Can Global Warming Be Slowed by Complex Concept of Carbon Trading?

By refusing to sign on to the Kyoto climate treaty, Americans have insulated ourselves from the complexities of the carbon market the European Union has been trading in for the last three years. But that state of ignorance, while not exactly blissful, is about to end.

On February 26 and 27, the international carbon trading financial community descended on San Francisco to present Carbon Forum America, the first American carbon trading conference to include a full trade show featuring 80 companies that manage carbon credit assets and trades, negotiate contracts, validate projects, and perform various other market services. Why California and why now?

California is the US leader on climate policy and now is the time the tea leaves are spelling out a coming certainty for investors. The first serious US climate change measure, the Lieberman-Warner bill, has passed out of a Senate committee. All three front-running presidential candidates have acknowledged a cap-and-trade system for carbon emissions is inevitable.

US regional programs like the Western Climate Initiative are picking up steam, and 32 states have now adopted hard emissions targets. The conference sponsor, the International Emissions Trading Association, is banking on the idea US investors will embrace a worldwide carbon trading market that reached $60 billion in 2007 and could mushroom to $300 billion or more very soon. But what exactly is a carbon market?

At a press briefing, IETA president and CEO Henry Derwent acknowledged the concept was a difficult one to explain. "Carbon is an externality, not a commodity. People say, 'What on earth do I need that for? It's not a pork belly.'"

Derwent said investors should look at carbon trading as a form of derivative like a hedge fund. He defended the idea of traders making a profit from carbon trading. "They should be taking a margin for a service. If they do their job well they will provide the world with energy with a lower risk of climate change."

Environmental critics of a cap-and-trade system worry carbon traders, like other derivatives traders, will get carried away and game the system to produce excessive profits for themselves. But the biggest issue as the US contemplates its first national climate bill is the how to allocate the emissions under the cap.

The European Union Emissions Trading System established under the Kyoto protocol gave away emissions allocations to polluting industries in a grandfathering scheme. This depressed the price of carbon and got the market off to a slow start in 2005. The Lieberman-Warner bill would repeat this strategy in the US by giving away over half of the pollution allowances -- worth billions of dollars -- to big industries like coal-burning electric utilities.

By contrast, both Clinton and Obama advocate auctioning 100 percent of the allowances. One hundred percent auctioning is a litmus test for much of the environmental community, which sees the revenues as a crucial source of funds to pay for research and development of renewable energy and to support low-income people who will be hurt by higher prices.

In fact, a cap-and-trade system with 100 percent auctioning of allowances is functionally not very different from a carbon tax. At a Carbon Forum plenary session on potential federal greenhouse gas regulation, representatives of some big corporations weighed in on the auctions debate and other issues.

Ralph Moran, West Coast Climate Change director for British Petroleum, said his company supports some amount of auctioning, but it will dramatically increase the cost of doing business. He warned there was no guarantee government would use the revenues from auctions wisely. Rich Rosenzwieg, Chief Operations Officer of Natsource, a carbon trading firm, continued the theme of mistrust in government. He said we should start small with auctions because "the public won't support giving government billions of dollars in revenue."