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 additional 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).

Comments

[SubsidyEye:]

Interesting article, with useful graphics. Thank you, Walter Kurtz!

Aug 17 08:47 AM

[AirBoss:]

Explains why Bartiromo did a CCX/Sandor profile this weekend.... ;-)

Aug 17 09:12 AM

[Ferdinand E...:]

You seem to have missed something author. In terms of economic history - and probably also some economic theory - cap-and-trade was worthless the first time the expression was used.

Aug 17 09:39 AM

[Aaron Joseph:]

The author ignores the fact that prices collapsed before Waxman Markey was even in the news. Take a look at the author's 2nd chart - when the bill actually passed in June of this year, CCX prices were already trading at all time lows.

No, Waxman Markey did not kill the CCX contract; prices collapsed with natural gas (as well oil, stocks, and other markets) in late 2008 and early 2009. Now, as markets, particularly stocks, have rebounded, the CCX remains depressed. Waxman Markey probably isn't helping, but other U.S. carbon markets like the Regional Greenhouse Gas Initiative have seen the value of their voluntary offset contracts hold up. The story behind the path of CCX contracts is not nearly as simple as the argument given in this piece.

Aug 17 10:27 AM

[Walter Kurtz:]

Great comment from Aaron Joseph - much appreciated. I'd like to clarify a couple of items:

1. Waxman Markey timing issue is correct. However long before the bill was proposed, the market participants were well aware that as the financial crisis hit hard, Congress will have no appetite for any bill that would cause the US industry to cough up funds for carbon allowances.

2. With regard to RGGI, it's a mandatory program implemented by some states. From www.rggi.org:

"RGGI is the first mandatory, market-based CO2 emissions reduction program in the United States.

The states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, and Vermont are signatory states to the RGGI agreement. These ten states have capped CO2 emissions from the power sector, and will require a 10 percent reduction in these emissions by 2018."

If participants are forced into this program by their respective state governments, it will certainly improve the pricing relative to the CCX contract.

Aug 17 01:48 PM

[searcher:]

Which State will be the first to defect from the compact as the vangaurd reaches burnt over territory?

Aug 17 02:07 PM

[Fred W:]

Over allocations killed the first run in Europe as well. Congress can't shoot straight so they will get it wrong one way or another.

Aug 18 01:29 PM