8/9/2019 US Cap-and-Trade Program: Options for Compliance
1/13
Carbon Market Analyst
A US Cap-and-Trade Program: Options or Compliance
TO THE POINT CONTENT
UPCOMING REPORTS
POINT CARBON RESEARCH All rights reserved 2009 Point Carbon
RESEARCH
North America
2 Executive summary
2 Introduction
2 Sizing up the gap
6 Compliance options10 Market implications
12 Conclusion
13 Contacts
Assessing the Impact o the Reces-sion on US GHG Emissions
A Post-2012 Global Climate Change
Agreement What Role or International Forestry
and REDD credits
The Emission-to-Cap in the cap and trade program proposedby Rep. Waxman would be 205 million tons in 2012, growing to1.4 billion tons by 2020.
This gap could be cut in hal i complementary policiespromoting clean energy and energy efciency standards arealso passed. The long term impact o the economic recessioncoupled with ambitious policies could create a long market or
the rst compliance period.
In 2012, the domestic osets supply will be too scarce to fllin the gap. Certied Emission Reductions (CERs) could helpmeet the gap, placing US acilities in competition against other
international buyers.
In 2016, because o the limited domestic oset supply, some
uel switching may be needed, rapidly pushing prices up.
To remedy high prices, we anticipate the development o anew international oset programs, where sectoral and REDDcredits could play a much larger role.
In 2020, a large reliance on uel switching would bring pricesup over $50 a ton. These high prices would render economicallyattractive most other compliance options, including purchases
o international allowances and a wide range o internal
abatement measures
April 2, 2009
8/9/2019 US Cap-and-Trade Program: Options for Compliance
2/13
Carbon Market Analyst North America
2 All rights reserved 2009 Point Carbon
CMA April 2, 2009
This report provides an overview o compliance options
under a US cap-and-trade program using the discussiondrat proposed by Rep. Waxman on March 31st, 2009.
We rst estimate the size o the emission-to-cap (E-t-C),
or the dierence between projected US greenhouse gas
emissions and the cap this is the amount by which
covered entities collectively will have to reduce their
emissions to comply with the carbon limits. We estimate
this gap at 205 million tons in 2012, growing to 1.4 bn
tons in 2020, i business-as-usual projections ollow the
path orecasted by the Energy Inormation Agency.
The bill includes a wide array o complementary
policies to reduce emissions, notably a renewable
electricity standard, an energy eciency standard, and
improvements to uel economy and carbon-intensity otransportation uels. These policies could cut the E-t-C in
hal, reducing the gap to 87 million tons in 2012, a mere
1.2 percent o the total cap. Coupled with the eect o
the economic recession, the program could start long in
the rst compliance period (2012-2013). We orecast the
2020 gap at roughly 760 million tons, 15 percent o the
cap that year.
We then investigate the main compliance options or
lling this gap: osets and internal emission reductions.
The bill authorizes 2 bn oset credits or compliance,
evenly split between domestic and international osets.
Domestic osets will likely constitute the least expensivecompliance option, but with a pipeline currently below
20 million tons per year, we oresee a shortage o these
credits.
International osets are also unlikely to ll in their quotas,
although we orecast a potential supply o Certied
Emission Reductions (CERs) o over 700 million tons
globally in 2015. US acilities would have to compete
with European emitters and Kyoto countries or these
credits. Other orms o international osets could be
developed, notably sector-based credits and Reduced
Emissions rom Deorestation and orest Degradation
(REDD) credits and help make up the shortall.
In terms o internal abatement, uel switching has the
largest potential aside rom energy eciency. The
cost o uel switching can rise rapidly depending on uel
prices. A high price o carbon would trigger a negativeeedback loop and incentivize other internal abatement
measures, such as industrial energy eciency,
improvement to chemical processes, etc. This would
bring prices back down to a level where uel switching is
the most economical available option.
High carbon prices would also create an incentive to
link with other carbon markets, such as the European
or the Australian emission trading systems. LInkages
with other markets would not necessarily bring prices
down but could help dampen price volatility.
Executive summary
IntroductionThe prospects or a carbon market in
the US are looking better by the day.
Lawmakers in Congress are actively
discussing a climate bill, and hopes
are high that cap-and-trade legislation
may be passed by the end o the
year.
This issue o Carbon Market Analyst
North America looks at complianceoptions under a US cap-and-trade
program. We rst estimate the size
o the emission-to-cap (E-t-C), or
the dierence between projected
emissions under a business-as-usual
(BAU) scenario and the cap, and then
investigate the main compliance
options to close this gap: osets and
internal emission reductions.
This report provides an analysis o
supply and demand dynamics under
a US cap-and-trade program and sets
up the conceptual ramework or
price ormation in a uture US carbon
market.
We provide snapshots o three
milestone years during the rst
decade o the program - 2012,
2016 and 2020 - and discuss which
compliance option is likely to be
preerred in each o these years.
We look at the carbon price range
involved and implications or the
carbon market, assuming no major
technological breakthrough occurs in
this time rame.
Sizing up the gapUnder a compliance program,
demand or emission reductions is
derived rom the gap between the
emission cap established by the
government and actual emissionsrom covered sources.
Setting the cap
In the White House budget proposal
released February 27, President
Obama stated his reduction targets
14 percent below 2005 levels by
2020; 83 percent below 2005 levels
Hopes are high thatcap-and-trade leg-islation will pass by
the end o the year
8/9/2019 US Cap-and-Trade Program: Options for Compliance
3/13
Carbon Market Analyst North America
3 All rights reserved 2009 Point Carbon
CMA April 2, 2009
by 2050. More recently, on March
31st, Representative Waxman (D-
CA) and Markey (D-MA) released adiscussion drat setting even more
ambitious medium-term targets
starting in 2012 at 3 percent below
2005 levels, declining to 20 percent
below 2005 levels by 2020 and 80
percent below 2005 levels by 2020
(see Figure 1 and Table 1). While
these targets may change in the nal
climate bill, we take them as the
best available indication o the depth
o the cuts to be expected and use
them in this analysis.
We also use the scope proposed
in the Waxman discussion drat, an
economy-wide coverage o all sectors
except or waste and agriculture.
Some sectors are phased into the
program over the rst years, creating
steps in the curves representing the
cap and the emissions rom coveredsectors in Figure 1.
The sector phase in provision means
only 68.2 percent o US emissions
are covered in 2012-2013, but this
number increases to 75.7 percent in
2014-2016 when industrial acilities
are phased in, to eventually reach
its maximum at 84.5 percent in 2016
as the requirement extends to local
distribution companies. The scope
remains at 84.5 percent o total
emissions through the rest o the
program.
Business as usual emissions
We use with the business as usual
(BAU) emissions projections, which
illustrate the path US greenhouse gas
emissions levels are expected to take
given existing environmental policies
and regulations. The projections are
based on the US Energy Inormation
Agencys (EIA) Annual Energy
Outlook released in December 2008.
BAU emissions or the US as a whole
are projected to increase rom 7,294
million tons (mt) in 2012 to 7,380 mt
in 2020, a 1.2 percent growth.
These projections account or
the new Corporate Average Fuel
Economy (CAFE) and the renewable
uel standard passed in theDecember 2007 Energy bill. They
also include the reductions rom
existing state renewable portolio
standards. In Figure 1 we chart total
US emissions (top dotted line) and
emissions rom covered sources only
(solid line) against the cap.
Emission-to-Cap
As shown in Table 1, we nd that in
2012, covered sources will have an
estimated annual emission-to-cap(E-t-C) shortall o approximately
205 MmtCO2e, or 4.1 percent o
BAU projections, total
US emissions
BAU projections,
covered sectors Cap
Emission-to-Cap
(EtC)
2012 7 294 4 975 4 770 205
2013 7 301 4 979 4 666 313
2014 7 273 5 506 5 058 448
2015 7 282 5 513 4 942 571
2016 7 307 6 175 5 391 784
2017 7 336 6 199 5 261 938
2018 7 364 6 223 5 132 1 091
2019 7 378 6 235 5 002 1 233
2020 7 380 6 236 4 873 1 363
2030 7 894 6 671 3 533 3 138
Table 1: E-t-C in the Waxman-Markey drat proposal
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
Million
tonsCO2e
Business-as-usual projections, total US emissions
Business-as-usual emissions from covered sectors
Waxman reduction targets from covered sectors
Figure 1: Emission-to-Cap in the Waxman-Markey proposal
Waxman sets ambi-tious medium andlong term emission
reduction targets
8/9/2019 US Cap-and-Trade Program: Options for Compliance
4/13
Carbon Market Analyst North America
4 All rights reserved 2009 Point Carbon
CMA April 2, 2009
speed at which the economy will
recover rom the current recession is
unknown.
We do not attempt to capture thispotential recession eect on US
emission levels but consider possible
that emissions would be lower than
projected during the rst years o
the program. This would reduce the
gap between emissions and the cap
even urther. The eects on long term
emissions, however, would probably
be negligible.
Proposed Policies
In addition to the eects o the
economic slowdown, US GHGemissions, and thereore the E-t-C,
could look dramatically dierent i
some urther energy command-and-
control measures are passed ahead
o or in conjunction with legislation
establishing a cap-and-trade
program. Such regulations are under
discussion and would have a large
eect on long term GHG emission
their estimated BAU emissions.
This gap is anticipated to increase
to approximately 571 million tons by2015 and up to nearly 1.4 billion tons
by 2020. The shortall in 2020 is then
22 percent o BAU emissions rom
covered sectors.
Lower Emissions?Actual emissions will likely be lower
than even the most recent EIA
orecasts because o recently-passed
policies, proposed policies, and the
impact o the economic recession.
Enacted Policies
The Obama administration has
passed important policies and large
investment programs in the past
two months, notably the American
Recovery and Reinvestment Act,
better known as the stimulus bill, and
the proposed 2010 ederal budget.
Both packages contain signicant
investments in clean energy and
energy eciency, and could by one
groups estimate reduce business-
as-usual emissions by 61 million tons
annually rom 2012 onwards (see
Textbox 2).
Furthermore, the Annual Energy
Outlook projections, dated December
2008, likely do not ully account or
the deepening economic downturn
and its lasting eect on greenhouse
gas (GHG) emission levels. Analyses
o the recessions eect on Europes
emissions have estimated close to
six percent reduction in emissions
rom 2007 to 2008, partially due to
decreased industrial output rom
energy-intensive sectors such as
cement and pulp and paper. The
levels in the US. Two sectors are the
most likely targets or broad-reaching
regulations: the power sector and
the transportation sector. New
climate-oriented regulations in bothsectors would evoke large amounts
o emission reduction.
Power sector
A national renewable electricity
standard (RES), mandating that a
minimum percentage o electricity be
generated rom renewable energy, is
under discussion in Congress and
could be passed as early as this
summer. A proposal introduced by
Sen. Bingaman (D-NM) early 2009
would require that 20 percent oelectricity sold in the US come rom
renewable sources by 2025. A similar
bill proposed by Rep. Markey aims
or 25 percent renewables by 2025.
This provision was included in the
Waxman-Markey drat and would
reduce emissions by an estimated
57 mt in 2012, growing to 279 mt by
2020 (see Textbox 2).
Many studies show the potential savings rom energy eciency most recently,McKinseys report Reducing US Greenhouse Gas Emissions: How Much at WhatCost? announced close to one billion tons o GHG emissions could be reducedrom energy eciency measures alone, at a cost o zero or less (negative cost, i.e.a net saving). I this is true, why do we even need energy eciency standards?
Economically, energy eciency appears to be an obvious investment, yet the shitstoward better-insulated buildings and ultra low-energy appliances are not occurringon the massive scale that their economic protability would suggest. Three typeso hurdles typically get in the way o eciency improvements according to energyeciency experts Arthur Roseneld and Paul Stern. First, structural issues, like thetenant/landlord dilemma, prevent useul investments rom taking place becausethe decision-makers and the beneciaries are disconnected. Second, the economicprotability o eciency investments is not always as clear cut as economic theorywould imply. Discount rates (the time-value o money) and interest rates aced by
individuals can be signicantly higher than those used by economists in calculatingthe worth o energy eciency investments. Finally, individuals and companies donot always behave rationally in the economic sense and may elect to keep pricierincandescent light bulbs because they preer the quality and color o the light to thato cost-savings compact fuorescent lights.
Because economic rationality is oten not enough to trigger these energy eciencyinvestments, standards and public action are needed to overcome structural andnancial hurdles. Cap-and trade can also trigger some energy eciency investments,but only i carbon prices are high enough to make a large dierence on the energybill.
Textbox 1: Energy efciency: the answer to it all?
BAU projections donot ully account orthe deepening eco-
nomic downturn
8/9/2019 US Cap-and-Trade Program: Options for Compliance
5/13
Carbon Market Analyst North America
5 All rights reserved 2009 Point Carbon
CMA April 2, 2009
Energy eciency standards are
also being discussed in Congress.
The Save American Energy Act,introduced by Rep. Markey (D-MA)
and Sen. Schumer (D-NY) establishes
a ederal energy eciency resource
standard, requiring utilities to
reduce electricity demand by 15
percent and natural gas demand by
10 percent by 2020. This mandate
could lower emissions by 39 mt in
2015, increasing to 262 million tons
by 2020 according to the ACEEE (see
Textbox 2). Other measures included
in the drat bill promote appliance
eciency standards, improved
building eciency standards, etc.and would also reduce emissions.
Transportation sector
President Obama lists two key
measures or the transportation sector
in his energy agenda: increasing uel
eciency standards and passing alow-carbon uel standard (LCFS). As
a Senator, Barack Obama supported
the Fuel Economy Reorm Act, which
proposed a our per cent per year uel
economy improvement beginning in
2009 or passenger cars and 2012 or
light trucks. The proposed LCFS set
targets o uel carbon-intensity at 10
percent below 2005 levels by 2020.
The National Commission on Energy
Policy has estimated the combined
eect o both proposals at 550 million
tons worth o reductions by 2020.
The Waxman-Markey bill contains an
LCFS provision that only takes eect
when the Renewable Fuel Standard
ends, in 2022, and mandates the
EPA to harmonize uel eciency
standards building on Caliornias
tailpipe emission standards (the
Pavley bill), but does not set
specic targets.
E-t-C Stimulus RES Energy Efciency New E-t-C
2012 205 61 57 0 87
2013 313 61 52 5 195
2014 448 61 104 18 265
2015 571 61 103 39 368
2016 784 61 156 58 508
2017 938 61 151 88 638
2018 1,091 61 220 117 693
2019 1,233 61 210 214 747
2020 1,363 61 279 262 761
Table 2: Eect o mandated emission reductions on E-t-C
All numbers in million metric tons o CO2e
Smaller gap long market?
We account or the emission
reduction potential o the big ticket
items in the Waxman-Markey bill and
estimate the size o the new gap in
the short and medium-term, up to
year 2020. Hence we exclude the
eects o transportation policies,
as the main measures are either
unspecied or only take eect ater
Compliance period Annual E-t-C
2012-2013 141
2014-2015 316
2016-2017 573
2018-2019 720
2020 761
Table 3 -E-t-C by compliance periodThe E-t-C could behalved by comple-mentary energy pro-
visions in the climate bill
Reduction orecasts or the stimulus bills are drawn rom an analysis commissionedby Greenpeace in January 2009. Consultancy ICF evaluated sixteen energy,environment, transportation and technology provisions included in the initialEconomic Stimulus Package and quantied the expected emission reductions romeach o them.
The emission reductions rom renewable electricity standards are detailed in aPoint Carbon report dated February 23, 2009: Greenhouse Gas Reductions romRenewable Electricity Standards.
For energy eciency, we used the American Council or an Energy EciencyEconomy (ACEEE) report: Laying the Foundation or Implementing a Federal Energy
Eciency Resource Standard, published March 18, 2009.
Our estimate or transportation is based on a memo dated June 2007 by the NationalCommission on Energy Policy and the International Council or Clean Transportation.The study quanties reductions rom a low carbon uel standard (LCFS) and the FuelEconomy Reorm Act and nds the combined measures would yield 550 milliontons by 2020. This orecast is likely overestimated because it does not account orthe Energy bill passed later that year and uses the 2007 AEO BAU orecast.
Point Carbon does not support or promote any o the policies studied, nor does itassociate with the policy positions rom the authors o these studies.
Textbox 2: Sources or Emission Reduction Estimates
8/9/2019 US Cap-and-Trade Program: Options for Compliance
6/13
Carbon Market Analyst North America
6 All rights reserved 2009 Point Carbon
CMA April 2, 2009
2023. As shown in Table 2 and Figure
2, the new E-t-C is roughly halved by
the complementary policies, leavingonly hal the initial gap to be reduced
by market orces.
Another way to look at these numbers
is by compliance period (Table 3). The
Waxman-Markey bill establishes two-
year compliance periods, allowing
companies to borrow and bank rom
one year to the other within the two-
year periods. By smoothing out the
dierences created by the phase-in
provision, compliance periods provide
a clearer picture o the reduced but
growing gap over the rst nine yearso the program.
Because the E-t-C constitutes such
a small percentage (2-5 percent) o
the total cap rom 2012 to 2014, it
is possible that the program could
actually be over-allocated in its earlyyears. Should the impact o the
recession be lasting on emission
levels, and should the transportation
provisions yield early reductions, US
emissions could be lower by a ew
hundred million tons, potentially
making the system long. This over-
allocation would be unlikely to last
because o the steeply declining cap
and thereore would not threaten the
long-term integrity o the program.
Conversely, the orecasts could
be overestimating the expected
reductions rom the policies by
using an outdated baseline, or
because o overlap between the
policies - making the sum less than
the parts. In this case the gap would
be larger and a larger role let to
markets.
Compliance OptionsWe now turn to compliance options:
ways to ll the gap between actual
emissions and the cap, under a price-
driven, market-based mechanism.
Companies regulated under a cap-
and-trade program typically ace
three main compliance options:
reduce their own emissions
(internal abatement);
purchase allowances;
buy oset credits.
Economic theory warrants that
companies will opt or the least cost
option rst, moving up the marginal
abatement cost curve until their
emissions match their allowances.
In other words, a company will only
attempt to reduce its emissions
i it anticipates that doing so willcost less than buying osets or
allowances. I the market unctions
without distortions, allowance prices
should refect the marginal cost o
abatement.
We take a closer look at the
compliance options most likely to
be on the margin: osets and uel
switching. For each we oer, to the
extent possible, a volume and price
assessment.
Buying osets: the cheap wayout?
Osets are emission reduction
credits rom project-based activitiesthat can be used to meet compliance
as a supplement or alternative to
reducing ones own emissions. The
use o osets is usually subject to
a quantitative limit, or quota, known
as supplementarity. The Waxman-
Markey bill sets a very large ceiling
or osets o up to 2 bn tons annually,
evenly split between domestic and
international osets.
The total amount o osets allowed
into the system is roughly 1.5 bn tons
per year rom 2012 to 2015, then 1.7bn rom 2016 to 2020, amounting
to 30% o the cap in average. The
drat bill also suggests a 20 percent
discount rate or oset credits,
calling or 1.25 oset credits to claim
one ton o CO2e (one allowance).
Domestic osets
The oset market is developing ast
Figure 2: Whats let to markets?
4,000
4,500
5,000
5,500
6,000
6,500
2012
2013
2014
2015
2016
2017
2018
2019
2020
MilliontonsCO2e
Remaininggap
RES Energy Efficiency StimulusThe Waxman-Markeybill sets a generousceiling o up to 2 bn
tons or osets
8/9/2019 US Cap-and-Trade Program: Options for Compliance
7/13
Carbon Market Analyst North America
7 All rights reserved 2009 Point Carbon
CMA April 2, 2009
in the US, largely in anticipation o
a regulated market. Point Carbons
oset database Carbon Project
Manager North America lists mostoset projects in the US and Canada.
The current pipeline o projects is
about 20 mt annually in 2012.
Not all oset credits currently traded
on the voluntary markets would
qualiy under a compliance program,
however. Restrictions on project
types and quality would likely weed
out a signicant number o projects,
rom which oset credits are currently
generated. Projects in capped sectors
(such as energy eciency) would not
qualiy as osets anymore but asinternal abatement.
The Waxman-Markey bill does not
establish an exhaustive list o eligible
project types. We use elements
rom previous cap-and-trade bills to
distinguish between projects likely
to make the cut or not, and conclude
that ve oset type categories are
Figure 3: US carbon oset pipeline with likely eligibility
0
5
10
15
20
25
y2000 y2001 y2002 y2003 y2004 y2005 y2006 y2007 y2008 y2009 y2010 y2011 y2012
0
5000000
100
00000
15000000
20000000
25000000
Fuel Switching
Energy Efficiency
Renewable Energy
Industrial Processes
Geosequestration
Biosequestration
Forestry
Soil Sequestration
Fugitive Emissions/CMM
Agricultural Waste
Landfill Gas
Likely-EligibleMilliontonsCO2e
most likely to qualiy under a ederal
compliance program: agricultural
waste, orestry, ugitive emissions
(coal mine methane), landll gas
and soil sequestration. (See our
previous report, US Osets: Outlook
or Supply and Demand, published
January 22, 2009, or more details).
As illustrated in Figure 3, only about
hal o the projected volume would
qualiy i screening out the non-
eligible projects, bringing the supply
to about 10 mt in 2012.
Could US osets ever come close
to lling the E-t-C gap? It is highly
unlikely, i not impossible. Even
though we anticipate investment in
osets to rise sharply as the beginning
o the cap-and-trade program nears,
the increase in available credits is
unlikely to get even near the limit. US
oset supply will be constrained by
sheer physical limitations - there are
only so many sites (landlls, arms,
and elds) that could potentially
qualiy and host oset projects. I
osets are discounted at a ratio o
5 to 4 as suggested in the Waxman
bill, the amount o credits would be
even less adequate. The suggested 1
billion ton limit on domestic osets in
the bill hence sets a theoretical limit
on demand, but the real limitation
will be on the supply side.
The role o domestic osets will bedetermined by how they compare
nancially to other compliance
options. Current average over-the-
counter oset prices vary rom $4.00
to $9.00 a ton depending on project
types and certications, and CCAR
utures (Dec12 delivery) trade at
roughly $7.00 a ton on the Chicago
Climate Futures Exchange.
It is highly unlikely
US osets could evercome close to lling
the E-t-C gap
8/9/2019 US Cap-and-Trade Program: Options for Compliance
8/13
Carbon Market Analyst North America
8 All rights reserved 2009 Point Carbon
CMA April 2, 2009
International osets
In addition to domestic osets,international osets are also likely
to qualiy as a compliance option in
the US. Again, the Waxman-Markey
bill allows up to one billion tons in
international osets or compliance.
The dynamics or international
credits are much more complex, as
US emitters will be competing with
entities covered by the EU Emission
Trading Scheme and parties to the
Kyoto protocol or those reduction
credits.
The current international oset
system is the Clean Development
Mechanism (CDM) and Joint
Implementation (JI) under the Kyoto
Protocol. Point Carbons database
Carbon Project Manager anticipates
that around 1,850m Certied
Emission Reductions (CERs, credits
rom CDM projects) and Emission
Reduction Units (ERUs, credits
EUAs (Europe)AEUs
(Australia)
2012 15 ($19) A$21.75($14.50)
2015 48 ($63) A$23.25($15.50)
2020 48 ($63) Not available
Table 4 - International allowances
2012 prices are uture prices traded onthe exchange (2011/12 or Australia)Point Carbon orecast or Phrase 3 EUETS prices and traded 2012/13 uturesor the Australian CPRS
rom JI projects), will be issued by
2012. Ater 2012, the orecast is
much more uncertain (see Textbox3), as the uture o the CDM will
be renegotiated in Copenhagen in
December 2009. However, given
Point Carbons main policy scenario
or post-2012, CER volumes could
increase to 715 mt in 2015, beore
down to 75 mt in 2020 (see our CMA
The Future of the CDM: Supply
Forecast to 2022, November 26,
2008).
Prices will play a determining
actor in the nal use o CERs.
Secondary CERs (Dec12 delivery)are orecasted by Point Carbon at
21 ($28) and usually track European
Union Allowances (EUAs) at a
discount. I EUA prices are higher
than a US allowance price, the use o
international osets will be secure in
Europe - but i EUA prices are close
to US prices, US emitters could have
a shot at securing some o these
credits.
International negotiations are
increasingly ocusing on two new
types o international credits:reduced and avoided deorestation
(REDD) projects and sectoral credits
(see Textbox 3). The Waxman-Markey
bill signals a strong interest in both
credit types by allowing their use or
compliance. Sectoral credits are still
at an early design stage but enjoy
strong political support on both sides
o the Atlantic (see Textbox 2 and our
Analyst Update: ECs sector crediting
proposal, rom March 19, 2009).
REDD also enjoy political support but
ace with major challenges related
to accounting, monitoring, and
enorcement. We have no indication
o volume or prices or either o these
mechanisms, but we expect they will
play a large role in compliance post-
2012.
The uture o the CDM will be renegotiated in Copenhagen in December 2009, in an attempt to address concerns about thequality o projects, the countries where they are located, and eorts to redene eligible project types. An important source osupply uncertainty stems rom the discussion on project types and reorming the approval process. Stricter approval criteriacould lead to a dwindling o the supply, possibly matched by tough import limits by the EU ETS in Phase 3.
Another source o uncertainty comes rom the act that countries currently hosting most o the CDM projects China, India,
Mexico, South Korea, etc. might take on mandatory targets ater 2012 in a successor agreement to Kyoto, which wouldend the supply o oset credits coming rom those countries. The emissions reduced by CDM projects taking place in thosecountries would then count toward the respective countrys achievement o its emission reduction obligation. This expectationthat more countries will take on legally binding reduction commitments post-2012 explains the dramatic all in supply between2015 and 2020.
CERs could be replaced by sectoral credits, a proposed mechanism based on a no-lose target or a set o industrial installationsin advanced developing countries. Under this proposal, the group o installations, ideally covering a whole industrial sector,would have an emission target below its business-as-usual emissions. I it reduces emissions below the target, it will be givencredits equal to the dierence between the target and actual emissions. But there would be no penalty i the targets are notmet. The mechanism is anticipated to generate larger volumes o reduction credits than the CDM.
Textbox 3: Wither the Clean Development Mechanism?
Sectoral credits enjoystrong political sup-port on both sides o
the Atlantic
8/9/2019 US Cap-and-Trade Program: Options for Compliance
9/13
Carbon Market Analyst North America
9 All rights reserved 2009 Point Carbon
CMA April 2, 2009
International allowances
The Waxman bill also permitsemitters to use allowances rom
other emission trading programs
or compliance. Until recently, this
would have applied to the EU ETS
exclusively, but the implementation
o a carbon pollution reduction
scheme by 2010 in Australia, as
well as the expectation that other
countries (New Zealand, South
Korea) may ollow suit, opens up new
possibilities.
Volumes are potentially large, since
the entire pool o allowances rom the
other trading programs could be used
or compliance. The Waxman-Markey
bill does not set any limitation on the
use o international allowances or
compliance, so that the limitation is
more likely to come rom prices.
At current prices, European Union
Allowances (EUAs) and Australian
Emission Units (AEUs) could
constitute an attractive compliance
option. Figure 4 plots prices or EUA
utures (Dec 12 delivery). However,
Point Carbon anticipates prices will
increase in the EU ETS, as the cap
or its next compliance phase (Phase
3, 2013-2020) is very strict. We
orecast prices at 42 in 2013 and
48 on average over the whole phase
(assuming no linkage with the US).
To conclude domestic osets will
not ll much o the gap as they are in
short supply. US osets are currently
the least cost option but this might
change i we see the same trend
as in the CDM market. CERs are
priced based on their value in use
(i.e. as substitutes or EUAs) and not
based on marginal production costs.
US osets would then track US
allowance prices at a discount.
The role o international osets is
more uncertain. The CDM may not
be the right vehicle or the long term
supply o credits to the US market. I
an agreement is ound in Copenhagen
on sectoral credits and / or on REDD,
these would likely constitute the bulk
o the credit fow into the US.
International allowances could play
a large role i the various emission
trading programs establish linkages
allowing ree trade rom one program
to the other.
Internal Abatement
We now consider ways to reduce
emissions or large compliance
players, internal abatement.
As the import limits o osets and
international allowances are de acto
almost unlimited, the split between
oset credits and internal abatement
as compliance option will mainly
depend on prices.
Emitters have many emission
reduction options, including
Our analysis o the role o international allowances assumes that US emitters couldpurchase allowances rom Europe or Australia, but that the reverse is not true. In thelong term, however, one could oresee increasingly integrated global markets whereallowances would be reely traded rom one compliance program to another. TheEuropean Commission suggested in a recent Communication that it ambitioned tosee an OECD-wide market - including all major industrialized countries by 2015.
I there are no restrictions on the use o allowances in other markets, this wouldlead to a global, unique carbon price. In practice, countries are likely to set a limit,or quota, on how many oreign allowances can be used or compliance creatingdierent subsets o prices.
Even i direct trading o allowances is not allowed, international osets couldindirectly link dierent programs, as emitters in each country would be competingor the same credits. Hence policy developments abroad could play a role in price
ormation and market dynamics in the US in the medium to long term.
Textbox 4: Towards a global market?
Figure 4: EUA uture prices
0
5
10
15
20
25
30
35
40
Jan-08
Feb-08
Mar-08
Apr-0
8
May-08
Jun-08
Jul-0
8
Aug-08
Sep-08
Oct-0
8
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Price/tCO2e
EUA 2012
The limitation on the
use o internationalallowances will come
rom prices
8/9/2019 US Cap-and-Trade Program: Options for Compliance
10/13
Carbon Market Analyst North America
10 All rights reserved 2009 Point Carbon
CMA April 2, 2009
improvement o industrial processes,
reducing methane leaks in pipelines
and rening, limiting the use o high
global warming potential (GWP)
gases fuorocarbon gases, etc. We
ocus on uel switching exclusively
because it is more likely to deliverlarge numbers o emission reductions
and thus be on the margin.
Fuel switching
Large reductions can come rom the
power sector: as the price o carbon
penalizes more carbon-intensive
uels (coal, petroleum) than natural
gas or carbon-ree generation, the
economics start working in avor o
the less carbon-intensive uels (see
our report The Power o Carbon, June
2008 or a detailed analysis o this
issue).
The amount o reductions at any
given carbon price varies with the
relative price o the uels. Point
Carbon created a simplied model
to evaluate the amount o reductions
associated with uel switching rom
coal to gas by applying a carbon price
to the electric generation feet by
region. Switching varies by region,
but the model assumes that price
would trigger the switch regardless
o any technical impediments.
Figures 5a and 5b show emissions
reductions rom uel switching in
$5 increments. Figure 5a uses spot
uel prices rom March 2009 ($4.35
natural gas, $49 coal, $63 SO2, $625
Nox) while Figure 5b plots the uel
switching curve using uture prices
or December 2012 delivery, as o
March 24, 2009 ($7.45 natural gas,$67 coal, $35 SO2, $650 Nox.)
The gures illustrate the extreme
sensitivity o uel switching to actual
uel prices. A carbon price o $10 a
ton yields over 120 mt o reductions
in GHG emissions in one case, and
a mere 10 mt in the other. I natural
gas is relatively more expensive than
coal, it takes a higher carbon price
to make the switch economical on
power markets.
Fuel switching has a potential or large
volumes o emission reductions.
However, i coal prices are low, the
carbon price needed to realize this
potential can climb very rapidly, as
seen in Figure 5b. I uel switching is
expensive and is setting prices on the
carbon market, it will provide a strong
signal or emitters to look into other
internal abatement measures. These
abatement measures would create
a negative eedback loop that would
eventually pull back down prices,
to the point where uel switching
is more economical than any other
abatement strategy.
Market Implications
Price ormation
Prices on the carbon market are set,
like those o other commodities,
by the intersection o supply and
demand. Figure 6 represents a
conceptual marginal abatement cost
curve. In this example, we assume
US Fuel switching curvefuel spot prices
$0
$10
$20
$30
$40
$50
0 50 100 150 200 250 300 350
Million tons CO2e
U
SDp
ertonofCO2e
Figure 5: Fuel switching curve in the US, spot and 2012 uture prices
We use NYMEX spot and 2012 uture uel prices as o March 24, 2009
US Fuel switching curve
future fuel prices (2012 delivery)
$0
$10
$20
$30
$40
$50
0 50 100 150 200 250
Million tons CO2e
U
SDp
ertonofCO2e
Reductions rom uel
switching are ex-tremely sensitive to
uel prices
8/9/2019 US Cap-and-Trade Program: Options for Compliance
11/13
Carbon Market Analyst North America
11 All rights reserved 2009 Point Carbon
CMA April 2, 2009
domestic osets are the lowest
cost compliance option, ollowed by
international osets. Fuel switching
(internal abatement) comes next,with international allowances at the
higher end o the range.
The demand intersects the marginal
abatement curve at 205 million
tons (the 2012 E-t-C without
complementary policies), calling
or some amount o uel switching
and bringing prices to around $30
a ton. Should energy eciency and
renewable electricity standards be
adopted, the demand curve would be
lower, and would intersect the MAC
curve at 87 million tons. Internationalosets would be on the margin, no
uel switching would be needed, and
prices would be below $15 a ton.
Conversely, as the size o the E-t-C
gap grows over time, the demand
curve will shit to the right because
emitters will need more allowances
to cover a greater shortall. This will
push prices up the uel switching
curve i no other type o reduction
takes place. As discussed above, the
MAC curve is itsel subject to change
as oset supply and uel prices
change over time.
We now tie the pieces together and
discuss likely compliance strategies
or selected compliance periods in
the rst decade o the cap-and-tradeprogram.
2012-2013 Few reductionsneeded
The rst compliance period would
require about 140 million tons o
reductions each year. US osets
will not suce to meet the gap.
CERs would constitute the next
most attractive compliance option.
I prices on the EU ETS have not
recovered, EUAs could also be part o
the compliance mix and would bring
prices on the US market to about
$20 a ton. I emissions and pricesrecover in Europe by 2012, prices in
the US would likely be set by CERs
and could thereore track EUAs at a
discount. This would constitute the
rst hint o market linkages.
It is also possible that the scheme
would be somewhat over-allocated i
the recession has an enduring eect
or i energy eciency investments
deliver their theoretical emission
reduction potential. The program
would not be compromised i
it started with a brie period o
over-allocation, provided that over-
allocation is small: participants would
likely bank allowances or later years,
when the caps get tighter. This would
prevent prices rom crashing to
zero. The bank would create a small
cushion to help buer volatility rom
uel prices or unoreseen exogenous
events.
I the eect o complementary
policies is lower than expected,
market participants will have
to procure more osets and
international allowances or turn to
internal abatement.
2016-2018 A wide array oabatement strategies
By the time the third compliance
period rolls in, the gap will have
grown to over 550 million tons:
this strong demand or allowances
calls or a wide array o reduction
strategies. All available US osets
will be tapped and the demand or
international osets will increase.
The gap could still potentially be met
through international osets, possibly
including the new credit types romsectoral and orestry programs.
I the competition or international
osets was such that osets could
only cover hal the gap, 250 million
tons o reductions would be needed.
Such volume o uel switching would
call or very high prices, up to $85 a
ton. Hence other compliance options
would likely come into the mix
Figure 6: Conceptual MAC curve
$0
$10
$20
$30
$40
$50
$60
0 100 200 300 400 500 600
Million tons CO2e
USD
pertonofCO2e
Volume
Price
Fuel switching
US Offsets
Intl Offsets
Intl Allowances
Demand curve
Marginal Abatement
cost curve (supply)
Demand goes up
as EtC grows
US emitters will haveto compete withother countries or
the international credits
8/9/2019 US Cap-and-Trade Program: Options for Compliance
12/13
Carbon Market Analyst North America
12 All rights reserved 2009 Point Carbon
CMA April 2, 2009
other internal abatement measures.
International allowances, even priced
at 50 a ton, could remain attractive.
Figure 7 shows the wide array o
compliance options that will be
necessary to meet the gap in the
medium term.
2020: The breaking point?In 2020, with a gap close to 800
million tons, we would approach the
point where meeting the gap under
current technological constraints
becomes very costly unless the
supply o international credits is
sustained and aordable.
High carbon prices could also raise
the interest in creating linkages
with a large number o countries.
The larger market could help
dampen the volatility derived rom
uel prices and would theoreticallyenable all participating countries to
take advantage o the lowest cost
reductions through the market.
This is especially true i countries
like South Korea or Mexico set up
their own trading program, where
reduction costs could be lower than
in Europe or in the US.
Figure 7: Meeting the E-t-C
5200
5400
5600
5800
6000
6200
6400
BAU Stimulus RES EnEf Remaining
emissions
Dom.
offsets
Int'l
Offsets
Fuel
switching
Cap
What to expect post-2020
Our analysis was ocused on the
short to medium term as it allowed
us to project the impact o policies
currently under discussion and to
assume no major technological
breakthrough would occur. But with
a rapidly declining cap, change within
the system will quickly become verycostly, providing a strong incentive
or technologies in the development
stage today like carbon capture and
storage or electric cars. Osets
play a key role in helping keeping
prices down while this transition
takes place, since investments in
cleaner power plants and new energy
systems take time. Whereas osets
provide a temporary x and a useul
cost-containment mechanism, they
do not substitute or necessary long
term changes.
ConclusionAll signals indicate that the new
administration and Congress are
serious about their commitment
to lower GHG emissions. The
dominant strategy involves a mix o
command-and-control and market-
based mechanisms. The regulatory
provisions energy eciency and
clean energy standards or the power
and transportation sectors have thecapacity to evoke large reductions
at a airly low cost, especially or
energy eciency measures. These
provisions are not only crucial or the
US to meet its target; they will also
lower signicantly the price o carbon
on the traded market.
US osets are unlikely to play a
large role as a cost-containment
mechanism because their supply
is very constrained. An increase
in investment will help increase
the available volumes, but the keylimitation is physical rather than
nancial.
The degree to which the internal
abatement option o uel switching
is deployed largely depends on the
level o reductions achieved by the
other options. Some amount o
switching will occur, but the carbon
cost at which uel switching becomes
economical is very volatile and does
not provide the clear, predictable price
signal needed to redirect investments
towards clean technology in the longterm.
These limitations put the spotlight on
international osets and allowances,
where larger amounts o emission
reductions could come rom
developing countries at lower costs.
But uncertainties related to the
upcoming international negotiations
still cloud orecasts both or volumes
and prices. The experience with
the CDM shows, however, that
maintaining high standards and
submitting projects to a stringent
evaluation process raises prices
even or initially low-cost projects.
International allowances and linkages
with other emission trading system
could also help temper prices in the
medium term. The outcome o the
Copenhagen negotiations will thus
have signicant implications or the
US carbon market.
8/9/2019 US Cap-and-Trade Program: Options for Compliance
13/13
Ofces
United StatesPoint Carbon North America
1200 First St, NE
Suite 310
Washington, DC 20002
Phone: +1 202 289 3930
Fax: +1 202 289 3967
UK
Point Carbon, UK
Second Floor
102-108 Clerkenwell Road
London, EC1M 5SAUnited Kingdom
Phone: +44 (0)20 7253 7878
Fax: +44 (0)20 7253 7856
Ukraine
Point Carbon, Ukraine3 Sportyvna Ploscha
Entrance IV, 4th oor
Olymp Business Center
01601 Kiev Ukraine
Phone + 38 044 499 0308
Fax: +38 044 499 0309
Representatives
JapanJPower
Ms. Sumie Nakayama
Tel +81 3 3546 9375
Mizuho Inormation and
Research Institute, Inc.
2-3 Kandanishiki-cho
Chiyoda-ku Tokyo
101-8443 Japan
Tel +81 3 5281 5410
Fax +81 3 5281 5466
yasushi.setoguchi@
gene.mizuho-ir.co.jp (Ofce)[email protected] (Res.)
Editorial inquiriesEmilie Mazzacurati
Tel +1 202 289 3930 ext. 252
Fax +1 202 289 3967
Kjetil Royne
Tel: +47 22 40 53 40
Fax: +47 22 40 53 41
Sales inquiriesPoint Carbon Sales Team
[email protected]: +1 202 289 3930
Fax: +1 202 289 3967
Other inquiriesPoint Carbon, Norway
(Main Ofce)
P.O. Box 7120 St.Olav
N-0130 Oslo
Norway
Tel +47 22 40 53 40Fax +47 22 40 53 41
Website
www.pointcarbon.com
Contacts
13 All rights reserved 2009 Point Carbon
CMA April 2, 2009
A Point Carbon publicationCopyright 2009, by Point Carbon.
All rights reserved. No portion o this publication may be photocopied, reproduced, scanned into an electronic retrieval system, copied to a database, retransmitted,
orwarded or otherwise redistributed without prior written authorization rom Point Carbon. See Point Carbons Terms and Conditions at www.pointcarbon.comThe data provided in this report were prepared by Point Carbons Trading Analytics and Research division. Publications o Point Carbons Trading Analytics and
Research division are provided or inormation purposes only. Prices are indicative and Point Carbon does not oer to buy or sell or solicit oers to buy or sell any
fnancial instrument or oer recommendations to purchase, hold or sell any commodity or make any other investment decision. Other than disclosures relating to
Point Carbon, the inormation contained in this publication has been obtained rom sources that Point Carbon believes to be reliable, but no representation or war-
ranty, express or implied, is made as to the accuracy or completeness o this inormation. The opinions and views expressed in this publication are those o Point
Carbon and are subject to change without notice, and Point Carbon has no obligation to update either the opinions or the inormation contained in this publication.
Point Carbons Trading Analytics and Research division receives compensation or its reports. Point Carbons Trading Analytics and Research division reports are
published on a subscription basis and are not issued at the request o any client o Point Carbon.
Top Related