Urges Rigorous Oversight and Disclosure Requirements

Oct. 7, 2009

Commissioners Note Price Collar would Counter Market Manipulation and Excessive Speculation

Washington, DC - The Commissioners of the bipartisan National Commission on Energy Policy (NCEP) today released a new report, “Oversight of the Greenhouse Gas Market”, recommending that greenhouse gas markets be subject to the same regulation and oversight as other commodity markets under financial market regulation and reform legislation being considered by Congress.

“Cap-and-trade programs are designed to reach an emissions target at the lowest possible cost. The trading mechanism associated with cap-and-trade provides companies with flexibility and limits costs to consumers. Previous environmental markets—such as those created to address SO2 and NOx emissions— have demonstrated the value of this approach. These programs have achieved lower-than-projected costs, spurred innovation, and produced verifiable environmental results,” NCEP said in its report.

“Despite this track record, recent failures in the regulation of the housing and credit markets and extreme volatility in energy markets have cast doubts on the transparency, integrity, and fairness of financial markets in general. These concerns, coupled with the potential magnitude of an economy-wide market for greenhouse gas (GHG) allowances, have led policymakers and stakeholders to seek assurances that a strong regime will oversee and regulate this brand new market.”

“Oversight of GHG markets should be addressed in the context of broader reforms governing commodity, credit, derivative, and other financial markets,” the NCEP report said. “An approach that regulates GHG markets the same way as similar commodity markets would be preferable to a piecemeal system that could undermine broader goals of regulatory consistency and transparency of financial markets. Congress may adopt GHG legislation before more general financial oversight reforms are put in place—in which case consumers and other stakeholders will demand that concerns about market abuses be directly addressed in the legislation. If so, then the Commission recommends that interim oversight measures be adopted in order to build confidence in GHG markets and mitigate concerns that these new markets could be easily manipulated.”

“Ultimately, the Commission believes that it is possible to maintain the benefits of a cap-and-trade program in terms of promoting innovation and cost savings, while minimizing opportunities for market manipulation and fraud,” the report said.

NCEP has identified several specific program design elements that it believes are critical for striking this important balance:

• Rigorous oversight and disclosure requirements should apply to all aspects of the GHG allowance market, including derivative products. Consistent with this approach, there should be stringent penalties for abuses and there may need to be new mandates for position limits, clearing and margin requirements, reporting and disclosure, and other aspects of regulation. Ultimately, these elements should be made consistent with larger federal efforts to reform and regulate financial markets.
• It is difficult to impose the “right” amount of regulation and oversight for a new market before that market develops. There are simultaneously significant risks of failing to anticipate potential abuses and of undermining economically productive activities. We believe that broader architectural design features that allow the market to function but limit the potential for abuse are preferable when developing a new market. To the extent that climate legislation imposes specific restrictions on certain market activities, there should be authority to modify these restrictions based on credible evidence or evaluations as the GHG market develops and as broader market reforms are implemented.
• Many of the same design parameters that make for an effective GHG trading program also help prevent market abuses. These include clear rules for trading, transparent reporting of emissions data, rigorous verification and monitoring of emissions and offset reductions, clear and stringent penalties for violators, and equal access to the markets and information by all participants. Additionally, permitting regulated entities to bank and borrow allowances across compliance periods and including a well-crafted offset program will not only improve the cost-effectiveness of the program but will also increase the elasticity of allowance supply and demand and thereby reduce the risk of manipulation.
• Comprehensive market reforms will take some time to implement. In the meantime, a price collar would help counter concerns about market manipulation and excessive speculation. In its purest form, a price collar would be a simple price cap that is paired with a minimum price floor, both of which escalate in a pre-determined manner over time and phases out after an initial period. In our view, this is the single most transparent way to limit significant price volatility, whether caused by market speculation or other factors. As discussed in our previous paper “Managing Economic Risk in a Greenhouse Gas Program,” a properly designed allowance reserve coupled with a price floor offers many of the benefits of a simple price cap and provides greater certainty about cumulative emissions reductions over the life of the program.
• Because spot and futures transactions in emission allowances will be conducted similarly, regulation should be consistent across the spot and futures markets. As such, it will also be efficient to rely on a single regulatory agency to oversee both markets. That agency should have clear jurisdiction over spot and futures transactions, along with the resources and personnel needed to adequately oversee all relevant markets. Moreover, because it is likely that markets for emissions allowances and derivative products will develop abroad, there will be a need to coordinate regulatory oversight with these venues to avoid circumvention of domestic regulations.

Today’s paper is the third in a series of specific recommendations on key issues designed to provide way forward for Congress to pass mandatory climate change legislation during the 111th Congress that President Obama can sign into law. In addition to today’s report, NCEP has already released recent recommendations on climate legislation provisions dealing with cost containment and also with offsets. Reports on permit allocation, state-federal roles and international participation and U.S. competitiveness will follow in coming weeks. In June, the Commission provided an overview of these issues in its “Forging the Climate Consensus” report.

Today’s “Oversight of the Greenhouse Gas Market” report and others in the “Forging the Climate Consensus” series are available at: www.bipartisanpolicy.org

The Members of the National Commission on Energy Policy are:

William K. Reilly Co-Chair, Senior Advisor, TPG, Inc.; Former Administrator, U.S. Environmental Protection Agency

John W. Rowe Co-Chair, Chairman and CEO, Exelon Corporation

Susan Tierney Co-Chair, Managing Principal, The Analysis Group; Former Assistant Secretary of Energy

Philip R. Sharp Congressional Chair, President, Resources for the Future; Former U.S. Representative, Indiana

Neil Z. Auerbach Founder and Managing Partner, Hudson Clean Energy Partners

Marilyn Brown Visiting Distinguished Scientist, Oak Ridge National Laboratory; Professor, School of Public Policy, Georgia Institute of Technology

John E. Bryson Emeritus Chairman, Edison International; Emeritus Chairman, Southern California Edison

Ralph Cavanagh Senior Attorney and Co-Director, Energy Program, Natural Resources Defense Council

Erroll B. Davis Jr. Chancellor, the University System of Georgia

Senator Rodney Ellis State Senator, Texas

Leo W. Gerard International President, United Steelworkers of America

Robert E. Grady Managing Partner, Carlyle Venture Partners, The Carlyle Group; Former Executive Associate Director, Office of Management and Budget

F. Henry Habicht Managing Partner, SAIL Venture Partners, LLC; Former Deputy Administrator, U.S. Environmental Agency

Newton B. Jones International President, The International Brotherhood of Boilermakers

Richard A. Meserve President, Carnegie Institution; Former Chairman, U.S. Nuclear Regulatory Commission

Mario Molina Professor, University of California, San Diego

Sharon L. Nelson Former Chair, Board of Directors, Consumers Union; Former Chief, Consumer Protection Division, Washington Attorney General's Office

Marvin E. Odum President and Upstream Americas Director, Shell Oil Company

Richard L. Schmalensee Howard W. Johnson Professor of Economics and Management and John C Head III Dean, Emeritus, Sloan School of Management, Massachusetts Institute of Technology

Norm Szydlowski Former President and Chief Executive Officer of Colonial Pipeline

R. James Woolsey Vice President, Booz Allen, Hamilton; former Director of Central Intelligence

Martin B. Zimmerman Clinical Professor of Business, Ross School of Business, University of Michigan; Former Group Vice President, Corporate Affairs, Ford Motor Company

Jason Grumet Founder and President of the Bipartisan Policy Center; Executive Director of the National Commission on Energy Policy

###

---

National Commission on Energy Policy