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Where information is effectively infinite, intelligent people will be involved in a Darwinian struggle to be heard above ... [hover]
- Michael H Goldhaber

Articles filed under 'Environment'

Intelligent Financial Engineering

One of the main failings of much (most?) mainstream reporting and commentary on financial markets and financial services is that all too often it reduces the issue to a black or white caricature of the reality. Absolutist headlines are more compelling I guess… And at the risk of sounding elitist, I suspect that too many journalists writing on the subject of financial derivatives and financial engineering more generally, are not sufficiently comfortable with the subject to form more nuanced analyses. It must also be said that ‘Wall Street’ has been content to perpetuate the aura of mystery that surrounds derivatives; this attitude was a natural consequence of their traditional business model which was predicated on information arbitrage – aka ‘knowing more than your customers.’

I have to admit, I can understand why – given the egregious behavior of so many ‘financial engineers’ over the past 5 years or so, and the very real and unfortunate consequences now being borne indifferently by guilty and innocent alike – the public might rally around the pitchfork journalists and the witches’ coven they claim to expose. And my frustration is aggravated as this reminds me that through their reckless actions, a bunch of greedy, cynical, cowardly so-called professionals have put in peril the very real and tangible benefits modern financial technology can bring to the global economy and human society; something I passionately believe in. Think of the jerks you knew when you were a kid: the ones that didn’t know when to stop, the ones that pushed until the adults were forced to intervene, the ones that ‘ruined it for everyone else’. (I suspect it’s not just a metaphor: it wouldn’t surprise me if many of the worst offenders were these kids growing up…)

And so, given this context, I hope you’ll understand why I was especially heartened when I read about JPMorgan’s simple but innovative use of carbon derivatives to drive sales of more efficient cooking stoves in east Africa:

JPMorgan (JPM, Fortune 500) is quietly pushing the boundaries of the carbon market – a sprawling international experiment to reduce the greenhouse gases that cause global warming – by subsidizing the distribution of efficient cooking stoves in poor countries. Because the new, improved stoves save fuel and produce less carbon dioxide than traditional stoves, they generate so-called carbon credits that can be sold to companies or individuals who want to offset their own emissions.

The business is complicated, controversial and potentially very profitable.

How profitable? If all goes according to plan, JPMorgan will expand its support for cook stoves from Uganda into Kenya, Ghana, Cambodia and beyond. Each stove is estimated to reduce carbon dioxide emissions by two to three tons a year; each ton generates a credit worth $10 or $15 a year, and potentially more, for the bank.

“If you can distribute 10 million stoves, you are talking about a substantial tonnage of carbon,” says Odin Knudsen, who oversees JPMorgan’s carbon finance business. Do the math – you could be looking at a business with modest costs and between $200 million and $450 million a year in revenues.

But even here we run into the biases I highlighted above – “…complicated, controversial…” How? Why? Completely unsubstantiated. But I suspect most readers will read this and involuntarily nod their heads in agreement, conditioned to accept these assertions as given. Complicated? The author misses the irony, given that within the article the trade is succinctly and accurately described. I suspect most readers understood. Controversial? How so? To whom? The author fails to back this up with any real evidence or even a compelling example of what could go wrong. (Even though there are a few fairly obvious ways such an initiative could ‘go off the rails’, that would be worth reporting.) I assume it is just a knee-jerk assumption that any big bank making money from poor people is doing something evil.

Putting that meta-analysis aside…what a great initiative. While only scratching the surface, this kind of transaction is typical of what I believe we will see more and more of as we move to the sixth paradigm. The really exciting part is how this illustrates what is possible when you start to marry global financial markets to local, micro-economic outcomes. Take it one step further and you can start to provide credit secured on individual carbon allowances, to finance efficient capital investments. Or imagine not just selling a stove, but a fix-price fuel contract in tandem. And where the stoves are used for heating, embedding weather derivatives in the contract as well.

I hope they have much success with this initiative. I look forward to hearing more about it in the next few years (and maybe getting involved in some way…) I just hope the individuals at JPMorgan driving this project weren’t those immature jerks in high school! ;)

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