Price Ceiling Sought on Carbon Markets

August 3, 2009

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From political pundits to a think tank, the new prevailing wisdom on carbon trading suggests there should be a series of price caps in order to prevent the sort of rampant speculation that caused such mayhem in the commodities and derivatives markets.

A price ceiling on carbon dioxide emissions permits, as well as a guaranteed minimum price, would thwart unhealthy speculation from the financial sector, Jason Grumet, who advised President Barack Obama on energy during his campaign, told the Senate agriculture committee in late July.

“Consumers don’t like volatile prices. One group that does like volatile prices is Wall Street,” said Grumet, now president of the Bipartisan Policy Center, reports the Edmonton Business Journal.

The Brookings Institution also is calling for a price ceiling. In a guest column on Politico, three members of the Brookings Institution advocate for the Senate, in its version of the climate bill, to put in place a “price collar.”

They write: “By preventing the policy from being either unexpectedly lax or unexpectedly stringent, a price collar protects both investors in green technologies and households and preserves strong incentives to abate. The price floor proposed in the House bill would start in 2012 at $10 per ton of carbon dioxide equivalent and rise by 5 percent annually. Our research suggests that adding a ceiling starting at $35 per ton and increasing both the floor and the ceiling by 4 percent per year would increase cumulative emissions over the period from 2010 to 2050 by about 6 billion metric tons, or about 4 percent relative to a policy without a price ceiling.”

Essentially, if the ceiling is triggered, more permits would be auctioned. If the price floor is reached, a higher reserve price would be triggered, under the Brookings Institution plan.

Yet another institute, the Nicholas Institute for Environmental Policy Solutions at Duke University, has issued a working paper on the subject.

“Balancing Cost and Emissions Certainty: An Allowance Reserve for Cap and Trade” (PDF download) calls for a compromise between the idea of price-based policies to limit climate change and a clear, quantatitive limit on emissions. The paper’s authors state that the allowance reserve would serve as a quantative limit, and bridge the gap between divergent interests.

While some are calling for “cap and trade with a safety valve,” the Nicholas Institute’s idea of an allowance reserve would put in place both a ceiling price for cost relief, as well as a maximum number of allowances to be issued.

“Much like a safety-valve mechanism can mimic either a pure price or pure quantity control, depending on how the cap and safety-valve price are set, an allowance reserve can mimic a pure price, pure quantity, or safety-valve approach, depending on how the ceiling price and volume are set,” the working paper states.

Essentially, the Nicholas Institute seeks a carbon scheme that can be both market-driven and regulated. “In order to achieve dynamic efficiency, prices need to adjust regularly so that current prices continue to reflect discounted expected future prices. A cap-and-trade program with banking, borrowing, and eventual adjustment of the cap can achieve that result if economic agents have sufficient foresight and capacity to form rational expectations about the longer term,” the paper continues.

With Congress set to wind down, the Senate will take one more crack at the climate bill this week, but no progress is expected until the conclusion of August recess, reports the New York Times.

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