Rising concerns about the impact of greenhouse gas (GHG) emissions on the environment have led to the creation of cap and trade programs in areas such as the European Union, Australia and even South Korea. While the U.S. has not, at this point, implemented a national cap and trade program, emissions trading programs are in place in the Northeast and Mid-Atlantic. The goals of these programs are to place a value on GHG emissions through an auction based system of allowance of emissions, essentially creating a value for releasing GHGs in to the atmosphere and imposing penalties if a source of emissions exceeds its allowances. Ultimately, the goal is to reduce overall emission by making it cost prohibitive to emit excess pollutants.
What Is A Cap and Trade Program
An auction based system under which a regulatory authority, such as a state public utility commission or other governmental body, creates a set number of emission allowances for the release of pollutants. These allowances provide the owner with the ability to emit a set amount of pollutants. Typically, the set amount of allowance is designed to reduce pollution over time, essentially creating a “cap” on emissions. Some of the emissions are allocated to existing sources of pollution while the remainder is auctioned off to the highest bidder. Once these allowances are purchased they can be used to off-set emissions or “traded” to other parties who need additional emissions credits. Under a typical program, if a pollution source exceeds its allocated and purchased allowances, a significant fine is imposed to discourage continuation of such behavior.
Regional Greenhouse Gas Initiative (RGGI)
RGGI is a cooperative effort among nine states – Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island and Vermont – to reduce greenhouse gas emissions. The following chart shows the states that participate in the RGGI project. RGGI states use a market-based cap-and-trade approach designed to lower CO2 emissions by 10% over time. This is accomplished by requiring generators over 25 MW in size to hold emission allowances equal to their emissions over a 3 year time period and allowances are allocated to generators in quarterly auctions. The RGGI program allows for GHG reduction or carbon sequestration projects outside of the generation sector to count toward compliance requirements. Proceeds from the auction of emission credits are used to improve energy efficiency and enhance the deployment of renewable energy technologies
The following chart compares RGGI auction results over a 4 year time period.
Sorce: Based on Auction Results Reports published by Potomac Economics, Independent Market Monitor for RGGI
Over the four year time horizon, the clearing price has ranged from a low of $1.93/allowance in 2011 and 2012 to a high of $2.80/allowance in 2013. This suggests that allowances are getting more expensive as they decrease in amount and as bids are entered that exceed the total amount of allowances available.
Impact of RGGI On Energy Risk Management
While the RGGI initiative has laudable goals, it also, in conjunction with recent actions by the Environmental Protection Agency (EPA), will have an impact on energy risk management. Specifically, as credits become increasingly expensive, this cost will ultimately get passed on to the end-user in the form of higher energy prices since generators will have to recoup the costs of such credits through their power costs.
While the cost of RGGI allowances is still relatively small (under $3/ton), these costs are likely to increase over time as the number of allowances shrink. Therefore, from an energy risk management perspective, end users need to be aware of the potential future impact of the RGGI cap and trade program.
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