Shapiro: Don’t Regulate Energy Market

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There’s a certain irony in the recent push to apply stricter regulation to commodity and other financial markets — just as we’re contemplating creating new markets that are even harder to regulate.

To an economist — and political observer — the effort in certain respects amounts to taking a step forward on a path that circles back around to where we started. Even as our lawmakers try to rein in Wall Street some, they’ve simultaneously been advancing cap-and-trade legislation that would create a new, highly complex, opaque and volatile market for around a trillion dollars in new financial instruments. And that’s not counting their inevitable derivatives.

Once linked to global markets also trading emission permits — as its advocates support — this new market would dwarf most other areas of commodity trading. And because the commodity to be traded — energy, through the emissions it produces — is so fundamental to economic activity, the economy would have a big stake in how this new market behaves. Further, the prices set and traded for permits in this market would inevitably and unavoidably be very volatile, while additional trading in derivatives could threaten the market’s ability to deliver its primary objective: a fair (if not stable) price for emissions.

These are all dynamics that resemble much too closely for comfort those that helped to bring about last year’s financial market meltdown.

The Waxman-Markey bill, the House version of this scheme, passed by a single vote. This narrow margin suggests how tentative support for a cap-and-trade approach still is, despite some of the most extensive lobbying efforts and political horse-trading in recent memory. In fact some major environmental groups such as Friends of the Earth and the Environmental Justice Campaign actually oppose the bill, because they don’t believe its convoluted scheme can deliver either the emissions reductions our planet needs or economic stability.

They also know that putting a national emissions trading program into real-life practice could be a very drawn-out process. It could take years to establish the new markets for trading carbon permits and bring regulators up to speed. These problems also could be exacerbated by the scheme’s complexity and the public’s consequently limited understanding, which may produce resistance when the scheme leaves people’s energy prices more volatile as well as higher. Additionally, the House-passed bill gives away 85 percent of the initial carbon permits to special interests, making it one of the biggest pork-barrel bills in our history.

Still, the biggest drawback of the bill is the weakness of its response to the climate crisis.

On top of the giveaways, the price volatility — which economists warn is inevitable under a cap-and-trade system — will undermine the incentives for businesses and households to invest in the new low-carbon technologies. In the first three years of the European Union’s cap-and-trade system, its permit prices moved up or down by an average of 20 percent per month. Combined with the existing volatility in energy prices driven by international supply and demand, a U.S. emissions trading program will make it virtually impossible to reasonably predict prices, undermining future investments based on some expectations about the future price of carbon.

This volatility is built into the bones of cap-and-trade. Because the price of carbon and the permits to emit it will move with the relationship between energy demand and the supply of permits, inevitable developments such as faster or slower growth than anticipated, unexpected weather shifts, geopolitical tensions and natural disasters all will move those prices up or down. As a consequence, these permits would soon give rise to widespread speculation, since speculators make their money off the sudden shifts in price that are inherent to a cap-and-trade system.