Can China Pressure the U.S. Into Cap And Trade?

Cap and trade has been buried in Washington, D.C., but it could be brought to light by an unlikely source.

Travis Hoium
Travis Hoium
Oct 11, 2015 at 10:00AM
Energy, Materials, and Utilities

Could oil use come under pressure by China's new cap and trade scheme?

Cap and trade shouldn't be the political football it's become today. It's a conservative idea with market based incentives that would make it more economical to build clean energy where such energy is cheap and cheaper to burn fossil fuels where that's the cheapest form of energy. But the concept has become politicized and politicians have taken an easy out by suggesting that the U.S. can't fight climate change on it's own (i.e., without China) so why try? 

In the last few weeks, China may have changed both the political and economic realities of climate change at cap and trade by announcing it will begin charging for emissions of CO2. The impact on the U.S. could be tremendous and something like cap and trade could now be around the corner.

Cap and trade could be a boon or a curse
At its core, cap and trade puts a cap on carbon emissions and allows industry participants to trade emissions rights with each other. In theory, a solar plant in Arizona could trade its clean credits with a coal plant in Maine, compensating the solar plant for being clean and costing the coal plant for being dirty. This should make clean energy more economical and also promote its development where the economics make sense and not just based on state mandates.

The devil is in the details though. How are credits allocated? Who is covered? How are carbon credits traded? What time frame do credits cover?

Image: First Solar.

These are just a few of the questions cap and trade proponents have to answer, and until recently there hasn't been much political will behind the system. But that may change now that China says it will begin a cap and trade structure in its own economy. 

Right now, China says that a cap and trade system would cover most of its economy, but there are precious few details to prove that's true. If China does implement cap and trade, though, reducing emissions in the process, what would the U.S. excuse be not to? 

Pressure on the U.S.
China's announcement puts more pressure on the U.S. to do something about its own emissions. President Obama and President Xi of China have agreed to work together on emissions and climate change and this was a salvo from China's side.

So far, Obama has said the U.S. will lower emissions 28% by 2025 and will invest $3 billion in the U.S.'s Green Climate Fund to help other countries go green. Again, the devil is in the details of how that goal will be reached but there are some broad outlines ahead of the next major climate negotiations in Paris in December. That's when the U.S. and China could be jockeying for lead negotiator position. 

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It's then that energy investors, whether they're in coal, natural gas, oil, solar, wind, or any other kind of energy source should start paying attention to climate negotiations. 

How can investors win?
Like I've said, the details of any cap and trade or climate change deal are important, especially for investors. But this is where you can consider if these factors are tailwinds or headwinds for your company.

Any sort of deal will only help the two largest solar project developers in the world: First Solar (NASDAQ:FSLR) and SunPower (NASDAQ:SPWR). The companies build and own projects long-term through their joint yieldco 8point3 Energy Partners (NASDAQ:CAFD), so if they can sell carbon credits it would be icing on the cake. As two of the better capitalized companies in renewable energy I would look there first.

This could be another tailwind for a company like Tesla Motors (NASDAQ:TSLA) as well. Tesla has made hundreds of millions of dollars selling zero emissions vehicle credits to other automakers and depending on how rules are written it could benefit from cap and trade as well. At the least, the energy storage business would likely get some benefits from a scheme to lower emissions.

On a broader level, I think it's important for investors to think about whether or not cap and trade could help or hurt their investments. Companies in renewable energy would definitely be beneficiaries, but fossil fuel companies wouldn't be such a clear answer. This could put even more pressure on coal companies than market forces have already and even natural gas emissions could become an issue for businesses and utilities.

Making sure low emissions are a help to your investment and not a hindrance will be key to mitigating risk in energy over the next decade. The world is changing and you don't want to be on the wrong side of changing emissions standards.