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Energy Risk & Markets

Allowance trading needs oversight, but don’t overdo it.

Fortnightly Magazine - July 2008

at $4.5 billion. 5 Thus, introducing some kind of legal safeguards to prevent the potential adverse consequences of “Enron-style manipulation” in the emissions markets might be smart politics. But there also is the danger of unintended consequences if an irrational fear of speculation causes Congress to structure those safeguards in a way that chills the market participation needed to create robust, liquid allowance markets. When weighing these competing goals, Congress has not yet struck the right balance.

Too Many Chefs

Senators Feinstein and Snowe introduced the “Emission Allowance Market Transparency Act of 2007” (S.2423) last December. In a press release accompanying the bill’s introduction, Sen. Feinstein said “the measure is designed to prevent future Enron-like fraud and manipulation in greenhouse gas credit markets.” An individual or entity that violates the statute or the EPA’s regulations would be subject to a fine of $1 million, up to 10 years in prison (five years more than under the CFTC or FERC anti-manipulation rules), or both, per violation. The bill would not create any private right of action, leaving enforcement to government prosecutors.

The bill would facilitate price transparency in the emissions allowance markets, taking into consideration the public interest, market integrity, fair competition, and consumer protection. The “markets” include “markets for real-time, forward, futures, and options.”

Notwithstanding the broad purpose of the bill, the proposed definition of “emissions allowance” could create unintended oversight gaps. The bill would define an emission allowance as “any allowance, credit, or other permit issued pursuant to any federal law (including regulations) to any individual or entity for use in offsetting the emissions of any pollutant (including any greenhouse gas) by the individual or entity.”

On the one hand, the reference to any allowance “issued pursuant to any federal law” would appear to cover allowances for non-GHG emissions like SO 2, thus broadening the scope. On the other hand, this same language would exclude some important types of allowances and other certificates, credits or offsets, such as those traded in the voluntary, state, and international markets, or federal allowances that an emitter holds for uses other than offsetting its emissions. It also would exclude allowances that Congress issues to non-emitting entities, such as states and localities, non-profits and possibly distribution utilities.

It also isn’t clear whether the definition would apply to allowances traded in the secondary markets. For example, the federal government might issue an allowance to an emitter so that it can offset its pollution emissions, and this allowance would be covered. However, none of the GHG legislation currently being considered would require a receiving entity to use an allowance only to reduce its emissions. Indeed, that would be anathema to a cap-and-trade program, which is designed to give emitters flexibility to choose how to manage emissions compliance, including by selling the allowance for cash. Once an allowance leaves the initial recipient’s possession, it is no longer held by the entity contemplated by the definition of a regulated allowance, and might not fit the definition in the Feinstein-Snowe legislation.

Dueling Agencies

To address market manipulation in the emissions