On the announcement that the Clean Energy Jobs (CEJ) bill cleared a key Senate committee last week, Friends of the Earth complained:
The bill’s backbone is a poorly regulated carbon trading scheme that entrusts the Wall Street bankers who brought us the current economic crisis with the responsibility to solve global warming.
Sheesh.
Of course, this isn’t true. It’s not even sort of true. It’s just an attempt to torpedo a bill by sowing confusion about an important and sensitive issue. (There are some of legitimate critiques of the bill— and Friends of the Earth (FoE) makes some of them — but this one is a red herring.) You can rest assured that if CEJ passes it will not be administered by Bernie Madoff.
At heart, the argument is not about CEJ or cap and trade. It’s about a basic mistrust of market economics. And it has high stakes: it’s rhetoric that could sabotage a real chance to put a legal limit on greenhouse gas emissions.
This kind of critique isn’t a first for FoE. In fact, in March 2009, they authored a surprisingly influential and widely-cited critique of carbon trading: a 13 page policy paper called “Subprime Carbon: Rethinking the World’s Largest New Derivatives Market” (summary here). The paper does make a few sound points along the way, but it substantially over-reaches in its conclusions. What’s worse, however, is that the paper is dressed up to appear to be a critique of cap and trade, but the substance really applies only to offset programs — and then only in a debatable and hypothetical way.
In a nutshell, the argument spins out a doomsday scenario in which bad offsets replay the housing bubble, muck up the financial sector, and destroy the global economy. More specifically, the argument goes like this: FoE worries that financial firms would intermediate in providing carbon offsets by purchasing offsets and offset derivatives (especially futures), some of which could be of questionable value. Firms might then repackage and securitize the offset products, much as happened with mortgage-backed securities, selling them to various kinds of investors and ultimately, perhaps, to the firms regulated under the carbon cap. If it turns out that large numbers of offset projects go bad (meaning that they cannot be certified as legitimate offsets because they do not sufficiently reduce carbon), then the offset-backed securities could be worth less than they were believed to be. And if the carbon derivatives market is sufficiently gigantic (as FoE believes it will be), the reduction in value of carbon derivatives might to a worldwide financial collapse mimicking the recent asset bubble collapse in 2008.
As you can see, there are several strands of argument and it takes a moment to untangle them. Let’s dig in.
Offsets—and problems with offsets—are not unique to cap and trade
Before we wade in, let’s get something straight: offsets are not unique to cap-and-trade programs. A carbon tax program — a real one, I mean, that has a legitimate chance of passing Congress — would almost certainly include offsets, allowing polluting firms to purchase offsets rather than pay the tax. Similarly, straight up regulatory policies can also include offsets, just as voluntary carbon reduction schemes do now, by allowing polluters to acquire offsets instead of reducing emissions. In other words, risky offsets are not just a problem for cap and trade but for any carbon-reduction policy. And because offsets are not unique to cap and trade, it follows that the arguments in “Subprime Carbon” — the risk of bad offsets screwing up the financial sector — is a worry for any realistic carbon policy. Simply put: the concern about so-called “subprime carbon” is no grounds for objecting to cap and trade per se.
But of course, FoE isn’t objecting to a generic version of cap and trade, but to a specific bill, the Clean Energy Jobs Act, which does allow a large number of offsets. So maybe the first thing we need to figure out is whether the program’s offsets are likely to go bad.
Will offsets go off?
I’m not about to wade into the whole hairy debate about offsets here, except to say that I think FoE is rightly skeptical about the integrity of offset projects, at least as they’ve been conceived so far. Poor quality offsets are, in my judgment, the number one risk to the environmental integrity of US climate policy. And I worry that because the major cap-and-trade bills allow large numbers of offsets, they could create demand-side pressure for offset providers to produce a lot of offsets, which could in turn reduce the quality of the offsets in circulation.
But let’s be clear, this is a worry about the environmental integrity of the program, not about its potential to single-handedly destroy the world economy.
(Quickly, however, there are some practical solutions the offset problem. CEJ, for example, goes a long way toward restricting them, devoting literally hundreds of pages to offset provisions and oversight. Regardless, any offset-allowing legislation will require ongoing regulatory vigilance by both government agencies and independent auditors. And since there will always be some degree of uncertainty inherent in offsets, it’s smart to “discount” them—stipulating that, say, 5 offset credits are equal to 4 carbon credits—which is exactly what CEJ proposes to protect the program’s environmental integrity.)
Bad offsets—even if they do happen, which is debatable—would not, of course, necessarily lead to financial catastrophe. So what’s the risk? This is where FoE’s arguments start getting slippery.
Might bad offsets threaten the economy?
FoE postulates that the sheer size of a market in carbon and derivatives will be so huge as to pose an existential threat to the global economy. Then, the argument goes, large-scale market manipulation by bad actors could have severe consequences.
You could argue about the scale of the markets created by carbon policy. (I think FoE is blowing it way out of proportion, but what do I know?) Nonetheless, offsets — and potential offset derivatives and other carbon market products — are going to need regulation, plain and simple. It’s just like with housing. The correct policy response to the housing bubble is not to simply outlaw mortgages, or even the trading in derivatives based on mortgages, but to provide regulations that improve transparency and protect the public interest. The same pragmatic regulatory approach should go for carbon.
Fortunately, FoE isn’t the only one to notice this. The major cap-and-trade bills advanced in Congress actually do include stringent market oversight provisions. (In a later post for this series, I’ll go into more detail about the provisions in CEJ.) One good regulatory approach is the Carbon Market Oversight Act, which will reportedly get rolled into CEJ. Another solution, which FoE notes, is the Derivatives Market Transparency and Accountability Act, which passed the House agricultural committee and would require carbon to be regulated as an ordinary commodity—a potentially smart idea and one that is supported by the chair of the Commodity Futures Trading Commission.
Just as the financial markets need regulation, so will any carbon or carbon-derivatives market. Everyone agrees about this. It’s simply not a controversial subject. That’s why important regulation is included — and more is soon to be added — to the Clean Energy Jobs Act. Toward that end, FoE may make a positive contribution. They have recently promoted some constructive ideas in a joint letter with industrial polluters and in a follow-up paper on carbon market regulation.
Climate policy in a market economy
I don’t want to minimize concerns about market manipulation. There’s no way to be certain that we won’t see another harmful bubble in western capital markets. (To the contrary, history strongly suggests that bubbles are an engrained feature; see The Devil Take the Hindmost by Edward Chancellor for a good survey.) Yet there are few who would seriously consider banning trading in stocks, bonds, or the numerous derivatives products that populate the financial landscape because we generally believe that the advantages of markets outweigh their risks. It’s the same for commodities: there’s no movement afoot to ban trading in oil or pork bellies — and rightly so. Fundamentally, carbon need not be any different. There is good reason to believe that regulation and careful oversight can substantially reduce, even if never entirely eliminate, the risk of sinister financial activity.
And that’s just the point. These concerns aren’t really about cap and trade. They’re not even really about the Clean Energy Jobs Act. They’re about finance and markets and capitalism. It’s worrisome stuff, no doubt, but it’s hard to see why this albatross should be hung around the neck of a serious carbon bill with a serious chance of becoming law. As Paul Krugman has argued, hysteria about carbon speculation is “not a case of the perfect being the enemy of the good, it’s a case of the perfect being an enemy of the planet.”
Aaron Keating
Misplaced though FoE’s critique may be in terms of policy, it would be unwise to take it too lightly from a political communication perspective. In fact, the title of the report makes it clear that whatever policy analysis is contained therein is more wool than wolf.For months now, Americans have heard about how “complex” financial instruments took down the stock market, put their mortgage underwater, gutted their retirement accounts, and for good measure put them (or someone they know/love) out of a job. If you can get someone to sit still long enough for you to explain cap and trade to them, most people get how and why it works. But if opponents are able to tar the idea with the “complexity” brush—associating it with shady brokers, subprime loans and taxpayer liability—I fear no one will even stop to listen.
Stacey W-H
Thank you Eric! I have made this same argument many times and continue to debate on this subject. It is a very complicated problem with no easy fixes. But Job #1 of anyone concerned on this issue is to do the research and understand what it is that is being discussed. For the record, I agree offsets are the weakest link in carbon policy. Reducing the number of offsets allowed would increase environmental integrity. However, raising the amounts increases the likelihood of getting reductions passed into law. There will be compromise on this – but we need to keep our eyes on the prize: stay focused on ensuring the big reductions are happening and keep offsets on the fringe of the reduction activity. If enough of us speak up on this, we can influence the number of offsets allowed. But with so many picking away at whether or not to support cap and trade, our position on limiting offsets is weakened. I understand that there is a great reluctance to entrust environmental protection to the market system. It’s important to understand that the only aspect of the cap and trade program entrusted to the market is the price. It is, in fact, a powerful, science-based regulatory system which uses price signals to influence the flow of capital towards the least carbon intensive activities. Some of the arguments I’ve heard center around changing the basis of our economic and political system as a way of addressing climate change (creating a more localized economy). I believe climate policy should ultimately have the same outcome of a fairer, more localized economy—and it’s much closer to actually happening than overthrowing capitalism. Gradually weaning ourselves from carbon would happen in a more organized, methodical way then economic revolution.You continue to do a great job of advancing our understanding of the issue, getting to the heart of our concerns and providing a platform for debate.
David Silverstein
The problems will cap-and-trade are not limited to offsets. Cap-and-trade does add complexity and we don’t need it. The political advantage of cap-and-trade is that the tax can be hidden in complexity and special interests can make back-room deals with congress on emissions permits. The current senate bill based on cap-and-trade does not reduce emissions allowances from 2012 levels until 2022. Additionally, many permits will be given away for free to industries which compete globally. In Europe, that’s about 75% of industrial emissions. So, there will be no actual emissions reductions at all until after 2022.Thus, any reported emissions reductions are based solely on offsets. Since offsets are very difficult to verify, this will invite fraud. Consider companies that go into the business of creating domestic and international offsets. Companies selling offsets at a profit would be encouraged to exaggerate their offsets and cut corners to increase profits, forcing other companies to either do the same or go out of business. Financial firms would buy the cheaper offsets and securitize them, take a profit and essentially hide the offset source, effectiveness and compliance. This is very similar to what happened with mortgage origination. Home owners often are unable to even find out who owns their mortgage, much less what pool it went into. So, the same thing that happened with mortgages can easily happen with offsets, except the result would be large transfers of capital to financial firms and ineffective carbon reductions. Why hand control of carbon emissions to the financial industry to pick and choose the offsets they like? Instead of enriching financial firms, shouldn’t that capital be used to reduce carbon emissions instead? There have already been exaggerations of a factor of 10 on large corporate projects. The major risk is that carbon emissions are not actually reduced and climate change accelerates to the point of being unstoppable. That risk is bad enough and it really isn’t necessary.A carbon tax system is a better approach, and it really does not have to provide emitters an alternative of buying offsets directly. Further, a global carbon tax can be the same across the world, removing the problem of corporations moving manufacturing to avoid lower carbon emissions costs. Then, carbon tax revenues of each nation can be used nationally for developing low-carbon infrastructure, research, adaptation and yes, purchasing offsets, but without the kind of market pressure likely to induce fraud. Governments can manage offset projects with bids and audits, just as transportation and highway systems are now. But then again, why not give the financial markets control of the roads too? Investors could build roads wherever they want, and road-miles would be pooled and sold off as derivatives. Would that make an effective highway system? I don’t think so. All around, with a carbon tax, we would have a faster and more effective reduction of carbon emissions, because the pressure to reduce industrial carbon emissions would be more consistent and offset projects would be based on reality.
ray benish
I think it is extremely naive to believe that turning over our energy sector, notably our most critical economic and environmental sector, to Goldman Sachs will result in anything other than ordinary citizens paying exorbitant rents to the traders representing the “trade” inherent in “cap and trade”. The continuing commoditization of our commons, moving from air and soon to include water is inherently destructive. Case in point, some 8-10 years ago an energetic and capable Administrator of the regulatory body charged with regulation of commodity markets identified the unregulated derivatives market as a point of serious concern. She identified the problem and posed a solution—closer regulation and greater transparency. She was quickly sidelined and brought to heel by a small number of very powerful Wall Street supporters including Robert Rubin, Hank Paulson and Alan Greenspan. Hence, no regulation of derivatives market and the ensuing economic meltdown.Should cap and trade pass that includes protections from predatory practices by bankers and traders, these protections will be bypassed and very likely to be repealed as Wall Street primes the anti regulation lobbying effort that will buy off congress as well as the executive branch. Two years into our current fiasco where money center banks successfully looted our public treasury of close to $3 trillion and still no meaningful reform of financial regulation.We need to limit the role of Wall Street in deciding our energy and emissions future. Does any reader really believe that the powerful interests on Wall Street give a dam about climate change?