The great carbon trading scandal *
By Rowena Mason
Carbon allowances, Europe’s main weapon against climate change, have an impact on every household, yet the scheme is open to fraudsters and profiteers.
Within a few clicks of a computer mouse, stolen goods worth €28m (£24m) had bounced from the Czech Republic to Poland, Estonia and Liechtenstein before disappearing.
Distracting local regulators with a fake bomb scare, thieves behind the heist had made off with 500,000 carbon allowances – intangible products worth around €14 each that are the European Union’s main weapon against climate change.
Companies, such as those in the utility and heavy manufacturing sectors, are obliged to own allowances for each tonne of carbon dioxide they produce. The bulk are given away free by member state governments, but can then be traded between market participants to penalise heavy polluters and reward the more energy efficient.
It sounds complicated and remote from everyday life, but the system has a very obvious impact on everyone living in Europe. It pushes up household bills and the price of manufactured goods in return for the wider social good of falling carbon emissions. The high economic cost to consumers and businesses is why it matters that the €90bn market across 27 European countries works effectively.
In the context of such a big industry, €28m is perhaps the equivalent of stolen penny sweets from the corner shop. But part of the reason it has caused so much concern is that this is the fourth time that the carbon market has been hit with a major scandal.
People thought the carousel fraud on carbon was the tin-pot scheme of small-time crooks, but over the past two years it escalated into an organised crime depriving taxpayers of €5bn in revenue. At one point, fraudsters accounted for up to 90pc of all market activity in some European countries, with more than 100 people arrested mainly from Britain, France, Spain, Denmark and Holland.
Another deep controversy hit last March, when it emerged that some governments, in particular Hungary, had started “recycling” credits, or selling on old ones that had already been used for financial gain. Old credits can be legally sold to the so-called voluntary markets, favoured in places such as Japan, where companies that want to “greenwash” their image buy credits to show their environmental credentials to customers. But it is fraudulent if the allowances end up back in the official European system, as they did on this occasion.
Then came the first signs of pure carbon credit theft in the middle of last year in a wave of “phishing” scams, with market participants sent emails trying to persuade them to divulge their passwords.
By December, criminals had stolen credits from Romania in a hacking attack, prompting the closure of its national registry, and allowances were also reported missing in Switzerland. Barclays Capital claimed the whole market had descended into “fiasco” – but still there was no market-wide action to tighten security.
With this latest theft from the Czech Republic, the European Commission finally closed the entire spot-trading market indefinitely.
Experts are most worried that the scandals could discourage financial investors trading for fear of buying credits that were stolen or used for money-laundering.
The European Commission admits that around half of Europe’s registries are not protected against fraud. Britain is meant to have one of the best and claims to conduct identity checks on everyone who registers as a carbon trader.
However, a cursory glance at the online records of the British register shows a number of unusual traders in the mix. The Sunday Telegraph found dozens of tiny UK-based companies, whose primary business appears to be anything from selling consumer goods to electronics, sitting on the list of account holders. Many give addresses in suburban residential streets of cities in Yorkshire, Lancashire, Essex and other places not known for their links to the world of high finance. Among them are businesses with unreachable addresses and Hotmail, Gmail or Yahoo email accounts for company representatives. Some of them no longer even exist, according to records at Companies House.
Some have begun to question whether it would be safer to bring in much stricter regulation akin to the Financial Services Authority’s approval of “fit and proper people” to do business.
Trevor Sikorski, head of carbon markets at Barclays Capital, has put forward a radical idea: allow access to accounts only to financially regulated parties or those industrials and utilities who need allowances to comply with the law. “While this is not a guarantee of no future problems, it will make such fraud more unlikely and this is certainly what the market’s integrity needs,” he says.
However, it’s not just speculative profiteering and outright fraud that have caused outrage. There is also concern that industry is going to get huge windfall profits from the sale of carbon allowances accumulated during lower activity in the recession. One of the main problems highlighted by bodies such as the Committee on Climate Change is that there are too many free credits floating around. This means it is often cheaper for companies to just pay and pollute than invest in energy efficiency.
Professor Michael Grubb, one of its members, argues that the over-distribution of free allowances by government “risks creating windfall profits for some energy-intensive industries and is driving up the price of carbon for the rest of EU business”. The number of free allowances is meant to reduce over time. But powerful lobbying efforts by the industrial industries meant more were handed out than needed and now steelmakers and coalburners have already stockpiled huge numbers they can sell for profit .
One other serious challenge is the unreliability of “offsets”, a type of allowance that permits developing countries to profit from reducing their emissions. Low carbon projects, such as wind farms in Africa, are given credits to reward them for not making carbon, which can be sold on to European polluters who need allowances to cover emissions.
Critics argue that many inappropriate projects with dubious green credentials are getting handed out allowances all over the place. For example, a Chinese hydroelectric dam, for which people had to be displaced from their homes and was already planned long before trading came into force, is being showered with the high-value credits. Even high-carbon coal plants can get credits, if they can claim their technology is the most efficient type.
The worst offender has been “industrial gas credits” which were banned by Europe last week from 2013 onwards. These were allowances for destroying dangerous greenhouse gases used as refrigerants called hydrofluorocarbons. It costs 7p to eradicate gases equivalent to one tonne of carbon dioxide and the resulting offsets could be sold on the market for about €11, giving a total return of more than 99pc.
Developers found this so lucrative they were creating the gases purely to be destroyed and adding to other dangerous by-products in the atmosphere. In the end, industrial gas credits made up 85pc of the market.
Critics say this is awarding free money to Chinese and Indian developers straight from the utility bills of European consumers with no environmental gain. In fact, Michael Wara of Stanford University estimates it unnecessarily cost billpayers $6bn.
Natasha Hurley, policy adviser at CDM Watch, says: “Industrial gas credits have been totally dominating the system and have no environmental integrity. The whole problem with offsetting is that it’s difficult to prove. There is a huge challenge to ensure one offset does represent reductions.
For all those lobbying for change, there are others worried about what a radical overhaul would do for businesses which must plan how many credits they will need.
Miles Austin, director of the Carbon Market and Investors Association, describes the ban on industrial offsets as a politicised decision that kept market participants in the dark. Industrials that need to buy carbon allowances were concerned about the large reduction in available credits and its potential to push up prices.
“Political decisions need to be characterised as such. Doing otherwise will reduce the pool of capital that is available, by increasing the risk, and the cost of capital available,” he says. “The most worrying aspect is the process by which it was done. There are no objective criteria that allow investors to assess it properly. The process is a complete black box.”
This chaos at the heart of carbon market regulation is the most concerning thing for countries about to embark on trading.