Carbon flows, financial markets and climate change mitigation

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Environmental Development

Environmental Development 1 (2012) 10–24

2211-46

doi:10.1

E-m

journal homepage: www.elsevier.com/locate/envdev

Carbon flows, financial markets and climatechange mitigation

Arthur P.J. Mol

Department of Social Sciences, Wageningen University, The Netherlands

a r t i c l e i n f o

Article history:

Accepted 26 October 2011After initial debates and controversies, from the late 1980s

onwards market instruments became fully accepted in environ-

Keywords:

Carbon markets

Financial markets

CDM

EU ETS

Voluntary markets

Networks and flows

Environmental governance

45/$ - see front matter & 2012 Elsevier B.V

016/j.envdev.2011.12.003

ail address: [email protected]

a b s t r a c t

mental governance. However, with their inclusion in transna-

tional and global environmental governance, market institutions

seem to be in for a new round of discussions. Transnational

carbon markets stand out in these debates, especially since the

recent financial crisis made the world aware of the vulnerability

of global financial markets. This paper uses a sociology of flows

perspective to review current debates on the emerging global

carbon markets as new – initially state-created – institutions to

mitigate climate change. Do carbon markets aim primarily at

climate change mitigation or mainly at financial gains? Who

controls the functioning and outcome of these transnational

carbon markets? And is there a risk of a global carbon market

crisis, not unlike the global financial crisis? The paper concludes

that current discussions and decisions on carbon market archi-

tectures are conducive for the future role of carbon markets in

climate change mitigation. States are just one of the many actors

shaping carbon markets and thus managing carbon flows.

& 2012 Elsevier B.V. All rights reserved.

1. Introduction

Since at least the mid-1990s, climate change is dominating the environmental agendas, firstespecially in developed countries but by now around the world. A wide variety of strategies andmeasures are proposed and implemented to mitigate climate change, at different scales. Many ofthese measures and strategies have a clear nation-state focus, as nation-states still must be regarded

. All rights reserved.

A.P.J. Mol / Environmental Development 1 (2012) 10–24 11

main actors, institutions and platforms for designing and implementing climate change mitigation.But new institutions, less strongly related to nation-states, are emerging. The design andimplementation of carbon markets – the subject of this paper – is arguably one of the most far-reaching new institutions to handle climate change.

The use of economic and market institutions in environmental protection predates carbonmarkets and has a history of over 30 years. Experimenting with economic and market mechanisms,dynamics and institutions in modern environmental policy and governance was motivated by whathas become known as state-failure (Janicke, 1986): the shortcomings of the state in the provision ofcollective environmental goods. State failures related to, among others, high costs, low effectiveness,lack of forcing technological innovation, and low legitimacy. In the 1970s and 1980s many developedstates started to implement environmental taxes, charges, and deposit-and-return systems. Later,this widened to the introduction of payments for environmental services and tradable emissionrights. At least until the mid-1990s most market-based strategies, measures and institutions – alsowith respect to climate change – were organized and set by the nation-state and hardly crossednational boundaries. However, in entering the new millennium this seems to have changeddramatically. The emergence of transnational carbon markets forms perhaps the best evidence thatmarket institutions in climate change mitigation (i) are no longer restricted to what Beck (2005) callsthe ‘nation-state container’, and (ii) have gained in importance. Various carbon markets have beendeveloped over the past decade and these are becoming increasingly interlinked. Globally, the 2010value of the various carbon markets was $142 billion, more than double their 2007 value. The U.S.Commodity Futures Trading Commission believes carbon derivatives could become the mostimportant commodity market ever; it ‘‘estimates that the carbon derivative market could be worth$2 trillion USD by 2017’’ (as cited in IATP (Institute for Agriculture and Trade Policy), 2009: 3). Hence,we are witnessing the design and implementation of a major new economic institution to mitigateglobal climate change. Newell and Paterson (2009: 80) rightly conclude that ‘‘climate politics areincreasingly constructed by, through and for markets’’. But global market institutions in climatechange mitigation are not undisputed, and debates amplified when the recent financial crisis madethe world aware of the vulnerability of global financial markets.

Against this background, the main objective of this paper is to analyse emerging global carbonmarkets as new institutions to mitigate climate change. The paper focuses on three questions: Whois in charge of the development and implementation of transnational carbon markets? Can carbonmarkets be considered an instrument for mitigating climate change, or have they transformed intomerely institutions for financial gain? And can carbon markets become equally vulnerable to system(near-)collapse as financial markets? The paper starts by developing a perspective instrumental forthe analysis of carbon markets as climate change mitigation institutions. Subsequently, the currentstate of affairs with respect to global carbon markets is introduced, as well as the debates and criticalissues surrounding them. Finally, to find answers to the questions formulated above, the issue ofgovernability of carbon markets is addressed, drawing upon analogies with financial markets inparticular.

2. Analysing carbon markets: flows and networks

Initially, market instruments and institutions in national environmental governance were lookedupon suspiciously, especially following analyses of market failure as being the root cause of modernenvironmental problems (e.g. Schnaiberg, 1980). But during the 1980s and 1990s fundamentaldebates and controversies on and opposition against market institutions in national environmentaland climate change governance pacified to some extent. The strong emergence of ecologicalmodernization ideas and models, articulating the role of markets and economic/financial/privateactors in environmental and climate governance, changed the focus of debate: the question was nolonger whether, but how, where and to what extent markets and economic actors can bestcontribute to sustainability (e.g. Mol et al., 2009). This research programme further widened ingovernance studies (e.g. Kooiman, 2003; Treib et al., 2007) around themes of private governance,public–private partnerships, non-state market-based governance, and the like.

A.P.J. Mol / Environmental Development 1 (2012) 10–2412

However, especially with their inclusion in transnational environmental and climate governance,market institutions seem to be in for a new round of discussions, often coined around the notion ofneoliberalization of nature. This concept refers to nature (e.g. fish, biodiversity, forests, water, andnow carbon) becoming commodified, privatized, and unevenly distributed and accessed, withconsequences for management institutions and strategies (Mansfield, 2004; Heynen and Robbins,2005; Castree, 2008). Especially within geography, carbon markets have been interpreted as the mostrecent example of such processes of neoliberalization of nature (Bumpus and Liverman, 2008; Baileyand Maresh, 2009; Newell and Paterson, 2009). Where the neoliberalisation of nature literature iscritical on nature being marketized, ecological modernization scholars emphasize the possibilities ofthe market becoming ecologized. But both focus on the same tendency: ‘‘like it or not, neo-liberalcapitalism(s) will provide the context and historical moment in which action has to take place. Thisimplies engagement with prominent actors in neo-liberalism from business and finance, whosestrategies need to be aligned with the goal of climate protection’’ (Newell and Paterson, 2009: 81).

In understanding new institutions and practices in global climate and environmental mitigationscholars in both traditions have recently applied the concepts of networks and flows. Examples ofempirical studies using these concepts are on the car system (Urry, 2004), office buildings inmetropolises (Presas, 2005), nature/biodiversity (Van Koppen, 2006), biofuels (Mol 2007),sustainable fish trade (Bush and Oosterveer, 2007), carbon offsets (Bumpus and Liverman, 2008),and mega-events (Mol, 2010). The theoretical foundation of this new network/flow perspective is tobe found in the sociology of network and flows.

The sociology of networks and flows is not so much one clearly formulated consistent theory, butrather a new perspective for understanding the contemporary globalized world. Common idea is thatnetworks and flows are the new constituting elements of globalized modernity. It is fruitful to useUrry’s (2000, 2003) work on the sociology of mobilities to operationalise these concepts. Urrysuggests that networks and flows operate in three spatial patterns or modalities: regions, GloballyIntegrated Networks (GINs), and global fluids. Regions consist of objects, actors and relations(networks) primarily geographically clustered together, often within one country. They arecharacterized by fixed and solid relations within a nation-state container, showing ‘directional’mobility of flows, constrained by the fixed boundaries of that region. This is the typical modality thatdominated the pre-globalization era. Globally Integrated Networks, GINs, consist of more or lessstable, enduring and predictable relations between nodes or hubs, stretching across different regions,with relatively walled routes for flows. GINs cross national boundaries and thus becomedeterritorialised, although place-based moorings ensure that they do not become footloose. Theydeliver the same kind of outcomes at all nodes, with limited adaptation to local circumstances:‘‘its products are predictable, calculable, routinised and standardised’’ (Urry, 2003: 56–57). Largemultinational corporations (e.g. Shell), agro-food networks, and civil society network organizations(Greenpeace, WWF) are typical examples. Global fluids are spatial patterns structured neither byboundaries nor by more or less stable relations, but by large flexibility, liquidity, gel-like movementand permeable boundaries. Fluids demonstrate no clear point of departure or arrival, no clearsequential dependency, just deterritorialised movement with no necessary end-state or goal.Migrating people, financial capital, the Internet, and social movements are typical examples. Theunpredictability and complexity that is so central in Urry’s notion of global modernity is especiallyrelated to this latter modality of fluids. But notwithstanding the increasingly deterritorialized,footloose and stateless character of global financial, economic and information GINs and fluids,Hoogvelt (1997), Sassen (2006), and others have illustrated that such flows have to be processed atplaces (the metropolitan cities), that they originate their profit from places, and that they have to‘settle down’ at places.

Power in networks is related to access to, inclusion in and exclusion from, and control over flows,both through being on and off the network and through power relations inside the network.According to Castells (2004) it is the power elites that operate at the most crucial nodes of globalnetworks, who know best how to handle the switches, codes and programs that govern global flowsof money, capital and information, at the expense of the ordinary people who have no access andcontrol. The socio-material networks that ‘structure’ the mobility of flows are shaped by these powerrelations; but these networks also ‘structure’ power positions around these flows, access ‘rights’ to

Table 1Traded volume and value of voluntary and regulatory carbon markets, 2007–2010 (based on World Bank, 2011; Bloomberg,

2011).

Markets Volume (MtCO2) Value (US$ million)

2007 2008 2009 2010 2007 2008 2009 2010

Total regulatory 2920 4704 8586 8188 64,100 135,100 143,700 141,900

� EU-ETS 2061 3093 6326 7025 50,100 100,500 118,500 119,800

� CDM (prim. & sec.) 791 1467 1266 1099 12,900 32,800 20,200 19,800

� Other regulatory 68 154 994 64 1100 1800 5000 2300

Total voluntary 66 127 97 127 335 729 408 394

Total global markets 2986 4831 8685 6823 64,435 135,829 144,108 142,294

A.P.J. Mol / Environmental Development 1 (2012) 10–24 13

the flows, and the strictness of boundaries for different kinds of flows. The ability of states – as one ofthe power containers – to regulate mobilities differs between the three modalities. With respect toregions, states are still the major governing actors, although under globalization they can no longerdetail the social patterns and regularities. With Globally Integrated Networks, states have becomeless able to act purposefully in regulating mobilities—that is, to influence the direction, speed, form,contents, and outcomes of mobile flows. The relevance of states and directional governancedecreases further with respect to global fluids. Global fluids are barely touched by activities ofnation-states, nor are state authorities very important constituting forces in structuring socio-material networks.

Hence, global flows and networks are key entrance concepts to understand current practices andinstitutions. The idea of solid boundaries and fixed clusters, especially within a nation-state/societycontainer, is at least complemented – if not sometimes replaced – by borderless global flows andnetworks. This perspective of flows and networks will be used for understanding carbon markets asinstitutions in climate change mitigation. These markets, as socio-material networks, structuremovements of carbon offsets, allowances, financial compensations, information, and – in the end – CO2.

3. Voluntary and regulatory carbon markets

Carbon markets are the systems where permits or allowances to emit greenhouse gasses orcredits earned by not emitting greenhouse gases (offsets) are traded. We have to speak in plurality asthere is not yet one single, fully integrated global market for credits and allowances (as there is forfinancial capital), but rather a number of separate markets that are in a process of further linking andintegration (see for instance Bumpus and Liverman, 2008; and the EU Linking Directive [2004/101/EC]).It is common to distinguish between voluntary carbon markets and regulated or compliance carbonmarkets (see Table 1). By introducing them separately we also point at the differences that continue toexist in the size, organization, development and governance of these carbon markets. The regulatory/compliance markets are stronger state- and EU-based, organized and governed; while the voluntarymarkets are generally more networked and non-state governed, often without centralized oversight, andare known as the ‘Wild West’ of the carbon markets (Bayon et al., 2009).

Voluntary carbon markets are defined as all purchases of carbon credits that are motivated bydrivers other than regulatory compliance. Currently, two major voluntary markets exist: the ChicagoClimate Exchange (CCX; established in 2003 and the only functioning private system) and thebroader non-binding Over-the-Counter offset market (where exchange occurs between two privateparties without being reported to regulatory authorities). The CCX is a voluntary but legally binding

1 Towards the end of the 2000s a proliferation of trading platforms could be noted, be it not embedded in a cap and trade

program. Beside the CCX there are: the Carbon TradeXchange (CTX), the China Beijing Environment Exchange (CBEEX),

Climex, Montreal Climate Exchange (MCeX), Tianjin Climate Exchange (TCX), World Green Exchange, The Green Exchange,

and Africa Carbon Credit Exchange (ACCE).

A.P.J. Mol / Environmental Development 1 (2012) 10–2414

and rule-based greenhouse gas emission reduction and trading (or: cap-and-trade) system.1

Members join voluntarily and agree to its legally binding reductions policy. The unit of trade isCarbon Financial Instruments (CFI, equalling 100 tCO2e2) and there are three types of members: Fullmembers with significant GHG emissions and committed to reduce emissions with establishedpercentages and data verification (110 members in January 2010); Associate members withnegligible GHG emissions but commitments to fully offset 100% of their indirect emissions (e.g.through travelling; 37 members by May 2010); and Participant members such as project developers,offset providers, offset aggregators, liquidity providers, and exchange participants (253 by April2010). Baselines, annual emission data, and registration of offset projects are verified by the USFinancial Industry Regulatory Authority (FINRA). The Over-the-Counter market is not driven by anyemission cap and the carbon credits sourced (usually referred to as Verified Emission Reductions,VERs) originate from emission reduction projects. This market is driven by purely voluntary buyers(who immediately retire their credits after purchase; 80% of them are private companies) and pre-compliance buyers (who purchase VERs either because they will become regulated or because theywill trade in them). The first voluntary purchase of carbon offsets took place in 1988 (from a forestryproject) and the (voluntary) market operated in a relatively sheltered, philanthropic niche until 2005(with by then an annual trade of 11 MtCO2e). Around 2005 the concept of offsetting becamemainstream and the number of transactions increased sharply, till 127 MtCO2e in 2010 (see Table 1).But with that also the initial simple value chain became more complex, increasing the numberof intermediaries (brokers, aggregators, exchanges, etc.). In addition, credibility, legitimacy, andenvironmental effectiveness have emerged as key issues of debate in voluntary carbon markets,resulting recently in the emergence of third party standardization and verification of carbon creditsby a variety of verifiers (globally at least 19 in 2009). Often these verifiers also establish (emission-tracking and/or credit-accounting) registries, but these registries are not always linked or integratedand remain standing alone (in 2009 at least 18 credit-accounting registries were counted in thevoluntary market; Hamilton et al., 2009; Bloomberg/Ecosystem Marketplace, 2010).

This volume of voluntary market trade is however only a fraction (o2%) of the carbon trade inregulatory carbon markets (which equalled 8118 MtCO2e in 2010; Table 1). Regulated carbonmarkets are driven by regulations and can be distinguished into Kyoto protocol regulated markets(Clean Development Mechanism, Joint Implementation, and Emission Trading) and various regionalinitiatives especially within the US.3 Here, the Kyoto driven carbon markets are by far the largest, ledby the EU Emission Trading Scheme (EU ETS), and the Clean Development Mechanism (CDM).

Following a failure to install an EU carbon tax and to seduce the US into the Kyoto protocolobligations, the EU agreed on an Emission Trading Scheme in 2003 (through two directives) andintroduced it in 2005.4 The EU ETS was developed to have a cost-efficient reduction of greenhousegasses, where reductions take place at the cheapest locations and technology innovation isstimulated (which hence led to deterritorialised carbon markets). Billions of euros cross borders on aweekly basis, more than 11,500 installations are involved (covering 45% of European CO2 emissions)

2 tCO2e (or MtCO2e) refers to (million) ton carbon dioxide equivalent, a unit used to bring all greenhouse gasses under one

denominator.3 E.g. the Regional Greenhouse Gas Initiative RGGI among 10 east coast states, since 2007; the Western Climate Initiative

WCI among 7 western states, with 6 states joining as observers, starts in 2012; the Midwestern Greenhouse Gas Reduction

Accord MGGRA among six states, with three states as observers, starts also in 2012. The American Clean Energy and Security

Act (H.R. 2454, the so-called Waxman–Markey Climate Change Bill) calls for a federal cap and trade system by reducing GHG

emissions with 3% in 2012, 20% in 2020, and 83% in 2050 (all compared to 2005 emission levels). It passed the House of

Representatives in 2009 but lost momentum for consideration in the Senate late 2009 and 2010. The Kerry/Lieberman

American Power Act (aimed to include the Climate Change Bill) failed to be decided upon by Congress before its November

2011 elections.4 The Emission Trading directive (2003/87/EC), which established the legal and operating foundations of the scheme, and

the Linking directive (2004/101/EC), which sanctioned and specified the terms under which EU Allowances may be traded

with CDM and JI credits. The first trial phase was from 2005 to 2007; the second is from 2008 to 2012. The EU ETS has been

revised in 2008 for the period after 2012, the so-called third phase (EU, 2008). See Skjærseth and Wettestad (2008) and

MacKenzie (2009: 151–176) for a detailed analysis on the emergence of the EU ETS.

A.P.J. Mol / Environmental Development 1 (2012) 10–24 15

and thousands of people find their work in this market. Governments hand out emission rights(so-called European Union Allowances, EUAs), related to their national allocation plans, which haveto be agreed upon by the European Commission, as these plans have to be in line with EU greenhousegas emission caps. Every year companies are granted emission rights (in February) and they have tomake sure that they hand in sufficient emission credits compared with their emissions (ultimatelyby April 30 of the next year). The emission credits are compared with the company emission report,as verified by an EU registered verifier. Penalties are up to h100 per excess tCO2e during 2008–2012(phase II of EU ETS). Every EU country has set up an emission registry, linked to the EU CommunityIndependent Transaction Log (CITL). Owners of emission rights have an account in any of theregisters, and transactions of emission rights are recorded in these registers. Any shortages orleftovers of emission credits can be traded, either directly, via trade platforms, or via intermediariesor brokers. Following the Linking Directive 2004/101/EC, the EU ETS allows operators to purchaseand use CDM (and Joint Implementation) credits (see below), subject to certain qualitative (e.g. typeof projects) and quantitative (e.g. these credits have to remain supplemental to domestic actions)conditions. Other regions are developing more or less similar emission trading schemes forgreenhouse gasses and have started implementing them: New Zealand, as decided in 2009; USA withregional initiatives and a national scheme still in debate; Australia with a regional New South Walesinitiative; China with voluntary experiments in Tianjin, Beijing, and Shanghai. After an initial‘neo-liberal’ first phase, the EU has progressively gained regulatory strictness in governing thesecond and third phase.

The Clean Development Mechanism was launched in 1998 and operationalized in 2000. Underthe CDM, industrialized countries (or organizations in developed countries) pay for projects thatcut or avoid greenhouse gas emissions in less developed countries, by buying Certified EmissionReductions CERs (1 CER equals 1 tCO2e) that can be applied to meet their own greenhouse gasemission targets. In less than 10 years, the Clean Development Mechanism has developed intoan institutionalized global trading mechanism and practice. The idea is that entities in recipientcountries benefit from the infusion of advanced technology and investment that allow theirfactories or energy generation plants to operate more efficiently and/or cleanly; and that entities indeveloped countries reach their emission reduction targets economically efficiently. Moreover, theCDM is supposed to reward developing countries for reducing emissions, without punishing them ifthey fail to do so. The Executive Board (EB) is the international regulatory agency for the supervisionof this market. Its role is to oversee, as an independent governance body, the implementation andadministration of the CDM, develop procedures for the CDM, accredit designated operational entities(DOEs),5 and issue CERs. Apart from this highest level CDM organization, the Clean DevelopmentMechanism foresees a standardized implementation structure for host countries, DesignatedNational Authorities (DNAs) in host and receiving countries to look after implementation, legallybinding standardized contracts between buyers and sellers (so-called emissions-reduction purchaseagreements ERPA), and an International Transaction Log to list and regulate CER transactions.Estimates of the global CER supply potential for the first commitment period (2008–2012) rangebetween 1400 and 1700 MtCO2e, while projections of global requirements to meet Kyoto targetsrange between 1800 and 3300 MtCO2e. China and India have been the main host countries (with 60%of global CERs trade in 2010), and the UK, Switzerland, the Netherlands, and Japan have been themain CER buyers (around 70% of global CER trade in 2010; see http://cdm.unfccc.int/Statistics/index). In 2009 and 2010 the CDM market decreased in terms of volume and value following thefinancial crisis and the lack of post-2012 clarity, especially after the Copenhagen Climate summitfailure in December 2009.

At the moment each of these markets has its own particularities. But there are also significantsimilarities and linkages: in exchanges, calculations, verification rules and procedures, and actor

5 Designated operational entities (DOEs) are independent auditors that assess whether projects meet all CDM eligibility

requirements (validation) and whether projects have achieved greenhouse gas emission reductions (verification and

certification).

A.P.J. Mol / Environmental Development 1 (2012) 10–2416

involvements (see Bailey and Maresh, 2009; Bumpus and Liverman, 2008). Some even hypothesizethat we might in the end move to one globally integrated carbon market.

4. Carbon market debates

These new carbon markets in-the-making are confronted with various forms of criticism, rangingfrom imperfections in their design and implementation up till fundamental critique drawing onparallels with financial markets and the latter’s collapse in 2008/2009. In reviewing these debatesfour major issues are distinguished, starting with smaller imperfections and ending with morefundamental controversies. Some critiques are more relevant for particular carbon markets, althoughthat distinction is not always made by the offenders.

The first set of more friendly and constructive critiques on carbon markets deal with design andimplementation imperfections, but leave the main objectives, goals, and fundaments of carbonmarkets unchallenged. The Clean Development Mechanism has raised criticism of various kinds, forinstance around estimation protocols of carbon credits, where regulators, environmentalists andoffset experts come with different amounts of credits for similar projects. Wara (2007) claims thatCDM directs investments mainly to the ‘low hanging fruits’ such as end-of-the-pipe hydrofluorcar-bon projects, leaving investments in less profitable but more valuable multiple-goal projects (such ason renewables) for the developing countries after the CDM has ended (although that is changingrecently; Wara and Victor, 2008). Michaelowa and Jotzo (2005) point to the substantial transactioncosts involved with baseline development, project registration, verification, and certification,especially for small scale projects, making CDM a cost-ineffective arrangement. Others have pointedto the conflicts of interest of especially validators of CDM projects: as they are paid by the projects,they would have little incentive to stringently apply validation criteria (Haya, 2007; Lohmann,2009a). Stern (2008) criticized CDM for its emphasis on projects, and not focusing on sector-specificefficiency targets and sector-based decarbonisation plans, which could more easily enlarge annualcarbon revenues. Wara and Victor (2008) make a similar plea for programmatic CDM; but they alsocriticize CDM for preventing further involvement and commitment from non-Annex 1 countriesto the Kyoto Protocol (a standpoint regularly ventilated by among others the U.S. government).A number of authors conclude that, for these reasons, CDM should be seen as an inefficientinstrument to combat global warming (Tollefson, 2008; Wara and Victor, 2008).

Comparable to CDM, also the EU ETS (in its first and second period, until 2012) is believed tohave a number of design shortcomings: (i) EU ETS is a decentralized system for setting nationalallocations, allowing states control over the quantities of allowances; (ii) it excludes some highemitting sectors from emission caps and trade, e.g. aluminium industry and aviation; (iii) EU ETSonly covers and thus regulates CO2 emissions and none of the other five greenhouse gasses; (iv) EUAswere handed out free of charge following grandfathering, instead of being auctioned; and (v) toomany emission permits were handed out initially, leading to price drops, significant ‘windfall profits’and hardly any emission reductions. A number of these shortcomings will most likely be corrected inphase III of the ETS (2013–2020), now that the European Commission is strengthening its regulatorypower (EU, 2008; Bailey and Maresh, 2009). Some of these points also emerge in the U.S. plans fortrading systems (Bailey, 2010; Gilbertson and Reyes, 2009).

These comments on the design and operationalization of carbon markets are further strengthenedby a second set of debates, which question the environmental fundamentals under carbon tradingmarkets. Central question here is: are the various voluntary and regulatory carbon markets stilllinked to and fulfilling environmental rationalities; or have they become just economic/financialmarkets where profits fully overrule environmental logics? Especially the larger (environmental anddevelopment) NGOs (such as the big 10 Washington-based groups), environmental authorities, andenvironmental scientists are ventilating this criticism and propose changes in the carbon marketinstitutions. Within CDM, this debate is framed in terms of additionality (of GHG reductions): CDMprojects (and the gained CERs traded) have to result in an additional reduction/prevention ofgreenhouse gas emissions and additional financial investments. Some argue that most CDM projectswould also have been implemented without CDM incentives, questioning the current use of the

A.P.J. Mol / Environmental Development 1 (2012) 10–24 17

additionality criteria in project approval and claiming that many/most CERs are ‘hot air’ (Haya,2007).6 Also the baseline scenarios against which additionality needs to be proven are subject tocriticism, as these would be often set too high (Wara, 2007; Lohmann, 2009a, b), causing theemission on unrealistically high CERSs in terms of carbon offsets. This comes together with perceivedlimitations of the verification and control capabilities of the current institutional lay-out for such acomplex global carbon market.7 Hence, some critics question the valuation of assets (not unlike whathappens in financial markets), when excess carbon credits are issued without actual reductionstaking place. This could result in loss of confidence in the value of carbon credits. To conquer that,private sector carbon auditors approved by the UN have become involved, to build trust in thesystem (not unlike credit rating firms in the financial system). Others analyse the rationale in thecarbon market as just providing additional cash flow for already approved projects, where onlythe main economic players (such as financial institutions, large industrial firms, and energycompanies; Lohmann, 2009a: 50–53) gain profit. Just like the financial derivates market, the carbonmarket would drive innovators to constantly seek and design new products to price the future. At thesame time, we see the CDM Executive Board becoming stricter in approving projects, showingsensitivity for this kind of criticism.

In the EU ETS it has been especially Ellerman and Buchner (2008; Ellerman et al., 2010) whoquantitatively assessed the – quite limited – emission reductions (2–5%) of the first pilot phase(2005–2007). Others have been far more critical of the environmental achievements of the ETS,arguing that within the EU zone no emission reduction took place following the ETS scheme (instead,targets were reached only by offsetting elsewhere) (Gilbertson and Reyes, 2009). The questionwhether we have here an environmental or a purely economic market returns in discussions onpriorities when managing price fluctuations in carbon markets: should the system be managed withthe aim of environmental certainty (of emission reductions) or with a focus on price managementand protecting business against high costs. In the EU, ETS price fluctuations have been quite large(between USD 10 and USD 30 per tCO2e), initially following over-supply of EUAs and later followingthe financial and economic crisis (early 2009). Calls for price floors, caps and corridors, and a carboncentral bank to regulate supply, have emerged among politicians, analysts and traders (see Sterk andKruger, 2009; similar calls have emerged in the US when legislating the Climate Act). But up till nowany market intervention has been strictly opposed by the European Commission, using environ-mental arguments.

Third, and related to the former point of additionality and ecological rationality, carbon marketsare changing dramatically, from simple and direct buying and selling of carbon credits (now lessthan one-third of the volume of carbon investment) towards global institutionalized and complexfinancial market institutions. In these carbon markets, carbon credits and reductions are increasinglyabstracted and detached from on-the-ground time-place settings. CO2 emissions have been replacedby symbolic tokens (CERs, VERs, INFs, EUAs) and with the commoditization of symbolic emissionrights and offsets they become tradable in global markets across large time and space distances(and object of ‘neoliberalization of nature’ criticism). Hence, by 2009 financial and technical tradeaccounts for a greater portion of carbon market activity than trade for compliance purpose (Kossoyand Ambrosi, 2010: 16). This comes together, and is also caused by, a growing power of the existingprivate financial sector in carbon markets (with among many others JPMorgan, Barclays, andDresdner Kleinwort strongly entering this market), the establishment of many new carbon traders(such as Eco-securities, Climate Care; see http://www.endscarbonoffsets.com/ for a list of carbon

6 In China most CDM projects are on hydropower, and most CDM hydropower projects are in China. While hardly any

hydropower project is now build without CDM, there is no increase in hydropower projects after CDM has been installed. This

criticism of International Rivers (cf. Haya, 2007) has definitely played a role in the fact that its site is blocked in China.7 Increasing pressure on the CDM Executive Board resulted in turning down 50 Chinese wind mill CDM projects just

before the start of the December 2009 Copenhagen UN conference on Climate Change, contributing to stalemate positions on

climate policy between China and the US. China called for ‘‘enhancement of objectivity and transparency in the approaches

(y) of additionality’’ and to ‘‘improve consistency in its decision-making’’, while the US and EU called for increased

transparency from China in setting feed-in subsidies, GHG emission data monitoring, reporting and verification (Lewis, 2010).

A.P.J. Mol / Environmental Development 1 (2012) 10–2418

traders, also per credit type), and the role of the financial service industry and infrastructure incarbon market developments (see Knox-Hayes, 2009).

This all has two major consequences. First, it becomes increasingly difficult for actors in thecarbon market to relate traded allowances and credits to place-and-time specific CO2 emissionreductions. To ensure that this relation still exists, the carbon market increases in complexity, as it isin need of sophisticated methods and systems of registration, calculation, verification, auditing, riskand uncertainty assessment, insurance systems, and transparency in order to remain trusted. Hence,we can witness in the EU ETS, in the CDM and in the voluntary offset market a rapidly expandingbody of, among others, regulations and procedures, advanced calculation methodologies, registries,carbon accountants, certification and verifications systems and organizations, and risk analysts. Asthe markets are still in full development and rather fragmented, there is still no full harmonizationamong registries, verification protocols, certification standards, and regulations, giving additionaldoubts to the ability to reduce uncertainties among traded abstract tokens such as CERs and EUAsand to build trust in the market. Some actors, such as the General Accounting Office of the US(USGAO (United States General Accounting Office), 2008), doubt whether such systems will ever beable to ensure full certainty and thus trust in the carbon market. Second consequence is that theabstract carbon markets increasingly become subject to and partly dominated by instruments,practices and products of creative investors, banks, traders, brokers, and speculators who see theseGHG emission rights and offsets just as financial products, as a means of profit making. Thus we see afurther diversification and specialization in carbon market networks, where specific actors becomeexperts in specific market actions (see Schneider et al., 2010; Kossoy and Ambrosi, 2010). In the EUETS, for instance, manufacturers with carbon emissions have hardly been involved in trading yet,whereas energy generators and financial institutions have been quick to set up carbon tradingdepartments in their companies and developed strategies to increase profits by commodity pricedifferences in spot and future markets (Bailey, 2010). There is ample room for gaming by the morepowerful market actors, for the development of new (complex) products that can be traded, and thusfor the emergence of a secondary market (where repackaged carbon is sold for the second, third ortenth time; see below). At the same time, the expanding carbon market community is still a tightlyknitted network and – also due to its complexity – not very open, with fast changing positions ofindividuals between private carbon trading consultancies, carbon investment funds, governmentalagencies, UN regulatory agencies, the World Bank, environmental NGOs, energy corporations,financial institutions, and the like (see Lohmann, 2009a: 54, for some examples). That means thatconflicts of interest occur and financial and environmental integrity are not safeguarded. We havehere a clear example of Castells’ power elite, who – with clear technical and market information andknowledge advantages on a new and complex system – programmes the market and knows how tohandle the switches and codes to favour their outcome.

Fourth and finally, these debates have recently spilled over in the drawing of parallels with systemfailures in complex financial markets, and especially the recent financial crisis that started in 2007.Here carbon markets are believed to increasingly mirror the global financial market. The recent sharpgrowth in carbon markets comes together with a flood of new traders, brokers, retailers andspeculators seeking high financial returns, financial investors shifting portfolios to carbon derivates,and investment banks that develop new instruments. There is trade and speculation in carbonfutures, swaps, options,8 forwards, and even something equivalent to Collateralised Debt Obligations(e.g. Kossoy and Ambrosi, 2010). Bundling carbon credits from several projects and projectdevelopers, and splitting these again in different risk levels to sell them again to investors, is inprinciple not too different from the securitization strategies on mortgages in the US (which werebehind the recent financial crisis). These products promise to deliver carbon allowances or credits ata certain price, quantity and specified date in the future, as spot prices vary strongly but also becauselarger profits can be made. For instance, in the late 2009 CDM carbon market a spectrum of pricingformulas has emerged for (future) projects, from fully fixed to fully variable, with diverging risk

8 The volume of carbon options market started in 2007 with some 50 MtCO2e but passed 500 MtCO2e and USD 10.6

billion in 2009, most notably in the EU-ETS (Kossoy and Ambrosi, 2010: 16–17).

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profiles, and prices per tCO2e ranging between h2 and h9. These carbon securities further obfuscatethe quality assessment of the underlying carbon offset projects and the relation with sustainabilityand CO2 emission reductions. Chan (2009) sees ‘subprime carbon’ emerging on the market: carboncontracts with high risks of not being fulfilled in terms of greenhouse gas emission reductions. Veryyoung and unstable markets with new instruments make prices volatile, spur the development ofsubprime carbon, and may create bubbles. When carbon contracts are bundled with otheragricultural and non-agricultural contracts into commodity index funds,9 this may make especiallyagricultural cash and future prices volatile, with dire consequences for food security. Hence,according to some, carbon can then become ‘‘the next Toxic Asset’’ (IATP (Institute for Agricultureand Trade Policy), 2009). These developments towards a growing complexity and absence of stringentregulation in carbon markets mean that (state and market) financial and economic institutions, agenciesand organizations influence the terms, rules and functioning of carbon markets, and not their (state andnon-state) environmental counterparts. Brought back to the essence, this criticism of carbon marketssees the possibility of wider system collapse, instead of just carbon markets failing to deliver climatechange mitigation, because: (i) carbon markets are expected to growth in size, degree of integration andglobal reach; (ii) they parallel with financial markets in terms of abstraction, instruments, networks, andfinancial motivations; (iii) they increase in complexity; and (iv) they can further integrate with othermarkets. A variety of protest groups such as Rising Tide, Climate Justice, Climate Action Network Europe,Sink Watch and Carbon Trade Watch articulate this analysis and position, often as part of and in linewith fundamental criticism on neoliberal capitalism and the privatization of nature (e.g. The DurbanDeclaration on Carbon Trading, signed by a large number of NGOs in 2004 in Durban, South Africa;http://www.durbanclimatejustice.org/durban-declaration/english.html).

5. Managing global carbon complexity

In the end, these debates are in essence questions on the actor-networks that (can and do) shapeand influence increasingly global and complex systems of carbon cap-and-trade, and related carbonflows. Are carbon markets and flows becoming global fluids, where a variety of network actors havelimited management power to direct and ‘control’ these flows? Does this mirror recent failures inmanaging financial markets by financial networks (see also McKenzie, 2009)? In exploring carbonmarkets management parallels will be drawn with analyses of financial market governance.

In 2007 the financial crisis emerged in the US when it was recognized that (i) the loans, whichhave been sold and re-sold were much less valuable than previously assumed (leading to quickand massive selling), and (ii) the institutions holding these loans could end up in financial trouble,limiting the credit provision between financial institutions due to fear of limited repayments abilities. Inmany analyses of the causes of this financial crisis, complexity of financial instruments and systems hasbeen a common denominator. Following that line, global financial flows are conceptualized as globalfluids, barely governed by states but influenced by multiple decisions of multiple actors. Financialsystem complexity explains that we can hardly foresee and predict major and sudden shifts or collapsesof the financial system, let alone that states can prevent them. But we have to be careful in embracingcomplexity arguments in explaining the recent global financial system (near) collapse. Christophers(2009) criticizes those who blame the complexity of the financial instruments (e.g. Collateral DebtObligations, Credit Default Swaps, Asset-based Commercial Papers) or of the financial system for thatcrisis. First, blaming complexity often means that the nature of the prevailing financial structuresand processes are not blamed, as these cannot be readily understood. Second, by blaming complexity(i) incomprehension of financial actors is approved as a legitimate reason; (ii) complexity is given agencyand thus is reified; and (iii) those financial network actors who had and have the capacity to shape thereal financial world are being dismissed from any responsibility or blame. If complexity is blamed as the

9 As anticipated by the American Clean Energy and Securities Act of 2009, HR 2454,111th Cong., Section 351, Carbon

Market Assurance, 1054. This all led Michael Masters, a hedge fund manager, to call for the banning of such commodity index

funds and similar instruments (see http://www.cftc.gov/stellent/groups/public/@newsroom/documents/file/hearing080509_

masters.pdf).

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fundamental cause, public and private actors within the financial system lose agency and thusresponsibility and accountability. Crotty (2009) argues that we should not just blame abstractcomplexity, but rather the specific way the financial system is organized (the so-called New FinancialArchitecture) and is constructed and governed by the prevailing actor-network. The growing globalintegration of financial markets came with government deregulation, larger power for major financialactors and specific constructed characteristics/flaws: perverse incentives (such as bonuses) creatingexcessive risks, development of complex financial products that could not be priced correctly, bankskeeping rather than insuring risky financial products, risky assets that were kept off-balance and thusinvisible, fundamental but known flaws in risk assessment systems through Value at Risk (VAR) models,tightly integrated credit markets that amplify a crisis in one financial product in one country across theglobe, and the poor functioning of credit rating agencies in the system due to self-interests. Hence, the2008/2009 financial crisis should not be explained by just financial complexity, but by the specificorganization and power distribution of the contemporary financial system. And restructuring (oradaptation, in complexity theory terminology) can prevent a repetition of such financial systemnear-collapse. According to Crotty and others (e.g. Stiglitz, 2010; D’Arista and Griffith-Jones, 2010)internationally coordinated restructuring of the financial market and its governance architecture is keyin preventing future catastrophic financial crises. And there is currently a wide debate on the exactmeasures and modes to reconstruct the financial system governance, on the new parameters of theadapted financial system/architecture, and on the actors/institutions/networks that should be in chargeof such reregulation.

So where are the parallels with carbon markets? Also with respect to carbon markets, there existworries about the growing complexity and thus manageability of (future) carbon markets and flows.Carbon markets are starting to witness similar complexities as financial markets; or as Bailey (2010:149) puts it: ‘‘The resulting [carbon, AM] market is undeniably complex’’. The growing complexity ininstruments, the expanding number and complexity of traded products, the global spreading andinterdependency of markets, the global expansion and reach of carbon flows, and the complicatedvalue-chains/networks in carbon markets, make these markets not just more liquid, but also lesstransparent (for market players, for governing bodies, and for climate advocates)10 and concealhazards, uncertainties, and risks. For instance, according to a survey among 700 public and privatecarbon experts the carbon trading market is particularly vulnerable to accounting scandals similar tothose symbolized by Enron and WorldCom (Greenhouse Gas Management Institute, 2009). It isespecially the growth of the secondary market that increases complexity, speculation, and apotential fall of additionality. The outlook of becoming the largest derivate market in 10 year time(IATP (Institute for Agriculture and Trade Policy), 2009; Chan, 2009) attracts major new marketplayers far beyond the conventional climate change community of polluters/buyers, environmentalstate authorities and environmental advocates. Hence the network that manages carbon marketflows now also involve large investors, major private banks (but also the World Bank), large-scaleenergy companies, traders, speculators, hedge funds, lobbyists, central banks, large consultancy andaccountancy companies, finance and trade ministries, and the IMF (see Schneider et al., 2010). Thepower balances between these actors in the networks that construct and influence carbon marketsand flows vary among the different markets. The design of regulatory carbon markets rests stillsignificantly with (inter)governmental agreements, with still ongoing political debates on, amongothers, how to issue allowances, the setting of caps for the emission of greenhouse gasses for specificperiods, the percentage of caps to be covered by carbon trading compared to domestic emissionreductions, requests for national government interventions for price stabilization, and transparencyof monitoring, registration and verification. Bailey and Maresh (2009) analyse how industrial andfinancial interest groups and some member states had a significant influence in the first period ofEU ETS, but the European Commission progressively strengthened its political authority in managing thesecond and third period. Hence, the regulatory markets are to a significant extent politically-generated

10 The integration of the EU ETS, the CDM, the US and Australian carbon markets, and the voluntary markets will make it

difficult for administrators ‘‘to tell whether an incoming allowance has maybe been freed up by use of an external trading unit

which they themselves would not accept for compliance’’ (Schule and Sterk, 2008: 12).

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and -managed markets, with a compliance aspect related to greenhouse gas emission reduction. Butthe networks designing and managing these markets and related carbon flows contain influentialeconomic and financial actors that have a key interest in these markets. New associations of these actors(such as the International Emissions Trading Association ITEA, the Emissions Marketing Association, andthe Carbon Markets and Investors Association) and new platforms (such as the annual Carbon Expo) arekey in lobbying and influencing the (future) rules of these compliance markets at UN, EU and nationalforums (as became clear with drafting the EU ETS first phase and the US Waxman-Markey ClimateChange Bill). In the (smaller) voluntary markets these latter private (financial and economic) actors areeven more powerful, as key constructors and governers of markets and carbon flows. These voluntarymarkets are scarcely state-regulated and in that sense reflect (more than the regulatory markets) thepre-2008 financial markets. In the voluntary market networks of financial and business actors (traders,investors, banks, project developers, verifiers, consultants, energy companies, and the like) form not onlya market force in that they direct the flow of carbon credits and finances, but they are also the mainconstructors of the rules and codes of these market institutions and platforms and the ones whereknowledge on its functioning is located.

The current (voluntary and regulatory) carbon markets have a lower degree of complexity thanthe pre-2008 financial market. Compared to the value chain from mortgages to credit default swaps,the value chain/network of carbon markets is still shorter, less complex, with fewer actors (alsobecause few individuals are involved yet), and arguably with higher transparency levels. And,although there is carbon derivates trading over-the-counter, it is not (yet) executed by poorlyregulated and off-the-books structured investment vehicles, hedge funds, and the like.

These differences in both political/state involvement and complexity between financial and(especially regulatory) carbon markets have at least two explanations. First, carbon markets arestill very much in their initial design stage, where political actors are still significantly involvedin designing and determining the architecture, rules, principles, and access of carbon markets. Oncea global integrated and mature carbon market is institutionalized and functioning and currentideas of personal carbon trading materialize (e.g. DEFRA, 2008; Fawcett and Parag, 2010), thecarbon market architecture might start to look more like that of complex financial markets. Second,carbon markets differ from financial markets with respect to the normative goal the former have tofulfil in order to remain legitimate: efficient climate change mitigation. Such a normative goal isabsent in financial markets. This normative goal would imply that regulatory involvement wouldalways be larger in climate markets compared to financial markets, regardless of its (initial ormature) stage.

If legitimate carbon markets have to efficiently reduce greenhouse gas emissions, some degree ofmanaging carbon markets and flows need to be put in place. We can see two modes of carbon marketmanagement emerging. First, continuing and stringent governmental management and regulation isproposed to limit price volatility (and thus speculation), banking and the creative creation of newfinancial products; to monitor, control and verify environmental additionality; to give out andreduce carbon allowances; to set boundaries to offsets vis-�a-vis domestic reductions; etc. But suchstate-dominated management is not undisputed and without challenges, as these carbon marketsare globalizing and continuously face deregulatory pressure. Business lobbies successfully influencedEU ETS market design towards commercial advantages (Gilbertson and Reyes, 2009: 35, 44, 89;Meckling, 2011) and business and financial networks (such as the US Coalition for EmissionsReductions Projects CERP) were active around the Climate Change Bill in the US, lobbying massivelyin favour of offsets, against strong regulatory oversight, against auctioning allowances, in favour oflax caps, against strong EPA authority, but not necessarily against the start of what could become aone trillion carbon credit market. Carbon trading and investment networks show strong requests andlobbying for self-regulation, and more than incidentally find a willing ear by financial and economicstate institutions (Chan, 2009). A second form of management of carbon markets moves beyondstates and is focused on reputation, verification, accountability, standardization of contracts, andcertification of products. The current development of standardization via IETA contracts, the use ofmarket penalties by non-delivery, and the emergence of verification and certification fits in thisstrategy and locates management power in non-state actor networks. Via certification sub-primecarbon can be distinguished from (for example) ‘gold standard’ carbon, in order to prevent firms

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seeing suddenly their reputation being jeopardised when using carbon credits with no relations toreal CO2 emission reductions. Certification systems are designed to bring trust in deterritorialisednetworks that exchange goods. NGOs are widely desired partners of certification companies as theybring trust and legitimacy in carbon credits and re-direct carbon flows towards sustainability.Several standards have been developed and are certified with the assistance of NGOs, such as theGold standard, supported by 60 NGOs, the Climate, Community, and Biodiversity Standard (CCBstandard), and even the dominant Voluntary Carbon Standard (VCS). By securing environmentaladditionality and rationality certified carbon products obtain significantly higher prices; Bloomberg/Ecosystem Marketplace (2010: 69) noted average prices (for 2009) ranging from 15.2 (CDM/JI) to 0.8(CCX) US$/tCO2e for carbon credits with different certifications in 2009. But such ‘private management’only works when carbon markets and market actors are transparent; when verification, certification andrating systems are themselves governed (as we learned from the rating systems in the financial market);and when all are closely and powerfully followed and watched by independent (public and private)environmental advocates.

But this distinction between state and non-state management is secondary in understandingcarbon flows governance. Of more importance is that two types of networks are struggling overdecision-making power and management of carbon markets and flows: financial networks of banks,investors, hedge funds, speculators, traders, consultancies, Ministries of Finance, the World Bankand IFIs; and environmental networks of (supra)national environmental authorities, the EuropeanCommission, environmental movement organizations, environmental verification and certificationinstitutions, and the CDM Executive Board. Which networks have the largest influence on setting therules and codes in these carbon markets, and thus directing global carbon flows? Hence, the climatechange mitigation success of any global integrated carbon market is neither a matter of complexity,nor a matter of public/governmental versus private governance, but more about the kind and outlookof the global networks that are able to detail the architecture of carbon markets and by that ‘govern’the content, direction, speed, and pattern of global flows (of carbon credits/allowances, relatedfinances, information, and finally CO2).

6. Conclusion

Global climate change mitigation through carbon markets should not primarily be understoodand analysed in terms of nation-states and societies, but rather in terms of networks and flows.While in the language of the Kyoto protocol, and of the subsequent UNFCCC Conventions of theParties, nation-states are the main categories for mitigating climate change, the growing importanceof carbon markets has changed the climate governance scape dramatically, with new commoditiesbeing traded (e.g. CERs, VERs, EUAs, etc.); new financial flows; new governance actors, arrangementsand networks; and new power balances.

The standard interpretation/perception is that GHG emission reductions are governed byconventional categories of states and societies through the setting of caps. And that global marketnetworks (through CDM, JI, EU-ETS, the regional trading systems in various countries, and voluntarymarkets) determine where, how and at what costs GHG emissions are efficiently reduced. But thisstandard model no longer reflects reality. The complex relation between place-and-time-specificGHG emission reduction obligations and the ‘production’, trade and consumption of carbonallowances and offsets over large time-space stretches make that setting caps is just one act in amuch wider process of governing GHG emission reductions. Thus, international networks of traders,project developers, state agencies, international organizations, certifiers, banks, energy companies,brokers, investors and speculators govern carbon markets, and influence the speed, quality, place,time, and direction of flows of money, emission credits, offsets, and information; and thus in the endalso of GHG emissions. The degree to which state-agencies are important actors in such networksvaries among different carbon markets, depending on the specific carbon market architecture.Overall, with carbon markets as major global institutions in current climate change governance,states lose their dominant role in climate change mitigation. But this does not mean that carbonflows should be interpreted as out-of-control global fluids.

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Hence, in understanding (present and future) carbon markets one should not concentrate onnation-states, but rather on how – and what kind of – networks are and will be in charge of shapingcarbon markets and flows and determining their ‘climate change mitigation profile’. Key questionwill be how strong and well-positioned (state and non-state) environmental advocates and networksare in securing environmental additionality and rationality, and in condemning ‘hot air’. Have theseenvironmental networks sufficient power and access to prevent carbon markets and flows becoming‘reduced’ to primarily financial ones?

In that sense, it is currently less necessary to advocate for the use of financial and market institutionsto mitigate climate change, as ecological modernizationists did for two decades. That ‘battle’ is won:economic institutions are widely used in climate governance, even at the global level. It is now vital toensure that climate change mitigation rationalities remain the dominant logic in these new institutions,even when their intricate connections with financial rationalities and markets are recognized.

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