Market bullish on cap and trade after Obama win

Market participants are bullish on prospects for the creation of a US federal cap-and-trade scheme following Senator Barack Obama’s presidential victory, but remain uncertain about when and how a system will be put in place.
Obama beat Republican presidential candidate John McCain by winning 349 electoral votes compared to McCain’s 163, according to the latest tally. Obama won 52 per cent of the popular vote versus McCain’s 44 per cent.
Market participants applauded this decisive win, predicting it will help ease the creation of a national cap-and-trade scheme. (Source~: Pointcarbon)

“We knew both candidates were for cap-and-trade; the real difference now is that there is a strong Democratic majority in Congress and a Democratic president so there is less likely to be gridlock,” said Lenny Hochschild, managing director of greenhouse gas services at environmental broker Evolution Markets.

The increasing likelihood of a cap-and-trade system in the US also lends credibility to the global carbon market, said Emmanuel Fages, a carbon analyst at Societe Generale.

“It reinforces that the carbon market is here to stay and that market mechanisms are key tools to the fight against climate change,” said Fages.

Obama seeks to implement an economy-wide cap-and-trade programme that cuts US carbon emissions 80 per cent below 1990 levels by 2050.

The Democratic president-elect, who will be sworn in on 20 January, also promises to set annual emission-reduction targets and to introduce a mandate to cut emissions to 1990 levels by 2020.

Details of when a cap-and-trade scheme would start and what kind of system it would be have yet to become clear and market participants were hesitant to speculate on the implications his campaign climate proposals could have.

“In the longer term, it is hard to see what supply-and-demand implications it will have because we don’t know what the rules are going to be yet,” said Fages.

Dwarfing the EU ETS

What market participants do project is that the US carbon market under Obama’s proposed economy-wide emissions trading programme could dwarf Europe’s existing market.

Hochschild predicted the size of the carbon market in the first year of the programme could be 5.75 billion tonnes of CO2 equivalent.

This is the size of the economy-wide cap-and-trade programme envisaged by Senator Joe Liberman and retiring Senator John Warner in their climate change bill, which failed to withstand a filibuster in June. Their bill covered nearly 80 per cent of all domestic economic sectors.

By comparison, the EU emissions trading system covers 2 billion tonnes per year from installations that produce energy, process ferrous metals, and the mineral industries and pulp and paper industries.

If the average carbon price is $20 per tonne, the US carbon market could be worth $600 billion, said Hochschild.

Aggressive auctioning

During his campaign, Obama also pledged to auction 100 per cent of allowances under a cap-and-trade scheme, which could potentially raise up to $300 billion in revenues, according to market experts.

But some market participants raised concerns that 100 per cent auctioning could hamper the effectiveness of a scheme.

Josh Margolis, co-chief executive officer of environmental broker CantorCO2e, said 100 per cent auctioning could dissuade regulated entities from reducing carbon emissions.

“It takes away resources for emission reductions. You need allocations to invest in emission reduction programmes,” said Margolis.

“It turns a cap-and-trade programme into a cap-and-fee programme,” he added.

Carbon price and offsets

Big questions also remain over how the price of carbon will develop under Obama’s proposed scheme.

Hochschild predicts there will be a strong effort to keep the price of carbon down through inclusion of offsets.

“If we do get a federal cap-and-trade, there is likely to be extreme sensitivity to the price of carbon,” said Hochschild.

“We could see broader flexibility in respect to offsets to accomplish the goal at minimum cost,” he added.

So far, Obama’s cap-and-trade plan has not specified how many offsets would be allowed for compliance under the scheme.

Fages predicts a large US offsets market will grow depending on what kind of cap-and-trade legislation is passed. Some market participants believe US domestic offsets will be favoured over international offsets under cap-and-trade legislation.

“Probably one of the first things that is decided is what kind of offsets will be accepted. Then I think you will see a lot of project development in the US,” said Fages.

Preemption question

A big question also remains over the fate of regional cap-and-trade schemes in the US, such as the Regional Greenhouse Gas Initiative, the Western Climate Initiative and the Midwest Greenhouse Gas Reduction Accord.

Margolis said the market may see a slowing of regional cap-and-trade programme development as efforts get underway to pass cap-and-trade legislation at the federal level.

“If you are short on resources and believe Congress will step in to create a system at the national level you might have questions about developing a regional programme that could shortly be replaced by a federal programme,” said Margolis.

By Kim Moore – kmo@pointcarbon.com

Washington DC