Future US carbon market to learn from EU mistakes: observers

(pointcarbon, Houston)Hard lessons learned from Europe’s emissions trading system (ETS) will shape the way a prospective cap-and-trade programme in the US will be designed, according to market participants.

Lessons from first phase (of the EU ETS) are being reflected in design parameters in US schemes,” Abyd Karmali, global head of carbon trading at Merrill Lynch, told the Platts carbon trading conference in Houston on Thursday.
Karmali said policymakers in the US were leaning toward auctioning off emission allowances over "grandfathering" them in order to prevent companies from making windfall profits the way some electricity generators had during the first phase of the ETS.

The EU cap-and-trade market, which was launched in 2005, is the world’s biggest market for trading emission allowances for carbon dioxide (CO2).

However, the trading period 2005-2007, considered a pilot phase by EU regulators, saw the price for CO2 allowances plunge – in part because large industrial emitters were given too many emission allowances for free.

In order to bolster the price for CO2 allowances and to prevent the potential for large emitters to earn windfall profits, EU regulators have tightened allowance handouts and introduced an auctioning system, where in the trading period 2008-2012 member states can auction up to 10 per cent of their total emission allowances. Future trading periods will see increased auctioning.

Karmali pointed out that US legislation for emissions trading is already preparing for auctioning. For instance, the Lieberman-Warner bill, which is headed for a full Senate vote this year, requires 24 per cent of all emission allowances to be auctioned off from the day a nationwide cap-and-trade programme begins.

This is also reflected in most of the 10 northeastern states participating in the Regional Greenhouse Gas Initiative (RGGI). The RGGI states have declared they would auction off nearly 100 per cent of their assigned emission allowances when that trading programme kicks off in January 2009, Karmali said.

Neil Eckert, chief executive of Climate Exchange, which owns the European Climate Exchange and the Chicago Climate Exchange, said that the European experience will be a “crystal ball” for a future US market.

“You will learn the lessons that we have learned off the European market,” he told the conference, noting that the ability to “bank” allowances (carrying them over into a future compliance period) will play a significant role on prices in a future US market.

Eckert said the inability of European generators to bank allowances rather than free allowance allocations was at the root of the price crash of emissions allowances on the ETS in 2006.

“The real problem is that there was no ‘bankability’ in pilot phase into the next phase,” he said. “The market was either going to be infinitely long or infinitely short.”

Steve Schleimer, director of energy and environmental market regulation at Barclays Capital, said the RGGI programme has already corrected that mistake in its design by allowing “unlimited banking” between the programme’s compliance periods.

Unresolved issues

Despite learning some early lessons from Europe, Schleimer said there are two questions that have yet to be resolved in the design of the RGGI market, which has less than a year to go before its highly-anticipated launch.

“What is the reserve price going to be and what are they going to do with the unsold allowances?” Schleimer asked.

He referred to RGGI’s possible response to observer concerns that the market will be long when it goes live in 2009, as a report last summer found that the northeast’s emissions have fallen in recent years due to favourable weather conditions and fuel-switching from oil to natural gas.

To account for this initial over-allocation, some state environmental officials in RGGI have suggested using a reserve price, or minimum bid price for allowances, to ensure that the permits bring in revenue. Allowances not purchased at such a minimum price would be retired, decreasing supply in the market.

On the federal side, Gary Hart, a consultant at ICAP Energy said that the Lieberman-Warner bill does not spell out what Congress would do with the to the $20 billion that he estimates would be generated by auctioning CO2 emission permits.

“Will they really use that for research on carbon capture and sequestration?” he said.

He added that there is still uncertainty as to what the baseline year would be against which emission reductions would be measured.

Still, Karmali said the launch of a US emissions trading scheme is likely to get off to a rocky start.

“It’s going to be a soft scheme from the outset. You can expect to have a price crash. That I guarantee you,” he said.

Houston