Trading places

Around the world, more and more companies are starting to trade emissions allowances or hedge their weather risk. New markets, new contracts and new regulations were introduced in each of these markets during 2001 and a range of new broking and advisory services were launched. Given this rate of change, it is hardly surprising that Environmental Finance’s annual poll of these markets features several new names. Graham Cooper and Martin Grice report

Two events cast a dark shadow over the markets in weather derivatives and emissions allowances in 2001. September’s attacks on the World Trade Center were keenly felt by all in these markets but Cantor Fitzgerald was especially badly hit. The dramatic collapse of energy trader Enron two months later removed one of the pioneers of the weather market and a major force in US emissions trading.

Both firms feature prominently in this year’s annual Environmental Finance poll of these fast changing markets, as they did in last year’s inaugural survey. But the long-term impact of these disasters remains to be seen.

Houston-based Enron was the clear overall winner of the ‘Best Dealer’ title in the weather derivatives category in 2000. But our latest poll – conducted in November 2001 – reveals that its crown was clearly slipping ahead of its share price, as it lost out to Element Re for the title of Best Dealer in North America.

Founded by an ex-Enron team led by Lynda Clemmons, the Connecticut-based firm is a subsidiary of reinsurance company XL Capital and has quickly won an impressive reputation for its weather derivatives expertise. Clemmons attributes the firm’s success to the fact that the team is dedicated to the weather market rather than covering a mix of products and is supported by dedicated accounting, credit and legal functions. The company has already branched out from its strong position in the US market and is trading overseas weather contracts. But it plans at present to conduct this business from its Stamford headquarters. “It’s easier to control growth from here,” says Clemmons.

She predicts that it will take several months for the full impact of Enron’s collapse to be felt in the weather market. “The demise of Enron will not be felt until firms start looking at summer transactions,” she says.“We will find out in April how many end-users have been hurt,” she adds. But even if the company fails to emerge from protection under Chapter 11, most traders say the fall-out from the disaster could be good for the weather market in the medium term. Enron’s experienced team of weather risk specialists are likely to find jobs with other companies and help stimulate further growth in the market, they say.

Enron held on to first place in the fastgrowing European weather market but had to share the title of Best Dealer with its Houston-based rival Entergy-Koch Trading, which has rapidly established itself as a force to be reckoned with outside the US since setting up a London weather desk early in 2001. As this issue went to press in early December, Enron was operating with a skeleton staff of just three on its London weather desk.

The other main area of demand for weather hedging outside the US is Japan, but this year’s poll revealed no clear winner in the ‘Best Dealer’ category for Asia.

Among the weather brokers, New Jersey-based United Weather retained its clear lead in the North American market but lost out to GFINet in Europe. GFI entered the European market in March 2001 with a team of two and has since appointed two more weather brokers in the US. Olivia Goldsmith, one of the firm’s London weather brokers, says several large players are stepping into the market to fill the gap left by Enron and says she hopes the firm’s experienced traders will remain in the market.

TFS Energy, which came a strong second to United in the North American market, held on to its lead as Best Broker in Asia.

Despite Enron’s loss of dominance in its US homeland, its enormous influence in the weather market was guaranteed by the tremendous success of its internet-based trading platform EnronOnline. This was the easy winner in the new ‘Best Online Service’ category, although shortly after the survey was completed in late November, the system ceased trading weather contracts.

The second new category introduced in this year’s poll – Best Advisory Service – was won by Risk Management Solutions. This California-based company is best known for licensing its data and technology, says Paul VanderMarck, managing director for weather risk products. But this frequently involves advising clients, he notes, and the company also undertakes consulting projects, which involve advising on pricing methodologies and risk management, he adds.

Weather risk specialists are generally confident that there is plenty of life in the market without Enron and point to several major innovations which will shape the business in the coming year. Several banks are poised to enter the market; new indexes and data sets are being launched; exchange-traded futures contracts have just been introduced on the London International Financial Futures and Options Exchange; and five swap contracts were launched in late 2001 by the Atlanta-based Intercontinental Exchange.

Enron was also a significant force in the emissions trading markets – buying most of the 2001 sulphur dioxide (SO2) allowances in this year’s auction at the Chicago Board of Trade in March. And, shortly before its November collapse, it sold some 900,000 allowances in a single trade, which caused the market to spike sharply higher when the transaction became public knowledge. As in last year’s survey, however, the company failed to merit a place among the winners in the 2001 Environmental Finance poll. Indeed, no clear winners stood out in the ‘Best Trading House’ category for any of the emissions markets.

Among the brokers, Evolution Markets retained its lead in the SO market and achieved its declared aim of also being named Best Broker in the 11-state Ozone Transport Commission market for nitrogen oxide (NOx) allowances. It had to share this title, however, with last year’s winner – fellow Manhattan-based broker Natsource. This category was one of the most closely contested, with Cantor Fitzgerald’s Environmental Brokerage Services close behind the winners.

Evolution has some six staff dedicated to broking SO2 and NOx allowances and president Andy Ertel attributes the company’s success to “our focus on long-term relationships” in these markets.“We are good at speaking the language of end-users,” he adds.

A significant – and long-awaited – expansion of the NOx market began in the second half of the year when the first trades under the NOx SIP Call programme were claimed by Evolution and Natsource. By the end of November, several trades were being reported each week in this new market. As more states announce how they plan to allocate emission allowances under this programme, traders expect to see a substantial 19-state market evolve.

Regulatory changes and legal threats continue to dog both the SO2 and NOx markets, however, leaving many utilities crying out for greater certainty to help them in their capital spending decisions. Few established markets have seen such dramatic revisions to their rules as the Regional Clean Air Incentives Market (Reclaim) in the Los Angeles area. Prices of NOx allowances in this market rocketed during the Californian power crisis of 2000, prompting regulators to exclude most electricity generators from the market. Cantor Fitzgerald’s Environmental Brokerage Services was again voted Best Broker in this market.

Much of the regulatory uncertainty hanging over these markets is likely to be resolved when the US administration eventually produces its proposals for multi-pollutant legislation setting out new targets for reductions in SO2, NOx and mercury.

Carbon dioxide seems certain to be excluded from this government initiative but US trading in greenhouse gas (GHG) emission reductions is growing in response to single-company, regional and other climate change initiatives. Outside the US, progress is even faster towards a flourishing market in ‘carbon credits’. By early December 2001, four trades had been reported in the mandatory Danish carbon market and more than 85 companies had expressed interest in participating in the UK’s voluntary GHG trading scheme which is due to start in April 2002.

“There is more and more a feeling of the world moving to GHG reductions through trading programmes,” says Jack Cogen, Natsource president.“We’re getting enormous interest [in GHG reduction trading] from companies around the world since Marrakech,” he adds, referring to November’s United Nations climate change conference. The Marrakech meeting helped pave the way towards a global market in GHG emissions.

It is still early days for a pure broking function in the carbon market, with much handholding required to see early trades through to completion. Nonetheless, the poll shows Natsource to have established an early lead in this role thanks, in part, to strong support from voters in Japan where the company has set up a joint venture with Mitsubishi Corp.

The firm has been spending heavily, building a team with impressive experience in climate change policy, asset management and broking. Natsource was also the clear winner in the related market in renewable energy certificates, which is developing in the US, Europe and Australia.

Natsource also polled strongly in the Best GHG Advisory Service category but was beaten to the title by CO2e.com and EcoSecurities. “This demonstrates the success of our business model,” says Steve Drummond, chief executive of CO2e.com. “Our core business is brokerage,” he insists. But the company is carrying out a series of trading simulations and claims a strong financial focus which helps it to develop structures which enable companies to release additional environmental value from their operations.

Drummond says the company anticipates an upsurge of activity in North America and he is optimistic about business opportunities in Russia and the economies in transition. He expects to see trading in the UK’s voluntary market pick up towards the end of the year and is also bullish about prospects for the new UK market in renewable energy certificates – one of the tools the government is deploying to help lift the share of UK power generated from renewable sources to 10% by 2010.

CO2e.com was also voted the Best Online Service for GHGs, a category in which it currently faces little competition. The company’s web-based service comprises a broker-assisted market for trading emission reductions; a suite of tools to help companies manage their GHG emissions; a register of consultants and experts; and updates on international developments in the emerging GHG market.

Sharing the podium for best GHG Advisory Service is EcoSecurities, a fast-growing environmental consultancy based in the UK. “We are doubling in size every year,” says director Pedro Moura Costa, “but we still cannot cope with demand”. At least 80% of the company’s work is GHG-related, he estimates, with business drawn from both the private and public sectors. He expects to see growing demand for the firm’s services from governments following the agreement on the Kyoto Protocol reached at Marrakech in November.

South American voters were particularly strong supporters of EcoSecurities, which comes as little surprise to Moura Costa, himself a Brazilian. The company has an office in Brazil, full-time representation in Argentina and a part-time representative in Peru, he notes. South-east Asia is a possible focus for expansion in the coming year, he says.