US cap-and-trade inevitable - market could be worth $1 trillion

Submitted by Andrew Lord

Economic researchers at New Carbon Finance released a report this week estimating that the US will be home to a carbon market will be worth $1 trillion by 2020. The forecast assumes that the US will implement an economy-wide cap-and trade system within 4-5 years and that the system will be confined to domestic trading only.

Currently, the US House of Representatives and Senate are discussing 13 different climate change bills, most of which propose a market-based solution such a cap-and-trade system. It is likely that some version of one of these bills will be passed after the US presidential election. All three front-runners in the presidential race have declared their support for a mandatory cap-and-trade system. Both Hillary Clinton and Barack Obama would like to see emissions reduced by 80% from 1990 levels by 2050. John McCain, who sponsored the McCain-Lieberman Climate Stewardship Act introduced in 2003, hopes to achieves a more modest reduction of 60% over the same period.

The impact of a cap-and-trade system is forecasted to be enormous. Researchers expect the carbon trading market to be worth about $1 trillion by 2020, more than twice the size of the EU ETS. This forecast is based on an estimated carbon price of $40 per tonne as early as 2015. A price of $40 per tonne is expected to raise the cost of electricity by 20%, of gasoline by 12%, and of natural gas by 10%.

The researchers noted however that the impact need not be so severe. All 13 bills currently under consideration share a common feature: they would limit the trading of emissions to the US only. They all restrict trading with other cap-and-trade systems, such as the EU ETS, and forbid participation in the Kyoto Protocol's Clean Development Mechanism (CDM) and Joint Implementation (JI) projects. If the system permitted international trading and participation in CDM and JI projects, the price of carbon would be closer to $15 per tonne. A price of $15 per tonne would only raise the cost of electricity by 7%, of gasoline by 4%, and of natural gas by 5%.

The increasing likelihood that the US federal government will implement a cap-and-trade system will have repercussions both domestically and abroad. Domestically, a federal system could displace many initiatives that are already under way. For example, several states have already committed to participate in regional cap-and-trade systems, most notably the Regional Greenhouse Gas Initiative (RGGI) in the Northeast and the Western Climate Initiative in the West. Some states are also taking local action. For example, California intends to implement a cap-and-trade system for its electricity market.

Internationally, the leadership of the US could prompt other jurisdictions to implement similar programs. For example, Japan announced this week that it would study the feasibility of a cap-and-trade system, an idea that it had vehemently opposed in the past. US leadership abroad may not just be by good example: there is already talk of imposing trade sanctions on imports from countries unwilling to participate in mandatory emission caps.

It is almost certain that Canada will follow the lead of its neighbour to the south. The question is one of timing. The federal government may sit tight until the US makes its move. However, some provinces seem more restless. BC, for example, just announced a new carbon tax (see below) and is already a member of the Western Climate Initiative. Regardless of when the government makes its move, pro-active Canadian businesses should start planning for change now.