January 13, 2010
Deloitte Forensic calls it “the white collar crime of the future.” Kroll, a business risk subsidiary of Marsh & McLennan, the global professional services firm, calls it “a fraudster’s dream come true.”
These two global financial services firms are referring to carbon trading markets, a business that is estimated to explode from $132-billion in 2009, mostly in the European Union, to $3-trillion by 2020 as jurisdictions around the world join in carbon trading, part of the “cap and trade” system that governments are embracing.
Under cap and trade, companies need permits for the right to emit CO2 as part of their operations. The permits, in effect, guarantee that excess carbon emissions will be “offset” by third parties that will, for example, sequester carbon by growing trees. These permits, which are being traded on carbon exchanges, akin to stock exchanges, have caught the attention of law enforcement officers, who have seen an upsurge in fraud.
Says Chris Perryman of Europol’s Criminal Finances and Technology section in The Hague, in referring to the $7.4-billion in fraud that have occurred in the last 18 months in the EU’s carbon market: “It is clear that [carbon trading] fraudsters are fully aware of the potential that trading in intangible commodities has to further their ends. Such goods or services can be traded without the need to be physically moved or transported, which represents an obvious opportunity to frustrate Law Enforcement efforts to track and trace transactions.” So much fraud has been occurring that, Europol estimates, up to 90% of all carbon market volume in some EU nations was related to fraudulent activities.
Permits for CO2, a tasteless, colourless and odourless gas, epitomize an “intangible commodity.” The underlying commodity for these permits, CO2, until recently had few producers, few customers and few commercial uses. With the rise of fears over global warming, governments decided to turn this niche gas into what could soon be the world’s most traded commodity — by comparison, oil, currently the most traded commodity, logs an estimated $2-trillion in annual trade.
But unlike oil and other commonly traded commodities, CO2 is a commodity with no inherent value. Most transactions involving carbon permits involve parties that have no interest in the CO2 — the value lies in the permit. If no CO2 is actually offset, neither buyer nor seller would suffer a loss. The only incentive anyone has in dealing with this intangible commodity is in avoiding fines or suffering bad PR.
What kind of fraud do private auditors and law enforcement alike believe inevitable? Take the example of an Indonesian forest operator who provides a permit to a German manufacturer, to offset the German company’s excess CO2 emissions. The German company receives a certificate as proof that it has offset its emissions. It will be content, as will the Indonesian company that planted the trees. The German firm won’t know if the Indonesian has sold permits for the same forest to companies in Canada and the UK and it won’t care — the German firm, like the others, will think they have helped the planet by planting a forest and they will have obtained what their businesses need — a permit to continue operating. There are no identifiable victims. The only loser — if there is any — is the planet, and it won’t be blowing the whistle on this crime.
Because buyers and sellers will rarely have an incentive to police their carbon transactions, “tight, frequent, ongoing monitoring will be fundamental to the integrity of any cap-and-trade system,” states ClimeCo, a carbon consulting firm. Yet the likelihood of that occurring is next to nil because the regulators will be official bodies like the UN — think Oil-For Food Program, says Kroll. Moreover, governments themselves will balk at the cost that would be entailed in meaningful regulation. Because CO2 is ubiquitous in society, affecting most industrial processes, an army of inspectors and auditors would be needed to properly check the countless transactions that would occur to ensure that no company’s carbon footprint was understated, that every windmill contracted for in faraway lands was indeed built, that every meter measuring the flow of gas piped underground was recording CO2 and not air and that every seedling committed to be planted was planted.
Apart from phony projects — Kroll likens them to “the Soviet Union’s Potemkin villages built to show off a phony communal paradise to naïve foreigner visitors” — Kroll, in a report published last year in its Tendencias journal, tells us to expect companies to create entitlements for themselves by “pumping up the baseline,” say by pretending they have historically been emitting more greenhouse gases than in fact occurred, thus creating a government entitlement that they can then turn into cash.
Deloitte, in a report released last November, echoes such concerns, taking particular aim at problems likely to emerge under Australia’s Carbon Pollution Reduction Scheme, in which the country’s largest greenhouse gas emitters will be required to offset their carbon footprint. Says Deloitte: “even a cursory look at the global carbon market in its current form reveals some carbon credit fraud ‘red flags’ that simply cannot be ignored.”
Deloitte also warns companies to be on the lookout for the entry of organized crime into the Australian scheme, which is slated to take effect this year. “For example, a money launderer could use illegally obtained funds to purchase wind turbines for an offset project, especially those projects occurring in developing nations,” Deloitte explains. “The launderer would then seek reimbursement for the wind turbines from a company seeking to purchase carbon offsets.” In doing so, the launderer is able to use illegally obtained funds for legal purposes — concealing the wealth obtained from illegal activities.
In the final analysis, carbon markets are political constructs controlled by politically empowered regulators who will be gatekeepers to a multi-trillion dollar market. The regulators themselves would become too numerous to regulate. This then becomes the tried and true recipe for good old fashioned and widespread corruption.
Patricia Adams is an economist and executive director of Toronto-based Probe International.
Categories: Carbon Credit Watch