Editors’ note: This is the first in a series exploring the state’s carbon trading program. California’s newly approved carbon cap-and-trade program promises to stimulate investments in a Golden-Green state. The greenhouse gas emissions market “is another important building block in California’s effort to create a clean and vibrant economy,” California Air Resources Board chair Mary Nichols proclaimed after unanimous final approval of the nation’s first economy-wide carbon trading program last month. Viewing the market through green-tinted glasses has an eerily familiar ring--or rhyme--to it. Similar claims were made about other market schemes, which were placed high on a wall and like Humpty Dumpty had big falls. The traits in common include: -Market complexities. -Billions of dollars at stake. -Traders exploiting market weaknesses for personal gain. -Regulators lacking the ability and/or means to stay ahead of the trading game. -Market crashes hitting innocent bystanders--taxpayers and ratepayers--the hardest. In 1996, I covered the European Union’s efforts to launch a monetary union. It was full-steam ahead for establishing the euro in place of German marks, French francs, and Italian lira. The stated rationale was that a single currency for participating member countries would bring economic prosperity. Business transactions would be more efficient. Travellers would no longer be loaded down by wallets with a mix of foreign coins and bills. European leaders ignored warnings that by giving up national sovereignty over currency, nations--like Greece and Italy--could no longer use tools that helped keep their economies together during debt crises. At the same time, California was putting together its less-complex electricity deregulation scheme. The proposed new energy market was to make way for efficient energy trading that would lower utility bills. Little thought was given to whether it would crash down, so much so that it was unanimously adopted, like today’s carbon trading program. California’s deregulation scheme shattered in 2000-01. Today, desperate attempts are underway to maintain Europe’s single currency. Those who mostly had little say about the markets--citizens and ratepayers--suffer. Could California’s complex cap-and-trade scheme see a similar fate? It’s likely. Its multiple layers could well make it next to impossible to keep tabs on how it’s working, leading to its implosion. Many details of California’s trading scheme--set for its first emissions rights auction next year and enforcement in 2013--remain unknown. I don’t question Air Board staff intentions but key elements necessary for success include market transparency and effective oversight and monitoring. California’s trading market involves all the king’s horses and men: utilities, oil companies, cement and glass manufacturers, natural gas suppliers, and in 2015 the transportation sector with its millions of tail pipes. These industries that emit carbon gases from stacks are to get allowances that they can sell at a profit if they reduce greenhouse gas emissions or buy them if they are short. In addition, third-party speculators removed from the underlying regulated industries will be making nearly instantaneous trades. Their modus operandi is profit, and thus the potential for excessive speculation and fraud in the allowance and offsets markets. “These folks are wired to find a gap in the rules and shoot money through that gap,” Mark Ferron, California Public Utilities Commission member, noted during a Nov. 10 meeting about protecting consumers from gaming in the renewable energy market. The Air Board insists that ongoing monitoring and experts will stabilize the carbon market–both in the trading of allowances and the use of offsets associated with renewable energy, forestry, and agriculture projects, some in remote areas. “Trust us” assurances have been heard before. Monitoring computerized trades is tricky and resource intensive, a job not suited for an environmental regulatory agency like the Air Board. In addition, how will the agency keep tabs on what is happening on the ground at far away offset projects said to represent additional emission reductions from an installed wind or solar project, for example. Consider potential problems already brushed aside by regulators including: -Potential concealment of trade information, including the price of traded allowances. -Credits changing hands so fast outside of normal auctions that regulators will be swimming in data and may be unable to keep track of who actually owns emissions rights. -The policing of offsets to make sure they result in real emissions reductions. The Air Board basically plans to have third parties--perhaps paid for by the industries they oversee--attempt to keep the offset project market honest. Assuming third parties handle trading in the offset market, what conflict of interest rules will be in place and will regulators be able to enforce them? In late September, regulators announced they sought to hire by the end of the year outside consultants to provide financial services and market monitoring for the auction, expected to entail 2.5 billion allowances. Mid-week, the Air Board reissued a request for proposals for cap-and-trade services because of an “inconsistency” in which proposals were sought in French rather than English. The Air Board now wants proposals in early December. The issue is not so much mistakes, which are inevitable, but their consequences--in particular who is to bear them. Likely it will be utility ratepayers and consumers who had little or no say in the program. The Commodity Futures Trading Commission’s involvement in the state’s carbon trading provides little reassurance given what has happened in the nearly impenetrable derivatives market. Highlighting that point is the CFTC’s homepage, which notes the futures industry “encompasses a vast array of highly complex futures contracts.” Soon to be added to the list are derivatives from California’s cap-and-trade market. Another less than reassuring sign is that one of the state trading market’s cheerleaders is financial whiz Michael Milken, who went to prison for financial fraud. I wonder if Ivan Boesky--who proclaimed “greed was good,” and also was convicted for fraud--will soon play in the state’s trading market. At least Bernie Madoff’s been sidelined. There’s also the potential fallout of emissions dumping in poor communities caused by shifts in the generation of emissions in response to the market. The supposed invisible hand of the market won’t bother to pick up those pieces. If that’s not enough, another big potential problem is that the state market may result merely in swaps of power sources--with power from emission light resources sent to California and dirtier power sent elsewhere, achieving no overall carbon reductions. How can state regulators stay on top of the resource mix of energy importers and such possible “resource shuffling (see story on BC Hydro below.)? So many intricate pieces are getting melded together. My hope is that it falls sooner than later to minimize the fallout. Meanwhile, all I can advise is steer clear of the wall where possible.
