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<p align="left"><font face="Arial"><strong><small>About The Author:<br>
<br>
</small></strong><span lang="X-NONE" style="color: black"><font size="2">
ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon
Markets Group has practiced law related to the finance of environmental and
energy projects and companies for 40 years. In particular, he has analyzed
and executed a wide variety and substantial value of project financings. He
chairs the American Bar Association’s Committee on Carbon Trading and
Finance, serves on the Board of the American Council for Renewable Energy,
and has been a senior official in the Federal Energy Administration. He is
a graduate of Brown University, Yale Law School and Harvard Business School.</font></span></font></p>
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<img src="../images/feldman.gif" alt="Washington Viewpoint by Roger Feldman" border="0" width="375" height="75"><p align="left"><b><u><br>
December 2007</u></b></p>
<p align="center"><font size="6"><b>Casablanca</b></font></p>
<p><strong>by Roger Feldman --
</strong><b>Andrews Kurth, LLP</b><strong><br>
</strong><font face="Arial" size="2">(<em>originally published by PMA OnLine
Magazine: 2008/01/26</em>)<br>
</font><span style="font-size: 10.0pt; font-family: Palatino; color: black">
</span></p>
<div>
Casablanca is really the ultimate movie about energy. Rick plays “As
Time Goes By”; the markets, for good or ill, lurch along. So, too, do
climate change regulation proposals. It is easy to believe, especially
at this time of year when energy legislation shimmers like the Northern
Lights, “Louis, I think this is the beginning of a beautiful
friendship.”
<p>But it would be unwise to forget that Casablanca, after all, was
nothing more than a big Moorish bazaar, the culture of genies granting
wishes, filled with greed and superstitious hope. America’s particular
energy bazaar also has two very different genies hovering over it. One
is the volatile price of oil, whose price movements appear to be beyond
our control, and which inevitably affects the price of other energy
commodities, notably natural gas. The sour smell of possible market
manipulation is always in the air. The other is a new unknown genie: the
still-mysterious price of carbon offsets, whose impacts on the
marketplace promise to significantly rearrange the relationships of
traditional energy commodities and alternative energy sources. </p>
<p>These two genies, natural gas and carbon, have something else in
common, besides their ability to impact the stability of the energy
prices and roil the shaky economic health of our country. This is the
current status of the regulation of their trading markets. </p>
<p>Ever since 2000, natural gas has been permitted to trade as an
“exempt commodity,” on lightly regulated “ECMs” — exempt commodity
markets. (The Commodity Exchange Act, as amended extensively by the
Commodity Trading Modernization Act, provides for three tiers of
regulation of the exchanges by the Commodity Futures Trading
Commission.) You may remember that a company called Enron (which thought
itself the mother of all genies) was a proponent of natural gas trading
of this type; that at the time of the California deregulation meltdown
there was an incomplete effort to rectify this situation in recognition
of the havoc which the potential for manipulation had wrought. It was so
sufficiently incomplete that there have, in the very recent past,
occurred meltdowns of hedge funds like Amaranth resulting in misguided
speculation in the market, which caused a minor financial crisis and
post-hoc FERC apoplexy. “It’s time to round up the usual suspects,” as
they say in Casablanca: stuff that genie back in the bottle. Recently,
Senator Levin introduced the not-so-subtly named “Close the Enron
Loophole Act,” which would revoke the earlier regulatory exemptions, and
at least require the Commodities Futures Trading Corporation to apply
its more stringent rules to supervising gas trading markets. The
underlying policy hypothesis — which may have some merit (although it
turns a blind eye to the overarching impact of the oil genie) is that
such regulation will “prevent price manipulation and dampen the
excessive speculation that [has] unfairly increased the cost of energy
in the United States.” </p>
<p>But the Enron Loophole bill would go further than that, extending
CFTC regulation to a class of derivative contracts related to assets not
previously treated as jurisdictional: emissions from hydrocarbon
combustion, including not only sulfur dioxide (SO<sub>2</sub>) and NOx
which have been subject to a cap and trade regulatory scheme for well
over a decade, but also carbon dioxide (CO<sub>2</sub>), the greenhouse
gas whose regulation is still the subject of nascent statutory schemes
on a regional and state basis, as well as a variety of voluntary
programs which have spurred the creation of contracts which can be
traded in new as-yet-un-codified rights. Note: It is not the
environmental credits themselves, but the trade in futures, that would
be regulated.</p>
<p>The initial reaction to the overall Levin proposal must be similar to
that of Captain Renault in Casablanca upon discovering that illegal
gambling is rife at Rick’s place: “I am shocked, shocked--.” Or as a
CFTC commissioner riffed at a recent hearing on the subject: “Who’s in
charge?”</p>
<p>The need for regulating the trade of established energy commodity
futures could not be more clear. There continue to be issues as to who
is best equipped to do it: The FERC (because of its natural gas
regulatory responsibilities), the SEC (because of its superior
compliance capabilities -- albeit not generally applied in CFTC turf),
or the CFTC (which has developed significant experience in the
regulation of other types of commodity futures trading). </p>
<p>As to regulation by the Levin legislation of environmental emissions
affects - what might best be called “markets in gestation,” the issue is
not that we would be shocked that the emergence of the potentially huge
new market could produce manipulation. The only question for most
observers is: How should regulation evolve? Richard Sander and the
Chicago Climate Exchange have suggested that climate futures are so
recently developed a commodity that an exchange dealing with them ought
to incur the burdens of heavy CFTC regulatory oversight. Some observers
might suggest that this position is not a wholly disinterested one, as
that is one of the CCX’s products. But that is not really the point. </p>
<p>There is a more basic issue, which may well receive greater attention
in the coming months as carbon regulation takes shape: whether trading
in carbon futures is a subject which deserves oversight not just by the
CFTC from a trading manipulation standpoint, but as matter whose
collateral energy policy ramifications are so great that there also
ought to be a formal Energy/EPA coordination of policies and oversight.
</p>
<p>The first reaction of many is to shrink in horror from this
anachronous thought. Have we taught ourselves nothing over the vast two
computer-powered decades of the speedy potential of markets to do valid
price discovery, as opposed to the bungling politically-influenced
decisions of bureaucrats? (See “The Horrid Case of Natural Gas Before
Deregulation” vols. 1960-1990.) After all, as Casablanca says, “a kiss
is just a kiss.” A trade is just a trade. Markets are an article of
faith of our libertarian age. </p>
<p>There is obviously some truth in that position. Still a small voice
is heard: have we learned nothing from Enron? When there are
interrelated market commodities whose prices or delivery can be
arbitraged and/or manipulated, societally counter-productive things can
happen (and have happened). And is not astute manipulation of the
currently unregulated commodities, such as the twin genies, capable of
similar mischief and collateral impact on our electric power markets?
Should we really believe Treasury Secretary Hank Paulson who, musing on
subprime loan regulation, exclaims that nevertheless it is a good thing
that traders and bankers stay one step ahead of regulation?</p>
<p>There is a wise middleground position between free markets and
command-and-control, based not in trading regulation but in the
definition of how the carbon markets will be structured, allowances
allocated, trades verified, transactions monitored and, above all,
whether unforeseen perturbations in the cross-fuels and energies markets
could result. Once public law turns lose the “Invisible Hand” in a gasp
of green excitement (combining environmental virtue with market
secularity) without first considering its energy price and policy
implications, the genie of speculative future markets is out of the
bottle. (Perhaps there is something to be gleaned from the post-Enron
FERC and Congressional analyses of what went wrong, in terms of the
establishment of some on-going energy/environment market monitoring
team, which leaves commodity regulation to the commodity regulators.)</p>
<p>At the opening of the movie, Casablanca is characterized by insulated
introspective thinking. Rick thought only about himself. The resistance
leader, Victor Laszlo, thought only about the needs of the movement.
Ilsa thought only (most of the time) about love. By the arrival of the
closing credits, there has been growth to broader thinking. This is the
spine of the story, the power of Casablanca. Is there a lesson for our
Energy Casablanca? Perhaps too much to hope for. Welcome to 2008.
“Here’s looking at you kid.”<br>
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<p class="MsoBodyText" align="left" style="margin-bottom:0in;margin-bottom:.0001pt;
text-align:left"><font face="Arial" size="2">
<span lang="X-NONE" style="color: black">ROGER FELDMAN, Co-Chair of Andrews
Kurth LLP Climate Change and Carbon Markets Group has practiced law related
to the finance of environmental and energy projects and companies for 40
years. In particular, he has analyzed and executed a wide variety and
substantial value of project financings. He chairs the American Bar
Association’s Committee on Carbon Trading and Finance, serves on the Board
of the American Council for Renewable Energy, and has been a senior official
in the Federal Energy Administration. He is a graduate of Brown University,
Yale Law School and Harvard Business School.</span></font></p>
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