Trading in preparation for America’s first mandated cap-and-trade scheme for greenhouse gas emissions started on Friday on the Climate Futures Exchange. Futures and options contracts for 70,000 permits were traded under the Regional Greenhouse Gas Initiative, a cooperative of 10 Northeastern and Mid-Atlantic states whose governments have agreed to cap the emissions from power generation beginning in January of 2009. The first set of allowances will be auctioned off in September this year. The RGGI transactions represent the first trading in the U.S. under a government mandate and happened now, ahead of the auction, in a hedging move to lock in low prices in case the cost of allowances spikes.
The soft launch reveals some of the obstacles a cap-and-trade scheme must overcome. The RGGI (say “Reggie”) scheme covers only emissions from power generation and sets initial caps higher than historical levels — 188 million tons per year from 2009 to 2014, declining by 2.5 percent per year for four years. Already analysts are predicting that the high caps will keep prices low for at least the first six years. This is a problem that plagued the vaunted European Trading Scheme in 2006 and caused a collapse of carbon prices.
Pricing of carbon permits is a sticky bit of business and is directly related to the number of permits issued. The benevolent invisible hand is supposed to find the appropriate price for the permits but so far carbon prices on markets all over the world have been too low to effect real reductions. Deutsche Bank analysts estimate that it will take carbon prices of at least €35 ($51.58) a ton to get power companies to switch from dirty coal to cleaner natural gas in the European market. On Friday the RGGI permits were traded at $5.58 per ton of avoided carbon dioxide, while the EU market was trading at €23.6 per ton on Monday morning.
RGGI isn’t the only regional consortium of states to plan for a cap-and-trade system. The Western Climate Initiative, a group of seven states and four Canadian provinces, issued a draft of its proposed plan to institute a regional cap-and-trade system last month. The group’s proposal would have states start monitoring emissions in 2010 and reporting them in 2011 in preparation for a cap on carbon emissions starting in 2012. The WCI’s goal is to cut emissions 15 percent below 2005 levels by 2020.
Pay attention to the operations of these nascent markets, as they will likely grow into national schemes when the next administration moves to institute a federal cap-and-trade system on carbon emissions, which both candidates have said they endorse.