Carbon futures Market failure

Alarms over global warming are making strange bedfellows. Greenies are snuggling up with the bond traders while those free marketers plead with governments to set a starting price for carbon emissions.

A prized wit and leader of the Chicago School, the late George Stigler, observed that we cannot know the price of cheese on the moon until someone bids for it. What makes carbon emissions any different?

Once the trading starts, the carbon traders won’t differ one iota from their counterparts in cocoa futures or speculations on the exchange rate for this time next year. Out of carbon trades will sprout carbon futures which will bloom into carbon derivatives.

This is the era of financialisation. Zillions tumble through Wall Street with an insatiable appetite for your super, pensions and savings. As William Burroughs remarked: they don’t want your money; they want all your money.

Since these dealers play with fictitious capital, it is no surprise that one of the keenest analyses of what they do comes in a work of fiction. Tom Wolfe set his 1988 novel, Bonfire of the Vanities, in an earlier and far smaller wave of Wall Street frenzy.

Its protagonist is cross-examined by his six-year-old daughter. Her playmate has just boasted that her father employs 80 people publishing books. Not to be outdone, the trader’s cherub races to demand: “Daddy … what do you do?”

“Well, I deal in bonds, sweetheart.” That is no answer for a child: “What are bonds? What are deal?” He makes it simple. He raises the money to build roads and hospitals.

“You build roads and hospitals Daddy? That’s what you do?”

He has to admit that that is not exactly what he does. He just helps to build them.

“Which ones?” Again, he must disappoint her. He just raises the bonds for other people to build them.

Her mother intervenes. She invites their child to imagine that a bond is like a piece of cake that daddy keeps handing around until he has gathered “enough crumbs to make a gigantic cake” of his own. When he snaps back, their honey-bun begins to cry.

In 2000, the Greenies knew better than to applaud a trade in water licences. Their sale increased usage while the traders made it rain money.

Carbon traders promise to offset emissions. But the less carbon, the fewer trades become possible, and he fewer golden crumbs to accumulate. Carbon trading threatens to end in tears among environmentalists – though not at McBank. Can it be an accident that the home of McBank had the world's first scheme?

17 May 2007

The conversion of the Coalition to a national carbon market is another reason to scrutinize this free trade solution to death on earth. Will it enrich the traders more than reduce CO2?

A spokesman from the 230 or so academic economists who, last week, called for action to reduce greenhouse gases voiced his doubts about the efficacy of carbon trades. He preferred a tax because the revenue would go to the government.

Taxes cuts are more to the government’s liking in an election year. And that is what one carbon market already delivers. The mechanism for this transfer of revenue is explained in a new book, Voluntary Carbon Markets, by three senior staff at Ecosystem Marketplace, published by Earthscan and with a Foreword by Al Gore.

They begin with the boast that “turning units of pollution into units of property” is “magic at work”. Did they mean a slight-of-hand trick?

In discussing the NSW Greenhouse Gas Abatement Scheme launched on 1 January 2003, the authors give the game away:
"Under the scheme, energy producers exceeding their allotment of emissions can offset them either by surrendering NSW Greenhouse Abatement Certificates (NGACs) purchased from other producers, or by paying an $11/tonne fine. ‘Prices started at about A$6 a tonne when the scheme started’, says Ken Edwards, a broker at Sydney-based Next Generation Energy Solutions. Prices, say observers, are trading above the fine because operators can get tax benefits from buying GHG credits, but not from paying the fines."

So, carbon trading can reduce government revenues, not add to them. This triad of enthusiasts for carbon trading bear witness to why it is a sub-optimal solution to anything except transferring money.

Other economists support a carbon market because they believe that markets are the most efficient method for achieving every human wish. Some promoters of the market admit to its occasional failures. Here, for instance is what the god-father of the market theory, Friedrich-August von Hayek, wrote about managing environmental costs in The Road to Serfdom (1944):

“Nor can certain harmful effects of deforestation, or of some methods of farming, or of the smoke and noise of factories, be confined to the owner of the property in question or to those who are willing to submit to the damage for an agreed compensation. In such instances we must find some substitute for the regulation of the price mechanism.”

1 June 2007