Worries about “gaming” or market manipulation often crop up as objections to climate and energy legislation. While these concerns are understandable, they are not warranted—and they can be addressed in a well-designed system. So let’s look at some of the most common myths.
Myth #1: Cap and trade markets have no track record.
* The US Acid Rain Program, administrated by the EPA, has a track record dating to 1995. The program exceeded the SO2 emissions cap years ahead of schedule and for only one-fourth the cost that was expected. After more than a decade of operation, analysts have concluded that the SO2 cap-and-trade program has been successful and free of gaming.
* The EPA also runs the NOx Budget Trading Program—designed to reduce smog-contributors—which has been similarly successful, and free of market shenanigans too.
* The Regional Greenhouse Gas Initiative (RGGI), the nation’s first climate cap-and-trade program, has been fully operational for more than year—with great success. Close inspection has revealed no evidence of anti-competitive conduct or market gaming. In fact, the program has met its early goals so easily and so cheaply that some advocates are calling for the carbon cap to be tightened ahead of schedule.
Europe’s cap-and-trade program has failed.
The European Union’s Emissions Trading Scheme (ETS), begun in 2005, has created a Europe-wide carbon market that is a remarkable success story—both environmentally and economically.
* Thanks to the ETS, Europe is on track to meet its emissions-reduction obligations under the Kyoto Protocol.
* In fairness, there were some hiccups in the rollout of the ETS— including an initial overallocation of allowances to polluters, insufficiently stringent offset provisions, and some price volatility. Yet these problems resulted from European efforts to create a system on “training wheels” without complete information. And in fact, the problems are fixable and are already being addressed as the program evolves. US policymakers can learn from Europe’s early design mistakes, but they should recognize that there are not fundamental flaws in the policy or the carbon markets.
Carbon markets are at risk of Enron-style tricks or wild derivatives speculation.
Common-sense regulation makes carbon markets no riskier than the markets for pork bellies or soybean futures. As US cap-and-trade programs have demonstrated, well-regulated markets can reduce pollution cost-effectively.
* Restricting trading to registered exchanges is a smart idea, at least at the outset of the program. One good example is the “Carbon Market Oversight Act of 2009,” sponsored by Senators Dianne Feinstein (D-Calif.) and Olympia Snowe (R-Maine), which puts the Commodity Futures Trading Commission in charge of the carbon market, and creates other restrictions on market behavior.
* Other particulars of market design also help. To minimize price volatility, authorities can ensure transparency about prices and the number of permits available. Opening auctions to all bidders with adequate financial reserves, conducting auctions frequently and early, and limiting the number of permits any one actor may hold—all these things will help keep prices stable and prevent market manipulation.
* Carbon markets have built-in disincentives to manipulation: neither the public wants it (because it could raise power bills), nor do the market participants that buy permits (because they don’t want to pay more to pollute).
Of course, as with any policy, cap and trade’s success will ultimately depend on strong oversight, transparency, and vigorous enforcement. But there is every reason to believe that a well-crafted and -regulated system can function smoothly and cost-effectively.