Guest Commentary By Elliott Piggott, MD Trayport:

As climate change moves higher up the political agenda, the announcement of new US legislation such as the Waxman-Markey climate bill demonstrates the US’s increasing progression to support the global carbon markets and reduce emissions.

Initially approved in June this year, the Waxman-Markey bill mandates that the US reduce Greenhouse Gas emissions (GHG) 17% below 2005 levels by 2020, as well as set up a national market for pollution permits in 2012. Once officially passed by the US Senate this autumn, the bill will then give emitters the ability to purchase carbon offset credits to meet their obligations via initiatives such as auctioning. The advantage of auctioning credits is that it provides a more market orientated price for carbon, by encouraging decisions to be made by emitters either to take action and reduce emissions directly or pay a reasonable price to purchase credits. However despite auctioning now being recognised as highly effective for increasing market efficiency and reducing any distortion associated with free allocation, this subject continues to be the centre of much debate concerning successful models and pricing structures, both on a European and Global level.

Overall, there are strong correlations between the European Union Emissions Trading System (EU ETS) and Waxman-Markey, as Europe aims to reduce Emissions 21% below 2005 levels by 2020, only 4% higher than WM. So in the current situation, the US could certainly benefit by learning from the perceived previous mistakes made by the EU ETS, which may have been to initially allocate too many offset credits. Since free allocation runs the risk of not providing enough incentive for GHG reduction, this could lessen the impact of the overall initiative. Further trends also indicate that auctioning in the EU will increase as free allocation decreases. So by allowing too high an initial free allocation, the US model may effect a negative impact on its specified targets.

However once implemented, the Waxman-Markey bill will undoubtedly generate extensive global awareness and encourage European based traders to have a stronger interest in US activity, creating significant opportunities for cross-border trading, especially in Europe. In addition, over the past 12 months Trayport has noted an increased level of interest from US traders who are becoming progressively more active in the European markets, potentially in anticipation of bills such as the Waxman-Markey being passed. Also, with their extensive experience in trading the European markets, US based companies will be well positioned to hit the ground running in the US when these secondary markets become active.

On the face of it, Waxman-Markey is a good move since the market has always encouraged the formation of a cap and trade system much like in Europe. Also, since the European market has been waiting in anticipation for the route the US will take, the bill will almost certainly have a strong and positive effect on European carbon trading. In the long term, much will depend on an International Agreement being formed to create a global market. If an agreement is passed, there could be a ‘correction’ in the pricing of EU contracts to align with other trading systems. However, this is very much up in the air, and will largely be dependent on the outcome of Copenhagen 2009. Also, since there are now additional dependencies on the creation of an International Agreement, such as other major producers of GHGs – China and India not being any closer to engaging, and the Australian senate having recently rejected their plans for GHG reductions, it remains to be seen whether or not this bill is strong enough to be perceived as a viable initiative for working out an international climate change agreement.

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