Michael Giberson
The headlines about fraud in Europe’s carbon credit trading system (2010: “Fraud Besets E.U. Carbon Trade System,” 2009: “Europol: $7.4 Billion Lost from Carbon Trading Fraud in Europe“) seem to confirm what some critics of carbon credit trading have been saying all along (2007: “Carbon Trading Open Invitation To Fraud,” 2007: “The greenhouse gas emission trading scam“). Are these news stories proof that the critics are right? Are carbon credit markets inherently susceptible to fraud?
Victor Flatt, at Flatt Out Environment, says no, these stories are just show the growing pains associated with a new market.
The fraud perpetrated on the EU exchange was basic garden variety thievery. Criminals got access to an asset (carbon credits) and stole them. This could (and has) happened with many assets, and is a risk of electronic records and trading. … The one way that this can be attributed as uniquely related to the carbon market is that the entire trading system is new, and new systems present more opportunities for thievery, rent-seeking, and fraud. It seems clear that the security protocols on some of the EU country registries were not sufficiently strong or that market participants were not educated enough about the protocols of the exchanges to protect their security information from “phishing.” Luckily, the amounts in play were relatively small, they were quickly discovered, and this will provide lessons for future security upgrades.
So far the RGGI trading in carbon credit appears to be fraud free. At least my searching through news reports and the market monitor’s statements doesn’t turn up any fraud complaints.
Market manipulation can be achieved without fraud, and whether or not the European market is susceptible to manipulation is not revealed by the above complaints. Again, so far at least, the RGGI markets have not shown evidence of market manipulation. (The RGGI design team did go to some lengths to design a market that would be difficult to manipulate.)
Of course, since these trading markets are essentially created by legislative action, they could be revised by legislative action. The temptation to jump in and “fix” the market will rise any time enough legislators think that the prevailing carbon credit price is too high or too low. Existing pollution credit trading programs in the U.S. have escaped such meddling mostly by being too small to be of much interest. Also, they seemed to work so well that few people wanted to mess with them. Carbon credit trading won’t be “too small to be of much interest,” so its best protection from after-the-fact legislative meddling will be to work so well than few people will want to mess with it.
That and, of course, continuing public support for the underlying science of climate change that is motivating efforts to control greenhouse gas emissions in the first place.
I agree with your and Victor F.’s views on the EU ETS fraud, both the VAT issues from last year and the recent hacking incident. That isn’t the end of the story however.
Fraud, and potentially manipulation, is far more likely to occur in the offsets component of the market than in the allowance trading. It’s here that there will be temptation to game rules to create counterfeit supply and where regulators will face the greatest challenges with respect to information asymmetry and participant incentives.
Market manipulation might also be more likely under different cap and trade design approaches. Both the EU ETS and the RGGI system are downstream and allow non-compliance (speculative) participants. That is not true of an upstream system like the CLEAR Act (Cantwell). In that setting, there are far fewer participants and a small number that would, of necessity, hold or control substantial portions of the market. That is at least a potential recipe for market manipulation claims.
Of course there will be tremendous fraud. There is fraud in the usual government program where the intent is to buy something. There will be even more fraud when the intent is to buy nothing (!), in fact to buy a negative something, defined as less carbon than was previously produced. Carbon credits are a license to print money by setting levels politically.
And, because nothing is actually delivered, the entire scheme depends on regular and detailed investigation to verify that (1) carbon was being produced, and (2) now less carbon is being produced. How are they going to do that?
For example, there is much fraud now in subsidizing biofuels, but it is entirely legal and tolerated politically. I would guess that politicians are profiting from the loophole.
Demands for Crackdown on Biofuels Scam
12/15/09 – stopglobalwarming.org
Up to 10% of biofuel exports from the US to Europe are believed to be part of the rogue scheme reaping big profits for agricultural trading firms.
The “splash and dash” scam involves shipping biodiesel from Europe to the US where a dash of fuel is added, allowing traders to claim 11p a litre of US subsidy for the entire cargo. It is then shipped back and sold below domestic prices, undercutting Europe’s biofuel industry.
The trade is not illegal, but flouts the spirit of producing green fuel by transporting it needlessly across the Atlantic at a time when campaigners are voicing concern about emissions from global shipping.
Public support today is very weak; and, is based on the perception of a low/no cost process.
Public support would “tank” when faced with the impacts of both: a ~$65 billion per year incremental federal revenue stream from either a carbon tax or allowance sales; and, the impacts of the investment of ~$700 billion per year in new low/no carbon emissions facilities and equipment to actually reduce carbon emissions.
When it became obvious that global carbon emissions were continuing to rise, despite the economic pain in the US, as the result of continually growing emissions from China and India, among others, the entire process would collapse and take its perpetrators down with it.
Andrew_M_Garland:
Note the date on the article about “splash-and-dash”: April 1, 2008. Later in 2008 Congress changed the law regarding biofuel subsidies so that only fuel sold for use in the U.S. is eligible. As a result, splash-and-dash is no longer an issue.
05/29/09 – Canada threatens trade action against U.S. ‘black liquor’ wood subsidy
In a joint letter to Congress, Canadian ambassador to Washington Michael Wilson and his counterparts call on the United States to close a loophole that allows pulp and paper companies to take advantage of a tax credit for using alternative fuels.
They say American companies are reaping up to $8 billion a year by mixing in a pulp byproduct called black liquor with diesel fuel, qualifying for the credit, in contravention of World Trade Organization rules.
Some companies claim credits that amount to approximately 30 per cent of the selling price of pulp, the diplomats assert.
To Libert,
You might see the governments actions to end “splash and dash” as confirmation of good government. I see it as the belated end to years of misguided subsidy (costs to us) that allowed that theft to occur in the first place.
The above story about black liquor is about another such scheme to capture subsidies, with the usual distortions and costs to the markets involved. There are a lot of schemes, most of which go unreported, and all of which go on for years before being modified.
Politicians can create these schemes faster then public opinion can shut them down.