Comment on carbon markets

There follows my attempt to grapple with the complex subject of carbon markets in Monday’s Fund Strategy.

Last week’s Financial Times investigation into carbon markets raised fundamental questions in an area where the City hopes to become world leader. They go beyond whether manipulation is taking place.

The FT says there are many examples of “carbon credit” projects yielding few if any environmental benefits. Credits are often worthless and do not lead to reductions in carbon emissions. Many companies profit from doing little. And companies as well as individuals are often charged excessively for European Union (EU) carbon credits.

Two factors seem to be behind such alleged malpractices. First, governments have made available a gross oversupply of permits in the official EU market. Wholesale prices for permits have plunged as a result. Second, many of the companies involved in the carbon offset market have minimal expertise and their activity is often unverified.

Such malpractices should not come as a surprise. In the climate of extreme moral righteousness over global warming many people are so desperate to demonstrate environmental credentials they are ripe for manipulation. In addition, the “markets” for carbon trading are not really markets at all. They are the artificial creations of governments that control how many permits are issued.

The problem at the heart of so-called carbon markets is their acceptance of the polluter pays principle. Although this principle has a superficial appeal – individuals or companies should pay for their pollution – it is divisive and damages innovation.

While it is true that industry, for example, can create environmental costs it also generates huge social benefits. Carbon markets create a way of levying a charge on companies for such costs. Yet there is no equivalent mechanism for paying them for the non-commercial benefits that result from their business.

As a result companies have an incentive to be cautious about innovation. New products or production processes will incur environmental costs. Therefore companies hold back on innovations that could have enormous social benefits.

The costs of pollution should be borne by society as a whole rather than individual firms. Since we all benefit from economic activity the costs of dealing with pollution should be managed collectively.

Carbon trading embodies a principle that is divisive and damages innovation. In addition, it is open to manipulation and involves creating “markets” that are entirely artificial.