Advancing public and private policymakers’ understanding of the complex interactions between climate change and the economy is critical to taking the most cost-effective action to reduce greenhouse gas emissions. Read More
March 5, 2010
By Janet Peace and Timothy Juliani
This article originally appeared in Point Carbon News.
At the heart of any successful cap-and-trade program is a well-functioning market for the trading of emissions allowances. At the same time, the recent high-profile market scandals and crises have led many to question market mechanisms in general. Rather than leading to a wholesale indictment of markets, these events should instead highlight the critical need for appropriate market design, transparency and oversight. Luckily, Congress has the opportunity to design the carbon trading market oversight framework at a point in time before long-standing carbon trading practices and systems have been fully established.
A well-designed carbon market should reflect a balance between free market activity and regulation. To the extent that the market cannot be manipulated or distorted, it can achieve its purpose—to spur innovation and reduce GHG emissions at the least possible cost to the economy. Policies should include effective means to prevent excessively high prices, extreme price volatility, and irresponsible risk-taking. Thousands of businesses would be affected by a mandatory GHG emissions trading system, and it is in the public interest to ensure the market functions efficiently and allowance prices generally reflect the balance of supply and demand.
The challenge faced by lawmakers and regulators is to create conditions that provide effective transparency and oversight while allowing market participants to structure contracts that best fit their specific circumstances. A central question in this regard is whether carbon market transactions should be allowed to take place in the over-the-counter (OTC) market as well as on exchanges. While exchange-based trading allows more transparency and possibly more direct access for market regulators, many argue that OTC trading should also play a key role in a carbon market.
Both exchange-based and OTC trading have their strengths and weaknesses. Trading on exchanges provides transparency, ease of oversight, the virtual absence of counterparty risk, and market liquidity. Excessive speculation can be curbed to some degree through position limits, while daily cash settlement and clearing services lower the risk of default and limit the potential for negative ripple effects if default occurs.
While exchanges are not a panacea and do not ensure the absence of excessive speculation or market manipulation, they do provide a fair trading platform for market participants and regulators alike to see and access prices for carbon commodities. The centralized, standardized, digitized, and rules-based nature of exchange-based trading lends itself to efficient and effective oversight, provided that exchanges are required to take preventive measures and regulators are authorized to protect markets from abuse. The high level of transparency associated with exchange-based trading facilitates regulatory market surveillance as well as price discovery and competitiveness.
On the other hand, exchanges only offer standardized contracts, and have significant collateral requirements, which can make it more difficult for some important market participants, such as utilities, to participate. OTC transactions provide greater flexibility than those on an exchange, as contracts can be customized more precisely to a company’s particular risk management needs, and a wider array of assets can be used as collateral for transactions. This can be particularly helpful both to smaller participants and to utilities, which may look to minimize their carbon risk over a period of decades while maintaining significant cash resources for infrastructure investments. Offset contracts provide another example of the need for customization, as the volume and timing of future credits can be uncertain due to factors such as project approval, verification, and performance. A non-standard OTC contract might be necessary in such cases.
There is no question that a market approach provides the clearest and lowest-cost incentive to reduce GHG emissions and invest in new technologies. In developing the most effective carbon market, lawmakers and regulators have several options for improving oversight of exchange-based and OTC trading. They include the imposition of position limits, clearing and collateral requirements, reporting obligations, and restrictions on participation in certain types of transactions. While OTC markets are more challenging to regulate by virtue of their decentralization and traditional lack of transparency, nothing technically prevents regulators from establishing the types of requirements above for OTC trades as well as those on exchanges.
In the end, both OTC and exchange-based systems can have roles to play in a federal carbon market, and it may be possible to maintain a role for OTC transactions while ensuring an appropriate level of regulatory oversight and efficient market operation. The challenge faced by lawmakers and regulators is to strike the right balance between market transparency and oversight, and the ability of market participants to structure contracts that best fit their specific circumstances.
An expanded discussion of this topic can be found in the new Pew Center brief, “Carbon Market Design and Oversight: A Brief Overview.”
Janet Peace is Vice President for Markets and Business Strategy at the Pew Center on Global Climate Change.
Timothy Juliani is the Pew Center's Director of Corporate Engagement.
February 17, 2010
Contact: Tom Steinfeldt, (703) 516-4146
MARKET-BASED SOLUTIONS CAN GROW U.S. CLEAN ENERGY ECONOMY
Pew Center Briefs Point to Clean Energy Jobs, Detail Carbon Market Oversight
WASHINGTON, D.C. – The Pew Center on Global Climate Change has released two timely publications that make the case for market-based clean energy and climate solutions.
Clean Energy Markets: Jobs and Opportunities, a new brief, explains how investment in clean energy technologies will generate economic growth and create new jobs in the United States and around the world. Comprehensive, market-based national policy that attracts investment in clean energy markets can help create these economic benefits.
A second brief, Carbon Market Design & Oversight, assesses the opportunity now before Congress to create the optimal design and oversight mechanisms to ensure a viable, transparent, and robust carbon market.
“It’s in our economic self-interest to ramp up development and deployment of U.S. clean energy technologies so that we can compete in the rapidly growing global clean energy markets,” said Eileen Claussen, President of the Pew Center on Global Climate Change. “It’s not too late for the U.S. to position itself as a global clean energy leader, but we must act now. Passing comprehensive climate and energy legislation that prices carbon will give businesses the certainty needed to unleash millions of dollars in clean energy investments that will create U.S. jobs and expand economic opportunities.”
Worldwide, clean energy markets are already substantial in scope and growing fast, explains the Clean Energy Markets brief. Historically, regions where an industry gains an initial foothold are more likely to become a major center of growth for the industry. In the United States, comprehensive climate and energy policy can give nascent clean energy industries this initial start by attracting investment in clean energy markets and helping to create homegrown jobs.
In crafting sensible, market-based climate and energy policy, lawmakers should build on best practices and lessons from a number of existing markets to create the optimal carbon market design and oversight mechanisms. The Carbon Market brief provides policymakers a thorough yet concise assessment of the key considerations involved in establishing a sound, transparent U.S. carbon market. These include:
- Roles and rationales of exchange-based and over-the-counter markets;
- Options for improving oversight of these markets;
- Assessments of potential regulatory agencies for a U.S. carbon market; and
- Comparisons of carbon market oversight provisions in legislative proposals.
“Effective carbon market oversight will be critical, but it is fundamental and achievable,” said Claussen.
For more information about global climate change and the activities of the Pew Center, visit www.c2es.org.
The Pew Center was established in May 1998 as a non-profit, non-partisan, and independent organization dedicated to providing credible information, straight answers, and innovative solutions in the effort to address global climate change. The Pew Center is led by Eileen Claussen, the former U.S. Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs.
February 17, 2010
Download the full brief (pdf)
At the heart of any successful cap-and-trade program is a well-functioning market for the trading of
emissions allowances. The sulfur dioxide allowance market created under 1990 Clean Air Act
Amendments to control acid rain is an example of such a success. At the same time, several recent highprofile
market crises, such as the 2008 petroleum price spike, the crash of subprime mortgage and credit
default swap (CDS) markets, the Lehman bankruptcy, and the Madoff Ponzi scheme have led many to
question market mechanisms.
Yet, these events should not be viewed as indictments of markets in general, as our entire economy is in
fact a market-based system. Rather, they serve to highlight the critical need for appropriate market
design, transparency and oversight. Luckily, Congress has the opportunity to design the carbon trading
market oversight framework at a point in time before long-standing carbon trading practices and
systems have been fully established. This presents the opportunity to get the system right from the
Oversight is critical because a carbon market will be intimately connected to other energy markets,
including natural gas, coal, petroleum, and electricity. Because of these links, the potential exists for
manipulation of one or more of these markets to result in pricing issues in the others. Furthermore,
while a carbon market has many characteristics of a traditional commodity market, it also differs in two
- First, the carbon market exists specifically to address an environmental goal—to reduce greenhouse gas (GHG) emissions—and regulated entities will have no choice but to participate.
- Second, there is a limited supply of emissions allowances, determined by the government, which
will decrease over time.
So in essence, both demand and supply are created by the government. To address these realities,
lawmakers should build upon best practices and lessons from a number of existing markets to create the
optimal design and oversight mechanisms to ensure a viable, transparent, and robust carbon market.
Click here for a related article that appeared in Point Carbon News.
Click here for the press release.
In Brief: Economic Insights from Modeling Analyses of H.R. 2454 — the American Clean Energy and Security Act (Waxman-Markey)
Economic models are an important tool for evaluating the potential impact of proposed legislation on our economy. This brief compares modeling analyses of the House-passed clean energy and climate bill (H.R. 2454) conducted by seven different groups including government agencies, non-governmental organizations, and an academic institution. It identifies key similarities and differences among these analyses and draws the following conclusions:
- GDP will continue to grow robustly with the passage of the House bill.
- Household income grows robustly across all models with many models finding relatively modest impacts.
- The availability of low-carbon technologies to generate electricity is crucial to minimizing the costs of achieving the greenhouse gas (GHG) reduction targets in the House bill.
- The more offsets included in the program, the lower the costs.
- The degree to which the modeling analyses accurately reflect key provisions in the House bill will impact their estimates of costs.
Download full brief (PDF)
Domestically and internationally, climate action in 2009 laid critical groundwork for potential breakthroughs in Congress and global negotiations in 2010. Yet with an issue as complex and political as climate change, turning groundwork into policy is a challenge. 2010 will undoubtedly be a pivotal year for climate change – but first it is instructive to take a look back at what happened in 2009 and how that shaped where we are today.
We captured these highlights in our annual Year-in-Review Newsletter – a useful compilation of 2009’s big climate change stories and related insights. The year’s major domestic action included passage of the landmark House climate and clean energy bill along with numerous Obama administration efforts to improve our climate and economy. These accomplishments included the stimulus bill’s $80 billion in clean energy-related funding and EPA actions, including the endangerment finding, the greenhouse gas reporting rule, and stricter auto-efficiency standards.
Copenhagen consumed international climate attention in 2009, culminating in the pre-dawn hours of December 19 when final touches were put on an accord directly brokered by President Obama and a handful of key developing country leaders. While many questions remain after Copenhagen, our summary of the conference provides a sound starting point for grasping what transpired at the year’s largest climate event.
The lead-up to 2009’s main events required a great deal of work, and some of the year’s highlights include the detailed Blueprint for Climate Action released one year ago this month by the influential business-NGO coalition U.S. Climate Action Partnership (USCAP). More industry leaders also showed support for mandatory climate action by joining our Business Environmental Leadership Council (BELC). And efforts to reach business communities, employees, and families expanded through the Make An Impact program. In partnerships with aluminum manufacturer Alcoa and utility Entergy, we continue to provide individuals with strategies to save energy and money while protecting the environment.
We continued to educate policy makers and opinion leaders, producing reports, analyses, and fact sheets on topics ranging from clean-energy technologies, climate science, competitiveness, and adaptation. Featuring expert insights and thoughtful opinions, we informed broad audiences about the immediate need for climate action. And our timely, relevant work moves forward in 2010 as we seek progress in addressing the most important global issue of our time.
Tom Steinfeldt is Communications Manager
Calculating the Benefits of Climate Policy: Examining the Assumptions of Integrated Assessment Models
Prepared for the Pew Center on Global Climate Change
by Michael D. Mastrandrea
Woods Institute for the Environment, Stanford University
Download full paper (pdf)
Policy-relevant results of Integrated Assessment Models (IAMs) are sensitive to a number of uncertain assumptions that govern model simulation of the climate, society, and the policy response to climate change. Uncertainties remain in understanding of the rate and magnitude of climate change, the nature and severity of climate impacts, and the ability to cope with those impacts. Methods for quantifying and comparing climate damages across different regions and different time periods are fiercely debated. This paper examines assumptions that are central to model estimates of the benefits of climate policy in three well-known IAMs, and discusses their consistency with current natural and social scientific research. Different IAMs take different approaches to dealing with these uncertainties, and understanding their assumptions is critical to interpreting their results, since those results can change dramatically when assumptions are varied.
Download the Paper (pdf)
The Offset Quality Initiative (OQI) responds to the intensifying debate over international offsets by releasing a policy paper assessing offset quality in the Clean Development Mechanism (CDM). In the paper, titled “Assessing Offset Quality in the Clean Development Mechanism,” OQI gives the international offset program a passing grade, but named specific reforms that are necessary to ensure and improve quality moving forward.
The CDM, created as a greenhouse gas (GHG) reduction “offset” program under the Kyoto Protocol,
provides developed countries an opportunity to achieve their emission reduction targets cost-effectively by investing in GHG reduction projects (“offset projects”) in developing countries. Over the past several years the CDM has been subject to a number of critiques, many of which question the program’s ability to generate high quality offsets.
“As the first large-scale offset program in the world, the CDM had to develop standards, procedures, and other infrastructure necessary to ensure offset quality. While there have been concerns about the quality of offsets, especially regarding additionality and third party verification, OQI’s analysis shows that the CDM is making improvements to address the concerns of its critics,” said Michael Gillenwater of the Greenhouse Gas Management Institute, one of six OQI member organizations. “As OQI’s recommendations are adopted, particularly those regarding additionality and third-party
validation/verification, the CDM could provide quality international offset credits for use in a future U.S. cap-and-trade program.”
OQI is a coalition of six leading nonprofit organizations—The Climate Trust, Pew Center on Global Climate Change, Climate Action Reserve, Environmental Resources Trust/Winrock International, Greenhouse Gas Management Institute, and The Climate Group—that provides leadership on GHG offset policy and best practices. The group neither endorses nor opposes the CDM, but rather seeks to provide an impartial assessment through the lens of the eight offset quality criteria outlined in OQI’s 2008 white paper, “Ensuring Offset Quality: Integrating High Quality Greenhouse Gas Offsets Into North American Cap-and-Trade Policy.”
OQI writes that “CDM’s processes perform sufficiently against most of our core offset quality criteria.” The group notes that the CDM has made progress in some areas of concern, citing recent actions such as the Executive Board’s suspension of two third-party auditors for rules violations. There is still room for improvement, however, and recommendations include streamlining and standardizing additionality tools and restructuring the third-party verification system.
“High-quality international offsets have a critical, cost-saving role to play under a federal climate policy,” said Janet Peace of the Pew Center on Global Climate Change. “Policymakers, however, must be confident that offsets will yield real, lasting carbon reductions. This paper serves as a resource to help build this confidence, and we look forward to working with policymakers on effective ways to integrate offsets into reasonable climate policy.”
The Offset Quality Initiative (OQI) was founded in November 2007 to provide leadership on greenhouse gas offset policy and best practices. OQI is a collaborative, consensus-based effort that brings together the collective expertise of its six nonprofit member organizations: The Climate Trust, Pew Center on Global Climate Change, Climate Action Reserve (formerly The California Climate Action Registry), Environmental Resources Trust/Winrock International, Greenhouse Gas Management Institute, and The Climate Group.
The four primary objectives of the Offset Quality Initiative are:
- To provide leadership, education, and expert analysis on the issues and challenges related to the design and use of offsets in climate change policy.
- To identify, articulate, and promote key principles that ensure the quality of greenhouse gas emission offsets.
- To advance the integration of those principles in emerging climate change policies at the state, regional, and federal levels.
- To serve as a source of credible information on greenhouse gas offsets, leveraging the diverse collective knowledge and experience of OQI members.
The Offset Quality Initiative achieves its objectives through the development of white papers and
regulatory comments, through presentations and workshops, and through meetings with key
policymakers, media, and other stakeholders. For more information, please visit the OQI website.
No, Chairman Bingaman isn’t lurking around the Capitol avoiding calls from his landlord. We’re talking about economic rent.
This week, the Senate Energy and Natural Resources Committee continued its excellent series of hearings on climate change policy options. At issue this time was a hearing “on the costs and benefits for energy consumers and energy prices associated with the allocation of greenhouse gas emission allowances.” Whether or not cap-and-trade programs were more or less transparent and costly than carbon taxes and fees was a topic debate during the hearing, as it has been throughout the series.
Dr. Denny Ellerman, recently retired senior lecturer at the Sloan School of Management at MIT, kicked off the hearing with some powerful testimony, including thoughts on how different carbon control programs create economic rent. He offered:
Welcome to our new blog. This blog presents ideas and insights from the Center and its experts on topics critical to the climate conversation. These topics include domestic and international policy, climate science, low-carbon technology, economics, corporate strategies to address climate change, and communicating these issues to policymakers and the public. Our bloggers include policy analysts, scientists, economists, and communication specialists – all of whom are working to advance solutions to our climate and energy challenge.
Thank you for visiting our blog, and check back often for more timely posts.
Tom Steinfeldt is Communications Manager
Featured in MetalMag's June edition. See page 66.
New Administration Puts Carbon Reduction on the Agenda
By Andre de Fontaine
During the past decade, climate change steadily has moved up the political agenda. Now, with a new administration in Washington, D.C., that has demonstrated a clear commitment to action, comprehensive climate-change legislation appears ripe for passage within the next couple years. As a result, many industries are appropriately wondering what the new regulatory environment will mean for their businesses.
First, it is important to note that reducing greenhouse-gas (GHG) emissions will impose a cost to society, though that cost is likely to be small and manageable within the context of the overall economy. These costs must also be balanced against the costs of unabated climate change, which are projected to be much greater than taking action now. Still, there likely will be distributional impacts as the U.S. transitions to a low-carbon economy, with certain industries being able to handle the transition with greater ease than others.
The green-building industry widely is expected to be a major beneficiary of public policies to reduce greenhouse-gas emissions because policymakers recognize two related facts. First, the country’s existing buildings are major contributors to climate change, accounting for about 43 percent of U.S. GHG emissions; and second, a number of low-cost mitigation options available involve improving the efficiency of new and existing buildings. Additionally, as the nation is mired in a serious economic downturn, efforts to stimulate the economy are increasingly focused on green buildings as a major source of new jobs in the coming years. For example, the recently enacted American Recovery and Reinvestment Plan of 2009 contained billions for weatherization assistance for low-income households, grants for states to improve the efficiency of residential, commercial and government buildings, and tax credits for energy efficiency improvements to existing homes.
While these stimulus provisions will benefit the green building sector in the near term, longer-term policy, in the form a cap and trade system for GHGs is also on the horizon. How does a cap-and-trade program work? The government sets an annual cap on allowable emissions, which declines over time. It then distributes allowances to entities– free of charge, through an auction, or a combination of the two – to entities included in the program. These typically are major emitters, like power plants and large manufacturing facilities. The total number of allowances distributed must match the total emissions allowed under the cap.
Regulated firms must hold and submit to the government one allowance for each ton of GHGs they emit. This creates a market for allowances—a carbon market—and an economic incentive for firms to reduce emissions. Those that easily can cut emissions can position themselves to purchase fewer allowances and/or sell excess allowances to firms that face higher reduction costs.
Buildings would not be directly regulated under the cap, but they could be impacted by increases in electricity and fuel costs attributable to the price of carbon. These higher energy prices will, over time, make investments in efficiency more attractive in the buildings sector.
This year the prospects for aggressive government action appear better than ever. President Obama has made clear his commitment to cap-and-trade legislation and related clean-energy policies, and key members of the U.S. Congress have pledged fast action in moving climate change legislation forward. Adding to the momentum for action is a strong push from the business community. This especially is noticeable in the advocacy efforts of the U.S. Climate Action Partnership, a unique coalition of 25 businesses and five nongovernmental organizations that is calling on Congress to pass comprehensive climate legislation this year.
Even as the country faces a significant economic challenge, business and political leaders increasingly are vocal about their commitment to addressing climate change--not at a later date, but right now. The green-building industry uniquely is positioned to ride this wave and make a major contribution in the country’s transition to a low-carbon future.
Andre de Fontaine is a Markets and Business Strategy Fellow at the Pew Center on Global Climate Change. He works with the Center's Business Environmental Leadership Council (BELC), a group of 43 largely Fortune 500 corporations that have partnered with the Pew Center to address issues related to climate change. He also engages in Pew Center analytic work on climate-related markets and investment issues.