On U.S. Greenhouse Gas Trading Markets

Earlier in my career, I was heavily involved in the establishment of the first wide-scale emissions trading program: the sulfur dioxide (SO2) allowances that were created as part of the acid rain mitigation provisions of the U.S. Clean Air Act of 1990. By virtually all accounts, the SO2 allowance market has been highly successful in enabling significant SO2 reductions across the U.S. at much lower cost to society than would otherwise have been the case. This experience should serve as a useful model for how to deal with greenhouse gas (GHG) emissions that contribute to global climate change.

Unfortunately, at least for U.S. stakeholders, that really hasn’t happened yet. Leadership in emissions trading markets has now shifted to Europe, where the EU countries have adopted a GHG trading scheme similar in structure to the U.S. SO2 allowance program, except instead applied to GHG emissions.

Because of a lack of any federal initiative to date in the U.S., it has been the states that have taken the lead in developing trading markets for GHG emissions. For instance, several states have sought to impose GHG trading schemes, such as the Regional Greenhouse Gas Initiative in the Northeastern U.S. But, these remain as yet concepts, still to be implemented in the future.

As of today, the only markets in the U.S. aiming to address global climate change are the so-called “REC” markets. Rather than markets on the GHG emissions themselves, several states have encouraged the penetration of cleaner power generation technologies by creating tradeable renewable energy credits (RECs) associated with each kilowatt-hour of electricity from a REC-eligible source.

In my view, the state-level REC markets have two fundamental flaws:

  1. Many states with RECs have implemented different definitions of what sources qualify for REC treatment. In turn, this means that, rather than one nationwide REC market, we instead have separate REC markets for each state that have created RECs. While a number of firms (such as Evolution Markets) offer brokerage services in these various REC markets to help counterparties find each other and facilitate transactions, inevitably such balkanization of the REC markets serves to reduce the ability to transact relative to what could be achieved with a national market. Without adequate market “liquidity”, commodity markets tend to wither away into idleness. If that happens to the REC markets (as it has to some already), then the program is effectively useless. To advocates who claim that their renewable source of energy has an additional monetary value that can be monetized through REC trading, I can only say: “Watch out.”
  2. More fundamentally, REC markets do not address the problem of emissions directly, but rather address them only indirectly by encouraging the adoption of new renewable energy sources. But, other than the significant difference in emissions, is wind or solar energy really “better” than coal-based energy? Is it better than reducing electricity consumption by an amount that offers the same environmental benefit? Why shouldn’t there be any incentive for owners of pre-existing coal-fired powerplants to reduce their GHG emissions by 99%, or even 9%? And, why should wind or solar energy qualify for RECs just by regulatory edict, but not some potential future zero-emission energy source (such as ocean or fusion)?

For these reasons, I believe REC markets are doomed to eventual failure, hopefully to be replaced by a true U.S. cap-and-trade GHG market. The good news is that most proposals for addressing climate change that have been increasingly emerging in the U.S. Congress include cap-and-trade mechanisms of one form or the other. It may take a few more years, but I am optimistic that a bill of this type will eventually be passed and signed into law. Once imposed, we can sweep the various state REC markets into the dustbin.

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