Monday, January 22, 2007
New ideas from old Europe
How an American carbon-trading system should work
IN RECENT weeks, a rush of climate-change bills has started circulating in America’s new Congress. Eminent names are behind them: in the Senate, Joe Lieberman and John McCain have sponsored one, Dianne Feinstein another and Jeff Bingaman, chairman of the energy committee, a third. A national cap on emissions of carbon-dioxide, the main greenhouse gas, looks closer than ever.
But how should American regulations work? Part of the approach is likely to be a carbon-trading system, which companies prefer because it is more flexible than a carbon tax. The basic idea is that power plants and manufacturers will be allowed to emit a certain number of tons of carbon dioxide. If they exceed that amount, they must buy “credits” from companies that pollute less than their allowance. One day the price of a tonne of carbon may be as widely quoted as that of a barrel of oil.
At a conference last week in Houston, the heart of the energy world, traders and energy companies gathered to discuss the shape of carbon markets to come. America has two models to work from. The European Union (EU) has been trading carbon-dioxide credits since 2005, in an effort to meet its obligations under the United Nations’ treaty on climate change, the Kyoto protocol. It has had plenty of blips, including last April, when prices of carbon plunged by more than half as traders realised that some countries had emitted less than believed. But now, hedge funds and speculators are joining the trading—a sign of a liquid and robust market.
Another model for America is closer to home. America was the first country to be involved in emissions trading. Ironically, credit goes partly to George H. W. Bush—father of the current climate-change sceptic in the White House—whose signing of the Clean Air Act in 1990 authorised trading in sulphur-dioxide emissions to combat acid rain. The effort was hugely successful, and nitrogen oxide was added later.
Some lessons are immediately clear. First, predictability is crucial. One downside of the EU’s system is that companies do not know what will be required after 2012, when Kyoto’s provisions expire. That makes it difficult to plan power plants or factories with long lifespans.
Traders should also be prepared for early jumps in prices. This happened at the start of America’s nitrogen-oxide trading, and during the first year of the EU’s scheme. Scary as they may seem, the rises are a logical result of adjusting to a new market. Companies may be reluctant to sell their credits, in case they become needed later, and buyers are eager to make quick purchases lest the price rise further.
The most important thing is putting a trusted trading structure in place initially. That includes an accurate tally of emissions, and a sensible allocation of permits. Mason Henderson, who heads the emissions-credit desk of Cantor Fitzgerald, a securities-trading company told the conference in Houston, “If you don’t get it right from the start, you’re not going to catch up.”
If Congress does not act, that could be the worst case of all for businesses. Several states are looking into developing emissions-trading schemes, creating a potential patchwork of conflicting regulations. California’s green governor, Arnold Schwarzenegger, last year signed legislation to cut greenhouse-gas emissions in his state by 25% below their current trajectory in 2020. This will probably involve trading, though details are scant. In the north-east, seven states have banded together to reduce emissions from power plants. Trading is scheduled to start in 2009.
Notwithstanding Mr Schwarzenegger’s plans to partner with the north-eastern initiative, companies would far prefer a consistent national system. “You don’t want someone to move their business from the Houston area to Louisiana because it’s cheaper,” says Mr Henderson of Cantor Fitzgerald. That is part of why even oil companies are signalling openness to a national emissions-trading scheme, and the industry is awaiting word on whether President George Bush will make any carbon-related announcements in his state-of-the-union address this week. In the long run a global scheme linking American and European markets and beyond—with accompanying improvements in technology that reduces emissions—will be an even better way to address a global problem.
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