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As Carbon Market Stumbles, Other Environmental Markets Succeed

Trevor Curwin, |Special to CNBC.com
Friday, 12 Nov 2010 | 2:58 PM ET

Though the future of a cap-and-trade-based carbon market now looks grim, there are other less-known environmental markets that are up and running—and attracting investor attention.

Markets like the wetlands mitigation credits—aimed at solving the damage caused to crucial wetlands by industrial and commercial activities—are worth billions and already well-established, says Michael Van Patten, CEO of environmental markets firm Mission Markets.

Wetlands
Jeff Hunter | Getty Images
Wetlands

“As it stands, compared to the compliance carbon markets they’re microscopic,” says Van Patten, comparing the $3.5 billion wetlands credits market to the $20 billion carbon markets in Europe where polluters are required to offset their carbon footprint. “But compared to voluntary carbon (markets), they’re big.”

Voluntary carbon markets, where companies interested in purchasing carbon credits to reduce their carbon footprint can buy offsets without being forced by a cap-and-trade scheme, are worth about $500 million in the US currently.

The core assumption of all environmental markets is that natural processes—pollinating creatures that promote food production, wetlands that filter polluted water or forests that capture carbon—have certain critical functions for the human species and thus have real economic value.

Determining that value, however, can be challenging and controversial.

A late-90s study by ecologists and economists put a $33 trillion price tag on these “ecosystems services,” about double the planet’s GDP at the time, but the current reality is one of much smaller regulatory regimes with related markets for different credits.

Acid-rain emissions, water rights, renewable energy certificates and energy efficiency certificates are all good examples of such specialized, yet fragmented micromarkets.

Each pose their own unique management and transparency issues, and thus generate their own information services models and platforms to bring sellers of various credits together with buyers.

The wetlands mitigation credits market amply demonstrates that.

Wetlands mitigation credits are created by setting aside or restoring wetlands in “mitigation banks,” which create credits that polluters then “withdraw” if they need to offset their activities.

In 1992, there were 46 such banks, but a 2005 inventory by the Army Corps of Engineers, the banks’ overseer, estimated 450 banks in operation—of which 59 of had sold all their available credits—and another 198 banks in the proposal stage.

Since polluters could pay an “in-lieu” fee rather than buy credits—effectively a tax on pollution —or undertake their own wetlands restoration efforts, the growth in the number of banks shows how expensive self-restoration can be, and how few “bankable” wetlands may remain.

And since credits aren’t fungible—destroying a wetland in Louisiana can’t be offset by restoring one in Maine—that means each bank represents a local need for credits by a polluter.

The wetlands market is unlikely to be a speculators’ one anytime soon, with buyers hoarding freely trading credits to force up prices.

The more likely upside for investors will be in being most adept at “buying low and selling high” on the wetlands set aside in each mitigation bank, says Ricardo Bayon, co-founder of EKO Asset Management Partners, whose firm looks for opportunities to monetize environmental assets.

This market works more like real estate than the commodities-like feel of carbon markets, say both Bayon and Van Patten, with investors seeing returns by backing the best local “developers.”

Over time, says Van Patten, the more transparent and complete the information is on the portfolio of wetlands in each “bank,” the more informed buyers can be in the future.

That means financial institutions and institutional investors could see profits from better determinations of wetlands value that they could then lend against, or from more accurate assessments of expenses and impact of a polluter’s liability.

For wetlands mitigation, EKO’s Bayon says he’d like to see the playing field tipped towards private mitigation banks, whose potentially higher fees should increase competition, driving overall costs down for polluters.

But environmental markets still turn on regulations, and with a new Republican majority in the House, there is some concern some regulatory changes could lose momentum or be scrapped altogether.

Though Van Patten admits that's an issue, he notes regulations such as the Clean Water Act and Endangered Species Act "have been around for years and years", making them virtually untouchable, and adds increased EPA enforcement "will continue to drive the use of market- based mechanisms."

Political trends and cycles aside, Bayon is also bullish on environmental markets overall.

The lack of federal action in the near future will be offset by state and regional carbon emissions markets will fill the gap.

A 20-year veteran of the environmental markets arena, he says that while markets like wetland mitigation are still “in their infancy,” transaction transparency and practices have improved greatly since he started his career.

But he says he sees investor momentum picking up as the markets becomes more reliable and as investors focus their resources on sustainability issues.

“It’s gotten a lot of people thinking about it." says Bayon.