Subprime Carbon: With “solutions” like these, who needs problems?

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Hot on the heels of Obama’s statements that a carbon market similar to the European Union’s greenhouse gas regulatory scheme would be centerpiece to his climate policy, Friends of the Earth has released a great overview of the proposals on the table.

They warn that the lynchpin of US and global climate policy seriously risks replicating the boom and bust, experimental marketplace created in the last 10 years for mortgages and other debts. Like those markets, carbon trading is increasingly sparking fraud and wreaking havoc on prices. Moreover, it risks superseding, distracting from — and even discrediting — more legitimate efforts.

Some excerpts - detailing the emergence of “subprime carbon”  and “bundled carbon securities” - follow.

Carbon Derivatives:

Carbon trading is fundamentally derivatives trading. Currently, most carbon is sold as simple futures contracts (a type of derivative). These contracts contain promises to deliver carbon allowances or credits in a certain quantity, at a certain price, at a specified date. Today’s carbon markets are small, but if the United States adopts carbon trading on the scale envisioned by most federal cap-and-trade bills, carbon futures will become what Commodities Future Trading Commissioner Bart Chilton called “the biggest of any derivatives product.”

Subprime Carbon:

” Subprime carbon” — called “junk carbon” by traders — are contracts to deliver carbon that carry a higher risk of not being fulfilled, and thus may collapse in value. They are comparable to subprime loans or junk bonds, debts that carry a higher probability of not being paid. Carbon offset credits (credits derived from projects designed to reduce greenhouse gases) can carry particularly high risks because many things can go wrong with offset projects. Not only do such projects face normal commercial and operational risks, but independent verifiers may find that a project has not reduced the projected amount of emissions, for example; or an agency issuing credits (e.g. United Nations) may determine that a project failed to comply with relevant standards. Subprime carbon particularly can become a problem because sellers can make promises ahead of time to deliver carbon credits before the credits are issued, or sometimes even before greenhouse gas emissions have been verified.

Carbon-backed securities:

In November 2008, banking giant Credit Suisse announced a securitized carbon deal that bundled together carbon credits from 25 offset projects at various stages of UN approval, sourced from three countries and five project developers. These assets were then split into three portions representing different risk levels and sold to investors, a process known as securitization. Carbon-backed securities sound hauntingly close to mortgage-backed securities because they are indeed very similar in structure. Although the Credit Suisse deal was relatively modest, future deals could become bigger and more complex, bundling hundreds or thousands of carbon credits of mixed types and origins, perhaps enhanced with agreements to swap more risky carbon credits for safer assets (such as government-issued emissions allowances) as “insurance” against junk carbon. Moreover, it could be as difficult, if not more, to analyze the quality of the numerous underlying carbon offset projects as it is to analyze U.S. mortgages.

For more information on this and other bogus climate solutions, check out Rising Tide’s new guidebook, Hoodwinked in the Hothouse.