World’s Largest Derivatives Market – Subprime Carbon

Nathan Martin calls attention to the worlds largest derivatives market in the Carbon Cap and Trade system. He links to a great CNBC video on “The Carbon Challenge”, in which former Governor and DNC Chairman Howard Dean declares “I am terrified of a Bernie Madoff in the Cap and Trade business who is selling stuff that doesn’t exist”.

Let me be clear that I believe effective energy and carbon policy is the single most urgent and important matter for government to address. I fully agree with President Obama when he suggested on January 26 that ” no single issue is as fundamental to our future as energy. America’s dependence on oil is one of the most serious threats that our nation has faced. It bankrolls dictators, pays for nuclear proliferation and funds both sides of our struggle against terrorism. It puts the American people at the mercy of shifting gas prices, stifles innovation, and sets back our ability to compete.”

The problem is that his proposed solution – creating a Cap and Trade Carbon Derivatives market is a bad idea. Its another huge hand out to Wall Street rather than a clear, effective and transparent solution to the problems the President cites. What is really needed is a large very straight forward carbon tax. And such a tax should be coupled directly with an equal economy stimulating reduction of regressive taxes on employment or perhaps a simple cash payment to citizens such as that Alaska provided for all its citizens for years from the taxes it imposed on oil exports.

Michelle Chan, director of Friends of the Earth Green Investments and  author of a FOE report called “Subprime Carbon“, cautions that there are already 130 Wall Street funded climate change lobbyists in Washington. According to her report, “today speculators do the majority of carbon trading, and they will continue to dominate as carbon-trading markets grow.” The report further suggests that “unfortunately, the federal cap and trade proposals put forth so far would create a system that poses almost identical challenges as those in the mortgage-lending industry.”

According to Carbon Offsets Daily, the chairwoman of the Senate Energy and Natural Resources Committee’s energy subcommittee, Sen. Maria Cantwell, D-Wash has suggested that “I have serious concerns about how a cap-and-trade program might allow Wall Street to distort a carbon market for its own profits,”

In a recent presentation at Dartmouth College, famous NASA climate scientist James Hansen was unambiguous in declaring “Cap and Trade is Not Going to work……in Europe it has been completely ineffective.” He instead advocates a major carbon tax sufficient to give every American a several thousand dollar a year direct cash rebate, making his proposal the most progressive form of taxation.

Unlike the successful SOx and NOx trading markets, with limited sets of players and trading opportunities, along with relatively straight forward rules, the proposed carbon markets promise to measure and pay for all manner of hard to quantify “carbon offsets” and huge numbers of players.

US Commodities Future Trading Commissioner Bart Chilton is quoted by the Financial Times as predicting carbon markets would become ” the biggest of any derivatives product in the next four to five years. And that would of course mean overtaking T-bills [Treasury] and any contract that is out there right now.”

The real challenge is not just one of carbon market regulation, as most of government folks seem to see as a solution to the challenges posed by this staggeringly huge new derivatives market. Some of the most fundamental premises and definitions in the proposed carbon markets allow  hard to value and potentially questionable “offsets” that leave lots of room for abuse and manipulation.

Bloomberg reports that “under a cap-and-trade system, the federal government would set an overall ceiling, or cap, on greenhouse gas emissions. The cap would be divided into billions of emission permits, each conferring the right to emit the equivalent of one metric ton of carbon dioxide.” It goes on to state that in the administration’s budget plan, President Obama proposed to “auction all credits for carbon-dioxide emissions, raising at least $646 billion from 2012 to 2019 that would be used for a tax cut”.

But already some members of Congress are proposing to simply  give “free allowance allocation to the utility sector of 40 percent, consistent with the sector’s share of CO2 emissions.”  It would be interesting to track utility company campaign contributions relative to the supporters of this proposal.

Inevitably both at its inception and in inevitable continual tweaking of the rules, these kinds of artificially created markets will be subject to continual political pressure and manipulation.

The Bloomberg article reports that Jeffry Sterba, a former chairman of the Edison Electric Institute and the chairman of a major utility, pressed for free credits to utilities. He suggested that free permits for utilities are necessary because cutting greenhouse gases “will be costly and raise electricity prices substantially.” But the “problem” Sterba cites is precisely what is needed for clean solutions like solar, wind and other renewable energy resources to compete economically in the market and actually start addressing climate concerns in a serious way.

The theoretical benefit of Cap and Trade over a straight Carbon Tax like that proposed here and the Raise Wages, Cut Carbon Act proposed by Congressman Bob Inglis, is that Cap and Trade theoretically sets strict limits to carbon output, while Carbon Taxes very simply raise the price of carbon emitting activities and assumes that market forces in the real economy will provide appropriate carbon emission reductions.

The lack of clarity in the Cap and Trade Carbon markets could create the kinds of wild swings seen in Europe. The Wall Street Journal reports that in Europe, “prices for carbon permits have whipsawed from a high of 30 euros a ton to a low of 2 euros a ton.”

To address concerns about speculation, volatility and “cheating”, the Center for Clean Air Policy and several Democrats in Congress are calling for a “Safe Cap-and-Trade” with prices for carbon permits heavily regulated. Their faith in regulators overseeing unnecessarily complex government mandated  market interventions is typical of the divergence in thinking of those favoring Free Markets vs Intervention.

Most businesses and business oriented organizations generally favor a straight forward carbon tax, especially an economically beneficial and revenue neutral carbon tax offset by taxes on productive activity like job creation. With the “economic externalities” of fossil fuels more fairly accounted for with a straight forward tax, non carbon emitting solutions can compete more fairly in the real economy. With long term clarity and predictability on the price of carbon emission in the real economy provided by a clear and simple carbon tax, both businesses emitting carbon and those offering alternatives can plan around predictable real markets in the real economy.

The Carbon Tax Center offers a good summary of Carbon Tax vs. Cap and Trade.

Giving them the benefit of the doubt regarding regarding their good intentions, the thing the good government folks don’t seem to understand is that putting a price on carbon emission through a simple, clear straight forward tax will have a far more beneficial  impact on real carbon emissions in the real economy by spurring innovative solutions.  The creation of an artificial mandated market subject to endless regulatory manipulation and speculation that nobody can really trust can’t possibly reach the goal of carbon emission reduction nearly as well. What Governor Dean is most concerned with – “selling stuff that doesn’t exist” – pretty much sums up the very definition of mandated offset markets. It seems to me that in their insistence on the chimera of specific assured carbon emissions levels and theoretical predictability on future CO2 levels in the atmosphere, well intentioned environmentalists and politicians are paving the next road to financial hell with unintended consequences of their good intentions.

And with proposals like simply handing free carbon credits to the utility sector which is reported by the legislation’s own sponsors to be producing 40% of US carbon emissions, Cap and Trade would be ineffective in its intended mission right out of the gate.

A cynical view is that government folks really just want to impose a tax that doesn’t look like a tax and another way to give massive handouts to their friends.

Realizing, as US Commodities Future Trading Commissioner Bart Chilton clearly does, that what is being proposed is the worlds largest derivatives game, with the rules all being made up and Wall Street players all heavily engaged in the rule making, one could become even more cynical about the real intended beneficiaries of all this. Hopefully we haven’t already forgotten the hard lessons of the mortgage derivatives fiasco.

In “Is Cap and Trade a Dead Policy Walking?”, Robert Shapiro of the progressive think tank NDN suggests that “after Wall Street’s meltdown, the proposition for another round of the financial merry-go-round that produced the worst economic crisis in our lifetimes seems either very naive or very cynical”. He also suggests that “for years, many politicians and environmental leaders have believed that any kind of tax to deal with climate change would be dead on arrival. That may be changing, especially if the tax is paired up with rebates to take away much of its political sting. More importantly, the costs and lessons of the financial crisis may effectively swamp the prospects for cap-and-trade. If cap-and-trade has become a dead policy walking, those who care deeply about climate change will find that a carbon tax system has become the last, reasonable policy standing”.

The Wall Street Journal article suggests “one possible side effect of the financial-market fallout and concerns about more toxic assets” is  “growing support for a straight carbon tax, rather than a complicated cap-and-trade plan.”

One can only hope we have learned something from the sub-prime mortgage crisis. If we did, Congress would quickly debate and pass the Raise Wages, Cut Carbon Act, but with much higher carbon tax rates than currently proposed, while directly offsetting increased costs of energy from carbon taxes with decreases in payroll taxes, the most regressive form of federal taxation. Alternatively a simple and major rebate to all citizens as proposed by James Hansen would also be a great solution both to the climate and the economic problems we face.

But instead of supporting that kind of effective, progressive and economically rational solution, all indications are that Congress seems headed toward creating the next huge financial derivatives bubble and ultimately the Sub-prime Carbon Crisis. Whether cynical self serving greed  or naive good intentions are ultimately responsible for impending Cap and Trade legislation, the results will likely be the same.

The speculators on Wall Street must be pleased that once again, their servants in Washington are serving them well. And this time they have the environmental community doing their heavy lifting, lobbying and marketing for them.

It is past time to move beyond expedient political horse trading to develop serious solutions to our fossil fuel addiction. We need bold and serious leadership.

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1 Comment

Filed under Climate Policy, Economic Policy, Energy Policy

One response to “World’s Largest Derivatives Market – Subprime Carbon

  1. Wasn’t that money suppose to “recapitalize” the bank…good job bernanke? Funny how 70% went in bankers pockets. How about pass a law stripping them of all their bonuses for 3 years!

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