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Trading Sub-prime Carbon

The first niggling doubt about carbon trading came when I showed up at Carbon Forum America in San Francisco in February and found 1400 enthusiastic people and a trade show of 80 companies touting the next big thing.

The second was when I sat down at lunch next to a man who said he was getting out of online gambling — too sleazy for him — and going into carbon trading.

Carbon trading is beginning to look inevitable as it is pushed by a coalition of interests we have rarely if ever seen in this country — Wall Street, the mainstream environmental movement, Democrats, Republicans, the three major presidential candidates, and even — with free carbon — polluters.

If that isn't enough to give pause, there's the record of the earliest attempt at trading carbon in Europe. There, a carbon-trading system has existed for three years, but recent data shows that European Union greenhouse gas emissions rose 1.1% in 2007. The problem was that the constituent EU countries, yielding to lobbying and fearing loss of competitiveness, gave away too many carbon permits. The price of carbon collapsed, but lower caps are going into effect this year. The current price on the European Climate Exchange is around $37 a ton, and the market has grown to an estimated $60 billion, up 80% from the previous year, despite the false start.

The Senate is expected to begin debate on the bi-partisan Lieberman-Warner carbon trading bill (S2191) in June, and Senator Joe Lieberman recently announced he almost has 60 veto-proof votes. The Regional Greenhouse Gas Initiative, covering seven northeast states, has recently begun preliminary trading, and California is busy formulating a proposal.

Wall Street will get the use of the halo of the mainstream environmental movement for its potent lobbying army. Environmental Defense, in particular, takes pride as the inventor of the emission trading scheme that it says solved the acid rain problem, is set to take a leading role. The organization recently condemned a Congressional Budget Office study that found that a carbon tax would be cheaper and more effective.

Any kind of tax is, of course, politically toxic, so the big remaining issue is how the rights to emit carbon will be allocated. Should they be given away free or auctioned off? If auctioned, how would the proceeds be used?

Giving the permits away could mean a multi-billion dollar bonanza for emitters, especially coal-burning utilities. A Point Carbon study estimated the windfall profits for European utilities would be as much as $100 billion between 2008 and 2012 in a permit give-away.

Currently the Lieberman-Warner bill splits the difference: half to auction and half free.

Jim Rogers, Duke Energy's outspoken CEO, recently told a Wall Street Journal conference in Santa Barbara that the advocates of auctioning are an "unholy trinity": politicians with "visions of sugar plum and earmarks" dancing, carbon traders looking for an auction-led explosion of their business; and "radical environmentalists who want to punish anybody who uses coal."

By carbon traders, Rogers means the financial industry. Every major financial house in New York and London has set up carbon trading operations. Very big numbers are dancing in their heads, and they need them to replace the "wealth" that evaporated in the housing bust. Louis Redshaw, head of environmental markets at Barclays Capital, told the New York Times, "Carbon will be the world's biggest market over all." Barclays thinks the current $60 billion carbon market could grow to $1 trillion within a decade. Four years ago Redshaw, a former electricity trader, couldn't get anyone to talk to him about carbon.

The Los Angeles Times looks upon California's cap and trade scheme, presently under design by the PUC, with trepidation. They see the return of Enron, the ruthless electricity traders who brought the state to its knees in 2001 and bankrupted its major utilities. "This is a staggeringly complex undertaking," said the paper in a recent editorial, "that will once again create opportunities for dishonest traders to manipulate the market."

At first glance, cap and trade is a simple and appealing idea. Place a cap on carbon emissions that can be ratcheted down until it is low enough to stop the worst consequences of global warming. Polluters have the flexibility to use or sell their credits, whichever makes business sense. Investors can finance carbon-reducing projects by selling their credits on the market. The climate doesn't care where the emissions are reduced, just that they are. Everybody wins.

Indeed, many say that cap and trade was proven when it cleaned up acid raid in the northeast in the 1990s more cheaply than regulation could have done. Critics like the Hammarskjold Foundation say that the availability of cheaper low-sulfur coal was more important than trading, which only started after 20 percent of the sulfur dioxide had been eliminated. Only one chemical and a small number of firms were in the market, many only traded within their company.

"A greenhouse gas reduction program," points out environmentalist David Morris, "targets at least a dozen chemicals and encompasses hundreds of millions of targeted facilities. And measure and monitoring equipment is unavailable."

In any case we probably are going to get a carbon-trading law, and we can only hope it will reduce carbon a lot. The best insurance that it will is to auction the carbon permits and use the proceeds to finance the Apollo/Manhattan Project all-out effort that will be needed to develop, demonstrate and deploy the technology of the new low-carbon economy.

Yes, of course, we don't want the government picking winners — like, computers, jets, the internet and so on. But do we want the carbon traders or marketers picking the winners? Their bets will likely be the short-term pay-offs, the cheap, low-hanging fruit and current technology. Will this market invest in the advanced technology that will be needed to solve a global problem whose dimensions become more alarming with virtually every new report?

We should turn to what is being called the sub-prime debacle for clues. The crisis really is about excessive speculation and risk taking, and commissions and fees that ate into the capital flow to the real economy. The finance industry made about 44% of profits of all U.S. corporations in 2007 (compared to 10% for manufacturing), but was responsible for only about 20% of gross national product.

There is also the smaller but growing market for voluntary off-sets. Worldwatch carbon scholars Zoe Chafe and Hilary French have written, "Perhaps the most crucial issue is... to prove that GHG reductions are indeed happening as marketed."

They report that EasyJet, a low-cost airline in Europe, warned carbon offset buyers to beware the "snake oil salesmen" that lure do-good customers into paying exorbitantly high fees for offset services of questionable value. The airline has begun to purchase the credits for its customers from the U.N.'s Clean Development Mechanism set up under the Kyoto protocol. Inadequate certification of carbon credits was a hot topic at the Carbon America Forum but help seems to be on the way. There are several good certification systems, such as the Gold Standard, developed by the World Wildlife Fund.

If carbon is the next big thing, how would this play out? Would we securitize the credits — cut them into small pieces and sell them off in batches to investors? Would they be assets that would leverage massive, unsustainable debt (once credit recovers from its last orgy) then falter as the news gradually seeps out that the credits were bogus. Would capital be siphoned off from investment on the ground by fees and commissions? This, in fact, is what has been happening in the U.S. economy for 20 years.

To me, this is fundamentally a simple proposition: charge those who use the atmosphere for waste disposal a fee equal to the value of this service. The value would be at least the cost of measures and technology needed to eliminate the waste. In theory there is no reason why a well regulated, transparent private market couldn't do this. But would a market based largely on speculation do this? We still do not have an honest market for commodities and securities despite repeated crises caused by our casino-style financial system.

Looking at all these uncertainties and the inevitability of carbon trading, I say the government should sell the carbon rights to the highest bidders, take the money, and invest it in green technology. The cap itself will be an incentive to reduce emissions, and, let's think politically, the polluters could even get some of the money back (as in Denmark) for real, certified carbon-reducing investments.

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