6 April 2008
 After the huge interest in last week’s commentary by clean tech investor Investeco on alternative beta in alternative energy, we dispatched our intrepid “fly on the wall” (see his previous posting from London) to one of the biggest events on the clean tech investing calendar, the Wall Street Green Trading Summit. We asked him to report back on any new markets that were ideally suited for an alpha-centric investor. Here’s what he found…
Dear Alpha Male,
 (Thanks for the assignment on this side of the pond. Much easier on the wings than the last gig.)
Anyone who thinks alpha is finite and non-renewable ought to check out the market inefficiencies the burgeoning clean tech sector. According to the International Emission Trading Association, the international carbon market was worth approx. $70 Billion US in 2007 and according to New Carbon Finance the US market alone could equal $1 trillion by 2020.
Still, converting the sun’s energy in alpha isn’t like taking candy from a baby. Such enormous growth might suggest that, in terms of generating alpha, low hanging fruit should be plentiful. However, this was not the message to be taken from this gathering. There may still be plenty of opportunities for generating alpha in emissions trading, but unless you’re exploiting opportunities in places like Russia and the Ukraine, you’re going to have to work harder to get it than ever before. The vast capital (intellectual and financial) getting into the sector has already eaten up the lowest hanging of the fruit.
“Seeing the Forest for the Alpha”
What strategies are managers using to attempt to produce this alpha? One strategy discussed at the summit is the purchase of aggregate interests in the various environmental credits produced by emission reduction projects (such as the NOx, SOx, Energy efficiency, tax, and carbon emission credits), and then ‘unbundling’ those credits for sale. This ‘unbundling arbitrage’ takes advantage of the fact that credits can be sold individually for a higher price than it takes to obtain or produce them together. One intriguing variation on this ‘unbundling’ strategy discussed at the summit is the purchase and conservation of large tracts of forest around the world, and ‘unbundling’ and selling the various carbon and biodiversity credits available in connection to that forest under various statutory regimes. Several presenters noted that the cheapest way to obtain cheap credits for resale may be to actually finance the projects from which the credits are derived.
Alternative (energy) beta
Another way to produce alpha, or at least alternative beta, may be to exploit the extremely low correlation between the performance of general market indices, and the performance of emission credits. Various research such as
Daskalakis/Psychoyios/Markellos (2006) found that the performance of the carbon market is not correlated to either other financial assets or interest rates. In fact they found that correlation between carbon credits and each of the DAX, Morgan Stanley Europe Index, S&P 500, Morgan Stanley World Index, Morgan Stanley Euro Credit Index, Euribor (both one week and one year), and US Tbill (13 weeks) are historically not significantly different from zero. A sage (or lucky) trading strategy should therefore be able to generate non-correlated gains by utilizing the emission markets.
“Regulatory Arbitrage”
Furthermore, it is possible to play regulatory arbitrage by purchasing deeply discounted “voluntary credits” now and sell them when (and if) they become exchangeable for regulatory credits. According to the Katoomba group, an Australian marketplace information provider, the regulatory credits currently trading in Europe are selling at an approx. 3 month average of US$34.15/ton, whereas the voluntary credits trading on Chicago exchange are trading at just approximately US$5.69/ton. Given that every remaining 2008 presidential candidate supports mandatory emission reduction “cap and trade” programs, simply buying and waiting for the appreciation of the voluntary credits when they become regulatory credits may seem like a sure-fire plan. The potential increase in the price of carbon is colorfully illustrated by the following performance chart generated from the Chicago Climate Exchange website which shows what happened on super Tuesday (February 5, 2008) when the eventual presidency of McCain, Obama or Clinton (all cap-and-trade supporters) became a virtual inevitability.
Despite the potential allure of making such a bet, sentiment at the summit was that the substantial regulatory risk, and the risk of betting on the exchange rates between mandatory and voluntary credits, already fully justifies the heavy discount of voluntary credits at this time, and thus that speculation in such credits is not a good plan.
The end of the beginning?
As the environmental trading market begins to matures, the easiest opportunities for alpha may have been, or soon will be, arbitraged out. It may be the end of the beginning of this space. However, given the inevitable explosive growth in the space, there should be substantial opportunities to exploit new sources of alpha. No matter what your social views are on the environment - or even your views on the clean tech sector as a whole - it seems that new securities, regulations, and types of investors will continue to create market dislocations that are the bread and butter for hedge funds and other alpha-centric investors.
Must buzz off now. Getting Blackberry Thumb.
F.O.T.W.
 Email this post to a friend
 Print This Post
|
