Andy Stevenson's Blog: Moving Beyond Oil

It's Getting Uncomfortably Crowded at the Top

2010-03-10T20:35:03Z

Over the next two decades, 2.6 billion new consumers will enter the ranks of the global middle class. This rise in global wealth is expected to test the ecological limits of the planet as demand for raw materials, food, and fuel rise, water becomes more scarce, and global warming makes the climate less certain.

The only way to avoid these very real threats to our long term prosperity is to make economic growth radically cleaner and leaner. This process begins at home by passing comprehensive climate and energy legislation.

The following is a list of 5 ways our world is expected to change under business as usual growth assumptions:

1. The second world becomes the “new” first world

The combined GDP of the largest emerging countries (Brazil, Russia, India and China or BRICs) is expected to be larger than the G7 developed countries by the year 2035. This power shift from the “old” first world to the “new” first world is likely to create significant tensions in a resource constrained world.

2. Global demand for many commodities triples

Demand for key industrial commodities like steel is expected to triple over the next two decades as another 700 million passenger light duty vehicles hit the road. India and China alone are fore casted to increase vehicle purchases by 250 million cars as their populations grow richer. Demand for copper, bauxite, and other raw materials are also expected to rise significantly as countries aim to double global gross power generation capacity at a cost of nearly $14 trillion.

3. Rising oil demand to be met with new finds in unstable countries

Oil demand from China and India is expected to nearly double over the next twenty years. This rise in demand is expected to create new global tensions as nearly two-thirds of existing oil wells will have run dry by this time and new finds will be sourced by politically and socially unstable countries.

4. Food demand to rise 50% as arable land and water become more scarce

Food production will need to increase 50% by 2030 as a larger, richer global middle class increases their daily caloric consumption. This will create one of the biggest challenges as growth rates for arable and harvest able land are predicted to slow while the population in areas under extreme water stress rises from the current 3 billion to 4 billion by 2030.

5. The planet to struggle to meet these challenges

Increased demand for just about everything is expected to put yet more pressure on the planet’s carrying capacity. According to Global Footprint, the world, which already exceeded its bio-capacity in 1990, will be running at an unsustainable 180% of its carrying capacity by the year 2030.

Clearly these changes are far from trivial and are likely to become even more challenging due to the impacts of climate change. While climate deniers argue that the planet has gone through warming spells before and as such there is no reason to be concerned about these impacts, this line of thinking completely ignores the real life risks of having 8.2 billion people, generating over $100 trillion of GDP, on a planet already running far beyond its carrying capacity (the business as usual case in 2030). When these factors are taken into consideration, it becomes painfully obvious that we are running a sub-prime bet on our future where even modest climate missteps are likely to prompt situations that can quickly spiral out of control.

While passing comprehensive energy and climate legislation won’t change the global growth trends, it will enable the US to step up and help transition the global economy to a low carbon, lower impact growth model. This powerful leadership role would also help US companies to grow jobs and profits, enhance our energy security, reduce risks to our military personnel, and keep global growth from pushing the planet beyond its limits.

Putting America First in the Clean Energy Jobs Race

2010-02-04T17:01:34Z

The United States Senate is considering policy that has the power to reinvigorate the economy, create millions of American jobs, increase our energy security and open up vast new exports markets for American-made products. That policy is comprehensive energy and climate legislation. We need the Senate to unite behind this legislation to put America first in the clean energy jobs race.

The Next Great Global Industry

The clean energy industry offers significant growth opportunities for American businesses. Under a global policy aimed at keeping carbon concentrations below 450ppm, clean energy investments are forecast to exceed $13 trillion over the next two decades. This represents an eighty-five fold increase in clean energy investment relative to today and five-fold increase over business as usual forecasts though 2030 - investments that pay for themselves in lower energy costs and are expected to directly benefit US manufacturers of cleaner cars, cleaner fuels, and cleaner power (see table below) and companies involved in improving industrial, power plant, and building efficiency.

The industries listed above represent enormous opportunities for energy investors in the twenty-first century. The U.S. has the technology edge in these markets if we act now.

For example, the increase in demand for cleaner cars offers a multi-trillion dollar opportunity for American auto manufacturers. Under policies aimed at cutting emissions for the global car fleet in half, US manufacturers of hybrids, plug-in hybrids, and electric cars are expected to see their markets grow substantially over the next two decades as global demand for these vehicles reaches nearly 800 million units. This is a far better outcome for domestic manufacturers than under business as usual where internal combustion engines remain dominant and production continues to flow to the lowest cost producer countries.

Jobs for Americans - But Time is of the Essence

We have an opportunity to create 1.9 million new clean energy jobs in America by 2020 under a comprehensive clean energy and climate bill, but only if we act now. According to Bloomberg New Energy Finance, China is currently ranked number one in clean energy asset investment and last year outspent the US nearly three to one on new build renewable energy projects (see graph below):

If we continue to delay our own commitment to the clean energy economy, U.S. will lose our competitive position in global markets for products that were originally developed here with U.S. research dollars. Instead of leading the clean energy market, we will be reduced to dependence on foreign alternative energy products.

Jobs that Enhance our Energy Security

Passing clean energy and climate legislation is not just smart business policy but smart energy security policy as well. For instance, under the House-passed climate bill, the US could cut its consumption of foreign oil by 30% over the next two decades causing trillions of dollars to be reinvested in the American economy that would otherwise be sent overseas to buy oil.

This would be accomplished by using incentives under the bill to 1) re-tool US facilities to build cleaner cars and 2) capture CO2 at power plants that can then be used to increase domestic production of stranded oil (using a well established recovery technique known as enhanced oil recovery with CO2). A combination of policies to both reduce domestic oil demand and increase domestic oil supply that is expected to lower our oil import bills by $1.8 trillion through 2030 (see graph below):

Furthermore, the increase in oil production is expected to generate over $300 billion in additional oil royalty revenues for states and the federal government over this time frame, more than enough to pay for these incentives.

An Energy Bill is Not Enough

Investing in energy efficiency and clean energy deployment, as well as requiring utilities to obtain a percentage of their electricity from renewable sources, are important policies for the Senate to adopt; however passing energy-only legislation is short-term thinking that will only deliver short-term results. The U.S. will not reap the full benefits of these policies unless they are complemented by a cap on carbon emissions. Only comprehensive clean energy and climate legislation can create both the sustained incentives and long-term price signal necessary to maximize energy efficiency and commercialize innovations in renewable technologies.

A Road to Recovery and Profitability

In sum, passing energy and climate legislation pays back with jobs, enhanced energy independence, and competitiveness gains that cannot be found in a business as usual scenario. We must commit to a new energy economy. We look to the Senate for leadership in crafting and passing a comprehensive climate and clean energy bill in the coming weeks. For the sake of our country’s economic future, we cannot wait.

The blog post was co-written by Nicole Lederer, Co-Founder, Environmental Entrepreneurs

Paul Krugman's Affordable Truth Sees Climate Bill Helping Revive the Economy

2009-12-07T16:56:22Z

Today's op-ed column by Paul Krugman, "An Affordable Truth" supports a view that a cap and trade bill designed to dramatically cut our greenhouse gas emissions is “affordable, essential”, and can help our economy recover faster.

The article describes how financial incentives under climate legislation will work to meet our environmental goals. Under a cap and trade program, businesses will be given a free market signal that tells them they will “be able to increase their profits if they can burn less carbon.” A market based approach to addressing climate change which Mr. Krugman argues should be welcomed by “conservatives that claim that the magic of the markets can deal with any problem”.

Mr. Krugman also reviews the cost projections of the House-passed cap and trade bill and finds that “emissions limits would slow the economy’s annual growth over the next 40 years by around one-twentieth of a percentage point — from 2.37 percent to 2.32 percent”. Hardly the doom and gloom projections you hear from conservatives and an amount that likely overstates the actual costs given our history with other cap and trade programs.

Further, “cap and trade” is expected to create the jobs and investment opportunities needed to help our economy recover sooner. Indeed, Mr. Krugman argues that now is an especially good time to start a project like this as “the prospect of climate-change legislation could spur more investment spending” which “is exactly what the economy needs”.

To support this, Mr. Krugman describes how the opportunity under cap and trade to retrofit buildings, when construction costs are low, can help put people back to work and make existing buildings more valuable as demand for more energy efficient buildings increases over time.

These incentive based investments are not just limited to the building sector. Mr. Krugman could have included how cleaner cars, more efficient motors, carbon trapping power plants, and cutting edge wind and solar power technologies, all incentivized under the climate bill, can help re-power the country as well. Efforts that not only make good business sense as they improve the energy productivity of our manufacturing base, but also make good energy security sense as they help drive down our dependence on foreign oil.

Lastly, Mr. Krugman concludes that he is feeling optimistic about the climate talks beginning in Copenhagen this week. That President Obama’s attendance is sending a strong signal that he expects “real progress” on this issue and that we all need to be part of the solution. A solution that “would save the planet at a price we can easily afford.”

The Dollars and Sense in Trading Carbon

2009-12-03T18:57:42Z

The "trade" portion of the cap and trade bill is getting a lot of heat from the left and the right as being just another way for the banks to get rich and leave us with the bill. These concerns are certainly understandable given the fact that the American consumer is still holding the bucket as the government mops up Wall Street's last great idea for a new market. Indeed, the idea of creating a new market for anything would seem completely absurd were it not for the fact that solving global warming is a multi-trillion dollar challenge that cannot simply be met by taxing people into submission.

According to IEA estimates, the world needs to invest an additional $10.5trln in low carbon technologies over the next two decades alone to keep greenhouse gas concentrations limited to 450ppm. In the US, banks are needed to lend over $2trln to cash starved companies from 2010-2030 to help them improve their energy efficiency, develop cutting edge renewable technology, and build the cleaner cars needed to achieve these targets. Investments that will need to be financed by banks and best facilitated through a cap and trade program like the one being put forward in Congress.

The following is a short Q&A about how carbon trading is being set up under the cap and trade bill and why it will be successful in achieving our environmental goals:

Q: Okay, maybe we need the banks to lend, but do banks really need to be involved in the trading side as well? Why can't we just limit trading activity to emitters only?

A: On the face of it calls for an "emitters only" market for carbon trading certainly sounds appealing. Emitters could buy allowances from the government and trade them amongst themselves, allowing us to spend less time on "trading" carbon allowances and more time on "capping" our carbon emissions.

Unfortunately, this system is expected to prove a more expensive option for the consumer and the planet. In an "emitter only" market, trading costs would be high as it would be no ones job to make markets in carbon and all of the participants will have identical needs. Furthermore, if banks are excluded from an "emitter only" market they would be less likely to lend money (as they will be unable to hedge these capital investments), making our reductions targets even harder to achieve.

Q: Fine, but how are we going to stop Wall Street from turning this into a massive profit center?

A: Under the House-passed Waxman-Markey bill, over-the-counter (OTC) trading for carbon emission allowances is banned full stop and all trading is expected to take place on exchanges. This means the banks are not going to be making money from OTC trading in the carbon markets (a cash cow business for them in oil and the other commodities markets). As a result, the banks will be limited primarily to broking on exchanges and income from lending. Sensible, "day job" businesses that will keep the banks from turning the carbon markets into a casino.

Q: But how are we going to keep speculators from driving prices up and down like a roller coaster?

A: I can answer that question in three words, "regulation, regulation, regulation". Congress is drafting the rules for the carbon markets in a way that will help make them the best regulated markets in the country. This means strong position limits, strict oversight, reporting requirements, and the ability to enforce the rules with fines or jail time or both. Rules that will keep speculators in check and help ensure that carbon trading is conducted in a way that is in keeping with the cap and trade program's long-term objectives.

In addition, the "market stability reserve" introduced under the Kerry-Boxer bill will help keep volatility down by injecting additional allowances into the market above a certain price threshold. In a given year, the "market stability reserve will be allowed to auction up to 25% of a year's total cap into the market at this minimum reserve price. This represents four times as many allowances needed to meet the largest percentage increase in carbon emissions since 1990 (adjusted to reflect a 3% declining cap). A wall of additional allowances that can be used to keep speculators in line and keep price spikes from hurting consumers pocketbooks.

In sum, fighting global warming is not just an environmental challenge it is also a massive financial challenge. A $10trln challenge that requires allowances to "trade" on an exchange as a way to best facilitate the loans and investments needed to meet our climate goals. Lastly, Congress is not relying on the bank's word that they will do better next time when it comes to the carbon markets. The rules are being established to keep speculators in check and give the regulator the oversight authority needed to keep this exchange based new market viable over the long term.

Cleaner Cars to Drive Down our Gas Bills by 10% under Climate Bill

2009-11-15T18:13:41Z

While the oil lobby continues its gas attack on climate legislation, a recent government study suggests that accelerating CAFE standards under the Waxman-Markey climate bill would actually lower our gas bills by more than 10% over the next two decades (see graph below):

Under the EIA's Accelerated CAFE Case analysis of the Waxman-Markey bill, the average fuel economy of a car on the road is expected to improve by roughly 0.6 mpg over the next two decades. While this may not seem like a lot, the EIA calculates that by the year 2030 these improvements will save over 91 billion gallons of gasoline (see graph below):

In fact, the EIA forecasts that this reduction in oil demand is large enough to reduce imports by 10%, cut our CO2 emissions by over 900mln tons, and actually lower global oil prices by around 3.5% (see graph below):

These benefits from building and driving cleaner cars are expected to allow our gas bills to continue to fall even as oil prices and carbon prices continue to rise. Furthermore, by making fewer trips to the gas station (a benefit in its own right in my opinion), consumers are even forecast to see their gas bills fall below what they would have been without a climate policy in place.

This is not something you are likely to hear from the oil lobby. The oil lobby only wants us to focus our attention on the costs associated with capping our greenhouse gas emissions and does not discuss any of the benefits we are expected to gain from driving more efficient vehicles. If we separate out the carbon costs in a gallon of gasoline from the clean car savings in a gallon of gasoline (using the EIA's data), we find that they largely offset one another and in fact the clean car savings starts to outpace the carbon costs by the year 2026 (see graph below):

Climate Policy will Help Accelerate Deployment of Cleaner Cars

According to EPA estimates, domestic automakers will need to make $56bln in incremental technology investments between the years 2012 and 2016 to meet President Obama's 35.5 mpg CAFE target. A funding requirement that is expected to be recovered through the sale of these more efficient cars and light trucks.

While some of these investments are already in place, the Waxman-Markey climate bil is expected to provide the temporary assistance needed to fully make this transition. Under the bill, the auto companies with have access to over $20bln in re-tooling incentives and $25bln in loan guarantees. Enough investment capital to achieve President Obama's CAFE targets, dramatically improve the competitiveness of domestically produced automobiles, and create thousands of new clean car jobs.

In sum, the EIA's modeling of the Waxman-Markey climate bill shows that investments in cleaner cars can help drive down our gas bills by over 10% under climate legislation. Investments that will help us achieve President Obama's accelerated CAFE targets, cut our CO2 emissions output, reduce our dependence on foreign oil, lower global oil prices, and help create thousands of good paying manufacturing jobs for America's workers. Benefits that will make passing climate policy a clean energy bargain for the American consumer.

Americans are Dying to Support our Fossil Fuel Habit

2009-10-26T06:12:42Z

A new report from the National Research Council of the National Academy of Sciences (NAS) reveals that our energy bills are $120bln higher than they appear due to the "hidden costs" associated with the air pollution created by burning fossil fuels. The NAS report, which was commissioned by the US Treasury on behalf of Congress, estimates that over 90% of these hidden costs are due to premature death, implying that at least 18,000 Americans die each year to support our fossil fuel addiction (see table below):

The report concludes that these estimates are conservative as they do not include any costs related to climate change, national security, other pollutants, or the impacts of mountain top coal mining and that if these other costs were included they would raise the hidden cost of fossil fuels far higher than the $878 per household estimated using the assumptions underlying the NAS report.

Paying for our Fossil Fuel Addiction with Our Lives

According to the analysis, over half of these hidden costs come from the burning of coal to generate electric power. We currently burn over a billion tons of coal each year, releasing millions of tons of dangerous pollutants into the air in the process. The NAS report estimates that the "hidden" costs of these emissions at $62bln per year or around $530 per family on average. For people who live east of the Mississippi River, along the Ohio River Valley, in the Middle Atlantic and the South, however, these "hidden" costs are significantly higher as are the risks that these costs may be "paid" for by a loved one.

The report does note that these hidden costs from burning coal are actually expected to fall somewhat to around $38bln per year by 2030 as cleaner plants come on line. While this is a significant improvement given that coal consumption is expected to rise by 20% in 2030 under business as usual, it still means that over 165,000 Americans are expected to die prematurely due to the production of coal-fired power. It must also be remembered that this trillion dollar "hidden" cost is additional to the effects of producing over 50 billion tons of CO2 pollution from these facilities during this timeframe. Costs that are expected to accelerate the impacts of climate change around the world.

Under climate legislation, however, these hidden costs are expected to decline as coal-fired power is steadily replaced by cleaner alternatives. Indeed, under the government modeling of the ACES climate bill, coal consumption is expected to fall by 50% when compared to business as usual forecasts. This reduction in coal consumption is expected to not only help reduce the number of lives lost from breathing dirty air by the thousands but also lower our cumulative CO2 output from coal plants by around 25% between now and 2030.

The other large source of hidden costs comes from the combustion of transportation fuels. According to the study, air pollution from vehicles costs us $56bln per year ($36bln from light-duty and $20bln from heavy-duty vehicles). This works out to about 29 cents a gallon or roughly $330 per household per year. What is more, tailpipe pollution is not expected to improve over the next two decades according to the NAS report. This means that by the year 2030, the cumulative air pollution damages from burning transportation fuels and coal are expected to exceed $2trln. An extremely high cost of our addiction to fossil fuels given the 340,000 premature deaths this figure represents (see graph below):

Natural gas is the final fossil fuel source of air pollution included in the study with externalized heath costs of around $2.14bln per year ($741mln from electric power and around $1.4bln from heating our homes, offices, and powering our industrial output). This roughly translates into an additional 0.16 cents per KWh of natural gas power if it were included into our fuel bills, adding around $18 per year to household energy costs. While this is a relatively small hidden cost, the overall hidden costs of natural gas with respect to global warming are still significant. Indeed, under climate legislation natural gas is expected to replace coal as our second largest source of CO2 emissions (after transportation fuels) by the year 2030 (see graph below):

In sum, Americans are literally dying by the thousands to support our addiction to fossil fuels. In fact, you and I have a better chance of dying from air pollution than we do from homicide. What is more, while the "hidden" costs highlighted in the NAS study are only a small portion of the overall hidden costs associated with our current energy economy, they present an immediate threat to our friends and family that cannot easily be ignored. Costs that should make us even more vigilant in our efforts to pass strong climate change policy and help create a cleaner energy future.

Senate’s Climate Bill Puts Green Collar on Carbon

2009-10-05T17:48:07Z

Senators John Kerry and Barbara Boxer have introduced a "green" price collar on carbon under their draft climate bill that should be applauded by emitters and environmentalists alike. A green price collar that will; 1) maintain the integrity of the carbon cap, 2) lower price volatility, 3) put a limit on emitter costs, 4) better ensure the program's long term viability, and 5) help to tighten the carbon cap. Best of all, the Kerry-Boxer bill is able to do this by putting market participants to work defending the price collar rather than fighting it.

The Market Stabilization Reserve (Sec. 726 of The Clean Energy Jobs and American Power Act ) would amend the strategic reserve language used under the ACES bill in the following three ways:

First, the Market Stabilization Reserve replaces the ACES price trigger formula with a pre-determined ceiling price that starts at $28/ton in 2012 and rises by an inflation adjusted 5-7% annually. Using this fixed ceiling price in combination with the ACES fixed floor price (which starts at $10/ton in 2012 and rising 5% per year thereafter), the Kerry-Boxer bill looks to create a trading band or "price collar" on carbon allowances values over the life of the program (see graph below):

Second, the Market Stabilization Reserve nearly doubles the number of allowances available to defend the price collar. While the ACES bill limited the strategic reserve to providing an additional 10-15% of allowances established under the cap in a given year to fight price spikes, the Kerry-Boxer bill would increase this amount to 15-25% of the total number of allowances established. An amount of allowances large enough to create a high degree of certainty that the carbon prices will remained contained within the price collar band (see graph below):

And finally, unlike under the ACES bill, the Market Stabilization Reserve may purchase domestic and international offsets to supplement the number of allowances available in the reserve pool. These changes in the strategic reserve language under the Kerry-Boxer bill are expected to lower carbon price volatility and give emitters greater assurance that their carbon costs will be contained within the price collar band.

Furthermore, the Kerry-Boxer bill creates a market based mechanism that encourages market participants to actually work to defend the price collar. A dynamic that is expected to make the Kerry-Boxer price collar truly "green" as this would enable a higher percentage of allowances from the Market Stabilization Reserve to be retired from the program instead of used to fight price spikes.

To illustrate, let's suppose carbon prices in the year 2020 were trading at a price of $43.75, just 5 cents below the $43.80 collar price ceiling. From a market participants point of view, these market conditions create a strong incentive to not only stop buying allowances but actually begin to sell them in the hope that they will be able to buy them back later at lower prices (once market speculators have been driven out of the market).

The reason for this is that at a carbon price of $43.75, a market participant knows two things; 1) that the risk/reward of buying allowances is lousy given the amount of allowances on offer under the Market Stabilization Reserve to defend the $43.80 level* , and 2) the risk/reward of selling carbon allowances is quite good, as market participants also know that the allowances they sell to help reverse the supply/demand imbalance in the market can be covered with minimal cost in the Market Stabilization Reserve auction.

As a result, a market participant is likely to act in a way that protects the price collar from being triggered, creating not only a programmatic benefit by keeping the Market Stabilization Reserve largely in tact, but an environmental benefit as well as more of these allowances can eventually be retired from the program over time.

In sum, the Kerry-Boxer draft climate bill should not only be commended for moving up our target on emissions reductions from 17% to 20% by the year 2020, but for also creating a "green" collar on carbon. A green price collar that will create better cost and program certainty for emitters, while still maintaining the program's long-term environmental integrity under the cap.

* The 1.2 billion allowances available to defend the price collar in this case (the equivalent of 25% of the 4.8 billion allowances established in 2020) is roughly the equivalent of six times the largest annual change in our emissions output over the past two decades. The average change has been around 70 million tons or around 6% of allowances on offer in the Market Stabilization Reserve.

Strong Regulation to Keep Carbon Markets Program Viable

2009-09-15T05:22:28Z

In a recent WSJ article entitled "Cap and Trade: Recipe for Disaster", Louisiana State University economist Joseph Mason outlines his concerns that special interests have already taken control of the European carbon markets and that the US carbon markets are unlikely to fair any better. That given the poor performance of Federal Reserve in preventing blow ups like Enron and AIG, even a Fed-like regulator for the carbon markets will not be enough to keep a cap and trade program viable over the long term. Instead, he recommends in a recent paper that Congress abandon the idea of a cap and trade program in favor of a more “elegant” carbon tax.

Putting aside the challenges of creating a carbon tax, Professor Mason’s concerns that a carbon market would be too difficult to oversee is worthy of further discussion.

Professor Mason is correct in arguing that without strong regulations in place, the carbon markets would be prone to the same kind of wild price fluctuations seen in other markets today. However, he fails to see how creating a new market from scratch gives us the ability to avoid these market excesses. For example, under the Senate’s carbon market oversight proposal, the carbon regulator would create an exchange based market where speculators are required to adhere to strict position limits and reporting requirements. These requirements are expected to effectively ban the "dark" or unreported trading practices that have plagued the other derivatives markets and lower carbon price volatility over the long term. The ACES climate bill would pass similar measures for the energy commodities, driving down price volatility in these markets as well.

Further Professor Mason’s assertion that “special interest have already succeeded in “capturing” the European carbon markets program” also lacks merit. While the EU carbon markets have been subject to two crashes over the past five years, both of them were one-time experiences that won’t be repeated here. The first price crash was caused by an over-estimation of emissions by market participants. This won’t happen in the US because we will have the emissions data ready at the get-go. The second price crash was caused by the fact that the allowances in their trial period became worthless at the end of the trial. This also won’t happen in the US because all allowances will be bankable for use in future compliance periods.

Although Professor Mason also refers to the recent price volatility in the European carbon markets as "extreme", if anything these markets are demonstrating that they aren't being pushed around by market speculators. Currently, 80-90% of trades are either cleared through or take place on registered exchanges. The remaining trades are non-reported OTC trades which are small in scale, tailored to meet specific emitter needs, and do not have a large influence on day to day market prices. Further, the European carbon markets themselves are behaving as we would expect them to behave, rising when economic growth is running above trend, and falling when economic growth is running below trend (see graph below). This counter-cyclical behavior compares favorably to a carbon tax which would not be nearly as flexible in meeting the challenges of the business cycle.

In sum, while Professor Mason is right to highlight the urgency of assuring the carbon markets, his arguments don't support his conclusion that a carbon regulator would not be effective in supporting the cap and trade program. A Fed-like carbon oversight committee, like the one envisioned in the Senate climate bill, creates regulations that can protect the carbon markets from excessive speculation and allow us to meet our long term environmental goals.

API Climate Study Fails to Demonstrate Need to Increase Refiner Allocations

2009-08-26T15:37:16Z

An American Petroleum Institute study released this past week makes three rather deceptive claims about the impacts of climate change policy on the oil refinery industry in the US.

The first claim is that legislation to cap carbon emissions will cause a large drop in US refinery capacity utilization. In fact, the main reason that US refinery production will drop is that demand for transportation fuel is going to fall - the product of the Obama administration's higher standards for fuel efficiency and greenhouse gas emissions.

API projects a baseline case of continued high gasoline consumption and as a result refinery capacity utilization of 83.3% in the year 2030. In contrast, EIA accounts for the fuel savings from the higher mileage and lower GHG emissions standards in their baseline case, and expects refinery capacity utilization rates will only be around 77.6% in 2030 (in line with API's Basic Climate Policy Case). While API may wish that US consumers will continue to drive gas guzzling SUVs forever, the reality is that higher vehicle standards are expected to dramatically lower US oil consumption and are the reason why capacity utilization rates for US refiners are expected to remain subdued over the long term.

The second deceptive claim is that climate legislation would significantly cut US refinery output. The API study forecasts that US refining throughput will fall by up to 4.4 million barrels per day or 27% by the year 2030. The API study produces this result by 1) assuming an inflated baseline demand for transportation fuel - far higher than projected by the federal government's Energy Information Agency, and 2) assuming extremely high carbon prices - prices driven up by assuming no international offsets and little technology innovation. Under more reasonable assumptions, the projected drop in US refinery output shrinks to a tiny fraction of API's scary numbers. For instance, when you compare US refining output under API's own "Basic Climate Policy Case" in 2030 with the EIA's baseline case (which includes reduced demand from cleaner vehicles), the 4.4 mbpd drop in refining throughput in their key finding quickly shrinks to less than 600 thousand barrels per day (see table below):

The third deceptive claim is that legislation to cap carbon emissions will lead to a significant shift towards non-US refining capacity, investment, and employment, at the expense of US refiners. The main point of the API report is to argue for giving away more allowances for free to US refiners (they would receive 2.25% of the allocation under the House-passed bill). If this claim were to be true, we would expect to see a significant increase in the percentage of refined product coming from non-US refiners once these free allowances sunset in the year 2026. However, when we look at API's own "Basic Climate Policy Case" analysis of climate legislation, we see that non-US refining imports are actually projected to drop between the year 2020 and 2030 (see table below), making API's claims that imports will surge seem rather inconsistent with even their own analysis.

In sum, the API assessment fails to demonstrate a need to increase the allocation of allowances to domestic refiners. Their study also fails to prove that legislation to cap carbon emissions would significantly decrease domestic refinery production, and increase refined imports.

Sage Words on Climate: Buffett and the Butterfly Effect

2009-08-23T20:46:16Z

In an NYT op-ed column this past week titled "The Greenback Effect," Warren Buffett voiced his concern that unchecked government spending by Congress is "spewing a potentially damaging substance into our economy" known as "greenback emissions". According to Mr. Buffett these so-called "greenback emissions", which presumably rise out of the smokestack of the US Treasury, are dangerous to the financial integrity of the economy as they can create "butterfly effects" similiar in their unpredictabiilty to carbon emissions. Butterfly effects that could one day "melt" the value of our currency in the same way that "unchecked carbon emissions are likely to melt the icebergs".

While Mr. Buffett was clearly talking about carbon emissions as a way to illustrate how rising budget deficits can carry unintended, unpredictable consequences, the parallels he draws between our fiscal deficit and our carbon deficit are worthy of a more detailed discussion.

Like our national deficit, our carbon deficit is rising at a pace that is unsustainable over even the short run. As Mr. Buffett notes, our budget deficit is currently rising at a pace of 185% of tax receipts. A level of increase that must be reigned as soon as possible before it creates an undue burden on future generations.

This same case can also be made for our carbon deficit, which is growing at an even more alarming rate. At the current pace of emissions, we are expected to be committing the planet to a 2 degree Celsius rise in surface temperatures as early as the year 2035*. Such a rapid temperature increase is expected to create profound financial as well as strategic challenges for the US. From food and water shortages to rising seas levels to a sharp increase in the number of "failed" states around the world, climate change carries both economic and military security risks that are extemely hard to quantify, even for the Pentagon.

Another parallel between these twin deficits is that they both can be addressed by following progressively tighter targets over time. In the case of our budget deficit, Mr. Buffett recommends that Congress rein in spending and increase tax revenues as a way to tighten our belts. In terms of our carbon deficit, Congress is looking to set a declining cap on the cumulative amount carbon we can emit into the atmosphere from now until the year 2050. This declining carbon budget is expected to drive down our carbon deficit, and would also make Mr. Buffett happy by reducing our balance of payments deficit through enhanced energy independence.

A final parallel is the role the Chinese play in both these debates. If we wish China to become more active in our debt markets, Mr. Buffett insists that we need to avoid the temptation of the printing press and begin to demonstrate that we are committed to taking responsibility for our budget deficit. This same approach also applies to our carbon deficit. If we wish China to become more active in solving global warming, we need to demonstrate that we are committed to passing climate legislation sooner rather than later.

In sum, Mr. Buffett's article draws an interesting parallel between the uncertain costs or "butterfly effects" of climate change and that of our rising national debt. While Mr. Buffett has argued that Congress must show the political will to cut our "greenback emissions" in order to save the dollar, it seems the same arguments can be made to get Congress to cut our carbon emissions through climate legislation in order to save the planet.

* Assuming a 1.5% average annual increase in global emissions, concentrations of greenhouse gases are expected to reach 550 ppm CO2e by the year 2035 and commit us to a minimum rise in surface temperatures of 2 degrees Celsius (Stern Report pages 193-202).

Energy Reforms Critical for Assuring Carbon Markets

2009-08-12T22:51:51Z

A new report to be released later this month by the U.S. Commodity Futures Trading Commission (CFTC) is expected to reveal that contrary to their previous findings, speculators were in fact to blame for generating a "significant" amount of the price volatility in the oil markets last summer. In response to these new findings, the CFTC's new Chairman Gary Gensler has concluded that the CFTC needs to institute a series of reforms designed to reign in this kind of speculative activity. While Mr. Gensler's solution of creating position limits for exchange traded energy futures looks like a step in the right direction, the CFTC needs the authority to go farther.

Indeed, Congress needs to pass legislation that would allow the CFTC to expand its authority by setting position limits and reporting requirements for all trading that takes place in the energy markets. Oversight provisions that would effectively ban the "dark" or non-reported trading practices that have allowed speculators to ply their trade from the shadows without detection for far too long.

Congress could accomplish this by passing the ACES climate bill, which already includes a series of energy market reforms that would allow the CFTC to set strict position limits and requires all "dark" trading to come into the light. Reforms that would also help provide lower price volatility in the carbon markets and provide the kind of long-term market assurances needed to keep a cap and trade program viable over the long term.

The following is a check list for Congress to consider in creating meaningful position limits for the energy markets:

1. Position Limits need to be Inclusive

The CFTC's proposal to create position limits in the energy markets need to include trades that take place in both the exchanged traded as well as over-the-counter (OTC) traded markets. Creating position limits only for exchange based trades would only encourage more trading to take place in the "dark" markets and leave the regulator more in the dark themselves as to what's going on.

By requiring position limits to be inclusive of both OTC and exchange trading markets, participants would be forced to comply with aggregate position limits rather than simply switching their trading to the OTC swap market to avoid compliance like the U.S. Natural Gas Fund did earlier this year.

2. Position Limits need to be Enforceable

Even if the CFTC agrees to create aggregate position limit for the energy markets, it does not have the authority to enforce them. OTC trades in the energy market are exempted from regulatory oversight and these exemptions would need to be repealed if the CFTC is going to be able to require that trades are reported into the regulator to help them track aggregate position limits.

Congress can help the CFTC fight "dark trading" in the energy markets by passing legislation similar to the energy reforms suggested in the ACES climate bill. These provisions would set strict reporting requirements for all participants in the energy markets and provide a number of other regulatory reforms that would help put speculators on notice that their days of running rough shod over the energy markets through "dark trading" are numbered.

3. Position Limits need to be set at an Appropriate Level

Another important requirement to be considered is the level of the position limit itself. As a rule, position limits should reflect the amount of time needed to unwind a given position without becoming disruptive to the markets. Under normal market assumptions (which of course are rare), a position size of say 5% would generally require 10 days to unwind without becoming disruptive to the markets - a position size of 10% would require roughly three to four weeks and a position size of 15% or more would require one to two months and would not be able to be unwound without having a material impact on market prices.

It is in this context that a relatively low position limit is favored for the energy markets. The CFTC already has experience setting low position limits for the agricultural commodities and similar limits are encouraged to be developed for the energy markets as well. The carbon markets under the ACES bill for example would carry the same speculative position limit as an agricultural commodity like wheat, which has a speculative limit of roughly 2% of the markets open interest.

4. Strict Reporting Requirements Would Ban "Dark Trading"/ Reduce Credit Risks

By creating strict reporting requirements for all energy transactions, Congress would effectively be banning "dark trading" as it is currently being conducted today. Speculators would no longer be able to rely on the anonymity of the OTC markets to disguise their trades, making their games less effective in pushing around prices in these markets.

These requirements could be enhanced by requiring all transactions to be cleared through a registered exchange. In this way, the CFTC would be able to almost eliminate credit risk from energy trading and lower price volatility in these markets even further.

In sum, the US consumer has paid a high enough penalty for poor market oversight in the energy markets. The CFTC has acknowledged that more needs to be done to reign in speculation but their suggestion of position limits should only be considered a half-measure as it is currently proposed. Position limits need to be inclusive, enforceable, and appropriate to the markets and Congress can ensure that these requirements are met and that "dark" trading is banned by passing energy market reform provisions similar to what are already included as part of the ACES climate bill.

A Price Collar Won't Protect the Carbon Cap

2009-07-28T22:02:19Z

A brief Politico article last week titled "Time for a Price Collar on Carbon" argued that a price ceiling should be included in the Senate version of climate legislation as a way to better ensure the bill's passage. While the authors of the article believe a price ceiling is necessary to get the bill over the finish line, they fail to weigh the costs a price ceiling would impose on 1) the cap's integrity; 2) low carbon investments; 3) the price of carbon allowances in later years; and 4) our ability to negotiate a binding global agreement on emissions reductions over time.

Simply put, the cap and trade program is designed to limit our cumulative emissions over the period from now to 2050 through a declining cap. If a cap and trade program were to allow emitters to ignore the cap, and buy an unlimited number of carbon allowances at a ceiling price, we would be forced into making one of two bad choices. Either we would have to abandon our emissions budget, leading to more dangerous climate change, or we would have make much steeper emission reductions in the future, causing the program to be much more expensive than necessary.

While the authors argue that the cost containment provisions used under the ACES bill are "merely moving stringency from one year to another without actually limiting the overall cost" of the program, they are not taking into account the cost savings generated by accelerating low carbon investment under a market based approach. Lower carbon prices under a price ceiling may save emitters money in the short run, but they would be doing this by sending a false price signal to the market, delaying the low carbon investments needed to grow clean jobs and keep carbon prices low over the long term.

Lastly, creating a price ceiling in the US would also make securing a global agreement on carbon emissions more difficult as the rest of the world would demand that they be allowed to abandon their emissions budgets as well.

In sum, putting a price collar on carbon emissions would serve to limit the integrity of the cap, reduce investment, make securing a global agreement more problematic, and leave us with expensive carbon debt that could only be paid back by raising carbon prices over the long term and should be avoided under cap and trade legislation.

5 Reasons Why Trading Allowances Will Help Meet Our Climate Objectives

2009-07-22T03:53:18Z

While the Senate does appear to support the scientific and environmental need to put a cap on our carbon emissions, some Senators remain fearful that the “trading” portion of the cap and trade bill will just be creating another derivatives market for speculators to “sink their teeth into”. As a result they feel that only emitters should be allowed to trade carbon allowances and Wall Street should be left out the market entirely.

On the face of it, this approach seems fairly sensible given what a mess Wall Street has made of the energy, mortgage, and credit default swaps markets over the past few years. Instead of creating a “trading” market for carbon allowances, we would instead create an “emitters only” market for carbon allowances where the emitters could just trade between themselves. Then we wouldn’t have to worry about creating another derivatives market and the program could focus less on trading and more on ways to ensure the integrity of the cap over time.

Although this solution sounds like the most straightforward approach, if we are actually looking to design a carbon program that will keep transaction costs down, accelerate the deployment of low carbon technologies, bridge the credit gap, lower overall program costs to the consumer and best ensure we meet the environmental objectives of the program a “trading” market approach where non-emitters can participate will deliver far better results than a “emitter only” market for carbon.

The following is a list of five reasons why the “trading” market detailed in the ACES bill would be more effective than an “emitter only” market:

1. Trading Markets Lower Transactions Costs / Improve Market Liquidity

A well regulated, exchange based carbon “trading” market like the one described in the ACES bill would have very low transaction costs relative to an “emitter only” market. Market makers and speculators would compete on an exchange to narrow bid/offer spreads and reduce overall trading costs for market participants under a “trading” program. This would compare favorably to an “emitter only” program that would tend to have wider spreads and higher transactions costs as emitters would only tend trade sporadically and be less focused on providing liquidity to the overall market.

2. Emitter Only Trading is Not Immune from Volatile Price Swings

An “emitter only” program would tend to be more volatile than a "trading" market when market fundamentals have changed. This is due to the fact that an "emitter only" market would have too few sellers of allowances when the economy was strong and have too few buyers of allowances when the economy was weak, as emitters would be all looking to trade in more or less the same direction. A “trading” market on the other hand would have several different kinds of actors involved in the market on a day-to-day basis and as a result would be more balanced and less prone to this kind of unwanted market volatility.

3. Emitter Only Trading is Not Immune from Market Manipulation

While it can be argued that an “emitter only” program would tend to be less volatile due to the lack of speculators in the marketplace, this would not mean that an “emitter only” market would be immune from market manipulation. In fact, the presence of several large emitters, whose compliance obligations would be larger on a percentage basis than the speculative limits allowed under the ACES bill, would have the ability to meaningfully influence carbon prices leaving the market prone to the same “games” played by speculators in other markets.

4. Trading Markets Accelerate Low Carbon Investments

Like them or not at the moment we need the banks to provide the trillions of dollars of loans needed to fund our transition to a low carbon economy. One way for the banks to start lending again is to provide loans to emitters for low carbon investments backed by the collateral value of their carbon allowance allocations. This kind of lending is desperately needed to accelerate low carbon investments and can only effectively take place in a market that allows “trading”. An “emitters only” market would not provide enough flexibility to use carbon allowance values as collateral as the banks would not be able to sell the allowances in the market if the covenants of the loan were to be broken. As a result, many economic investments under a "trading" market program would be delayed under a "emitter only" market program due to the inability to finance these kinds of projects without using carbon allowances as a form of collateral.

5. Trading Bridges the Credit Gap / Lowers Overall Program Costs

In a credit constrained world, the ability to tap the collateral value of allowances lowers an emitter’s borrowing costs, allowing them to accelerate investments in the low carbon technologies needed to meet our environmental objectives. In this way “trading” not only helps bridge the credit gap faced by emitters but also helps to lower program costs overall by enabling these technologies to scale up faster. A more rapid deployment of these technologies will allow us to more easily keep pace with the declining cap on carbon emissions and keep carbon costs low.

While the benefits of a “trading” market approach may be persuasive, recent comments on the Senate floor that trading “makes no sense” would still be valid if the ACES climate bill simply outlined a plan to create another unregulated playground for the banks and hedge funds to play in.

Fortunately the 400 pages of carbon market assurance regulations written in the ACES bill moves us 180 degrees away from creating another one of these “dark” markets where speculative traders thrives in the shadows. Unlike these markets, the carbon derivatives regulation under the bill would 1) require all trading to take place on exchanges, 2) prohibit over-the-counter (OTC) trading, 3) limit speculative activity, and 4) severely restrict overseas allowance trading. Additionally, if the Senate carbon market oversight provisions were also to be incorporated into the bill, carbon would be regulated under an independent Carbon Markets Oversight Committee that would be responsible for ensuring that carbon trading is conducted in a way that is in keeping with the programs long-term environmental objectives.

Furthermore, the ACES bill would also repeal many of the regulatory exemptions granted to the energy markets under the Commodity Futures Modernization Act of 2000. By banning OTC trading, introducing position limits, and increasing reporting requirements for oil and natural gas market participants, the bill would help ensure that market price volatility would fall in these markets and that the “rollercoaster ride” we experienced last summer at the pump would be shut down and no longer open for business.

In sum, carbon "trading" markets have benefits that cannot be replicated by an "emitters only" market. Like it or not at the moment, we need the banks to be involved in the carbon markets as they are expected to provide trillions of dollars in financing for the deployment of the low carbon technologies needed to cost effectively acheive our climate goals. Lastly, while fears that we are creating another "speculative orgy" are not well founded with respect to the carbon markets, it is important that the Senate remain vigilant with respect to the energy market reform provisions in the ACES bill. These provisions will greatly improve the ability of the carbon trading markets to do their job and put speculators on notice that the energy commodity markets are coming back into the light.

Palin's Alaska State of Mind on Energy Taxes the Rest of Us

2009-07-14T22:35:00Z

The soon to be former Governor Sarah Palin's "plan" to keep America addicted to fossil fuels and to abandon the President's cap and trade program for carbon pollution is not only a disastrous climate policy, it is even worse as an economic policy.

We need to find ways to cut our dependence on oil, reverse the loss in manufacturing jobs, and ensure America's place as a global economic leader. Cap and trade policy will meet these challenges while "drill here, drill now" would have us keep our heads in the sand and hope it all goes away someday.

Governor Palin's energy policy prescription to increase offshore drilling clearly shows she isn't one of "those who knows and understands the issue". Access to credit and high commodity prices are far bigger drivers of investment than access to new oil and gas fields. The truth is that domestic production is driven by the prices the oil and gas firms can charge us. When the price is painfully high, they "drill, baby, drill" but when the price drops as it has in the past year those drill rigs disappear faster than cockroaches when you turn the light on. In Sept 2008 there were over 2,000 production drill rigs in operation; last month there were only around 900, a nearly 60% drop. This didn't happen because the government put lands off limits. It happened because companies who want us to believe their only interest is in bringing us as much cheap oil and gas as we can possibly burn, lose interest when the price drops.

Indeed, Governor Palin knows this better than anyone as she has spent the past several months trying to woo bankers into financing her states $26bln natural gas pipeline project - a task she had yet to accomplish before abruptly leaving office.

If the Governor truly cared about increasing America's oil production, she would actually be supporting the ACES climate bill that passed through the House of Representatives last week. Under the bill, billions of dollars of support will be given to utilities to capture the carbon dioxide from their smoke stacks; a portion of the billions of tons of carbon would then be piped to oil producers for use in enhanced oil recovery (EOR). According to the Department of Energy, enhanced oil recovery with CO2 has the economic potential to recover between 45 and 89 billion barrels of stranded domestic from existing wells.

The state of Louisiana alone has 6 billion barrels of stranded oil that could be recovered using enhanced oil recovery with CO2. This is about as much oil as is thought to exist in the Artic National Wildlife Refuge and would triple the states current oil output over the life of the climate bill, creating billions of dollars in tax revenue and tens of thousands of jobs in the process.

Accelerating the deployment of carbon capture at power plants, and using the CO2 to recover trillions of dollars worth of stranded oil in existing wells is something that would never happen if our economic and climate futures were left up to Sarah Palin and her buddy Newt Gingrich.

Furthermore, "drill, drill, drill" is really just another way of saying "tax, tax, tax". Just like a cigarette smoker, we have become numb to the higher prices that have come with our addiction to oil. In fact, the average American household has paid an additional $2,500 over the past five years just keeping up with our oil habit (see graph below):

The Palin plan would continue to stick an oil needle in our arm forever or at least until demand from China (which is expected to rise from 9% today to 15% of total demand in 2030) pushes prices beyond our means. What choice will we have then other than to simply swear, shrug and open our wallets even wider?

President Obama, on the other hand, is actually trying to treat our addiction to foreign oil by requiring cars to be cleaner. By passing standards that improve CAFÉ to 35.5 mpg by the year 2016, and providing up to $45bln to help re-tool the US auto industry under the cap and trade bill, President Obama's plan is expected to lower our oil consumption by 1.4mln barrels a day by the year 2020. Providing a cumulative savings to American households around $1,900 through the year 2020 using the EPA's gas price forecasts (see graph below):

While Governor Palin's points about jobs were really only talking about jobs in Alaska, the amount of capital required in creating those energy jobs she was referring to is simply outrageous. The $26bln pipeline she wanted to build was only expected to employ 9.300 people at its peak and a fraction of that number thereafter, which is roughly $3mln of investment per temporary job. This compares with the nearly 300,000 clean jobs that could be created with the same amount of capital under the climate bill, which are jobs that are accessible to middle and lower middle class workers in the lower 48 states (and Hawaii) and can help America re-power its economy by getting more people back to work.

Indeed, the Waxman-Markey climate bill would actually help accelerate investments and create jobs in the new industries needed to help the economy recover faster. Larry Summers highlighted this connection between climate and economic policy in a recent speech by pointing out that cap and trade would "spur a whole range of green investments in the present, when our economy can benefit from all the investment it can get".

In fact, Larry Summers believes that we have an opportunity to create "millions of jobs" transforming our energy economy but only if we act now. According to Summers, "the evidence is clear: we can choose to lead these (low carbon) industries, with all the commensurate economic and political and environmental benefits, or we can choose to lose out on these jobs and these opportunities."

As an example of the industries Larry Summers is referring to, a recent ACEEE study sees potential to create 935,000 new jobs in the US semiconductor industry through the advancement of "smart" grid technologies. These technologies have a better than 2-1 payback in energy savings and would create an additional $1.2trln in energy costs savings over the next two decades if enabled to scale under the Waxman-Markey climate bill. Semiconductor sensors are just one example of the technologies needed by utilities and manufacturers to transition their businesses to a low carbon model, investments based not on goodwill, but on their high return on capital under climate legislation.

In sum, the Palin plan is simply bad business. Maybe not for Alaska but it certainly is for the rest of us. Sarah Palin's shock and awe concerns about the cap and trade bill demonstrate less about where the bill goes wrong than about how little she understands of its content. There are provisions in the climate bill that dramatically increase our domestic oil production, they just don't require us to tear through pristine wilderness first in order to get to them. Lastly, no one is saying that the transition President Obama is proposing will be an easy one, but as Nobel Prize-winning economist Paul Krugman recently said, "if you really believe in the magic of the marketplace, you should also believe that the economy can handle emission limits just fine."

The Senate's Role in Getting Carbon Market Regulation Right

2009-07-07T18:34:18Z

As the Senate begins to weigh in on the climate debate with its own version of climate bill, the issue of carbon market oversight still remains a major concern to many members.

The final bill that passed through the House created many important restrictions on trading that should ensure the carbon markets will meet with their primary environmental objectives, but more can still be done on the Senate side to ensure that the rules will not benefit speculators over time.

The following is a brief description of what the ACES bill said (including the managers amendments), what issues are left to be resolved, and where the Senate can improve on the good work done in the House ACES bill:

What the ACES climate bill said about carbon market regulation:

The Federal Energy and Regulatory Commission (FERC) has been put in charge of regulating the emission allowance, offset credit, and Federal renewable electricity credit markets. FERC will establish rules to 1) provide effective and comprehensive market oversight, 2) prohibit fraud and market manipulation, 3) ensure transparency, 4) create position limits and margin requirements (as necessary), 5) create a fair, orderly, and liquid national market system for these allowances, 6) limit or eliminate counterparty risk, market power concentration risk, and other risks associated with "trading regulated allowances outside of trading facilities" and 7) create a series of enforcement provisions to ensure the integrity of the new markets, including fines and jail time for offenders.
The Commodity Futures and Trading Commission (CFTC) has been put in charge of regulating the derivatives markets for emission allowances, offset credits, and Federal renewable energy credits. While the guidelines for determining the regulations for the derivatives markets are similar to those for the cash markets under the FERC, these carbon derivatives are to be regulated by the CFTC under the Commodity Exchange Act (CEA). Under CEA regulatory guidelines, the carbon market derivatives must be traded over a contract market designated by or registered with the Commission (effectively banning OTC trading). The CEA would also require any foreign board of trade to have the approval of the Commission before establishing a similar product.
The ACES bill also includes rules that would require the CFTC to create position limits, reporting requirements, and market oversight provisions for the oil, natural gas, coal, and electricity markets. SEC. 351 would also essentially ban OTC trading for these commodities, ensuring that these markets are less volatile and less subject to price spikes. A new section (SEC. 358) has been added, however, that could make these provisions null and void if over-arching derivatives reform is passed into law.
While the 10% default position limits on carbon derivatives have now been deleted from the ACES bill, regulation under the CEA should establish position limits that are far more aggressive with respect to speculation (see table below):

What issues should the Senate focus on?

1) Oversight Enforcement

While the CEA does have aggressive position limits in place, some have recently argued that these position limits are being (politely) ignored by the markets and not well policed by the CFTC historically.

The new Chairman of the CFTC Gary Gensler has now acknowledged that speculators played a role in last years spike in commodities prices but more needs to be done than just saying we will try harder next time. Enforcement is a critical component of regulation and the Senate can help ensure that this becomes a higher priority for the CFTC in drafting their version of the climate bill.

ACTION ITEM -Make Enforcement a Priority for the CFTC

2) Closing the Loophole for Avoiding Energy Market Oversight

The House bill included a last minute null and void clause in the energy market regulation section of the bill which deserves further scrutiny in the Senate. Under SEC. 358, Effect of Derivatives Regulatory Reform Legislation, several important sections dealing with market oversight of the energy markets in the ACES bill (the most significant of which is SEC. 351) would be deleted if derivatives regulatory reform is passed into law.

While over-arching legislation that reforms the derivatives markets should take priority over the provisions in the bill, the term "reform" is clearly subject to interpretation. If the Senate chooses to leave this section in place it should at least try to include a definition of "reform" that serves to provide a minimum amount of conditionality to repealing these important sections of the bill.

ACTION ITEM - Require That Only Meaningful Energy Market Reforms Would Make Climate Bill Provisions Null and Void

3) Resolving Issues with respect to Over-the-Counter Trading

Over-the-counter trading is an issue that is far from being resolved as these types of transactions have various degrees of buy-in from emitters, the banks, and offset providers alike.

Unregulated OTC derivatives contracts not only increase market volatility, but they also create a significant amount of counter-party risk that can paralyze the markets as evidenced during the collapse of Enron, AIG, and Lehman Brothers.

Ideally the Senate will choose to leave the OTC ban on carbon derivatives in place, but without assurances on how OTC trading will be dealt with for other energy derivatives, it is not clear that the issue can be settled as simply as that.

According to a recent report from Goldman Sachs, the carbon markets could become the third largest trading market in the world over the next several decades. While the US market is only expected to account for roughly a quarter of this global market, the rules written today by Congress will most certainly affect how this trillion dollar market will evolve over time and how it will interact with the other energy markets going forward. As a result, the Senate should focus on both short and long term concerns with respect to how the OTC market will evolve and impact the carbon markets.

While banks are likely to tell the Senate that OTC trading is cheaper for their customers-as their customers can post less collateral for these transactions than they would at exchanges-there are two fallacies with this argument. One is that insufficient collateral is the reason we got into ourselves into this credit crisis in the first place, so saying we should do it again (this time with taxpayer money at stake) is a bit ridiculous. The second is that what the banks are really saying is that OTC is a lot cheaper for them because they don't normally post collateral against these transactions. The Senate needs to see through the thin veneer of these arguments and at a very minimum require all OTC energy and carbon trades to be cleared through market exchanges (as is done in the coal markets today).

ACTION ITEM - Write the OTC Rules for a Growing Carbon Market