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  • Dan Morain

Dan Morain: Can market for clean-air credits resist profiteers?

Published: Sunday, May. 27, 2012 - 12:00 am | Page 1E
Last Modified: Tuesday, Feb. 26, 2013 - 8:08 pm

A promise of big money has a way of quieting nagging questions.

So it is with California's cap and trade program. The Air Resources Board is pressing ahead with the creation of a market to begin reducing greenhouse gas emissions. Answering doubters, the ARB estimates the state will receive $1 billion a year in revenue.

In this cash-strapped state, many interests have their hands out. Environmentalists see ways to fund their projects, legislators hope to use it to pay for their favored programs, and Gov. Jerry Brown envisions using the money to help to build high-speed rail.

True believers see cap and trade as the key to implementing AB 32, the landmark 2006 legislation intended to combat climate change. But it also is a gamble, one that could sidetrack the state from other important though less flashy efforts to reduce greenhouse gas emissions.

In concept, cap and trade is simple enough. The Air Resources Board has identified 600 sources of air pollution in the state and has determined what their emission levels ought to be. That's the "cap."

Say an oil refinery exceeds its emission cap. The oil company could cut emissions or, more likely, buy credits from owners of other sources of pollution who fall below their caps, or offset pollution from its refinery by, say, paying to protect forest land.

The reality will be anything but simple when the opening auction takes place in November, unless you happen to be a sophisticated energy trader, or one of the high-end lobbyists, consultants and ARB officials who have spent the past six years devising the system.

Initially, California hoped to create the market with Western states including Oregon, Washington, Arizona and New Mexico. One by one, they dropped out. Now California has linked not with another state, but with the Canadian province of Quebec.

To create the market, the ARB established the Western Climate Initiative Inc., a nonprofit corporation based in Delaware. Its mission includes setting up the cap and trade auction, policing the market against manipulation. The state will take its cut from the trades.

The nonprofit's board consist of six members for now. Two are high-ranking ARB officials. The others are from Quebec and, oddly, British Columbia, which is not yet part of the cross-border compact.

Because cap and trade involves money, Wall Street is involved. The Environmental Markets Association is a trade group composed of lawyers and energy traders seeking a piece of the business. Its members include Goldman Sachs, which made a killing from the housing bubble and mortgage-backed securities and derivatives, financial instruments that led to the crash of 2008.

All along, the Legislative Analyst's Office has been issuing warnings. In an extraordinarily blunt critique last June, the analyst noted that there would be no fewer than three markets where emissions and offsets would be traded, including a primary market, a spot market, and a derivatives market in which contracts would be swapped as hedges and investments.

"Carbon markets are, by their very nature, complex. In general, the more complex the markets are, the more challenging it will be to regulate them, and the more susceptible they become to manipulation and fraudulent activity," the analyst wrote, adding that "the cap and trade system as designated by ARB is particularly complex."

The California Air Resources Board has a well-deserved reputation for being an innovative regulator. Over the decades, its rules have helped reduce smog and pushed automakers to produce more efficient vehicles.

The board has environmental credentials, but, the legislative analyst noted, "has no experience in regulating such markets and its lack of technical expertise and institutional knowledge of such matters increases the chance that market manipulation could go undetected."

ARB chairwoman Mary D. Nichols disputes that assessment, saying, "Cap and trade is very simple." Similar systems have operated for decades in other contexts. Cap and trade works in Europe and in Northeastern states.

"I think we have a pretty good sense of what can go wrong," she said.

A few legislators aren't quite so certain.

In a budget subcommittee hearing last month, Sen. Jean Fuller, a Republican who represents the oil patch in Kern County, asked a series of hard questions about cap and trade. Unable to get sufficient answers, she sent a letter last week asking for answers in time for another hearing on Wednesday.

The board didn't respond.

Fuller doubts the wisdom of AB 32, and is a Republican in a town dominated by Democrats. But state agencies ignore any senator's request at their peril. Last week, she pushed for an audit of cap and trade, and Sen. Joe Simitian, a Silicon Valley Democrat and subcommittee chairman, agreed.

"The last half-dozen years make us all a little nervous about market mechanisms that are complex beyond comprehension," Simitian said later.

Cap and trade does have a familiar feel. Back 1996, the Legislature approved a bill to deregulate energy. Then, the promise was that there'd be competition among electricity providers, and rates would fall by up to 20 percent.

Then-Sen. Steve Peace helped write the legislation, and remembers the fallout. Enron and other buccaneers manipulated the deregulated market. The state had rolling blackouts. Traders made millions. A few went to jail. Others remain in the business, and will be involved in cap and trade.

Peace predicts cap and trade markets will "work for a while, and then comes the moment. The moment is when the traders get the opportunity to cash in. The moment comes because these guys will make a lifetime's income in that moment."

Nichols doesn't see it that way: "This is not restructuring the electricity system. We're not effecting changes in the way business operate. We're just getting them to think about carbon emissions."

I hope she's right. But let's recap: California has an alliance with Quebec to create a market in which emission credits will be bought and sold, overseen by a nonprofit headquartered in Delaware. Goldman Sachs will be involved. What could possibly go wrong?

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