Carbon Credit Watch

Carbon market may turn subprime, says expert

(May 3, 2010) The carbon market may suffer a fallout similar to what happened recently to the subprime market in the United States.

For a closer look at what could happen to the emerging carbon market, look no further than the recently collapsed subprime market in the United States. According to Sophie L’Helias, a corporate governance expert, if we fail to fully understand the carbon market, we run the risk of replaying the recent subprime crisis—except this time, on a global scale.

L’Helias, writing in Corporate Knights, says the expected growth in value of the carbon market—potentially reaching $3-trillion by 2020, making it larger than the subprime market and hedge fund industry in 2008—should be a warning sign for regulators, as it’s collapse would be felt in markets around the globe.

One problem, in particular, is the global nature of the carbon market—making any sort of effective regulation incredibly difficult, says L’Helias.

Another problem is the difficulty in tracking carbon credits—tracing them back to a specific issuer or even to a country of origin. Unlike traditional commodities, L’Helias argues, there is no tangible product. Instead, investors are buying proof that somewhere in the world, someone has agreed not to produce carbon.

A recent scandal in Europe highlighted this problem. Officials in Hungary, after receiving spent carbon credits from domestic CO2 emitters then sold the used credits—some 1.7 million for nearly 20 million Euros—in the expectation that they were going to a buyer in Japan for re-use by Japanese firms to meet that country’s imminent carbon cap-and-trade regulations.

But the carbon credits eventually made their way back to Europe, where they were considered worthless by investors who discovered they were holding “spent” credits. The ensuing melee cast doubt on the authenticity of all carbon credits and caused the European carbon credit market to shut down for three days. In an email to Probe International, the European Climate Exchange says the European Commission has since adopted legislation to prevent the problem from reoccurring.

Fraud has also plagued the market. Forensic auditors Deloitte, and the EU law enforcement agency Europol have been warning that carbon trading markets are “a fraudster’s dream come true” because they deal in an “intangible commodity”—CO2. Last year, European authorities admitted that 90% of the carbon trading volume occurred for the purpose of value-added-tax fraud.

Yet these problems, among others, haven’t scared away major investors on Wall Street. “In the past three years,” L’Helias writes, “Morgan Stanley, Goldman Sachs and JP Morgan Chase, to name a few, have developed, acquired or partnered with businesses that are responsible for issuing, registering, auditing, rating, inspecting, certifying or trading carbon rights.”

“Some banks have even created carbon banks that accept carbon rights as collateral.”

L’Helias warns that the interest of major Wall Street players in carbon markets could potentially turn the carbon industry into a “formidable money machine,” riddled with exotic financial instruments that would help create a trillion dollar shadow market.

But there are more participants in carbon markets than just big Wall Street firms—ordinary consumers are also being drawn in too. Citing a report by the David Suzuki Foundation, L’Helias says more than 140 carbon brokers and retailers are now selling carbon offsets online to consumers interested in offsetting their carbon footprint for activities such as flying, electricity consumption, and film projects.

That is disquieting, says L’Helias because the growing carbon consumer industry is even more opaque than the carbon financial industry.

“There are few if any consumer standards to market these products, verify how the investments in green projects are made, whether they are effective in reducing carbon emission or whether these projects actually exist,” she writes.

A recent investigation by the Christian Science Monitor and the New England Centre for Investigative Reporting showed that the market for voluntary carbon credits has been selling credits backed by empty promises rather than tangible environmental benefits.

According to the investigation, the carbon market has become a haven for middlemen of green schemes “that range from selling protection for existing trees to the promise of planting new ones that never thrive.”

L’Helias argues that without a proper regulatory foundation, the emerging carbon market could create a carbon bubble that would destroy the public’s trust in market-oriented methods to reduce greenhouse gas emissions, or to solve other matters of public policy.

But the real problem, says Patricia Adams, the Executive Director of Probe International and a carbon market watchdog, is that carbon markets are not real markets.

“Carbon markets are political constructs promoting the exchange of a ‘credit’ that has no value beyond the PR value in the permit,” she says. Trading in an intangible product without inherent value to either buyer or seller means that the market will be virtually impossible to regulate. That is the true source of instability in this so-called “market” says Ms. Adams.

Meanwhile, she adds, the collapse of a multi-trillion dollar carbon market should not reflect badly on real markets that can, and do, provide a means to exchange the risks and rewards of products and services between the buyer and seller.

Brady Yauch, Probe International, May 3, 2010

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