This is the fourth post in five-part series on the details required to get carbon policy right. See also parts one, two, and three.
We now get into an issue that will seem a bit arcane, because no one's talking about it, at least not explicitly. But it's a real choice, and in many conversations about carbon policy we are implicitly getting it wrong.
Should we price carbon in spots, or strips? Or, to take it out of financial jargon, should we:
- set up markets such that people who are selling or buying emissions credits have to go to the market with each incremental ton to determine what the price will be (a "spot" market), or
- set up markets such that buyers and sellers can enter into long-term contracts for the emissions they will produce/reduce (a "strip" market)?
Before talking about carbon, we need to take a brief foray into electricity deregulation, specifically back to the early 1990s, when academics were developing rules for how a deregulated market would work, based on broader theories of how markets work. As a reminder, the central test of a good carbon policy is whether or not it encourages investment in carbon-reducing technologies. Replace the word "carbon" with "electricity" and you've got a good test for whether the attempt at electric deregulation worked. It didn't.
In those states which elected to deregulate their wholesale power markets, the driving theory was that if you provide a spot price for power, and allow any buyer or seller to trade at that spot price, you will liberate the power of markets.
While there are many complicated details to these transactions, that is basically still the way all these markets work, whether at PJM, ISO-New England, NYISO, or any number of foreign markets. There is a fair amount of regular trading volume on these markets today, and so it may sound odd to hear someone say they don't work. But they don't, for the simple reason that it's really hard to get comfortable spending billions of dollars of capital based on a gamble about where future prices are going to go.*
A thought experiment may be helpful. Imagine that you have a billion dollars -- about enough to build a modestly sized coal plant (or, if you prefer, around 400 MW worth of wind turbines). You have the good fortune to be planning your project in a deregulated state, so you don't need to get a bunch of permission slips from the local utility to build your plant. You just need to get permits, connect to the transmission system, and build. Now, for the sake of argument, we will stipulate that the average price on those power markets for the last year has been sufficiently high that -- if your plant was operating last year, and selling into those markets -- you would have earned $200 million/year in net revenue. That sounds pretty good, right? Five year payback, or an 18 percent return on your investment over the next 15 years. Would you build the plant?
This pretty quickly raises an obvious question: what's the price on the market going to be next year? The answer: You have no idea. Sure, you can predict. You can hire consultants to make forward price forecasts. But when all is said and done, if you build this plant, you are placing a bet with risks you cannot control. What if the economy slumps, demand for power falls, and the spot price collapses? You lose. What if spot prices go up? You win. Which is more likely? You don't know.
This is not to say that no one will build the plant. Some people have a higher tolerance for risk and will build anyway, in the belief that they have some underlying knowledge of where power markets are going. Some of them will be right. Some of them will be terribly wrong (witness Calpine's stunning $16 billion bankruptcy which, at core, was the result of a bad bet on the way that gas and electric prices were going to move on those spot markets).
But here's the rub: we didn't have to design the market that way. Indeed, there is no real market that works that way. (And by "real," I mean a market that traces its origins back to one dude who had something another dude wanted and negotiated a price, as opposed to ones whose rules were crafted by academics and regulators.) If you live in New England and buy fuel oil to heat your house, you have a whole choice of payment options. You can pay each month based on the price of oil. You can prepay and lock in your price for the year. You can pay a little more on delivery in exchange for a predictable fixed contract. And so on. Ditto for any number of other volatile commodities that we all buy on a regular basis.
And, ironically, the old, regulated utilities never build plants on spot prices. When they build a plant, they hold a rate case and then lock in their price. (They will also then buy long-term "strips" on their fuel contracts to ensure that they don't get pinched between future fuel and electric price volatility.)
Note that this is not to say that strips are always better than spots -- simply that if you want people to invest capital, you need to provide the option to sell on a long-term strip, short-term spot, and any crazy hybrid of the two. And those options naturally emerge whenever governments simply allow buyers and sellers to meet up, negotiate deals, and get out of the way. Risk-averse buyers will naturally gravitate towards risk-tolerant sellers and vice versa, ultimately creating a mélange of spots, strips, futures, swaps, hedges, derivatives, and all those exotic-sounding increments that are the hallmark of a functioning market. (For those not familiar with the terms, don't worry -- they can all be thought of as different ways to bundle risks, with higher risk "flavors" offering potentially greater -- but more volatile -- returns and lower risk options offering stabler -- but generally lower -- returns.)
Relevance to carbon markets
You can probably see where this is going. How are we going to price carbon?
As a tax? Notwithstanding my prior post, this approach isn't even as good as spot, since it is a price set from a regulator on high, stipulating a fixed price with no market correction to capture the vagaries of supply and demand.
As an auction, with periodic re-auctions to reset the price, as Gar suggested? That gives us something like a spot but has all the problems that we've seen in the last decade in the electric sector.
As a government-established trading floor, modeled on the electricity sector? That simply repeats the problems we've already faced in the electric sector.
Here's the salient point. As of today, the only way you can buy or sell carbon (in the U.S.) in voluntary markets is on a spot basis. And the majority of the trading structures that are being considered in Congress are implicitly spot markets. And spot markets will have little impact on the decision-making process of those who want to invest money in projects to reduce greenhouse-gas emissions.
To the extent that there is a simple solution, it is this: trust markets. Let buyers and sellers meet up and trade in whatever fashion they like, and you'll get what you need. (With suitable government oversight, of course.) And if regulators cannot trust markets, then at least take advantage of the government's balance sheet to build in long-term contracts from the get-go. But don't assume that a spot price alone is sufficient.
*Point of candor: In the clearing prices for power (PJM, ISO-NE, etc.) that were set up as purely spot markets, one can now find other parties -- primarily financial traders -- who will buy and sell long-dated contracts, finally giving some semblance of "strips" to these markets. However, those transactions remain external to the regulated market, and it bears noting that it has taken about a decade for these players to arrive.
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Comments
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Green Texan Posted 8:19 am
31 Mar 2008
First place to start are new electric power plants...If they can build non-fossil fueled plants, great. If they can verifiably capture and sequester carbon, great.
If there are good, verifiable, and long-term carbon offsets available, OK. If offsets are allowed, this will "create the market" for carbon trading.
Much simpler approach, with less of this arcane nonsense few understand.
This one simple rule can get everything started. There is no need for great conceptual castles made of sand -- no matter how ornately elaborated they may be.
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JMG Posted 8:34 am
31 Mar 2008
OK, so don't pick a set price per ton -- set an initial per ton tax at a plausible level and then modify monthly until the desired carbon emissions level is reached. Requires no brilliance from a "regulator on high," just a willingness to allow government the same flexibility that the markets like to insist that they offer.
If all the money is being used to reduce payroll taxes and insulate the poor from the regressive nature of the tax and to clean up pollution, people won't really care -- as carbon emissions go down and more carbon-free sources are funded, the bite on any person will go down.
What's always interesting is that, in attacking carbon taxes, cap-and-gamers always pretend that taxes are and must always be crude instruments that look clumsy next to cap-and-game schemes. But it's purely a mental construct.
Save your community: Cut greenhouse gas emissions 5% per year.
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Sean Casten Posted 8:44 am
31 Mar 2008
The elegance of a trading system is that an excess of demand will drive up the price and an excess of supply will drive it down. Which in turn creates stimulus for greater or lower reductions. (Indeed, for all it's flaws, a great success of the SOx trading program was that the price plummeted as more supply came on line than was predicted and people found they could reduce SOx much more cheaply than anticipated. Could we have done it better? Absolutely - especially if we got rid of the grandfathering - but I have a hard time contemplating any tax-based structure that would have come close to this one.)
Taxes simply don't work that way, for the simple reason that there is no feedback loop that doesn't go through a political process. Even with perfectly intentioned regulators who have nothing but society's best interests at heart, that still introduces a time constant between supply/demand and price. And I'm pretty sure that even that ideal doesn't exist...
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naturescene Posted 12:28 pm
31 Mar 2008
Granted, this article is rather technical for some and may put some people to sleep, but you made an excellent point:
"if you want people to invest capital, you need to provide the option to sell on a long-term strip, short-term spot, and any crazy hybrid of the two. And those options naturally emerge whenever governments simply allow buyers and sellers to meet up, negotiate deals, and get out of the way."
It's really not a question of which is better, spot vs strip, but a question of whether or not we will allow the market to evolve. We don't really need to set up tons of rules at the beginning - in fact, doing so provides ammo for the people who claim "a tax is just so much easier than cap-and-trade."
Create the market, provide the base operating rules, and let it go to work.
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Sean Casten Posted 11:36 pm
31 Mar 2008
These details are indeed boring. (Although some of the boredom must be laid at the doorstep of my writing style.) But the matter - and unfortunately, we in the environmental community have historically fallen in love with naive dreams of what we think the rules will do, without really understanding what the details will cause. As my friend Ken Colburn says of much environmental policy, "Great marquee, lousy movie". We need to start making good movies.
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Adam Stein Posted 12:34 am
01 Apr 2008
Related question: do you have an opinion on banking and borrowing? Not really the same as strips, but helps to smooth the peaks and valleys of prices. How about carbon price floors?
www.terrapass.com/blog
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Capster Posted 2:08 am
01 Apr 2008
In the end I am in agreement on your key point - we should trust markets. We should/will have strips, spots, and all the financial permutations that the market wants to invent. A stock is just like an offset - it's a spot price. The NYSE has then allowed all sorts of derivatives, puts, calls, etc to be built around these as hedging tools. I do believe this will happen with carbon. Now, I disagree with your comment that it took 10 years for this to happen with electricity. The NYMEX was trading electricity in various forms in the late 90s. Mostly spot pricing, but once deregulation occurred, there were other ways to hedge your electricity position. Some were "dirty" hedges, but options were there.
As for deregulation - well, I disagree that it didn't work. That's surely another discussion altogether. But in some well constructed markets, it has worked very well. In some markets that were badly constructed, it didn't. You seem to imply that the purpose for electricity deregulation was "to encourage investment in electricity reducing technologies" (correct me if I'm wrong). But that's not right - the reason for deregulation was to lower overall electricity prices, to allow some market forces to push prices down, and to give customers a choice in how they bought their electricity and gas - fixed price, variable, fixed with cap, etc. Innovation was certainly one of the possibilities, and we've seen enormous growth in investments in new energy technologies since deregulation in the late 90s/early 00s. Much of that is due to deregulation forces.
Good ongoing dialogue.
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Sean Casten Posted 3:20 am
01 Apr 2008
A system with a carbon tax, for one - since it is all stick and no carrot. (No bank is going to pay someone for a long-term right to their actual profit margin and that which they would have had if the energy costs were lower due to the lack of a carbon tax on the dirty guys.)
Similarly, if we do an auctioning system with periodic re-auctions as Gar suggested in the post that started this whole thread, you'd also lose any ability for the financial community to pay for long-term strips at known prices.
>do you think legislation needs to explicitly encourage the development of a strip market?
Good question. Legislation needs to recognize that without the ability to sell long-term strips, it is limiting it's ability to attract investment. Whether this recognition leads to a built-in strip price or simply to a regulatory structure that can attract financially sophisticated participants is a bit of an either/or - but with the caveat that the less certain the spot market, the longer the time constant before those financially sophisticated folks engage. So if we write legislation that has a spot structure and a phase in (which could be quite reasonable, from a political-caution perspective), we are inadvertently creating a structure that is going to keep smart money on the sidelines for a while. The current US VER market is telling in this regard: I can sell voluntary carbon reductions on spot markets today, and there are a lot of big-money players in those markets, but no one is selling strips because they look at all the noise in DC about future carbon bills and are reluctant to make long term bets until they have some clarity about what the long term looks like.
> do you have an opinion on banking and borrowing?
Candidly, I haven't thought much about it. Your thoughts?
>How about carbon price floors?
I'm generally opposed, for the same reason that I'm opposed to caps, in the sense that they distort capital allocation. The example is all those economies with fixed exchange rates, where the natural price deviates from the market price, and massive arbitrage opportunities arise. (Which, depending on the boundaries of the law, may rapidly evolve to fraud.) I was in Poland years ago (pre-peristroika) and the "official" exchange rate was about 1/7th of the black market rate, creating all sorts of goofy opportunities for tourists to make a buck on arbitrage, traders to fill the void - all in clear violation of the law. Putting caps & floors on carbon pricing create some of the same issues, in the sense that they either over- or under-price carbon relative to the price that can be justified by supply and demand. (Note that I am implicitly assuming a market mechanism - this is a very different issue if the price is established by regulation.) Once you have that disconnect though, you are guaranteeing that someone is going to be making profits at the expense of the system, either by paying an artifically depressed price for their right to pollute or by getting paid too high a price for their ability to clean things up.
Specific to a floor though, there is a separate issue: there are massive amounts of investment opportunties that save money and lower GHG emissions (e.g., they have a negative cost). A floor effectively assumes that these don't exist, creating windfall profits for those who create negative costs. And realize that as a guy in the negative-cost business, I am speaking against my financial interests by arguing against floors, since those windfall profits would accrue to me - but it wouldn't be good policy.
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Sean Casten Posted 3:32 am
01 Apr 2008
My beef with deregulation is that it moved the ball in the right direction, but given the ability to throw a 100 yard bomb, it opted for a 1 yard quarterback sneak. (And we still have 99 yards to go).
Examples:
Markets were opened up at the wholesale level, but distribution utilities retained their monopoly. Since the biggest opportunities to control costs are at the load (through heat recovery, use of opportunity fuels and local, hard-to-transport renewables, and by virtue of displacing upstream T&D), this effectively made deregulation an opportunity for nothing more than fuel switching and changes in plant dispatch order. Which have, indeed created benefits, but only of the very limited sense. As Amory Lovins has pointed out, "if you're standing under a tree full of low-hanging fruit, shake the damn tree." Our deregulatory model opted instead to go for the stuff at the top... and that low-hanging fruit largely remains unplucked.
Up until very recently, the wholesale power markets were structured only to allow big players to participate. I believe the Cal-PX traded in 50 MW chunks when it first opened, essentially providing no way for someone with a small, local generator to participate. Similarly, many of the markets still require very high fees to participate - whether it be deposits to sell into capacity markets or costs to get a spot in an interconnect queue. This is starting to change, but as initially set up, these fees were flat, making it proportionally more expensive for smaller participants to get into these markets.
Finally, with the notable recent exception of ISO-NE and PJM, the deregulated markets have been blind to load-sited measures (load curtailment, efficiency, etc.) This has the result of making it a good system to install new generation, but a lousy system to encourage conservation (or, per Lovins again, they are blind to "negawatts".)
They are starting to change - but only after 10 years of existence. And yes, there are traders starting to come about, but I'd still say that this is the early days of those markets. If I'm a regulated utility with a rate case, I can basically get a 15 - 20 year strip on the power when I build a plant. On todays deregulated markets, by contrast, I can get 5 - 10 year strips, tops. Better than it used to be, to be sure - but still on the short end of what you really need to incentivize investments in long-lived, big dollar energy assets.
If you're interested, more of my thoughts on dereg here.
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rcire Posted 5:17 am
01 Apr 2008
"Here's the salient point. As of today, the only way you can buy or sell carbon (in the U.S.) in voluntary markets is on a spot basis."
You are omitting a significant portion of the market that includes participants engaging in long-term transactions identical to the definition that you provide as a "strip" market. Numerous parties engage in long term transactions to purchase VER's on a regular basis. Am I missing something here?
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Sean Casten Posted 5:31 am
01 Apr 2008
If you know of someone out there who's currently trading long-term strips at more than $1 - 2/tonne, please send them our way. I'd love to be wrong on this one.
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rcire Posted 5:51 am
01 Apr 2008
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Pangolin Posted 6:41 am
01 Apr 2008
That's the essence of this argument; skim at the top and bill at the bottom. We played that game in California and the result was looting by corporate elites payed for by the taxpayer and the retail utility customer.
We played the "free market" game with the real-estate mortgage sector and the result is the grinding crash of the financial sector accompanied by a surplus of both empty houses AND homeless people.
We played the market game with the Iraqi occupation and the result is mercenaries that obey no law and the alienation of every muslim in the world. Plus billions of dollars that vanish every week with no hope of return.
Sean- I keep getting the sneaking suspicion that your projects only show black ink if coal is cheap but carbon offsets are supported. If electric power was expensive they would just move their plants elsewhere, like to Greenland. If the feed-in came from nuclear or wind at the same price as coal the project might not provide the return on investment. Only by providing a service that offsets the carbon emissions from cheap coal power do you appear to be comfortable. Where would that money come from if not from the polluter? Hold onto your wallets people.
When, like Vinod Khosla, an industrialist argues that the only possible solution is the one that puts money in his pocket first the rest of us should worry.
"Markets" are not a magic wand unless we are talking about the kind of market where those who make the rules get to profit from a captive population that requires services without options for substitution. Those "markets" make a great deal of money for the rulemakers; until they crash.
Put the Carbon Back
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Sean Casten Posted 7:14 am
01 Apr 2008
On the positive side, folks like that are starting to show up at the periphery, setting up US offices and monitoring the Congress so that they can move when the inevitable finally happens. But it is a peculiar environment we are in when you can get paid to lower carbon in China but not in the US... and all because the US decided not to engage in int'l treaties that didn't include China.
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Sean Casten Posted 7:45 am
01 Apr 2008
All that said, I do want to clarify a few points, because you are suggesting a set of motives that are 180 degrees away from my actual motives:
I don't support markets because I'm trying to screw the little guy. I support markets because I know of no better way to benefit every guy. Are they always perfect? Of course not - nothing is. But having traveled fairly extensively in Eastern Europe pre-glasnost (which, at that time, required spending large portions of your day standing on line for food and train tickets), I can assure you that life for those "at the retail level" is a heck of a lot better when Adam Smith's invisible hand is allowed to work. Closer to home, I have also lost a lot of projects where I could provide cheaper, cleaner power to a customer, but was blocked by a regulatory model that places the interests of electric utility shareholders above their customers. Again, where Adam Smith's hand is blocked, the customer loses. (Note also, per my prior posts that there is a big difference between being pro-market and being pro-business. Your criticisms of California, Iraq mercenaries and corporate elites is a valid criticism of situations where we put the interests of private business above the interests of competitive markets. But no-bid contracts, rigged power auctions and federal shareholder bailouts are the opposite of a competitive market - which is precisely the thing that I am arguing that we need more of.)
I'm not sure why you think that I'm an advocate for cheap coal. For the record, I see the rising cost of coal-fired power as good news, because it means that coal-fired power prices are finally starting to reflect their true costs (much of the cost increase is, after all, due to the fact that new plants must be Clean Air Act compliant - which, when one considers CO2 emissions and the destruction of Appalachia, is not remotely synonymous with "clean".) If coal-fired power is cheap and dirty, then it implies that our options to pursue cleaner sources must impose an economic cost. This is what the coal lobby would like us all to believe - but it isn't so. Coal-fired power is actually expensive and dirty. Which means that pursuing a cleaner path will actually lower energy costs. That's cause for great optimism - but only once we can get to a point where the pundits no longer presume that cheap/dirty is true.
At core, the reason that it is important that we get GHG policy right is not because of my business, your business or Joe the Rag Man's business. None of those individuals make a lick of difference to the challenges we all face. What does matter is that every one of those collective businesses and individuals look at our GHG policy and conclude that it is in their economic interests to take immediate action that dramatically lower GHG emissions. So far, that policy not only doesn't exist, but actually encourages the opposite. The sooner we can fix those incentives, the better off we will all be.
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David Roberts Posted 8:45 am
01 Apr 2008
grist.org
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RealCarbon Posted 1:40 pm
01 Apr 2008
Here's how it works:
You have a project. Say, a dairy methane project. You install a biodigester that collects the methane that would otherwise be vented into the atmosphere and burn it off, either through a flare or through a turbine to crate electricity. Say you have 4,000 cows and reduce 20,000 tons of CO2e.
Once you're verified (and occasionally before, but expect a lower price) you go out to the market to sell your offsets. This is where you make your first decision - do you sell spot or strips. If you are pretty confident the price of carbon is going to go up and you want to maximize profit and are willing to wait for it, then spot is a good call. If you want cash up front because you are afraid of market risk or need it to install a digester on your next farm, then streams are a good way to go.
Generally stream pricing is calculated by agreeing upon a strike price. Say you want to get $4 for your 2007 vintage tons and $5 for 2008, $6-2009, $7-2010, etc. Then you apply a net present value discount. Assume you can take the money you'd get from selling future vintages and make a 20% profit with that income elsewhere (a good standard is 5-10%). You would then discount each price according to the time value of the money. It's a little too complex to write down here, but for the sake of example say your average predicted income is $6/ton but you'll take $5/ton because of net present value.
Now, the buyer of the carbon (the trader) holds onto the risk of the tons he bought from you. He is going to hope the price goes up through increased demand (or manipulate the market buy buying up as much supply as becomes available, thereby creating an artificial shortage). His goal is to sell the tons for a value greater than the sale price plus the time value of the invested capital. This means for a 2009 he paid $5 which he believed would be worth $6 would have to be sold for greater than $6 to make a profit.
As a project developer, this is the most likely fate of the offsets you create. It's an efficient market and these trades happen over the counter. There are plenty of buyers out there will to buy strips and plenty of brokers capable of negotiating these deals. These deals are happening NOW.
Alternatively, there is a payment on delivery structure where you agree on a strike price where a project developer and a buyer agree on an annual price and contract for payment to the project owner as tons are delivered. For variable projects where the total number of tons cannot be predicted, this is called "unit contingent," meaning the price paid depends on the amount of tons of CO2 reduced. If the project reduces less than expected, the buyer pays only for those tons. If the unit reduces more, the buyer pays more. There are also fixed contracts where a buyer pays a flat fee annually for whatever is reduced. Again, the more risk the buyer assumes, the less he expects to pay.
As far as power goes, you're clearly not familiar with a power purchase agreement (PPA). A utility could sign a PPA with you to buy your power for a long term period of time at a fixed price. There are also options to protect you in case the price surges. You could say you'll sell a MWh for $10 for a ten year period, but if the spot price goes over $10 then you get 25% of the difference between the $10 and the spot price in addition to the $10.
The problem for a project developer is NOT selling strips. It's pretty easy to do. The problem is that no one knows what the carbon market will look like. Will it be cap and trade? Will it be command and control? Will there be a carbon tax? Will your dairy be regulated, meaning you then have to buy back offsets in order to avoid punishment?
All these risk factors are causing short strips. Five years is nothing for many offset projects. If a forest owner were able to sell a 20 year strip of credits, we would see far more of that type of project development because he can hedge risk by making a long term sale. The problem is that buyers are far too afraid of market risk to enter into a contract for longer than 5 years. Regulatory risk is the number one enemy of carbon offset developers.
If a robust cap and trade market allowing domestic and international carbon offsets is put into place with clearly defined rules, we should see much longer strips as utilities and other regulated entities enter into long term purchase agreements with projects, which is exactly what utilities are currently doing for RECs under RPS requirements.
You should take some time to learn more about environmental markets and exactly how they function before you write anymore blogs and ESPECIALLY before you start spending 1.5 billion dollars. It seems like you're working on some good stuff.
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Pangolin Posted 2:16 pm
01 Apr 2008
Complexity in "market" policy in recent history has had a tendency to provide a smokecreen for fraud. I'm not doubting that cogeneration is a good thing. I'm all for cogeneration. I just start to get suspicious when the flow chart starts to have three dimensions which I see a lot of in "cap and trade" proposals. I'm certainly not alone there.
Given two systems:
A Carbon Tax: CO2 emissions or the equivalent are taxed so that the mean wind power project and the mean solar thermal project are slightly cheaper than burning coal. All emissions are penalized. Then consumers and utilities decide how to generate their power and whether to conserve or pay the penalty. Taxes are simple to compute and everybody has a chance at saving on the cost of the penalty.
And....
Cap and Trade: CO2 and other GHG emissions are capped and a system that is probably opaque to the majority allows some emissions to be continued in exchange for "emissions savings" elsewhere. Due to documentation costs emissions reduction credits will not likely reach the retail level. The "market" in emissions reductions may be subject to political gaming due to complexity of structure. The largest existing "cap and trade" carbon market, the EU, hasn't demostrated an ability to reduce GHG emissions overall.
I have no objections to a market where the rules are clear and the market has proven an ability to demonstrate an overall benefit to the common good. Competition within a structure is good for everybody. Where the rules aren't clear they frequently aren't fair either.
In one sense David is right; I don't trust major players to play fair when they have a chance of getting their fingers in the pie before it leaves the kitchen. All sorts of disastrous mischief has been done recently in the name of "markets" and frequently damage the many to profit the few.
I actually don't even expect to win this arguement. I expect that a cap-and-trade system will be enacted and then it will fail. Money will wander all over the map, strange projects will be started and abandoned half completed and emissions will continue to rise past the caps due to loopholes. A small number of people will get very, very rich. Like California's energy fiasco, the real-estate fiasco, and the Iraq contract fiasco the same parties who sold the disaster as "market policy" will then claim that it somehow didn't fit the definition of a fair market.
Some of us have to try to stop the disaster anyway. These "market policy" proposals are like the song "McArthur Park;" everybody knows the the cake gets left out in the rain but nobody knows who does it. I just wish we could wait for the last disaster to wash clean before we cue the damn song again.
Put the Carbon Back
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Sean Casten Posted 10:45 pm
01 Apr 2008
I agree that there is a robust international market. I also agree that there is a burgeoning US market. What we've seen is that there are opportunities for strips internationally, but not domestically, at any meaningful price, for exactly the reason you mention (future uncertainty). This thread notwithstanding, I am actually cautiously optimistic that we will get to markets in the US with strips built in at good prices - but we're not there yet, and many of the ideas kicking around the environmental community (for example, that a carbon tax is better than a cap & trade model) effectively preclude strips. Thus, this post.
I'm quite familiar with the model you outline, discounting carbon back to the present. Note though that this is somewhat different from a strip, but the difference is one of tactics. (Some may choose to own the long-term strip while others will want the discounted cash flow.) As a general rule, the discount rate back to the present carries a risk premium since - in your biodigester example - the purchaser of the offsets cannot control whether or not you will do a good job maintaining & operating your carbon-offset device. Maybe that's OK, maybe it's not - but for simplicity here, I framed it as a long term price, payable to the offset producer only when the offset actually occurs, as opposed to in advance of when the offset will probably occur. It is a difference primarily of financial engineering though.
Agree that additionality is primarily a problem for voluntary markets. However, we do have regulated markets (like RGGI) that have offsets built into their structure and are therefore going to require some entity to make a decision about how to allocate $ amongst competing offset requests. Even though this is a compliance model, it does have a lot of similarity to the voluntary market, and I'm personally not certain at this point that those rules won't evolve to include some sort of additionality test. Are you?
Yes, PPAs provide strips. But a PPA with a utility is vastly over-rated, since the interests of the parties are not aligned. The old PURPA PPAs were at heavily discounted prices that took no measure of location-specific pricing, time-of-day or other system benefits. Yes, you can get better PPAs today in the restructured markets, but that has emerged in spite of the dergegulatory process, not because of it. Note also that historically, the best possible PPA has been a behind-the-fence PPA, such that I generate <100% of an industrials electricity and they in turn enter into a long-term contract with me for that power. Those have always existed, always will and again have nothing to do with the nature of deregulation (except of course, in those handful of states that still prohibit you from selling a kWh-denominated contract if you are not The Regulated Utility). However, the absence of comparably priced PPAs on wholesale (e.g., power-exporting) markets has led many developers - including yours truly - to undersize projecs, such that they only serve the local load and don't export to the grid. The net result of this is that there are a lot of plants out there that are clean, efficient and undersized as a direct result of the lack of competitive long-term contracts for exported power. This is actually a pretty good test of a regulated market: if the price of a commodity falls by 50% when it's point of sale shifts 1 inch to the left and that difference hasn't been arbitraged away, it's a pretty good sign of regulatory malfeasance. That's exactly what happens in power markets if that 1 inch happens to be the point of common coupling with an electric load and the distribution utility.
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