U.S. Carbon Offset Policy: Risks, Uncertainties and What We Can Learn from Current Financial Markets

Abstract

Climate change has become an increasingly important topic of political discussion and public concern. Although the United States has not signed the Kyoto Protocol, some individuals, companies, municipalities, states and regions have made either voluntary or regulatory efforts to reduce their greenhouse gas (GHG) emissions. Many observers believe the U.S. will institute a national carbon policy sometime during the current administration. Most public policy experts believe a cap-and-trade program will be part of any U.S. climate change policy. A trading program will presumably include both carbon allowances and carbon offsets. This Masters Project investigates what lessons policymakers can learn about regulation, oversight and transparency from the recent credit and financial market crisis. The research and analysis will suggest how policymakers can apply these lessons to help build the nascent carbon offset market into a robust, trusted, viable and liquid financial market over the long term. The research method included conducting twenty-nine interviews with specific questions for each group of participants. Ten financial market respondents, eleven carbon market respondents, five NGO respondents and three public policy experts were interviewed. A thorough literature review of current environmental commodity markets was conducted, too. The results address three distinct areas. First, what went wrong in the financial markets is scrutinized. Specific findings suggest too much complexity, too much leverage, and an overall lack of transparency caused most problems. Second, how the carbon market, in general, can avoid these problems is revealed. A consensus advocates utilizing a central clearinghouse with margin requirements for market participants while limiting the number of derivative products to the simplest of futures and options. Finally, explicit guidance for the offset market is given. This market must reduce the number of standards and registries. Furthermore, the conflict of interest inherent in the current verification and validation model for offset approval needs to be eliminated.