How the system is gamed
Worldwide economic experiences show that when product markets reach truly global levels there is a tendency for them to outstrip regulatory control and oversight. In practice this occurs because market regulations and their prudential oversight are nationally structured. Admittedly, there is usually an element of inter-governmental coordination at the regional or international level, but as a rule for the major countries this does not significantly subordinate national control. Thereafter, innovations in traded instruments are oriented towards making money from gaming the regulatory and oversight system.
This process was in operation during the recent period of global financial market expansion where it took the form of intensive securitization. This led to the 2008 global financial crisis, at the core of which lay US sub-prime private household mortgage-backed securities and their associated credit default swaps (insurance). By all accounts these were the principal ingredients of what has come to be acknowledged as an international asset bubble, which burst in a perfect storm of events, exposing how incredibly toxic and risky these sub-prime mortgage-backed securities and credit default swaps had become.
The gaming of the regulatory and oversight system was fully exposed during the crisis. First, it became clear that the risks attached to the sub-prime household mortgages were never properly assessed. Second, rating firms in the industry had failed to perform. Instead of maintaining their regulatory independence, they became hostage to the firms that financed them. Third, underwriting standards had become so poor that analysts now opine this was fraudulently done. Documentation was also so poor that the mortgage assets which underlay most of the securities could not be traced! Trading also occurred in unregulated and opaque over-the-counter firms. As a consequence, credit default swaps did not provide market ‘insurance’ as they were intended to do but instead represented gambles, where investors bet on the survival of 1) the very instruments they traded on the markets 2) the very businesses they were dealing with and 3) even the countries in which they were located. Thus, while the mortgage industry was gaming the regulatory system for loans, the banks dealing in credit default swaps were similarly gaming governments based on their expectation that some financial firms would be held to be too big to fail. The net overall effect of such operations led to the systematic understatement of risks throughout the market place.
Sub-prime carbon
Today operatives in the carbon market are similarly gaming it. This is being done both intrinsically (through market practices and organization, as will be discussed today) as well as extrinsically (through the rapid influx of fraudsters and other criminals on the climate exchanges, as will be shown next week). A process similar to the securitization that occurred in financial markets is now becoming more commonplace on climate exchanges, thereby embedding serious systemic and intrinsic weaknesses on the climate exchanges. Firms are now bundling together baskets of varied carbon offset projects at different stages of approval, execution, implementation, and completion, located in several countries and jurisdictions. These baskets are then split, spliced, and divided into different tranches of risk for marketing, similar to the securitisation of financial instruments which occasioned the explosive growth of toxic derivatives and credit default swaps.
In this process products traded on climate exchanges are being further and further removed from specific identifiable and readily traceable carbon offset projects. This makes it difficult to accurately assess their underlying risk, resulting in the real dangers of 1) the excessive growth of sub-prime carbon and 2) opening the floodgates to the invasion of corrupt firms, fraudsters, and organised criminal elements posing as genuine operatives on climate exchanges.
Clearly such developments are far removed from the worldwide shift to the de-carbonization of production and consumption, which I have argued remains the only assured way of containing the risks of global warming and climate change. To those readers who may believe that I am overstating the intrinsic difficulties confronting the current operations on the world’s major climate exchanges, I recommend they ponder the implications of a recent statement by the Chief Executive Officer of the huge Dutch multinational (Royal DSM):
“They are now already in development derivatives of carbon dioxide (CO2) prices that are so complicated that I do not understand it any more… if you get a reservoir of derivatives, which becomes so big it becomes an industry in itself that is very dangerous because you can get the tail wagging the dog.“
Summing up
As it is presently functioning the carbon market cannot deliver a magical solution to the global climate problem. It is no silver bullet to relieve humanity from one of its gravest challenges. Market solutions as proposed by neoliberals, prioritize innovations in market practice rather than decarbonisation in rich countries. This might well end up exacerbating rather than alleviating the global climate problem. Consequently, I would recommend to poor rainforest countries that they avoid reliance on solutions, which depend primarily on the expectation of money flowing from rich countries to theirs, as payment for global environmental services they provide. Instead primary emphasis should be on ensuring that the historic polluters live up to their historic responsibilities, acknowledge the climate debt owed to poor countries and carry the main burden of resolving the global climate problem.
As Eric Phillips observed during the initial debates over the LCDS, the commodification of the global climate problem evades rather than engages the global ethical dilemmas. Unsurprisingly, the Kyoto Protocol and the European Union Emissions Trading Scheme are unintentionally encouraging the world’s worst emitters to drag their feet and seek solace in the purchase of emissions allowances/credits and carbon offsets.
From an economic standpoint, the basic scientific problematique can be summed up as follows: carbon taken out of the ground (fossil fuels) when utilized yields noxious carbon dioxide equivalents in a way that is for all practical purposes irreversible (in that it would take millennia to recycle). In contrast, above ground processes of carbon release can be made reversible. This is because trees can be re-grown or their cutting down avoided. There is therefore no equivalence between the atmospheric burden of below ground and above ground carbon. Given this fundamental scientific dilemma, the only secure solution to the global climate crisis is for a structural shift to de-carbonized forms of energy by all countries – rich and poor alike, with the former carrying most of the burden.
