Getting Out of the Carbon Derivatives Market

So stated a recent Friends of the Earth report, "Subprime Carbon? Re-thinking the World's Largest New Derivatives Market." The report, written by Michelle Chan, explains that most carbon allowances and offsets/credits are sold as futures or forward contracts and are therefore a type of derivative. FoE warns that the carbon derivatives market is at risk from "subprime carbon" - contracts to deliver carbon that carry a relatively high risk of not being fulfilled and may collapse in value. They are comparable to subprime loans or junk bonds, which are debts that carry a high risk of not being paid.

"Subprime carbon would most likely come from shoddy carbon offset credits, which could trade alongside emission allowances in carbon markets."

FoE points out that the financial crisis shows the dangers in the US rushing to establish a large carbon derivatives market "without first establishing robust and and effective mechanisms to govern it."

In a confluence of bad economic times and political unpopularity for Kyoto's offsetting scheme, the Clean Development Mechanism (CDM), 60% of market players - companies like Morgan Stanley, Electricite de France SA, and Mitsubishi Corp. - are scaling back, delaying or outright canceling their CDM investments.

The sharp economic downturn in the EU is leading to a drop in greenhouse gas emissions, resulting in less need for the EU allowances (EUAs) mandated under the Union's cap-and-trade program and for CDM credits.

This falling interest from CDM credit buyers follows a January proposal from the European Commission that would ban the use of CERs post-2012 from the major polluters in the developing world like China, India, and Brazil, which are currently hosts to more than two-thirds of all CDM projects.

Given the many problems with the CDM, shrinking it can only be a very good thing.