Across Uganda, thousands of women warm supper over new clay-and-metal stoves. The US$8 ($11) pots burn about two-thirds as much charcoal as the open-fire cooking typical of East Africa, where forests are being chopped down in the struggle to feed the region's 125 million people.
More than 6000km away, at the Charles Hurst Land Rover dealership in southwest London, a Range Rover Vogue sells for £90,000 ($207,000). A blue windshield sticker proclaims that the petrol-powered vehicle's first 45,000 miles (72,420km) will be carbon neutral.
That's because Land Rover is helping Ugandans cut their greenhouse gas emissions with those new stoves.
These two worlds came together in the offices of Blythe Masters at JPMorgan Chase & Co. Masters oversees the New York bank's environmental businesses as the firm's global head of commodities. In 2007, JPMorgan brokered a deal for Land Rover to buy carbon credits from ClimateCare, an England-based group that develops energy-efficiency projects around the world. Land Rover is using the credits to offset some of the CO2 emissions produced by its vehicles.
For Wall St, these kinds of voluntary carbon deals are just a dress rehearsal for the day when the United States develops a mandatory trading programme for greenhouse gas emissions. JPMorgan, Goldman Sachs and Morgan Stanley were among those watching closely as 192 nations gathered in Copenhagen this week to try to forge a new climate-change treaty that would, for the first time, include the US and China.
Those two economies are the biggest emitters of CO2, the most ubiquitous of the gases found to cause global warming. The Kyoto Protocol, whose emissions targets will expire in 2012, spawned a carbon-trading system in Europe that the banks hope will be replicated in the US.
The US Senate is debating a clean-energy bill that would introduce cap-and-trade for US emissions. A similar bill passed the House of Representatives in June. The plan would transform US industry by forcing the biggest companies to calculate how much CO2 and other greenhouse gases they emit, and then pay for them.
Estimates of the potential size of the US cap-and-trade market range from US$300 billion to US$2 trillion.
Banks intend to become the intermediaries in this fledgling market. Although US carbon legislation may not pass for a year or more, Wall St has already spent hundreds of millions of dollars hiring lobbyists and making deals with companies that can supply them with "carbon offsets" to sell to clients.
JPMorgan, for instance, purchased ClimateCare last year for an undisclosed sum. This month it paid US$210 million for EcoSecurities Group, the biggest developer of projects used to generate credits offsetting government-regulated carbon emissions. Financial institutions have also been investing in alternative energy, such as wind and solar power, and lending to clean-technology entrepreneurs.
The banks are preparing to do with carbon what they've done before: design and market derivatives contracts that will help clients hedge their price risk over the long term. They're also ready to sell carbon-related financial products to outside investors.
Masters says banks must be allowed to lead the way if a mandatory carbon-trading system is going to help save the planet at the lowest possible cost. And derivatives related to carbon must be part of the mix, she says. Derivatives are securities whose value is derived from the price of an underlying commodity - in this case, CO2 and other greenhouse gases.
"You can't have a successful climate policy without the heavy, heavy involvement of financial institutions," she says.
As a young London banker in the early 1990s, Masters was part of JPMorgan's team developing ideas for transferring risk to third parties. Among the credit derivatives that grew from the bank's early efforts was the credit-default swap (CDS) - a contract that functions like insurance by protecting debt holders against default. Last year, after US home prices plunged, the cost of protection against subprime-mortgage bond defaults jumped. Insurer American International Group, which had sold billions in credit default swaps, was forced into government ownership, helping trigger the worst global recession since the 1930s.
Now, that story - and the banks' wider role in the credit crisis - has become central to the US carbon debate. Washington lawmakers are leery of handing Wall St anything new to trade because the bitter taste of the credit debacle lingers. And their focus is on derivatives. As well as credit default swaps, the most notorious derivatives are collateralised debt obligations or CDOs - bundles of mortgages and other debt that were sliced into tranches and sold to investors.
"People are going to be cutting up carbon futures, and we'll be in trouble," says Maria Cantwell, a Democratic senator from Washington state. "You can't stay ahead of the next tool they're going to create."
Cantwell last month suggested that US state governments be given the right to ban unregulated financial products. "The derivatives market has done so much damage to our economy and is nothing more than a very-high-stakes casino - except that casinos have to abide by regulations," she said.
In carbon markets, many of the derivatives would be futures, options and swaps that would allow a company to lock in a price for carbon, as it would for any other commodity related to its business, Masters says. Such derivatives are negotiated every day by airlines trying to guarantee future prices for jet fuel and by farmers setting a future price for their crops. A large, liquid market in carbon credits would serve to keep their price low, JPMorgan says.
"The reason why this is important is not because it's going to create a new forum for us to buy and sell; it's because the scale of what's being contemplated here is absolutely enormous," Masters says. "It's going to affect your kids and my kids. The worst thing would be to introduce legislation that doesn't achieve the environmental goal; that would be a crime of epic proportions."
Michelle Chan, a senior policy analyst in San Francisco for Friends of the Earth, isn't convinced. "Should we really create a new $2 trillion market when we haven't yet finished the job of revamping and testing new financial regulation?" she asks.
Chan says that, given their recent history, the banks' ability to turn climate change into a new commodities market should be curbed. "What we have just been woken up to in the credit crisis - to a shocking degree - is what happens in the real world," she says.
Even George Soros, the billionaire hedge fund operator, says money managers would find ways to manipulate cap-and-trade markets.
"The system can be gamed," Soros said at an economics seminar in July. "That's why financial types like me like it - because there are financial opportunities."
Masters says US carbon markets should be transparent and regulated by the Commodity Futures Trading Commission (CFTC). Standardised derivatives contracts - securities that can be bought and sold by anyone - should be traded on exchanges or centrally cleared, she says.
In a US cap-and-trade market, the Government would allot tradeable pollution permits, called allowances, to emitters of CO2 and other greenhouse gases. The market would also probably include offsets - credits generated by companies such as EcoSecurities that would have to demonstrate to US agencies that the offsets really do mitigate pollution.
Point Carbon, an Oslo-based firm that analyses environmental markets, estimates that by 2020 the US carbon market could surge to more than US$300 billion.
That's based on an assumption that the allowances, each representing a ton of carbon dioxide taken out of the atmosphere, would trade for US$15. Bart Chilton, a commissioner of the CFTC, which would probably be one of the regulators of the carbon market, says it could grow as large as US$2 trillion.
As they wait for a US cap-and-trade system, the big banks are busy building, not trading. Goldman Sachs, for example, has fewer than 10 traders dedicated to carbon around the world.
"Carbon right now is not about sitting in front of a screen and clicking," says Gerrit Nicholas, Goldman's head of North American environmental commodities.
"It's all about running around talking to clients about what they can expect, how big it can be and what their risk is."
Abyd Karmali, who heads global carbon emissions at Bank of America Merrill Lynch in London, says companies, banks and investors are all watching Congress.
"A lot of people are focused on Copenhagen, but what happens in Washington on federal cap-and-trade is, arguably, more important," says Karmali, who is president of the Carbon Markets and Investors Association, an international trade group.
"This market is still in its very early stages. US cap-and-trade would make an order of magnitude of difference."
Although President Barack Obama and his economic team support cap-and-trade, Washington politics could defeat it.
The House bill passed in June by just seven votes, and senators on both sides of the aisle worry that imposing pollution caps on industry will result in higher energy bills for consumers at a time when US unemployment tops 10 per cent.
US cap-and-trade, as currently configured in both the House and Senate bills, would mean the Government sets an upper limit on emissions of seven greenhouse gases, including CO2, methane and nitrous oxide, for thousands of power plants, refineries and factories. Over time, the caps would fall, pushing emitters to adopt clean-air technology.
The Government would give some free pollution allowances to companies to help them meet their caps during the first years of the programme. Emitters that invest in cutting their pollution would have allowances to sell; those that don't would have to buy.
The allowances - similar to those that sold in Europe in mid-November for €13.50 ($28) - would be tradeable on an exchange or, if Congress allows it, between parties in an over-the-counter market. Companies would account for carbon in long-term strategic plans, bankers say.
For instance, utilities such as American Electric Power, which produces power from coal, would hedge the price of carbon over periods of a decade or more. The company is the biggest US greenhouse gas emitter in the Standard & Poor's 500 index, according to the London-based Carbon Disclosure Project. Companies like AEP would retain financial institutions to come up with customised derivatives contracts to help them manage their risk.
Derivatives contracts designed for a particular company or transaction, known as over-the-counter (OTC) derivatives, are a hot-button issue in the larger debate over how the US banking system should be regulated.
Most credit default swaps and collateralised debt obligations are OTC derivatives. They are created and traded privately - not on any exchange - and can be illiquid and opaque, says Andy Stevenson, a financial analyst for the Natural Resources Defence Council, an environmental group that supports the Senate legislation. The House cap-and-trade bill bans OTC derivatives, requiring that all carbon trading be done on exchanges.
The bankers say such a ban would be a mistake. Over-the-counter derivatives are a US$600 trillion market, much of which consists of interest-rate swaps designed to hedge risks for individual companies. "It's a concern of ours if they limit the market," says Pat Hemlepp, a spokesman for AEP. "It reduces the options when it comes to cap-and-trade. We do feel it's best to have banks and other parties able to participate."
The Senate environment bill, dubbed Kerry-Boxer for Senators John Kerry of Massachusetts and Barbara Boxer of California, the two Democrats who introduced it, contains little detail on how the cap-and-trade market would work. It sets a price floor of US$11 per ton on carbon. The bill also creates a strategic reserve of allowances that the Government could use to flood the market if the price of carbon shoots up.
"It will be the best-regulated market in the country," Stevenson says. "The effort is to make all of the trading known to the regulator. That wasn't the case in the mortgage market."
Wall St sees profits at every stage of the carbon-trading process. Banks would make money by helping clients manage their carbon risk, by trading carbon for their own accounts and by making loans to companies that invest to cut greenhouse gas emissions.
A clear US price on carbon, determined in a large market, would help drive billions of dollars into investments to clean the air, says Richard Sandor, founder and chairman of the Chicago Climate Exchange and the Chicago Climate Futures Exchange. He is also the principal architect of the interest-rate futures market.
"What's important is the price signal," Sandor says. "It will stimulate inventive activity and cause behaviour to change." The Chicago Climate Exchange, the biggest US voluntary greenhouse gas emissions trading system, trades 180,000 tons of carbon a day, up from 40,000 tons in 2006.
Over time, carbon, like other commodities, needs markets linked around the world, Goldman's Nicholas says.
"If you believe the science and that something needs to be done, the market probably needs to be big," he says. "Carbon could become an important commodity. I'm not saying it will be bigger than others, but it will be another important business for us."
Critics, including Senator Cantwell, see a smaller, simpler market in which pollution permits would be publicly exchanged only among fossil-fuel producers. Such a system may block progress on the environmental goals, says JPMorgan's Masters.
"We say, 'Let's incentivise people to have the lowest-cost opportunities to avoid carbon emissions,"' she says.
Friends of the Earth's Chan is working hard to prevent the banks from adding carbon to their repertoire. She titled a March FOE report Subprime Carbon? In testimony on Capitol Hill, she warned: "Wall St won't just be brokering in plain carbon derivatives - they'll get creative."
Carbon isn't like other commodities, Chan says. The Government's goal to reduce pollution means it will gradually reduce the number of allowances it issues, and that will be a powerful incentive for speculators to try to corner the market and drive up the price.
While banks say they're a long way from packaging securities from environmental credits now, Chan points to two deals that Zurich-based Credit Suisse Group completed in 2007 and 2008 that each combined more than 20 different offset projects, then sliced them into tranches and sold them to investors. The securities were the equivalent of carbon CDOs, Chan says.
Chan has an ally in hedge fund manager Michael Masters, founder of Masters Capital Management, based in the US Virgin Islands. He says speculators will end up controlling US carbon prices, and their participation could trigger the same type of boom-and-bust cycles that have buffeted other commodities.
In February 2009 House testimony, Masters - who is no relation to Blythe Masters - estimated that the early 2008 price bubbles in crude oil, corn and other commodities cost US consumers more than US$110 billion.
The hedge fund manager says banks will attempt to inflate the carbon market by recruiting investors from hedge funds and pension funds.
"Wall St is going to sell it as an investment product to people that have nothing to do with carbon," he says. "Then suddenly investment managers are dominating the asset class, and nothing is related to actual supply and demand. We have seen this movie before."
Still, companies need the financial markets to help them drive down their greenhouse gas emissions at a reasonable price, says the NRDC's Stevenson. "There are trillions of dollars needed to make this transition, and companies need the banks," says Stevenson, a former trader for a London-based hedge fund firm.
Stevenson dismisses as overblown the concern that banks will soon be packaging greenhouse gas allowances into securities that look like CDOs.
The banks stand to make more money, he says, as lenders to companies that need to invest in new power plants and factories to reduce their emissions. "I would argue that this is only a bonanza for the banks in that they get to go back to their day jobs - which is lending money," Stevenson says. "I'm suspect of them generating a lot from carbon trading itself in the early years."
A relatively small-scale cap-and-trade effort called the Regional Greenhouse Gas Initiative tells a cautionary tale. The RGGI is a CO2-reduction programme established by a group of northeastern and mid-Atlantic states in 2003 with a goal of cutting CO2 emissions from power plants in the region by 10 per cent by 2018. Ten states are now members.
Trading in the companies' pollution permits began in September 2008 - in the middle of the financial crisis. As of the middle of last month, prices of the pollution permits were down 50 per cent, according to data compiled by Bloomberg.
Meanwhile, the 10 best-performing investment funds with climate change or clean energy as a central goal all plunged 40 per cent or more in 2008, according to data compiled by London-based New Energy Finance. The shrinking global economy sapped momentum for developing new environmental projects.
"To mobilise capital now and begin a transformation to new energy technologies is a very risky business," says Ken Newcombe, founder of C-Quest Capital, a Washington-based carbon finance business that invests in offsets.
"Returns have to be reasonable to take on those risks."
Newcombe is the former head of Goldman's US carbon market origination and sales department and one of the world's first carbon traders. Private money, including capital from banks, hedge funds and other investors, must keep flowing into the system to realise global environmental goals that the Copenhagen meetings will try to hash out, he says.
"The ultimate objective is economic efficiency," Newcombe says. "How can we reduce the cost of implementing important public policy? Having a pool of risk capital is absolutely vital to the smooth introduction of a cap-and-trade regime in the US."
As Washington debates climate policy in the shadow of the recent financial meltdown, lawmakers have a right to be wary, Newcombe says.
"There's legitimate concern that there may be unseemly profits or untenable risks," he says. "But a problem now is that the critical objective of stabilising the financial system could lead to an overregulation of the carbon market." Meanwhile, the industrial firms that would be affected by cap-and-trade are eager for the game to begin, says Lew Nash, a Morgan Stanley executive director and the firm's US point person on the carbon markets.
"There is such a fog right now in terms of how the legislation is going to work," Nash says. "There is a real economic desire here for price signals that will permit the market to properly price carbon. Our customers have little choice but to participate in this evolving market."
Nash says his clients aren't just looking for help figuring out how to use carbon trading to manage their emissions caps. Pricing carbon will also set the tone for strategic investments. If a company wants to build a new factory, for instance, it's going to need to factor prospective carbon emissions into its construction and operational plans, Nash says.
Supporters of cap-and-trade see, over many years, a remaking of the US industrial landscape and a sharp reduction in the gases that cause global warming. Little will happen, though, until the debate is resolved between the bankers who want more liquidity and the lawmakers who demand more regulation.