By Jim Kharouf
Getting global agreement on environmental policies is incredibly difficult. But as the history of the North American carbon market illustrates, even getting regional players on the same page is no easy task.
“If I had to describe the carbon markets in the U.S. and Canada, it would be two steps forward, one step back,” said Dan Scarbrough, president and chief operating officer of IncubEx, a consulting firm that specializes in product and business development for environmental markets.
Over the past 15 years, a patchwork of state and regional carbon cap-and-trade markets has evolved in the United States and Canada. These separate markets have endured a number of political and economic challenges, but today they are showing more trading interest than ever before.
The goal of the cap-and-trade model is simple – creating economic incentives to lower emissions. A limit is set on the amount of carbon that a company can emit. Companies that go over their limits have to go into the carbon market and buy emission credits. Companies that reduce their emissions below the target level, for example by switching to cleaner fuels, can sell those excess credits.
For more than a decade the European Union has been running a cap-and-trade program through its Emission Trading Scheme. But in the U.S., there has been no consensus at the federal level on how to address climate change. As a result, leadership on this issue has emerged at the state level, primarily in the northeastern and western parts of the country.
RGGI Rising in the East
In January, New Jersey Governor Phil Murphy signed an executive order directing the state to rejoin RGGI; former governor Chris Christie withdrew the state from the program in 2011. New Jersey could formally rejoin next year and analysts expect the state to start participating in auctions in 2020.
Meanwhile, Virginia Governor Terry McAuliffe ordered the creation of a market-based carbon program for state utilities that aims to link to RGGI. A bill in the state legislature to join RGGI failed to pass, so the Virginia Department of Environmental Quality drafted a plan to create a cap-and-trade program that is linkable to RGGI. As such, its program would not generate any revenues from auctions, as RGGI states do. But Virginia would set its standards in line with RGGI and even use the RGGI auction process. A final draft rule from the department is expected sometime this year, setting the stage for Virginia to connect to RGGI with a slightly different set-up.
RGGI is also going through a process of internal change aimed at accelerating its impact on pollution. The original goal was a 45% reduction in annual power sector emissions by the year 2020. Last fall, RGGI announced a new goal to cut another 30% by 2030. In effect, this means utilities will have to find ways to lower their emissions even further or pay for additional carbon credits, sparking additional interest in the secondary market for these products.
“With a greater amount of players with natural positions in the market, we believe that will help increase liquidity in the market,” said Evan Ard, managing director at Evolution Markets, one of the longest operating environmental and energy-focused brokers in the space. “And with Virginia, we’ll see a little more geographic diversity.”
In contrast to RGGI, the Western Climate Initiative has had mixed fortunes. When it was founded in 2007, five western states were on board with the project, but by the time it launched several years later, only California and two Canadian provinces, Québec and Ontario, remained committed.
The WCI took another step back in June when the Progressive Conservative Party won a majority in Ontario. In early July, Doug Ford, the new premier, pulled the Canadian province out of the cap-and-trade program, delivering on a promise he made during the campaign, and prohibited regulated entities in Ontario from trading emission credits. In response, California and Québec immediately closed their markets to trading with Ontario entities.
Prices for carbon allowances took a hit, but market participants took the exit in stride. Just by itself, California ranks as the fourth largest carbon market globally, and its carbon credits represented 83% of the WCI allowances last year, with Quebec holding the other 17%. Ontario had only just linked to the WCI market in September 2017 and was expected to represent about 26% of the market, but had only participated in a few auctions.
Meanwhile California has renewed its commitment to cap-and-trade. The state recently extended its program out to 2030, giving market participants the certainty that this market will be around for quite awhile.
In addition, the loss of Ontario may be offset by newcomers. Nova Scotia is planning to go live in January 2019 with a cap-and-trade program covering about 20 companies. The province has joined WCI, but mainly for help in program design; no trading link with the other jurisdictions is in the works yet. Meanwhile, Mexico is developing its own national emissions trading system and may join the WCI too.
With all of these moves, market participants have been more engaged in North American carbon futures markets. ICE lists futures on state and province-based carbon allowances. As of the end of July, year-to-date volume in California Carbon Allowance futures and options reached 300,000, more than 50% higher than the volume in the comparable period of 2017. Year-to-date volume in RGGI futures and options reached 75,000 contracts, compared to just under 54,000 for the comparable period of 2017.
Market participants say the North American carbon and renewables sectors are showing more interest and life than they have in years. The key to any market is to have a healthy balance of commercial users, financial players and speculators. This market appears to be attracting all of those from utilities to hedge funds, said Robert Vujtech, global head of energy for the prime services arm of Société Générale in the U.S.
“For awhile it was really concentrated with just end users,” Vujtech said. “But we have carbon funds. We still have the utilities and other commercial end-users. And so we’re seeing a wide variety of participants in this space.”
Evolution’s Ard said the ultimate goals for these markets are being met. With more certainty, internal improvements and participation from additional states and provinces, there is more optimism about these markets than in recent years.
“These markets have been performing well recently, and you can chalk that up to a couple of things,” Ard said. “The markets for the most part have been designed well, and the underlying goal of using these markets to improve the environment have been proven to work. That’s another reason they continue to live on. These programs are in the best shape they’ve been.”
Jim Kharouf is a veteran journalist and editor in the financial markets and serves as contributing global markets editor for John Lothian News, as well as a media content provider for several firms in the financial markets.
Republished with permission by MarketVoice | https://marketvoice.fia.org/articles/carbon-trading-north-america-two-steps