Trends I'm Watching

Emissions Trading: An Investment Opportunity?

Trend: Emissions trading is a free market approach to pollution control that may grow rapidly in the future as laws are passed reflecting concerns about climate change.

Charles Morand at Alternative Energy Stocks describes how emissions trading works and discusses some potential opportunities in climate exchanges in the future. Excerpts below.

Link: Alternative Energy Stocks: Carbon Finance…The Next Bonanza

Goldman Sachs took, on September 20, 2006, a 10.1% stake in a little outfit known as Climate Exchange plc (LSE:CLE) for approximately $23 million. Admittedly, by Goldman Sachs standards, that’s peanuts. Not to be outdone, Morgan Stanley unveiled a plan on Thursday October 26 to invest a whopping $3 billion in global carbon markets over the next few years....

What is carbon trading and how does it work?

Emissions trading is an innovative concept that was first used in the US to reduce emissions of the acid rain-forming gases NOx and SO2. It entails placing a cap on the total emissions of a given pollutant within an imaginary ‘bubble’ (e.g. an industrial district, a city, a state, or, in the case of carbon dioxide (CO2), the whole planet), and allowing emitters of that pollutant to sort out, among themselves, who should emit how much of that limit based on factors such as the nature of their industries, the efficiency of their operations, periodic requirements for higher commercial output, etc.

The Global Carbon Market

An interesting thing about CO2 and other greenhouse gases (GHGs) is that they are global pollutants, meaning that the end result of their presence in the atmosphere in large quantities will be the same whether they came from a Chinese power plant or an American SUV. This spells great possibilities for coordination between national regulatory bodies and the eventual setting up of a global marketplace for CO2 emissions rights.

The market for CO2 emissions currently exists in 2 forms: (a) in jurisdictions where there are legislative frameworks with formal targets in place to control GHGs, such as in the EU, carbon markets, as they are called, form the cornerstone of regulatory implementation, and (b) in areas where there are no regulations but certain market players adopt voluntary emissions targets, such as in the US, carbon trading is one tool used to meet those targets. The actual exchanges used to carry out carbon trades are known as climate exchanges, although many trades also occur in OTC markets.

In the EU, the Emissions Trading Scheme (ETS) came into force on January 1, 2005. That year, the first one during which selected facilities were subjected enforceable regulatory limits, the value of the market reached $8.2 billion. By half-year 2006, carbon finance information provider Point Carbon reported that the ETS’ value already stood at $12.5 billion. Point Carbon estimates that the global carbon market, including both the ETS and voluntary initiatives such as the Chicago Climate Exchange (CCX), will be worth upwards of $27 billion by the end of 2006, up from around $12 billion in 2005 and $377 million in 2004. Now the ETS will continue to account for the bulk of this until other jurisdictions adopt mandatory GHG targets, and that’s where the fun begins.

Most folks outside of environmental or political punditry circles probably didn’t pay too much attention to the signing into law of Assembly Bill 32 in California just a few weeks back. AB 32 will impose firm caps on GHG emissions in that state, the 6th largest economy in the world, starting in 2012, and will in all likelihood rely on carbon trading to achieve its targets. The Regional Greenhouse Gas Initiative (RGGI) is another interesting development that has been in the works for some time. RGGI will cap GHG emissions from power producers in Northeastern and Mid-Atlantic states and establish a trading system starting in 2009. Even more interesting is the growing number of commentators that now predict federally-imposed GHG emissions targets sometime in the near- to medium-term.

Seeing as the US (a) accounts for about 25% of global GHG emissions and (b) houses the most liquid financial markets in the world, we could be talking about some pretty big money here. A recent Financial Times article estimates that, should consensus be attained on a plan to fight global climate change between the largest emitting jurisdictions, expenditures could top $1,000 billion within 5 years. Seen under this light, those recent announcements by Morgan Stanley and Goldman Sachs look increasingly less like a means to placate environmentalists and earn a little goodwill, and increasingly more like pretty sound strategic positioning to cash in on one of the biggest business opportunities of the 21st century.

Closing Thoughts on Carbon Finance

To those who kick and scream every time you hear the words climate change or Kyoto, stop your senseless whining! I've got two pieces of news for you. First, there is far more scientific consensus on this then Fox News would have you believe, and GHGs will be regulated one day or another, whether you like it or not. Two, it’s not all downside. You need to get that poisonous idea out of your mind and look at this like Goldman is, i.e. like a big opportunity to cash in.

Is there going to be a massive transfer of wealth away from inefficient and dirty companies towards cunning investors who understand carbon trading? That remains to be seen but I and some big institutions strongly believe that to be the case. I see a great opportunity in carbon finance for those who can navigate the waters ahead.

The Wilshire 5000 moves up for the week ending 10/27/2006

Trend: The daily line rose Monday through Thursday and then took a dive at mid-day on Friday this week. The 50-day moving average continues to move above the 200-day moving average. The daily line remains well above the previous 52-week high set in early May.

Here's a 12-month chart of the Wilshire 5000* (a proxy for the stock market as a whole), showing the 50 and 200 day moving averages.

*The Wilshire 5000 is sometimes called the "total stock market index" or "total market index" because it includes more than 7,000 of the 10,000-plus securities that are publicly traded in the United States. All publicly-traded companies with headquarters in the U.S. that have readily available price data are included in the Wilshire 5000. Finalized in 1974, this index is extremely diverse, including stocks from every industry. Although it's a near-perfect measure of the entire U.S. market, the Wilshire 5000 is referred to less often than the less comprehensive S&P 500 when people talk about the entire market.

Virtual World Software Platform

Trend: Virtual world software could soon be crossing the tipping point on the Internet.

Patrick Cox at TCS Daily describes a potentially killer app for the Internet — a virtual world platform that would make developing applications much less expensive and allow players to use the same tools in different worlds. People who don't have kids under 30 may be unaware how big this marketplace is. For researchers, simulations of real world events will be easier and more useful.

Link: TCS Daily - The Next Big Thing

Forces are coalescing that will produce a shift comparable at least to the spread of broadband. This change will have enormous financial, cultural and political repercussions, and the most interesting aspect of the coming transformation is that it will not be some new and unexpected thing.

Rather, the Web for many will become the cliched 3D virtual reality that has been so overused as a literary and cinematic device that most of us have forgotten how compelling that vision was when it first appeared. Before describing this evolutionary leap, however, we should spend a little time thinking about the key event that led to the last one: the Internet you are using now to read these words.

There seems, ironically, far less discussion of VR today than there was then and the very term has a distinctly cheesy ring to it now. VW for virtual worlds, in fact, seems to have replaced VR among serious researchers

...WoW is a particularly important development in VWs and MMOs as it gained five million subscribers in only a year's time. The initial $50 fee for the software needed on a player's own computer would have represented significant revenues by themselves but there is a $15 monthly subscription fee as well. With over 6 million players, WoW's developer, Blizzard, earns around $1 billion in subscription fees annually.

WoW has already become much more than a fantasy VR role-playing game. Hundreds of thousands if not millions of people are using the realm for a multiplicity of non-game purposes, including political rallies and virtual church services. There are dozens of other successful MMOs, and hundreds are trying to attain that status. America, however, is not the world center for MMOs, that being Korea where online gaming has its own television channels with ESPN type coverage for top games and gamers, as well as its own courts dedicated to online crime. Millions of "gold farmers," mostly third world techies with a low cost of living and a high degree of game savvy, are making their livings by manual labor, "grinding" to earn assets that are sold online to wealthier and less patient Westerners.

...Like AOL and CompuServe a decade ago, virtual worlds exist as a relatively small number of isolated, walled-off realms, each requiring the user to download separate software. Just as the Internet did not become the social force it is today until Netscape tore down the walls separating Internet fiefdoms, virtual world technology is currently limited.

There is, however, something going on that has the potential to change that, and quickly. Not coincidentally, a team of core developers from Netscape's early days is now developing the equivalent of a virtual world browser for MMOs....

Their plan is to provide virtual world creators the client, server, and development tools to create an MMO world. The entire technology platform is free for non-commercial use, so academics are paying nothing to create economic, architectural, sociological and other simulations. For-profit enterprises would pay royalties, but only when their games or other applications collect money from consumers, not before.

This is significant because, until now, creating a complex virtual world required tens of millions of dollars in initial development costs alone. The Multiverse technology, currently in beta-testing, claims to lower the cost of virtual world production to a fraction of its current stratospheric level. For many purposes, such as personal online spaces, there would be no cost at all.

Most importantly, however, all these Multiverse-based worlds, and many are already in development, would be compatible. With the Multiverse client software, users will be able to access any virtual world built using the company's technology. Virtual worlds will become, in effect, ubiquitous. The Metaverse.

via Emergic.org

The Wilshire 5000 levels off for the week ending 10/20/2006

Trend: The daily line leveled off for this week. The 50-day moving average continues to move above the 200-day moving average. The daily line remains above the previous 52-week high set in early May.

Here's a 12-month chart of the Wilshire 5000* (a proxy for the stock market as a whole), showing the 50 and 200 day moving averages.

*The Wilshire 5000 is sometimes called the "total stock market index" or "total market index" because it includes more than 7,000 of the 10,000-plus securities that are publicly traded in the United States. All publicly-traded companies with headquarters in the U.S. that have readily available price data are included in the Wilshire 5000. Finalized in 1974, this index is extremely diverse, including stocks from every industry. Although it's a near-perfect measure of the entire U.S. market, the Wilshire 5000 is referred to less often than the less comprehensive S&P 500 when people talk about the entire market.

Web Site Visitors: How Many?

Trend: Web traffic continues to grow while current methods of measuring that traffic become less accurate.

BusinessWeek.com describes competing methods of measuring traffic online that leave advertisers, investors, and even Net companies almost flying blind. New technologies Ajax and RSS are clouding the already muddy picture. Excerpts below.

Link: Web Numbers: What's Real?.

The dirty little secret of Silicon Valley is that no one knows exactly who is going where on the Web. That flies in the face of the impression that online advertising is the most dependably trackable ad medium of all time, a big reason spending on Web ads is expected to grow 33% this year, to $16 billion. But confusion over traffic measurement could cast a chill over the Web 2.0 craze. Valuations for startups such as Facebook Inc. and YouTube Inc. appear to be doubling every few months, but those numbers are based on traffic figures that could be misleading.

From the start, measuring online traffic was a juggling act. Rather than simply relying on a Web site's traffic reports, advertisers traditionally compared that data with information from Nielsen//NetRatings Inc. (NTRT ) and comScore, independent services that recruit Web surfers to record their mouse clicks. Those outfits argue that there are many reasons not to just count the clicks off a Web site's server logs. For instance, comScore points out that servers would count pop-up ads as a page view if the tracking service didn't filter them out.

Independent traffic analysis becomes more important as bigger chunks of advertising flow online and the threat of "click fraud," which inflates ad bills, grows bigger. No wonder that a host of newer services, such as Alexa and Hitwise, are highlighting the weaknesses of the older traffic-measuring companies and are muscling onto the scene with alternatives. By providing some free traffic data via their Web sites, these outfits make it easier for anyone to publish an estimate. But they also have their own blind spots and are making side-by-side comparisons vastly more confusing.

To see why there's an opening for new ways of measuring traffic, look at what has happened to the old standard for gauging online growth, the page view. As the Internet evolved during the 1990s, advertisers came to rely on the number of pages a site served up each month as their most reliable metric. With the rise of new programming and distribution technologies, however, page views suddenly look less relevant. For instance, the beauty of a site such as Meebo is that it is built with software tools called Ajax, which speed up Web surfing. When you log onto Meebo, instead of loading a new page for every mouse click, only the log-in section is loaded. But no matter how long people stay on Meebo, they're technically viewing only one page.

Ajax isn't the only technology that's upending traditional Web measurement. Real Simple Syndication, or RSS, lets people sign up to have news articles, blog posts, or audio interviews from their favorite sites sent directly to their computers. But since they aren't surfing around, none of the sites gets credit for the page view.

For advertisers, the problem is that while any one method of measurement may capture certain Web technologies or demographics, it misses others. An alternative to counting page views, for instance, is to measure reach, which is a calculation of each site's usage as a percentage of all Net traffic.

The best hope for clarity is for Web ad giants and small fry alike to work with the established measurement services to improve their tracking ability. ComScore and Nielsen//NetRatings are beginning to respond. ComScore, for instance, now reports the number of requested videos at online video sites, rather than page views or unique visitors.

Some observers expect that in time a variety of metrics, such as time spent online, will be applied to different services until one measurement that combines a set of factors can emerge. Until that happens, though, the Internet will have to deal with the discrepancies. And Web metrics, like company valuations, will remain a crapshoot.

Trends and the Average American

Trends: Some significant changes:
the top federal tax rate in 1975 was 70%; in 2005, it was 35%.
The personal savings rate was 10.5% in 1975; in 2005, it was -0.4%.

Barry Ritholtz at The Big Picture provides some data points from a Forbes magazine article.

Link: The Big Picture: The Average American: 1967 And Today.

Fascinating data points in a Forbes magazine looking at "Mr. And Mrs. Median over the decades."

Median Income (Men)*

1965 $28,599
1975 $33,148
1985 $42,847
1995 $39,186
2005 $41,386

* All figures in 2005 inflation-adjusted dollars, except where noted. Source: Census Bureau

~~~

Median Income (Women)

1965 $9,533 (33% of men)
1975 $12,697 (38% of men)
1985 $27,720 (65% of men)
1995 $27,990 (71% of men)
2005 $31.858 (77% of men)

Source:Census Bureau

~~~

Income Share of Middle 60% of Wage Earners

1965 52.3%
1975 52.1%
1985 50.4%
1995 47.6%
2005 46.2%

Source:Census Bureau

~~~

Household Net Worth

1965 $254,740
1975 $268,234
1985 $292,143
1995 $345,321
2005 $465,970

Source: Moody's Economy.com

~~~

Personal Savings Rate

1965 8.5%
1975 10.5%
1985 11%
1995 5%
2005 -0.4%

Source:Commerce Department

~~~

Misery Index (Inflation Plus Unemployment)

1965 6.1%
1975 17.7%
1985 10.7%
1995 8.4%
2005 8.5%

Source: miseryindex.us

~~~

Top Federal Tax Rate

1965 70%
1975 70%
1985 31%
1995 40%
2005 35%

Source:taxpolicycenter.org

Bull Market Cycles

John Hussman, Ph.D., the President of Hussman Investment Trust where he manages the Hussman Strategic Total Return Fund and the Hussman Strategic Growth Fund, describes the current market in the context of a bull market cycle in John Mauldin's Outside the Box on the Investors Insight web site. Excerpts below.

Link: InvestorsInsight : John Mauldin's Outside the Box

The current Market Climate in stocks is characterized by unfavorable valuations, but modestly favorable market action. Valuations are sufficiently high that we can already conclude that total returns on the S&P 500 over the coming 5-7 years will probably fall short of Treasury bill yields. The current bull market has already lasted beyond the historical norm, and though the S&P 500's percentage gains of the past several years haven't been spectacular from a historical perspective, this has been among the longest periods the market has ever gone without a 10% correction.

Temporary versus permanent returns

I've noted before that the "median" bull-bear market cycle is 4 years in duration (with a regularity that is typically attributed to the election cycle). Since there's some variation though, the average is closer to 5 years: about 3.75 years of advance, at roughly 28% annualized, and about 1.25 years of decline at roughly -28% annualized. While the individual variations are very wide, an "average" bull market return is 152%, followed by a decline of about -34%, for a total return of about 67% (roughly 10.7% annualized).

It's important to notice what this implies. An average bear market ultimately turns a 152% bull market total return into a 67% total return over the full cycle. That is, less than half of a bull market's trough-to-peak gains are typically preserved when you measure from trough-to-trough. It's hard to emphasize this enough.

Consider even the unusually long advance from December 1994 through September 2000. During that period, the S&P 500 achieved a total return of 277%. During the ensuing bear market decline (to the October 2002 low), the market lost about 46%, resulting in an overall total return of 104% for the complete 8-year period. Even if you take the whole span from 1990-2000 as a single bull market, the ensuing 2-year bear reduced the total return from a 536% total return to a 245% full-cycle return.

In short, bear markets typically nullify over half of the preceding bull market advance. This is helpful to remember as investors rush to chase the speculative tail of an already aged and overvalued bull run.

Market Climate

As of last week [Oct 13, 2006], the Market Climate for stocks was characterized by unfavorable valuations and modestly favorable market action. The implications of this for the long, intermediate and short-term are reviewed below.

On a long-term basis, we know that rich valuations are closely associated with disappointing long-term returns. Investors can certainly get good results focusing on long-term valuations alone, but as I noted earlier, that can also be very frustrating because it can invite extended periods when the "value-only" approach lags the market. For this reason, we do accept a "speculative" exposure to market fluctuations if our measures of market action are sufficiently favorable.

Indeed, on an intermediate term basis, the current overvaluation is mitigated somewhat by a modestly favorable tone to market action. That's sufficient to warrant a small call option position to "soften" our fully hedged stance. If the market can pull back moderately without losing its favorable internals, I would expect to increase that call position to 1-2% of net assets.

On a short-term basis, despite the modestly favorable tone of market action, the status of the market at the moment can be classified as "overvalued, overbought, and overbullish." The S&P 500 currently trades at 18.3 times record earnings (on record profit margins), stocks are clearly overbought on the basis of a variety of technical measures, and advisory bulls exceed 50%. Historically, this set of conditions has been associated with short-term market losses, on average, even when our broader measures of market action have been favorable.

The Wilshire 5000 continues to move up for the week ending 10/13/2006

Trend: The daily line moved up significantly for the week. The 50-day moving average continues to move above the 200-day moving average. The daily line continues to climb above the previous 52-week high set in early May.

Here's a 12-month chart of the Wilshire 5000* (a proxy for the stock market as a whole), showing the 50 and 200 day moving averages.

*The Wilshire 5000 is sometimes called the "total stock market index" or "total market index" because it includes more than 7,000 of the 10,000-plus securities that are publicly traded in the United States. All publicly-traded companies with headquarters in the U.S. that have readily available price data are included in the Wilshire 5000. Finalized in 1974, this index is extremely diverse, including stocks from every industry. Although it's a near-perfect measure of the entire U.S. market, the Wilshire 5000 is referred to less often than the less comprehensive S&P 500 when people talk about the entire market.

Big Oil Says Forget about Peak Oil

Trend: Big Oil denies that Peak Oil is real; therefore, alternatives to fossils fuels are not needed.

Jim Jubak at MSN Money describes the efforts of Big Oil representatives to reassure oil consumers that there's plenty of oil for the forseeable future. According to their pronouncements, there's no reason to develop alternative energy technologies. Why would anyone doubt their motivations?

Even if Peak Oil is predicting the decline of oil too early, what about climate change and dependence on terrorist supporting states?

Has Big Oil dropped the price of oil recently to stifle the development of alternative energy technologies?

Below are some excerpts from Jubak's article.

Link: 3 stocks for a world running out of oil - MSN Money

...the National Petroleum Council, a federally chartered and privately funded oil-industry research group, ...graciously agreed to a request from the U.S. Department of Energy to "study" claims that world oil production has peaked. Lee Raymond, former chairman of ExxonMobil and current chairman of the National Petroleum Council, will chair the study, due in the summer of 2007, of "peak oil." Proponents of peak oil say that while the world isn't about to run out of oil tomorrow, global oil production has peaked, in 2005 possibly, or will soon peak, around 2010 possibly.

Talk about putting the fox in charge of the henhouse.

We can anticipate the study's conclusion from public comments made by ExxonMobil and Raymond. Mark Nolan, ExxonMobil's chief in Australia, told an oil-industry conference in September that "the end of oil is nowhere in sight." ExxonMobil officials are fond of citing the U.S. Geological Survey study that estimates that only 1 trillion barrels of a total 3 trillion barrels of conventional recoverable oil has been produced.

You don't have to be much of a conspiracy theorist to understand why companies sitting on the biggest oil reserves would want to convince us all that oil production hasn't peaked. If the slide to crisis isn't gradual, it could set off alarm bells and lead to a crash program to develop alternatives to oil -- not a happy development for oil companies. A base price of $55 a barrel this year, $60 next year and $65 the year after that is certainly preferable to a sudden peak to $200 a barrel that leads to the vast investment in wind and solar power and alternatives to gasoline-powered vehicles. Too much investment in alternatives could drive down global demand for oil while oil owners still have a big supply of oil in their inventories. Better to convince consumers there's plenty of oil so they'll keep buying even as the price gradually increases.

Listen to state-owned Saudi Aramco's Chief Executive Abdallah Jum'ah make exactly this point at a speech in Vienna in September:

The world has produced only 18% of the earth-producible potential of 5.7 trillion barrels of oil, he said, using a resource estimate 90% above the U.S. Geological Survey's estimate. "That fact alone should discredit the argument that peak oil is imminent, and put our minds at ease concerning future petroleum supplies." The remaining 4.7 trillion barrels of oil is enough to last more than 140 years, he added.

In other words relax, do nothing and just keep buying our oil with your dollars.

Peak-oil advocates such as Kenneth Deffeyes, an emeritus professor of geology at Princeton University and author of "Beyond Oil: The View from Hubbert's Peak," pretty effectively punch holes in those numbers, in my opinion. I don't know if Deffeyes hit the mark exactly when he pegged December 2005 as the peak year for global oil production, but I am convinced by his geologist's logic in predicting a long-run decline in oil production from conventional sources in the near past or the not-too-distant future. (I highly recommend "Beyond Oil" for its solid summary of the geology behind peak oil and its level-headed assessment of other energy sources.)

Climate Change Poses Serious Risks to Insurers and Insured

Trend: Insurance costs for areas vulnerable to the effects of climate change will rise significantly while green buildings and renovations may get discounts.

GreenBiz News describes a new report that says the insurance industry should do more to address the growing impact of climate change-induced damages.

Link: GreenBiz News | Climate Change Poses Serious Risks to Insurers and Customers, Says Report.

The report, the first of its kind in the U.S., examines the latest scientific findings about climate change, specifically on forest fires, storms and floods, and the potential impact on the insurance industry and its customers.

The study, Climate Change and Insurance: An Agenda for Action in the United States (download - PDF), was issued by Allianz Group, one of the largest insurance providers in the world with operations throughout the U.S., and World Wildlife Fund (WWF), a leading conservation organization.

As detailed in the report, climate change has the potential to significantly alter and intensify destructive weather patterns in the U.S., leading to increased flooding, forest fires, and storm damage. The most direct risk to the U.S. will likely come from hurricanes, which are expected to become more frequent and powerful.

Additionally, rising sea levels over the coming decades could inundate many U.S. coastal cities, and portions of some coastal states. Forest fires could become even more frequent and larger. These changes could make insurance unaffordable for customers in high-risk areas. In fact, insurance premiums in states vulnerable to hurricanes are already increasing, and in some cases, insurers are exiting these markets altogether.

The report provides several concrete recommendations for addressing the potentially adverse consequences of climate change in the U.S. One key recommendation is for both governments and insurance companies to help correct market distortions and communicate appropriate signals to homeowners, businesses, and consumers moving into high risk areas. The report points to the need by regulators to consider carefully the impact of programs like the National Flood Insurance Program, which keep insurance rates artificially low. By masking the real price of risk, such policies encourage overdevelopment in high risk areas.

In addition, the report suggests U.S. insurers begin incorporating future potential climate change impacts such as continued sea level rise and longer fire seasons into planning, rather than relying only on historical data of past weather events.

The report also recommends that insurers influence land use development and planning in high risk areas. For example, conserving coastal mangroves provides a natural buffer from storms, surges and waves; forest preservation can reduce mudslides. Another way to minimize losses related to climate change, the report says, is to promote storm-resistant and energy- efficient building materials, improved building codes, and better public education about their benefits. "This emphasizes the win-win opportunity for customers presented by energy efficient buildings that also incorporate state-of-the-art protection against wind damage, fire, and water influx," says Booth.

Fireman's Fund Insurance Company, a unit of Allianz AG (Charts), this fall plans to introduce commercial insurance policies designed to support and encourage the development of "green" buildings that save energy and reduce emissions of greenhouse gases. One of the products will provide a discount to LEED (Leadership in Energy and Environmental Design) or Green Globes certified buildings. A second commercial property product will upgrade customers to energy efficient or "green" products when replacing damaged items such as roofs, windows, equipment, lighting systems and hot water heaters. Finally, a third product will provide commissioning coverage to inspect systems such as HVAC after installation for proper installation and efficiency.

In line with the report's recommendations, Allianz is taking several actions to help develop solutions for its customers and the industry as a whole. These include investing $600 million in renewable energy projects over the next five years, introducing a new tool based on Google Earth in the U.S. to help customers better manage their exposure to natural catastrophes, and cutting its own greenhouse gas emission by 20% by 2012. In light of the report's findings, Allianz is also planning to begin developing new products that address global warming and will start researching ways to integrate the anticipated potential future impacts of climate change into its risk models.