feature
What Course for
Carbon Trading?
Although still without a legislative mandate, a marketplace for carbon trading is beginning to develop.
R I C H A R D A. NEY AND JERALD
L.
SCHNOOR
s the millennium turns, policy makers and stakeholders are engaged in a major environmental transition, one which requires that the world's economy be grown in a manner that takes into account profound global environmental constraints, such as limiting greenhouse gas (GHG) discharges to the atmosphere—it is no longer acceptable to return C0 2 to it without paying a price. In essence, society must internalize the externalities of global pollution and do it in a costeffective and socially acceptable manner. A carbon trading and GHG market that responds to this challenge is emerging in the United States. Its development is under way despite the Senate's failure to ratify the Kyoto Climate Convention and without formal legislation to mandate its enforcement. The enterprise is gathering momentum and aims to limit GHG emissions through the use of marketplace forces and voluntary industry actions. Although there is enthusiasm for the venture, there are also substantial uncertainties concerning the viability of such an approach for GHG management. Primary them is the as yet unanswered tion of whether this bottom-up approach to address climate change can mature and result in full implementation of an effective GHG trading program. Despite these unknowns many industry leaders and entrepreneurs are willing to undertake the marketplace experiment They believe that it will eventually become necessary to come to grips with increasing GHGs in the atmosphere whether or not climate change has already occurred In fact, a growing number of companies believe that early action is cost-effective and in their best interests. As stakeholders, they no longer consider the science of climate change to be the main focus of debate. Rather, their focus has evolved into a concern over the nature of a proper course of action for GHG reduction policy. They believe that industries positioning themselves now to address climate change will be more competitive in the global marketplace of the 21st century. They also believe that a national or international carbon trading program will eventually be mandated, and that they can save money by documenting early reductions of their own or by purchasing carbon emission credits in an emerging market.
A
Beliefs and commitments Businesses and business-partnered organizations have expressed basic tenets underlying the need to proceed with GHG policy (and reduction mechanism) development and have indicated target re© 2000 American Chemical Society APRIL 1, 2000/ENVIRONMENTAL SCIENCE & TECHNOLOGY / NEWS • 1 7 7 A
TABLE 1
A résumé of carbon trading activity As summarized, brokers have helped initiate several GH6 emission trades between several buyers and sellers. Key: Ag, agricultural; mton, metric tons; ston, short tons; Cantor, Cantor-Fitzgerald Environmental Brokerage Services; EFP, Environmental Financial Products, Ltd.; ERT, Environmental Resources Trust; and Nat, NatSource. Broker
Seller
Reduction type
Purchaser
Cantor Cantor
Sherwood Foresty CQuest/IGF Insurance
SW Utility GEMCO
2,000,000 6,000,000
ston C 0 2 mton C
EFP
Zahren Alt Power
Ontario Power
2,500,000
ton C 0 2
ERT
Niagara Mohawk
Nat
U.S. Generating Co. and PG&E Energy Trading
Ag carbon storage Ag methane reduction Ag carbon storage Landfill methane capture Fuel switching and energy efficiency Fuel switching and energy efficiency
A riparian zone buffer strip of hybrid poplar trees is capable of annually sequestering 10 tons of carbon per acre into aboveground biomass.
duction commitments that they will try to achieve on a voluntary basis. Established in 1998, the Pew Center on Global Climate Change developed the Business Environmental Leadership Council (BELC), which includes members such as Boeing, Lockheed Martin, British Petroleum, Maytag, Whirlpool, DuPont, Toyota, 3M, and United Technologies. In a joint s t a t e m e n t (i), BELC makes the following assertions: • First, we accept the views of most scientists that enough is known about the science and environmental impacts of climate change for us to take actions to address its consequences. • Second, business can and should take concrete steps now in the United States and abroad to assess opportunities for emission reductions, establish and meet emission reduction objectives, and invest in new, more efficient products, practices, and technologies. • Third, the Kyoto agreement represents a first step in the international process, but more must be done both to implement the market-based mechanisms that were adopted in principle in Kyoto and to more fully involve the rest of the world in the solution. • Fourth, we can make significant progress in ad1 7 8 A • APRIL 1, 2000 / ENVIRONMENTAL SCIENCE & TECHNOLOGY / NEWS
Suncor Barnhard/Columbia Earth Coalition
Tonnage
100,000 10,000,000 10,000
Units
mton GHG mton GHG ston C 0 2
dressing climate change and sustaining economic growth in the United States by adopting reasonable policies, programs, and transition strategies. In support of these tenets, BELC has made significant pledges for early action. British Petroleum commits to a 10% GHG emission reduction by 2005; DuPont will reduce carbon equivalent emissions (mostly nitrous oxide and fluorocarbons) by 65% below 1990 levels and use 10% renewables at global facilities by 2010; Shell will reduce its GHG emissions by 37 million tons (10%) by 2002; United Technologies will reduce energy usage by 25% by 2007 from a 1997 baseline; and Motorola pledges to reduce perfluorocarbon emissions by 50% (the industry-wide standard reduction is 10%) in 2010 from a 1995 baseline (2). Precedent for a "cap and trade" program for carbon, one that both supports and encourages these corporate objectives, can be found in the previous success of the sulfur dioxide (S0 2 ) trading program, which achieved its goals at minimum costs. The S0 2 program was created by the Clean Air Act (CAA) Amendments of 1990. CAA legislative amendments required emission reductions of greater than 50% (10 million tons), with an imposed cap of 8.9 million tons of total allowable S02 emissions by 2010. Most industries were initially wary of the CAA requirements, indicating that emission reductions of that magnitude would only come at a huge cost to the economy, perhaps exceeding $8 billion per year. Projected allowance costs were pegged at $1000 per ton of sulfur reduced. In fact, required emission reductions were achieved at only a fraction of originally projected costs: And although the cost of an allowance was initially quite high, sulfur reductions proved easier and less costly to achieve than anticipated under $2 billion per year. Most of the savings realized were due to improvements in scrubber technology and to the unexpectedly low costs of fuel switching. Although currently, the cost of a tradeable S 0 2 allowance is low, about $200 per ton (3), trading has been relatively light. What trading has occurred, mostly among companies having plants located in several states, has contributed to the program's suc-
cess. The undertaking is presently relatively small, limited to the roughly 100 utilities that have provided most of the reductions. The emission trading mechanism is, however, growing in popularity among industry stakeholders, as it allows flexibility in finding the best solution for each company. Moreover, compliance monitoring is simple, via the use of continuous monitors placed on stacks under EPA's guidance. Development of a global carbon trading program under the auspices of the United Nations could expand the marketplace, but it would be technically much more complicated than the U.S. sulfur emissions trading program. Potential obstacles notwithstanding, the issue is being considered. For example, the Fifth Session of the Conference of the Parties to the U.N. Framework Convention on Climate Change—the formal body responsible for making rules under the Climate Convention of 1992—met last November in Berlin and discussed three so-called flexibility mechaisms: • emissions trading—carbon allowance trading among developed countries; • joint implementation—climate credits for contributing to emission reduction projects in other developed countries; and • clean development mechanisms—credits for investments in projects in developing countries. The total quantity of emission reduction credits that can be traded or purchased under these mechanisms by any one country is highly controversial. Nations, such as the United States and Canada, could choose to accomplish much of their required emission reductions by purchasing allowances from other developed countries that do not need their entire quotas, or by investing in projects in developing countries at a fraction of the cost required to make reductions in their own countries. Russia and Ukraine are among the biggest supporters of unlimited flexibility mechanisms because they have registered huge carbon emission reductions due to a restructuring of their industries following the 1991 breakup of the Soviet Union Technical obstacles for implementing flexibility mechanisms abound in the Kyoto accords, including how to monitor for compliance and how to assess penalties for noncompliance in a global-scale trading community having hundreds of thousands of emitters. Opponents of flexibility mechanisms feel that many emission reduction projects would occur anyway in the absence of a trading program, simply as an integral part of industrial modernization, and that the mechanisms should not serve as loopholes for some countries to avoid making emission reductions in their own backyards.
Trading inches forward Despite uncertainties, carbon is being traded today, not only because industries foresee an enforceable international treaty, but because they believe it is prudent—based on cost, public relations, and competitiveness. Bills are currently before Congress for early action on energy efficiency and carbon trading— for example, the Chafee, Lieberman-Mack Senate File
High-tech windmills, such as these at a western site, are in place at a windmill farm at Alta, IA. Consisting of 250 wind turbines rated at 750 kW each, and newly dedicated in October 1999, it is the second largest facility of its kind in the nation, supplying approximately 1 % of the total delivered energy in Iowa.
547, and Lazio bill H.R. 2520—but the legislation remains controversial. Most environmental groups object to the lack of verification by independent third parties on carbon emission reduction and sequestration projects. Complicating matters, industries participating in the Department of Energy's Voluntary Early Reductions Program are claiming credit for large, controversial emission reductions that have been criticized by the General Accounting Office. Several brokerage firms are already specializing in environmental emissions markets for sulfur oxides, nitrogen oxides, and volatile organic compound allowances and have moved to brokering agreements on carbon emission credits as well (see Table 1). Natsource, Inc., New York City, has three fulltime GHG brokers who tailor transactions to the specific goals of their clients. Most of their trades are associated with energy-efficiency improvements and fuel switching, which result in verifiable GHG emission reductions at fossil fuel power plants. The emission reduction credits are marketed to heavy users of energy and to electric utilities. Both see them as a means to forestall fuel switching and renovation of old equipment as well as an action that may permit them to avoid purchasing GHG credits and allowances at much higher prices in the future Carbon trading is currently executed on a caseby-case basis and involves individualized contracts between purchasers and sellers who have been brought together by a broker. The sellers of the credits guarantee that they can provide carbon emissions reduction or sequestration for a specified period of time against a designated baseline year; the buyer agrees to pay a price for that credit, or has the right to purchase it in the future (a call option). In one recent example, Canadian utilities arranged to offset their future C0 2 emissions by paying Iowa farmers to sequester carbon by storing it in woody biomass and as organic carbon in soils (4). The deal (see Table 1) was brokered by CQuest APRIL 1, 2000 / ENVIRONMENTAL SCIENCE & TECHNOLOGY / NEWS • 1 7 9 A
(Right) Switchgrass is being cultivated for carbon sequestration below ground and for harvesting to replace coal. (Below) The Ottumwa Generating Station in Iowa, a coal-fired power plant, will produce 32 M W from use of switchgrass as part of its fuel.
Ltd. and IGF Insurance Company, of Des Moines, IA, which hope to take the program nationwide after testing it in Iowa. Storage of carbon in trees and soils removes it from the global atmosphere for a prolonged period (>50 years), a sufficient amount of time for the approach to be judged a mitigation strategy. Participating farmers could be paid as much as $3 per acre to store carbon in soils and woody biomass (see photo on page 178A) and will be enrolled this spring by IGF's network of 250 crop insurance agents (5). This would eventually result in only a small income stream to farmers but it is a supplement to beneficial actions already undertaken that have merit, such as reducing soil erosion controlling runoff water or creating wildlife habitat A major remaining obstacle for agricultural sequestration credits concerns problems with verification of what is being accomplished. Presently, the extent of third-party verification of carbon emission reductions or sequestration varies, and the period of time that carbon is sequestered by such sinks remains controversial. The 5th Conference of the Parties to the Climate Convention considered aboveground carbon storage to be more easily documented. CQuest also arranged an agreement between a large public utility that uses coal-fired power plants to generate electricity in the Southwest and Sherwood Forestry in Des Moines, IA, for over 2 million tons of carbon sequestration. The utility has five call options, which it can choose to exercise during 20002004 for 400,000 metric tons of carbon sequestration in above- and below-ground reservoirs. A transaction cost, usually on the order of a few cents per metric ton of carbon traded, is paid to brokerage firms for arranging such an agreement or call options. By setting up an agreement now, the utility can "lock-in" low-priced credits before adoption of any formal commodities exchange, at which time credits or 1 8 0 A • APRIL 1, 2000 / ENVIRONMENTAL SCIENCE & TECHNOLOGY / NEWS
allowances could become expensive. Currently, the cost for carbon emission credits is about $0.60-1.10 per metric ton of carbon. This is low, considering the expected cost of carbon allowances, $10-20 per ton, if a formal program is mandated at national or international scale. Obviously, there is an advantage to parties who purchase call options now at low prices, but they also face the risk that their emission reduction credits will not be allowed under future, as yet undetermined, rules. In general, emission reduction credits which are more difficult to measure such as agriculture sequestration credits are lower-priced and are of greater risk than industrial energy efficiency or fuel-switching credits Some observers like Richard Sandor of Environmental Financial Products Ltd in Chicago IL are optimistic about financial prosnprts "Farmers will have aboveground like corn other will be hplow ground in soil carbnn Therp's a potpntial for billions of dollars in farm income " he savs The Global Livestock Group (GLG) of Washington, DC, markets another type of agriculture credit (6). Costeffective livestock projects, such as reductions in methane emissions from manure management and capturing methane during waste treatment, are provided as low-cost credits to investors. According to Bernard Du Charme, GLG's business manager, "Each corporate planner knows what best fits their company's emissions reduction portfolio." With a variety of credit arrangements available, a high-emitting utility or industry may choose to purchase a mix of credits: some inexpensive, relatively risky credits that may not be viable under future programs and some well-documented higher-priced emission reduction credits with greater probability of future acceptance On Ian. 18, 2000, the World Bank made a major announcement that could further carbon trading, creating a Prototype Carbon Fund, which encourages participating countries to receive emissions credits in exchange for financing GHG emission reduction projects in developing countries. Nine companies and four countries are enrolled initially at a cost of $5 and $10 million, respectively (7). One issue that remains unresolved is who can claim the credit for emission reductions or sequestration, and thus, who can derive the benefit of selling the credit if a full carbon trading program develops. An international program under the auspices of the United Nations and the Climate Convention would likely allow trades between large entities, governments, or multinational companies. A national program might allow for credits and trades among smaller users, state governments, and municipalities. It remains to be seen whether small producers of credits will be able to benefit from future programs but for market forces to work the parties who make the emission reductions must be able to enjoy the benefits Only then will there be incentives for further reductions lower costs and newly discovered efficiencies
Wind power alternative National energy deregulation bills presently before Congress would require up to 7.5% of power generated to come from renewable energy (wind, solar, geothermal, and biomass) by 2010. If enacted, such legislation would create an immediate market for green power in the United States, but it is not clear that congressional action is forthcoming. Notwithstanding this uncertainty, a small market is already emerging because several states (Connecticut, New Jersey, Pennsylvania, and Texas) recently deregulated their energy utilities and required some fraction of energy output to come from renewables. Via a renewable portfolio standard, Texas is requiring 5% of its energy to come from renewables by 2010. In October, under state energy guidelines, Iowa and Minnesota both dedicated new wind farms— collectively, approximately 250 turbine units rated at 750 kW each, with a combined power generation capacity of 190 MW. Wind power is an easily verifiable emissions reduction credit and is rapidly gaining favor in the United States and across Europe. When electric utilities replace a portion of their fossil fuel power-generating capacity by wind, it is a clear carbon credit for future trading programs. This trend toward wind power is especially evident in northern Europe, the United States, and Canada, with power costs of about 4.5C per kilowatt hour (kWh). A federal energy credit of 1.2(t/kWh makes wind turbines competitive with conventional coal or natural gas-fired power plants. Farmers who allow the turbines on their land lose very little acreage and enjoy annual revenues of approximately $3000 per turbine (see photo 2 on page 179A). The impact of a deregulated marketplace on renewable energy power generation, including wind power, remains uncertain. In a deregulated market {Environ. Sci. Technol. 1999,33 (23), 494A-499A), consumers have the option of purchasing power from different generators, much like the telephone communications industry today. Only if a sizable portion of consumers are willing to pay more for green power from renewable energy sources will a market be created for wind, solar, and biomass over other energy options. Today, various state energy authorities are cooperating with companies, such as Enron Wind Corp., in Tehachapi, CA, to document carbon credits from wind power installations based on avoidance of carbon emissions at coal-fired power plants Enron is a supplier of wind turbines and currently a member of the Pew Center on Global Climate Change
Biomass energy possibilities Corn (to produce ethanol for transportation) and wood (for its fuel content) are trie most common forms of biomass energy used today. Research is proceeding on the use of switchgrass, poplar, and willow trees as partial replacements for coal in coalfired power plants or as heating fuels. C^arbon emissions could be reduced if a portion of the fuel used in coal-nred power plants were replaced by switchgrass, a renewable resource that farmers know how to grow efficiently (see photo on
previous page). In terms of GHG emissions, switchgrass is nearly a net zero-emission fuel because the C0 2 released during combustion was previously sequestered from the atmosphere during the growing season. The only carbon emissions associated with burning switchgrass include those required to grow, harvest, and transport it to the power plant. The practicalities of switchgrass use are being studied. The Chariton Valley Resource Conservation and Demonstration Project, Centerville, IA, a government cooperative with funding from the U.S. Department of Agriculture and the Department of Energy, will harvest 4000 acres of switchgrass and use it to produce 32 MW of energy at the Affiant coalfired power plant in Ottumwa, IA (see photo on previous page). Five percent of the heating value of the coal will be replaced by switchgrass. The practical maximum replacement amount could be about 10%. An environmental life-cycle assessment of the demonstration project has been completed by the University of Iowa-Iowa City. Results suggest a net GHG savings of 135,000-176,000 tons of carbon equivalents per year if 5% of the fuel used is switchgrass (8). Key questions remaining include operational problems; nitrogen oxide and nitrous oxide emissions generated from combusting switchgrass, which contains nitrogen; and the carbon sequestration potential in the root zone of the grasses.
Need for early action The economic impact of cutting net GHG emissions to Kyoto levels, or some other fixed target in the future, might be reduced significantly by taking early action now (see Figure 1). An early action program was proposed by the late Senator Chafee (R-RI), and conceivably, enactment of such a program could increase the prospect that emission reductions and resulting credits would be recognized in a future governmental trading system. Stabilizing atmospheric concentrations of carbon dioxide at today's levels will require large reductions, as much as 60-70% of present fossil fuel emissions (9). To achieve such dramatic cutbacks, society must consider decarbonization on a much greater scale and deploy entirely new systems for energizing the economy. Energy efficiency, renewables, and carbon sequestration will certainly play roles in this endeavor, but they will not be sufficient in the face of increasing emissions and the practical accommodations necessitated by legitimate needs of undeveloped countries that are faced with poor economies and slow growth. Consequently, stabilization will require national and international mandates if dramatic cutbacks in emissions are to be accomplished The question of the current debate is when (and how) should we act given the multitude of uncertainties surrounding science and policy ODtions? The carbon trades that are taking place today serve several critical functions and are relevant to current policy discussions. Taken as a whole, today's emission trades are d e m o n s t r a t i n g that costeffective emission reductions can be discovered. They provide many stakeholders—including brokers, contract lawyers, market participants, environmental APRIL 1, 2000/ENVIRONMENTAL SCIENCE & TECHNOLOGY/ NEWS • 1 8 1 A
FIGURE 1
Value of "early action" to reduce greenhouse gas emissions The longerthe delay before beginning emissions reductions, the more it will cost to accomplish. Costs of reducing emissions are reflected in the steepness of the slopes of dashed lines for returning to an emissions baseline. Trajectories are shown for reaching a future fixed target achieved in 2010. In this hypothetical case, the solid line represents a business as usual (BAU) emission growth model, similar to that predicted for the United States. The straight dashed line represents a target similarto Kyoto. Each of the three dashed llnes representthe trajectories that must be followed in orderto reach the fixed target and depend upon the ccmmencement date for reductions. In achieving the target, ,he earlier rhe reductton program starts, the flatter the reduction curve. Each line's slope represents unit cost so that the steeper and faster the reduction made, the greaterthe cost per unit reduction. This is why an official early action program would be economically beneficiall The emission trading market emerging today is contributing to the recognition of this need and is creating a momentum for early action.
Electric utility deregulation is a second major force leading to carbon trading activity in the United States and is independent of a future political program to address climate change. Deregulating power generation markets opens the door for a variety of power producers, each attempting to gain market share through product differentiation. Multiple surveys have indicated the general public's willingness to pay a premium price for "green power". Carbon credit trading will play a role in this marketplace by rewarding clean technologies and through the concept of "washing"—attaching sequestration or other green credits to traditional fossil fuel electric generation. Carbon reduction credits are purchased by a fossil fuel-fired producer and then attached to that power, creating electricity that is "washed clean" of its potentially negative effects on climate. Although carbon trading might be one mechanism for accomplishing the emissions reduction task, it is presently a nascent market that is emerging absent the mandate of any binding international treaty or federal legislation. Eventually, government mandates will be needed to add impetus to this approach. The market is currently developing principally because some industries and entrepreneurs believe that it is now prudent to act. Whether this grassroots market will prove to be the embryo of a full-fledged carbon trading program remains to be seen
Acknowledgments Note: MMTCE, million metric tons carbon equivalent.
groups reviewing trades, and providers of scientific verification of claimed reductions—an opportunity to gain experience with the trading process. Completion of trading contracts and attempts to fulfill them provide case histories that can be used in support of efforts to develop future governmentsanctioned trading programs. Moreover, the number of groups having a direct stake in seeing that a crediting program moves forward is growing as trading continues to increase. Competitors of current participants are beginning to recognize their stake, and this has led the more risk-averse organizations to clamor for a sanctioned early-action program that reduces the risk inherent in early trades.
Future prospects Two forces are converging to create the carbon reduction credit marketplace. The first is an emerging market driven by national and international politics. Participants in this market are attempting to perform a risk management function by purchasing a wide variety of reduction credits. They are attempting to get a head start on the future, regulationdriven market by purchasing credits at prices lower than those expected later. Additional benefits include experience gained with trading, creation of an infrastructure, and development of a corporate culture that allows the utility or industry to successfully navigate the market when it fully arrives. 1 8 2 A • APRIL 1, 2000 / ENVIRONMENTAL SCIENCE & TECHNOLOGY / NEWS
We thank Larry Bean, Sharon Tahtinen, Tammie Foster, and Craig Stark of the Iowa Department of Natural Resources for participation in this project, and Kitty Sibold of EPA's Global Climate Change Program for financial support. The Center for Global and Regional Environmental Research at the University of Iowa provided technical support for this effort. Special thanks go to Malva A. Mancuso for estimating carbon sequestration potentials in Iowa.
References (1) Business Environmental Leadership Council, www. pewclimate.org/belc/statement.html (accessed Jan. 17, 2000). (2) Hileman, B. Chem. Eng. News 1999, 77 (39), 25-26. (3) Kerr, R. A. Acid rain control: Success on the cheap. Science 1998, 282 ((539), ,104-1027. (4) Lai, R., et al. The Potential lf U.S. Cropland to Sequester Carbon and Mitigate the Greenhouse Effect; CRC Press: Boca Raton, FL, 1999; 128 pp. (5) Perkins, J. A New Crrp for rowaa :arbon. Des Moines Register, Nov. .4 ,9999 p. 11A (6) Global Livestock Group. www.TheGLG.com (accessed Sept. 23, 1999). (7) Bilefsky, D. World Bank Launches Carbon Trading System. Financial Times, Jan. 19, 2000, p. 6. (8) Ney, R.; Schnoor, J. L. A Life-Cycle Analysis ofGHG Emissions at the Chariton Valley RC&D Project; Center for Global and Regional Environmental Research, University of Iowa: Iowa City, IA, Dec. 1999. (9) Intergovernmental Panel on Climate Change. Climate Change 1995—The Science of Cllmate Chhnge; Cambridge University Press: New York, 1996. Richard A. Ney is an associate eesearch scientist and Jerald L. Schnoor is codirector of the Center for Global and Regional Environmental Research and professor in the Department of Civil and Environmental Engineering, University of Iowa, Iowa City, IA.
