Carbon credits' slow lift-off

Johannesburg - Though Sterling Waterford received offers for about 290 000 of its latest issue of carbon credit notes - against the planned range of 800 000 to 2.5 million - director Philip Bouwer is upbeat.

"The issue spanned the worst two weeks for financial markets in the past 100 years, so we're pretty damn pleased we got it off the ground at all."

Just what are carbon credit notes? It's difficult to explain without lapsing into incomprehensible jargon, but basically they're a derivative security with indirect exposure to carbon credits. Those are a key element of the Kyoto Protocol, which seeks to address the problem of increasing greenhouse gas emissions.

When Russia became the 55th nation to sign the protocol, it came into force on February 16, 2005. That made emission reduction targets for the period 2008 to 2012 adopted by more than 30 industrialised countries binding under international law.

By implementing emission reduction projects in developing countries, enterprises in such countries may add to the allowances of carbon dioxide they may emit. Those allowances have a tradeable value and can be bought or sold.

It's a fast-growing global market. Unless economic strain takes the heat off environmental issues, analysts estimate the total value of global carbon assets will reach $1 trillion by 2012 - not taking into account any future participation by the US.

It's possible, but difficult, to invest in carbon credits directly. While the market is volatile, they trade at a premium to carbon credit notes. Secondary market credits are well traded in earlier vintages in European markets, especially in London. At the time of Sterling Waterford's latest issue, December 2008 contracts were trading at €20.80. So at the moment, those notes are the only way for local investors to participate.

The notes were issued at R175.4805, equivalent to €13, and will be settled in cash in 2012. A previous issue was denominated in dollars and offered physical settlement: Bouwer says the euro is now more appropriate, while the SA Reserve Bank indicated it prefers cash settlement. In any event, no investors in its previous issue opted for physical settlement.

Trade since the notes were listed on the JSE on October 14 has been thin but has crept up. Bouwer attributes that to technical factors, the rand's weakness and "most importantly, the fact that the note is tightly held, with most investors committed to hold to maturity to benefit from the anticipated up-tick in the carbon price towards 2012".

Partly due to the small free float, with the total issue initially valued at only R51m, and no doubt also in the hope that market conditions will improve, Sterling Waterford plans a third issue in the first quarter of 2009.

Carbon credit notes aren't an investment for all but they're an interesting combination of socially responsible investment and a rand hedge. And they could prove rewarding.

Sterling Waterford claims its first carbon credit note was a world first and between its issue in January 2005 and maturity in June 2008 it returned a total of 250%.

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