Cap and trade in the U.S.: prospects and scenarios

Those whose business is to predict the development of U.S. government policy sometimes feel like heavy metal fans after a loud concert. In the area of climate change policy, the sheer volume of information from news stories, editorials, advertisements, blogs, TV talking heads, and radio experts sometimes sounds like a featureless roar. But listen carefully, and the white noise will tell you some useful things.

Everybody wants the answer to two basic and related questions. First, will there be federal climate legislation? And second, if yes, what will it look like?

The difficulty of answering the second question is why it’s taking so long to answer the first. But the president recently nominated a Northeast state official as assistant administrator of the EPA’s Office of Air and Radiation. It is no coincidence that the nominee, Gina McCarthy, is a Connecticut commissioner of the Regional Greenhouse Gas Initiative (RGGI), America’s first and only operational cap-and-trade system covering greenhouse gases. RGGI involves 10 Northeastern and Mid-Atlantic states.

This comes as congress grapples with how to introduce climate change legislation that puts a price on carbon emissions. Many congressmen and senators wonder if this is the right thing to do in a recession. There has been noise that Obama wants to pay for his middle class tax cut with revenues from carbon, whether by way of a tax or a cap-and-trade scheme, and that congress, which is run by Democrats, isn’t happy about that (see NY Times article). Maybe that’s why climate change was barely mentioned in the president’s Tuesday press conference or in his subsequent public statements.

But there will be pressure from the EPA to start regulating greenhouse gases (GHGs) through existing statutory authority. With an experienced cap-and-trade designer in Ms McCarthy, expect EPA to give congress some pretty specific advice on where and how to design a politically salable cap and trade system.

RGGI covers only power plants, and its carbon price has been given a floor through three carbon allowance auctions, the most recent of which established an allowance clearing price of US$3.51. An allowance represents the right to emit one additional metric ton of carbon dioxide over a prescribed emission cap.

Will congress pass legislation to implement a national system similar to RGGI? Barbara Boxer, chairman of the Senate Committee on Environment and Public Works, is pushing hard for coordinated policy action with EPA on climate legislation.

So there is support for an RGGI-like system at the highest levels in the U.S. government. Opposition to cap-and-trade seems to have rhetorically coalesced around the prospect of fancy carbon-based derivatives cooked up by the same Wall Street geniuses who brought us asset-backed commercial paper. A cap-and-trade scheme, say its opponents, will sow the seeds for future derivatives disasters—and future bailouts.

Cap and trade proponents will surely point to the flexibility of RGGI to reassure skeptics that a similar national scheme won’t cause the sky to cave in. And by “flexibility” I mean cheapness of the auctioned allowances. At $3.51 per ton, who will be deterred from emitting carbon?

The question is not rhetorical. There are plenty who would strongly object to $3.51 per ton. Think of the Dark Green Spread, and stay tuned.

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