Energy Risk & Markets


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

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

Fortnightly Magazine - July 2008

“Cap-and-trade won’t work.”

So says the Los Angeles Times in a March 10, 2008 opinion. 1 Recalling the state’s experience when it deregulated the power markets and how that effort enabled “unscrupulous traders such as Enron to manipulate the market” the newspaper warns, “We could be looking at deregulation déjá vu . Carbon-trading markets are easy to manipulate and produce volatile energy prices, and the political influence of business and other lobbies can skew the system to produce unfair outcomes.” 2

Although this opinion focuses on California’s attempt to manage greenhouse gas (GHG) emissions, federal lawmakers have expressed similar concerns as Congress considers omnibus climate change legislation. Senators Dianne Feinstein (D-Calif.) and Olympia Snowe (R-Maine) have proposed anti-manipulation laws for the emissions markets premised on laws applicable to manipulating securities prices. The Lieberman-Warner Climate Security Act of 2008 (S.3036), the leading federal cap-and-trade proposal, would establish a “Carbon Market Working Group” to ensure the integrity of the emissions allowance markets.

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Is the U.S. on the right track when it comes to regulating the emissions markets? Not necessarily.

Anti-Manipulation Proposals

Conventional wisdom is that, due to the distraction of the November elections and the state of the economy, Congress will wait until at least 2009 to enact a federal cap-and-trade program, including any emissions market oversight provisions. Nevertheless, this year’s Congressional activity will set the stage, so it’s worth focusing now on the debate over how Congress should address concerns about the impact of GHG-reduction efforts on consumer prices, including the price of energy.

One aspect of the debate is to what extent a market-based cap-and-trade model is vulnerable to market manipulation and whether speculator participation in the emissions markets will raise the price of allowances or make them more difficult for emitters to secure. For example, another L.A. Times opinion piece, from May 28, 2007, observes, “Also hoping to profit, honestly or not, would be carbon traders. Large financial institutions would jump into the exchange to collect commissions on carbon trades, just as they do with crude oil and wheat. This presents opportunities for Enron-style market manipulation.” 3 An October 2007 Congressional Research Service report made a similar point, noting, “Since there is widespread suspicion that excessive speculation by hedge funds and others has affected energy prices in recent years, the possibility that the price of allowances could also be subject to distortion or manipulation will be a policy concern.” 4

Why might Congress worry? The sheer size of the carbon markets suggests to some that the ill effects from their manipulation might be considerable. The Congressional Research Service estimates the United States is expected to distribute 5 billion GHG allowances per year, valued at between $72 to $122 billion (likely more) as compared to the current SO 2 markets that involve 9 million annual allowances valued