Pollution Is Good Business

March 13, 2008

All three remaining presidential candidates favor a mandatory cap-and-trade CO2 system. Is now the time to buy carbon contracts?
  • Can conservation and capitalism mix?
  • CCX or NYMEX?
  • Will it really work?

Who knew dirty air could be such good business? Last year, the global carbon credit market topped $30 billion, and traders exchanged more than 1.6 billion metric tons of CO2 emission permits worldwide.

Unlike the rest of the world, however, the U.S. remained largely skeptical of carbon trading. Long after the EU adopted the Kyoto Protocol, we refrained from implementing any mandatory emissions limits or trading structures. (Smells too much of Al Gore-style eco-evangelism.)

But on March 17, St. Patrick's Day, NYMEX's Green Exchange launches its first carbon futures for trade, effectively opening up the States' infant carbon market on the world's largest commodities futures exchange. That - combined with the fact that all three remaining U.S. presidential candidates favor a mandatory CO2 trading system - might just turn the U.S.' current emissions trading scene into a major vehicle for global climate change.

Or will it? Analysts still can't decide whether carbon trading is an innovative application of free-market capitalism, or a wild goose chase for greenies. It all comes back to the hotly debated question: Can good business and conservation coexist?

Cap-And-Trade 101

Since 1751, we've spewed about 315 billion tons of carbon dioxide into the atmosphere - about half of that in the last 40 years. The IPPC estimates that, if left unchecked, global greenhouse gas emissions could rise another 25-90% over year 2000 levels by 2030 (CarbonPositive). That's bad news, since greenhouse-gas-related climate change also brings rising sea levels, crop failures and even worldwide species extinctions.

Policy makers and environmental groups have floated several approaches toward curbing greenhouse gas emissions, but few proposals have gained as much traction as emissions trading, also known as "cap-and-trade."

Cap-and-trade is simple enough: Governments (or international agencies) set a limit or "cap" on the total amount of CO2 a country can emit each year. Companies are issued emission permits, or "allowances," that give their factories the right to emit a certain amount of CO2 (or its polluting equivalent in other greenhouse gases). The cap alone should drive many companies to upgrade to more eco-friendly equipment, thus cutting down their emissions.

Since low-emissions companies won't need all their allowances, they can sell their surplus on the open market as "credits." Polluters that can't or won't upgrade their technology can purchase these credits to cover their emissions excess.

In addition, companies can pay someone to reclaim CO2 through green projects called "offsets." Calculated to absorb a given amount of atmospheric carbon, offsets effectively cancel out those extra emissions from high polluters. Common projects include planting forests to suck up greenhouse gases, or recovering methane from a landfill to fuel power plants.

Yes, the cap-and-trade system still allows polluters to pollute. But in theory, companies that can easily and cheaply curtail their output are likely to do so, since they can profit from selling excess credits. Indeed, the more they cut back, the more money they stand to make. Thus, CO2 reduction occurs as the least financial burden to society.

Reaction At Home

And yet, the cap-and-trade scheme isn't perfect. An accurately valued market depends on careful, rigorous measurement of CO2 emissions across local, national and global levels. It also requires an independent third party trustworthy enough to verify when offset projects have taken place, and that their emissions savings were counted properly. But companies cheat, particularly by exaggerating their CO2 output. And in many systems, the same third parties verifying an offset's legitimacy are also in charge of approving the project, too.

Some critics argue that cap-and-trade is fundamentally flawed, that it doesn't solve the carbon problem so much as redistribute it. Since low emitters just sell their pollution rights to the highest bidder instead of retiring them, pollution isn't reduced beyond the initial cap restriction. There's also the problem of "grandfathering," where the government gives credits to polluters, instead of charging for them.

Still, many analysts consider cap-and-trade better than its alternatives - the carbon tax or emission fees. True believers can point to the example of sulfur trading, which, in the last 10 years, has successfully curbed sulfur emissions in the U.S. by more than 50%.

Politicians in Washington are already sold on a CO2 cap-and-trade scheme; two separate bills in Congress propose a mandatory nationwide cap. For example, the Senate bill, America's Climate Security Act, would limit carbon dioxide emissions to 15% below 2005 levels by 2020, while still allowing state and regional initiatives to impose more stringent restrictions.

On the local level, 22 states have explored or established voluntary cap-and-trade programs, many modeled after the EU's system. The Regional Greenhouse Gas Initiative, supported by 10 Northeastern states, is set to start next year and aims to reduce CO2 emissions to 10% below the 2009 level by 2018. A similar collaboration, the Western Climate Initiative, involves seven Western states and even two Canadian provinces.

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