Tuesday, August 11, 2009

The collapse of the CCX carbon emissions contract

This may be a surprise for some, but "cap and trade" has been in place in the US for years. The trading is done via a firm called the Chicago Climate Exchange (CCX), a creation of Richard Sandor (the inventor of the CBOT bond futures). The contracts traded represent 100 metric tons of carbon emissions each (see contract specs) There is one catch with this cap & trade program though: the member firms' participation is voluntary. From CCX:
CCX emitting Members make a voluntary but legally binding commitment to meet annual GHG emission reduction targets. Those who reduce below the targets have surplus allowances to sell or bank; those who emit above the targets comply by purchasing CCX Carbon Financial Instrument® (CFI®) contracts.

So why would firms participate on a voluntary basis? A couple of reasons. One is they would like to be perceived as good citizens, the other is they wanted to get ready for the real cap & trade. With full expectations that Democrats in the office would implement this type of program, many firms joined voluntarily to get ahead of their competitors and learn the process.

But when the long awaited legislation finally showed up, it wasn't exactly what everyone expected. Under the so called Waxman-Markey American Clean Energy and Security Act of 2009, companies would be required to have “allowances” for all the greenhouse gases (carbon) they emit. Between 2012 and 2026 about 90 percent of the allowances would be given away for free. The chart below from the Heritage Foundation (which by the way really wants this bill to go away) shows what percentage of the emission allowances would be free.

So here is the question. Why would you pay for a carbon credit (an allowance) if the government will give it to you for free, even if Waxman-Markey passes? If it doesn't pass, there is no cap on emissions at all and a carbon credit becomes worthless. Either way in the immediate future there is little value in the CCX allowance contract:

The allowance contract used to trade like a commodity, somewhat linked to US natural gas (natural gas is seen as a cleaner burning fuel). It spiked in 08 when energy and other commodities hit records. People felt that if Obama was going to win, cap & trade was just around the corner. But the recession hit hard and Congress was loathe to inflict addition pain on the hard hit US industry by imposing a costly program - the timing was very wrong. So they watered down the bill, in effect killing the CCX contract. This program will come back some time in the future - it has to eventually, given the impact of emissions on global climate. But for now CCX will struggle to stay profitable, trading a nearly worthless emissions allowance (it's hard to generate volume when there is little speculator interest).

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