A year after the collapse of Lehman Brothers touched off a global crisis, concern that wild financial speculation and trading abuses would undermine a U.S. greenhouse gas emissions market has put the "trade" part of the proposed national cap-and-trade program on trial.
Distrust of commodity traders and suspicion about the motives behind Wall Street's brassy support for a sprawling global market are fueling skepticism on both the political left and right that trading emissions allowances can curb the economic cost of addressing climate change.
In testimony before the House Agriculture Committee on Tuesday, the chairman of the Commodity Futures Trading Commission sought to allay concern on Capitol Hill that policymakers have been too slow to push unregulated financial trading onto commodity exchanges and under federal oversight.
"The law must cover the entire marketplace, without exception," Gary Gensler assured lawmakers. Agriculture committees in the House and Senate are poring over the Obama administration's plan for regulating over-the-counter (OTC) derivative contracts, such as commodity "swaps" traded by financial brokers.
The freewheeling financial dealing eluded regulators and was blamed for runaway energy prices and unscrupulous trading practices in recent years. From the perspective of the Senate's toughest critics of using a cap-and-trade program to combat global warming, the size and scope of a potential carbon market look too much like those of the market that created mortgage securities and credit default swaps that collapsed the housing bubble.
"Cap and tax is going to be a recipe for green-collar crime, for greed and for abuse," declared Sen. John Barrasso (R-Wyo.) last week. "I'm very concerned that any 'cap and tax' scheme is simply going to benefit the same Wall Street elite who got us in this financial mess we're in today."
Sen. Lisa Murkowski of Alaska, the top Republican on the Energy and Natural Resources Committee, echoed Barrasso's comments at a Sept. 15 hearing. She warned that a new trillion-dollar carbon allowance and offset credit market will be "securitized, derivatized and speculated by Wall Street like the mortgage-backed securities."
The House in June adopted a cap-and-trade bill meant to ratchet down carbon dioxide emissions. The White House and groups supporting the concept say the market-based approach is an efficient way to control the cost of meeting mandatory emissions limits.
Under the program, the government sets an emissions limit and distributes tradable credits to electric utilities, industrial plants and other major emitters. If a company exceeds its emissions cap, it must buy additional carbon allowances on an open commodity market, where prices fluctuate. A coal-fired power plant that can't cut its emissions can also purchase "offsets," which support clean-energy projects that need financial capital. That global market for carbon allowances is valued in the trillions of dollars.
Supporters point to the cap-and-trade program adopted in the 1990s for sulfur dioxide and nitrogen oxide emissions that cause acid rain. Public health benefits have been high, and at a far lower cost than anticipated.
But a deep well of skepticism has emerged in the Senate about whether the same environmental program should be applied to a far bigger carbon market.
"I assure you, with trillions of dollars roaming around, there are hucksters all over this world that can figure out a way to benefit," Sen. Bob Corker (R-Tenn.) told his colleagues on the Senate panel, suggesting offsets bought by U.S. companies could end up financing fraudulent environmental projects in other parts of the world.
The most efficient solution or a vehicle for manipulation?
Corker likens the cap-and-trade plan to the Rube Goldberg cartoons of the early 20th century. Goldberg drew complicated, byzantine machines designed to do simple tasks.
But alongside the rhetorical flourish that colors the debate are ongoing policy discussions among U.S. regulators at the CFTC and Securities and Exchange Commission about how to put controls on energy commodity trading before carbon credits become the next big asset class for Wall Street investors. If trading proliferates and little-understood financial products are created to carry carbon contracts, the concern is that carbon prices could go through the roof.
Congress is expected to tee up financial regulatory reform after health care. Strengthening oversight of energy futures and derivatives that trade on electronic platforms, and not regulated exchanges, is seen as a big first step to boost confidence in regulators and close regulatory gaps before they emerge.
Following the U.S. Treasury Department's lead, CFTC and SEC officials say they intend to tighten the screws on fraud and market manipulation, but still keep the door open for Wall Street and money managers to put financial heft behind a carbon credit trading market. Off-exchange electronic trading could be where a lot of that trading is done.
Gensler has reiterated support for ensuring that all standard commodity futures contracts trade on regulated exchanges such as the New York Mercantile Exchange, including carbon futures and options contracts, and as is the case with sulfur dioxide credits traded under the acid rain program. In addition, regulating dealers of over-the-counter derivative contracts would open customized financial products to regulatory scrutiny. He also targeted electronic trading platforms, saying "standardized" contracts should go through regulated clearinghouses that can decide if a contract is too risky for the parties and the market.
"If we're just a cop on the beat on the one side, then there really is a public policy concern or gap," Gensler said at a meeting in New York last week on the regulatory regime for a future carbon market. "But if we're able to police the whole market, then you have more opportunity to have standardized and customized contracts."
Senate Republicans with a strong resistance to carbon commodity trading aren't the only ones who are worried. Sens. Byron Dorgan (D-N.D.) and Maria Cantwell (D-Wash.), both staunch supporters of addressing global warming by putting a price on carbon emissions, also have voiced concerns.
But side by side with those doubts by key players in Congress is an all-out push by financial services companies for regulatory flexibility.
This secondary market is expected to develop quickly once a cap-and-trade program is in place. Investors would buy and sell carbon futures, options and specialized carbon swaps on the same trading platforms used in the giant energy sector.
Concerns about money chasing money
One concern is about money chasing money, causing roller-coaster price swings in the carbon market.
On Tuesday, Gensler told the House panel, "We should eliminate exclusions and exemptions from regulation for OTC derivatives." But in discussions about a carbon market, the regulator has sided with financial industry and utility lobbyists pushing for exemptions for custom-tailored contracts, which would be used to hedge against long-term carbon price increases or to set up an offset development contract.
Jack Cogen, president of Natsource and chairman of the International Emissions Trading Association, which represents 170 big industrial emitters and financial services companies, has pressed regulators not to exclude futures and derivatives -- just the type of contracts that some in the Senate argue put the entire market in jeopardy. He has urged policymakers not to force banks out of carbon trading and to ensure carbon trades in all corners of the financial markets.
Banks are necessary to stand in the market as an intermediary, buying and selling allowances and creating cash liquidity, Cogen says. Other contracts would manage price risk. He asserts that regulators have plenty of tools to protect against market manipulation, including the ability to enforce a limit on the volume of carbon contracts a single trader can control in a particular market. Cogen, however, has urged regulators to be flexible in setting those trading limits for a global carbon market.
"Forcing banks or other non-emitting sectors away from carbon markets would remove the very source of financing necessary to build new, more efficient and cleaner manufacturing centers and power plants," Cogen told CFTC regulators recently.
Cogen said opening carbon to a variety of markets would dampen the potential that carbon prices will be tied too closely to energy commodity prices, which have been highly volatile in recent years.
"The climate price is highly correlated with energy, except when it isn't," he said in an interview. "That's why you need separate markets."
Carbon markets are expanding fast, both in the United States and in Europe. Trading on the voluntary Chicago Climate Futures Exchange, for example, more than doubled in contract volume since the first half of 2008. Trading volumes are also rising quickly on Climate Exchange's London platform.
The ramp-up in trading has helped to trigger additional efforts in Washington to control carbon prices. Investor-owned utilities are pushing for a "price collar" to control the upside of price swings, and they also are pushing for the allocation of more free allowances to coal-fired power plants. That might lower the number of allowances in the trading mix just enough to help stabilize prices, they assert.
A lingering wariness could affect the Senate vote
"It's still possible to come up with sensible legislation that has a well-designed cap-and-trade system," said Robert Stavins, a professor of business and government at Harvard University's Kennedy School of Government.
The financial meltdown last year and unemployment resulting from the economic recession have exacerbated the uneasiness. "Those problems naturally cause everybody in society to be more wary of markets," Stavins said. But he, along with an army of advocates for opening a carbon market to financial speculators testifying before the CFTC and Congress in recent weeks, warned against regulatory overreach.
"When a single horse has escaped from the barn, it doesn't mean you kill all the horses," he said. "It would be inappropriate to close down the financial markets."
Supporters of the cap-and-trade approach assert that well-designed legislation and regulatory oversight would safeguard a carbon market from hucksters and illegal trading practices. They contend that the loudest critics raise the specters of Enron-style market manipulation and excessive financial speculation as straw men they can easily slay and as handy excuses to oppose legislation.
"One of the things that really struck me was the amount of discussion about market manipulation and market oversight," said Eileen Claussen, president of the Pew Center on Global Climate Change, at the CFTC meeting in New York, referring to discontent expressed in the Senate.
Critics come from both sides of the spectrum. Lawmakers who don't trust markets and those who are not expected to favor any global warming bill, regardless of what it says, warn that the trading half of the equation could send the economy into another tailspin if not regulated properly.
"It's worth pointing out that this whole issue is very key to what actually might happen or not happen," Claussen said.
"We have the securitization of carbon credits in Europe already, working efficiently," Joseph Mason, a financial market expert at Louisiana State University, testified to the Senate. "My only problem is hanging a substantial amount of U.S. economic growth on those innovative products."