fund managers predict strong demand for carbon credits despite post-2012 uncertainty.

The failure of negotiators to broker a legally-binding climate treaty with concrete targets at the Copenhagen summit last December kept participants uncertain over how a carbon market would look after the Kyoto protocol expires in 2012.

The two-week negotiations also failed to deliver specific details about how the clean development mechanism (CDM) would evolve after the climate treaty expires.

On top of this, the potential of carbon market investors to venture into new markets, such as the US, is in doubt as carbon capping legislation in the US Senate has stalled.

But managers of North American-based carbon funds continue to see opportunities in CDM projects – albeit different from today’s – after the Kyoto protocol expires.

They are also still optimistic about demand for domestic pre-compliance carbon credits despite uncertainty over US climate change legislation.

Funds that invest in certified emission reductions (CERs) – carbon credits issued by the CDM – see a market continuing for CERs, though in a much different form.

“We believe there is still a need for the CDM. It will not disappear. But the market will not be appropriate for large countries, such as China and India,” said Claude Devillers, founder of New Jersey-based Merzbach Carbon Finance.

New focus

The firm, which funds CDM projects and aggregates carbon credits, predicts large developing country emitters, such as China, will no longer be hosts of CDM projects as these countries develop their own cap-and-trade markets.

China is currently the largest host of CDM projects.

“The CDM market will be a very probable means to support carbon abatement in developing countries in the strictest sense,” said Devillers.

He estimates the CDM will be pared down, creating carbon abatement opportunities in only the least developed countries.

“Since we assume large countries will no longer be a part of the CDM, it will become a more discrete market. At the same time it will remain an important flexible mechanism for larger markets in the EU, US, China etc that will increase the need for CDM credits.”

Others agree a framework for a post 2012 CDM will exist, but that it will look quite different to today’s mechanism.

“There will be some sort of framework that will create space for CDM projects,” said Harold Buchanan, managing partner of California-based investment firm CE2 Capital Partners.

“Clearly the party is over in 2012 for CDM. What develops post Kyoto remains to be seen. I don’t think the credits will be called CERs,” he added.

New game, different players

Market participants also think the make-up of funds in post-2012 carbon market will be different, as many of the traditional CDM market players have already disappeared, said Devillers.

“Except the final users and some banks, the early players in the CDM market have now been acquired or have merged; new players have emerged; and the overall landscape of players in the carbon markets has dramatically changed.”

One source said well-known investors in CERs, such as Natsource, have become less active.

Natsource, an asset management firm, has two carbon funds – Greenhouse Gas Credit Accreditation (GG-Cap) and Natsource Asset Pool (NAT-CAP) that invest in the CDM and JI markets.

Richard Rosenzweig, chief operating officer of Natsource’s Washington DC-based operations, pointed to the uncertain future of compliance markets after the Kyoto protocol expires as well as US climate legislation.

“Right now there is no assurance what might happen with mandatory markets,” said Rosenzweig.

Newer and more nimble?

Managers of smaller carbon funds are more upbeat about their ability to jump on opportunities in the post-2012 carbon market compared to their larger counterparts.

Dwayne Strocen, CEO of Toronto-based CO2 Global Climate CTA Fund, which focusses on exchange-traded CERs, EU allowances (EUAs), and voluntary emission reductions, said larger funds may find it harder to compete than more nimble firms.

“Large corporations need to look at projects that are enormous. But there are small projects that are profitable. There is still good money to be made,” said Strocen.

Others see carbon funds with lesser capital falling by the wayside if carbon prices decline.

“Many entities are not well-funded and will struggle,” said Buchanan at CE2 Capital.

North America

In the North American pre-compliance offset market, funds have come under pressure as prices for carbon credits have dropped amid growing scepticism over the passage of US climate legislation.

For example, prices for climate reserve tonnes (CRTs), voluntary carbon credits issued by the Climate Action Reserve, have fallen 20 per cent amid a drop off in demand due to uncertainty over a US climate bill, said Jonathan Stack, a broker for CantorCO2e.

CRTs are viewed as one of the most likely type of voluntary carbon credits that will be fungible in a federal cap-and-trade scheme.

Strocen said he has seen a big drop in demand for pre-compliance offsets, especially from North American corporations.

Many companies that bought pre-compliance offsets in the expectation of national compliance regimes emerging now see these offsets a waste of money, said Strocen.

“They say they are not going to spend another nickel until they understand what the government expects of them,” said the fund manager.

Long-term vision

Nevertheless, large investors such as pension funds are still interested in putting their money into carbon investment vehicles because they still see opportunities for making money, said Strocen.

“A lot of investors do not know their CERs from their EUAs. Their understanding of the carbon market is at a macro level. They still see long-term opportunities.”

For some fund managers, whose main focus is in the US pre-compliance and voluntary offset market, their hopes are still high that US climate legislation will be passed.

Keeping the faith

Indeed, some investment vehicles are so upbeat about the potential market for US pre-compliance offsets that they have set up carbon funds to focus on these sectors.

Eko Asset Management recently announced it was near to closing on a $8-10 million fund for forestry and agricultural offsets.

The fund will focus on pre-compliance forestry offsets, such as those issued by the CAR and the Voluntary Carbon Standard, said Ricardo Bayon, partner at Eko.

Buchanan is certain offsets will be part of a US climate bill, given their potential to reduce compliance costs.

“There will absolutely be offsets (in climate legislation). The cost of mitigation requirements are too critical.”

By Kim Moore – kmo@pointcarbon.com

Washington DC

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