Chicago exchanges head for green war over carbon emissions

Green may be the hue of environmentalism, but it's still the color of money to the Chicago futures exchanges vying for control of the nascent trading market in carbon emission credits.

CME Group Inc., the world's largest futures exchange, and the Chicago Climate Exchange, led by Richard Sandor, inventor of bond futures, are both angling to dominate a market that could generate $120 billion in carbon-credit trading annually if a so-called cap-and-trade system becomes the law of the land.

“We are talking about what will be the biggest commodity ever traded,” said Mr. Sandor, executive chairman of London-based Climate Exchange PLC, which owns the Chicago exchange. At 6 billion metric tons, the U.S. carbon emissions market is expected to be about three times the size of the European market, where another of Mr. Sandor's exchanges dominates trading. “Every time a mandated market has come through, it's provided us enormous opportunities.”

Such a mandate is in climate legislation that passed the U.S. House last month; the bill faces a tough fight in the Senate, but the Obama administration supports so-called cap-and-trade regulations as a way to reduce global warming.

Passage of the legislation would set off a furious race between Mr. Sandor's Chicago Climate Futures Exchange and CME. The Climate Exchange has an early lead — it handles the lion's share of carbon credits trading under the Regional Greenhouse Gas Initiative, the nation's first mandatory carbon-emissions reduction program. It also dominates across the pond, where Mr. Sandor's European Climate Exchange has an 87% market share in futures on European emissions permit trading.

And Mr. Sandor brings deep experience: He helped design the U.S. Environmental Protection Agency's acid-rain reduction program, launched with the 1990 Clean Air Act and credited with driving down emissions of acid-rain producing sulfur dioxide. In 2003, he built the Chicago Climate Exchange, the first U.S. voluntary carbon emissions market.

The Climate Exchange is the “offering to beat,” Chicago-based Raymond James analyst Patrick O'Shaughnessy said in a recent note summing up the competitive landscape of cap-and-trade. “We believe that the Climate Exchange's dominance in the European and U.S. carbon markets will be too much for other challengers to overcome,” he said.

But if any exchange can overtake Mr. Sandor, it's CME. The Chicago juggernaut, which handled contracts tied to a quadrillion dollars of assets last year, is in talks with regulators over the creation of a Green Exchange owned jointly with market participants including Constellation Energy Group Inc., Goldman Sachs Group Inc. and J. P. Morgan Chase & Co. By waiting for legislation to take clearer shape, CME may be able to craft its exchange to match the new regime.

“We are not too late, but we're not too early,” said Randy Warsager, director of green products at CME, which recently launched several emissions-based contracts, including ones targeted at the European market. Those contracts will be moved to the Green Exchange once it is launched.

Christopher Rodriguez, CME's managing director of business development, said CME's advantage is partly sheer size, with its extensive list of clearing members and its global electronic trading system. Also important, he said, will be savings for traders, who will put up only one margin deposit to trade on the Green Exchange and the CME-owned New York Mercantile Exchange, which controls oil and natural gas futures.

Mr. Sandor, 67, points out that CME's dominance hasn't helped it establish much of a foothold in existing emissions markets like Europe, and that his clearing and technology agreements with IntercontinentalExchange Inc., Nymex's biggest rival in energy-futures trading, give him similar reach and efficiencies. Last month, Atlanta-based ICE took a 4.8% stake in Climate Exchange.

“We've done pretty well over the last three years of competition with the big boys,” Mr. Sandor said.

Still, Climate Exchange PLC has lost money during that time. And despite explosive growth in Europe, volume has tapered this year at its U.S. exchange in part because investors worry that existing contracts will become obsolete under the federally mandated cap-and-trade system.

As the bill currently is written, Climate Exchange contracts won't qualify for trading under cap-and-trade, said Allison Shapiro, who studies voluntary carbon emissions markets for Washington, D.C.-based Ecosystem Marketplace. Still, she said, if Mr. Sandor successfully petitions the EPA to admit the exchange's contracts to the federal system, trading “could see huge growth until 2012.” After that, she said, it's unclear what role, if any, established exchanges will have.

“The only thing definitive at this point is that the Commodity Futures Trading Commission makes the rules over this,” she said.

Ann Saphir is a reporter at Crain's Chicago Business, a sister publication of Pensions & Investments