Double Counting in the Carbon Markets

March 26th

As the US gets closer to considering Cap and Trade legislation once again, in the Senate this time, a troublesome story appears in the Economist that would make even the strongest supporters of doing the right thing on Global Warming a little queasy. (“The Wrong Sort of Recycling” Hungary’s sale of used carbon credits damages investor confidence. March 25, 2010. The Economist)

No doubt the Hungarians would feel that they had been slandered – after all it was out of their hands. And it’s OK to sell credits twice in Japan. So its unfortunate that this sent the market in Paris into turmoil.

But perhaps we get ahead of ourselves…The Hungarian Ministry of Environment and Water issued 800,000 certified emission-reduction credits (CERs). As the Economist explains “CERs are generated by the Kyoto protocol’s “Clean Development Mechanism, whereby reductions in greenhouse gases in developing countries can produce a carbon credit for use in industrialised markets.”

What happened with this sale of CERs was that Hungarian firms had already put the CERs to good use offsetting their own emissions. The Economist explains that Hungarian officials reported that the credits were ultimately destined for a buyer in Japan and in Japan you can use credits twice, something that you cannot do in Europe.

The point of having a carbon market is to be able to price the right to emit carbon dioxide efficiently. The Economist quotes Yuichi Takayama of Tokio Marine Asset Managementas explaining, “In Japan’s view, so long as some environmental benefit has occurred, then the CERs have a value”.

Not so much in the view of the European carbon markets. The CERs were not simply sent from Hungary to Japan but instead found their way onto BlueNext that is an exchange based in Paris. “By the time that the European Commission realized what had happened, all hell broke lose. BlueNext temporarily suspended trading.” The price fell and investor confidence appeared to be shaken. Since this trade was not in a government’s hands no one broke the rules.

In Europe you are not supposed trade the same credit twice. There has been support for making different kinds of credits fungible. The market will be bigger if new entrants aren’t discouraged from coming in. But if the new players bring credits that are sold in Hungary and again in Japan and then on the European exchange there’s going to be resistance from investors and then there won’t be a market at all.

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