Adventures in smog trading

A world market for buying and selling pollution credits is poised to take off and could be our best chance to stop global warming. Too bad George Bush won't let it happen.

Published June 4, 2003 7:30PM (EDT)

Fifteen years ago, Mark Trexler developed the world's first agroforestry project aimed at offsetting the environmental impact of industrially produced carbon dioxide emissions.

The awkwardly titled AES/CARE Guatemala Agroforestry and Carbon Sequestration Project was based on a straightforward premise: Scientists believe carbon dioxide is a major contributor to the greenhouse effect. Trees remove carbon dioxide from the atmosphere as they grow. A large-scale reforestation project in Guatemala, therefore, would help cancel out, or "offset," the carbon dioxide emitted in North America by AES Corp., an American electricity company. The project would also displace emissions-producing activities such as logging and slash-and-burn farming.

Today, Trexler is the president of Trexler and Associates, a pioneering climate-change mitigation services firm in Portland, Ore. He travels the globe locating and developing carbon-offset projects for the private sector. These range from rural solar-electrification projects in India to methane gas recovery efforts in Ohio.

Some of the companies he works with, such as New Hampshire's Stonyfield Farm Yogurt, are reducing their greenhouse-gas "footprints" as part of a socially responsible business ethic. But the big-time polluters, such as J-Power, one of Trexler's energy-sector clients, are hoping to capitalize on market opportunities arising out of global climate-change concerns. Their goal is emissions trading, in which companies buy and sell greenhouse-gas emissions reductions (acquired from carbon offset or mitigation projects) on the commodities market.

In an emissions-trading market, a steel refinery in Gary, Ind., could purchase the pollution credits generated by a reforestation project in Guatemala. Theoretically, the incentives provided by such a market would lead to a boom in carbon-offset projects and an overall decrease in the amount of greenhouse gases present in the earth's atmosphere.

Several recent developments suggest that the global market for greenhouse-gas emissions reductions is heating up. Last December, Canada ratified the Kyoto Protocol, which mandates limits on pollutants that contribute to global warming. The international treaty is now just one vote short of becoming law in 100 countries. The European Union has already adopted plans for full-scale trading in greenhouse-gas emissions reductions, the key market mechanism under Kyoto. And this June, trading begins on the Chicago Climate Exchange, the first CO2-emissions reductions market in the United States.

"The carbon emissions trading market," proclaims, a London-based global greenhouse-gas brokerage, "has arrived."

Not everyone is so optimistic. Trexler, a lead author for the Intergovernmental Panel on Climate Change, whose scientific assessments helped create the political momentum behind the Kyoto Protocol, is one of the skeptics. For one thing, maintaining the environmental integrity of a global emissions-trading system is an enormously complicated task, he says, prone to all kinds of corruption and sketchy science. But even worse, in 2003 the major roadblock facing the development of a legitimate emissions market is the Bush administration, whose antipathy toward the climate-change issue in general and the Kyoto Protocol in particular means that, so far, U.S. companies have little incentive to reduce their greenhouse-gas emissions.

Even if the rest of the world endorses the treaty, says Trexler, it remains to be seen whether an international trading system can get off the ground without the participation of the United States, where most of the demand for emissions reductions would come from.

"To create a successful trading system you have to create a scarce commodity," he says. "So without the political initiative to regulate greenhouse gases, you can't have a trading system." The United States' failure to endorse the principles of the Kyoto Protocol is exactly why Trexler is hesitant about predicting a "meteoric rise" in market activity. "A couple of years ago, there were expectations that the global greenhouse market would be a $10 billion enterprise by 2010," he says. "But now whenever I see my broker friends in New York, they say, 'Jeez, when is anyone going to start making money on this deal?' Because it hasn't really materialized."

There's a certain irony to the Bush administration's rejection of the Kyoto global warming treaty. Call it Oedipal. In 1990, President George H. Bush signed into law the Clean Air Act, which led to the creation of an emissions-trading system to limit pollutants responsible for acid rain. Widely considered a political and environmental success story, the law reduced lethal pollutants such as sulphur dioxide for a fraction of what it had cost before.

Sulfur dioxide emissions trading operates according to a "cap and trade" arrangement. Under this system, the government puts a cap on the level of allowed emissions. Polluting industries that can reduce emissions cheaply or efficiently earn pollution "credits" or "permits" (the legal terms for emissions reductions in a regulated system), which they can sell to other companies who can't make the reductions on their own.

So here's the paradox. Carbon dioxide emissions trading under the Kyoto Protocol is based on the cap-and-trade system the United States developed under the Clean Air Act. "It's an American plan, and America's not playing," says David Doniger, a former Kyoto treaty negotiator under President Bill Clinton and now policy director of the Climate Center at the Natural Resources Defense Council. "Cap-and-trade was invented in America and sold in Kyoto over the great objections of the Europeans and Japanese. Now they're going to do it, and we're going to fall behind."

In yet another reversal, the Bush administration has seized on the Clean Air Act as a way of justifying its opposition to the Kyoto Protocol. "Kyoto doesn't have a bearing on emissions trading," says David Deegan, public affairs officer for the Environmental Protection Agency. "The administration's position is that CO2 is not a pollutant under the Clean Air Act and should not be regulated as an air pollutant." Carbon dioxide, Deegan explained, occurs "naturally" in the atmosphere.

This is not the kind of scientific analysis that makes hope spring eternal among people advocating limits on greenhouse-gas emissions. "After Kyoto," says Trexler, "the U.S. presidential election is the single most anticipated event in the climate-change community."

If Kyoto does become international law -- the United States and Russia are the key players who have yet to ratify -- industrialized countries would have to lower their greenhouse-gas emissions from their 1990 levels by an average of 5 percent beween 2008 and 2012. Developing countries wouldn't have a cap on their emissions. But under a program called the Clean Development Mechanism (CDM), industrialized countries would be able to earn credits by investing in emissions-reductions projects in the developing world.

This, in a nutshell, is the Kyoto Protocol. "Without emissions trading," says Trexler, "the prospect of successful climate-change policy is dead. There is no other way to involve developing countries, where most of the emissions will soon be. Trading is the vehicle for getting them money, unless you're going to give it to them through foreign aid, which isn't going to happen."

Without trading, he adds, polluting industries in the United States will remain "in a coma" on this issue. "Companies will trot out all these studies saying, 'It's going to cost us $30, $40 or $80 a ton to do emissions reductions, and it will be financial Armageddon.' It's only with the trading component that you can argue it will be $5 or $10 a ton. That's how you make progress politically."

Market mechanisms are Trexler's mantra -- as well as his livelihood. But he's also the first to point out that problems with what he calls "environmental integrity" could derail the system -- especially under the Clean Development Mechanism, where companies are already banking credits in anticipation of Kyoto. "We have a lot of concern that the market could run into serious environmental credibility problems three or four years in the future," says Trexler. "You can already see the dissertations being written about how this was all a fraud, how all these projects were bogus."

To understand how this might happen, start with what Trexler describes as a "massively confusing and contentious area": the rules defining a legitimate emissions reduction under the CDM.

"If you're bringing an emissions reduction from a noncapped country into a country with a cap and counting it against that country's cap," says Trexler, "how do you ensure the integrity of the transaction? You could have a lot of paper flow and money changing hands, but did you actually reduce emissions at the end of the day?"

To resolve this dilemma, the Kyoto Protocol includes something called the "additionality" rule. The rule states that CDM projects generate legitimate emissions reductions only if they are "additional to any that would occur in the absence of certified project activity." For example: Compare the emissions from a power plant with the emissions of the same power plant after an energy-efficient upgrade. The difference represents the additionality, and the company that develops the upgrade project gets the credit, literally.

But what if inefficient power plants are an anachronism and the power plant was going to be upgraded as part of standard business practice? In that case, there would be no "certified project activity" specifically aimed at emissions reduction, so there would be no additionality and no credit.

Or what if a company invests in a forest-protection project to sequester carbon in southern Brazil, but it ultimately leads to increased logging activity in northern Brazil? Since there is no net reduction in greenhouse-gas emissions, does the company earn the emissions credit?

"The additionality conundrum gives everyone a headache," says Trexler. "Some people say we'll never be able to solve this question. But if you drop the additionality requirement, there's no point in doing any of this."

Additionality decreases the opportunities for industrialized countries to earn credits for cheap, possibly worthless projects in the developing world. (CDM Watch, a nonprofit based in Indonesia, monitors ongoing emissions-reductions projects for just that reason.) But defining allowable credits in an emissions-trading system is a broader concern, especially when each sector has a different way of reducing its greenhouse-gas footprint.

"The beauty and problem of greenhouse gases is that almost everything you do releases carbon," says Trexler. For example, Fannie Mae has launched an initiative to aggregate energy efficiency savings from retrofitting homes to trade on the emissions market. In the transportation sector, some people suggest that funding Internet car pools might apply. A cottage industry has sprung up trying to figure out what qualifies as a legitimate pollution credit, says Joe Goffman, director of Air Quality and Climate programs at the Environmental Defense Fund, a major proponent of emissions trading. "It's a significant intellectual challenge."

However, Trexler points out that many of the "integrity" issues surrounding emissions trading disappear once you have a political system in place to regulate and monitor transactions. Carbon credits are a unique commodity precisely because their value is determined entirely by public policy. Given the current policy vacuum, questions -- and complications -- abound.

Last year, a Japanese utility client, J-Power, helped fund the development of Trexler and Associates' "forward price" modeling software, which predicts the cost of carbon credits under different additionality scenarios, as well as a "sensitivity case" in which the United States ratified the Kyoto accord. "This is a company that faces potentially billions of dollars in risk," said Trexler. "The big question people want to know is, What is the price of carbon going to be? In five years? In 10 years?"

Today, emissions reductions trade at about $2 to $3 a ton, not enough, Trexler observes, to fund the renewable energy technologies the greenhouse market was supposed to foster. Companies getting into the market now, he says, assume that the cost of pollution permits will go up after Kyoto goes into force, especially if the United States endorses the treaty. He cites the case of another Japanese client, with whom he recently developed a landfill-gas project in Argentina and a methane-recovery project in Uruguay -- both carbon-offset projects. "Their goal is to amass actual credit that will count in a future trading system," he says.

But that brings up another big question: Will pre-Kyoto credits be guaranteed post Kyoto? "There are a lot of things companies could be doing now to reduce their emissions internally," says Trexler. "But you could build a very strong case that they shouldn't be doing anything since they might not get credit later on." What's more, since the United States has yet to impose a cap on emissions, companies aren't exactly champing at the bit to buy emissions reductions -- the optimistic posturing of brokers notwithstanding. "Trade away," urges their Web site, "there's no better time than the present."

Of the estimated 200 million tons of greenhouse-gas emissions reductions traded on the global market last year, the biggest buyers were funds the World Bank has set up, such as the Carbon Fund or a similar fund set up by the Dutch government. Canada had been buying up large quantities of U.S. reductions, but cut back considerably after a battle last year over U.S. compliancy with Kyoto.

As for the pending Chicago Climate Exchange, 13 companies, including DuPont, Ford Motor Co. and American Electric Power, have voluntarily agreed to cap and trade their emissions by 4 percent over the next few years. "We're thrilled these companies are making that kind of foray," says Goffman. But as long as there's no mandate to decrease their emissions, he says, there's not much incentive for them to spend money purchasing reductions.

"In the voluntary market," says Goffman, "everybody's a seller."

Ten years after pioneering a successful market approach to sulfur dioxide emissions, the U.S. government is keeping the global greenhouse-gas emissions market from moving forward. In this context, it's no surprise that the Bush adminstration's new Clear Skies program would, according to Doniger, "slow and weaken" efforts to reduce sulfur dioxide emissions compared to existing requirements under the Clean Air Act. It's just one step further away from the made-in-America cap-and-trade system.

Such political developments are precisely why Trexler and Associates has decided to direct more resources toward the "voluntary market": companies that probably won't be regulated should an emissions cap be imposed, but choose to invest in carbon-mitigation projects for public relations or marketing purposes. A prototype client is Stonyfield Farm Yogurt, for whom Trexler has developed a carbon-offset portfolio of straw-bale house construction projects in China and methane-recovery projects in Ohio. Other companies are developing products that appeal to environmentally conscious consumers. For example, Trexler is currently in discussion with a foreign car manufacturer that wants to bundle four years of carbon offsets into cars it sells on the North American market. Car buyers could appease their sense of environmental guilt by paying extra for their gas-guzzling SUVs -- the premium would go toward funding the establishment of offset projects.

"If one car company does that, then maybe another will, until companies bundling offsets become business as usual. The question in these kinds of cases is whether you can get a consumer response."

Not that Trexler has abandoned all hope of working in a government-created marketplace. Reflecting increased activity on the international front, Sumitomo Corp., a major Japanese trading house, bought 20 percent of Trexler and Associates last year, positioning Trexler for new strategic alliances in Asia. And his generally dour assessment of the emissions-trading situation brightens considerably when he discusses the prospect of the Democrats taking the White House in 2004. Under that scenario, he says, the price models show that "radically different things could happen: The junk disappears, you're dealing with real projects, real prices and real reductions."

Should Bush retain his high popularity ratings, there are some backup plans. One Senate bill, the Clean Power Act, would put a cap on carbon dioxide; and another, the McCain-Lieberman bill, would put a cap on a basket of six greenhouse gases.

"The market is poised around some very important issues, and so are we," says Trexler. "I've said for years that if the world ultimately decides to take climate change seriously, we'll look back on today's efforts as badly misdirected -- as opposed, for example, to simply agreeing to a global emissions cap of some sort. For political reasons, we're stuck using some very imperfect solutions to get the ball rolling. The question is whether we're careening in the wrong direction ... and whether we're going to be able to get things back on track."

"Global warming remains the single most important environmental problem facing the world community. The science on this issue continues to improve, not dissipate. So do you give up? No, we're not going to make that decision."

By Linda Baker

Linda Baker is a journalist in Portland, Oregon.

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