Sunday, September 20, 2009

preventing Enron disaster in new carbon markets

Many serious people worry that the new carbon markets that would
be created by the Waxman-Markey Act would lead to trading disasters like what caused
last year's economic collapse. The Senate Energy Committee held a hearing on this recently,
but last Friday (September 18) there was a public briefing at the Senate which got a bit deeper into the risk, and what we could do to prevent it. Here is my personal view of what I heard and what it means:


At 11AM today, there was a public briefing at the Senate Visitors' Center with three speakers – Michelle Chan of Friends of Earth (FOE),
Tyson Slocum of Public Citizen (and an advisor of sorts to the Commodities Futures Trading Commission, CFTC), and Adam White of Wall Street (head of . They addressed the same issues of market manipulation with allowances and offsets that the Energy Committee discussed, but arrived at different conclusions.
White said: under Waxman-Markey, allowances prices would be guaranteed to rise at least 5% in value every year, and would be bankable forever. Under those conditions, Wall Street is guaranteed to flood the market with far more money than the core emitters provide, and create incredible volatility. There is some analogy to oil – but it would be far better if price discovery for present allowance prices were not perturbed by Wall Street, and if Wall Street were limited to two functions: (1) providing finance for actual clean energy projects; (2) creating a futures market outside of the allowance market per se, regulated by CFTC, and largely restricted to trades over exchanges.
All three speakers called for narrow price collars, to prevent speculation, and avoid the situation in Europe where excessive volatility made it hard to get the needed real-world investments. Strictly speaking, narrow price collars could be adapted, perhaps by a formula which raises them when the US is behind its reduction targets, and lowers them when we are ahead.
All three said we should limit banking to a year or two, because the net effect of banking is to increase speculation and volatility. The speakers have all worked on regulatory issues surrounding world oil prices – but they say that even the best regulatory solutions for the price of oil as such are of limited power, and that we are better off simply avoiding volatility altogether in the price of allowances as such. They also recommended adding one critical word in Waxman Markey: instead of saying allowance trading is open to folks who are NOT covered entities, make it covered entities only.
They said that the acid rain cap-and-trade system did not include offsets and was not open to noncovered entities.
Chan repeated FOE’s position that offsets – at least international offsets – should be reduced as much as possible, or,
better, eliminated. Under the projects-based approach to offsets, a project is a PROMISE – a kind of derivative, with all the risks that trading in derivatives implies. Credit Suisse has already started to package POSSIBLE offset projects in a bundle,
before any approval, using the same risky procedures that were used with mortgages, leading to last year’s economic meltdown.
White cited a recent Goldman-Sachs analysis of Waxman which pointed to four really big winners:
(1) Exelon and Entergy, because of their heavy nuclear portfolio and the way the allowances are written;
(2) Chicago Mercantile Exchange (CME) and ICE international exchange… because of the large volume of speculative trading expected. But, he said, there would be three other big winners they chose not to report – Goldman Sachs itself, J.P. Morgan and Morgan Stanley, because those banks would run the unregulated over-the-counter trades where most of the money would change hands, and where their insider information would let them get a big edge.
Everyone agreed that Wall Street is like a “Houdini,” that could not be kept out in any case. Chan: if we can’t keep them from the party, we can at least make the party (allowance price setting as such) less attractive to manipulation and fraud,
by making it AS SIMPLE AS POSSIBLE with the minimum possible insider aspects. She praised the Cantwell bill.
White noted a lot of internal conflicts of interest getting in the way of a rational market (especially at the five big winners),
and noted that a lot of the people who used to work for Enron have moved to those companies, taking similar business plans, discussed in recent conferences he cited.
Slocum of Public Citizen said we really should never lose sight of the really important milestone which matters here –
setting a global price for carbon.
White then said that preventing manipulation and fraud for a truly global cap-and-trade system would be nearly impossible, as their recent experience with the world oil market has taught them. He would prefer a global price set by some other process. To reduce problems in the futures markets, he likes a bill by Wyden – not the energy storage bill, but another bill to cut out inappropriate tax breaks for trading in futures markets which provide perverse incentives amplifying speculation.
They also discussed examples of past manipulation and fraud in energy markets, who is investing where and why,
and what kind of people are being hired.

So far as I know, there is no nation of earth which is really including these issues/possibilities
in preparations for Copenhagen. I have asked many of the people who work on "border adjustments" for the US about putting in EXIT CRITERIA. They all say: "We just want to use judgment about what is or is no comparable."

I would say: "When you go to a store to offer to buy something, do you say 'Give it to me,
and I'll use my judgment what to pay'? The international carbon price is what matters here, and to get to the kind of treaty we need, any US law must be clear and straightforward

about a simple way to turn off these border adjustments." And then... there are crucial details, but not any conversations yet allowing discussion of them!

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