US Carbon Market Bets On Impending CO2 Rules – Dow Jones Newswires

Dow Jones Newswires, December 11, 2008

SAN FRANCISCO (Dow Jones)–U.S. carbon market participants are betting the new Congress and administration will act soon to regulate greenhouse-gas emissions, despite uncertainty about when and how new rules will take shape.

Even before President-elect Barack Obama, who has pledged to fight climate change, emerged victorious in November, the U.S. carbon markets were optimistic the U.S. would regulate CO2, as Republican candidate John McCain had made similar promises. With leadership changes under way in Washington, including Obama’s reported pick of Lawrence Berkeley National Laboratory director and Nobel laureate Steven Chu as energy secretary, optimism for federal carbon regulation has never been greater.

Like other markets, the carbon markets have taken a hit from the global financial crisis and credit crunch, but trading is still active due to expectations that federal climate change legislation is coming soon.

"We are seeing carbon-reduction projects and trades that would never have occurred just six months ago," said Josh Margolis, co-chief executive of environmental brokerage CantorCO2e in San Francisco. "A perfect storm fueled by the winds of local, national and international activities guarantees that we will have federal climate change legislation." 

Carbon Regulation, Trading Heat Up 

The only U.S. greenhouse-gas regulation in place is in New York, New Jersey and the eight other Northeastern states that are members of the Regional Greenhouse Gas Initiative. The program, called RGGI, or "Reggie," is aimed at cutting carbon emissions from power plants. The governments in those states periodically auction pollution allowances that energy companies can use to cover their emissions, or sell if they’re able to cut their emissions more than required.

California is moving ahead with carbon regulation, and plans to participate in a cap-and-trade program with six other Western states and four Canadian provinces in a program called the Western Climate Initiative. The governors of six Midwestern states and the premier of Manitoba have similar plans as part of the Midwestern Greenhouse Gas Accord signed a year ago.

The RGGI program is small and the other programs haven’t kicked off yet, but this hasn’t stopped energy and industrial companies from investing in the carbon markets to get ahead of the curve.

Carbon credits, which are tied to emission-reduction projects like those that remove methane gas from landfills, can be purchased by individuals or organizations who want to offset their carbon footprint, or by energy or industrial companies that are looking to hedge their exposure to future U.S. carbon limits. Companies that purchase carbon credits on this basis, called "precompliance" buyers, now dominate the U.S. voluntary carbon market, said Lenny Hochschild, a managing director and carbon broker at Evolution Markets in New York.

"A year ago, it was difficult to distinguish what was a pure voluntary play, versus what was a pure precompliance play," Hochschild said. "Today the market is clearly in precompliance mode." 

Pricing Carbon In Chicago 

One carbon market participant, the Chicago Climate Exchange, is so sure the U.S. will establish carbon regulations in the next couple of years that it recently launched a futures contract for 2013 federal CO2 emission allowances.

If U.S. climate change regulations don’t materialize by then, sellers can deliver allowances from the RGGI market, or from Europe’s Emission Trading System, instead.

While the 2013 allowance contract is based on probability rather than fact, it reflects market expectations, gives participants an ability to hedge, and provides a benchmark for "what the price (of allowances) would be," said Richard Sandor, chairman and chief executive of the exchange.

"In general, we’re seeing big interest," Sandor said. "We put up (the 2013 contract) because people wanted to see a bid-offer spread, and people wanted to begin to think about what the market would look like in 2013."

U.S. CO2 allowances for 2013 closed trading Thursday on the Chicago exchange at $11.50 a metric ton, while RGGI 2008 allowances closed at $3.40 a short ton, or $3.12 a metric ton.

The difference between the two prices reflects the assumption that a federal program, such as the one proposed last year by Sens. Joseph Lieberman, I-Conn., and John Warner, R-Va., would cut nearly four times more CO2 emissions than the RGGI program, said Vernonique Bugnion, managing director at carbon research firm Point Carbon in Washington.

The Chicago exchange doesn’t identify individual traders, but a unit of oil major Royal Dutch Shell PLC (RDSA, RDSB) said it participated in the first trade of the 2013 allowance contract, and Sandor said other participants include members of the Chicago exchange. CCX members include power companies such as American Electric Power Co. (AEP), NRG Energy Inc. (NRG), Dynegy Inc. (DYN) and Mirant Corp. (MIR). Ford Motor Co. (F), Sony Corp. (SNE), and units of Bank of America Corp. (BAC), JPMorgan Chase & Co. (JPM) and Royal Bank of Canada (RY) are also members.

Since the contract’s Nov. 19 launch, about 100,000 metric tons of CO2 equivalent have been traded. By contrast, more than 23 million tons of RGGI CO2 allowances have traded on the exchange since Aug. 15. And more than 2 billion tons of European CO2 allowances traded on the company’s European Climate Exchange from Jan. 1 to Oct. 13.

The financial crisis has had some impact on the purely voluntary side of the U.S. carbon markets, but it doesn’t appear to have slowed down the precompliance market, market participants say.

Prices for voluntary carbon credits have stayed pretty close to $8 to $9 per metric ton of CO2 equivalent, said Milo Sjardin, head of North American research at New Carbon Finance in New York, which publishes bimonthly market surveys.

"People are pretty bullish about the potential for cap and trade," Sjardin said. "Obama has been pretty clear that he’s going to do something … about climate change."