Money to burn: carbon trading and a profit-making opportunity

The cost of the repurchase agreement, Emanuel says, would probably be around 2.5% of the total value. In other words, the company would be getting E150m in financing for 2.5% without dipping into its existing bank facilities. Most finance directors would snap your hand off for this. Emanuel adds that the repurchase option is only one of a series of financially rewarding opportunities being missed by companies caught by the ETS.

Risk averse
However, Emanuel says it is often very difficult to get anywhere near finance directors to appraise them of the fact that their company is sitting on this possibility and has, in fact, been sitting on it and doing nothing since the ETS was introduced in 2005.

Instead, all too often, they find themselves talking to a variety of people ­ including health and safety officers ­ none of whom have the slightest incentive to generate any profit for the company from compliance and all of whom are, both by temperament and job description, wildly risk-averse.

“You can’t blame compliance people for turning down these opportunities. They stand to gain nothing from any upside we can generate, since they are not personally rewarded in any way for a positive outcome from such a contract. Moreover, in their eyes, entering into the contract looks like a risk that, if it goes sour, could terminate their career,” Emanuel says.

We come back again to the point that if the responsibility for carbon trading is allocated to the wrong slot in the organisation, significant revenue loss, viewed from a financial perspective, is the inevitable outcome.

Emanuel has a classic story which illustrates the kind of closed-loop thinking that a pure compliance focus generates. EUAs are multi-year certificates, but they are not ‘eternal’. They are issued for a ‘phase’. The first phase of EUAs, issued in 2005 and 2006 expired in 2007. The present phase of certificates expire in 2012. For the first phase, this meant anyone sitting on 2007 vintage EUAs in 2006 was sitting on an asset that was going to have zero value at a point in 2007.

“We went round Europe explaining to companies that they needed to monetise any spare certificates before they became valueless. Time and again we were told, “So what? They cost us nothing, so we lose nothing.” he says.

Underdeveloped market
Lizzy Ooi, a consultant at Deloitte specialising in advising clients on issues around carbon trading, says the reason companies are not monetising their carbon allowances as a routine feature is the perception that the market is not well developed yet ­ a conclusion that Emanuel vigorously refutes. Ooi’s point, however, is that there is a distinct lag between perception and reality.

“There is no doubt that the spot market has really taken off over the past year, but the message still has to filter through,” she says. According to Ooi, it is now fairly straightforward for companies to sell spot and buy back futures on exchange, effectively creating an expensive repo market to parallel the securities lending market. However, this market is still in its infancy.

Ooi also says that placing carbon trading under the auspices of a company’s compliance or risk management team risks putting it in the hands of staff who have little understanding of how to hedge any trading strategies they might employ. “Compliance people would always rather be long and have a buffer against the time when they have to submit the certificates rather than looking to optimise their assets more efficiently,” she says.

However, Ooi suggests that the problem goes deeper than this. Even if a compliance team was to outsource dealing to an experienced carbon broker, there are problems that need to be resolved. “The results would still have to hit the general ledger and they need to know how to account for it in their books and records.” If they start trading, then IAS39 will apply and fair value accounting raises its head.

Doubtless, the carbon market will sort itself out as it develops in the years ahead. But the sums involved are already far from trivial and any finance director looking back on the formation of a market which, in the eyes of many experts, is set to be as big as the foreign exchange market ($1 trillion traded daily), could hardly help suffering a pang at the wasted opportunities along the way.