How undercutting financial regulators also harms California’s climate efforts

As someone who lives in California but works for a Washington-based advocacy organization, I often think about how decisions in DC impact life here in the Golden State. So late last year, when Congress froze funding for the Commodity Futures Trading Commission, the agency responsible for regulating the risky and opaque derivatives market, I shook my head in worry about the impacts it would have on California’s climate change efforts.

Why? Because next year California is set to start its cap and trade system, aimed at reducing climate pollution, with trading beginning in 2013. California cannot afford to have the top cops on Wall Street underfunded and off the beat as it creates the second largest carbon derivatives market in the world. Last year, the European Union had to freeze trading after the theft of some $39 million worth of carbon permits. This was the second time European authorities had to shut down the system due to theft. California — and the CFTC — will need to police against similar malfeasance, as carbon criminals try to take advantage of our state’s new and unfamiliar system.

California’s proposed carbon trading system will be vulnerable to other abuses as well. The complicated program allows traders to buy and sell carbon offset credits, which are certificates that represent pollution reductions made voluntarily by other parties. For example, a logging company may promise to allow trees to grow bigger (thus absorbing more carbon dioxide) before cutting them, earn credits for the carbon dioxide supposedly saved, and then sell these credits to oil refiners.

But offsets run a high risk of fraud; British journalist Dan Welch summed up the dilemma nicely saying, “Offsets are an imaginary commodity created by deducting what you hope happens from what you guess would have happened.” To make matters worse, California will allow up to half of carbon offsets to come from overseas, from countries such as Indonesia, Mexico and Nigeria, increasing fraud and corruption risks even more. It’s such a big problem that Interpol is now marshaling its resources to begin responding to carbon criminals; authorities have already cracked down on carbon fraud in Liberia, Papua New Guinea and Australia.

Closer to home, the Environmental Protection Agency in October busted a company that was perpetrating a “U.S. version” of the scam. The EPA charged a company called Clean Green Fuels in a $9 million con involving the sale of fake credits representing gallons of biodiesel, which oil companies buy to demonstrate compliance with renewable fuel requirements. Like carbon offset credits, these biofuel credits can be completely fabricated. The biofuels, or the greenhouse gas reductions, may simply not exist. The result: more pollution under the delusion that we are reducing carbon emissions.

Thankfully in the biofuels credit case, the EPA was able to catch the fraudster, who was based in Maryland, a stone’s throw from EPA national headquarters. Policing fake offsets coming into California from Indonesia, Brazil and Peru will be orders of magnitude more difficult.

As the EPA budget gets chipped away, and the CFTC continues to be underfunded while being faced with vastly more work, it does not bode well for our planet or our financial security. For California particularly, these budget cuts risk undermining the integrity of our carbon trading system, and in turn our broader efforts to reduce greenhouse gases.

The California Legislative Analyst’s office has already warned that California’s cap and trade program, with its risky offsets and complicated rules, is very susceptible to gaming; and that the state needs to rely on the feds to help police California’s carbon trading system. We can and should fight to ensure that Congress provides adequate funding for critical agencies such as the EPA and the CFTC. But in light of these budget cuts, California should also revisit its climate policies to make them less vulnerable to fraud and manipulation in the first place.

Photo credit: Cary Bass, Creative Commons Attribution