I’ve always been a big proponent of free trade and open markets; however looking at the mounting problems facing the US I can’t help but think that perhaps some level of protectionism may find its way into the nascent US carbon market. Indeed, the current global fears about potential protectionist policies in the US have resulted in a high degree of anxiety, but could a healthy level of protectionism be the key that accelerates a functional carbon market in the US – in spite of it’s detriments to broader trade?

Wholesale protectionism in free markets rarely works. During the Great Depression this was a favored strategy however today most economists agree that it was an ineffective – and damaging – position.  However now that we are descending into a deep economic hole the U.S. is again flirting with protectionism. The “Buy American” clause in the recent U.S. stimulus bill has generated much debate, and we may very well see similar restrictions on the burgeoning U.S. carbon market.

We are sitting at a time in history where the confluence of market developments may force the hand of the US into such policies. With its economic system in ruin and an unemployment rate approaching 8%, it’s fair to say times are desperate in the US. At the same time we are facing what I would call the most serious environmental challenge in human history. Unfortunately, we need to find a way in which all challenges can be met.

At the center of this issue is the allocations and projects that make up most functional markets.  Depending on the regulatory framework carbon reduction projects can make up 5-25% of some markets. But with internal pressures facing the new US administration we may see a drastic increase in this percentage in an effort to create jobs and stimulate the economy. Other markets restrict the percentage of foreign investment via CDM but the US may further increase restrictions on such investments and provide incentives to build reduction projects in America. This will surely upset China and India (who have the lion’s share of current global CDM projects) as much of the world’s CDM developers are waiting for (and banking on) the immense demand to be generated from U.S. cap and trade.

Of course this all remains to be seen, nobody has a carbon crystal ball.  But when it comes to carbon markets it’s difficult to see how the U.S. will be able to make good on its assurances to the global community that international trade will flow freely. When it comes to carbon markets, I certainly hope it does.

As my first post to out blogs, I thought I would communicate why we do what we do here at Carbonetworks. We see software as a uniquely scalable solution to the problem of climate change, helping organizations reduce their carbon impact while protecting – or enhancing – their bottom line.  Through a dedication to innovation  in software, we can uncover opportunity to help drive solutions to the most pressing crisis of our time.

A Unique Opportunity for Innovative Software Technologies

Technological advances in software and infrastructure can be extremely rapid, especially when compared to other, more capital-intensive sectors. This presents a large opportunity for software companies, especially startups.  Restricted budgets will narrow the niche for carbon management solutions, but will create a more competitive environment for successful companies.

The environmental software business has been around for some time and there is a lot of market focus on this area, so it is important to investigate what makes a company successful – or unsuccessful – in this market. Companies in the environmental software space have been around for decades, tracking everything from water pollutants to air contaminants and particulates. It has been an unglamorous market that has rarely seen the spotlight of other technologies such as online search, SaaS, or other innovations. Until recently, recognized IT analysts barely tracked the sector, and have at times described the sector as a “technology laggard” – and vendors have responded with relatively little innovation. Much like markets that have come before it, the highly competitive environmental software market is bottom-heavy with a focus on data acquisition and management. Translating this data to make sense to a CFO or CEO is no small task, and with flat-lining or shrinking revenues it is very difficult for the market incumbents to react to a rapidly changing market.

This market situation is hardly surprising as it has happened before. The problem exists when there are many vendors in a market providing specialized information that simply isn’t of strategic value to a client’s executive. Then something happens in the market to cast the CxO’s eye on that information in response to some outside stimulus. The most obvious analogy here is Sarbanes-Oxley, where companies of all sizes required executive visibility of even the most detailed data, from financial data to system performance and delivery metrics. What’s more, this shift in focus happened almost overnight. Companies in many areas of software, including financial software and systems management, rushed to fill the gap by building and acquiring solutions that could translate their vast amounts of data into a format for use in the boardroom. Entire software markets sprang up in direct response, such as business service management and  financial compliance vendors.

The similarities between today’s carbon software market and these earlier markets are evident, however the overall market conditions have changed. This can help us identify unsuccessful and potentially successful companies. One way market conditions have changed is the position of the incumbents themselves. In the dot-com area, the existing software vendors had significant access to capital, supported by incredibly high stock valuations and healthy balance sheets. The overall economy was growing at a rapid pace with no signs of slowing down. Once the shift in the market and the path to the new customer (i.e., the executive) was identified, incumbent software vendors could build or buy their way across the gap.

Today it’s not so simple, with an slowing global economy, increasingly noisy market, shifting pending regulations, understandably confused consumers, and vague demands from the market to make sense of it all, today’s incumbent environmental software vendors are not in an enviable position. Many of them are generalists and cannot react to quickly changing market development and regulations. Their lack of capital (and financial backing) prohibits them from bridging the gap via the familiar build-or-buy scenario. Many established vendors in this market are left to retool their marketing message or provide add relatively small feature enhancements to attempt to address their changing market. However in many cases this is insufficient to bridge the gap to their new customer, the executive.

This problem is not isolated to established vendors; startups are also feeling the squeeze of tightening global markets brought on by the global economic crisis. Some analysts estimate that 80% of all startups will fail in todays’ economic climate (before you investors rush to the exits, consider that similar success metrics existed prior to the current economic crisis). Like established vendors, financial health will be a significant determinant in the success of startups at this juncture. Companies with healthy revenues or solid financial backing are well positioned to take advantage of the current economic situation, and capitalize competitors’ difficulties. As in all market downturns, those with healthy balance sheets will find significant opportunity in the misfortune of others. Startups with a strong financial position should take the lead from Warren Buffet: opportunities abound in in tough financial times as cash-strapped competitors more towards the auction block. The key is being prepared and recognizing these opportunities before the bigger fish do. The successful startup will be aggressive, positioning itself to take advantage of key acquisitions and investment rather than weathering the storm.

Successful software companies must be able to change their products and services to more clearly articulate the relationships between carbon, finance, and opex. In this time of uncertain regulatory timelines, solutions need to show the value of both short- and long-term reduction projects, providing a wide range of scenario planning and forecasting tools to help with critical business decisions. Moreover, solutions must address all levels of investment risk within client organizations, providing tools for both risk-averse/low-yield and high risk carbon investment scenarios. Lastly, these solutions must be flexible enough to include both internal and external financial vehicles, such as CDM, JI, and bilateral projects. In this time of corporate accountability and disclosure, successful solutions will show the value of corporate carbon management and reductions to stakeholders, including shareholders and the public.

Implications for the Carbon Market

The carbon market has emerged as a critical component of the new global economy. The significant drivers will be regulation and technological innovation, however current economic conditions are already affecting the carbon market. We will see new opportunities and risks in light of the new economic situation but technologies that are better able to adapt and innovate will have a better chance of success. When you consider the additional criteria of strong financial backing, a healthy balance sheet, and an innovative product pipeline, the list of companies well positioned in the carbon market becomes very small. Regardless of the depth and scope of the current economic crisis it will be a very interesting time in the carbon market for the foreseeable future.