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Catching Europe's Cold

Fortnightly Magazine - August 2009

it. In Europe, allowances are allocated entirely to emitters. Because those allowances have a value in the market, they have a price structure. But under Waxman-Markey the allocations are made to local distribution companies (LDC). Instead of emitters auctioning them straight away, you give them to someone else who, in essence, auctions them. The revenue is recycled through the LDC and they will sell the credits on the market for generators to use. LDCs will use the allocations to diminish the impact of the cost on their consumers. It’s a complicated way of doing it, but I understand the reasons.

 

Fortnightly: I’m not sure I understand it. Why not just allocate the credits directly to the sources of the carbon and cut out the middle man?

Scowcroft: It has to do with the structure of markets, where you have merchant generators and regulated generators, and regulated LDCs. If you’re a regulated company, will the regulator allow you to pass through the costs? That’s the key issue. In Europe, economic logic takes care of the cost, but in a regulated market, the regulators might say you can’t pass through the costs. Or they’ll let you pass them through but they’ll find some other way of getting their money back.

 

Fortnightly: So in theory, by allocating allowances to retail distributors, Waxman-Markey shields consumers from the costs.

Scowcroft: There was a lot of debate in Europe about whether the obligation should be placed on the emitter or on someone downstream. The decision we came to in Europe was that emitters ought to be responsible for emissions, as opposed to their customers or some third party. What you’ve got with Waxman-Markey is a sort of downstream scheme, where the [generator’s] customer is responsible for managing the allowances. They have a choice as to how they manage the obligation.

The reason for this difference has to do with the difference in viewpoints between the U.S. and European power markets. Having deregulated the electricity market in Europe, we don’t have tariffs, just prices. There’s an assumption that competition will keep prices down, which is true up to the point you can make enough money to invest in new plant. In the United States, regulated tariffs are negotiated with the regulator, and therefore I understand why we’d give allowances to the person who’s selling to the customer. That way you can shield the customer from the impact.

 

Fortnightly: A big question is whether this will work to reverse climate change. Arguably it won’t work without global effort and a global market for carbon credits. Do you think the Waxman-Markey bill puts us on the right path toward an international trading market?

Scowcroft: Yes, but I think there’s a lot of overly optimistic talk about having a common market. Europe is pushing for a common market by 2015. That’s optimistic. What we’ll see is a number of domestic markets forming, which over time will link together, in the meantime providing fundamental similarities— i.e., the caps are similar, an allowance is equivalent to a ton of CO