New global carbon trading market could be held hostage by speculators

The future of our planet is in jeopardy as greenhouse gas emissions from burning fossil fuels continue unabated. Treating these emissions as something that can be owned and exchanged on the market has been touted as a solution since the early 1990s, when United Nations negotiations to agree to limits on global warming began. In the latest round of talks in Azerbaijan, countries finally agreed on rules for a global carbon credit market.

I am currently researching the world’s largest system, the European Union’s Emissions Trading System (ETS). ETS, like other markets, is plagued by price speculation and fraud. If this template were replicated globally, it would only waste valuable time that could be used to stop and reverse greenhouse gas emissions.

The EU ETS is not the same as the UN carbon credit market. It remains to be seen what mechanism the latter will use to generate a price on carbon. But since both have their origins in the 1997 Kyoto Protocol, the first global agreement to limit climate change that will be replaced by the Paris Agreement in 2021, the UN carbon credit market will at least You can expect them to be similar.

That is, a cap-and-trade market in which regulators set a cap on total emissions and polluters are allowed to own and trade greenhouse gases in excess of this limit. The UN carbon credit market will likely have different caps for each member state. That is likely to depend on each country’s emissions reduction commitments.

Allowing market participants to set a price on emissions in this way could, for example, incentivize more efficient power plants. Companies that can make such changes to reduce emissions below the cap can sell excess credits to companies that cannot. Regulators are gradually lowering caps, with the hope that financial incentives will curb emissions and their negative impacts.

What ETS can teach the world

The EU ETS, like many other ETSs, is designed like a financial market. You do not need to manage a factory to participate in the EU ETS. A hedge fund manager or investment bank’s carbon trading desk will suffice. To effectively respond to climate change, these companies must consider their impact on the overall market price of carbon.

The participation of these financial speculators is pervasive in the EU ETS and is estimated to account for a large portion of the market’s multi-billion dollar trading activity. One financial industry source described the EU ETS as a place of “tremendous (price) volatility” driven by speculators anticipating changes in the price of carbon credits.

Volatility in global markets will hurt developing countries the most, which are the main beneficiaries of these markets. For example, the sale of carbon credits can help protect relatively undeveloped lands and forests, or finance renewable energy projects that not only reduce emissions but also guarantee energy and dignity to the most vulnerable people. It is possible. A collapse in carbon prices could fatally undermine the financing of such projects.

Speculators typically do two things. Estimate the price of carbon by analyzing past prices (similar to astrology, according to some economists) and then inventing and acting on stories about near-term events that will have some effect on carbon prices. It is to do.

Financial speculators are not the only ones who induce price fluctuations. Dishonest market participants are profiting from regulatory loopholes and also causing price collapses. One loophole concerned whether the EU would accept carbon credits under the Kyoto Protocol from a single emissions reduction project around the world.

This has led some industry participants to unnecessarily emit greenhouse gases that can be removed more cheaply, such as HCFC-22/-23, and then replace the subsequent emissions reductions with more costly removed greenhouse gases, such as HCFC-22/-23. It encouraged the conversion to credits measured in C0₂ equivalent.

This is a clear case of the carry trade (buy low, sell high) that is a staple of financial markets, forcing a reduction in the EU ETS carbon price and capping and trading on ever-increasing amounts of carbon. Damaged thoughts. Emissions are costly. Kudos to the EU for closing these regulatory loopholes, albeit almost a decade late.

Existing cap-and-trade markets, even when they are functional, have a questionable track record in reducing emissions. A 2021 study revealed that the ETS contributed less than 2% to the EU’s annual emissions reductions.

But the EU has also been a global champion of emissions reductions since the beginning of UN climate change negotiations. This shows that the EU’s tax system and green policies, such as renewable energy subsidies and sustainable investment funds, are working.

We need to see how the global carbon credit market for countries and companies deals with the problems experienced by the EU ETS.

The more this new global carbon credit market resembles another market with speculative storytellers and astrologers, the more price disruptions will occur and the more difficult the global green transition will be. It will be.

This article is republished from The Conversation under a Creative Commons license. Read the original article.