[DEBATE] : (Fwd) FT writer against carbon, sulphur and nitrogen oxide markets

[Patrick Bond]

("Wall Street and Chicago always like the creation of trading markets 
for new assets, especially if they can be inefficiently priced by the 
professionals. So while the coal people hate climate legislation, a lot 
of traders see an opportunity. One of the problems, though, is that 
there are already government-created markets for sulphur dioxide and 
nitrogen oxide emissions, and those markets are in trouble.")

http://www.ft.com/cms/s/0/be0478b2-e692-11dd-8e4f-0000779fd2ac.html?nclick_check=1

Financial Times
Hard battle ahead on market solution for pollution

By John Dizard

January 20 2009

Wasn't all that warm fuzziness over the election of Obama just so . . . 
so . . . warm and fuzzy?

Now for cold and hard-edged. That describes the emotions over 
intra-governmental fights that will start in earnest this week. The most 
immediate are over the nature of the economic stimulus, or who has the 
longest reach. When that is settled in the next two months, the struggle 
moves on to harder issues, such as reworking environmental law and 
regulation.

The most serious struggle will be over climate change, or the regulation 
of carbon emissions. You can forget all the chitchat about finding a 
consensus on this one: the coal people and the enviros are in this match 
until one side is carried out.

For now, it appears that most of the enviros working within the 
legislative process intend to use a cap-and-trade programme to reduce 
carbon emissions. That is, large carbon dioxide emitters such as 
coal-based utilities will be able to buy the right to produce CO 2 . 
Those who, one way or another, are deemed to have reduced carbon 
emissions can sell emission rights to other emitters. The programme 
would be designed so that over time the supply of carbon rights becomes 
tighter, the price higher and the incentive to reduce carbon emissions 
even greater. Climate change moderates, polar bears have more ice, and 
so on.

Wall Street and Chicago always like the creation of trading markets for 
new assets, especially if they can be inefficiently priced by the 
professionals. So while the coal people hate climate legislation, a lot 
of traders see an opportunity.

One of the problems, though, is that there are already 
government-created markets for sulphur dioxide and nitrogen oxide 
emissions, and those markets are in trouble. As I have written earlier 
in this space, a Federal appeals court decision on July 11 of last year 
appeared to kill the long-term value of credits under what was called 
the Clean Air Interstate Rule, a set of markets for pollution credits 
created by the Environmental Protection Agency. At a stroke, some tens 
of billions worth of rights to emit noxious gases were slashed in value 
by the court's ruling that the EPA had exceeded its authority.

The EPA, along with utilities and some enviros, asked the court to 
modify or reconsider its decision, and, unusually, the court had second 
thoughts. In late December, the court indefinitely stayed its 
cancellation of Cair, allowed the trading to remain in place, and told 
the EPA that it had to come up with a fix, sometime in the undefined 
future. That is the simple version.

So, the price of the right to emit one ton of sulphur over the next 
year, which had been up to $600-$800, fell back to as little as $100 
after the initial decision, and has now, after the court's 
reconsideration, risen to $150-$200. At $600, utilities found it 
economic to build new pollution control systems before they were 
required by law, since they could sell for a lot of money the emission 
credits they earned. EPA people say that in the past few years, a 
million tons a year of sulphur dioxide emissions have been averted by Cair.

Enviros, and others with a special interest in breathing air with less 
sulphur or nitrogen oxides, wanted fewer permits at higher prices. 
Coal-based utilities wanted more time to build controls, and less 
stringent rules. There was general agreement, though, that the mechanism 
itself was effective in accelerating pollutant reduction.

Now, though, the court ruling, and the wider realisation that allowances 
under cap-and-trade are not really property rights, has chilled such 
markets. Risk management committees for corporate buyers and trading 
houses are likely to hesitate before buying pollution permits that could 
lose value.

So any new market-based emissions controls had better have more 
certainty than the flawed Cair. In leaving Cair in place, the court 
seemed to reason it would retain its effectiveness in reducing emissions 
over the next couple of years, but that is not the case. Instead, the 
EPA's pollution allowance market people believe the low prices created 
by the uncertainty over the future of Cair will have the perverse 
incentive of inducing utilities to use up existing pollution allowances 
by emitting more than they would have, while postponing building new 
controls. Or so the agency's economic models say.

The EPA might appeal to the Supreme Court, but that would be a long 
shot. It would be extremely difficult to fix Cair markets through new 
regulation, as the appeals court ordered. One possible fix would be 
"command-and-control", non-market-based limits on emissions. Those are 
within the EPA's powers, but wouldn't help as a precedent for carbon 
cap-and-trade. However, the prospect of unpopular rules might motivate 
an otherwise preoccupied Congress to come up with a legislative fix that 
overrides the confused ruling.

The Cair mess shows that it is easy to get market design wrong. With 
mortgage and derivatives markets, that costs billions. With Cair, it 
costs shortened lives.