Ash wednesday
Avoid strong secondary carbon markets
By Gar Lipow
In solving the climate crisis we need to avoid creating the type of large secondary emissions trading market Kyoto did. Large secondary emission markets constitute a whole new sector with strong incentives that conflict with a really large drop in emissions. Maybe carbon traders are so noble and dedicated to saving the planet that financial self-interest won’t influence them. But, if your view of human nature is that incentives matter, then a strong secondary market creates a group of people with the wrong ones. If incentives matter, then a secondary carbon market runs a real risk of becoming the new sub-prime.
For example, it has been noted that the European Emission Trading Scheme and other emission markets tend to be subject to high volatility, something that undercuts long term success. Large price variations for emissions permits discourage long term investment in savings, because it is hard to predict the value of the savings. Volatility can also lead to crashes, where emission prices temporarily drop near zero, which further reduces investment in reductions. The problem is traders tend to profit in the short term from volatility, because prices that vary encourage a larger number of transactions; more transactions produce more profit. While there are regulatory approaches that can discourage such volatility, such as high mandatory minimum emissions prices, financial industries in general tend to resist this type of regulation.
Within finance, the short-term profits the regulations would cost are sharply felt as real. The long-term dangers are dismissed as airy theories, or perhaps dismissed as problems the industry adventure movies is confident it can handle without government aid. And then the theories turn out not be so airy, and the masters of the universe accepts trillion dollar bailouts. But perhaps the emissions trading industry is too altruistic and noble to act like typical financial institutions, and will support stringent regulation to reduce volatility.
Another problem is that traders will gain from as slow and small an emission phase out as possible. Up to a point profit from rising permit prices can make up for a drop in the number of permits. But if a carbon permit system is part of a process that successfully lowers total emissions, eventually the number of permits will fall faster than the price rises. At some point in a successful process, less-expensive, low-emission alternatives are found, and demand for permits drops. Depending on degree of success this may simply result in prices rising more slowly than the available number of permits drops, or in an actual drop in the price per permit. In either case, significant success will lead to the total dollar value of all permits combined dropping rather than rising. We might speculate that this incentive to keep the volume of permits as high as possible could lead traders to take advantage of loopholes that essentially create new counterfeit permits for them to sell. The bottom line is that once you develop a strong secondary market in permits, any system where there is a lot of reselling of permits after they are bought, you open the door to manipulation that contradicts the goal of actually lowering greenhouse pollution.
Note that this is not a problem with putting a price on greenhouse gas pollution. It is not even a problem with auctioning permits. It is specifically a problem with having a large secondary market in permits where they are sold, resold, and resold again. And potential problems are not limited to volatility and offsets (which are essentially legal counterfeit permits). Let me quote from Liz Bossley’s and Andy Kerr’s book, Climate Change and Emissions Trading: What every business needs to know:
according to the development brand on the side of the evolution of commodity markets described in group two, the next logical step in the development of the emissions market should be the emergence of a derivative market for swaps and options in emissions allowances. for the reasons described download fantasy downstairs it is vastly likely that the emissions deal in resolve see an options market develop, but that a shop for swaps is more problematic.
In short, unless brought short, any carbon pricing system with a strong secondary market is likely to develop the full wilderness of mirrors that damaged our current broader system. So how do we stop this?
We could try to do without price as means of solving the climate crisis, relying entirely on public investment and standard-based regulation. Public investment and new efficiency standards are actually more critical a
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