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ThE poTENTIAL foR AbUSES IN ThE CARboN dERIVATIVES MARkET

major regulatory concern in carbon mar- kets is their susceptibility to manipulation. First consider the potential for a market power manipulation. Market power manipulations in commodities such as soybeans or copper typi- cally exploit the costs of enhancing deliverable supplies. Physical commodity futures contracts typically specify that delivery can occur at a small number of locations. It is oen physically possible to enhance supplies in this market in response to a corner, but due to the costs of transportation, and the costs of distorting the ow of commodi- ties, it is costly to do so. e manipulator exploits this cost by demanding a premium to sell his con- tracts that is just below the cost that those who had sold contracts to him would incur to bring additional deliverable supplies to market. us, physical commodity market corners exploit the costs of moving commodities. A

Put dierently, transportation costs and other fric- tions make the supply curve of deliverable com- modities slope up. e manipulator can cause the price of the deliverable to rise by forcing the market up that supply curve. In theory, such costs are com- pletely absent in carbon markets. Carbon emissions rights will be represented by electronic entries in a central registry that are transferrable at a trivial

cost. us, it would appear at rst blush that a cor- ner or squeeze is not possible in carbon markets.

Reection on the experience in another market gives pause, however. Specically, squeezes occur period- ically in government securities markets, including the market for US Treasury notes and bonds. Just like carbon emissions permits, ownership of Trea- sury securities can be transferred electronically at trivial cost, yet squeezes occur nonetheless.

  • ese manipulations occur because there are other

frictions in the market. In particular, some owners of Treasury securities do not actively participate in the secondary market. ey purchase securities for investment and hold these instruments to maturi- ty. Not participating actively in the market, these traders may not make their securities available to those needing to make delivery against Treasury derivatives even when prices become distorted due to a squeeze. at is, the supply of Treasury secu- rities available for delivery may slope up because some owners are lured into the market only when price distortions are substantial.

In other words, the “oat” in a particular Trea- sury security may be far less than the amount out- standing.8 A trader who amasses a position that

8

  • e “oat” is the amount of the security actively traded in the market, and readily available for purchase or sale.

E N E R G Y S E C U R I T Y I N I T I AT I V E

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