FINANCE:

Sale of Chicago Climate Exchange to ICE reinforces weak carbon market

Richard Sandor spent the past decade peddling a big idea: that capitalism has a solution for global warming. The trading house he launched in 2003, the Chicago Climate Exchange, would be the locomotive pulling an American environmental revolution into the 21st century as smokestack industries bought and sold a commodity called greenhouse gas emission allowances. Carbon futures and options, so his theory went, would turn financial speculators into tree-huggers.

On Friday, Sandor and the other shareholders of parent company Climate Exchange cashed out of this big idea for about $600 million. The IntercontinentalExchange (ICE), an electronic futures and derivatives platform based in Atlanta and London, announced it had agreed to purchase the three exchanges, the Chicago Climate Exchange, Chicago Climate Futures Exchange and European Climate Exchange.

The combination brings the still-small U.S. carbon market closer to the profitable world of global over-the-counter (OTC) energy trading, which ICE specializes in. It also consolidates carbon emissions trading under the tents of two major commodity exchanges, ICE and CME Group, which operates the New York Mercantile Exchange's nascent platform for carbon trading, the Green Exchange.

"The combination of Climate Exchange's emissions markets and ICE's futures and OTC energy markets is an important and logical strategic combination for our customers and shareholders," said ICE's chairman and CEO, Jeffrey Sprecher.

In a statement, Sprecher noted that Sandor's idea paved the way for Europe's carbon cap-and-trade program. There, the exchange developed into the major platform for trading offsets in the form of E.U. carbon emissions allowances and certified emission reduction credits generated under the United Nations' Clean Development Mechanism.

A 'rough five years'

But the Chicago Climate Exchange and its sister futures exchange have struggled for traction in the United States. And it is in the U.S. market that Sandor had hoped to build a large trading operation that would be good for both business and the environment.

"This has been a rough five years," Sandor acknowledged in a telephone interview Friday. Sandor said the nature of ICE -- an energy-trading platform -- and the need to boost shareholder value and drive down the cost of trading carbon contracts led to the decision to sell. Shareholders needed to walk away happy, he said, in light of the roller-coaster ride that now defines climate politics and carbon markets.

"We thought it was the right combination with the right exchange and at the right time," Sandor said. "As other exchanges have merged, they've talked about the benefits of one platform, a single clearinghouse for both energy and environmental products, all of which will be healthy for the environmental space."

To some, ICE's buyout of Climate Exchange did not come as a huge surprise. The two have partnered almost since Climate Exchange's inception, with ICE providing the electronic platform for Climate Exchange's trading operations.

Still, analysts disagree on the likely reasons for the merger. Some said ICE recognized significant advantages to increasing its footprint in the European market, where carbon and energy trading are closely linked. Others said the ongoing tepidness of the voluntary U.S. carbon market, uncertainty that Congress can pass climate legislation, and high likelihood that U.S. officials will not let companies count existing emissions credits toward compliance in a federal program contributed to the decision to sell.

The European Climate Exchange represents about 90 percent of all exchange-traded carbon transactions under the European Union's Emission Trading System. "In Europe, you can't trade power without trading carbon," said Emilie Mazzacurati, manager of North American carbon market research at Point Carbon. "It only makes sense that there is further integration."

Buying into uncertainty, but potential growth

The U.S. carbon market is hamstrung by political uncertainty, but Mazzacurati said the Chicago Climate Exchange is still a smart investment for boosting ICE's position as a major trading platform in the United States. "In the U.S., it's really the potential growth that they're buying," she said, referring primarily to the futures exchange, which has a strong hand in developing offsets contracts.

The big unknown, she and others said, is what happens to the underlying trading program for emissions allowances. That program, which started out in 2003 with 13 charter members, including American Electric Power, DuPont and Ford Motor Co., requires companies to cut their emissions 6 percent by the end of 2010. Prices for those allowances have dropped to just 10 cents per metric ton of carbon dioxide.

Sandor started his career as an economics teacher at the University of California, Berkeley, during the 1960s. Financial engineering, however, became his line of work. He created interest-rate futures, which during the 1970s became a widely traded hedge against fluctuating rates. He went on to become the chief economist of the Chicago Board of Trade, and helped push onto that exchange U.S. EPA's acid rain program that requires electric utilities to buy and sell sulfur dioxide emissions permits. He figured that model, devised for a larger market, could work just as well for global greenhouse gas emissions.

Sandor sought start-up funding from the philanthropic Joyce Foundation for a carbon exchange in 2000. Trading permits to pollute and other financial contracts would allow the U.S. economy to absorb emissions reductions in the cheapest and most efficient way possible, he argued. If things went right, his voluntary carbon market would become a de facto platform for a national cap-and-trade program.

Prospects for that seemed brightest at the start of 2009, once President Obama took office and the House began writing language for a cap-and-trade bill. Since then, Congress has bottled up cap-and-trade proposals, and the public is again questioning the science of climate change. In addition, Sandor's exchange has often been the target of environmental groups and others concerned about fraud in the system. Offsets, often privately negotiated in the form of options contracts, allow a company to earn credits for helping fund emissions reductions in other corners of the world.

Inherent problems verifying agricultural emissions reductions on U.S. farms and in developing countries raised questions about the integrity of offset credits designed to count for real emissions reductions. Chicago Climate Exchange's decision to offer landowners payments for a broad list of offset projects, including no-tillage farming many had done long before the offset contract existed, attracted critics.

"Going forward we believe the pure voluntary market is most vulnerable in the U.S., where public opinion appears to be moving away from concerns over global warming," analysts with Bloomberg New Energy Finance wrote in a February research note.

U.S. carbon prices drop

Public opinion doesn't trump bill language and economics, though. Milo Sjardin of New Energy Finance said U.S. carbon trading volumes and prices have dropped through the floor as a result of clear signals from Congress, contained in both House and Senate versions of legislation, that offset credits purchased before 2009 could not be transferred into a federal compliance market. Where an oversupply of allowances goes after the Chicago Climate Exchange program expires in 2010 is also up in the air.

"Demand for emissions reductions could spill over into the OTC market," said the research note, creating fresh demand for offset projects.

Traders also withdrew from the Chicago carbon futures exchange during the past six months. Again, both the House and Senate bills would slash the value of speculative contracts trading as part of the Northeast's Regional Greenhouse Gas Initiative.

Cap-and-trade critics viewed Sandor's sell-off of the Chicago Climate Exchange as another signal that the carbon-trading approach to cleaning the air is too big and problematic to work in any practical sense.

"This is something that [Sandor] has been promoting for well over a decade," said William O'Keefe, chairman of the George C. Marshall Institute. "It has never taken off."

O'Keefe guesses that implementing and growing the carbon market ended up being far more difficult than Sandor anticipated. In the late 1990s, O'Keefe recalled, Sandor promoted the idea as if it would work like the New York Stock Exchange. "It's not like a regular market, it's not like the SO2 market," O'Keefe said, referring to the more limited trading of sulfur dioxide permits.

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