Trading
emissions PLC is listed on the AIM stock exchange (LON:TRE).
It is one of the most liquid carbon assets in the world and is managed
professionally. The portfolio is primarily invested in CER-generating
Chinese ERPAs, but it is also well-positioned to take advantage of upcoming
North American market. We wished that the fund had chosen a more conservative
cost-based valuation of ERPAs instead of the current fair value. Since
its inception, its performance has been volatile and has alternated
between that of a stock and that of a carbon credit. The last 6 months
have been disappointing. 
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TRADING EMISSIONS PLC
Executive Summary Trading
emissions PLC is listed on the AIM stock exchange (LON:TRE).
It is one of the most liquid carbon assets in the world and is managed
professionally. The portfolio is primarily invested in CER-generating
Chinese ERPAs, but it is also well-positioned to take advantage of upcoming
North American market. We wished that the fund had chosen a more conservative
cost-based valuation of ERPAs instead of the current fair value. Since
its inception, its performance has been volatile and has alternated
between that of a stock and that of a carbon credit. The last 6 months
have been disappointing.
Trading
emissions PLC is listed on the AIM stock exchange (LON:TRE).
It is one of the most liquid carbon assets in the world and is managed
professionally. The portfolio is primarily invested in CER-generating
Chinese ERPAs, but it is also well-positioned to take advantage of upcoming
North American market. We wished that the fund had chosen a more conservative
cost-based valuation of ERPAs instead of the current fair value. Since
its inception, its performance has been volatile and has alternated
between that of a stock and that of a carbon credit. The last 6 months
have been disappointing. 1. Investment suitability: very
liquid, problems with accounting practices
Type of return: cash. This fund is listed on the London AIM market. Hence, shareholders receive cash as return.
Liquidity: high. Its liquidity is similar to that of a stock, tradable daily with no lock-in period. In contrast, most carbon assets lock investors in for several years. Daily transaction volumes fluctuate widely around an average of 400,000 shares. This liquidity should be enough to ensure that an investment of €1M can be sold in a couple of days.
Jurisdiction: Isle of Man.The Isle of Man is a self-governing Crown dependency of the UK and is a well-known offshore financial center. There, assets under administration have grown to about from US$10B in 2003 to $60B today. Fortis and HSBC are among the largest asset managers operating there.
Custodian: BNP Paribas Securities Services. BNP Paribas enjoys a strong S&P AA+ rating.
Management fees: 1.5%, performance fees: 20% above 10%. The annual investment fees are 1.5% of the gross asset value, and the performance fees are at 20% of the profits, when profits exceed 10% of the gross asset value. The fund records the ERPAs at fair value, but we would prefer to see them recorded at historical cost. As a result, about £26M were paid in performance fees for the 2007 fiscal year.
Reporting: annual. Since the fund is publicly listed, the fund files a detailed annual report.
Type of return: cash. This fund is listed on the London AIM market. Hence, shareholders receive cash as return.
Liquidity: high. Its liquidity is similar to that of a stock, tradable daily with no lock-in period. In contrast, most carbon assets lock investors in for several years. Daily transaction volumes fluctuate widely around an average of 400,000 shares. This liquidity should be enough to ensure that an investment of €1M can be sold in a couple of days.
Jurisdiction: Isle of Man.The Isle of Man is a self-governing Crown dependency of the UK and is a well-known offshore financial center. There, assets under administration have grown to about from US$10B in 2003 to $60B today. Fortis and HSBC are among the largest asset managers operating there.
Custodian: BNP Paribas Securities Services. BNP Paribas enjoys a strong S&P AA+ rating.
Management fees: 1.5%, performance fees: 20% above 10%. The annual investment fees are 1.5% of the gross asset value, and the performance fees are at 20% of the profits, when profits exceed 10% of the gross asset value. The fund records the ERPAs at fair value, but we would prefer to see them recorded at historical cost. As a result, about £26M were paid in performance fees for the 2007 fiscal year.
Reporting: annual. Since the fund is publicly listed, the fund files a detailed annual report.
2. Investment Process: outsourced
but professionally structured
Organization: The fund's Board relies exclusively on EEA Fund
Management Limited for investment advice, and most of its Board members
are non-executive directors. The EEA Fund Management Team is headed
by Simon Shaw, who has extensive experience in traditional finance but
not in carbon projects. The young, 5-member team is diverse, and two
of the five members have each brought around 5 years of experience with
carbon markets and/or CDM projects. Click here
for Simon Shaw in his own words,
Carbon Assets: the company invests in CDM and JI's ERPAs (emission reduction purchase agreements). It also acts as a lender to or owner of projects, through structured debt, equity transactions, or strategic investments in companies exposed to carbon prices. The fund can invest in other environmental commodities such as SOx, NOx and VERs in North America, and has stated its interest in the upcoming mandatory carbon markets in North America.
Competitive advantage: Mr. Shaw believes that the inflow of new capital will lower the margins on ERPAs. Hence they take equity stakes in carbon projects to gain access to cheap carbon credits and preserve their competitive advantage.
Diversification: the fund invests in projects spanning a broad range of host countries, technologies, sectors, and regulatory frameworks. However, the degree of involvement of the management in driving or monitoring the investments is unclear.
Objectives: the management's goal is to generate 66MtCO2 in CERs between 2008 and 2012. In the 2008 interim report, the management expressed confidence in its ability to meet this target, having already contracted 57MtCO2 on a risk-adjusted basis (up from 42MtCO2 CERs in June 2007).
Contracted tCO2 per invested Euro: To assess how challenging this objective is, Dolfio uses the ratio of the project-risk adjusted tCO2 contracted per invested Euro. This measure allows investors to compare the carbon credits yields of fund managers, regardless of the size of their fund. We use Natixis European Carbon Fund (ECF) as a benchmark, since this fund is widely regarded as a success. As of April 2008, Natixis ECF has contracted 38.7MtCO2. Applying the Trading Emissions risk factor, Natixis would have a risk-adjusted contracted amount of 29.41MtCO2, with an initial invested amount of EUR143M. By comparison, Trading Emissions Plc has invested €440M (as of April 2005), and plans to contract 66MtCO2. The contracted tCO2 per invested Euro for Natixis ECF is 0.21 while the target contract tCO2 per invested Euro for Trading Emissions is 0.15. While this ratio is lower than that of Natixis, it also shows that their objective is reasonable.
Organization: The fund's Board relies exclusively on EEA Fund
Management Limited for investment advice, and most of its Board members
are non-executive directors. The EEA Fund Management Team is headed
by Simon Shaw, who has extensive experience in traditional finance but
not in carbon projects. The young, 5-member team is diverse, and two
of the five members have each brought around 5 years of experience with
carbon markets and/or CDM projects. Click here
for Simon Shaw in his own words, Carbon Assets: the company invests in CDM and JI's ERPAs (emission reduction purchase agreements). It also acts as a lender to or owner of projects, through structured debt, equity transactions, or strategic investments in companies exposed to carbon prices. The fund can invest in other environmental commodities such as SOx, NOx and VERs in North America, and has stated its interest in the upcoming mandatory carbon markets in North America.
Competitive advantage: Mr. Shaw believes that the inflow of new capital will lower the margins on ERPAs. Hence they take equity stakes in carbon projects to gain access to cheap carbon credits and preserve their competitive advantage.
Diversification: the fund invests in projects spanning a broad range of host countries, technologies, sectors, and regulatory frameworks. However, the degree of involvement of the management in driving or monitoring the investments is unclear.
Objectives: the management's goal is to generate 66MtCO2 in CERs between 2008 and 2012. In the 2008 interim report, the management expressed confidence in its ability to meet this target, having already contracted 57MtCO2 on a risk-adjusted basis (up from 42MtCO2 CERs in June 2007).
Contracted tCO2 per invested Euro: To assess how challenging this objective is, Dolfio uses the ratio of the project-risk adjusted tCO2 contracted per invested Euro. This measure allows investors to compare the carbon credits yields of fund managers, regardless of the size of their fund. We use Natixis European Carbon Fund (ECF) as a benchmark, since this fund is widely regarded as a success. As of April 2008, Natixis ECF has contracted 38.7MtCO2. Applying the Trading Emissions risk factor, Natixis would have a risk-adjusted contracted amount of 29.41MtCO2, with an initial invested amount of EUR143M. By comparison, Trading Emissions Plc has invested €440M (as of April 2005), and plans to contract 66MtCO2. The contracted tCO2 per invested Euro for Natixis ECF is 0.21 while the target contract tCO2 per invested Euro for Trading Emissions is 0.15. While this ratio is lower than that of Natixis, it also shows that their objective is reasonable.
3. Portfolio & Performance: in
need ofimprovement Investments in ERPAs: Investments are
primarily made in ERPAs in China: there are two HFC23 projects worth
11.3MtCO2, an industrial waste heat recovery project in the
Shanxi Province expected to generate 22.4MtCO2, and an additional
16 contracts across China for 10.1MtCO2. This is a significant
exposure to the China country risk, with at least 43.8 MtCO2
in credits out of the 66MtCO2 whole portfolio of credits
(MAKE LIST). This also raises questions on the fund's bargaining power
in securing the contracts needed to meet the goal of 66MtCO2
by 2012.
In the US, the Trading Emissions Plc's investments include a loan to Econergy and a 2% share of the company.
Neil
Eckert is the Chairman of both Trading Emissions Plc and Econergy. In
March, the fund made an offer to buy Econergy by exchanging shares worth
about £24M, at no premium. Ecoenergy rejected this offer. Trading
Emissions wants to take advantage of the current credit crunch threatening
the financing of 5 primarily Latin American projects. Other US investments
include a joint-venture with Element Markets, a company focused on generating
ERCs, and a majority stake in Environment Credit Corporation, a supplier
of carbon credits based in Colorado.
Outside of China and the US, Trading Emissions Plc's main investments are £33M for a 25% stake in Bionasa, a special purpose company focused on the development and operation of a biodiesel refining plant in Brazil, a majority stake in Sun biofuels in Africa for US$10M written down to US$4.6M, and US$20M for a 40% stake in Carbon Capital Markets who runs the Carbon Assets Fund, a fund with about €100M in assets under management. (MAKE LIST!!! WAY TOO LONG)
Smaller investments include 97% of a company studying a 255MW run-of-river project in Peru, 86% of KWTE in Thailand, expected to generate 300,000 CERs a year, 47% of Asia BioGas Co., and a landfill gas project in Turkey expected to generate 1MtCO2 in VERs (MAKE LIST TOO LONG). However, several of those investments may lead to much larger project-based cash outlays.
Performance: We are concerned with the fund's performance over the past 6 months, as it has been worse than both the stock market and the price of carbon allowances. sCER is the main type of asset generated by the fund and should be a good predictor of the expected performance of the fund. sCER were trading at about 70% of the value of the allowances in 2007. However, since February 2008, we have seen the price of EUA increase from €21 to €24.5 per tCO2 while the price of sCER remained flat. From October 2007 to April 2008, the fund has lost 28% of its value, underperforming both the price of sCER (+3% over the period) and the stock market (-15%). This may reflect investors' concern over the value of sCER in 2011 and 2012, when most of the fund's credits will be generated.
Correlation to stock market, to EUAs: The fund's performance has been correlated alternatively with that of a stock and that of a carbon allowance. In the graph below, the prices for the fund, the Euro Stoxx index and the price of a EUA Dec'08 allowances are normalized to 100 on 22 Apr 2005.
This graph shows 3 phases in the life of the fund. In the first 6 months (phase 1), the fund had a 90% correlation with the DJ Eurostoxx index. Then its correlation with a carbon allowance (EUA Dec'08) surged to 80% while it was no longer correlated to the stock market (15% correlation). Over the past 6 months, with the decline in the stock market, the fund's shares have declined by 28% and have exhibited strong correlations to stock indices (e.g. DJ Eurostoxx 78%, FTSE 74%), while the correlation to the price of carbon disappeared (11% correlation). This suggests that the stronger market trend drives the price of the fund.
Discrepancy between the book and market value: the management released an interim report on the fund on March 27th, 2008, announcing a December 2007 net asset value per share at 181p. However, fund shares closed at 134p on December 31st, 2007. This represents a 26% discount on the book value stated by management. On March 27th, the day of the announcement, the fund share, now worth 114p, lost an additional 2p.
In the US, the Trading Emissions Plc's investments include a loan to Econergy and a 2% share of the company.
Neil
Eckert is the Chairman of both Trading Emissions Plc and Econergy. In
March, the fund made an offer to buy Econergy by exchanging shares worth
about £24M, at no premium. Ecoenergy rejected this offer. Trading
Emissions wants to take advantage of the current credit crunch threatening
the financing of 5 primarily Latin American projects. Other US investments
include a joint-venture with Element Markets, a company focused on generating
ERCs, and a majority stake in Environment Credit Corporation, a supplier
of carbon credits based in Colorado.Outside of China and the US, Trading Emissions Plc's main investments are £33M for a 25% stake in Bionasa, a special purpose company focused on the development and operation of a biodiesel refining plant in Brazil, a majority stake in Sun biofuels in Africa for US$10M written down to US$4.6M, and US$20M for a 40% stake in Carbon Capital Markets who runs the Carbon Assets Fund, a fund with about €100M in assets under management. (MAKE LIST!!! WAY TOO LONG)
Smaller investments include 97% of a company studying a 255MW run-of-river project in Peru, 86% of KWTE in Thailand, expected to generate 300,000 CERs a year, 47% of Asia BioGas Co., and a landfill gas project in Turkey expected to generate 1MtCO2 in VERs (MAKE LIST TOO LONG). However, several of those investments may lead to much larger project-based cash outlays.
Performance: We are concerned with the fund's performance over the past 6 months, as it has been worse than both the stock market and the price of carbon allowances. sCER is the main type of asset generated by the fund and should be a good predictor of the expected performance of the fund. sCER were trading at about 70% of the value of the allowances in 2007. However, since February 2008, we have seen the price of EUA increase from €21 to €24.5 per tCO2 while the price of sCER remained flat. From October 2007 to April 2008, the fund has lost 28% of its value, underperforming both the price of sCER (+3% over the period) and the stock market (-15%). This may reflect investors' concern over the value of sCER in 2011 and 2012, when most of the fund's credits will be generated.
Correlation to stock market, to EUAs: The fund's performance has been correlated alternatively with that of a stock and that of a carbon allowance. In the graph below, the prices for the fund, the Euro Stoxx index and the price of a EUA Dec'08 allowances are normalized to 100 on 22 Apr 2005.
This graph shows 3 phases in the life of the fund. In the first 6 months (phase 1), the fund had a 90% correlation with the DJ Eurostoxx index. Then its correlation with a carbon allowance (EUA Dec'08) surged to 80% while it was no longer correlated to the stock market (15% correlation). Over the past 6 months, with the decline in the stock market, the fund's shares have declined by 28% and have exhibited strong correlations to stock indices (e.g. DJ Eurostoxx 78%, FTSE 74%), while the correlation to the price of carbon disappeared (11% correlation). This suggests that the stronger market trend drives the price of the fund.
Discrepancy between the book and market value: the management released an interim report on the fund on March 27th, 2008, announcing a December 2007 net asset value per share at 181p. However, fund shares closed at 134p on December 31st, 2007. This represents a 26% discount on the book value stated by management. On March 27th, the day of the announcement, the fund share, now worth 114p, lost an additional 2p.
4. Team and Risk Management
Project risk: in its reporting, Trading Emissions Plc discounts
the carbon credits expected from its projects. The fund assumes that
76% of contracted carbon credits and 19% of carbon credits with signed
term sheets of exclusivity will be delivered. At first sight, these
amounts are reasonable if the projects are run by developers with a
good track record of delivering carbon credits. Counterparty risks are
bundled into these risk factors, but their individual contribution to
the overall project risk is not stated.
Regulatory risk: As Chinese assets account for 2/3 of the expected carbon credits, the portfolio is vulnerable to regulatory changes in China.
Market risk: the fund’s market position is monitored daily by the fund's investment advisors, but only quarterly by their Directors. The portfolio may include derivatives that can be bought or sold on an uncovered basis. We thus feel that this substantial risk deserves a closer oversight by the Board of Directors.
As mentioned above, we disagree on the accounting of ERPAs. The fund values contracted sCER using the current forward EUA price multiplied by the average ratio of sCER price to EUA price for the reporting period (68% at June 30, 2007 according to PointCarbon). Those amounts are discounted at an annual rate of 10% to determine the present fair value.
We would prefer that the fund use either a historic cost accounting method, or at least a more conservative sCER/EUA ratio to account for the possibility that a flood of sCER in 2011 and 2012 may depress their value.
Currency risk: While most of the assets are to be sold in Euros, and most of the investments are done in US Dollars, the fund does not seem to hedge any currency exposure. This may be due to the uncertainty surrounding the amounts to hedge.
Liquidity risk: the fund keeps most of its liquid assets in cash and cash equivalents (£266,000,000 on June 20, 2007), which is a prudent practice on volatile markets.
Management team’s track record: the Board is composed of members with backgrounds in international finance. Trading Emissions Plc Chairman Neil Eckert is also the Chief Executive of Climate Exchange Plc., which owns the European and the Chicago Climate Exchanges. Most of the Board's carbon market experience, however, comes from 2 members of EEA Fund Management: Des Godson, who joined EEA Fund Management in 2005 after 4 years at KPMG as a Climate Change advisor, and Julien Guest, who spent 5 years consulting on carbon issues and working on CDM projects. The team's limited carbon project experience not unusual in these emerging carbon markets.
Regulatory risk: As Chinese assets account for 2/3 of the expected carbon credits, the portfolio is vulnerable to regulatory changes in China.
Market risk: the fund’s market position is monitored daily by the fund's investment advisors, but only quarterly by their Directors. The portfolio may include derivatives that can be bought or sold on an uncovered basis. We thus feel that this substantial risk deserves a closer oversight by the Board of Directors.
As mentioned above, we disagree on the accounting of ERPAs. The fund values contracted sCER using the current forward EUA price multiplied by the average ratio of sCER price to EUA price for the reporting period (68% at June 30, 2007 according to PointCarbon). Those amounts are discounted at an annual rate of 10% to determine the present fair value.
We would prefer that the fund use either a historic cost accounting method, or at least a more conservative sCER/EUA ratio to account for the possibility that a flood of sCER in 2011 and 2012 may depress their value.
Currency risk: While most of the assets are to be sold in Euros, and most of the investments are done in US Dollars, the fund does not seem to hedge any currency exposure. This may be due to the uncertainty surrounding the amounts to hedge.
Liquidity risk: the fund keeps most of its liquid assets in cash and cash equivalents (£266,000,000 on June 20, 2007), which is a prudent practice on volatile markets.
Management team’s track record: the Board is composed of members with backgrounds in international finance. Trading Emissions Plc Chairman Neil Eckert is also the Chief Executive of Climate Exchange Plc., which owns the European and the Chicago Climate Exchanges. Most of the Board's carbon market experience, however, comes from 2 members of EEA Fund Management: Des Godson, who joined EEA Fund Management in 2005 after 4 years at KPMG as a Climate Change advisor, and Julien Guest, who spent 5 years consulting on carbon issues and working on CDM projects. The team's limited carbon project experience not unusual in these emerging carbon markets.
Questions or comments? Email us at info@dolfio.com.