A special thanks to the USDA, CFTC and Farm Foundation for the opportunity to speak at the Carbon Market Design: Issues and Opportunities Workshop on Monday in Washington. Nate Higgins and his team did a great job of putting the program together and featured a number of different speakers with a variety of viewpoints – some which embraced the markets-based approach and some which did not.

A few observations from this workshop. In the words of Richard Sandor, markets take years to build. So even though Congress closed the window on carbon markets in the near-term, others are on the way. Sandor also said that other countries look favorably upon carbon markets as part of the solution, especially in Asia where we may yet see new carbon markets appear in Japan, Korea and perhaps Australia and China. Markets is not a four-letter word there.

Another observation is that these markets are complex and fraught with misconceptions about them. This was the topic of my speech – that many people have a really poor understanding of them – from the media, to legislators to the general public. It’s also a highly emotional market, unlike any other – perhaps because it is directed toward an end – heading off global warming. Other commodities markets ebb and flow without much fanfare. Forget about crude oil for a minute. Look at other commodities such as cotton – record highs at $1.70 per pound with the lowest supplies in 8 years, grains, even metals such as platinum and paladium. But does that grab headlines or raise a national outcry that commodity prices are out of control, or worse yet, manipulated! Nah, not really.

Pete Kyle, professor of finance at University of Maryland, had little faith that a US carbon market would work. He favors a universal tax, or customs union that would set a price on carbon. Peter Crampton, another Maryland economic professor pushed for an international agreement on the price of carbon, but not quantity. To be quite honest, I couldn’t follow the logic. And on either suggestion, I never heard just how such plans would achieve the carbon reductions scientists say we need.

That’s the bottom line here isn’t it? Science has set the cap. Politicians have been allowed to set another cap – or in the case of Congress – no cap at all. What we need is a price mechanism that will allow companies to meet their cap obligations at the lowest cost. While much focus has been on the stumbles of the EU ETS, the fact is that the market overall is working relatively well. It hasn’t been perfect. Some mistakes have been doozies, no doubt. But if you look at how the market works – using a mix of differing market participants from utilities to hedge funds – and then you look at the price trends of that market – carbon contracts have indeed reflected the fundamentals of the EU market. It is working.

I attended the 25th Anniversary event for the Chicago Mercantile Exchange’s Eurodollar futures contract in 2006. Interestingly, the contract was met with incredible skepticism by the market when it launched in December 1981. In fact, it traded just over 1,200 contracts per day in 1982, its first full year of trading. Today, it’s the most actively trade short-term interest rate contract in the world. In December  2010, its 30th year, the contract averaged more than 2.2 million contracts, worth more than $2 trillion in notional value. 

So that gets back to the point that Dr. Sandor made. These markets take time to develop. They are not perfect. It would have been a colossal mistake to have just have given up on Eurodollars in year one. It is a mistake to just toss aside carbon markets today because there is skepticism or it is politically unpopular.

Jim Kharouf

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