[The below was submitted as a comment on an earlier post, and seems well worth highlighting. It is an insider's view on the Regional Greenhouse Gas Initiative (RGGI) of 10 northeastern states. The idea that speculators could enter the market to drive up the value of the permits is very intriguing. RP]

Overall I agree with Roger’s ultimate conclusion but I want to add some additional information. I was involved in the RGGI process since the beginning so I want to clear up a misconception about the current cap and I want to give my impression of the RGGI auction before the first one is held on September 25.

I do not think RGGI cap was set to reduce emissions because that wasn’t the primary purpose of RGGI. At the start of the RGGI process there was a tacit understanding amongst the participants that the real goal of RGGI was to develop the framework for a CO2 cap and trade program that could be used as a model for a national program. After all, the unstated reality is that it could never hope to actually have any impact on global warming. Anyone is welcome to debate that point but a 188 million ton cap and a 19 million ton reduction is certainly noise on the global level.

Much has been made about the RGGI cap relative to recent emissions and there were certainly political trade-offs in the cap values picked. Keep in mind however, that electricity prices in the RGGI states are among the highest in the nation. Obviously the stakeholders who were willing to participate in this symbolic gesture did not want to exacerbate the already high price differential. As a result the intent of the first five years of RGGI was to stabilize CO2 emissions, not actually produce a reduction.

Moreover, it should be kept in mind that there is a significant percentage of dual oil and natural gas fired capacity in RGGI. Since the time the baseline was defined, the price differential between oil and natural gas has changed so that oil firing and the higher CO2 emissions associated with it have dropped significantly. If that price differential changes back to historical levels then CO2 emissions will increase sharply.

There also was concern about leakage that suggested a less stringent cap was appropriate. If energy can be produced outside the RGGI region by facilities not subject to a cap and imported in then CO2 isn’t really being reduced. During the development of the program the regulators concluded that there wasn’t enough transmission capacity available to have a big impact. Naturally, the definition of big impact depends upon whose ox is being gored but clearly there was another incentive to not require a significant reduction.

Senator Schumer’s description of the plan to auction landing slots at NYC airports is equally applicable to the RGGI auction: “This is an ideological, untested experiment from those in an ivory tower”. The stakeholder process included regular meetings and continued for a couple of years through the development of the proposed cap and trade program. In that timeframe the concept of auctioning allowances reared its head. However during the analysis of impacts and discussion of results with all stakeholders, the impacts of the auction approach were not considered. Nonetheless, the auction approach became a political litmus test of one’s commitment to RGGI.

There is an ideological gulf between the advocates of the auction approach and those responsible for compliance at the affected sources. A prominent feature in US cap and trade programs is a hammer provision for the designated representative of the affected source. For example, every submittal of data or allowances for compliance includes a certification statement that includes the following: “I am aware that there are significant penalties for submitting false statements and information or omitting required statements and information, including the possibility of fine or imprisonment.” Consequently many of these facilities have adopted a policy of only operating when they have allowances on hand. Either that has to change if the company doesn’t win any allowances in the auction or there will be turmoil when facilities refuse to run without allowances.

Once the regulators decided they wanted to do an auction they hired academics to design the best auction format. To that end they did a great job. Unfortunately during this period the give and take opportunity to discuss issues and concerns in a viable stakeholder process stopped. As a result affected source concerns about the ramifications of the auction were not addressed. It boggles the mind that RGGI thinks that there won’t be any impacts on operating margins of facilities between a program that freely allocates allowances versus one that charges the facility for those allowances..

Coming into this auction the biggest unknown is who is going to participate and to what level. Obviously, the affected sources want to purchase enough allowances to meet their projected costs at as low a price as possible. If all the affected sources bid only for what they need, then the bidders that do not have compliance obligations will determine the auction clearing price. It may well be that the current financial crisis will prevent a major influx of bids from financial organizations but who knows. The fact is that if the non-compliance entities hold on the order of 25% of the allowances then the affected sources will have to purchase allowances in the secondary market from an organization that can charge whatever the market will bear. That suggests that this may be an investment opportunity that cannot be passed up.