Is Cap-and-Trade Kaput?

What’s in a name? Everything when it comes to a carbon dioxide cap-and-trade programme in the US. Energy industry prognosticators saw US adoption as almost inevitable just two years ago following the election of President Obama. Then opponents dubbed the initiative ‘cap-and-tax’, a moniker that became a death knell in a political climate wary of raising taxes. Cap-and-trade legislation died with neither a bang nor a whimper; but with a slammed door. Meaningful political debate stopped on the federal level, and the words ‘greenhouse gases’ apparently ceased to be used in Washington, DC.

‘Cap-and-trade has become a political anathema,’ says Jennifer Smokelin, a US environmental attorney with Reed Smith who specialises in climate issues. ‘I think it is safe to say anything called cap-and-trade, and anything that functions substantially like cap-and-trade, will not be passed as a legislative act in this Congress,’ says Smokelin.

What does US abandonment of cap-and-trade mean to the world, specifically Europe, which has the only major functioning carbon market? And will the renewable energy industry still thrive, without a US carbon trading programme?

Obama has failed to push through controversial carbon legislation (Source: White House)

The U.S. is crucial in any worldwide attempt to reduce greenhouse gases because it is such a high emitter. Even with the rapid advancements in China’s economy, the U.S. is expected to remain the largest source of petroleum-related carbon dioxide emissions for many years, emitting 2.6 billion tonnes to China’s 2.2 billion in 2035, according to the U.S. Energy Information Administration. Similarly, when it comes to carbon emissions from natural gas, the U.S. bests China by almost three times with 1.3 billion tonnes in the next 25 years. China does outdistance the U.S. for carbon emissions from coal, with forecasts showing it responsible for 10.5 billion tonnes in 2035, 55% of the world’s total. Still, the U.S. contributes a hefty share from coal as well: 2.4 billion tonnes, or 12% of the total in 2035.

From an economic perspective, Europe and the U.S. would have created a sizable trading market, had the U.S. gone forward with cap-and-trade, a programme that caps carbon dioxide emissions at a pre-set level and allows trading of permits for compliance. The European Union is the world’s largest economy and the U.S. the second largest; together they represent US$29.61 trillion in gross domestic product, as measured in purchasing power parity. Paired they comprise about three-fourths of carbon emissions from developed countries and roughly one-third of worldwide emissions.

EU Demoralised?

U.S. abandonment of cap-and-trade leaves Europe, alone, with the world’s only major carbon allowance and offset market. ‘European markets are the only game in town,’ says Lisa Zelljadt, senior analyst at Point Carbon, an Oslo-based marketing and trading analytics company. ‘They were expecting that there might be other large sources of demand around the world and other carbon markets they could link to, creating a global market which is more liquid. That’s not going to happen. So the European Union Emissions Trading System, this $2 billion programme, is going to go forward, and it is the only programme of that size.’

Smokelin says that for the EU this is demoralising: ‘When you move onto a course from a national standpoint, you want to see your like-minded countries move that way too’. Equally important, any part of the world going it alone faces singular economic pressure by putting a price on carbon at a time when fossil fuel use remains high. ‘Every widget made in Europe becomes more expensive than a widget made in a country without a cap-and-trade plan. That would then in turn build political pressure in the EU to take a look at whether a cap-and-trade system is the way to be going,’ Smokelin says.

The U.S. failure to pursue a carbon emissions trading market also gives good excuse for wavering nations to pause. For example, Canada is unlikely to move forward without its closest trading partner, the U.S., Smokelin says. And while Australia signed the Kyoto Protocol, it does not appear to be moving quickly toward cap-and-trade either.

That’s not to say no one will join Europe. Indeed, smaller regional efforts are underway in provinces in China, certain U.S. states and other parts of the world. ‘There will continue to be carbon markets but they will be more fragmented. It will be more regional programs at various levels,’ says Point Carbon’s Zelljadt.

Renewables Go Their Own Way

But while enthusiasm may be tenuous for carbon emissions trading markets, support for renewable energy remains strong. The industry framed itself as not only a solution to climate change, but also as an economic and job building resource. The message has stuck. The U.S. resisted cap-and-trade, but it added 16 GW of new electric generating capacity from wind, solar, and geothermal energy over the last two years, an increase of nearly 60%.

Even political foes of cap-and-trade seem to support renewable energy. With or without cap-and-trade, renewable energy is expected to continue its US expansion. Renewable energy will account for 45% of the growth in electric generation by 2035. If the federal production tax credit is extended for 25 years, renewable energy will expand even faster, with growth between 61% and 65%, according to EIA’s Annual Energy Outlook 2010. Worldwide, renewable energy use is expected to triple between 2008 and 2035, driven by the power sector where green energy’s share in electricity supply could rise from 19% in 2008 to 32% in 2035, according to the International Energy Agency’s World Energy Outlook 2010. IEA based its forecast on a ‘new policies scenario’ where governments live up to commitments they have made.

Annual global support for renewables in the New Policies Scenario (Source: IEA, World Energy Outlook 2011)

‘A lot of it has to do with the economy. When you are going through bankruptcy, you are really not interested in carbon credits,’ says Mark Thimke, a partner with Foley & Lardner and member of the environmental and energy team. ‘But renewable energy seems to have traction in Congress. It seems to be divorced from climate change and able to go forward in the political world,’ he adds.

President Obama appeared to be very aware of the shift in political winds during his state of the union address on 25 January. He never mentioned climate change. This contrasts with last year’s address, where ‘climate’ came up at least three times, including his proclamation that the US has ‘gone from a bystander to a leader in the fight against climate change’.

Nonetheless, in this year’s speech, innovation was a central theme, not environmentalism. Obama strongly reiterated his clean energy goals, devoting several minutes to the importance of green energy technologies. He called for increasing the nation’s research and development investments as a share of gross national product to its highest level in nearly 50 years. The US President also announced an aim to make clean energy, including wind, solar, nuclear, clean coal and natural gas, 80% of America’s electricity by 2035. In all, he said he wants to see an 85% increase in renewable energy with an eye toward making solar $1 a watt.

And while Obama may not be going after carbon dioxide emissions through cap-and-trade, he has made clear he is pursuing other methods. For one, he said he wants to end the $4 billion per year in tax subsidies to oil, gas and other fossil fuel producers. ‘I don’t know if you’ve noticed, but they’re doing just fine on their own’, he said, prompting laughter from Congress during the speech. The commitment is part of a G-20 pledge made in Pittsburgh in 2009 to phase out ‘inefficient’ fossil fuel subsides.

Further, Obama continues to pursue greenhouse gas restrictions through the Environmental Protection Agency, which has begun rolling out a series of rules under the federal Clean Air Act that require emitters to install best available control technology for greenhouse gas reduction. The authority of the EPA to impose such rules does face legal and Congressional challenges, however.

Should these initiatives continue — the removal of fossil fuel tax subsidies and EPA regulation of carbon dioxide — they still may not be enough, say some industry obeservers. Without a price on carbon, the playing field will continue to be unfair for renewable energy, they argue. Even if Congress passes a proposed national renewable energy standard (RES) — a requirement that a percentage of power come from renewable sorces — renewable energy may not ovecome the price inequity it faces. This inequity stems from externalities, like health care costs from polluted air, that fail to get factored into fossil fuel prices. In fact, a RES may heighten the problem, Smokelin says. ‘Without having a price on carbon, a RES is doomed to failure because renewables become just too expensive’.

California: A Game Changer

But is the U.S. really out of the game when it comes to carbon trading markets? Will individual states come to the rescue as they often do on green energy policy?

Already, 10 U.S. Northeastern states have a mandatory carbon cap-and-trade programme, known as the Regional Greenhouse Gas Initiative or RGGI. The initiative is too small, however, to have any significant impact on world carbon trading markets, in part, because it is confined to the power sector, capping its emissions at 10% by 2018.

But RGGI could be used as a prototype to exhibit the benefits offered through a market of its type, according to Stephen Cowell, chairman and CEO of Massachusetts-based Conservation Services Group. Under the RGGI model, about 80% of sales from allowance auctions go back to states for energy efficiency, renewable energy and other consumer benefits. The idea is to use allowance money to invest in technology that will reduce consumer energy costs. As of early 2011, the auctions had raised $775 million. While RGGI has not been without problems — some state governments diverted funds from clean energy to pay down their debt — it is largely seen as a cap-and-trade success story.

The message might spread if RGGI is described as cap-and-invest. ‘We undersold the benefits. We don’t articulate the true merits when we say “put a price on carbon” or just “cap it.” RGGI is the classic cap-and-invest strategy and the result is that total energy costs with RGGI are lower than without RGGI’.

RGGI may be too small to contribute significantly to a worldwide trading market; but California’s upcoming cap-and-trade market is not. The state’s voters expressed their continued support for the programme in the November 2010 elections by rejecting an attempt to delay it. About 60% of those voting turned down a measure that would have postponed cap-and-trade until state unemployment had dropped to 5.5% for four consecutive quarters.

The development of California’s carbon cap-and-trade scheme (Source: Point Carbon)

Now the state is clear to begin carbon trading effort in 2012. The programme is modeled after the European Union Emissions Trading System, and is expected to have a significant impact on world markets because of California’s size. California intends to reduce greenhouse gas emissions to 1990 levels by 2020 and secure 33% of its power from renewable sources by 2020. Different from RGGI, California’s cap is economy wide, meaning the cap applies to a host of emission sources, such as industrial processes, not just power.

California’s programme starts small, initially only encompassing power plants, and then gradually adding the other resources, until the emissions caps cover 85% of its economy. The Point Carbon chart (see below) shows how California’s cap expands over the years. It reveals that once emissions from transport fuels are included in 2015, the scope of the programme (and thus size of the carbon cap) nearly doubles.

After Europe, California will be the second largest carbon market in the world. Point Carbon expects it to be worth $1.7 billion dollars in 2012, the first year of compliance, grow to close to $10 billion by 2016, and possibly as high as $50 to $80 billion in 2020.

‘RGGI for all its good intentions is not regarded as something that will have global impact in terms of driving a carbon market. The California cap-and-trade programme, coming down the track like a freight train, I think is going to be very different,’ says Larry Goldenhersh, founder of Enviance, a company that offers information technology to companies worldwide to track and manage environmental assets, including carbon dioxide allowances.

Goldenhersh points out that with a population of about 37 million, California is home to one in nine Americans and is the world’s eighth largest economy. What’s impressive, he says, is that California’s voters decided to move forward with cap-and-trade during one of the nation’s worst economic downturns: ‘It is a very important example of a clear judgment of a large body of people in America who said that they will vote for the environment. That is real political will.’

The sheer scale of California’s carbon cap-and-trade will exert global influence (Source: E.ON)

Given California’s size and worldwide economic clout, it will force the US federal government to rethink its stand on a national programme, he adds, saying: ‘The eighth largest economy is going to tell the world what it thinks the price of carbon is. You can’t just ignore the eighth largest economy in the world. From a regulatory perspective it is very, very important. I don’t think this is going to be lost on the Congress one bit. I think there is going to be an immense amount of pressure to do something on energy and climate’.

CSG’s Cowell also remains confident that Congress may still act in favour of a carbon cap-and-trade initiative. ‘I’ve been at this for 30 years; it’s never too late. I’m not ready to throw in the towel. And as the President said, we have to invest the clean technology of the future. Or we will even more quickly fall behind countries that are seeing the future.’

So Is Cap-and-Trade Really Dead in the U.S.?

Two years ago it seemed likely the U.S. would join the EU and institute cap-and-trade. But political sentiment shifted radically. Two years from now the same could happen again with a turn back toward a market-based greenhouse gas reduction programme. For now, however, world excitement has ebbed about cap-and-trade, but not renewable energy, a resource that has successfully positioned itself as the solution, whether the problem is environmental or economic.

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