Last week’s column noted that the unprecedented and spectacular growth of the global carbon market in the space of a few years makes it one of the most dazzling symbols of the awesome power of market expansion contained in globalization. However, like its counterparts in financial, credit, and money markets, there are deep flaws embedded in the carbon market. As a result these threaten market rupture/failure, which could in turn provoke a crisis of such enormity as to put at risk the very foundations of the auto-centred development of global market capitalism. For the coming weeks I shall consider three sets of these flaws. These are in order of treatment: 1) flaws arising from a misconception of the forest carbon segment of the market, (on which the LCDS is predicated on becoming a part of) 2) flaws intrinsic to market practices and organization and 3) extrinsic flaws, which specifically alludes to the recent invasion of the carbon market by fraudsters, con artists, and organized crime.
Misconception
Among investors, traders, other market operatives, as well as market analysts and governments in several rich countries there is a firm conviction that trading in forest carbon offsets constitutes easy pickings, when compared to more costly domestic efforts aimed at the decarbonisation of production processes and consumption patterns in rich countries. From their perspective, domestic efforts require substantially reduced reliance on fossil fuels for energy which is very costly, while harvesting forest resources in poor countries reduces carbon dioxide in the atmosphere far more cheaply. It is convenient from this point of view to label the forest carbon offsets market as an opportunity for harvesting low-hanging fruit (as it is termed) in the fight against global warming and climate change.
Why, we may ask, is this belief so firmly held? Readers following these columns would be aware that scientific opinion confirms that one of the world’s best technical means for removing carbon dioxide from the atmosphere is the utilization of the natural photosynthetic capability of natural forests. This can be done through their efficient, cost effective and sustainable management. More generally, as I have previously pointed out, this entails sustainable land use, land use change and forestry practices (LULUCF). From this perspective, therefore, forest carbon projects (such as Guyana’s proposed avoided deforestation of its pristine forests as elaborated in the LCDS) are low-hanging fruit, which rich countries like Norway are seeking to capture through arrangements like the Guyana-Norway Memorandum of Understanding (MOU).
Two fundamental areas of concern about the Guyana-Norway MOU are therefore relevant. The first is that in pursuing the harvesting of Guyana’s low-hanging fruit Norway is implicitly shifting much of the burden for combating the problems of global warming and climate change from rich to poor countries. We would expect that as an economic calculation, Norway’s monetary compensation for forest carbon projects in Guyana will always be less than it would cost Norway itself to take domestic action to reduce its carbon dioxide emissions.
Secondly, and more importantly, I believe that this attempt at burden shifting from rich to poor countries embodies a basic accounting fallacy. To the extent that poor countries’ contribution to the removal of carbon dioxide in the atmosphere is designed to compensate or substitute for emissions occurring in rich countries, then from a global standpoint there is no net increase in the global effort at decarbonisation! All the scientific data, however, point to a situation in which to be successful both poor and rich countries have to make efforts to decarbonise, with the rich countries (as the historic polluters) carrying the major share of the global effort. I shall return to this false accounting; showing by way of a simple example, the fallacy inherent to this strategy of governments in rich countries and operatives in the global carbon market.
Unique investment class
As investors and traders in the forest carbon offset market present it, forest carbon projects are considered to be a ‘unique’ investment class for several reasons. One is that investors can take debt or equity positions in the forest carbon projects themselves. Second, traders can engage in spot, forward, or options transactions based on the carbon dioxide equivalents produced by the projects. As readers already know, these are expressed in metric tons of carbon dioxide equivalents (mtCO2e).
Yet another reason is that the carbon market has grown so rapidly that significant deficiencies are only now emerging. Thus it has become uncertain as to how to effectively validate projects and the carbon dioxide they are expected to sequestrate. Further, unlike other major financial and credit markets, there is a distinct lack of institutional support in the form of organisations dedicated to the rating of projects on the climate exchanges. Such support helps to reduce risks and encourage the growth of insurance and other risk-mitigating firms.
It has also emerged that several of the forest carbon projects lack clearly defined property rights and ownership regimes. This absence complicates the nature and extent of legal liability, statutory compliance requirements, and the asset structure of the properties involved. This is frequently aggravated by the fact that many projects involve several legal jurisdictions. Since as I have indicated before, the market does not physically exchange the commodity in question (carbon dioxide) but property rights to these, continued lack of clarity as regards to property rights in projects could have a crippling impact on the growth of the forest carbon market.
Finally, the overwhelming bulk of the projects involved in the forest carbon trade are of a long-term nature. This immediately means that forest carbon projects will embody all the risks inherent to long-term project finance. This means there are currency risks due to fluctuating exchange rates, the probability of which increases with time. There are also fiscal risks as tax regimes too are increasingly likely to vary over time.
There are also the risks of expropriations and other related legal and political risks to the project, which rise, as time unfolds. Finally, there are systemic risks, which accompany all projects. These include well- known financial, accounting, transparency and governance risks.
Next week I shall consider the second set of flaws; those that are intrinsic to the practices and organization of the carbon market.