Warming Trend Is Hatching a Business

By Steven Mufson
Washington Post Staff Writer
Thursday, September 28, 2006; D01

U.S. governors, impatient with federal inaction on global warming, are taking matters into their own hands. The result could add impetus to an emerging industry.

California Gov. Arnold Schwarzenegger (R) yesterday signed legislation to cap greenhouse gas emissions. And seven Northeastern states, which together emit as much greenhouse gas as Germany, have banded together to set rules that would cut their emissions by 10 percent by 2019. Other states may join them.

"There isn't an actor at the table who wouldn't prefer a national program, but we can't afford to wait," says Franz Litz, climate change coordinator at the New York State Department of Environmental Conservation.

So the state leaders are modeling their efforts on the European Union, which has turned limits on greenhouse gas emissions into a multibillion-dollar worldwide industry.

Companies are already scrambling to take advantage of the E.U. system, which is an outgrowth of the global environmental accord known as the Kyoto Protocol. Arlington-based AES Corp. has dispatched teams to negotiate with Asian palm oil plantations over installing equipment to suck methane -- one of the most potent of a half-dozen greenhouse gases -- out of waste lagoons. The electric power company wants to convert it into energy and less harmful gases. In return, the firm would get credits it could use or sell in Europe.

The European system sets a cap for the continent's emissions of greenhouse gases, such as carbon dioxide. Every company producing significant amounts of greenhouse gases is issued a designated number of "allowances." If power plants and factories spew out more than their quotas, they have to buy allowances from firms that spew less than their allotments. Polluting companies can also buy credits from firms that are cutting emissions in the developing world.

The result: Gases that were once worthless now have a commercial value every bit as solid as coal, pork bellies or Treasury bills -- only with this commodity, companies are paid for what they do not deliver. According to Point Carbon, a research firm, $12.6 billion of greenhouse gas emission rights, called European Union Allowances, were traded in the first half of this year. The value of all existing allowances exceeds $70 billion.

The Northeastern U.S. governors' Regional Greenhouse Gas Initiative plans to begin a similar type of carbon trading by 2009. Schwarzenegger, who appeared last month beside British Prime Minister Tony Blair, said that linking a West Coast plan to Europe's was one option.

The idea of creating a market for trading air pollution rights began in the United States. Legislation passed in 1990 and implemented in 1995 established an acid rain program, which capped sulfur dioxide emissions and let companies trade their assigned shares. Sulfur dioxide emissions fell 30 percent. Economists say such plans meet environmental goals efficiently, without choosing between technologies.

The United States insisted that other countries adopt a cap-and-trade approach for greenhouse gases in the Kyoto accord but then never signed on while Europe moved ahead. Back then, the United States agreed to reach a target 7 percent below 1990 emissions by 2012. Now, the country is churning out 16 percent more than it did in 1990 and 25 percent more than either China or the E.U.

"It is ironic that 10 years after Kyoto was signed, there is a vibrant market in Europe, an emerging market in the developing world, and the U.S. is sitting on the sidelines," says Véronique Bugnion, Point Carbon's research director.

No one is on the sidelines in Europe. Power generators now count greenhouse gases -- measured in metric tons of carbon dioxide -- as one of their costs. "It's going to change the way you make decisions about deploying capital," says Garth Edward, trading manager for environmental products at Royal Dutch Shell PLC, which has 25 installations in the E.U. system. Energy efficiency projects, he said, "are going to move up the ladder faster."

Stockholm-based Vattenfall, Europe's fourth-largest utility, is building a pilot zero-emissions coal-fired plant in Germany using sequestration, which injects carbon dioxide into the earth instead of releasing it into the air. Vattenfall chief executive Lars G. Josefsson says removing the carbon dioxide will cost more than $25 a metric ton, but he says, "If we're going to have a problem with carbon dioxide, this is a good investment."

While the E.U. carbon trading scheme has given birth to an industry, it has also created controversy over how quotas are assigned and who gets stuck paying the bills. In Germany, utilities raised electricity rates, treating carbon emissions as a cost to pass along. Four utilities made $3 billion to $5 billion in windfall profits, Bugnion says.

There are disputes between countries as well as within them. Britain and Germany are cutting their greenhouse emissions sharply, while Spain's are still growing. Sweden relies mostly on hydro- and nuclear power for electricity; Germany relies overwhelmingly on coal. Countries are currently drawing up new caps for 2008-2012.

Setting baselines for emissions has been tough. Quotas are based on a company's emissions over the five years before the program began. Firms have sought higher baselines to get more allowances. In most nations, utilities were squeezed while industrial firms were given more than enough.

The numbers didn't add up the way people expected. In May, the E.U. revealed that actual emissions were well below the quotas, suggesting that baseline levels were set too high. That shocked the carbon trading market. The price of a ton of carbon dioxide crashed, dropping by two thirds and erasing $36 billion of value. Prices crept back up but tumbled in recent days.

The credits bought in developing countries pose other challenges. So far, companies find it cheapest to cut the most potent greenhouse gases, mostly in the developing world. A ton of methane, common in landfills and farms, equals 21 tons of carbon dioxide; a ton of hydro-fluorocarbons, a refrigerant byproduct, is worth as much as 11,700 tons of carbon dioxide.

Independent firms and investors are getting into the act. Ecosecurities, whose chief executive Bruce Usher is a former Wall Street derivatives trader, has become a broker and developer of projects in 26 countries, ranging from one to capture methane at a Chinese landfill to small hydropower dams in Honduras.

A London firm called Climate Change Capital has raised $830 million to reduce greenhouse gases for credits to be sold in Europe. AES is putting $325 million into a joint venture to produce 50 million tons of credits by 2012.

These credits need the blessing of the Clean Development Mechanism (CDM), a United Nations agency in Bonn. That process could get messy, and political. One criterion: "additionality," the buzzword for a project that wouldn't have happened without the credit system. That can be hard to figure out when high oil prices make conservation and alternative energy attractive. In July, the CDM rejected four projects, including two proposed by Ecosecurities, without saying why.

Not surprisingly, most credits are generated in countries with the worst environmental track records. China accounted for 62 percent of the CDM credits sold during the first half of this year. That raises a sensitive question: Should Europe be effectively subsidizing investments in pollution control that its economic competitor China hasn't bothered to make? Moreover, China is collecting a 65 percent tax on the sale of credits.

"Scientifically, it makes sense to take [greenhouse gases] out wherever you can do it most cheaply, but politically, it might be better to do it in your country," said AES chief executive Paul Hanrahan.

There is one functioning U.S. carbon market. On Earth Day 2005, Richard Sandor founded the Chicago Climate Exchange, but participation is voluntary. Member companies must trim 6 percent of their emissions by 2010. "The only ones who opt in know they'll meet the targets," says Point Carbon's Bugnion. Members include Ford Motor Co., DuPont Co., Motorola Inc., International Business Machines Corp., American Electric Power Inc. and half a dozen municipal governments.

Mandatory carbon trading may still be adopted in the United States. Cap-and-trade measures have been drafted by a handful of lawmakers. Sen. John McCain (R-Ariz.) co-sponsored an earlier bill.

"This is a big global problem, and we have a deficit in global governance," says Vattenfall's Josefsson. "If we could solve this, it could be a model for global governance."