The Flaws of Cap and Trade: Part II: The Validators

By Abel Collins

The second weakness in the administration of the cap and trade system is found in the creation and validation of the carbon credits themselves. Typically, a carbon credit comes into being when an industry proposes a new business model that will allow it to reduce its carbon emissions. Each credit is claimed to be the equivalent of one metric ton of carbon reductions. This credit is then sold to a dirty industry to offset its own pollution. The claimed reduction must be substantiated at the outset by an audit from a rating agency called a validator and must subsequently be verified to have actually occurred by another similar audit.

Worldwide, there are less than thirty such validators, and the market is dominated by just two. The industry or business looking to create carbon credits hires one of these validators to certify its creation. The biggest certification requirement, aside from actually curbing carbon emissions, is that the project meets an additionality standard, proving that the carbon reducing project would not occur without the capital made available through the credits. Once the credit has been sanctioned by the validator, it can be sold in the carbon market. Complicating this picture further is the fact that many of the emissions reducing projects get their funding from venture capital through the large banks that control the carbon markets.

Here, then, is the problem. The validators are paid by the industries that are having their projects regulated, creating a monstrous conflict of interest and potential corruption. Reviewing the work of the validators to this point, it has been discovered that forty percent of projects do not meet additionality standards. Furthermore, the credits only produce 65-85% of the reductions that they promised. When graded, none of the validators received a grade higher than a D. Whether through corruption or incompetence, this administrative system is a proven failure.

Looking forward, the carbon market is already the fastest growing commodity market in the world, and it promises to get exponentially larger if the United States adopts a cap and trade policy. Clearly, major improvements to the administration of cap and trade are necessary if it is to function effectively. The question is, at what cost. Even if the conflicts of interest can be mitigated, the sheer amount of resources and bureaucracy that will be needed for the validation and verification process will produce tons of carbon emissions. There has to be a better way.

Please go to the address below and read this important article from Harper’s Magazine for more information on the validation and certification process.
http://citizensclimatelobby.org/files/Conning-the-Climate.pdf

The Flaws of Cap and Trade: Part I: The Market

By Abel Collins

On paper, cap and trade offers a versatile regulatory strategy to reduce carbon emissions. Rather than the blunt tool of a blanket tax, the innovation of the carbon credit allows industries that might find it particularly onerous to cut carbon pollution to promote other sectors of the economy to make reductions in their place. By creating a carbon market, the world theoretically summons the mystical invisible hand of market efficiency theory to produce the most effective reductions.

Of course, market efficiency theory is now seen as a rather naïve economic model that is disproven on a daily basis, and ideas that make a lot of sense on paper are often met with resistance by reality. Such is the case with cap and trade. The translation of the theory into cap and trade reality is fraught with problems.

The most glaring problem is administration, and it is manifold. Before we delve into the many failings of the administration of cap and trade, it is important to note with administrative costs that resources dedicated to organizing and maintaining the system (administration) are resources that are being taken away from actually addressing the issue that the system is designed to resolve (e.g. healthcare). With cap and trade, there are two distinct areas of administration; the carbon markets, and the validation and verification of the carbon credits to be traded within those markets.

Large banks, notably J.P. Morgan and Goldman Sachs, have graciously offered to administer the commodity markets for carbon credits. They have not made this offer out of concern about global warming or because they have any expertise in environmental matters. No, like everything else they do, they run the carbon markets in pursuit of profits, and there are many to be had.

Not only do the banks get paid to oversee the transactions in the marketplace, they are further allowed to use this position of advantage as they trade within it. Of even greater concern is how they can manipulate the market through unregulated financial instruments (i.e. derivatives, CDOs, etc.). With massive government subsidies aimed at reducing carbon emissions and unlimited sums of low-interest money available to the big banks, carbon markets are primed for overleveraging and bubble formation. As the markets get more and more manipulated, they will become less and less transparent and farther removed from their mission. Indeed, the carbon market, itself, is a secondary approach, regulating an intangible commodity to address climate change, and it in no way needs to be made more abstract through financial wizardry.