CLIMATE:

Financial reform debate may influence future of cap and trade

The decision to take up financial regulatory reform before a climate bill in the Senate could have significant implications for the choice of a "trade" mechanism as the vehicle of choice to meet emission targets.

The House-passed climate bill and the version from the Senate Environment and Public Works Committee rely on markets and trading to help companies meet their greenhouse gas emission limits. The financial regulatory reform measures are aimed at restoring confidence and security to those markets, especially the over-the-counter derivatives market where much of the bad debt that sent the economy in a downward spiral occurred.

Supporters of cap and trade say work on financial reform will assure policymakers that regulation will be in place for a trillion-dollar carbon market.

But as lawmakers delve into the uncertain details of how far new regulations should go and the balance between systemic risk and market innovation, questions surrounding the effectiveness of the market to regulate carbon emissions may swing momentum in the opposite direction, critics of the current climate measure say. The more senators are educated about the complicated derivatives market, the more they may back away from the cap-and-trade structure.

"By the time we're done with financial regulatory reform, everybody's head is going to be spinning and they're going to be saying, Oh my gosh, how can you prevent this from happening again?'" Sen. Maria Cantwell (D-Wash.) said last month.

A greater understanding of the derivatives markets from a financial reform debate could even push policymakers toward "cap and dividend," which would auction a majority of the emission permits and return the revenue to American taxpayers, Cantwell suggested.

"People are moving more toward something that's much more streamlined," Cantwell said. "The bottom line is you don't want to have added volatility to the market when trying to solve [the emissions] problem. And that's clearly what the futures trading does. It adds volatility. What you want is a predictable price so that people can move forward and diversify."

Regulation reassurance

The need to assure senators that there are proper financial regulations in place before creating a massive carbon market is likely one of the reasons for moving financial reform first. Senate Majority Leader Harry Reid (D-Nev.) has indicated the Senate will move to the financial measure early next year, with climate and energy to follow in the spring.

"There are certainly some members who, with the House and Senate, and rightfully so, talk about what are the safeguards to ensuring that you don't have zealous speculation and complicated transactions," Carol Browner, director of the White House Office of Energy and Climate Change, said at a panel discussion last month.

"I think depending on what happens with the financial regulatory reform legislation, that may resolve some of the issues of concern looking across a whole variety of markets," Browner said. "If not, there are probably things that can be done within the bill that can answer a lot of those questions."

The House climate bill (H.R. 2454) already has regulatory language on the derivatives markets, although any financial reform bill the House passes will supersede that language. The EPW Committee bill (S. 1733) includes a placeholder for regulatory language with the idea that the Senate Agriculture Committee would insert a regulatory provision. The ag panel just started hearings on the derivatives regulation under new Chairwoman Blanche Lincoln (D-Ark.) last month.

Paul Bledsoe of the National Commission on Energy Policy said a broader discussion of the financial markets will reinforce the decision to use a cap-and-trade mechanism to contain greenhouse gas emissions. "The financial services debate has the potential to remind senators that a properly regulated market approach will be a far less expensive way to cut greenhouse gases than command and control through the existing Clean Air Act," he said.

A final financial reform bill may not even be necessary, Bledsoe said, noting that "positive committee action" in the House and Senate could provide the needed certainty for policymakers on carbon markets.

The carbon market will also be starting from scratch, so proper regulations can be put in place from the beginning, as opposed to the current financial markets, said Andy Stevenson, a finance adviser in the Center for Market Innovation at the Natural Resources Defense Council.

"The game is not necessarily in the hands of Wall Street as other markets are," Stevenson said. "A lot of the mistakes in the financial markets were made because they have been around for 40 years. Starting a carbon market today means we are starting from scratch, and we can head off a lot of these problems by passing strong regulation."

The pressures of Main Street

All along in the climate debate, some have questioned the cap-and-trade approach because of the potential influence of traders in the carbon market.

Sen. Byron Dorgan (D-N.D.), a key swing vote on the climate bill, said putting greater financial reform in place will not satisfy the problems of setting up a carbon market.

"Some will make the case that if you do financial reform that setting up a Wall Street trading system on carbon securities is less dangerous," Dorgan said. "I am not interested in setting up a trillion-dollar carbon securities market to tell us what the price of energy is going to be."

Tyson Slocum, director of energy at Public Citizen, said the current cap-and-trade bill creates another large role for Wall Street, which may not play well with Main Street.

"There are big implications for climate if we go this cap-and-trade route with derivatives reform because in public opinion it would be a bad idea to introduce a new multitrillion market overlaid on the derivatives market," Slocum said.

Nick Berning of Friends of the Earth said more time and closer examination of the carbon trading systems will expose the risks Congress takes in relying on markets.

"I think there is a lot more going on than whether just the Senate takes up derivatives reform," Berning said. "Whether they do that or not, the more people look at cap and trade the more problems they are seeing. It's not only just folks inside of Washington, but also activists. We've been hearing this from the right, but now we are hearing more and more concerns from the left as well."

A poll released yesterday by the U.S. Climate Task Force found that while most voters knew very little about cap and trade or cap and dividend, when the concepts were explained to them, 66 percent of Democrats, 58 percent of independents and 46 percent of Republicans favored the cap and dividend or carbon tax approach (E&ENews PM, Dec. 1).

The push by pro-climate bill, anti-cap-and-trade groups is also getting stronger. A film released yesterday by "The Story of Stuff," Free Range Studios, Climate Justice Now! and Durban Group for Climate Justice is aimed at the general public and attempts to explain the cap-and-trade concept in a simple way. It tells listeners that "the devils in the details" of cap and trade including free allowances and offsets will only line the pockets of Wall Street.

"There are real solutions out there, but cap and trade with its loopholes and promises of riches have made many people forget all about them," the film's narrator and creator Annie Leonard says. "We're not even close to a global agreement on a carbon cap to begin with, and duh, this is the whole point of cap and trade. But instead of hammering out a fair and strong deal, we're putting the cart before the horse and rushing off to trade schemes and offsets."

Watching the clock

The financial regulatory reform legislation not only affects the content of the climate bill, but its complicated issues are certain to take up a significant amount of the Senate's time. This leaves fewer and fewer legislative days for a climate and energy bill as health care looks likely to go through January and Reid wants to take a "jobs bill" before the financial regulatory reform bill.

Some senators who support climate and energy legislation say the extra time will benefit a climate bill.

Sen. Claire McCaskill (D-Mo.) said it would be good to take a break between two bills where senators have considerable differences. "Once health care is over, we've got to take everyone's temperature," she said. "I'm pretty new but I've got to tell you, after you do one really, really big, really, really hard thing that makes everybody mad, I don't think anybody is excited about doing another really, really big thing that's really, really hard, that makes everybody mad."

Sen. Amy Klobuchar (D-Minn.) said lawmakers can do two things at once. "The idea would be while the body is working on financial regulation, then during that same time we'll be getting the energy, the bipartisan group working on energy," she said.

Sen. Lindsey Graham (R-S.C.) said it gives him and Sens. John Kerry (D-Mass.) and Joe Lieberman (I-Conn.) breathing space to negotiate a new bill.

"I think what it does, it gives the Congress a chance to really look at this issue anew," Graham told reporters before the Thanksgiving recess. "We've learned, you know, Waxman-Markey and Kerry-Boxer don't have 60 votes. ... So once you price carbon, have a good nuclear title, offshore drilling for oil and gas -- every barrel found here is one less to buy, so it gives us a chance, I think, to come up with a new policy."

But legislating the greatest changes to the financial regulatory system since the Great Depression will not be easy, and the debate is not likely to finish quickly, as the Senate Banking Committee displayed during the first session on a draft financial regulatory reform bill introduced by Sen. Chris Dodd (D-Conn.).

Sen. Richard Shelby (R-Ala.), ranking member of the Banking Committee, said the bill needed to be completely rewritten and several Democrats, including the committee's No. 2 Democrat, Sen. Tim Johnson of South Dakota said they had issues with certain parts of the bill.

Senior reporter Darren Samuelsohn contributed.