The potential use of a Wall Street-driven cap-and-trade system to address global warming threatens the economy as well as the environment. Read on to learn more.
Congress is considering putting in place laws intended to reduce harmful greenhouse gas emissions through establishing a carbon trading system, also known as cap-and-trade. In its simplest form, cap-and-trade works by requiring polluters to buy government-issued permits to emit carbon dioxide. By limiting the total number of permits issued, the government theoretically can limit the total amount of carbon dioxide released into the atmosphere. Companies that hold more permits than they need (e.g. those that pollute less than they anticipated) are allowed to sell their excess permits to those companies that need more (e.g. those that pollute more than they anticipated).
But the cap-and-trade system being debated by Congress is actually much more complex.
Most proposals being considered by Congress allow both polluters and Wall Street traders to get involved in carbon trading. As a result, Wall Street is likely to end up dominating carbon markets, even though they do not actually need the pollution permits. Some players will be financial speculators, who want to make money by betting on whether the price of carbon will go up or down. Others will be “passive investors,” those who buy carbon and hoard it, hoping for -- and forcing -- the price to go up. If other commodities markets, such as oil and corn, are any guide, such investors will probably end up owning about 40 percent of outstanding carbon futures. And as carbon markets grow, Wall Street will develop complex new financial products based on carbon commodities, creating the kind of "innovation" that will likely outstrip the ability of regulators to keep up. In fact, there are so many ways that Wall Street can profit from this system -- that could soon reach $2 trillion -- that the financial industry has employed 130 lobbyists just to influence climate legislation.
Most leading cap-and-trade proposals would also allow traders to not only buy pollution permits, but also promises made by third parties to reduce their emissions voluntarily. These promises are called carbon offset credits, and they are rife with problems. One key problem is that the emissions reduction promises may fail to materialize, and the associated offset credits could then collapse in financial value. Dodgy carbon offset credits are known as “subprime carbon," and such failed promises are bad for the environment (because pollution isn’t actually reduced) and a waste of financial resources (since money spent purchasing the credits could have been invested in real solutions).
In the bills now being considered by Congress, some 30 percent of carbon traded could come from risky offset credits, resulting in a build-up of subprime carbon. If Wall Street distributes subprime carbon throughout the financial system in the same way they distributed subprime mortgages (e.g. large-scale securitization), subprime carbon could pose risks to the broader financial system and to the economy.
Despite the fact that carbon trading in Europe has not produced the intended emissions reductions, cap-and-trade is still at the center of a US strategy to reduce greenhouse gases. And because a cap-and-trade system creates so many entrenched political interests (from the Wall Street firms that will earn billions in fees, to the polluters who will receive some 85% of their emission permits for free), it will be next to impossible to fix or scale back a carbon trading system once we create it.
We have already seen how carbon trading discourages the adoption of alternative strategies to control carbon pollution. For example, in the UK the government balked at complying with a European Union policy of sourcing 20% of its energy from renewable sources by 2020. The reason – increased support for renewables would mean less demand and lower prices for carbon credits.
Similarly, when the US Senate took up the 2009 climate change bill, policymakers decided that instead of having the Environmental Protection Agency regulate landfills and pipelines for methane emissions (as the House version proposed), these sources would be left unregulated so that emitters could voluntarily reduce methane emissions and sell them as carbon credits. And it gets even worse: in the House bill, big business was able to roll back the EPA's ability to regulate carbon dioxide emissions from coal fired power plants by arguing that a cap-and-trade system would take care of it. Thus, carbon trading has the political effect of sidelining other strategies to reduce carbon emissions. Alternative strategies such as feed-in tariffs (providing producers of renewable energy with predictable above-market prices), industrial performance standards, and energy and fuel efficiency standards should be aggressively pursued as proven "no regrets" climate strategies, rather than a risky new carbon trading system.
- About subprime carbon (March 2009 report)
- About the dangers of designing a massive, complex and volatile carbon market (September 2009 report)
- About how a coalition of consumer groups and businesses have called for financial reforms to be put in place before carbon trading is established
- About our testimony to the House Ways & Means Committee (March 2009)
- About how commodities speculation harms people around the world (view video)
