Putting a Cost on Carbon

California, USA - The Regional Greenhouse Gas Initiative (RGGI) begins auctioning off permits today for the carbon dioxide that can be produced by more than 200 electricity generators in 10 Northeastern and Mid-Atlantic states.

The event comes on the heels of a key development of another cap-and-trade plan being pushed by seven states and four Canadian provinces. The Western Climate Initiative (WCI) unveiled recommendations Tuesday for its own trading regime scheduled for kick off in 2012.

Taken together, RGGI and WCI will serve as models for an impending federal cap-and-trade framework favored by both presidential candidates. Both trading programs will allow the market to put a price on carbon, which advocates say is needed to incentivize the shift to a low carbon economy.

"This is like Spring Training in baseball before the real games begin," said Terry Tamminen, an operating advisor of Pegasus Capital and energy advisor to California Gov. Arnold Schwarzenegger.

Five years in the making, RGGI, with today’s auction and the compliance period beginning in 2009, is North America’s cap-and-trade system closest to fruition. "It’s a historic achievement for the states," said Jonathan Schrag, executive director of RGGI Inc., the nonprofit coordinating the program.

The 12.6 million allowances to be auctioned beginning today are being offered by only six of the 10 RGGI states due to regulatory delays in New Hampshire, New York, New Jersey and Delaware. That means there could be some price volatility because electricity generators, investors and other buyers can only access 45 percent of what would be the normal supply of allowances.

But other factors could push the price per ton of carbon downward: RGGI’s first compliance period between 2009 to 2011 is aimed at stabilizing emissions, not reducing them, so generators will have three years to get a sense of how the market works without rushing in during this first quarterly auction. Also, many feel the cap is set too high, meaning there may be more allowances than are needed.

RGGI aims to keep carbon emissions at 188 million tons annually from 2009 and 2014. The cap would drop 2.5 percent every year between 2015 and 2018 for a total reduction of 10 percent. A report from nonprofit Environment Northeast (ENE), however, estimated that 2007 emissions from electricity generators rang in at about 172.4 million tons, or 8 percent below the initial cap due to warm weather and high electricity prices.

Tweaking the size of the cap, Schrag said, is up to the states. "They would have to make that kind of change … I believe the states are committed to reviewing the program at the end of the first compliance period," he said.

Still, price unpredictability can plague any new market. Peter Shattuck, an ENE research analyst, warned against losing sight of the larger picture: The importance of the RGGI auction is the auction itself.

"Regardless of the the relationship of the cap to emissions, the fact that the cap is there means that a carbon constraint will, in a significant way, enter the planning process," Shattuck said.

As such, many companies are re-thinking their game. Coal generators – owing to the high carbon-intensity of coal-fired generation – must incorporate the cost of carbon into prices and reconsider the viability of carbon-intensive generation in the absence of capture and sequestration technologies. The floor for the allowances is set at $1.86 per ton but many expect the price to settle at about $5 per ton, according to ENE.

The mere process of setting up and implementing RGGI also is important: It’s a test run to help regulators at the federal and regional levels figure out what works and what doesn’t.

"This is the practice round," Tamminen said. "It gets companies used to paying for something they previously weren’t. Ramping up slowly avoids an economic shock. It also avoids conflict so businesses aren’t rushing to the courthouse."

Take a Cue From RGGI

RGGI offers a glimpse of future regulations: "Business should see the writing on the wall that global warming pollution will be regulated," said Erin Rogers, a spokeswoman for the Union of Concerned Scientists. "They should start taking action now to reduce emissions and shift investment into cleaner technology to stay on the cutting business edge."

Learn best practices from companies now operating under the cap: "This is the framework we’ll be building off of and learning from moving forward," said Rebecca Lutzy, a senior analyst with consultancy Green Order Inc. Participating businesses will gain experience navigating the permit and auction systems, tracking and managing data, and learning the financial instruments developing around RGGI, such as trading tools and indexes.

Don’t miss out on the potential business opportunities: "There will be a huge service industry developed over lower carbon fuels, retrofits … all of which are great for the American economy because they can’t be exported out of the country," said Terry Tamminen, operating advisor of Pegasus Capital. Services springing up to support carbon trading also include banking, legal and consulting to help companies understand and enter the market. Lutzy suggests renewable energy providers could also benefit because a portion of the RGGI auction proceeds will be invested in low carbon technologies.

Position yourself for early action rewards Though RGGI doesn’t include provisions for early action, the WCI does. Companies that proactively reduce emissions ahead of the trading program stand to gain early reduction allowances and a possible seat at the bargaining table. "If a company has taken steps before, it’s not fair to make them reduce as much as a company that hasn’t done anything or may have even gotten dirtier," Tamminen said.

It’s also a test run of an auction-based system, unlike the European Union Emissions Trading Scheme (EU ETS) where carbon allowances were given away. That led to a lot of criticism surrounding steep carbon price declines and windfall profits for participating industries.

Auctioning the credits "splits responsibility," Shattuck said, forcing generators to add the expense to their books and share costs with consumers. The proceeds will open a significant revenue stream to invest in low carbon technologies and energy efficiency programs to reduce demand and ratepayer bills.

Meanwhile, the Western Climate Initiative aims to cut emissions 15 percent below 2005 levels by 2020. More aggressive than RGGI, the WCI will hit companies in carbon-intensive industries that emit more than 25,000 tons of carbon dioxide annually, such as refiners, cement companies and utilities.

The plan calls for at least 10 percent of allowances to sell at auctions, while allowing individual states to decide the amount each will give away. By 2020, at least a quarter of allowances would get auctioned off.

Environmental groups are angling for auctioned allowances, not give-aways. Erin Rogers, Union of Concerned Scientists spokeswoman, pointed out that RGGI also gave states the option of giving away allowances.

"The states realized (auctioning allowances) was the fairest, simplest and most effective way to go so we hope the same thing will occur with WCI," she said.

Still, the WCI poses other concerns, such as allowing companies to use offsets for up to 49 percent of needed reductions. "Unless the program is designed to auction the allowances and close offset loopholes, we don’t think it will be as effective as it could be," Rogers said.

Although the federal government is criticized over a perceived lack of leadership on climate change, it stands to gain a great deal from the trials and tribulations of RGGI, WCI and EU ETS when designing a national program. The Midwest Greenhouse Gas Reduction Accord also plans to establish a cap-and-trade.

"These states and regional partners," Rogers said, "are learning laboratories for the federal government."

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