How GHG emissions trading works
It is a remarkable fact, and one worth lingering on, that parties all over the world are creating systems to trade greenhouse gases and actually starting to barter, even though not required to by law. How do they go about doing that?
There are two different kinds of permit trading systems. In one version, cap-and-trade, government regulators issue emissions allowances up to pre-set caps for various kinds of GHG sources, such as an individual utility's power plants, within an overall national ceiling. Sources emitting less than permitted can sell excess allowances to sources exceeding their caps.
In the alternative, baseline-and-credit system, each source's performance is measured against a baseline, which is not necessarily fixed permanently and can, for example, be adjusted downward year to year. Those coming in below the baseline obtain tradable emissions credits.
Sound simple? It's not. Figuring how many credits parties are entitled to will be a small nightmare.
When a global GHG trading system is up and running, the governments involved will have complex rules to determine who's short and long. In the meantime, as trial transactions take place in experimental systems, the procedure is for the buyer and seller to obtain the services of some credible third authority, who confirms that the seller is entitled to a credit, known technically as a verified emissions reduction.
One of the organizations developing standards for such verification is the IEEE, whose Power Engineering Society has a committee writing rules to "quantify, verify, and certify" greenhouse gas reductions by electric utilities. A voting draft is to be ready this July, with a fully accepted standard ready for use by 2005.
Pending agreement on such standards, people have been improvising creatively. For example, several years ago, Ontario Power Generation Inc. (Toronto) agreed to purchase credits from USGen New England Inc. (Bethesda, Md.) for up to one million tons of carbon equivalent. They would be earned by sequestering and destroying methane that otherwise would be emitted from a landfill in Rhode Island.
Much more recently, says Corinne Boone, managing director of the Canadian operations of Cantor Fitzgerald's CO2e.com in Toronto, the company brokered a much bigger purchase of allowances by Ontario Power: the utility bought credits for 6 million tons, and options for 3 million more, from Blue Source LLC (Salt Lake City), an aggregator of emissions reductions. When IEEE Spectrum expressed surprise at a U.S. entity's being so active as a seller of allowances, Boone noted that about half of the U.S. states have adopted some kind of GHG reduction requirements, creating many opportunities for traders.
Down the yellow brick road
In this ever more complex Oz-like world, there's still plenty to work out. "When you're trading sulfur dioxide," says Daniel L. Chartier, president of the Emissions Marketing Association, "you know exactly what you're dealing with—it's like gold-backed currency." With CO2 and the other greenhouse gases, which must be stated for trading purposes in terms of carbon equivalence, prices are all over the map.
Steve Drummond, CO2e.com's CEO, told a gathering last July in Cologne, Germany, that parties have been trading CO2 experimentally in the context of the Kyoto Protocol's proposed Clean Development Mechanism, a financial device permitting credits to be used in energy-efficient development projects, at US $1-2 per ton of carbon equivalent. He said the Dutch government has bought reductions at US $7-9 per ton and the World Bank's Prototype Carbon Fund at US $3.50 per ton.
Drummond predicts that prices will settle at US $4-6 per ton by 2010, when a global system should be in place. Much depends, though, on how allowances are allocated between now and then.
Pricing, emissions-control technology, and other aspects of trading could get much more complicated as efforts to control other pollutants become part of the mix. The Bush administration, in a Clear Skies initiative unfurled last February, proposed expanding the trading of emissions credits from SO2 to NOx and mercury. In fact, utilities in 19 northeast U.S. states are setting up an NOx trading system to go into effect in 2004.
And lately, Senator James M. Jeffords (Ind.-Vt.) has been leading a campaign in Congress to get greenhouse gases included in Clear Skies. If Jeffords gets his way, the results could be devastating, observes Dallas Burtraw, a senior fellow at Resources for the Future (Washington, D.C.). This is because remedial measures taken to reduce GHG often differ a lot from measures used to reduce the other types of emissions. (Capturing and sequestering CO2 may be a good long-term option. At present, switching to other fuels is often the only realistic way of reducing GHG, whereas desulfurizing flue gas has been the principal means of achieving reductions in SO2 emissions and selective catalytic reduction is the main tool for NOx.)
Deregulation adds yet another wrinkle to trading. Burtraw points out that if the United States does end up setting limits to GHG emissions and establishes a cap-and-trade system, designing a method to distribute allowances will present a bigger headache for profit-making deregulated utilities than it was in the mid-1990s. When SO2 allowances were distributed among public utilities then, they were guaranteed returns based on their costs (the so-called cost-plus basis).
"Everybody should be talking about this," Burtraw told Spectrum. "Utilities now will be in the position of farmers who have just found oil under their fields. Those utilities aren't going to give away those future returns for free, any more than the farmer would. And how those allowances are distributed is a big issue with big implications for overall economic efficiency, as well as fairness."
How much would be at stake in that distribution? Billions of dollars a year just for SO2 and NOx. But if the United States were to adopt the Kyoto Protocol after all and strive for full compliance by 2012, requiring a 30 percent reduction in GHG emissions from 1990 levels, the allowance created would amount to "an asset with an annual value of about $450 billion [in 1997 dollars]," Burtraw and coauthors concluded last June in a study published by the Electricity Journal.
A much more modest U.S. program aiming to reduce emissions by 6 percent from a projected baseline level by 2012 would still generate allowances worth $14.8 and $32.6 billion a year. And what if the United States makes no commitments and establishes no GHG trading system? Will U.S. companies participate in the emergent global system anyway? You can bet your bottom dollar they will, because—as noted above—they already are.
To Probe Further
Read about GHGs in "The Emerging International Greenhouse Gas Market," Pew Center on Global Climate Change, March 2002, at http://www.pewclimate.org/
Look up "The Effect on Asset Values of the Allocation of Carbon Dioxide Emission Allowances," by Dallas Burtraw et al., in Electricity Journal, June 2002, pp. 51-62
A primer on "Multilateral Emission Trading," by Alexander E. Farrell and M. Granger Morgan, is in The Commons in the New Millennium, edited by Nives Dolsak and Elinor Ostrom, MIT Press, forthcoming