Cap and trade round-up: Show me the money?

While a federal carbon pricing scheme has long been declared dead in the U.S., late August saw a flurry of carbon policy activity in other markets, including Australia, European Union (E.U.), and California. Australia’s cap and trade scheme took an unexpected turn when Australia and the E.U. jointly announced on August 28 that their two emissions trading schemes would officially link up starting in 2015 and operate jointly by 2018. Meanwhile, in California, 150 major emitters participated in a practice allowance auction, mimicking the activity that will regularly occur in the cap and trade scheme that is scheduled to start in January 2013. The Australia-EU linkup and California’s upcoming launch represent two very different visions of cap and trade schemes.

In theory, cap and trade schemes exist for two functions: 1) to set a cap on emissions and decline that cap over time such as to reduce emissions of harmful greenhouse gases; 2) to introduce a price for carbon that signals to various sectors of the economy to innovate better and cheaper low-carbon technologies. It looks as if California’s emissions trading system (ETS) will successfully serve both of these functions. However, the E.U. and Australia ETS’s may fail to spur innovation, as oversupply of low-priced credits will continue to flood their markets for a while.

The E.U. ETS has seen incredibly low prices this year for both allowances and U.N. offset credits, dwindling to the range of €8 and €2 per ton of carbon dioxide respectively. These prices are comparable to the U.S. Regional Greenhouse Gas Initiative (RGGI), which covers northeastern U.S. power stations and has rarely seen prices above $5 per ton of carbon dioxide. The main reason is that baselines were set before the unforeseen circumstances of an economic crisis and low-priced natural gas came into play. In the E.U., similar factors are at play, with the added oversupply of UN offset credits applying further downward pressure. Australia has done away with its carbon price floor as it plans to join up with the E.U. ETS.

What are we to make of all these low prices? Are carbon markets actually working? Will they actually spur innovation needed for long-term deep cuts in carbon emissions? Harvard economist Robert Stavins pleads that we not fret at this point. He argues that the systems are indeed playing the cap function, while low prices are really due to exogenous factors rather than poor design. Other U.S. NGO’s point to the success of RGGI auctions in raising nearly $1 billion, which many states have re-invested into energy efficiency programs.

Meanwhile, California is looking like a golden opportunity. Bloomberg New Energy Finance notes that the value of California allowances for delivery in December 2012 are already closing at $19.50 per ton, about twice the value of E.U. allowances at a €7-8 per ton value. The firm’s forecast for prices in 2020 for both the E.U. and California markets sits at about $55 per ton.

The number of cap and trade schemes and pilots is rising. South Korea’s scheme was approved in May, while China’s seven pilot schemes are set to launch in 2013. As experience accumulates, hopefully design will improve and carbon prices will rise, guiding the world’s economies to a lower carbon future. And of course, there’s always hope for a federal scheme in the U.S. If President Obama gets re-elected and puts some skin into the carbon game, he will indeed prove that “climate change is not a hoax”.