Problems with "cap and trade"

http://www.npr.org/templates/story/story.php?storyId=123037162

While the US Congress is still wrangling over the implementation of a "cap and trade" market in the US (and its passage through the Senate is doubtful), it is already up and running in Japan, New Zealand, and the EU. So for Obama to claim at this week's State of the Union that the US is "leading" the effort to curb climate emissions is just hysterical. Those other nations pollute far less than us per capita, and are at least a decade ahead of us in terms of emissions management. For the record, Obama's actual quote was, "[The US has] gone from a bystander to a leader in the fight against climate change." Maybe he meant to use the future perfect tense.

First implemented to curb acid rain and now used for CO2/methane after the UN Kyoto summit, the cap and trade system works basically by the government imposing pollution limits/credits on various emitters. If company X exceeds its quota, then it must buy unused credits from cleaner companies (on an emissions market), or "offsets" that neutralize their pollution overage with green initiatives (investment in a wind fam, tree plantings, etc.). The global climate market is now worth $150B, and emissions offset certificates are the fastest-growing commodity in history. A previous posting described how celebrated NASA climatologist R. Hansen is against this system, so I won't repeat his arguments (http://worldaffairs-manwnoname.blogspot.com/2009/12/top-climate-scientists-slams-copenhagen.html).

Markets do have the ability to maximize wealth/efficiency, reveal true value, and improve conditions for millions of people, and they have in the past. But we also know that markets can degenerate into giant scams that benefit the super rich and those privy to extra information. Ironically, the corporate sector is at odds about America's involvement in global cap and trade. The energy industry is of course fiercely opposed (and has spent millions on ads and lobbying Washington), but Wall Street was actually disappointed that Bush pulled us out of Kyoto. They have lobbyists on the opposite side of the climate debate pushing for America's participation in the emissions market. Each day Congress stalls, they miss out on a ton of easy money, even more than what is being made at the current London-based climate exchange. Already Goldman, JPMC, Citi, Bank of America, Barclays, and others have trading desks there. 2 major entities are being traded: climate offset resources/credits and speculative derivatives based on carbon futures, with the latter just being a gambling hall for the price of carbon, similar to currency markets. Brokers and polluters are scouring the globe to find potential "green" projects that could qualify as carbon offsets to be sold to the highest bidder.

You can see that there are two major problems associated with the system. The first is inaccurate measurement/pricing, and the second is turning a "promise" into a tangible commodity. For the first, how do you accurately measure carbon emissions, avoid fraud/tampering, and decide how much pollution is tolerable by various industries? I believe the EU erred on the conservative side and flooded the market with too many emissions credits, thereby depressing their value. And how do you calculate if a solar farm in the Mojave Desert is offsetting a coal plant in Napoli? The UN, which manages the market under the Kyoto protocols, relies on "validation" companies to audit emission valuations (like how S&P or Moody's rate stocks). These companies assess the various polluters and offset projects, and assign appropriate emission values. But the UN actually had to take the 2 largest companies offline after investigations showed that they lacked sufficient expertise and quality control to make accurate assessments in 50% of their studies (accounting for 1/4 of the total market). The UN determined that some carbon offset projects were inflated at 15-35% higher CO2 savings than what they could reasonably provide. And in fact, that percentage probably holds true for the overall EU carbon market as well. Call it the carbon bubble.

Second, commodities markets rely on certain delivery. When you buy oil or pork bellies futures, you know you will receive ownership of those products at the amount, price, and time you agreed on. But carbon futures are promises and assumptions. Speculators buy offsets that claim to save X tons of carbon over Y months. But wouldn't it make more sense to buy and sell carbon savings that has already happened for sure? I will buy the 2009 carbon savings from this geothermal plant for Z dollars to offset my 2010 pollution overage. Some of the proceeds will go to fund future green projects, which in turn will be sold on the market AFTER they have delivered their climate benefits. What if your wind farm is sabotaged by rebels, or a storm wipes out your newly planted forest, or your resource doesn't even get built (since most offsets are not finished at the time of sale)? Since many offset projects are in undeveloped areas, there is less security and oversight. You already paid for the offsets and the government expunged your pollution, so contract-wise everything is fine. But the planet doesn't get the emissions savings it was promised.

If we really want to efficiently limit emissions, we first need a carbon tax, and then some elements of cap and trade can work properly. Because cap and trade on its own creates a huge, expensive, confusing bureaucratic infrastructure to manage. Half of the effort is wasted on upkeep and middle men each taking their cut. But if we had perfect information about pollution and offsets, as well as perfect pricing and monitoring, then of course the market would work. But all the corruption problems plaguing Wall Street also exist for cap and trade, though with less oversight resources and less institutional knowledge for the latter.

http://www.rollingstone.com/politics/story/31633532/as_the_world_burns
http://www.pbs.org/frontlineworld/stories/carbonwatch/
http://www.harpers.org/archive/2010/02/0082826