Death to the Chicago Climate Exchange ($7.40 to a nickel per CO2 ton, the market has spoken)

By William Griesinger -- November 18, 2010

“One of the keystones of the Climate Change alarmist movement was its audacious attempt to create a functioning market by monetizing the atmospheric gas known as CO2…. Certainly, gaming the system has always been at the top on the agenda of the new green eco-trader.”

– Patrick Henningsen, “The Great Collapse of the Chicago Climate Exchange,” 21st Century Wire, August 28, 2010.

We were tipped off by the August 28th headline, “The Great Collapse of the Chicago Climate Exchange,” by Patrick Henningsen, editor of 21^st Century Wire. And now it is official as reported by Chicago Business, Fox News , and Crain’s Chicago Business (sub. required): the Chicago Climate Exchange (CCX) is dead. Trading in carbon-dioxide (CO2) emission contracts at CCX has basically ceased with member emissions-reduction agreements expiring at the end of the year.

The death rattles have come with each price decline per ton of carbon credits. Compared to $7.40 per ton in May 2008 when cap-and-trade legislation was eagerly anticipated, CCX’s market price tanked to $0.10 per ton in August 2010 and half that last month.  So much for a contrived opportunity in a pretense  market.  What a difference a couple of years, a few scientific scandals, and old-fashioned political gridlock make.

Reuters reported in August that the CCE was facing significant layoffs and an operational scaleback only a few months after being acquired by publicly traded Intercontinental Exchange Inc (NYSE: ICE). ICE acquired CCX earlier this year in an all-cash deal totaling nearly $600 million, a shocking valuation given CCX’s lack of traction and a paucity of sustainable revenue (more on this later).

ICE is a nearly $1 billion revenue company and leading global operator of regulated futures exchanges and OTC markets for agricultural, credit, energy, currency and equity index contracts. In other words, ICE is a real-deal commodities exchange as opposed to the faux market for CO2. As an example of ICE’s scale, its Futures Europe unit clears trades in nearly half the world’s crude and refined oil futures, according to SEC filings.

Left Environmentalist Lament

It is fitting that real market forces have imposed their discipline on this Enron-like market, leaving climate alarmists in spin mode. Howard Learner, president of the Environmental Law and Policy Center in Chicago, told Crain’s: “What CCX pricing sadly demonstrates is that unless there’s a regulatory cap on emissions, there’s no real market.” Well there you go! Learner’s admission describes rent-seeking in a nutshell.

Fred Krupp, president of the Environmental Defense Fund, is equally discouraged. “Economy-wide cap and trade died of what amounts to natural causes in Washington,” he stated in regard to CCS’s demise. Natural causes? What is so unnatural about the outcomes of freely acting buyers and sellers in a market? Is coercion natural? Why is it a perversity where the public and politicians gives a thumbs down to climate-scare fakery, Mr. Krupp?

Criticism of cap-and-trade is not confined to so-called “global warming skeptics.” As I pointed out in my June 9 post, mainstream environmental groups such as Friends of the Earth (FOE) have harshly criticized the proposed Kerry-Lieberman cap-and-trade legislation, issuing the scathing Ten Ways to Game the Carbon Market.

FOE’s guide concludes “carbon offsets are especially prone to corruption and fraud,” detailing “Ponzi Carbon” schemes among other derogatory indictments of cap-and-trade. Further, a FOE senior policy analyst details how many of the scams are already taking place today under the European Union Emissions Trading Scheme (EUETS). Why would an emissions exchange in the U.S. be any different? The answer, of course, is it wouldn’t.

Joe Romm at Climate Progress (see Appendix below) even panned cap-and-trade sausage-making before his betters at Center for American Progress told him to play ball with Obama et al. Romm did not mince words:

This proposal is a dead end — and an even deader starting point. Shame on NRDC, EDF, and WRI for backing it.

With this proposal, the U.S. Climate Action Partnership has officially made itself obsolete and irrelevant.

Romm caved and joined the losing team–and just maybe sold his alarmist, interventionist soul to the devil. James Hansen, on the other hand, would have nothing of the cap-and-trade mirage.

Rent-Seeking: Risky Business

The struggles of CCX provide yet another example of the pitfalls in following a “rent-seeking” model of doing business. Not only does it add considerably to the cost of doing business–government affairs work does not come cheap—but the payoffs are fickle.

Rent-seeking opportunists look to obtain a politically-created shield of protection from the normal competitive forces of real markets where success is measured on a firm’s ability to satisfy consumer-driven needs. Rent-seekers accomplish this via favorable political arrangements, legislative mandates, government subsidies and other protections resulting in the creation of distorted and artificial market conditions that would otherwise not exist absent such political manipulation.

Though history is replete with examples of rent-seeking enterprises (think the transcontinental railroads or early U.S. shipping industry per author Burton Folsom’s Myth of the Robber Barons), it’s difficult to imagine a more egregious rent-seeking scheme than that concocted around the “trading” of carbon and offset credits.

Additionally, the CCX version of rent-seeking included not only the usual government suspects but also multiple financial market players all hoping to cash in at the intersection of government mandated emissions limits and the trading platform believed capable of carrying it out.

“One of the keystones of the Climate Change alarmist movement was its audacious attempt to create a functioning market by monetizing the atmospheric gas known as CO2,” according to 21^st Century Wire’s Henningsen, labeling it “a fantasy casino based on the doctrine of pure science fiction. He maintains, “Certainly, gaming the system has always been at the top on the agenda of the new green eco-trader.”

The rent-seeking approach only works, however, if the political class is able to deliver the goods on the underlying scheme. In the case of cap-and-trade, they have failed. With the failures at Copenhagen last December when its global taxation agenda was exposed, preceded by the Climategate explosion of Nov. 2009 and preceded even further by other documented exposures of junk science and data manipulation, the man-made global warming scaremongering movement has lost any semblance of credibility.

A Sweetheart Deal for CCX Owners?

I previously referenced the questionable financial terms of the CCX acquisition by ICE. Henningsen suggests that the original CCX shareholders bailed out for a “modest $600 million,” perhaps suggesting that they undersold their shares.

Au contraire.

Early CCX shareholders such as founder Richard L. Sandor clearly bailed out when their rent-seeking scheme appeared to be crumbling, but they did so with handsome upside on a failing business model. They received all cash at a ridiculous and unsupportable revenue multiple (at least 12X on my back-of-the-envelope calculation) with Sandor receiving well over $90 million for his 16.5% stake. The valuation was clearly outside the bounds of normal market metrics since CCX brought no positive earnings or sustainable revenues to the deal. Dumb green?

We need some investigative reporting. The financial terms of the acquisition should raise serious questions among ICE shareholders. Such as: How does a firm pay $600 million in cash for a basically worthless company with little to no recurring revenue? Additionally, the fact that ICE borrowed heavily ($200 million in debt) and depleted $377 million of its existing cash to finance the transaction is mind-boggling, especially given the historically strong market value of its stock.

One could envision a combination cash and stock deal. All cash is not supportable, not to mention the question of whether the acquisition should have been approved at all. ICE shareholders should be demanding clear answers regarding the diligence that led to the approval of this transaction and why large amounts of existing cash and substantial leverage were used, clearly weakening ICE’s balance sheet.

Based on SEC disclosures, ICE management claimed estimated “synergies” of the transaction would total $13 to $14 million by 2011, while failing to identify the derivation of those synergies. At the same time, contradicting its synergy claims, ICE discloses that charges and expenses associated with the acquisition will total between $17 and $20MM during the remainder of 2010 alone, completely wiping out any claimed synergies. $7 to $8 million of those charges, or roughly 40%, is dedicated just to cover interest expense on the new debt that was used to finance the acquisition.

The lack of media attention and investigations around the suspicious terms of this deal are interesting and speak volumes about the pass that political rent-seekers receive versus the scrutiny imposed on real market enterprises under similar and even less noteworthy circumstances. Contrast this treatment with the charade that the SEC engaged in when “convicting” Martha Stewart in 2004 of what amounts to some felonious fibbing when she intended to dump her ImClone stock. (Many, including journalists, still carelessly and incorrectly state Stewart was convicted of insider trading; that is false).

I am not suggesting there was criminal behavior or that laws were broken in the ICE acquisition of CCX. It just seems there must be a journalist somewhere with an interest in the economic terms of this deal and how the founder of a failed business model can walk away with over $90 million in cash, you know, in the interest of all stakeholders involved.

CO2 Gaming: A Fading Play

That Chicago would be the home of CCX is ironic. Why? Chicago has a long and storied history as the pioneer in the development of world leading commodities and futures exchanges. The Chicago Board of Trade (CBOT) was established in 1848, the world’s oldest futures and options exchange before being absorbed by the Chicago Mercantile Exchange (CME). The CME itself was established in 1898. These exchanges are global leaders in successfully creating markets for global companies to meet their risk management and hedging needs, quite the opposite of the contrived, political CO2 market.

CCX’s founder, Richard Sandor was a former chief economist of the CBOT and is a futures market expert. He was the principal architect of the interest rate futures market developed in the 1970s. Sandor knows full well how real commodities markets function. He pursued the rent-seeking model at his own peril. One must ask: Was this a T. Boone Pickens ego play? But he made a lot of money, funds that just maybe he can recycle against climate alarmism.

Conclusion

As Enron found out, rent-seeking as a business model is both high cost and risky. Lobbying for your existence is not cheap, and picking fights against consumers and the economy is bound to lose sooner than later–and give capitalism a bad name.

May the rise and fall of the Chicago Climate Exchange be a lasting example and memory of bad business.

Long live market capitalism in place of political capitalism.

APPENDIX: Joe Romm on the Blueprint for Waxman-Markey Cap-and-Trade

NRDC and EDF Endorse the Weak, Coal Friendly, Rip-Offset-Heavy USCAP Climate Plan

The U.S. Climate Action Partnership — a coalition of businesses and enviros once though to be important — have released their wimpy Blueprint for Legislative Action.

I can sort of understand why, say, Duke Energy, signed on to this, but NRDC and EDF and WRI have a lot of explaining to do. As we will see, this proposal would be wholly inadequate as a final piece of legislation. As a starting point it is unilateral disarmament to the conservative politicians and big fossil fuel companies who will be working hard to gut any bill. Kudos to the National Wildlife Federation for withdrawing from USCAP rather than signing on.

I think it is absurd for any serious environmental group to support permitting new coal plants that don’t capture and store the vast majority of their emissions. Yet as the WashPost reports:

The plan would also require any coal plant permitted after Jan. 1, 2015, to emit no more than half the carbon dioxide emissions now considered normal and require any newly permitted plant today to have the ability to be retrofitted to meet that standard.

These are bogus provisions. Nobody really knows what a capture-ready plant design is — this is the climate equivalent of “the check is in the mail.” Any significant number of such new coal plants will simply make it much harder to meet the 2020 target, at a time when we have more than enough low carbon technologies today to meet any such target affordably (see “Is 450 ppm possible? Part 5: Old coal’s out, can’t wait for new nukes, so what do we do NOW?” and below).

But it is the 2020 target and the issue of rip-offsets that make this proposal truly untenable. The Blueprint calls for requiring that U.S. greenhouse gases (GHGs) return to “80%?86% of 2005 levels by 2020.” That is essentially returning to 1990 levels, which the science clearly says is inadequate to stabilizing at 450 ppm, let alone the 350 ppm target that environmental groups should be seriously considering (see “Is 450 ppm politically possible? Part 8: The U.S. needs a tougher 2020 GHG emissions target“).

Worse, the science makes clear that you need a target below 1990 levels without allowing fossil fuel companies to offset their emissions — i.e. continue releasing CO2 into the atmosphere where it will linger with a mean atmospheric lifetime of 30,000 years.

But the already-lame USCAP proposal shoots itself in the (other) foot with its embrace of a staggering amount of rip-offsets.

Since USCAP is recommending a stringent emission target, we also recommend generous limits on the use of offsets to help moderate compliance costs, especially during the period when low carbon technologies are still achieving the economies of scale and commercial maturity that many currently lack.

Shame on my NRDC and EDF and WRI friends for signing on to such nonsense. The emission target is most certainly not “stringent” as I have discussed at length here. It doesn’t even match the target recommended in the 2007 Intergovernmental Panel on Climate Change Fourth Assessment Report — and that report certainly underestimated the speed and scale of climate impacts.

The final clause is both wrong and irrelevant — energy efficiency is a fully mature technology, as is biomass cofiring in coal plants as is cogeneration. Wind is ramping up at an astonishing pace, and solar thermal baseload can deliver large amount of affordable power by 2020. For a full discussion, see “An introduction to the core climate solutions.”

Note to NRDC and EDF and WRI: Obama has committed that “We will double the production of alternative energy in the next three years.” If the President thinks alternative energy is ready to ramp up rapidly starting now, why don’t you? You are supposed to be pushing the administration to do more than they plan to, not less!

But the unconscionable amount of rip-offsets USCAP embraces guts the entire effort:

Congress should set an overall upper level limit on the use of offsets for compliance in any year of 1.5 billion metric tons domestic and 1.5 billion metric tons international offsets.
• Congress should establish a Carbon Market Board (CMB) and give it the authority to set annual limits on the level of domestic and international offsets within the range of 2-3 billion metric tons total….
• Congress should specify that the initial annual limit on offsets will be 2 billion metric tons. CMB should have the authority to increase the annual limit to avoid undue economic harm from excessively high allowance prices….

You cannot be serious.

Remember, total U.S. GHGs in 2005 were about 7.2 billion tons (see “Bush policies cause U.S. GHG emissions to soar 1.4% in 2007“).

The USCAP plan would call for a reduction of 1.0 to 1.4 billion tons of U.S. GHGs in 2020, while allowing 2 billion or more tons of offsets, at least half of which don’t even have to be in this country. When would US carbon dioxide emissions see serious reductions under this plan? Who knows? It’s déja vu all over again (see “Boxer-Lieberman-Warner bill update: Probably no U.S. CO2 emissions cut until after 2025“).

Let me repeat once more, as a major 2008 analysis from Stanford found

… “between a third and two thirds” of emission offsets under the Clean Development Mechanism (CDM) — set up under the Kyoto treaty to encourage emissions reductions in developing nations — do not represent actual emission cuts.

And this led to the study’s stark conclusion:

… any offset market of sufficient scale to provide substantial cost-control for a cap-and-trade program will involve substantial issuance of credits that do not represent real emissions reductions.

The Government Accountability Office recently ripped rip-offsets: “The use of carbon offsets in a cap-and-trade system can undermine the system’s integrity.”

Also, the CDM is filled with fraud (see “You can call a rip-offset a CDM project, but it’s still a rip-offset“). Let’s remember that the West got suckered into giving China some $6 billion to destroy greenhouse gas refrigerants that probably cost Chinese companies $100 million to capture and destroy (for more details, see “Kyoto’s Great Carbon Offset Swindle“). Let’s remember that

U.N. regulators are also concerned that some independent auditors of these projects, who are responsible for vetting their environmental legitimacy, have been letting project developers push through ventures of questionable environmental value….

In a presentation to U.N. officials last fall, the head of Tüv Süd’s carbon business told U.N. officials that the quality of projects the auditors are receiving from carbon brokers is “going down,” according to the U.N. panel’s Mr. Schmidt, who was at the meeting….

“There is a high incentive” for companies to put together environmentally questionable carbon-credit projects, “because there is a lot of money that can be earned,” he said. “People are getting more inventive, so it’s getting harder to detect the black sheep.”

Let’s remember that instead of using the money to fund the transition to a sustainable economy, the World Bank “has loaned $1.5 billion to fossil-fuel companies to make minor greenhouse-gas reductions,” and “then sells carbon credits for those reductions,” and “takes its 13 percent cut”?

Let’s remember that “The vast majority of schemes that sell carbon credits to offset pollution are delivering 30% less than they promise“?

No serious environmental group — no person or group serious about keeping total global warming as close as possible to 2°C, no one who endorses a target of 450 ppm or lower, should endorse a final climate bill with more than, say, 5% very high quality offsets allowed.

The USCAP proposal has other features that are problematic. For instance, “USCAP recommends that a significant portion of allowances should be initially distributed free to capped entities….” Again, Obama himself has called for a 100% auction. As the Friends of the Earth response to USCAP says:

Put simply, the proposal would reward corporate polluters with hundreds of billions of dollars of giveaways, and its near-term pollution reduction targets are far weaker than what scientists have called for. The proposal is further weakened by its massive carbon offset loopholes. Were such a proposal to be enacted into law, it would fail to achieve the emission reductions we need in the U.S. and would undermine our ability to meaningfully and credibly engage in international climate negotiations. This is a dead-end approach that policymakers should reject.

Precisely.

This proposal is a dead end — and an even deader starting point. Shame on NRDC, EDF, and WRI for backing it.

With this proposal, the U.S. Climate Action Partnership has officially made itself obsolete and irrelevant.