As President Obama calls on Congress to pass a Cap and Trade bill that regulates greenhouse gas emissions, the US stands on the brink of launching the largest commodities market in history. The US emits roughly 7.2 billion metric tons of greenhouse gases every year and that number continues to grow. Investors are finding ways to play the ‘green movement,’ such as solar, wind and clean-coal technology. Beyond the renewable energy market, the voluntary carbon market presents a compelling investment opportunity. Here in the US, a private voluntary cap and trade market has existed in the US since 2003 in the absence of legislation. The Chicago Climate Exchange (CCX) has designed a private program that allows companies to reduce their carbon footprint in a cap and trade system, whereby if they cannot reduce their emissions in a given year, they can purchase another emitter’s excess allowances. In 2007, the system was a proven success, calling for its members to reduce their carbon footprint by 4% of 2000 levels. The actual reduction was 11%.

CCX launched in 2003 with 14 founding members and has grown the membership base to over 450 companies, representing emitters, offset providers (project based credits) and financial participants (market makers, investors and hedge funds). The member base represents 17% of the DJIA (DD, INTC, IBM, and UTX), 11% of Fortune 100 (including F, BAC, HON, MOT, SWY and IP), 22% of the largest CO2 emitting utilities (AEP, DTE, RRI, AYE, and NRG), 2 States (IL and NM) and 7 cities.

CCX Emitting Members contractually commit themselves to a 6% reduction by 2010 of 2000 emission levels. Companies join for a variety of reasons. Public companies have joined as a way to address resolutions filed by shareholders who want to know the company’s strategy to control global warming. Other companies have found a way to change processes, become more efficient and reduce their emissions beyond the caps required in our market. Thus they are able to monetize these efficiencies by selling excess allowances in the CCX market. Companies who are very active on Capitol Hill promoting cap and trade legislation want join in order to boost credibility. These are just a few of the myriad of reasons companies join the voluntary program. Additionally, CCX credits are distributed to projects that sequester, destroy or reduce Greenhouse Gas emissions. Projects go through a rigorous application process and must meet set protocols and standards before credits are issued.

Investors and hedge funds enter the CCX marketplace because CCX Credits have been recognized in pending legislation under the provision of “Early Action.” Meaning the US Government will recognize cuts made prior to legislation in specific programs such as CCX and will allow these early cuts to be grandfathered into the reduction schedule set in legislation. Should CCX be recognized, the credits traded on CCX will be fungible into a Federal Market.

The investment opportunity arises because ultimately, a federal market will trade at a higher price than a voluntary market. The European Union, which legislated Carbon Emissions under a cap and trade system in 2005, is the largest government mandated market and is seen as a benchmark for the price of Carbon Emissions. EU Carbon allowances have traded as high as €30 (~$45) last year while CCX credits hit a high of $7.40 in the same timeframe. Today, European prices have fallen to €14.50 ($19.50) and CCX now trades at $1.50. The discrepancy is simple. In the US, companies that have yet to reduce their carbon footprint and have in fact grown greenhouse gas emissions (who will ultimately be big buyers of carbon allowances for compliance) currently have the option to continue business as usual. These companies are not voluntarily joining CCX and expending millions of dollars to purchase credits in the open market to meet the cap compliance. Thus there is very little natural demand for Carbon Allowances in a voluntary system. When the US government passes a Cap and Trade law, these companies will be forced to participate in the system under law as they are in Europe. They must reduce emissions internally or go into the open market and purchase Carbon Allowances. And holders of carbon allowances will be able to sell at premium. This is why CCX credits have been likened to ‘political call options.’ Basically a binary play if the regulators recognize Early Action in Cap and Trade legislation.
Below is a price and volume graph for the CCX market since January 1st, 2007, which demonstrates the markets fundamental correlation to news.

**Political Activity
There are a number of different drivers that will ultimately help motivate legislators to pass a Cap and Trade Bill. The EPA has found that the mix of six Greenhouse Gases in the atmosphere may reasonably be anticipated to endanger public health and welfare. Thus under the Clean Air Act of 1990, the EPA will be allowed to impose limits on GHG emissions. To both industry and government , EPA regulation is not as ideal as legislation and thus, it is in the legislative branch’s best interest to pass a bill before the EPA flexes authority. In reaction to the finding, Rep. Ed Markey (D-Mass.) Chairman of the Energy and Environment Subcommittee, said “It is now no longer a choice between doing a bill or doing nothing. It is now a choice between regulation and legislation The EPA will have to act if Congress does not act, but they are right in the Obama administration to prefer legislation.” Sen. Joe Lieberman (I-Conn) said “We can wait for EPA to develop expensive, top-down regulations, or Congress can act first and pass legislation to address climate change in a way that creates jobs, keeps energy bills down, and ensures the continued competitiveness of American-made goods. I believe strongly that a cap-and-trade system is the best approach.”

Additionally, the United Nations will meet in December, 2009 in Copenhagen to come to a successor to the Kyoto Protocol, the original global Treaty which established Greenhouse Gas reduction targets and international policy. Given it’s absence in leadership under the Bush Administration, the US will need clarity in it’s Climate Policy in order to have a hand in negotiations this time around.

Currently, the House of Representatives has a draft bill under the ‘mark-up’ process in subcommittee. The Senate has promised to have a Bill out after summer recess.**