Breakthrough: The Unintended Consequences of Lieberman-Warner

Does the Lieberman-Warner Climate Security Act (here), which is up for a vote this week on the Senate floor and would regulate over $6.5 trillion in emissions trading, contain a loophole that would allow financial speculators to manipulate the price of carbon allowances, escalate the cost of U.S. emissions reduction efforts, and hinder the development of clean energy? Given the recent economic impacts of housing market speculation, such a large vulnerability could raise serious concerns among consumers, policymakers, and industry.

The potential vulnerability may rest in an "Emergency Off-Ramp" cost containment provision within the Boxer Amendment (Title V, Subtitle C), which instructs a government "Carbon Market Efficiency Board" to auction emissions allowances allotted for the future in order to allow polluters to delay their short-term emissions reductions and reduce their costs:

"[T]he administrator shall, not later than 2 years after the date of enactment of this Act, take a total of 6,000,000,000 of the emission allowances established for calendar years 2030 through 2050... and move them into the Cost-Containment Auction Pool."

Although the provision is intended to give relief to polluters facing high costs for emissions abatement, there is no precise definition of who may purchase or hold these future emissions allowances, or for what use. As a result, the Cost-Containment Auction could attract speculators - possibly even from within the polluting industries themselves - seeking to profit from buying the permits at a low price and selling at a higher future price.

The auctioned permits are guaranteed to clear at a relatively low price during the first years of the auction and rise significantly thereafter until 2050. As indicated by the amendment, the auction price will remain below $30 per ton at the beginning: "At the Cost-Containment Auction that takes place in December 2012, the Cost-Containment Auction Price shall be no lower than $22 and no higher than $30." The price of these permits is expected to increase as the low-hanging fruit of emissions abatement, such as efficiency, disappears in the first few years of permit use. The purchase and sale of these permits could thus prove a highly lucrative trade for financial speculators.

The implications of such a loophole could be enormous. If speculators own low-priced permits, they might attempt to drive up their price as high as possible to return a large profit, potentially causing greater harm to U.S. industries and consumers. If the volume of trading is relatively low, a small group of organized traders might be able to manipulate prices with relative ease. Speculators, financial lobbyists, and related interest groups might also exert political influence to hinder lower-cost emissions reduction options, such as the siting of nuclear energy and potentially carbon capture and storage technology. The more rapidly these lower-cost emissions abatement options disappear, the higher the allowance price would rise.

On the other hand, if the price of emissions allowances rises too high - increasing energy and consumer costs across the board -there will be great pressure from industry, consumers, and policymakers to auction more cost-containment allowances or dismantle the entire regulatory scheme. This will not be possible, however, if the majority of future emissions allowances are already purchased and owned by speculators, whose interest would be to keep the allowance price as high as possible.

Fortunately, it appears that most of this potential loophole was caught and fixed in the newest version of the bill released early last week. In Section 522, it states:

"(b) RESTRICTION TO COVERED ENTITIES. -- In any calendar year referred to in subsection (a), only covered entities that were required under section 202 to submit emission allowances for the preceding calendar year shall be eligible to purchase emission allowances at the cost-containment auction under that subsection.

(c) USE OF EMISSION ALLOWANCES PURCHASED AT A COST-CONTAINMENT AUCTION.--An emission allowance purchased at a cost-containment auction shall-- (1) be submitted by the purchaser for compliance under section 202 not later than 1 calendar year after the date of purchase of the emission allowance."

This implies that the auctioned permits could only by used by polluters during the year of auction, not held by speculators for future sale. However, firms could still "bank" their regular allowances in early periods - purchasing the auctioned cost-containment permits instead - and sell these banked allowances in the future for profit. As a result, the near term allowance price would rise more quickly because firms would be "saving" their allowances for a later period. As Dr. Gregory Nemet points out, if prices rose quickly at the beginning instead of reflecting the low cost of efficiency improvements and other low-hanging fruit, this could damage the political acceptability of the program.

Will Lieberman-Warner result in large unintended consequences that hinder the development of clean energy? Stay tuned - until the language is clearer, there's no telling. But all of this points to the conclusion that cap & trade will be an incredibly complex system, with a myriad of competing political interest and lobbyist groups, and without better oversight it may become one big regulatory fiasco that leaves clean energy in the dust.

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