Subprime Carbon: Environmentalists Warn About the Next Big Bubble

Keith Johnson, Environmental Capital, Wall Street Journal

President Obama and Congress are nowhere near drafting a climate bill, but the angst over the future carbon market is in full bloom. There are two good reasons for that: The recent financial meltdown in the U.S., and the recent carbon-market meltdown in Europe.

Today, even as Treasury Secretary Tim Geithner is urging Congress to adopt greater financial-market regulation, another Capitol Hill hearing room is full of concern about another market subject to price gyrations: the carbon market.

The biggest worry is how businesses are meant to adapt to a world where the price for a new must-have asset - the right to emit carbon dioxide - can swing so violently. In Europe, for instance, prices for carbon permits have whipsawed from a high of 30 euros a ton to a low of 2 euros a ton.

Just as sketchy home mortgages set the stage for the subprime mess in U.S.
banking markets, sketchy environmental initiatives threaten to create a "subprime carbon" mess, environmental group Friends of the Earth warned today.

If correctly valuing McMansions was tough, how hard will it be to properly price the environmental benefits of a Mongolian wind farm, or other measures meant to reduce emissions of greenhouse gases? Carbon permits are still derivatives, after all.

That's why Friends of the Earth is so leery of the climate proposals currently circulating around Washington. A cap-and-trade plan would create a huge new market in emissions permits at a time when Wall Street and Washington have their hands full figuring out how to police existing markets.

One key element in all the climate proposals floated so far is the use of "offsets," or the ability to purchase emissions reductions made somewhere else.

As Friends of the Earth says in a new report, "Subprime Carbon":
"Given the lack of proven mechanisms to govern commodities, it is imprudent to so hastily create the largest derivatives market in the world and foist it upon a new and untested regulatory regime."

One possible side effect of the financial-market fallout and concerns about more toxic assets? - Growing support for a straight carbon tax, rather than a complicated cap-and-trade plan.

Several of the groups testifying Thursday before the House Ways and Means Committee, including the Center for Clean Air Policy, called for putting "training wheels" on the cap-and-trade plan by carefully managing the price for carbon permits in the early years of the program. That's just one step removed from setting a carbon price, period - with a carbon tax.

Subprime Carbon?: Re-thinking the World's Largest New Derivatives Market

Friends of the Earth statement

26th March 2009

As policymakers debate Wall Street reform, there is little attention being paid to whether new regulations will be adequate to govern carbon trading and the carbon derivatives markets, which many experts believe could become larger than credit derivatives markets.

Most proposed climate bills rely on cap-and-trade systems to achieve greenhouse gas reductions, and the Obama administration also prefers this approach. But these bills do not seek to regulate carbon trading as a massive new derivatives market, which is, in fact, what it is.

This new report finds that
existing financial regulations, as well as those in major cap-and-trade bills, are inadequate to govern carbon trading, creating a potentially huge regulatory gap.

It also outlines how lessons from the current financial crisis apply to carbon markets. In particular, it raises concerns about "subprime carbon,"
risky carbon credits based on uncompleted offset projects (projects designed to sequester or reduce greenhouse gases).

Subprime carbon credits may ultimately fail to reduce greenhouse gases and, like subprime mortgages, could collapse in value, yet they are already being securitized and resold in secondary markets. The report recommends that lawmakers include carbon trading in current debates about financial reform, and warns against hastily creating carbon markets without proper oversight.