Features, December 2000/January 2001 Market Survey In the past five years, capital markets techniques have been brought to bear on a range of environmental problems, including air pollution and adverse weather. An Environmental Finance survey reveals which brokers, dealers and advisors have won most respect in these new markets New market leaders Enron and United Weather are the dominant players in weather derivatives, according to Environmental Finance's November poll, the first comprehensive survey of this new market. The Houston-based energy giant was voted Best Dealer in the three-year old North American market and in the newer European market but its main rival in Europe - French bank Societe Generale - captured the crown in Asia. "Europe and Japan are on the verge of taking off," says Mark Tawney, Enron's Houston-based director of weather risk management. There is likely to be a better mix of hedging demand in these younger markets, he adds, as there is growing interest from a wide range of industry sectors. The US market, by contrast, remains dominated by energy companies. Insurers have been significant players in the market in recent years but they were less active in 2000, Tawney says. Many insurers - generally sellers of weather protection - incurred losses as a result of three consecutive mild winters in the US. On the other hand, more trading companies have entered the market in the past 12 months, he notes. Enron's leading role in the market suffered a knock in 2000 with the departure of several of its weather team in March but it bolstered its already powerful market presence with the launch of weather contracts on EnronOnline in January 2000. Although the initial choice of contracts for this electronic trading system - based on baskets of cities - was not popular, it has proved highly successful following a switch to contracts on 11 individual cities in April. New locations will be added in 2001 and the addition of weekly contracts is being considered, Tawney says. This would attract more commodity traders to the market, he predicts. At present the shortest contracts are for one month. Most traders are reluctant to estimate the size of the global weather derivatives market in 2000 ahead of a PriceWaterhouseCoopers study commissioned by the Weather Risk Management Association, which is due to be issued in March. But Philippe Chauvancy, vice president of business development at United Weather says that in the final four months of 2000, volumes were up by 200% on the same period of 1999. He agrees with Tawney that the market is becoming increasingly international and predicts that banks will become much more active in the market in 2001. "This will change the whole structure of the market because of their distribution power," he says. The expected launch of weather contracts on established derivatives exchanges will also help boost the market, he says. New Jersey -based United Weather, a subsidiary of United Fuels, was nominated overall Best Broker in the weather market although it lost out to TFS Energy in Asia. The latter firm, based in Connecticut, was created by the August merger of the energy division of Tradition Financial Services with that of Sakura Dellsher Inc. It is headed by Kendall Johnson, former head of weather at TFS. Three Manhattan-based brokers dominate all three of the markets in emissions allowances covered in the survey - sulphur dioxide (SO2), nitrogen oxides (NOx,) and greenhouse gases (GHGs). Ironically, the most mature of the three markets - SO2 - was won by the new kid on the block, Evolution Markets. Founded in March 2000, the company owes its success to having quickly built a team which can deal equally well with sophisticated traders and newcomers to the market, says president Andy Ertel. The aim now is to apply this approach to the NOx market and then the emerging market in GHGs, he says. The SO2 allowance market, generally held up as a model of how successful emissions trading schemes can be both economically and environmentally successful, was created in 1995 under the US Acid Rain Program. Phase Two of the scheme, which began in January 2000, brought many small and mid-sized facilities into the emissions market for the first time. August 2000 was the busiest month on record in terms of the volume of contracts traded, and options activity in 2000 far outstripped that of previous years, Ertel says. And liquidity remains good, he adds, even after the plunge in prices in November on news that at least one major utility may scale back its allowance purchases following settlement of a dispute with the Environmental Protection Agency. If Evolution hopes to repeat its SO2 success in the NOx market, it will face two main rivals for the title of best broker. In fact, there are two major markets in NOx allowances in the US. The Ozone Transport Commission (OTC) market covers 11 states in the north eastern US along with the District of Columbia and part of Virginia. It was created in 1999 to reduce concentrations of ozone - a precursor of smog - in the region. Natsource was named best broker in this market, which was beset by regulatory disputes for much of 2000, as plans to force a further 22 states to reduce their NOx emissions were challenged in a series of lawsuits. (See Environmental Finance October 2000 page 5). These proposals could lead to a major expansion of the market. "The NOx market will accelerate in the next few years," predicts Natsource manager Michael Intrator. The second NOx market - the Regional Clean Air Incentives Market (Reclaim) - was created in 1994 to deal with a localised smog problem in the Los Angeles basin. Here, too, there has been plenty of drama as the tightening cap on emissions, a fierce heatwave and a power sector struggling to come to terms with deregulation, combined to send NOx prices soaring last summer. Having risen gradually during 1999, NOx Reclaim Trading Credits were changing hands for around $1/pound in January 2000. In July, however, they soared above $50/pound and by mid-December were threatening to break though $60/pound. Prices are expected to remain high in the first two months of the New Year, traders say, as companies have 60 days in which to buy any extra credits they need to cover the emissions they produced in the previous 12 months. Cantor Fitzgerald was voted top broker in this market. Clients of the company's Environmental Brokerage Service can buy and sell Reclaim Trading Credits via the firm's Continuous Clean Air Auction on its website. Josh Margolis, senior vice-president of the Environmental Brokerage Service notes that, thanks to the rise in prices, the total value of transactions in this market is far higher than it was in the past, despite the reduction in the number of credits available. And, despite the price surge, he says liquidity remains good, with 165,000 pounds trading in a single day in early December. As in the NOx market, Natsource and Cantor Fitzgerald shared the honours in the newest of the emissions markets - that for GHG reductions. Natsource came out on top as the Best Broker of GHG transactions but shared the top spot with Cantor Fitzgerald for Best Advisory Service. The fact that two brokers rather than specialist consultants won this category illustrates the changing nature of broking, particularly in immature markets. As pioneering trades in such young markets are very demanding in terms of advisory time and generally modest in value, brokers are increasingly charging separately for their advice in addition to the brokerage fees, which are usually based on the size of trades. Natsource has identified this as a major potential growth area for the company and has been busy hiring staff and forming alliances with other firms to help it exploit the emerging demand for expertise in this complex new area. Unlike SO2 and NOx, GHG emissions will be tradeable around the world, not just in the US. So, to ensure it can participate globally, Natsource has exploited its joint venture with leading money brokerage Tullett & Tokyo Liberty to spread its wings far beyond its New York base. It now has emissions trading capabilities in the UK, Canada, Australia and Japan, as well as the US, from which it hopes to gain first mover advantage in the GHG market. It has also been keen to publicise the trades in which it has been involved. One of the latest transactions it has arranged will see Epcor Utilites of the US receive 50,000 tonnes of carbon dioxide credits from Nordic energy group Fortum on 31 January. The credits were generated when Fortum made a fuel switch to biomass at one of its power plants. It represents the world's largest trans-Atlantic trade of carbon dioxide emission reduction credits, says Garth Edward, a GHG specialist at Natsource. Although the legal status of such credits is uncertain, the counterparties believe it is a valuable 'learning by doing' exercise. Cantor Fitzgerald, too, has been investing heavily to stake an early claim in this new market. In November it split off its GHG expertise from its EBS division to create an electronic marketplace for GHG trading, known as CO2e.com, under Carlton Bartels, formerly managing director of EBS. In addition to the New York team, CO2e.com already has staff in Toronto and Sydney and PriceWaterhouseCoopers, which is supporting the initiative, will soon have staff dedicated to the venture in London. The present structure is "just the cornerstone of the project," says Bartels. Another European office is planned, he says, and negotiations are underway with other companies who wish to become associates of the venture. Despite the failure of the UN climate change conference in November to agree on the groundrules for a future international market in carbon credits, most of those closest to the market are putting a brave face on the outcome. "It's perhaps a short-term negative for the market, but may be positive on the long run," says Natsource's Edward. The publicity which the event attracted has raised awareness and understanding of the issues and he anticipates a lot more activity in 2001. National GHG trading schemes are due to be launched in the UK and Denmark, he notes, and several US states are starting to monitor carbon emissions. "These are strong drivers for companies to take action," he says. How the survey was conducted More than 500 companies were sent a questionnaire or e-mail in November inviting them to nominate the leading brokers, dealers and advisors in weather derivatives and emissions allowances. In addition, the questionnaire was made available via the internet. Voters were asked to vote only in those categories in which they had direct experience and to make their judgements on the basis of efficiency and speed of transaction; reliability; innovation; quality of information and service provided and influence on the market, not just the volume of transactions handled. Some 110 completed responses were received. Only one vote per company was allowed and those firms that nominated themselves had their votes disregarded. Several respondents cast their votes for individuals rather than companies but these were assigned to the relevant company. In all other respects the counting was straightforward. Votes from Florida were treated in the same way as all others. FOR THE FULL STORY EVERY MONTH, SUBSCRIBE TO ENVIRONMENTAL FINANCE, OR CONTACT info@environmental-finance.com FOR OUR BACK ISSUES SERVICE