Trading Hot Air?

Hot air is often associated with politicians, but the new 110th Congress will try elevating that unflattering characterization to the status of a tradable commodity in hopes of stemming the perceived problem of man-made global warming.

New Speaker of the House Nancy Pelosi, D-Calif., and Senate Environment and Public Works Committee chairman Sen. Barbara Boxer, D-Calif., support Kyoto Protocol-like plans to limit greenhouse gas emissions and to trade permits to emit greenhouse gases – a.k.a “cap-and-trade.”

Speaker Pelosi’s and Sen. Boxer’s plans are supported by investment banking firms, such as Morgan Stanley and Goldman Sachs, that plan on profiting from trading so-called “carbon credits.”

Toward that end, Morgan Stanley vice chairman Jon Anda argued for cap-and-trade this week in a commentary in the Jan. 3 Financial Times. It’s a useful place for starting the debate over what will likely be a major political issue during 2007.

Anda starts out by saying that, “Whether you believe the science [of global warming] or not is beside the point. Policy should be more about risk than proof.”

He suggests that the financial markets are best suited to assess such risk.

But Anda already errs here in a major way.

First, while we are unlikely to ever have definitive proof regarding the extent of human impact on global climate, science is crucial in assessing the risk of manmade global warming. Financial markets regularly assess the risk of real events – life insurance companies, for example, base premiums on actuarial tables. But what is the actuarial table-equivalent for manmade global warming if not the relevant science?

Anda wants us “to think of climate change in cash flow terms: imagine a series of payments over many years to cover the damage from carbon emissions… Simply put, we have a carbon liability and the value of that liability is rising”

Here too, Anda errs in assuming that climate change must be a net loss for society. How does he know it won’t be a net benefit to society? Agricultural production, for example, has likely been significantly enhanced by the Northern Hemisphere warming that appears to have occurred over the past 200 years.

Accepting Anda’s carbon liability assumption for the sake of argument, how precisely would we identify “damage from carbon emissions”? Anda might claim, for example, that the damage to New Orleans caused by Hurricane Katrina resulted from manmade global warming. But bad weather is not unique to the post-Industrial Revolution world and fingerprint/DNA evidence equivalents for weather events don’t exist.

What about the lull in hurricanes during 2006? Since atmospheric carbon dioxide levels only increased between 2005 and 2006, was the lull a “benefit” of manmade global warming? Anda has obviously stepped into a scientific quagmire.

Anda argues that “voluntary corporate actions are inadequate in managing climate risk” and that a cap-and-trade “market” is the answer to our supposed carbon “liability.” He asserts, “The rationale is simple: market forces pick the winning green technologies.”

Ironically, Anda also observes in his article that, “[i]f consumers are willing to pay a premium price for green products, businesses will certainly produce them. Yet premium green products lack the market share to make a difference.”

So as much as he claims to like markets, Anda apparently doesn’t like the answer that markets are already providing on green products as demonstrated by their limited and, so far, unpromising market share. His appeal for a government-ordered cap-and-trade scheme to compel market interest in green products is as quintessentially anti-market as it gets.

Anda concludes his article by saying that approaching global warming from a financial perspective “allows the market to pick winners.” While it’s not so clear that mandatory cap-and-trade of the right to release an invisible and difficult-to-measure gas equates to any sort of genuine “market” for a truly valuable commodity, just who will Anda’s “winners” be?

Although he doesn’t mention this in his Financial Times article, one big future winner may be Anda’s own firm. Morgan Stanley announced last October that it “plans to invest in approximately $3 billion of carbon/emission credits, projects and other initiatives related to greenhouse gas emissions over the next five years.”

Another big winner may be Wall Street powerhouse Goldman Sachs, part owner of the European Climate Exchange and the Chicago Climate Exchange – the exclusive marketplaces for trading carbon credits.

Goldman Sachs doesn’t even have to place a bet on whether carbon credits are going up or down in value. Under cap-and-trade, the climate exchanges would be government-sanctioned climate bookies, so to speak, making money from the forced trading of carbon credits.

And although Anda avoids discussing the all-important flip side of his conclusion, just who are the “losers” providing the “winners” with their dubiously-gained profits?

That’s easy. Just look in the mirror. As outgoing chairman of the Senate Environment and Public Works Committee Sen. James Inhofe, R-Okla., wrote in the Dec. 18 Wall Street Journal, cap-and-trade “would cost the average American family more than $2,700 a year while having no measurable impact on global temperature.”

It’s no wonder that Morgan Stanley’s Anda urges us to ignore the scientific debate about global warming and to rush to embrace cap-and-trade. A few thousand dollars from each of us might mean billions for his firm and other Wall Street “winners” – giving a whole new meaning to “green investment.”