A Sneak Peek At Cap And Trade

There is nothing to hold in your hand in a cap and trade system. The permits to emit gases are not printed on sturdy paper to be framed and displayed. There are no inspectors making surprise visits to check off items on a list the way fire marshals or health department officials do. There are no shouting middlemen dashing back and forth in a big room to swap notes when they find a match between permit sellers and permit buyers.

The system relies on computers. Glowing screens keep track of complicated sets of numbers that represent vast amounts of gases–and money.

A big chunk of the American Clean Energy and Security Act of 2009 (also known as the Waxman-Markey bill for its sponsors in the U.S. House of Representatives) involves setting up a cap and trade system in the United States. That bill passed the House in June and is awaiting action in the Senate.

The idea is to set limits that will eventually lower the amount of greenhouse gases that enter the Earth’s atmosphere.

The European Climate Exchange
A fixed number of permits to emit greenhouse gases are issued to start the system. Each year, businesses receive permits that add up to that total. That’s the cap.

During a year, a business that emits fewer gases than listed on its permit can sell the rights to emit any leftover amounts to any other company so it can continue to emit more gases than its permit allows. That’s the trade part.

The European Union started that kind of system for greenhouse gases on January 1, 2005.

In an office building in London, men and women sitting in front of computer screens in the European Climate Exchange handle buying and selling permits from companies in 27 countries. They’re part of the European Union Greenhouse Gas Emission Trading System.

The European system covers emissions from businesses in five main areas: power and heat generation, oil refineries, metals, pulp and paper, and energy-intensive industries (such as making cement or glass). About 12,000 facilities scattered throughout Europe receive individual permits.

As gases from one place enter the atmosphere they mix, mingle, and move around the globe. Within a cap and trade system, the permits do not move from place to place. Only the names next to the numbers on the computer screens change.

There are no meters with spinning dials measuring the gases as they enter the atmosphere. Instead, scientists and accountants are creating international standards to estimate what amounts of gases form during all kinds of activities. The accuracy of these computer calculations of the emissions forms a key part of cap and trade systems.

The trading part of the European Union’s system is growing quickly. During 2008, energy traders in London handled computer transactions covering 618 million metric tons of carbon dioxide. By the end of May this year, trading in greenhouse gas emissions in Europe had already risen by more than 80 percent, to 1.13 billion metric tons.

Wall Street-style emissions trading
In an ongoing cap and trade system the cap gets tighter each year. The numbers on the permits get smaller, and overall the amount of greenhouse gases emitted is supposed to decrease as the trading system continues to operate.

But one thing increases–the prices businesses are willing to pay for the shrinking numbers on the permits.

In a typical market for commodities, such as bushels of corn or wheat, traders make contracts to buy or sell the grain. In the trading part of a greenhouse gas cap and trade system, buyers and sellers are not spending their money on greenhouse gases–they’re spending their money on permits that allow them to emit gases as part of their operations. The permits are the commodity.

The market for these permits is not limited to one year. Clever traders can speculate on what the market price of permits will be next year, or the year after, using Wall Street-style financial techniques to promise to buy and sell at certain prices in the future. Bankers and other financial advisors are figuring out how to help their industrial clients take advantage of changing prices for permits–and make a profit for themselves while they assist with trades.

Global trades of various kinds in these new emissions markets jumped from $100 million in 2002 to $92 billion by mid-2008. The European Union’s computer systems keep track of just a portion of those dollars. If the United States sets up a cap and trade system, the number of trades will jump even higher.

POLICING CAP AND TRADE’S $2 TRILLION BUSINESS

The result of a cap and trade system would be a huge Wall Street-style commodity market that would need careful regulation to try to prevent errors, or outright criminal misuse.

That’s why America’s Commodities Futures Trading Commission, a regulatory agency, is looking ahead to having more responsibilities.

CFTC Commissioner Bart Chilton says, “The potential size and scope of a structured carbon emissions market in the U.S. is unequivocally vast. It is certainly possible that the emissions markets could overtake all other commodity markets at some point down the road.”

Earlier this year, Chilton indicated the role of policing such a huge new operation could go to CFTC’s Energy and Environmental Markets Advisory Committee.

In April, Chilton said, “The mission, mandate, and membership of the EEMAC is being expanded to ensure that we are ready for what could be a $2 trillion market in the future.”