“…a Federal appeals court decision on July 11 of last year appeared to kill the long-term value of credits under what was called the Clean Air Interstate Rule, a set of markets for pollution credits created by the Environmental Protection Agency. At a stroke, some tens of billions worth of rights to emit noxious gases were slashed in value by the court’s ruling that the EPA had exceeded its authority…”

 

http://www.ft.com/cms/s/0/be0478b2-e692-11dd-8e4f-0000779fd2ac.html?nclick_check=1

The EPA, along with utilities and some enviros, asked the court to modify or reconsider its decision, and, unusually, the court had second thoughts. In late December, the court indefinitely stayed its cancellation of Cair, allowed the trading to remain in place, and told the EPA that it had to come up with a fix, sometime in the undefined future. That is the simple version.

So, the price of the right to emit one ton of sulphur over the next year, which had been up to $600-$800, fell back to as little as $100 after the initial decision, and has now, after the court’s reconsideration, risen to $150-$200. At $600, utilities found it economic to build new pollution control systems before they were required by law, since they could sell for a lot of money the emission credits they earned. EPA people say that in the past few years, a million tons a year of sulphur dioxide emissions have been averted by Cair.

So any new market-based emissions controls had better have more certainty than the flawed Cair. In leaving Cair in place, the court seemed to reason it would retain its effectiveness in reducing emissions over the next couple of years, but that is not the case. Instead, the EPA’s pollution allowance market people believe the low prices created by the uncertainty over the future of Cair will have the perverse incentive of inducing utilities to use up existing pollution allowances by emitting more than they would have, while postponing building new controls. Or so the agency’s economic models say.

The EPA might appeal to the Supreme Court, but that would be a long shot. It would be extremely difficult to fix Cair markets through new regulation, as the appeals court ordered. One possible fix would be “command-and-control”, non-market-based limits on emissions. Those are within the EPA’s powers, but wouldn’t help as a precedent for carbon cap-and-trade. However, the prospect of unpopular rules might motivate an otherwise preoccupied Congress to come up with a legislative fix that overrides the confused ruling.

The Cair mess shows that it is easy to get market design wrong. With mortgage and derivatives markets, that costs billions. With Cair, it costs shortened lives.