EMISSIONS MARKET PRIMER

Cap-and-trade is just over the U.S. horizon.

The Democrats, presently a majority in the Senate and the House of Representatives, were stopped only by the need for a filibuster-breaking 60-vote majority from enacting cap-and-trade legislation in June and they are expected to significantly gain strength in both houses in the upcoming November election.

(See Economy-wide Cap-and-Trade Proposals in the 110th Congress (Includes Legislation Introduced as of May 30, 2008))

Both presidential candidates are cap-and-trade advocates so regardless of who becomes president, the negotiations will be over the parts, not the whole.

With the consensus of scientific evidence and readily observable evidence mounting that the climate is changing, even politicians who remain doubters must act as if they believe what they do matters. (It does.)

There are only 2 widely accepted choices for how political leaders can take action. The many proposed large-scale cap-and-trade systems are designed like the one that on a small scale was effective at curtailing acid rain and reversing the damage to the ozone layer in the 1990s. Critics of cap-and-trade on the left of the political spectrum have proposed a more equitable cap-and-share variation of the concept.

Those at the other end of the political spectrum prefer a carbon tax. Economists prefer it. If, though, there was ever any doubt about the truth of the truism that a carbon tax (“a new tax”) is political poison, the current experiment in British Columbia is verification. (Liberal leaders there may survive but the concept is unlikely to endure across Canada, a more conservative nation than its western province.)

So some form of cap-and-trade is coming. What do companies that will be affected need to know?

Based on the findings of the Carbon Disclosure Project Report of 2007, a lot. Only a little over half the S&P 500 companies responded to the survey (though that was up 9% from the year before). Only 29% of the companies responding have emissions-cutting goals.

First, of course, companies need to know that their greenhouse gas emissions (GhGs) will be capped and everything they generate over the caps will cost them. But it’s not that simple.

A cap-and-trade system cannot be effective unless the caps are real and ratchet down, progressively curbing emissions. Many doubt legislators will have the commitment to put pressure like that on major campaign contributors. There will certainly, however, be some kind of caps. But it’s not that simple.

Companies will have, in effect, 2 caps. First, they will be allotted a portion of GhGs. Beyond that, they will be able to purchase “allowances” (permission to emit further GhGs) at auction. But it’s not that simple, either.

Companies may not want to simply await the inevitable when they understand that allowances may be allocated according to emissions history or emissions goals. Big difference.

If allocations are made according to emissions history, companies will want to have a history of high emissions so their free allowances are set high, making the transition to reduced emissions-generating more gradual.

If allocations are made according to goals, the companies that have already begun using emissions-cutting practices and technology (and those that begin soon) will be ahead of the curve and be able to get to the goals at a lower cost sooner.

Emitting companies have decisions to make. The decisions will impact their financial viability in the coming carbon-constrained economy. Decisions are always made on the basis of inadequate information. One thing the companies can be sure of: Cap-and-trade is coming.

How electricity prices will be impacted by a price on emissions from a tax or a cap-and-trade system. (click to enlarge)

The Emerging Carbon Market
Kim Padilla, July 9, 2008 (EnergyPulse)

WHO
Kim Padilla, Founder/President, Valencia;

WHAT
A carbon market, based on a cap-and-trade system, is coming to the U.S. economy. Padilla, a leading risk management business consultant, says now is the time for companies to understand what this means and make basic choices.

One of these Senate proposals is most likely to be enacted next year. (click to enlarge)

WHEN
The 110th Congress has already debated a cap-and-trade system. Following the November election, next year’s 111th Congress is expected to act on one of the proposals.

WHERE
- The U.S. is responsible for an estimated 30% of world GhGs.
- There are 5 regional emissions trading initiatives in various stages of preparation.
- 20 states have passed goals or regulations to cut GhGs.

WHY
- Although economists almost universally agree a carbon tax would be simpler and more effective than a cap-and-trade system, any new tax, even one to combat global climate change, is considered politically impossible.
- Markets like the Chicago Climate Exchange and NYMEX already have voluntary emissions trading by U.S. companies.
Financial analysts are already establishing valuations for emissions efficiencies.
10 bills were submitted to the 110th Congress for cap-and-trade systems.
- The biggest undetermined factors about the coming cap-and-trade system have to do with the GhG targets each company will be have (“allowances”) and the amount of allowances that will be given and the amount auctioned.
- Targets may be set according to historical emissions or targets may be set according to benchmarks.
- If targets are set according to history, companies with high present emissions will get more allowances for free and be at a competitive advantage. Companies using coal for power generation will likely benefit as they make the transition to gas, nuclear or New Energies.
- If targets are set according to benchmarks, companies already cutting emissions will be ahead. Companies using New Energies for power generation will likely benefit as they make the benchmarks sooner and have more allowances to sell on trading markets.

Competing House legislation is similar to the Senate proposals. (click to enlarge)

QUOTES
- Padilla, Venture: “The question isn’t if federal legislation will come, but rather ‘when’ and ‘in what form’.”
- Padilla, Venture: “Ultimately, the cost of carbon will be reflected in production costs and valuations of all companies. The combination of the initial target, credits, and the company’s approach to carbon will determine the impact on a company.”