The carbon market in the United States has developed slowly due to government opposition to regulating greenhouse gas (GHG) emissions and resistance to endorse the Kyoto Protocol. As a result, the US emitted 17 percent more CO2 emissions in 2008 compared to 1990, according to the German Renewable Energy Industry Institute (IWR). In contrast, a carbon market has flourished in Europe leading to Germany reducing its CO2 emissions by 17 percent and the United Kingdom achieving a 6 percent reduction over the same time period. However, the lack of federal regulations for reducing greenhouse gas (GHG) emissions in the US has stimulated the development state-based and regional carbon markets as well as voluntary carbon markets.

Many US states have introduced indirect GHG emissions regulations, including renewable portfolio standards (RPS), financial incentives for the installation of renewable energy, energy efficiency standards, building energy codes, and other government mechanisms to accelerate the development of renewable energy and the reduction of energy consumption. However, only one regional effort has started executing a cap-and-trade program while one state and two other regional initiatives have introduced policies to develop a cap-and-trade program in the future.

California was the first state in the US to introduce direct regulations for GHG emissions reductions. In 2002, the Pavley Bill required the California Air Resource Board (CARB) to limit the amount of GHG, especially CO2, emitted in auto exhaust. While CARB did introduce the regulations called Assembly Bill (AB 1493) in 2004, the opposition by the automotive industry and the US Environmental Protection Agency (EPA) resulted in legal proceedings which prevented the implementation of the California legislation. Florida is the second state that introduced GHG regulations. In June 2008, the state enacted the Florida Climate Protection Act, which authorizes the Department of Environmental Protection to develop an electric-utility cap-and-trade program. Pending legislative approval of the final plan, the cap-and-trade program may begin operation as soon as January 1, 2010. (PEW, July 2009)

The first direct regional mandatory and market-based carbon cap and trade policy in the US, the Regional Greenhouse Gas Initiative (RGGI), was introduced in December 2005 by the governors of seven Northeastern and Mid-Atlantic states: Connecticut, Delaware, Maine, New Hampshire, New Jersey, New York and Vermont. Since then, three other states - Massachusetts, Rhode Island and Maryland - have joined the initiative which mandates capping the regional power sector’s CO2 emissions from 2009 through 2014 at the annual level of 188 million tons of CO2 and reducing it by 2.5% per year (total 10%) during the 2015-2018 period. The RGGI apportions CO2 allowances among signatory states based on historical emissions and allows signatory states to allocate 75% of their allowances as they choose and attribute the rest to consumer benefit programs. The signatory states are not likely to allocate the allowances to electric generators for free, but instead sell them in a regional auction recognizing that generators are likely to pass the cost of allowances onto consumers, whether the allowances are received for free or purchased. The allowance auctions, where electric power generators buy, sell and trade CO2 emissions allowances, are scheduled to take place on a quarterly basis, with the next auction scheduled for September 9, 2009. More than 110 million allowances have been auctioned raising a total of $366.5 million since the first RGGI auction in September of 2008. During the fourth auction in June 2009 the clearing price of CO2 allowances amounted to $3.32 per allowance for the 2009 - 2011 control period and $2.06 per CO2 ton of allowances for the 2012 - 2014 control period. These prices are much lower in comparison to the August 2009 EU Emission allowances spot prices of around EUR 14.4 or US$20.6 per CO2 ton (European Energy Exchange, 2009).

In February 2007, another regional initiative, the Western Climate Initiative (WCI), was introduced to design a market-based approach for reducing GHG emissions involving California, Arizona, New Mexico, Oregon and Washington. Since 2007, Montana and Utah, together with the Canadian provinces of British Columbia, Manitoba, Ontario and Quebec, have joined the initiative. The cornerstone of the WCI strategy is a regional cap-and-trade program to be fully implemented in 2015 covering almost 90 percent of the GHG emissions in WCI states and provinces. WCI partners intend to develop implementation details for the WCI regional cap-and-trade program throughout 2009 and 2010, start reporting greenhouse gas emissions in 2011 for emissions that occur in 2010, and introduce the first phase of the cap-and-trade program on January 1, 2012, with a three-year compliance period. The second phase of the program will begin in 2015, when the program will be expanded to include transportation fuels and residential, commercial and industrial fuels, in addition to electricity fuels covered in the first phase.

On November 15, 2007, Illinois, Iowa, Kansas, Michigan, Minnesota, Wisconsin, and Canadian Province of Manitoba established the Midwestern Regional Greenhouse Gas Reduction Accord, the third regional initiative addressing carbon emissions reductions in the USA and Canada. Under this agreement, they agreed to establish regional GHG reduction targets consistent with the 60 to 80 percent recommended by the Intergovernmental Panel on Climate Change, and develop a multi-sector cap-and-trade system to support meeting the targets. The Governors of Indiana, Ohio, South Dakota and Ontario joined the agreement as observers to participate in the development of the cap and trade system. In June, 2009 the advisory group finalized their recommendations and these are yet to be endorsed by individual state and providential leaders.

Currently the US Senate is reviewing the 2009 American Clean Energy and Security Act (ACES) which was passed by the US House of Representatives on June 26, 2009. If the Senate passes the ACES, also called the Waxman-Markey bill, what would happen to the state- and regional-based incentives?

The ACES proposes a cap and trade system with a ceiling on CO2 emissions at the 2005 level of 7,602 million metric tons, a reduction of 3% by 2012, 20% by 2020; 42% by 2030, and 83% by 2050. The national cap-and-trade system would oversee and regulate carbon allowances and offsets and penalize entities such electric utilities and other energy-heavy industries deriving at least 30 percent of their annual heat input from coal, petroleum coke, or any combination of these fuels (ACES, section 116, page104). The ACES also includes a national combined renewable electricity/energy efficiency standard (RES). Under the RES, large electricity suppliers would be required to invest in renewable energy and energy efficiency submitting federal renewable electricity and electricity savings credits to meet the RES goal for each compliance year (ACES, section 610, page 16).

The ACES takes a significant step forward towards the implementation of a new and stronger system for the development of a low-carbon economy by accelerating the installation of renewable energy, energy efficiency and low carbon technologies. It is likely that the majority of the state and regional carbon market programs will follow the national policies and programs, even though their requirements might be more environmentally rigorous. However, the state and regional programs offer a trial and innovation opportunity for federal policies and programs.

The next blog will discuss how a voluntary carbon market has developed in the US alongside the state and regional carbon markets for the reduction of GHG emissions.

Over the past 10 years, US political leaders have played only a minor role in the global carbon offset market, changing their views about climate change and global warming with each new administration. Once a forerunner of the Climate Change Conference held in Kyoto, Japan in 1997, the United States failed to stay on the track, allowing the European countries to drive the development of a carbon offset market.

In the 1990s, the Clinton administration was involved in the crafting of the Kyoto Protocol, proposing the Joint Implementation Scheme to encourage international partnerships to enable low-cost reduction in greenhouse gas (GHG) emissions. Though the Clinton administration supported the Kyoto Protocol, it was not submitted for ratification after the Republican-led Senate made a statement that it would not ratify any treaty which did not include binding targets for developing nations expecting to be responsible for the majority of emissions in the future.

During the U.S. presidential campaign in 2000, George W. Bush promised to set mandatory targets for the reduction of CO2 emissions but expressed his reservation about participation in the Kyoto Protocol.(Dietrich, 2005) Later as president, he did not introduce domestic CO2 reduction targets. The U.S. also pulled out of the Kyoto Protocol discussions, with the Bush administration stating that the Protocol did not impose compliance on the countries responsible for the majority of CO2 emissions globally, and therefore, participation in such treaty could only cause serious harm to the US economy. The Bush administration also emphasized the importance of further scientific research about global warming, and proposed the use of alternative energy sources and “market-based incentives” such as a voluntary approach and energy-efficiency programs to reduce GHG emissions.(Dietrich, 2005)

The Kyoto Protocol required ratification by 50 nations in order for it to be recognized as a major international agreement according to United Nations. After Russia ratified the agreement in 2004, the Kyoto Protocol entered into force in 2005 without any reliance on US support. The Bush administration stayed isolated from the global debate on climate change throughout its eight-year term, continuing to favor an “aspirational” approach instead of mandatory CO2 caps to combat climate change. (Bohan, 2007).

President Barack Obama has been very outspoken about the importance of US involvement in climate change issues and the development of national regulations to reduce GHG emissions, lower energy consumption and accelerate the adoption of alternative energy technologies. However, Obama was not always supportive of the Kyoto Protocol. In 1998, as an Illinois senator, he voted for the bill condemning the Kyoto treaty and disapproving GHG emissions regulations in the state of Illinois to protect the coal industry, as Dilanian (2008) conveys in his article “Obama shifts stance on environmental issues”. The article states that Obama continued expressing his favoritism towards the coal industry during his election to the U.S. Senate in 2004 proclaiming that “there’s always going to be a role for coal” in Illinois. Dilanian (2008) points out that during Obama’s campaign for president, he addressed his opposition towards the bill by saying that the Kyoto treaty did not have “meaningful and achievable emissions targets,” and that he “did not believe that state agencies in Illinois should unilaterally take steps to implement a global policy on their own …”

However, in the U.S. Senate Barack Obama showed his favor towards environmental friendly policies by opposing then-President Bush’s air-pollution proposal for relaxing federal air pollution control restrictions. Although Obama continued sponsoring bills that provided coal subsidies, he shifted towards broader public interest the closer he moved towards the presidential elections.

In October 2007, Senator Barack Obama presented a plan to decrease the US dependence on foreign oil and fight global warming with a national “cap and trade” system across the economy to reduce greenhouse gas emissions including an auction system requiring power companies and other energy-intensive industries to pay for their pollution. He continued to encourage mandatory policies throughout his presidential campaign.

Thanks to growing global awareness of climate change issues and Obama’s emphasis on low carbon economy, the United States now is actively pursuing implementation of enforced reductions for GHG emissions and stronger energy efficiency legislation. As a result, the U.S. House of Representatives recently passed the Waxman-Markey bill (also known as American Clean Energy and Security Act - ACES) as a first step towards a regulated carbon market. The new legislation proposes national energy efficiency targets for residential and commercial buildings as well as a cap-and-trade mechanism mandating a reduction of 2005 emissions levels by 20% by 2020. The cap-and-trade system is set up to regulate carbon allowances and offsets for electric utilities and other energy-intensive industries. The Obama administration has repeatedly promised to pass federal legislation that would limit CO2 emissions in the United States, and continues to pressure the Senate to follow the House’s lead - emphasizing that the Waxman-Markey bill would create jobs, lower the cost of renewable energy and reduce oil dependency. In his speech at the first meeting of the Strategic Economic Dialogue between the United States and China on July 27, President Obama stressed the importance of the cooperation of world’s two largest emitters of greenhouse gases on climate issues.

The Kyoto Protocol expires in 2012. This December 2009, the UN and international government officials will meet in Copenhagen (UNFCCC COP15) to discuss the final details of a new climate agreement. The Obama administration plans to be actively involved in the negotiations of a new treaty trying to regain leadership in the international climate debate.  It remains to be seen whether Obama will act upon his words to become national and international leader in the fight against climate change.

The past resistance of the US government to establish national carbon reduction targets and to participate in the Kyoto Protocol has significantly slowed down the development of a carbon market in the United States. The next posting will describe how the carbon market has developed in the US in light of the resistance of the US government.

At a recent conference called, “Navigating the American Carbon World Conference and Trade Fair” sponsored by Point Carbon and IETA, PG & E,  April 1-3 2009. San Diego, California, there was a consistent general tone to the presentations on the importance of doing something about Climate Change, how little time we have to do it in and how the global community including the developing world must come together for a Post 2012 Climate Change Agreement in Copenhagen 2009. There was broad consensus from all speakers such as, Janet Pearce, Vice President, Markets and Business Strategy, Pew Center, Carl Pope, Executive Director Sierra Club, Nancy McFadden PG& E,  to firm targets for the next commitment period 2012-2017, followed by a series of rolling interim targets with a firm long term 2050 target for the U.S and the rest of the world.

It is expected that the U.S will join the Annex 1, first world Kyoto countries and take on an absolute Cap of greenhouse gas emission of 60-80% below 1990 levels by 2050. However, U.S presenters are very artful and one notices that U.S speakers never actually state that the U.S will ratify the Post 2012 Climate Change agreement without mentioning in the same breath, the need for a commitment to targets by the developing world.

Nancy Sutley, Whitehouse Council on Environmental Quality, raised the question of engaging with the BRIC (Brazil, Russia, India and China) nations on sector targets for developing countries. IETA (The international Emissions Trading Association) also discussed giving BRIC nations sector caps, in other words targets on specific industry sectors, which would expand over time to include more sectors. An example of a sector cap, which was often cited was the cement sector in China. Sector Caps for developing countries seems to be the compromise solution to allow the U.S. Congress to agree to an international agreement and not to be seen to be letting U.S competitors off the hook. My concern is what happens if the developing world does not agree to any kind of cap on emissions including sector caps, where does that leave the U.S?

Today, The Obama administration is convening a meeting of 17 major nations April 27-28 in Washington to begin talks on international action to address climate change. The talks are a prelude to the December UN meeting in Copenhagen to create a new global treaty on Climate Chane. These talks confirm the U.S position, which is to insist on greenhouse gas caps on developing countries. The meeting underway in Washington includes nations responsible for 75 percent of the world’s carbon emissions and includes Western European countries, Japan, South Korea, Brazil, China, India, Indonesia and Mexico. Michael Froman, Deputy National Security Adviser for International Economic Affairs, told journalists April 24 at the State Department’s Foreign Press Center, “We believe that it is critical that those 17 be able to make progress on the outstanding issues and reach political consensus if there is to be to a deal in Copenhagen”.

The issues under discussion in Washington this week were discussed at an IETA hosted side-event, “Making Markets Work for the Environment” at the Point Carbon Conference in San Diego earlier this month. IETA released a document on “Principles for a Post 2012 International Climate Change Agreement”, which captures the key debating points around the Post 2012 Climate Change Agreement under discussion in Washington.

IETA recommended that the parties agree to:

- Firm targets for the next commitment period 2012-2017 followed by a series of rolling interim targets with a firm long term 2050 target. (They did not specify the actual target).

- Longer commitment periods of 8 years not 5 to provide predicatability and certainty for business decisions.

- Support for differentiated targets for Annex 1 nations and new forms of commitment such as sectoral caps for BRIC nations. IETA stressed that criteria for differentiation needs to be clearly elaborated including ways in which non Annex 1, developing countries such as China and India can move to Annex 1 mid-period - a pathway for all nations to move to the higher standard of commitment.

- Develop long-term standardized global network of Inventories and Monitoring, Reporting and Verification systems (MRV). Indira Balkinson and Barbara TooleO’Neil of DNV raised the necessity for 3rd party independent validation at the Point Carbon conference. It is not practical diplomatically for the U.S EPA to audit overseas credits it is better to be done by independent validators.

IETA countered U.S criticism of Emissions Trading and the flexible mechanisms by stating the need to focus on the provision of a global carbon market that facilitates trading between private entities and Parties as a pillar of the next Climate Change Agreement.

IETA Supported:

- The existing Flexible Mechanisms: Emissions Trading, the Clean Development Mechanism (CDM), and Joint Implementation (JI), which has been the key to jump starting emission reduction activities as well as facilitating the flow of technology. (Currently, CDM allows for credits generated in a developing nation to be sold into a capped nation like the EU as a means to meet it’s cap). IETA supports continued access to CDM for developing countries without a sector cap or  for un-capped sectors, which would cover most developing countries and most sectors. CDM credits, (CERs) serve as a linkage between regional trading systems, a crucial function until a global direct linkage has occured.  Interestingly, Steven Messner of SAIC showed a slide that indicated without domestic or international CDM offsets, the price of carbon would double in the U.S., showing that purchasing CDM credits by the U.S. would reduce the cost of cutting carbon. U,S criticism of CDM is based on the notion that it involves transfer of U.S.D and technologies to developing countries like China, which is why the U.S argues for developing country caps.

- IETA indicated that a JI like mechanism, (trading between two capped nations) would become more important in a post 2012 international Climate Change Agreement as more countries would have caps.

-IETA also indicated that domestic offset projects will become a complement to Cap and Trade regimes, as they promote emission reduction within those Parties economies. There are numerous opportunities to enhance the use of domestic offsets alongside more traditional cap and trade mechanisms, particularly in areas such as forestry, agriculture, land-use change and waste. The discussion indicated that some European countries that did not allow domestic offsets in the 1st commitment period such as France and Germany were interested in domestic offsets to drive private sector activity, jobs and technology uptake.

- IETA supported the transferability of the existing carbon market projects in process through the CDM/JI to domestic offsets as new nations formally adopt emission limitations.

I found myself agreeing with the points made by IETA and suggest further reading of their material. In summary they are arguing for all existing and future market mechanisms, which have the explicit intention of attracting private sector investment to create a secure investment environment with clear rules for participation and crediting and to use the market to create the most effective way for the private sector to participate in the Post 2012 Climate Change Agreement.

Carbonflow CEO, Neal Dikeman developed the Carbon Trading Game, “to teach people how to better understand the nuances of Carbon Trading. The Carbon Trading Game, according to Richard Barber, CTO of Carbonflow is “a really good introduction to Carbon Trading - it is somewhat different to what you think it is going to be like. People run-away from coal-fired power stations very fast”. Mr Dikeman said that, “an interesting finding is that, price volatility by either the emitters or traders does not effect whether the Cap is met. If the Cap is an enforceable cap abatement of carbon dioxide (CO2) tends to happen whether people make profits or the price of carbon is high or not - ERGO the ENVIRONMENT WINS!

The Carbon Trading Game may well be the game that people need to play in order to understand how Carbon Trading actually works. This is particularly so as there is a debate going on in the U.S press about whether the Carbon Trading mechanisms, (New York Times March 1st 2009) should be maintained in the revised Kyoto Protocol to be reviewed in Copenhagen December 2009 by all nations of the world including the United States. The U.S is starting to criticize the market mechanisms, which were included in the original Kyoto Protocol at the behest of Bill Clinton in 1997. These markets mechanisms, which include CDM can be improved with software solutions like Carbonflow particularly suited to resolving issues like additionality and time to market, but not only. It would be unfortunate if the potential of  CDM was canceled out just as it is coming up to speed, simply because of a lack of awareness on the part of key U.S negotiators about solutions. It seems many do not understand how the Carbon Markets work.

Mr Dikeman says that, “the aim of the Game is to model how effectively the Cap and Trade Carbon Game can be at forcing and driving low carbon infrastructure change. It also shows how small changes in system design can have wide impacts on the cost of abating carbon, the price of carbon and who are the winners and losers. The Game shows the impact of uncertainties in carbon policies and markets have on the early changes in price and emitter behavior.

The rules are quite simple and only apply to the power sector. Other sectors could be added, however for the purposes of education the power sector is used, which happens to correspond to the current system in the North-East of the U.S, the Regional Greenhouse Gas Initiative (RGGI) and to the EU-Emissions Trading Scheme (EU-ETS).

THE RULES OF THE CARBON TRADING GAME

It is a 4 round game with an expanding cap in the power sector. The cap starts small and expands throughout the game.  Each round represents a commitment period 2012, 2017, 2022, 2027 of Kyoto Mark 1 and 11, where we auction more carbon permits per unit of power because the cap is expanding. Each round the number of credits auctioned is fewer 75%, 50%, 25%, 25%.

In the first round we allocate enough permits ahead of the auction to ensure an oversupply to run power plant and produce power. Each round we also auction off a random set of power plants coal, nuclear, gas, wind and hydro with different capacity factors. We auction of different fuels to run the power plants and then we auction of the carbon credits.

For example: One coal-fired power station and one supply of coal and two units of carbon credits is required to run the plant and produce electricity. In this model we were auctioning off the power plants using a 2nd price auction, which is one where, “the highest bid wins but pays the 2nd highest bid”. The next thing is to auction of the fuel using a dutch auction, where everybody bids the number of fuel units and price per unit. Everyone who wins pays the price they bid for settled in order of highest to lowest bid.

We have played multiple games of the Carbonflow Carbon Trading Game with Executives from Designated Operational Entities (DOE) like DNV and SGS, the auditors of the current carbon trading industry.

CONCLUSION and INSIGHTS OF THE CARBON TRADING GAME

1. Carbon prices tend to be higher in early rounds and stay flat or fade as commitment periods go on.

2. In the after-market, where players buy and sell fuel between themselves so they can run their plants, if you don’t have enough fuel and carbon credits you can’t run your coal or gas plant.  In this after-market we found that prices for fuel and carbon became highly inter-linked and have a large impact on the value of power plants and the mix of power production.

3. Also as might be expected high capacity renewable plants and low carbon power plants such as nuclear and wind are able to be sold for substantially higher prices than coal or gas plants with high emission factors and attendant fuel risks like not having enough fuel to run plants or the low emission factor and low capacity wind plants.

4. The most interesting thing is that the simulations confirm that the farther one goes into the commitment period the more inter-linked the fuel commodities and carbon markets become and the higher the discount to justify coal plant investment, even though coal fuel is in oversupply by the end of the game. This is an indication that coal and gas plants tend to be retired in favor of hydro-electricity, wind and nuclear plants. In the fuel markets the differential on a per KWH basis between low carbon commodities like nuclear and gas fuel tends to rise drastically and unpredictably higher than high carbon fuels like coal.

5. Under this simulation we assumed that fuel was always adequate to supply plants into the market. It does not appear to be clear. The price changes are driven by financial traders taking commodity bets and physical traders seeking to secure forward supply.

6. Price volatility by either the emitters or traders does not effect whether the cap is met. If the Cap is an enforceable cap abatement of carbon dioxide (CO2) tends to happen whether people make profits or the price of carbon is high or not - ERGO the ENVIRONMENT WINS!

7. The other conclusion is that Cap and Trade does push out the high emitting coal and lower emitting natural gas plants. The price per ton of carbon in most of our games varied between $20 to $80 dollars per ton per round.

CARBON OFFSET SIMULATION

We did simulate the impact of offsets like energy efficiency, which seem to provide emitters with the opportunity of making profits outside the cap and has a slightly moderating downward pressure on prices for carbon. In the early days it is a limited effect with virtually no impact towards the end of the game as the cap is reached.

HOARDING CREDITS and TRADING STRATEGIES

Trading strategies and hoarding of credits due to uncertainty in early rounds seem to outweigh the impact of the oversupply of allocation of offsets in the early rounds thus keeping prices down.

By later rounds the market expectation is that offset emitter energy efficiency and free allocation would mean emitters escape paying a price of carbon and abatement doesn’t occur. However, we find that the opposite is true, traders making a market for carbon and emitters buying to secure future carbon supply act in a way that supports the price of carbon because inventory of carbon stays high. As the game goes on carbon inventories are exhausted, low carbon fuel prices rise and the value of low carbon plants rise and high carbon fuel prices fall as companies more rapidly than expected shift to a lower carbon market.

Trading strategies are highly profitable as the industry grows and pure commodity trading strategies tend to do badly. The only obvious losing strategy is straight coal but that does not become apparent until later rounds and the last point is the winning strategy tends to be won by those that invest heavily on low carbon strategies as soon as possible.

In Conclusion, this is a fanatastic game to bring everyone up to speed on the mechanics of carbon trading and it has the benefit of showing actual human behaviuor, which can only be factored in when people are in the position of actually buying power plants and seeing what they would do when faced with a cap and a requirement to buy fuel and carbon credits to run their plants.

Carbonflow eRecord software to improve productivity of Kyoto Markets

Neal Dikeman, CEO of Carbonflow, a U.S company, which I am a co-founder of based in San Francisco is launching  version 1 of the eRecord software at the United Nations Climate Change Conference of the Parties (COP) 14 in Poznań, Poland held from the 1^st to the 12^th of December.

“The patent pending eRecord software will reduce costs, increase speed and transparency of the Kyoto Market mechanisms, particularly the Clean Development Mechanism (CDM) under the Kyoto Protocol”, said Mr. Dikeman, whose resume includes start up experience as cofounder of superconductor device manufacturer Zenergy Power plc (ZEN.L) and as Director of Business Development for the parent company of Yellowpages.com.

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