Climate Change & Environmental Services, LLC

What is all this about Cap and Trade?

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Courtesy of Climate Change & Environmental Services, LLC

Discussions about climate change policy focus on how we can reach the goal that a large majority of the world’s scientists believe is necessary: to reduce global greenhouse gas (GHG) emissions by 70-80% from a 1990 baseline by 2050. One suggested system to achieve this is called “Cap and Trade”.

Cap and trade has been bashed in many U.S. news talk shows (particularly among conservative commentators) so thoroughly that it has become tainted and even politicians who support aggressive GHG emission reductions are afraid to discuss cap and trade as a means to achieve this, lest they be associated with an unpopular approach. Let’s step back and learn what cap and trade is to determine whether it might afford a way to reduce GHG emissions with the least amount of agony to businesses.

What is the history of cap and trade, at least applied to environmental concerns? People will be surprised to learn that the first cap and trade program occurred in the U.S. and has been widely applauded across the political spectrum as a success in terms of meeting environmental goals in a way to minimize economic hardship. Another irony: this program was implemented by a conservative president (George H.W. Bush) against the fiery complaints of environmental groups. This cap and trade program was for the Acid Rain Program, Title IV of the Clean Air Act Amendments of 1990.

It was understood that several major parks and forests in the eastern part of the U.S. were being damaged (fish kills, trees dying, etc.) by “acid rain” caused by large emissions of sulfur dioxide (SO2) and nitrogen oxides (NOx) from large coal-fired power plants in the U.S. Midwest and south traveling hundreds of miles, converted in the atmosphere to sulfuric and nitric acids, and falling with rain. Scientists predicted that forests could recover if acid emission rates would decrease significantly.

President Bush’s USEPA implemented cap and trade into the Acid Rain Program, mandating a group of strategically located coal-fired power plants to cumulatively reduce SO2 and NOx emissions by 50% from a worst-case baseline of the 1980’s. Instead of the traditional “command and control” mandating each facility reduce emissions by at least 50% no matter how difficult it would be, cap and trade gave facilities the option of reducing emissions by less than 50% or even not at all as long as they can buy credits on an open market from other facilities that controlled their emissions by more than 50%. While environmentalists complained that this represented “buying one’s way out of reducing emissions”, for the power companies buying credits represented an extra option to consider. In addition, cap and trade also represented an economic incentive to overcontrol emissions as facilities could earn credits and turn them into revenue. From the government and public’s point of view, the approach represented a guarantee that acid emissions would be halved. Since effects are regional, the exact degree of reductions at each plant was less important than the overall decrease being met.

The program was a success. The group of power plants met the 50% reduction criteria for both pollutants and surveys showed they were pleased to have these flexible compliance options and the entrepreneurial opportunity to make money. A few years later, the USEPA successfully lowered the reduction criteria to 70%. Perhaps, most important, the Adirondacks of NY, the Shenandoah Valley of VA, and other areas “came back”. Damage to trees and lakes were reversed and they fully recovered.

So critics cannot say it has not been tried successfully. Can cap and trade work on a global level for GHG emissions? There are differences which can affect success. Meeting the reduction criteria was fairly easy for SO2 and NOx; for CO2 emissions from a power plant, it is more complex. More complex strategies must be developed and implemented to reduce GHGs, such as improving energy efficiency and using renewable sources of energy. It is likely that a large reduction in GHG emissions, if applied to a company, would be more expensive to achieve. However, as a result, carbon credits would be more valuable, as we see in the Kyoto and voluntary markets. Applied to climate change, we are looking at a worldwide program applied to more industries than certain power plants. Can we scale up a regional system covering only one industry to a worldwide system covering economy-wide sources?

Results appear to be mixed. The European Trading Scheme (ETS) was considered by many a failure in that the price of carbon credits fluctuated wildly in short times. Some companies made a lot of money by overcontrolling GHG emissions and selling at the right time; others spent a lot of money to comply. There is currently a mandatory climate change cap and trade program in the U.S., called the Regional Greenhouse Gas Initiative (RGGI) applying to power plants in 10 northeastern states. Beginning in 2009, they had to meet a baseline GHG emissions level based on actual emissions in the early 2000’s. Eventually a net decrease of absolute GHG emissions must be achieved. Cap and trade allows a plant to address unexpected electricity demand and still purchase credits to cover emissions. Virtually all credits are auctioned by the states, so one must pay to emit GHGs. In 2009, the price of credits remained fairly low for the entire year, alleviating concern that some power plants would stop generating electricity in fear that credits may be unavailable. It did help that a cooler than normal summer and a recession in 2009 helped reduce electricity demand compared to previous years.

Whether it is called “cap and trade” or whether the name is changed, a system of mandatory GHG emission reductions with incentives and credits is likely to emerge from an eventual federal climate change bill. The public, which favors addressing climate change, sees this as a way to guarantee a net reduction, while affected companies see this as a method to give them some needed flexibility. No matter what type of bill is passed, now is the time to prepare by doing the basics, such as preparing a baseline GHG emissions inventory and researching good payback strategies to reduce emissions.

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This Environmental News for You is not meant to be a complete discussion about cap and trade. Work with professional technical, financial, and legal experts to prepare. CCES experts can assist you in developing a program to address cap and trade and gain from of potential opportunities to gain market share and revenues.

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