The Regional Greenhouse Gas Initiative (RGGI), a cooperative effort designed to reduce carbon dioxide (CO2) emissions from electric power generators in 10 Northeastern states, appears poised to auction off its first batch of allowances today, but many participants - states, investors and regulated power generators - struggle with how to proceed.  RGGI applies to generators with a capacity of 25 megawatts or greater that rely on fossil fuels for at least 50% of their input power in Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island and Vermont.

Today’s auction involves only six of the 10 states, with the biggest contributor, New York, not participating in this first round.  The highest rejected bid sets the price all bidders must pay.  So, on the morning of the auction, we highlight some of the risks that investors face as they prepare their closed bids:

Impacts of U.S. Financial Crisis
Will the credit situation cause states and investors to rethink their entire strategy for participation in RGGI?
Financial institutions may be less active in the auction than previously contemplated as the current financial situation may inhibit participation in new and uncertain markets.  It’s not only the risk factors, however, that may limit participation; capital available to invest in RGGI appears to be dwindling.

Over Allocation of CO2 Emissions
Many believe that RGGI is way over allocated, as cumulative emissions initially were calculated to be 188 million tons of CO2 from 2009-2014, but now estimates indicate up to 40 million less tons are needed.  In any case, today’s auction will only cover 12.6 million allowances.  Many of the savvy investors and regulated facilities will sit this first round out and watch how others play their hands.

10 States with 10 Regulatory Programs
Investors and regulated facilities may take a “wait and see” approach.  The 10 sets of complicated and ever-evolving state rules and regulations of RGGI [e.g. New York’s recently adopted RGGI rules], along with the ambiguity of the bidding process, make the process of assessing risk a substantial challenge.  State imposed safety valves, like Maryland’s proposal to pull back 50% of its allowances from auction and freely distribute them to regulated entities, if the price hits $7 per ton, undermine a pure market system.  Another lingering concern to investors is a state’s ability to withdraw from their obligations under the RGGI Memorandum of Understanding upon providing the other states with 30 days notice.

While RGGI and the auction is certainly progress as there finally is compliance market for CO2 that appears poised to open for business in the U.S., many regulatory and political issues remain unresolved.  The real show may be still happening in the State Houses across the RGGI region, as representatives debate how to spend the auction money they hope to generate under the program.

For further information about this topic, please contact Akin Gump.