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11 September 2017 Financial Analysts Journal Book Review

Energy & Emissions Markets: Collision or Convergence? (a review)

  1. Ashok Talukdar, CFA

This comprehensive, qualitative, global treatment of the issues surrounding environmental financial liabilities is a primer for assessing the evolution of market-based solutions for these liabilities, including discussion of the localized experiences of emissions trading to date, the legislation and policy-making agenda driving the development of pollution markets, and suppositions about the future of the markets.

Book Review Editor’s Note: Tom James is a former part-time employee of Deloitte Consulting, and the book’s foreword is written by a former executive of Deloitte & Touche USA.

British economist Arthur Pigou’s vision was for environmental costs and other externalities to be factored into economic activity. Financial markets are now making his vision a reality that will soon be widespread.

Whatever other trends follow upon the U.K.’s Stern Review on the Economics of Climate Change ( ), the phrase “environmental financial liability” is destined to be brought into as common usage as “pension liability” was before it. If the notion that industry is responsible for global warming begins to gain wide credence, the related financial liabilities can only expand. That development will increase the pressure on policymakers to assess whether free-market mechanisms, given their short history, can deal with the matter effectively.

The environmental financial marketplace appears to have reached a stage of development similar to that of the credit markets of 15 years ago—or the stage at which energy markets were perhaps 15 years before that. Localized trading arrangements have begun competing in earnest to service global participants with standardized contracts. Standardized derivatives documentation is now in place, and policymakers have clarified the agenda. It is only a matter of time until the first large environmental financial liability structure captures the imagination of an investment banking world that so far has only been tinkering with such things.

Energy & Emissions Markets: Collision or Convergence? is a handy primer for assessing the evolution of market-based solutions for environmental financial liabilities. Authors Tom James and Peter C. Fusaro describe the pioneering experience of emissions trading in the United States and the subsequent launch of Europe’s regime. The book includes a useful overview of the legislation and policy-making agenda driving the development of pollution markets. Although the authors provide few clues about how international differences may be resolved, they show beyond doubt the importance of parochial concerns as a major source of price risk.

James and Fusaro illustrate how emissions pricing has begun to affect energy prices in Europe and why the pricing of both energy and emissions now has industrywide consequences for profitability. Included is a clear explanation of the relationship between various fuels and the process by which a new commodity market matures, such as standardization of contracts.

The book also features an indispensable glossary of the endless acronyms and abbreviations accompanying the growth of these markets, grounded as they are in the language of financial derivatives, scientific units of measure, and various methods of policy implementation.

Readers who work in industry will find that Energy & Emissions Markets arrives at a particularly opportune time. It offers chief financial officers a context for the first two years of the EU’s Emissions Trading System (launched in 2005) and the unprecedented recent price volatility in carbon emissions contracts, to which their company cash flows will be ever more closely linked. CEOs will find the book useful for assessing the impact environmental financial liabilities have on their everyday commercial activities, customers, employees, and pensioners/retirees. Corporate managers and policymakers generally will find this book useful as the business world approaches a tipping point for deciding whether financial markets will achieve the necessary emissions reductions or will simply become a form of pollution trading that enriches only bankers and consultants.

The main strength of Energy & Emissions Markets is its comprehensive, qualitative treatment, in a global context, of the issues surrounding environmental financial liabilities. It lays the groundwork for subsequent texts that can apply quantitative and methodological rigor as the environmental financial market evolves and prepares us to assess whether emissions markets will collide or converge with energy markets. Arthur Pigou would have approved.


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