The Shambles of the European Carbon Trading Market

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Pressure is growing at international climate change conventions for the carbon trading markets to go global, but recent events in Europe, the world’s most developed carbon trading market, illustrate only too graphically the challenges any such move would face.

In a recent Telegraph article, coverage highlights two disturbing issues in the European market that should make other regions pause for thought before embracing the idea. Firstly let us say that in principle, if we accept that carbon emissions should be reduced, then we are in favor of the concept of carbon credits as a means of encouraging polluters to reduce those emissions. A free market in carbon credits is better than government taxation because it allows companies to respond to what is best for their organization rather than all firms being forced to react in the same way; however, the experience in Europe has totally undermined the concept and the reality is that the same forces that have undermined the European market would have a major impact on adoption in other regions.

The first is the easier to prevent, although Europe has consistently and flagrantly failed to do so, and that is fraud. For the fourth time, carbon credits worth many millions have gone missing in the European market. In the most recent case, credits worth US$38 million were bounced from the Czech Republic to Poland, Estonia and Liechtenstein before disappearing. According to the Telegraph, local regulators were distracted with a fake bomb scare while thieves electronically made off with 500,000 carbon allowances each worth around US$19. Companies, such as those in the utility and heavy manufacturing sectors, are obliged to own allowances for each ton of carbon dioxide they produce. The bulk are given away free by member state governments, but can then be traded between market participants to penalize heavy polluters and reward the more energy efficient. Clearly someone ultimately pays for the value of these allowances and that, as always, is the consumer. Allowances push up household bills and the price of manufactured goods in return for the perceived wider social good of falling carbon emissions. The high economic cost to consumers and businesses is why it matters that the US$143 billion market across 27 European countries works effectively. The article estimates organized crime has cost taxpayers US$8 billion over the last two years and is so widespread that, in some countries, at one point it accounted for 90 percent of all market activity. Barclay’s Capital said the whole market had descended into a fiasco and one broker at a London trading company likened the running of the markets as more like a church raffle than a professional commodities market.

Trevor Sikorski, head of carbon markets at Barclays Capital, is quoted as suggesting that access to accounts only be permitted to financially regulated parties or those industrials and utilities that need allowances to comply with the law. While this would undoubtedly solve the leaky nature of the current system, it raises another concern that some parties have which is that the biggest beneficiaries of the market will be large financial institutions and the industrial polluters themselves, not the environment. It is already clear that industry is in line for huge windfall profits from the sale of carbon allowances amassed during the recession when production was down. Under industry lobbying and politicians’ pampering of their chosen industries, polluters were given far more free credits than they needed and steelmakers and coal-consuming utilities have stockpiled huge numbers of credits they can sell at a profit. Which brings us onto our second major concern: not only would industry pressure groups exert the same pressure on politicians to skew carbon markets set up elsewhere, but other markets would likely suffer from similar offset agreements to Europe’s whereby developing countries can “reduce their emissions by building a hydroelectric dam or wind farm and in the process claim carbon credits equivalent to the carbon emissions they would have saved if they had built a coal-fired power station. All they need to do is put a case to some gullible EU board that the project would not go ahead without them; even projects that were planned before the market came into existence have qualified for credits illustrating how spurious the case can be. Critics say this is awarding free money to Chinese and Indian developers straight from the utility bills of European consumers with no environmental gain. The article quotes Michael Wara of Stanford University who estimates it unnecessarily costs bill payers $6 billion.

The worst offenders have been “industrial gas credits,” which have just been finally banned by Europe from 2013 onwards. These were allowances for destroying dangerous greenhouse gases used as refrigerants called hydrofluorocarbons. It costs 10 cents to eradicate gases equivalent to one ton of carbon dioxide and the resulting offsets could be sold on the market for about $20, giving a total return of more than 99 percent. The article explains developers found this so lucrative they were creating the gases purely to be destroyed and, in the end, industrial gas credits made up 85 percent of the market.

So beware: if politicians come to the ballot box promoting what sounds like a great way of encouraging polluters to emit less greenhouse gases, the idea is neither simple (in application), cheap, nor a solution to environmental concerns. It results in a massive transfer of money from consumers to financial firms, industrial polluters and emerging market investors with little tangible benefit for the environment and none for us the taxpayer.

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