From the January 01, 2007 issue of Futures Magazine • Subscribe!

Patrick Weber: The Strategy of Carbon

“Trading is a lot like chess,” says Patrick Weber, 27, who runs the greenhouse gas emissions books for Dresdner Kleinwort out of London and is one of the world’s first full-time emissions traders. “You follow your own strategy, but also need to adjust it once you realize what your opponent is doing.”

A case-in-point: the massive plunge in the price of European Emission Allowances (EUAs) that took place in April 2006, after it became clear that European polluters obligated to reduce their emissions under the European Union Emissions Trading Scheme (EU ETS) had beaten their targets and would not have to scramble to buy EUAs on the EU ETS.

“Most analysts projected a shortage in the market,” he recalls. “We also figured prices should be above €25 (25 euros per ton of carbon emissions), and depending on fuel switch opportunities even up to €35, so when the market slid from €28 to €26, I held my long position.”

But then he saw the order flows from German industrials.

“These guys had been one of the biggest net longs in the market,” he says. “But they were selling their length in big size.”

So he began selling as well, becoming short while the market was still above €25. Prices eventually bottomed out below €10.

Since then, he says order flows have been his trustiest indicator. “If I don’t see these huge shifts in order flow, like we had then, I rely on fundamental analysis: the sentiment in the market, industrial growth, business confidence, or GDP growth or the direction of other energy prices like oil, gas, coal and power.”

Weber came to the markets via banking starting in 2000 with an apprenticeship at BB Bank in Cologne, and then moving to a work-study program sponsored by Dresdner Bank in Frankfurt, where he was able to complete a Bachelors of Business Administration at Frankfurt’s Business School for Finance & Management (HfB, Hochschule für Bankwirtschaft).

He first heard of carbon trading shortly after wrapping up a four-month stint with the bank’s quantitative department in New York. “I was looking for a subject for my graduate thesis, and figured why not take a look at emissions trading,” he says.

The bank was already active in the forward market for emissions trading and Weber was able to pick the brain of Ingo Ramming, who heads the project. The result was: A Market for Emissions Certificates — Frameworks, Price Drivers and Trading Instruments. “I submitted it in November 2004 and by the end of December the hybrids desk manager asked me to start trading a book on carbon emissions.”

The exotics and hybrids group traded a portfolio of currencies, interest rate products and weather derivatives. “Carbon was seen as a way of diversifying the portfolio,” he says.

Weber spent the early months of 2005 establishing trading relationships, but by May emissions were hot. “From April 2005 it was a full-time job to run the carbon emissions books, and the telephone was ringing without me doing anything.”

The orders were mostly from the buy side — meaning the bank had to be short to make a market. “We basically had to take risks to get the business on our books,” he says. “The value we added was that we could always show prices to our clients in a fairly illiquid market and even do that for bigger size – up to five or 10 times the volume in the broker market. If we found our risk getting too high, we would check the market and see if we could lay off some of it.”

As more banks entered the market, spreads narrowed and liquidity improved.

The bank adopted a policy of making a market by grabbing any cheap offers that showed up and being able to sell when large players needed to buy in quantity. “This paid off as the price went higher and higher.”

In the middle of 2006 Dresdner shifted carbon trading to the energy trading group and Weber moved to London. “We’ve already integrated emissions trading into our oil trading activities and will further integrate it into electricity, coal and gas trading.”

Since the beginning of 2006 he’s been focusing on developing a book on Certified Emission Reduction (CER) certificates, which are credits generated from audited clean energy projects in the developing world that have delivered certifiable reductions in emissions. European companies can use the reduced emissions to offset emissions or an investor can fund such projects and sell the CERs into the EU ETS.

“This stage of the CER market can be compared to the EUA market just two years ago when people were negotiating standard documentations,” Weber says.

And this time around, you can bet the phones will be ringing off the hooks as well.

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