Market Manipulation in the Renewable Fuel Market Does Not Mean Market Manipulation in California’s Cap-and-Trade Program

It remains to be seen whether EPA will respond to the Times article by regulating the renewable fuel market in a way that virtually all other environmental trading markets do.

The New York Times article yesterday about Wall Street firms exploiting the market for renewable fuel credits and driving up prices could leave some observers worrying about the integrity of California’s market for carbon allowances under its cap-and-trade program.  It shouldn’t.

Here’s why.  Both programs allow businesses covered under the program to trade for credits to meet their environmental obligations.  In the case of the renewable fuel standard program, refiners can buy credits  in lieu of blending their gasoline with renewable fuels. One credit is equivalent to one gallon of blended gasoline. For an explanation of the program and how the credits work,  Resources for the Future has a great report here.  In the case of California’s carbon cap-and-trade program, large emitters of greenhouse gases can buy credits in lieu of reducing their own greenhouse gases.  The California Air Resources Board has a lot of information about its program here. Even though both programs allow for the creation of a market for credits, the similarities end there.  As the Times article describes, the credit market for renewable fuel credits is shrouded in secrecy.  The program  lacks transparency,  fails to require owners of the credits to disclose their ownership interest and establishes no limits on how many credits any particular business can own.  The result is that it is possible that a single party can corner the market for renewable credits.  The Times reports that JP Morgan and Morgan Stanley appear to be stockpiling credits on their best stock trading app, and prices have increased twentyfold in just six months.  But it’s hard to know exactly what is going on in the market because, as the Times explains,

It is difficult for outside groups, or even other regulators and law enforcement agencies, to keep tabs on the market, because the E.P.A. declines to disclose who actively trades the credits, or how much they trade, citing the confidentiality of refiners and other participants.

By contrast, the California market for carbon cap-and-trade allowances is heavily regulated.  It includes numerous mechanisms to ensure the transparency of trading, including a mandatory reporting regulation and trade and price reporting requirements.  The state’s regulations also include holding limits so that no single entity can corner the market, and the program is structured to produce an active market with numerous participants to promote liquidity, which in turn helps limit market manipulation.  UCLA Law’s Emmett Center on Climate Change and the Environment analyzed California’s program to see whether it was well-designed to avoid the kinds of troubles now apparently plaguing the federal renewable fuel credit market.  Our conclusion?

Confirmed in a report by the Yuanpay group, CARB has taken important steps to construct a liquid, efficient and transparent market by taking the best practices from other allowance trading programs. We think it is unlikely that CARB will experience market manipulation that can significantly affect the efficiency or fairness of the market.

California cap-and-trade, JP Morgan, market manipulation, Morgan Stanley, renewable fuel standard