One of the unique features of cap-and-trade emission reduction schemes — apart from their stated goal of expunging the very commodity they are trading — is the regulatory and legal exposures they bring with them. Governments are able to change the rules, and aggrieved parties are likely to challenge the rules in court — all good news for lawyers, but not necessarily for investors.

Nowhere could this be highlighted more starkly than in the little-reported demise of a cap-and-trade scheme in the US, established and designed by the Environmental Protection Authority to cut the amount of smog-causing and ozone-depleting nitrogen and sulphuric oxides produced by coal-fired power stations.

In July, an estimated $US40 billion of emission allowances and credits — more than four times the annual value of Australia’s proposed carbon pollution reduction scheme — were rendered worthless by a shock decision from a US district court.

Several power utilities and the state of North Carolina and had petitioned the court to try and extract better terms from what is known as the Clean Air Interstate Rule (CAIR). What they did not count on, or even seek, was the court ruling the whole system invalid because of flaws in how the system tackled the emission of pollutants from upwind and downwind states.

CAIR, which was based on a successful cap-and-trade scheme that reduced acid rain in the 1990s — had been introduced in 2005 as the centrepiece of a new scheme to reduce emissions from power plants in the eastern US. It sought to cut nitrogen oxide emissions by 60 per cent from 2003 levels by 2015, and sulphuric oxide levels by 70 per cent over the same period.

The EPA estimated that CAIR would prevent more than 13,000 premature deaths and 19,000 heart attacks by the end of 2010, and deliver up to $US100 billion in annual health benefits, not to mention environmental savings on rivers, lakes and forests.

The unanimous court decision brought an instant halt to the scheme, wiping out an estimated $US21 billion of nitrous oxide allowances and up to $US20 billion of sulphuric oxide allowances.

The pain is already being felt by the utilities who bought allowances or who had generated credits by reducing their emissions. A Pittsburgh based utility called PPL announced in August that it expected a loss of around $US100 million on the value of credits that it had generated.

PPL in September said the decision meant it and other companies were reviewing the financial and operational implications for further investment in technologies that could reduce emissions.

The EPA is reviewing its options and has won an extension to a deadline to file an appeal. But the decision is being seen in US legal circles as a major setback to clean air programs in the US and the creation of similar mechanisms to reduce carbon emissions.

Apart from the problems of dealing with an uneven regulatory terrain, is the issue that such decisions appear to punish corporates who took actions ahead of compliance deadlines. It reinforces the need for a strong legal framework for a carbon scheme, being promoted by both presidential candidates, which in the US could generate a market worth more than $US500 billion.