The magic of the modern capital markets. You can invest in anything.
First, you need to turn something into a tradeable security. With derivatives, you can do this with almost anything. London has done it with the weather. The Kyoto Protocol has done it with Carbon Dioxide emissions. Kyoto introduced a “cap and trade” approach to regulating carbon dioxide, similar to the program put in place by the United States in the 1990s to control sulfer dioxide and acid rain. In a cap and trade system, countries limit the total amount of carbon dioxide emissions on a per country basis, and then issue those rights to their companies. Companies can then trade those rights with each other, and even potentially earn “new rights” by putting in place technology and programs to cut existing carbon dioxide emissions.
The Kyoto Protocol currently covers 160 countries, representing approximately 55% of all carbon dioxide emissions globally. The United States, China & India are the most notable signatories missing from the current pact.
Emissions trading has become a big market, and with global warming a hot topic again (sorry, I couldn’t resist), a lot of people have been looking at the carbon dioxide credits as more than just environmental regulation, but as an investment opportunity.
After all, it stands to reason that the right to release a ton of carbon dioxide into the air is not going to get cheaper going forward. And of course, if you buy that right, then some other company can’t, which means you potentially have taken that right off the market… until you sell it.
Now, what most people don’t know is that there is also a voluntary carbon dioxide emissions market here in the US, the Chicago Climate Exchange. There is also now a firm, called XShares, that is investigating creating an ETF based on the exchange.
In other news, UBS has created a new Emissions Index, based on the two European exchanges, which trade about 46% of all the global emissions rights today. There is no ETF for this index, yet, but where there is an index, there is usually an ETF to follow.
I’m going to file this away in my “watch” folder for the time being. Carbon emissions might be a very interesting commodity, since there will be strong secular pressure to limit the rights to emit greenhouse gasses in the future. Also, it stands to reason that lower emission caps in the future will mean increased costs for corporations, which means it might be an interesting diversification play versus the corporate stock & bond markets.