This analysis was also covered in an op-ed at AlterNet.
New analysis by the Breakthrough Institute concludes that the American Clean Energy & Security Act (ACES) could create a vast new carbon derivatives market subject to financial speculation and create a powerful alignment of economic incentives among the financial industry, carbon offset producers, and utilities and fossil fuel companies to weaken or oppose measures to reduce emissions in capped U.S. sectors.
Offset Industry & Utilities
The ACES bill would create new demand for domestic and international carbon offsets by allowing polluters to purchase these relatively cheap offsets in lieu of reducing their emissions. The bill allows for the purchase of 1 billion tons of domestic offsets and 1 billion tons of international offsets each year.
The use of offsets to meet emissions reduction targets has significant implications when evaluating the impacts of ACES. Offset utilization is one of the largest variables in the proposal determining both economy-wide emissions reductions and reductions in capped sectors of the economy, established carbon prices, revenues raised through auctioning allowances and revenues dedicated to clean energy, levels of private investment in clean energy driven by the program, and the revenues transferred from households and other domestic energy end-users to international interests through offset purchases.
How many of these offsets will be utilized is uncertain, however, if all offsets are utilized and purchased at the average allowance price estimated by EPA, the bill would create a domestic offset industry with annual sales of $20 billion per year by 2020. The profit margin on the sale of such offsets is also uncertain, but total profit from domestic offset production is likely to range in the billions of dollars each year. Below is a table estimating total potential sales compared to projections by the EPA (see here) and CBO (see here) on the utilization of offsets through 2020 (value estimates based on EPA price projection of $15/allowance in 2012 and $20/allowance in 2020):
The level of carbon offset sales will depend on the authorized level of offsetting, the cost of alternative emission abatement options, and the standards imposed on the creation of offsets. Both the producers and purchasers of offsets are likely to have an interest in maximizing the level of available offsets, in order to maximize profits and minimize costs.
For example, producers and sellers of carbon offsets may push for weaker evaluation standards in order to increase potential sales, such as maintaining oversight of domestic offsets by the Department of Agriculture instead of the EPA. Utilities and fossil fuel industry groups may lobby for an increase in the authorized volume of domestic and international carbon offsetting to avoid the more expensive task of reducing their own emissions. The demand for an increase in offsetting is likely to grow larger after the lowest-cost emission abatement options are used in the early years of the program.
Similar issues may apply to other areas of the ACES legislation, such as allowance distribution, emission reduction targets, renewable portfolio standards, and more. For example, reducing the free allocation of allowances to utilities and other incumbent energy industries in order to increase funding for clean energy technologies may be increasingly difficult in the future. The bill does not begin phasing out these free allocations until the mid-2020s, which will shield the profits of these industries.
The financial industry will also have an increasingly large stake in future climate policy. The ACES bill will result in a U.S. carbon market on the scale of $1 to $2 trillion per year by 2020, according to analysis by Point Carbon, New Energy Finance, and the U.S. Commodities Futures Trading Commission (CFTC).
The CFTC estimates a $2 trillion carbon futures market will be established within the first five years of ACES, with up to 180 million private contracts per year, roughly the size of the sweet crude oil and natural gas markets combined. This projection was echoed by a Point Carbon report in 2008 on the potential impacts of the Lieberman-Warner Climate Security Act, which contained similar cap and trade provisions to ACES, and a recent report by New Energy Finance (PDF) projects ACES will create a $1.2 trillion carbon market in the U.S. by 2020.
The potential profit margin for financial firms trading within this market is uncertain, however, estimates by Carbon Tracing, an independent consulting firm, suggest a relatively conservative profit margin in the range of 3 or 7% and up to 8 or 12% per year. An estimate of potential annual profit margin throughout the financial industry under these scenarios is here:
The policy interests of these financial firms may vary, but most are likely to push for weaker regulatory standards on carbon markets, larger volumes of carbon offset authorization, and provisions to increase the volatility of carbon prices, all of which would hinder progress on reducing U.S. emissions. For example, the financial industry will continually call for carbon allowance trading to be allowed OTC (over-the-counter), a form of derivatives trading that gives firms and traders the most leeway to leverage, speculate, arbitrage, and maximize profit by avoiding regulations. The greater the volatility in the carbon allowance and offset market -- and the larger the volume of offsets allowed -- the more trading, arbitrage, and speculation these firms can benefit from.
According to investigation by Public Integrity, financial firms have significantly increased their lobbying efforts on federal climate policy. Banks like Goldman Sachs, JP Morgan Chase, AIG, and other insurance and private equity firms have increased their climate lobbyists on Capitol Hill from approximately zero in 2003 to 130 in 2008, and about 20 additional lobbyists worked for firms and organizations wholly dedicated to carbon marketing last year. A report by Friends of the Earth found that the financial industry recently lobbied for weaker regulatory standards on carbon markets. In a letter to Senator Feinstein and Senator Snowe, who introduced a carbon market governance bill, the International Emissions Trading Association asserted that "the market itself recognizes the importance of integrity and exerts discipline on participants," citing a number of self-regulating tactics.
ACES would allow trading of carbon allowance and offset futures, however, the specific definition and regulation of these derivatives is unclear. ACES would authorize the Federal Energy Regulatory Commission to oversee emissions allowance and offset markets, but it would leave the decision of how to regulate the carbon derivatives market to the president. According to the analysis by CFTC, the derivatives portion of the U.S. carbon market will be the largest in terms of value.
The exact policy interests of these firms in the future is uncertain, but the incentives created by ACES are likely to result in an alignment between already influential financial, agriculture, and incumbent utility and fossil fuel firms. Regardless of how the carbon market and offset markets are regulated, each of these industries will have a predominant interest in both business as usual or higher emissions in capped sectors and laws that allow for firms to purchase more offsets rather than reduce their own emissions, particularly after the lowest-cost abatement options are depleted during the first years of the program. This new combined lobby could make it harder to reduce emissions in the future, either by enforcing a strict domestic emissions cap or by changing allowance allocations to increase public investments in low-carbon power sources.