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Catching Europe's Cold

Fortnightly Magazine - August 2009

2, and the mechanisms are comparable. If you have those similarities, then you can arbitrage between the two systems and ultimately they’ll come together.

Carbon is a bit like currencies in Europe. We used to have a number of different currencies and now we have the Euro. Eventually there was a conversion, but before that different currencies had different values, and people made money on arbitrage. That’s what will happen with international carbon trading, until people sort out the differences between schemes.

 

Fortnightly: What lessons should we learn from Europe’s experience developing a carbon market? How can we avoid a price collapse like what happened in the ETS?

Scowcroft: The essential element is that the initial allocations must be made on the basis of good knowledge of what the actual emissions are. That was the fundamental problem in Europe. To a large extent no one had accurate data on what emissions actually were, and the allocations were made on assumptions. Before emissions trading, CO 2 emissions were published by companies, but it was done by the environmental department. If it was within 10 percent, everyone was happy. But when you think about the value of CO 2 allowances, the CFO will say 10 percent isn’t good enough. We have to be more accurate, and that was the biggest lesson that came out of it. You can’t make proper allocations unless you have proper data. Otherwise what happened in Europe will occur in America.

There was a similar collapse in the sulfur market in the United States. It’s a feature of policy-driven markets. I don’t think the ETS price collapse was unexpected, but its size was unexpected.

If you start out with a good understanding and projection of what emissions are likely to be, you will have a good allocation.

Another important point: When you move to full auctioning the company will decide what its exposure is going to be. The company will decide how much to emit, and then it will go out and buy allowances to cover that amount. But with free allocations, America will have something like what we saw in Europe—negotiation of what emissions are and what they will be.

So your fate is in your own hands. Or rather, you’ll negotiate your fate based on data.

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