Financial markets posted their worst decline in May since 1940. While most investors are still licking their wounds, those who bet on the carbon financial industry are reaping gains from the global consolidation in the industry. In less than a decade, the carbon financial industry has been catapulted to the major leagues.
On May 27, Canadian media and data conglomerate Thomson Reuters announced it would acquire Point Carbon. Founded in 2000, Point Carbon is a Norwegian-based carbon consultancy that provides news, data, and analysis to hedge funds, financial institutions, businesses, and governments. Backed by investors such as Schibsted ASA, Norway’s largest media company, JPMorgan Chase & Co., and Mizhuho Financial Group, Point Carbon has a staff of 137 and offices in Asia, Australia, and the United States.
Thomson Reuters is following rival Bloomberg LP’s acquisition last December of New Energy Finance, a Point Carbon competitor. The news and data conglomerates will provide technology, marketing power, global scale, and a client base that neither New Energy nor Point Carbon could have developed on their own.
Thomson Reuters and Bloomberg made these strategic acquisitions because they saw increasing demand for carbon news and data services and large dollar signs on the horizon.
The real game changer may be the $603 million all-cash friendly tender offer announced April 30 by Atlanta-based IntercontinentalExchange (ICE) for London-based Climate Exchange. The merger could result in the creation of the first global exchange of carbon derivatives.
Derivatives are widely used financial tools that allow investors to trade an asset without actually having to own it. They are attractive because investors can leverage their investment to intensify gains as well as losses. The value of a derivative can rise significantly while the underlying asset barely changes in price, so investors use derivatives to speculate, but also to manage risks.
The target company, Climate Exchange (CLE), was founded in 2003 and is the leading owner and operator of environmental financial electronic exchanges around the world, trading products such as carbon derivatives. CLE operates the Chicago Climate Exchange, the European Climate Exchange and the Chicago Climate Futures Exchange and has affiliated exchanges in Canada, Australia, and China. Richard Sandor, the renowned cap and trade pioneer, is CLE’s Chairman and one of its largest shareholders.
ICE, a leading owner and operator of exchanges trading energy commodity derivatives, was founded in 2000 by the who’s who of oil, gas, and commodities trading. Initial investors include affiliates of BP, Royal Dutch Shell, Total, Duke Energy, Goldman Sachs, Morgan Stanley, Deutsche Bank and Société Générale. It operates in the U.S., the U.K., and Canada.
With 830 employees and a market capitalization exceeding $8.5 billion, ICE is exceptionally profitable. The company reported its sixth consecutive year of record revenues, totaling $994 million in 2009, a 22 per cent increase from 2008. In the first quarter of 2010, ICE’s earnings jumped 40 per cent over the previous quarter.
While some believe the 56.9 per cent share premium offered to CLE shareholders may be too high, the acquisition gives ICE global market share in carbon trading. Moreover, the merger will give ICE a monopoly in certain markets and increase its market power to impose its practices. The combined entity will be the market leader with the technology, know how, and resources to develop and operate carbon and environmental electronic trading exchanges on a global scale.
ICE’s Chief Financial Officer said in a recent Wall Street Journal interview, “The more time we spend with money managers, the more they come to understand our model, and the more interest we get.” Markets seem to believe ICE could once again benefit from the regulatory environment.
The same year ICE was founded, lobbyists representing Enron and other large energy market participants quietly inserted a provision in the Commodity Futures Modernization Act that later became known as the “Enron loophole.” The loophole exempted energy commodity derivatives from being traded on regulated exchanges and virtually eliminated regulatory oversight.
During those years of deregulation, ICE went on an acquisition spree and morphed into a multi-billion dollar cash machine.
It was not until 2008, after public outcry against high gas prices and allegations of speculative oil trading and price manipulation, that Congress closed the Enron loophole. Only then did the Commodities Futures Trade Commission (CFTC), whose hands had been tied, begin to oversee and regulate energy commodity derivatives.
It may not be a coincidence that ICE’s announcement to buy CLE came only days after the CFTC voted against regulating carbon derivatives in a widely reported unanimous 5-0 vote. The CFTC’s decision sent a signal to the market it had not ended the era of low regulatory oversight, giving a boost to innovative carbon financiers.
As public concern about global warming and rising energy needs increases, investors will seek to profit from these trends. In an age of high budget deficits, markets are betting carbon trading will become more appealing to governments that aim to curb greenhouse gas emissions without increasing their deficits.
Yet, if we don’t want to trigger another round of bailouts and want to limit the risk of a crisis provoked by deregulation, legislators and regulators need to step in to oversee the highly innovative, virtual, and increasingly global carbon trading industry.