Class Tests Carbon Trading, With Troubling Results

STEVE INSKEEP, host:

Congress has yet to approve a method to attack global warming on a large scale. One plan to do that was easily defeated the other day. But the state of California is working on its own system. The state has already approved a law to limit carbon emissions. Now state regulators face the hard part, trying to figure out how the law is supposed to apply to real people and real businesses. Some possible problems become apparent when you simulate the way the system works. And on a recent day, Rachel Myrow of member station KQED went to class with people who've practiced the system called cap and trade.

RACHEL MYROW: Here's how it works. Regulators set mandatory limits on various kinds of industrial emissions. Firms that need to exceed their limits, or caps, can buy permits from firms with allowances to spare. Hence the phrase cap and trade. If this sounds intimidating, it might help to go back to school...

(Soundbite of classroom)

MYROW: ...to Energy and Environmental Markets in room C210 at the Haas School of Business at U.C. Berkeley. There are two professors - Severin Bornstein and Jim Bushnell. The crowning glory of the course is a computer simulation of an electricity market. Professor Bushnell leads the postgame analysis.

Professor JIM BUSHNELL (U.C. Berkeley): So this is Game A, Round 1. What was your thought process in putting together your bids for your portfolio?

MYROW: Competing groups of classmates, each with different portfolios of power generating plants, vied with each other to get the best price for their power over three weeks. Professor Bornstein says the simulation was inspired by real world events when a few years back California was pushed into the national headlines. The state had deregulated its electricity market and soon after energy traders figured out how to game the market, nearly bankrupting the state's biggest utilities.

Professor SEVERIN BORNSTEIN (U.C. Berkeley): We first introduced the electricity strategy game during the electricity crisis so students would have a better understanding of what went wrong in the California electricity market by actually putting them in the position of firms, deciding how much to produce and how much to charge.

MYROW: Bornstein and Bushnell predicted California's energy crisis. They were ignored at the time. But in the classroom it becomes clear. Students put in a position to manipulate the market do so all on their own. For example, the professors updated the simulation to account for carbon trading. So after a first round of straight up power trading the teams had to reduce their carbon output by 10 percent, and trade permits. Professor Bushnell describes what happened next.

Professor BUSHNELL: Now, in Game A these guys bought up most of the credits and they announced we're tearing up half the credits. And so you've got to pay us a high price if you want to get carbon credits from us. Was anybody surprised by this or was sort of the rumors floating around? You guys were? Yeah, you guys were kind of upset about it.

(Soundbite of laughter)

MYROW: Class lesson number one: in any market, social concerns, even broader economic stability, take a backseat to making money as efficiently as possible. Professor Bornstein says it's critical to stress test your market design before you ring the opening bell.

Professor BORNSTEIN: What's going to happen in the real world when some people are out to make as much money as they can?

MYROW: He's not just talking from the sheltered confines of the ivory tower. Bornstein and Bushnell have experience as electricity regulators in California. It's a fair bet some of their students will go on to serve as carbon trading regulators.

After the class is over, Greg Croft says he was taken aback during the simulation, but not by his classmates gaming the market. His concern reflects the second big worry public policy makers have about carbon trading.

Mr. GREG CROFT (Student): It hugely increased electricity prices. I mean, this is the only example I've seen, and we had two different games going within the class. It happened in both games.

MYROW: Cap and trade is not the only strategy under serious consideration by economists, environmentalists and public policy wonks. Some of them would prefer to simply tax emissions. But taxes are widely considered a much harder sell politically. California regulators could decide to opt for cap and trade and taxes. Whatever strategy they go for, the state should prove a handy test case - a simulation, if you will - for the rest of the nation.

For NPR News, I'm Rachel Myrow. Transcript provided by NPR, Copyright National Public Radio.