Speculating on Carbon: The Next Toxic Asset

“At a time when derivatives trading has fallen in the wake of the financial crisis, volumes for trading greenhouse-gas emissions futures have exploded on the Chicago Climate Futures Exchange, the US’s biggest platform.”
Hal Weitzman, “Greenhouse gases offer growth prospects,” Financial Times, October 21, 2009.


As Parties to the United Nations Framework Convention on Climate Change (UNFCCC) prepare to meet in Copenhagen, the United States is advocating for a new agreement that will be consistent with U.S. climate change policy. But the terms of U.S. policy are far from agreed. It is not clear, for example, whether the carbon dioxide equivalent Greenhouse Gas (GHG) emissions will be treated as a tradable commodity within poorly regulated commodity futures markets. Here, we analyze the relevant U.S. climate proposals to determine their potential for inducing futures market price volatility. Sustained price volatility would disrupt the carbon price signals, which, in theory, will guide decisions about when and how much to invest in GHG reduction technologies.

We will look at the UNFCCC context of the U.S. legislation. Some of the drivers of commodity futures price volatility of 2006–2009 are summarized, since carbon will be likewise affected by these drivers, particularly to the extent that carbon is bundled into commodity index funds. The effect a proposed carbon derivatives market could have on agriculture prices and vice versa is also examined. The U.S. Congress has studied the European Union’s Emissions Trading Scheme (ETS), so the debate over the efficacy of the ETS for reducing GHG emissions is briefly summarized. Particular features of the draft U.S. legislation that could result in highly volatile carbon prices are also outlined.

IATP questions the efficacy of current U.S. cap-and-trade proposals to reach GHG reduction targets. However, it appears that the current framework for cap and trade will move forward, and it seems very likely to rely on the carbon derivatives markets as a chief means to reduce GHG emissions. Will carbon become the next toxic asset for multibillion dollar financial speculation? And how could we better achieve what Friends of the Earth’s Michelle Chan calls a “smaller, simpler and more stable” carbon market?1