Why emission trading should be suspended permanently

Emission trading has been suspended for more than a week now and it is not clear yet when the market will open again. The reason is fraud, again we should say. What has happened?

Underlying the carbon market in Europe is a system of national registries. If you are a company that is participating in the emission trading, you get an account in this registry. The emission rights that you get from the government (your allocation) are then put into this account. If you make a trade, for example you sell rights, they will move from your account to the account of your counterparty. The whole system is run over the internet. Smart fraudsters have found a way of hacking the registries. They get into people’s accounts, grab the rights that are there, transfer them to their own account and rapidly sell them in the spot market. By doing this, they have recently made some 30 million euro’s. The registries of Austria, Czech republic and Greece were affected.

I think it’s not surprising that this happens. Emission rights are money and where there is money there is fraud. Moreover, the market was created from scratch in 2005, which is also true for the IT-infrastructure that is to support it. That probably explains the loopholes in the security systems. The authorities are now ramping the security up and are refusing to re-open the registries for rights transfers before they have everything tested. This standstill is not without consequences. If there is no possibility of transferring rights from one account to another, there is no possibility of spot market trading. Therefore there has been no more spot market trading since the suspension. How long can this last?

Regular readers of this blog will know that my enthusiasm for emissions trading is very low. It is a classical example of a great idea that turns into a bad practice for several reasons:

  1. Emission trading creates an immense amount of organizational difficulties. Protection against fraud is a good example of that. But also for the participating companies, the system creates an important extra administrative workload. They have to lobby for allocations, manage the account in the national registry, report on emissions, have those reports audited, manage trades, etc. I can hardly imagine that this paperwork is beneficial to the environment.
  2. Both trading periods in ETS were over-allocated. As long as the system is over-allocated, it is not contributing to the reduction of emissions of carbon dioxide. It creates an extra – unasked for – source of income for those that have laid their hands on the excess emission rights. And it creates an extra cost for electricity consumers as power producers hedge the costs of emission rights by incorporating them in their pricing.
  3. And even if allocations were short, I still doubt whether emission trading would contribute to reducing carbon dioxide emissions. I’ve discussed this with a client last Thursday. He asked me what my prognosis for long term emission rights prices is. The only sensible thing I could answer was ‘somewhere between zero and infinity’. And he responded, ‘Well that is why we don’t take into account savings on emission rights when we make a decision on investment in increased energy efficiency’. The price signal is too shaky to be significant.

Emission trading has missed its goal (reducing emissions of carbon dioxide), has created unnecessary administration and has also been a source of financial fraud at several occasions. What more does it take to make this suspension permanent?

There are a few thousand people winning money by having a job as a consultant, trader, broker, software developer, auditor, journalist etc. in the emission rights market. They will do all they can to keep this monster alive that they have contributed in creating. The EU has prided itself about the creation of emission trading across the planet. Admitting that it is a failure isn’t very easy. But is it really so hard for common sense to win? How much more money needs to get lost?

5 thoughts on “Why emission trading should be suspended permanently

  1. Pingback: Tweets that mention Why emission trading should be suspended permanently « Energytics -- Topsy.com

  2. Dear Bennedict, I do not know much about emission trading but your blog would appear to be confusing cause and effect. The cause of low prices is the over allocation. Over allocation is also the reason for low trading volumes with the resulting volatile prices.
    I know for a fact that the Swedish power producer Vattenfall has opted to reduce its CO2 emission because of the expected costs of COS emission rights following the 2013 allocation round.
    It would appear to me to be a clear example of the maket doing what it is best at – influencing behaviour. Let’s continue trading as soon as possible.
    Felix

    • Thanks for your comment Felix. Your example of Vattenfall is very telling. You say they are reducing emissions because of “expected” costs. Most companies that I talk to want to be more sure of costs before they invest to reduce them. I don’t know the details of the Vattenfall plans, but I guess they are investing in renewable energy, mostly in Germany. Isn’t the main reason for doing this the very high subsidies for renewable energy in Germany (EEG)? I know many companies that are investing in emission reduction. But I know none that are doing this mainly because of emission rights costs. In best case this is cited as an extra reason to do something. But if the ETS would stand alone, I don’t think that there would be as much investment. Moreover, the power producing companies are more sure that they will have CO2 costs because the plans to auction rights to them instead of handing them out for free are getting very concrete. But my question is: what is the difference between auctioning emission rights and a carbon tax? What is the difference but a lot more complexity and unwanted side-effects such as the fraud that we have recently seen. Philosophically, I also prefer markets as a solution. But I guess that 2008 has shown us that markets cannot solve every problem. And I am deeply convinced that the same holds for emission trading.

      • Dear Bennedict, I am pleased to see we share at least the philisophical appreciation for the market. I am convinced that the market is the best instrument influencing human behavious ever “invented”. The fact that in 2008 – 2009 the financial market had severe problems does not mean that other markets did not work, on the contrary. In daily live we see each day how well markets work and we will see the same for emissions – the moment there is genuine demand for a scarce resource the markets will influence our behavious ever so much better than any government policy. I feel that, maybe, your disappointment with emissions trading is based on the fact that their is no market yet. Let’s see what the next 5 years will bring – you will be pleasantly surpised.

  3. Well Felix, indeed the next 5 years should show a lot. And as far as the philosophical approach is concerned. There are even many economists these days that don’t believe that a market is the best way of dealing with emissions of CO2. Read for example this article in The Economist: http://www.economist.com/node/16377337?story_id=16377337. I wouldn’t say this newspaper is not market-minded. But they realize that emissions trading entails to many problems: the allocation difficulty, the administrative issues, the lack of trading capabilities with most of the participants, foremost: the confusing price signal for long-term investments and now added to that all: the risk of fraud.

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