Banks See Green in Carbon Projects

Investing Directly Adds To Potential for Profits In Emissions Trading

By LEILA ABBOUD
December 18, 2007; Page C1

LONDON -- After piling into the burgeoning market for trading in carbon-emissions credits, some financial firms on Wall Street and elsewhere are going a step further, getting into the nitty-gritty of fixing leaking oil pipes in Russia and building hydroelectric dams in Latin America to create new credits themselves.

Those projects stand to reduce emissions of carbon dioxide into the atmosphere, one of the chief causes of climate change. The banks see a different kind of green, though. The projects can be converted into carbon credits, which can be sold at a profit on the European carbon market.

For financial firms such as Barclays PLC; Allianz SE's Dresdner Kleinwort and its carbon expert, Ingo Ramming; and Morgan Stanley, the decision to get their hands dirty with carbon-reduction projects is adding a new dimension to the emerging carbon-trading business. By getting directly involved, the firms are no longer simply acting as middlemen executing trades but are sometimes flexing their own financing muscle as well.

"It's a sign that the banks genuinely believe that the multibillion-dollar carbon market is only going to grow and grow," said Andreas Arvanitakis, an analyst at Point Carbon, a carbon-market research firm based in Oslo.

It is also forcing bankers to leave the trading floor and venture into the field in search of carbon-spewing power plants or dirty oil refineries they can help fix. Imtiaz Ahmad, who heads Morgan Stanley's carbon-trading business, has negotiated deals to put up wind turbines in China and build minidams for hydropower in Ecuador. Dresdner's Mr. Ramming has visited Siberian coal mines.

Last year, some €22.5 billion ($32.45 billion) in carbon credits were traded in Europe, a threefold increase over 2005, according to Point Carbon. In the first half of 2007, some €15.8 billion in carbon credits changed hands.

Since it began in 2005, the market, known as the European Union Emission Trading Scheme, has operated on a simple logic: Big polluters in Europe, such as electric utilities and oil refiners, are required to reduce their carbon-dioxide emissions under the Kyoto protocol. If they reduce their own emissions beyond a set point, they can sell the excess to others in the form of carbon permits called European Union allowances, or EUAs.

If they can't reduce their emissions, they must buy the permits from others who have extra permits. Banks act as middlemen, executing the trades for both sides.

Spending Less

As the market grows, other types of permits are coming into vogue. In addition to EUAs, companies can comply with Kyoto rules by turning in certified emission reductions, or CERs. These credits are generated by doing carbon-reduction projects in developing countries such as China and India. That was a key element of Kyoto and was intended to keep the overall cost of fighting global warming down. Setting up carbon-reduction projects in developing nations generally costs less than implementing them in industrialized countries.

Companies in Europe are increasingly eager to buy CERs because they are cheaper than traditional carbon-emissions permits, allowing them to comply with Kyoto rules but spend much less. For example, CERs can be bought for anywhere from €7 to €17 a ton of carbon emissions, depending on how far along the carbon-reduction project is. In contrast, a traditional EUA cost about €23 in recent trading.

But CERs also carry greater risks. Sometimes companies in the developing world go belly up before the projects are complete or they are unable to clear the complicated United Nations verification process needed before the credits can be issued. Companies that bought the rights to such CERs can be left in a lurch if the credits don't materialize.

Twofold Risk

For the banks, the risk is twofold: that individual projects they invest in never turn into credits they can sell or that the nascent carbon market unravels, leaving them holding worthless credits. "The banks are betting that emissions trading is here to stay and that the price of carbon will go up in the coming decades," Mr. Arvanitakis said. "If not, they won't be able to make a return and they could lose money" on these projects.

So far, only about €4 billion of CERs have been traded on the market.

That is why the banks smell an opportunity. They can use their expertise in project finance to sniff out the right carbon-reduction projects, help the companies carry them out and then buy the resulting CERs and resell them on the European market.

The risk that they could be left with unsold credits, they say, is low. "We know that there will be demand for these carbon credits," said Morgan Stanley's Mr. Ahmad. "We have lots of customers that have to comply with Kyoto."

For the banks, the key is to find the best way to zero in on promising carbon-reduction projects in the developing world. Some have formed partnerships with specialized firms that scout for and carry out these projects. Morgan Stanley, for example, took a 38% stake in Miami-based firm MGM International, which develops carbon-reduction projects in Latin America, China and India, among other countries.

Russian Venture

Dresdner has a joint venture with Gazprombank, the banking arm of Russian gas monopoly OAO Gazprom, to invest in and carry out carbon-reduction projects. Dresdner's Mr. Ramming spends about four days a month in Russia courting executives from power plants, natural-gas producers, oil companies or heavy industries.

His simple pitch: Upfront costs of a technology upgrade or other improvement that will reduce greenhouse-gas emissions can often be earned back by selling the carbon credits.

Dresdner's joint venture with Gazprombank will help the electricity utility JSC OGK-5 complete a €300 million revamp of a power plant in the Stavropol region of southern Russia to make it more energy efficient. Dresdner will help the plant navigate the U.N. bureaucracy needed to certify the project and will also line up buyers of the credits.

Mr. Ramming, who negotiated the project, said it was an example of how the carbon market can "act as a catalyst for change in the real world."

Write to Leila Abboud at leila.abboud@wsj.com

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