Something funny happened on the way to a carbon price floor…

The Kerry-Boxer climate change bill making its way – slowly – through the US Senate was pitched as a big improvement on its House-formulated counterpart, the Waxman-Markey bill.

Market as not only more politically savvy - by supporting nuclear and offshore oil drilling - the Senate bill also has a somewhat more ambitious target for CO2 emissions reductions (20 per cent from 2005 levels by 2020, compared with Waxman-Markey’s 17 per cent).

Kerry-Boxer, like Waxman-Markey, proposes a floor for carbon prices.  As Kerry and Lindsay wrote in their New York Times oped, the bill’s floor and ceiling on the carbon price are designed to “safeguard important industries while they make the investments necessary to join the clean-energy era”. Indeed, investment certainty is what the energy industry has been clamouring for.  The bill also proposes to raise that guaranteed floor price by 5 per cent per year. (Update: We should clarify that Waxman-Markey also outlines raising the floor each year.) But this, according to New Energy Finance, is where some problems could arise:

However, codifying a rise in the price virtually guarantees traders a return simply for by buying and holding credits. The knowledge that the first credits issued will have the highest potential upside will spur heavy activity early in the cap-and-trade program and artificially inflate the short-term price of credits. This, in turn, will likely get passed along to consumers in the form of higher energy prices. In addition, New Energy Finance modeling suggests that carbon prices, particularly after the early stages of the program, would be below the established floor price if they were fully left to the market.

“While well intentioned, placing the floor at the levels being proposed in this legislation would undermine the concept of freely traded carbon allowances since the price of those credits would be largely dictated by the floor,” said Milo Sjardin, head of US carbon markets at New Energy Finance.

It’s eerily suggestive of the energy ETF roll problem, only in reverse.

And what should be done instead? As Sjardin says:

“A more constructive way to go about addressing the problem would be to set a more modest price floor increase or establish more aggressive overall carbon reduction goals.”

NEF also estimates the carbon price would be slightly higher under Boxer-Kerry than Waxman-Markey: an average of $21 per tonne before 2020, compared with an average of $19.90 under the House bill.

Furthermore, NEF writes, removing international forestry credits from the scheme would raise the cost of carbon permits by 60 per cent. Forestry offsets, which can include paying landowners not to clear forests, are an easy target for critics of offsetting.  The bill itself would reduce US emissions by 7.1 per cent by 2020, more than double the 3.1 per cent they would fall without any legislation, due in part to the recession, clean energy support, and auto efficiency measures. With international offsets included, US emissions would fall 14 per cent from 2005 levels by 2020.

Whether the bill as a whole will gain the support it needs is far from clear.

“With Democrats deeply divided on the issue, unless some Republican lawmakers risk the backlash for signing on to the legislation,”  The Washington Post’s Juliet Elperin wrote today, as the bill goes before the Energy & Public Works committee, “there is almost no hope for a bill”.

Related links:

Will there be a shortage of carbon credits if Waxman-Markey goes through? (FT Energy Source, 16/09/09)
Waxman-Markey vote: Soil credits and trade restrictions (FT Energy Source, 26/06/09)

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