Barely five years after it was set up the European carbon market spot trading was suspended yesterday for at least a week because of fraud.

According to the Wall Street Journal 2 million permits worth at present $37.7 million (0.02% of total allowable) have gone on walk-about this week and, although they were forced to suspend trading, the European Commission says the Emissions Trading Scheme (ETS) system is still sound. The ban, which started on 19th Jan is expected to last at least until 26th Jan. For some countries it may be longer.

Just recently €7 million worth of EU Allowances (475,000) were stolen electronically from the Czech registrar of carbon emission allowances OTE (a private company). An anonymous bomb threat was made and whilst the building was cleared for 5 hours hackers went to work, changed the ownership of the certificates then illegally traded them.

The European Commission has been on at individual countries to update and strengthen their ETS security procedures in the wake of VAT fraud, a phishing scam and the resale of used credits.

The carbon trading system was set up to combat climate change by only allowing those who have bought the allowances to pollute the atmosphere thereby putting a price on CO2 production. This would force companies to go green in the quest to reduce costs. The allowances are tradeable so that those that don't use their allowances can sell them on and, with a cap on the amount of allowances produced, there should therefore be a cap on the amount of CO2 released. The ETS covers some 12,000 installations in the EU and each EU member country has its own controlling registry and security systems.

This of course has now turned into a massive bureaucracy running just like any other stock exchange with a lot of money involved. So it was bound to attract a lot of unwanted attention, a bit like putting a large candle in a room full of moths.

And why all the trading? To make this work you need to be able to measure the CO2 output of the installations to be monitored, so why not just tax them directly? That would force them to act to reduce the tax. By making the allowances tradeable you just shift the pollution somewhere else and make a profit for yourself in the process and a nice fat fee for the broker.

Some companies even 'offset' their emissions by paying for Chinese and Indian factories for example to cut their emissions. That of course allows them to continue polluting here. The European Commission is at least trying to put a stop to that.

A banker obviously thought the ETS system up. I wonder how long it will be before we see a fractional reserve ETS? We've already got the futures.

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