Cap and trade dead as Dark Green Spread reappears in North America

There is no way a North American cap and trade system will emerge in the near future. That prospect died when the U.S. president showed at the Copenhagen climate conference that he can’t, and won’t, pursue the environmental policies the green lobby demands. Probably just as well. The continental price of natural gas, the most critical factor to the success of a cap and trade system in the power generation sector, hit $6 on January 4. This means the Dark Green Spread, which favours coal-fired power generation when the fuel cost of gas is more expensive than that of coal, is back.

The Dark Green Spread is the difference, in a carbon-constrained power market, between the marginal cost of generating power with coal versus generating it with gas. Since 2002—with the very recent exception of the spring and summer of 2009—coal has been much cheaper, kilowatt-hour for kilowatt-hour, than gas. This means that for a cap and trade system to force coal generators to invest in gas-fired plant (which is around half as emission intensive), the price of CO2 would have to be high (see article).

How high? With gas at $6 per million Btu—i.e. where it is today—CO2 has to cost $33 per tonne in order to erase the Dark Green Spread. Above that, and it’s financially more favourable to offer gas-fired power to a wholesale power market. Below that, the advantage belongs to coal.

But this is all academic, since, to repeat, there is no way—as things stand today—that a cap and trade system will come out of the current U.S. congress and administration. This means that only a high carbon tax—perhaps indexed to the price of natural gas—will force power generators to shift from coal to natural gas. Today, that tax would be $33 per tonne. That is simply not going to happen.

In this policy environment, the only really safe investment is nuclear energy, which emits no CO2 at all. Of course this means utilities have to find a way to overcome the high up-front capital costs of building new plants. Governments could help with this: that is the whole point of the loan guarantees offered under the U.S. Energy Policy Act of 2005.

There is currently some wrangling between the administration and applicants for nuclear loan guarantees, which some suggest indicates lukewarm-at-best administration support for nuclear. But with cap and trade having become a complete non-starter, nuclear energy is America’s only hope of serious CO2 reductions.

I like nuclear’s prospects. The president will want to do something about climate change. He took his first step away from the green lobby at Copenhagen. He just needs to take the next one.

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