Chicago Climate Exchange

(CCX)
Marco Hickey
November, 2008

A research paper on the Chicago Climate Exchange (CCX). The basics of what a
carbon contract is, how it works, and where it is traded.,
 Today, many people worldwide engage in making some additional income, or even a
living from the financial markets. People buy and sell equities, the most common instruments
being common shares of a company. People purchase these shares based on their expectation(s)
of the company’s future. A more complex instrument to invest or speculate with, is the buying
and selling of options. Each “standard” option contract is for 100 common shares, and gives the
buyer the right but not the obligation to purchase the underlying shares for a set price (strike)
within a specific time frame. Through the options world has evolved a new type of instrument,
this is called a Chicago Climate Exchange (CCX) Carbon Financial Instrument (CFI) Contract.
Each CFI contract is equivalent to 100 metric tons of CO2.

The standard or target emissions level is set for Greenhouse Gas (GHG) emissions among
all industries. The amount a company can emit or pollute into the environment depends on the
size and product capabilities of that company. “CCX emitting Members make a voluntary but
legally binding commitment to meet annual GHG emission reduction targets. Those who reduce
below the targets have surplus allowances to sell or bank; those who emit above the targets
comply by purchasing CCX Carbon Financial Instrument (CFI) contracts” [1]. By selling these
contracts it allows for some companies, who chose to invest in technologies to reduce emissions,
to offset the cost of the technologies. Through this system it creates additional incentives for
companies to invest in technologies which reduce emissions, because they may be able to fetch
descent premiums by selling their surplus emissions offsets to other companies.

A recent article states that by registering these offsets through the Chicago Climate
Exchange, it makes it possible for the state of Virginia to reach its goal of reducing emissions by
30% by 2025.

CNX Gas announced today it has registered 8.4 million metric tons of emission
offsets for trading on the CCX, a legally binding greenhouse gas reduction and
trading exchange for emission sources and offset projects. CNX Gas' offsets
arose out of CNX Gas' coalbed methane capture project in Buchanan County,
Virginia, for the years 2003 through September 2007. Additional offsets are
expected to be generated in the future.

"This is a win-win-win situation for all parties involved here today," CNX Gas
President and CEO Nicholas J. DeIuliis said about the significance of the
relationship between CNX Gas, the Chicago Climate Exchange and the
Commonwealth of Virginia. "Not only are we creating value for our
shareholders through the registration of emission offsets on the Chicago
Climate Exchange, we are furthering the goals of Governor Kaine's 2007
Virginia Energy Plan, making Virginia a leader in addressing one of the most
important issues in the country today."

Dr. Richard Sandor, Chairman and CEO of Chicago Climate Exchange, echoed
Mr. DeIuliis' thoughts: "The Chicago Climate Exchange facilitates private
sector approaches to addressing the climate change issue and we are very

Original Research by Marco H. OptionMaestro.com

 pleased to partner with CNX Gas and to see the positive impact that our
partnership is having on Virginia and the country."

"CNX Gas' methane capture project in Buchanan County is exactly the type of
private sector initiative that will enable Virginia to achieve our goal of
reducing the Commonwealth's total greenhouse gas emissions by 30% by
2025,” remarked Governor Kaine. "Just to put it in perspective, the 8.4 million
metric tons of CO2 equivalents being registered by CNX Gas today, is
equivalent to the annual carbon emissions of 1.6 million automobiles.
Moreover, because CNX Gas sells the methane it captures, we are
simultaneously increasing the Commonwealth's indigenous energy production,
which was one of the goals I laid out in my 2007 Virginia Energy Plan [2].

This article is one example of how the Chicago Climate Exchange has been very successful in
getting companies to reduce emissions. The reason CNX would have the incentive to reduce
emissions is because they want to create some additional revenue off of their saved or “banked”
emissions. According to the market price (as of November 25, 2008), 2008 and 2009 sell for
$1.35 per ton or $135 per contract, and 2010 sell for $1.40 per ton or $140 per contract, CNX
could sell their offsets for a total of $11,340,000 for years 2008, and 2009, and $11,760,000 for
the year 2010. This additional $11,000,000+ could certainly help CNX reinvest in technologies
to even further reduce emissions, allowing them to sell even more future offsets, causing even
greater future profits. Not to mention the state of Virginia is becoming less polluted through this
system, which allows for other states to become more aware of the benefits of trading carbon
offsets.

Chicago Climate Exchange is growing at a phenomenal rate, starting with just 13

members in 2003, now has over 300, mainly due to increased concern over the environment and
global warming. Some people may argue saying the growth of the CCX will not help the
environment at all, because the same amount of emissions will escape into the air, because firm 1
will just sell offsets to firm 2, therefore the same amount of pollution is released into the air.
However that is not the case; take the law firm Sullivan and Cromwell for example. “In April,
New York's Sullivan & Cromwell joined the Chicago Climate Exchange, becoming the first
major law firm to formally commit to neutralizing its emissions of greenhouse gasses through the
purchase and retirement of carbon credits and the purchase of offsets. The move is the "socially
responsible" thing to do, according to the firm's chairman Rodgin Cohen” [3]. One can see that
something can be done to reduce emissions altogether, by purchasing CFI contracts and letting
them expire, or not using them for credit. This allows there to be less of the CFI contracts
available for the use of emissions, and one less contract used for emissions credit is 100 metric
tons less of CO2 released into the air. This article proves that something can be done by a
company or an individual to help reduce emissions globally. One could sign up for an account on
the CCX, and for just $135 could currently purchase a contract for 100 metric tons of CO2 and let
it expire, this would account for 100 metric tons less of CO2 to be released into the air.

Another company to become a member of the CCX is Bank of America. Bank of America
is “doing well by doing good”, this is that they are working on a trading platform for companies
to make it easier to engage in trading their offset contracts, and they are making it more known to
the investor world, Bank of America also expects to create additional revenue and profits from
Original Research by Marco H. OptionMaestro.com
their partnership with the Chicago Climate Exchange. Bank of America, being one of the
superior financial institutions will help build the reputation of the CCX in the financial realm.

Bank of America will play an active role in the growing emission trading
industry through our membership and investment in the exchange," said Richie
Prager, head of global rates, currencies and commodities for Bank of America.
"As we partner with CCX and launch our carbon emission credit trading
platform and products later this year, we will ultimately do well by doing good.
Helping individuals and corporations understand their carbon footprint, hedge
against it and reduce emissions to reach carbon neutrality is of paramount
importance in achieving an environmentally sustainable economy." Richard
Sandor, Chairman of Climate Exchange PLC, said "Financial solutions
promoting environmental sustainability lie at the heart of Climate Exchange.
Our ability to succeed is about the quality and focus of our members and
partners. In Bank of America we have a working, commercial relationship
which takes our initiatives into the day to day financial activities of a great
number of corporations and consumers. We are excited about the prospects
presented by the agreement and look forward to working with the Bank of
America team [4].

This is a leap in the right direction for the Chicago Climate Exchange. By partnering with one of
the most popular financial institutions in the world, the CCX will be able to attract more business
within the corporate world, which allows more people and businesses to become aware of their
carbon footprint, and will reduce emissions altogether. The more companies that are aware of the
opportunity to generate additional revenue by investing in technologies and selling their surplus
carbon offsets, the better the world is, this is also in part because there will be more buyers aware
who want to purchase offset contracts strictly to let them expire such as the Sullivan and
Cromwell law firm, allowing these contracts to expire means that there are less pollutants
emitted into the air meaning a cleaner world.

“As part of its CCX membership, joint venture and minority investment stake, Bank of
America has committed to: expand its greenhouse gas emission reduction target, provide
liquidity on the CCX, ECX and CCFE, Join CCX's Offsets Committee, purchase a minimum of
500,000 tons of offsets over a three-year period of time, treat CLE exchanges as preferred
providers for exchange traded environmental product execution, and develop and launch later
this year, carbon-related products and services for Bank of America's retail and institutional
customers who wish to reduce their own carbon footprint” [4]. With Bank of America providing
liquidity, this partnership makes it possible for the CCX to grow larger much easier. Also Bank
of America is setting an example among all financial institutions by agreeing to purchase
500,000 metric tons of CO2 over a three year period. If one firm is doing something that is adored
by the public eye, chances are that there will be other firms soon to follow to get the same
admiration. This would create an even higher demand for the offset contracts, which causes the
price per contract to increase, which in turn makes it more attractive for firms to invest in
technologies, causing a surplus of emissions contracts which they will be able to sell them for
additional revenue. In theory, this will cause an even greater benefit to the environment, because
there are large financial institutions purchasing large sums of offsets, just to let them expire, and
more firms striving to cut back emissions to generate revenue from selling their offsets.

Original Research by Marco H. OptionMaestro.com

 However, due to the recent global economic crisis it has caused the prices of carbon units
traded on the Chicago Climate Exchange to decline in value from almost $7.50 over the summer
(2008) to nearly $2 per contract in November (2008). This is mainly due to investors seeing an
economic downturn, which would result in fewer emissions because production will decline.
However a recent economic study suggest that the carbon trading market has “legs”, or that it
will not decline any further, because investors are starting to see value in investing in the carbon
emissions contracts. “On the financing side of the emerging carbon market in the United States, a
number of financial institutions and private equity players have begun to invest. Some
investment banks have set up carbon-credit trading shops on their commodity desks in
anticipation of the rising value of these speculative investments” [5]. This implies that when the
price has declined so rapidly investors start to see value in future contracts for carbon emissions
and will speculate to make a profit on the trading of these instruments. Some big investment
banks have added carbon contracts to their portfolios in the hopes that they will be able to sell
them for a higher price in the future. One reason they could be speculating is likely because they
are estimating a set date when the economic downturn will be over, and they will be able to sell
their carbon traded instruments for more than they bought them for at that set date in the future.
Many private investors are also speculating with these instruments as a way of diversifying, by
getting alternate investments outside stocks and bonds, so they will have a chance to make
capital gains from these when the economy starts to grow in the future.

Due to the recent economic turmoil, it may be worth it for companies such as CNX to
wait until the economy starts to expand before they sell their banked emissions, this would allow
them to get an even greater premium. As one can see from the chart below the CFI contracts
have traded above $7 per ton or $700 per contract in May of 2008, before plummeting to recent
levels of the $100-$200 per contract range.

(Chart from Chicago Climate Exchange website, Market-Chart)

Original Research by Marco H. OptionMaestro.com

The reason these CFI contracts have decreased in value so drastically is because the uncertainty
of the future of the United States’ economy, and the chances of a pro-longed recession. During
recessions manufacturing is reduced, which causes less emissions, which causes less demand for
CFI offset contracts, thus the price has been reduced. Based on historical data recessions
typically last twenty months, this would assume manufacturing to increase within a year or two
(or a much greater premium for the 2010 offset contracts versus the 2008 and 2009 contracts),
but these contracts suggest a pro-longed recession due to a measly five cent spread between
the2009 and 2010 contracts. If CNX were to hold and “bank” their current and near future
emissions, and the United States’ economy starts to grow rather than shrink, the demand for the
CFI contracts will most likely increase back to $700 or more, meaning that CNX could get
nearly $58,800,000 for these same 8.4 million emissions offset contracts. This could act as a
huge benefit to the company in the future. However this is a very tricky game, and CNX may be
forced to sell these contracts for less assuming they would not be able to use them for emissions
credits due to decreased production, and that they would not let them expire getting absolutely no
revenue from them.

All of this trading has caused these instruments to become very volatile as noted in a
recent article: “Prices in the emerging carbon market have been highly volatile, due to influences
as divergent as politics and weather. EU emission allowances and Kyoto trading instruments are
currently trading around 20 units per metric ton of carbon dioxide. Prices for units traded on the
Chicago Climate Exchange were as high as $7.50 per ton of carbon dioxide (approximately 5.57
units) over the summer, but have collapsed to around $2 per ton currently” [5]. This implies that
these instruments are extremely volatile ranging from $7.50 to $2 in a span less than 6 months.
This article also shows that some of these contracts called “voluntary carbon credits”, or carbon
offsets bought not necessarily by investors but those who strictly want to reduce their carbon
footprint, are trading at higher premiums. Some of the recent individuals and companies who are
reducing their carbon footprints vary from rock bands to fortune five-hundred companies as
noted from a recent article: “Asked five years ago what we did for a living, we got blank stares
when we responded "carbon trading" and "carbon investing." Now, with everyone from PepsiCo
to Google to Pearl Jam striving to offset their carbon footprints, placing a value on carbon
reduction has become commonplace” [5]. Interestingly enough these specific non-investor
contracts have not declined, but increased year over year, as more celebrities find it necessary to
fight global warming as found in a recent article: “A recent U.S. study noted that voluntary
carbon credits are trading at approximately $6.30 per ton, a price increase of 26% over 2007
prices and 60% over 2006 prices” [5].

Whether it has been the influence of these celebrities and or companies, or solely the
common interest of man to fight global warming, something has sparked the interest of society.
One can see this by evaluating the growth of the Chicago Climate Exchange since it was created.
“The global market for "carbon trading" grew 36 percent between January and September, to $84
billion from $67 billion, according to New Energy Finance, a London-based company that tracks
activity in energy markets. By year's end, the market is expected to surpass $100 billion” [6].
This is a huge feat for the Chicago Climate Exchange and proves it is serving the purpose for
which it was created. With more companies and role models worldwide stepping up to fight
global warming, by purchasing these contracts, it could have quite an impact on the world.

Original Research by Marco H. OptionMaestro.com

 The Chicago Climate Exchange has also influenced the emerging markets to create
similar exchanges. As recently noted in a research study conducted by Merrill Lynch “Another
piece of empirical evidence that Asian countries are serious about addressing CO2 emissions is
the fact that several countries are setting up carbon related exchanges. So far, according to
industry specialist IDEAcarbon, altogether 8 exchanges are being set up: two in Australian and in
India each, and one in Beijing, one in Hong Kong, one in Singapore and one in Tokyo. These
carbon-related exchanges will undertake such activities as Carbon Emission Reductions (CER)
futures, Voluntary or Verified Emission Reductions (VER) and other Carbon products amongst
others” [7]. This proves that Asian countries are jumping on the bandwagon to fight global
warming. As shown in the chart below one can see that China and India are leading Asia by
generating the most carbon credits through Clean Developmental Mechanism (CDM) projects.

Through these CDM projects, companies from these countries are generating carbon credits
which they will be able to sell on an Asian exchange, similar to the Chicago Climate Exchange.
China seems to be showing increased interest in getting these CDM projects underway by the
growth exerted in such a short period as stated from research by Merrill Lynch “According to
World Bank figures, the market of greenhouse gas tradition doubled last year to $70bn. China,
the world’s largest emitter, accounts for 73% of all CDM projects in 2007. As of August 2008
China had close to 1,500 CDM projects in the pipeline out of over 3,000 globally. China has
accomplished a very high issuance success rate and has over 60mn MT (metric tons) of CER
followed by India of 45mn MT” [7]. China and India through CDM projects have issued over
100 million metric tons of carbon credits, a phenomenal amount. A list of the countries
generating the most carbon credits (in millions of metric tons) can be seen from the bar chart
below.

Original Research by Marco H. OptionMaestro.com

From the chart above one can see that Almost 200 million metric tons of carbon credits have
been generated from just these 10 countries. If these countries keep investing in greener
technologies and continue to reduce emissions by at least this much, it is obvious the world will
be a much cleaner place.

There are many technologies which help reduce carbon emissions. The pie chart below
shows a complete breakdown of which CDM projects the Chinese are implementing.

Through these projects, China, the largest emitter of carbon worldwide, is cutting back at a rapid
rate. It is necessary to get complete global involvement to make a change in the global
environment. Though these projects may reduce only a small portion of overall emissions, it is a
step in the right direction, and is better than nothing. If the emerging markets continue to reduce
emissions at this rate, it will be very healthy for the global environment. The efforts of the

Original Research by Marco H. OptionMaestro.com

Chicago Climate Exchange have been somewhat responsible for the global push for change
toward a greener environment. Without the idea of the carbon traded exchange, there may not
have been any really good incentive for companies to invest in greener technologies today.

Though it is too early to evaluate any major effects the Chicago Climate Exchange has
had on global warming it is certainly a step in the right direction. With the efforts of many
individuals and companies worldwide, whether it is for investment purposes or simply to offset
their own carbon footprint, it seems this system could dramatically reduce future emissions
worldwide. If the Chicago Climate Exchange continues to grow at its current pace, and influence
emerging countries, the future of the world will most likely benefit even greater. One must think
with increased interest and exposure in the market for trading carbon offsets it will cause more
contracts to expire unused, due to individuals and companies trying to offset their carbon
footprint. A key factor to maintain rapid growth would be to make carbon trading more
understandable to the common public, this could be done by creating an easier to use trading
platform. Perhaps another way interest could be gained from the public would be to allow the
buyers to be eligible for a tax credit, assuming they never exercised the contract for emissions
credit. If individuals and corporations could write the expense of these unused offsets off of their
taxes, this could have a large effect on the amount of contracts that expire unused. If someone
were speculating and purchased a carbon offset contract near the annual high back in the summer
of 2008, that individual may choose to “do good” and let the contract expire for an overall loss of
$750, versus a loss of around $600 and allowing for that contract to be used for emissions credit
in 2008. Overall, as the Chicago Climate Exchange and the interest for carbon trading continue
to grow the world should become a less polluted place.

Sources

[1]Chcicago Climate Exchange. 2007. Chicago Climate Exchange. 26 November

2008 [LINK]

[2]"Governor Kaine Recognizes Efforts of CNX Gas to Reduce Greenhouse Gas

Emissions in Virginia: CNX Gas Registers 8.4 Million Metric Tons of Emission
Offsets for Trading on the Chicago Climate Exchange(R).” PR Newswire 11 June
2008: 1 ABI/INFORM Dateline. ProQuest. 26 November 2008 [LINK]

[3]Steven T Taylor. "Sullivan & Cromwell Makes Right Move by Joining Chicago
Climate Exchange." Of Counsel 1 Jun 2005: 3-4. ABI/INFORM Trade & Industry.
ProQuest. 26 November 2008 [LINK]

[4]"Bank of America Joins Chicago Climate Exchange, Makes Strategic Investment in

Climate Exchange PLC; Expands its Greenhouse Gas Reduction Goal.” PR
Newswire 25 July 2007: 1 ABI/INFORM Dateline. ProQuest. 2 December 2008
[LINK]

[5]Ann Grodnik, Radha Kuppalli. "Guest Words: Investors Willing to Bet U.S. Carbon
Market Has Legs.” Bond Buyer [New York, N.Y.] 17 Nov. 2008: 1 ABI/INFORM
Trade & Industry. ProQuest. 25 November 2008 [LINK]

Original Research by Marco H. OptionMaestro.com

[6]Elwin Green. "'Carbon trading' now big business.” McClatchy - Tribune Business
News 30 October 2008 1-2 ABI/INFORM Dateline. ProQuest. 26 November
2008 [LINK]

[7]Lu Yeung, Spence, Parekh, Chow. “Asia Carbon Snapshot.” 29 September 2008: 1-
16

Merrill Lynch. 1 Dec. 2008 [LINK]

Original Research by Marco H. OptionMaestro.com