Getting a Grip on Carbon Emissions (CEG, ED, PEG)

Last week, a consortium of ten states in the northeastern US held its initial auction of allowances to emit CO2. The Regional Greenhouse Gas Initiative (RGGI) has set a cap on carbon emissions of 188 million tons in 2009. Each of the more than 230 power plants in the ten states will be required to "pay" for carbon emissions with the carbon allowances at a rate of one allowance (usually called a credit) for each ton of CO2 emitted. Companies doing business in various aspects in these states include Constellation (NYSE:CEG), Consolidated Edison (NYSE:ED), and Public Service Enterprise Group (NYSE:PEG), among others.

The results of the auction were released yesterday, and more than 12million credits were auctioned at a clearing price of $3.07/credit, fora total of nearly $39 million. Demand for the credits totaled almost 52million credits. Only six states – Connecticut, Maine, Maryland,Massachusetts, Rhode Island, and Vermont – participated in the auctionbecause the others had not yet finalized their auction rules. Proceedsfrom the auction will be invested in energy efficiency and renewabletechnologies, and to provide protection for consumers from higherenergy bills as a result of the cost of the credits.

There is good news and not-so-good news in the results. The not-so-goodnews is that the clearing price was very low. The European Union’scarbon credit price is around $34/metric ton. A second issue is thatthe 188-million-ton cap is very generous, equaling more than the totalamount of CO2 emitted in 2007. If the goal is to reduce emissions, thensetting a cap that high is unlikely to do the trick.

The good news is that demand for the credits was more than four timesthe number of credits available. Power companies have three years tocomply with their caps, so subsequent auctions ought to see more actionand higher prices. And once New York sorts out its auction plan thebiggest player in the region will certainly influence the market.

In the context of what’s happening in the financial markets today, thisis pretty small beer. But dealing with carbon emissions is somethingthat faces the new President and the new Congress. If the country fallsinto a substantial recession, will a commitment remain to reduce carbonemissions even if prices have to rise to meet that commitment? Arecarbon emission reductions a nice-to-have or a must-have? Should theyremain off the books of the power generators or should a price be seton emissions, just like any other cost of doing business? These issuesdon’t yield a simple answer regardless of politics and ideologies.

Paul Ausick
September 30, 2008