Good COP, Bad COP

Addressing risk in the carbon market
by -- December 16th, 2009

A carbon market would face two general categories of risk — market risk and political risk.

The Nicholas Institute and the German Marshall Fund hosted a UNFCCC side event this morning titled “Designing a Transparent and Credible Global Carbon Market.” In his opening comments, Tim Profeta discussed the two types of risk that may affect a carbon market. The first general category is market risk. This includes the types of risks that we have seen in other markets over the past couple of years, including price volatility, fraud, manipulation, and excessive risk-taking. The second category of risk – risks created by the political process – sets a carbon market apart from existing commodity markets. Political concerns in the near term could prevent adoption of legislation which creates the market in the first place. In the longer term, political concerns about fraud or price volatility could lead policymakers to alter the climate legislation and undermine the market. Without confidence in the market’s long-term viability (and a long-term requirement to cut emissions), companies may be reluctant to make the investments necessary to cut their emissions – the ultimate goal of the market.

Patrick Woodcock, legislative assistant for Senator Snowe and one of the architects of the Carbon Market Oversight Act of 2009 (S. 1399), emphasized that this would be a new market and Congress has the ability to design it correctly from the outset. He listed some of the regulatory mechanisms that Senator Snowe believes are important for the carbon market – aggregate position limits, accreditation of traders and brokers, an accurate registry to ensure that the cap is set correctly at the outset.

With the proper levels of government oversight, enforcement, and market transparency, lawmakers could address both categories of risk to ensure a long-term, stable, and efficient market.

1 Comment

  1. Barry Parker (Duke 1977, BA)
    Dec 18, 2009

    The importance of clearing in nascent markets :
    I work in the freight market (ocean shipping) where a futures and swap market has developed over the past 25 years. When there is uncertainty and volatile, clearing has supported the growth of the freight market, and also emergent markets for swaps in commodities that move by freight. In a new market, where not everybody will know everybody, clearing will be vital. Most likely, some big market makers will take the role of “clearing brokers” and could intermediate the transactions in carbon as the market grows beyonds its present limited arena.

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