The United States will be home to a $1 trillion carbon emission market by 2020 if federal and state policymakers continue on their current path towards a comprehensive "cap-and-trade" program that is confined to domestic trading only. In an analysis of bills today before the U.S. Congress, New Carbon Finance research economists based in New York, Washington D.C. and London, U.K. predict that in 12 years a carbon-constrained U.S. economy that includes a cap-and-trade system allowing only domestic trades will produce:

A $1 trillion carbon trading market -- more than twice the size of the European Union's Emissions Trading Scheme;

• A carbon price of $40 per tonne as soon as 2015, which will result in a rise in consumer energy prices in real terms of roughly 20% for electricity, 12% for gasoline and 10% for natural gas -- as well as impacts on other prices as higher energy and transportation costs filter through the economy; and
• Major U.S. investments in renewable energy, energy efficiency, and greenhouse gas mitigation projects and technologies.

The analysis was released Feb. 14 by Michael Liebreich, CEO of New Energy Finance, parent of New Carbon Finance, attending climate change roundtable discussions at U.N. headquarters, New York.

Most of the 13 climate change bills being discussed in the U.S. House of Representatives and Senate propose some sort of market-based mechanism such as a cap-and-trade system, complemented by direct regulation.

Under a "cap-and-trade" system, the federal government would ration the amount of carbon dioxide and other greenhouse gases that businesses emit by issuing them permits. A business wanting to emit more than its entitlement may buy the right to do so from a business that emits less than its entitlement. The U.S. already has cap-and-trade systems in place for sulfur oxide compounds (SOx) and nitrogen oxide compounds (NOx).

The biggest buyers of greenhouse gas emission credits will be large emitters, especially coal-burning power utilities, petroleum refiners and other heavy industries like cement manufacturers.

An economy-wide cap-and-trade system for U.S. greenhouse gases operating within four to five years seems inevitable, the researchers say -- adding that it looks set to dwarf its counterpart European carbon market.

"Even if the current Bush administration rejects all of these bills, the next President will be less inclined to use a veto. All leading 2008 presidential candidates have endorsed the need for action and some have already supported significant emissions reductions," says Mr. Liebreich.

Democratic presidential candidates Democrats Hillary Clinton and Barack Obama both support efforts to establish a mandatory cap-and-trade scheme that would lead to an 80% emissions reduction by 2050 from 1990 levels.

Republican Senator and presidential frontrunner John McCain, meanwhile, was an early sponsor of climate change-related legislation, co-authoring the McCain-Lieberman Climate Stewardship Act, first introduced in 2003. Its 2007 revision would cap U.S. greenhouse gases, introduce a domestic trading emission system, and aim for a 60% emissions reduction from 1990 levels by 2050. Republican presidential rival Mike Huckabee has likewise called for emission caps.

Without exception, however, the bills before Congress either prohibit or severely restrict the transfer of allowances from trading systems in other parts of the world, including the EU's Emissions Trading System (EU-ETS), and the Kyoto Protocol's Clean Development Mechanism (CDM) and Joint Implementation (JI) schemes. The CDM and JI systems were established in part to facilitate emission reductions in developing countries, where they are relatively cheaper to achieve, with finance provided by the developing world.

Meanwhile, "America's Climate Security Act," co-sponsored by Senators Joe Lieberman (Independent Democrat, Connecticut) and John Warner (Republican, Virgina), is a product of bi-partisan compromise that has given it extra traction in Congress, according to New Carbon Finance. However, the Lieberman-Warner bill rules out international trading of credits.

Says Milo Sjardin, who heads the North American division of New Carbon Finance: "Excluding or limiting the inclusion of international project credits in any U.S. carbon cap-and-trade system will have two important consequences. For the U.S. market, it will rule out a significant source of inexpensive abatement, pushing the carbon price to unnecessary high levels. It will also remove most U.S. demand for international credits, hampering the growth of projects and technology transfer to developing countries."

New Carbon Finance predicts a U.S. carbon price of $35-40 per tonne as soon as 2015 if the Lieberman-Warner bill, with its blanket veto on international project credits, succeeds into law.

"We believe that, to smooth the transition to a carbon-constrained economy, any climate change bill should provide for international project credits, currently available at $10 to $20 per tonne," says Mr. Sjardin. "This component can then be reduced over time to achieve greater emissions reductions within the U.S."

Allowing carbon-constrained U.S. firms to trade credits with firms in China or India, for example, where emission reduction measures are relatively inexpensive, would yield an estimated U.S. carbon price as low as $15 per tonne, thereby saving the American economy about $145 billion per year, says Guy Turner, London-based Director of New Carbon Finance.

The impact on U.S. consumer level energy prices of a carbon price of $15 vs. $40 a ton is estimated by New Carbon Finance as follows:

At $15 a ton:

• Electricity would increase 7% in real terms from today's average U.S. retail price (marginally higher than increases seen over the past four years);
• Gasoline would increase 4% (approximately 13 cents a gallon in today's terms, small relative to increases caused by higher oil prices); and
• The impact on the price of natural gas would be 5%.

At $40 a ton:

• Electricity would increase 20% in real terms from today's average U.S. retail price;
• Gasoline would increase 12% (35 cents a gallon); and
• The price of natural gas would increase about 10%.

Tariffs on imports from companies that are not from a carbon-constrained economy

The company forecasts that any bill passed by the Congress is likely to include trade sanctions on imports from countries unwilling to participate in mandatory carbon emission caps, an idea also raised in the European Union.

"Developed nations may use this measure as a negotiating lever to put further pressure on large developing nations to reconsider their position, i.e. their ongoing refusal to consider hard reduction targets," says Mr. Liebreich.

"Although this arrangement seems to be a border tax adjustment it is possible that it can be done in a way that complies with WTO rules, provided a few conditions are met.

"Developing countries should bear in mind that even if they are successful in negotiating away the need to control their greenhouse gas emissions, they will likely face the impacts of climate change legislation through an indirect route, via their export trade balance, and potentially sooner than they think."