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A New Growth Industry: Carbon Fraud

As the U.S. Congress gears up to begin debate on a cap-and-trade system aimed at reducing emissions of carbon dioxide and other global warming gases, fraudsters are licking their lips at the multi-billion dollar potential for gaming the system.

As honey attracts bees, money draws thieves. Such is human nature. So if you create a new multi-billion dollar market, it won’t take long for the bad guys to find a way to get in on the game. The new game is called cap-and-trade and the new currency is the carbon credit. The federal budget put forth by the Obama administration earlier this year forecast revenues of $650 billion over 10 years from the sale of carbon credits. And worldwide, the global carbon trading market is expected to grow to $700 billion annually by 2013 and as much as $3 trillion by 2020 – a fraudster’s dream come true.                                                                                                                  Read orignal article by Kroll  Tendencias May 2009
Cap-and-trade is a market-based system that aims to decrease greenhouse gases in the atmosphere by capping the emissions of polluting companies and reducing those caps over time. If polluters produce emissions below their legal limit, they earn carbon credits which they can sell to companies that do not meet their targets. These credits can be bought and sold on regulated exchanges.

As the United States enters the uncharted waters of cap-and-trade, much of the debate will revolve around the impact of imposing such a quota system for polluters on the cost of doing business. Will cap-and-trade unfairly burden US industry? Will it lead to protectionist policies aimed at emerging markets where emissions are not likely to be capped for many years to come? These discussions are sure to overshadow the issue of fraud. But the artificial restraints of cap-and-trade are certain to propel a new generation of malefactors to quickly learn the art of concealing and trading  not stolen art or African ivory  but emissions credits.

While new in the US and Latin America, carbon markets have been operational elsewhere since 2005. London-based consultancy New Carbon Finance estimates that the global carbon trading market increased from $64 billion in 2007 to $116 billion in 2008, based mostly in the European Union. Globally, the carbon market could reach $669 billion by 2013, according to a report last month by market research firm SBI. That figure includes an estimated $117 billion generated by the proposed cap-and-trade system in the US. In Latin America, Mexican officials have already expressed interest in bringing large polluters, such as Pemex and Cemex, into a cap-and-trade market.

With such huge sums at stake, there is a growing recognition of the potential for fraud. A recent report by accounting firm Deloitte warns that fraud in carbon markets “may be especially prevalent during the early stages of regulation by those looking to take advantage of naive market participants.”

Although still in its infancy, a few of the possibilities for fraud in a cap-and-trade system include:

Pumping Up the Baseline – A baseline scenario is an estimate of greenhouse gas emissions that would occur in the absence of a proposed project. If a project, once completed, produces fewer emissions than its pre-established baseline, the difference can be sold for credits. This gives project owners an incentive to exaggerate a baseline in order to receive more credits than they deserve. In the absence of proper oversight, there is enormous potential for abuse.

Potemkin Factories – Jim Lane, Miami-based editor of Biofuels Digest, a daily online compendium of news stories and commentary on renewable energy projects around the globe, refers to a Potemkin factory as a project built specifically for the sake of generating emissions credits. Like the Soviet Union’s Potemkin villages built to show off a phony communal paradise to naïve foreigner visitors, new emissions reduction projects could be contrived in a similar manner. The Potemkin factory charge has been used in connection with plans to build refrigerant gas plants in China. Critics alleged that the plants, which produce the harmful greenhouse gas HFC23, could potentially generate more revenue from the sale of emissions credits than from their core business.

Outsmarting the Auditors – Clever crooks (think Enron) have been outsmarting even the most conscientious auditors for as long as they have been around. No matter how tight the controls are on carbon production and carbon reduction, the urge to cheat, especially with wildly fluctuating prices of carbon per ton, will be great. For example, highly sophisticated meters and other equipment will need to be installed at companies that claim to be sequestering carbon dioxide emissions. But, as one carbon credit expert recently observed, sometimes gaming the system is as easy as sending air through the meter instead of gas.

Good Old Corruption – Given the amount of money in play, there always remains the possibility that an agent whose job it is to monitor and verify emissions reductions could be bribed. It is worth noting that the auditors that are currently empowered to verify emissions reductions programs around the world are all certified by the United Nations. If the oil-for-food program is any guide, that kind of certification program is far from foolproof.

Controls to prevent such fraudulent activity have been debated and will continue to be discussed during and following the December 2009 Copenhagen Climate Conference, where environment ministers from 192 countries aim to craft an agreement to replace the United Nations Kyoto Protocol, which ushered in the era of cap-and-trade and will expire in 2012. Much practical experience has already been gained from the European Union Emission Trading Scheme, the world’s first operational cap-and-trade system, which went into effect in 2005. Nonetheless, the risks will remain.

While a simpler alternative to cap-and-trade, such as a carbon tax, would be less attractive to fraudsters, some form of carbon trading will likely come into effect in the US and eventually in parts of Latin America. Governments and companies wishing to play the game of carbon credits need to have their eyes open about the real risks of fraud. As Yuda Saydun, founder and CEO of Florida-based carbon operations consultancy ClimeCo, notes, “tight, frequent, ongoing monitoring will be fundamental to the integrity of any cap-and-trade system.”

Source: Kroll Tendencias May 2009 – The author: Shanti Salas (shsalas@kroll.com)  is an Associate Director with Kroll in Miami.

Filed under: Energy & Environment, Latin America, News, Risk Management, , , , , , , , , , ,

One Response

  1. […] From Kroll: With huge sums at stake, there is a growing recognition of the potential for fraud. A recent report by accounting firm Deloitte warns that fraud in carbon markets “may be especially prevalent during the early stages of regulation by those looking to take advantage of naive market participants.” Read the full story here. […]

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