Saturday, March 17, 2012

9 November 2010 – The Golden Peacocks of the Windy City


In early December of 2008, a number of colleagues and I attended a symposium at the Brookings Institution and had the pleasure of spending a couple of days listening to a variety of presentations.  Some of these were quite interesting.  The Institution and its staff were riding something of a post-election high, and were charged with enthusiasm for the incoming administration and its agenda.

One of the featured presenters, who seemed to be looking forward to that agenda even more eagerly than most, was a chap (whose name escapes me) from the Chicago Climate Exchange (CCX).  Headquartered on South LaSalle Street in the Windy City, the CCX bills itself as “North America’s only cap-and-trade system for all six greenhouse gases”.[1]  The Exchange operates in conjunction with the “Chicago Climate Futures Exchange”, which according to its website is “a landmark derivatives exchange that currently offers standardized and cleared futures and options contracts on emission allowances and other environmental products.”  In essence, the CCX provides North American businesses with the opportunity to voluntarily purchase “carbon credits” either on a daily exchange basis or in a futures market - much as one would purchase oil futures, pork belly futures, or even tulip futures, as Dutch investors did - in droves - during the great "Tulipomania" of 1636.

As is the case with any commodities trading concern, the trading of carbon credits is subject to a brokerage fee, and the trading agency also sustains itself from the delta between buying and selling prices.  This is where the CCX made its money, and the potential gains were predicted to be huge; when it was founded in 2000, the CCX's trading market was expected to grow to anywhere from $500B to $10T (yes, that's ten trillion).  This would, of course, have depended upon the passage of "cap and trade" legislation in the US to render the purchase of carbon credits by CO2 emitters obligatory.  That contingency, however, fell through last summer when Congress, despite the super-majority enjoyed by the Democrats for the past two years, failed to pass the requisite legislation.  Given the results of last week's election, the prospect of any such legislation being passed in the years to come seems remote.

Why is this interesting?  Well, because last Friday, the CCX - very, very quietly - went belly-up.  This should not have come as a surprise to anyone, as the bad news had been accumulating for some time.  Since early 2009, the price of a tonne of "carbon" on the CCX had dropped from around $2.50 to $0.05, a loss of 98% of its value (and a significant fall from the peak price of nearly $7.50 per tonne that was reached in 2007).  In August, Intercontinental Exchange (ICE), which had bought the CCX in April 2010 for $622M, announced that half of the 50-person work force at the CCX had been laid off, with more cuts to come.[2]

On 21 October, the final hammer-blow fell when the CCX announced that the carbon trading program was being scrapped.[3]

Strangely, the mainstream media have been fairly silent on the demise of this flagship carbon trading enterprise.  Thus far, according to a Google News search this morning, the only mainstream media outlets to feature a story on the subject have been Fox News, the Washington Examiner, and Reuters.  Such reticence on so newsworthy an event is perplexing, particularly given the high profile names associated with the Exchange.  According to a 2 August 2001 press release, the CCX received, as part of its initial funding, a $760,100 grant from the Joyce Foundation (more than 3/4 of its start-up capital) while Barack Obama was a board member.[8][9] The CCX and its founder, Richard Sandor, have been personally congratulated by Bill Clinton;[4] lauded by Al Gore during a 2007 speech to the Chicago Economic Club; and endorsed by Nancy Pelosi and Rahm Emanuel when they convinced Congress to offset its copious CO2 emissions by purchasing carbon credits from the CCX.[5]  Sandor has been twice named to Time Magazine's "Heroes of the Environment" list,[6] and has even received the "Golden Peacock Award" for his work in combating climate change.[7]  Surely, with this sort of profile, the CCX's woes are worthy of greater attention.

The decline and fall of the CCX is the direct result of the collapse of the price of carbon credits; it's hard to make a living on the margin of a commodity that is only worth 2% of what it was worth only 18 months ago.  From a strategic analytical perspective, of course, the interesting questions are (a) why did the price of carbon credits collapse, and (b) why didn't anyone see this coming? I'd imagine that ICE's managers, who are holding onto a $622M bucket of nothing right now, are asking these questions too.

The reader is free to speculate about the answer to (b), but the answer to (a) is simple.  In the price system, there is no such thing as "inherent value"; all value is relative.  In the free market, commodity prices are set by agreement between sellers who are free to sell, and buyers who are free to buy.  Value, in short, is established by the act of purchase and sale.  For example, I checked the TSE for the price of Canadian Tire Corporation shares (CTC) and discovered that they are worth $66.040.  1161 shares were traded yesterday, and the share price rose by $0.03 from open.  Yesterday, buyers and sellers, through the free act of purchase and sale, agreed that the value of one share of CTC was three cents too low, and fixed it.  That's the price system in operation.

The same thing happened to the CCX.  The value of a ton of carbon (t CO2 eq.) has been set by the free act of purchase and sale at $0.05.   It's as simple as that.  What might have changed things for the CCX, and what they have clearly been hoping for (and lobbying for, as when Sandor testified before Congress on emissions trading) since 2000, is government intervention in the market.  Legislation obliging emitters to offset their emissions through the purchase of carbon credits would have guaranteed a lucrative and practically unlimited market for the CCX, and would - in all probability - have netted its managers a nice heap of coin.

How much coin?  Let's scribble a few numbers on the back of an envelope, shall we?  According to the US DOD's Energy Information Administration, for the past decade, US electricity generators have pumped out between 2.3 and 2.5 trillion tons of CO2 annually.[14]  At the January 2009 price for carbon credits ($2.15 per tonne, well below previous and subsequent peaks), US fossil-fuel-consuming power generation companies alone would have been required to purchase about five trillion dollars worth of carbon credits every year.  In other words, the cost of generating electricity in the US from carbon-emitting sources (which account for about 60% of the US's generating capacity) would have gone up by about a third of the nation's GDP.  Even if the CCX's profit on a trade was only 1%, the Exchange would have been raking in $50B in profit annually just from carbon credits purchased by electrical generating concerns.  Not too shabby for a commodity that, a few years ago, was pretty much worthless to everyone except greenhouse operators, dry ice manufacturers and paintball enthusiasts.

Milton Friedman, writing in 1962, highlighted the nature of the price system and how governments, through intervention, can alter the conditions of the free market, transforming the nature of the free act of purchase and sale between buyer and seller: 

Fundamentally, there are only two ways of co-ordinating the economic activities of millions.  One is central direction involving the use of coercion - the technique of the army and of the modern totalitarian state.  The other is voluntary cooperation of individuals - the technique of the marketplace.

The possibility of co-ordination through voluntary co-operation rests on the elementary - yet frequently denied - proposition that both parties to an economic transaction benefit from it, provided the transaction is bi-laterally voluntary and informed.[10]

So why is the current price of a tonne of carbon on the European Climate Exchange running from 12-14 Euros,[11] while in North America a ton of carbon is worth less than a chunk of Double-Bubble?  That's simple, too.  The European Community's Emissions Trading Scheme is based not on the free market, as the CCX was, but on "central direction involving the use of coercion".[12]  The merits of rendering obligatory the purchase of carbon "offsets" may certainly be debated; but what is not open to debate is the fact that the value of a good or service cannot be accurately established when sellers are not free to decline to sell, and buyers are not free to walk away.

There is, as always, an upside to all of this.  The Department of National Defence, according to Assistant Deputy Minister (Infrastructure and Environment), is responsible for the production of something less than two million tonnes of CO2 per year, which is less than a single large coal-fired power plant.[13]  At the current price of a ton of CO2 on the CCX, DND could offset every dram of diesel, every erg of electricity, and every atom of aviation turbo it consumes, all for the bargain price of $100k annually.  Incidentally, that's about two-thirds the salary of ADM(IE).

Carbonaceously yours,


P.S..  Don't feel too bad for Sandor.  He had a 16.5% stake in the CCX.  The ICE purchase of the Exchange netted him $98.5M.[15]  The folks who bought carbon credits through the Chicago Climate Exchange, however…well, that's another matter.  Caveat emptor.


[1] [].  Significantly, the CCX doesn't trade water vapour, which comprises 96% of the GHG in the atmosphere, and which is 4 times as effective as CO2 at absorbing and re-radiating thermal energy.  But, I digest...

[10] Milton Friedman, Capitalism and Freedom, 40th Anniversary ed. (Chicago: University of Chicago Press, 2002), 13.  Emphasis in original.

[13] Taken from the following paper: D.A. Neill, A strategic framework for exploring alternative energy options in DND/CF (Ottawa: Defence R&D Canada - Center for Operational Research and Analysis, 2009).