A Changing Climate for Cap and Trade

President George H.W. Bush came into office in 1989 pledging to be the “environmental president,” and five months into his administration, he was ready to prove his bona fides.

Great quantities of sulfur dioxide (SO₂) were spewing into the atmosphere from power plants burning low-grade coal, degrading forests, acidifying lakes and streams, and killing fish and other wildlife.

Bush—or at least his environmental operatives—had a plan, one that the administration thought would appeal to both pro-business Republicans and tree-hugging Democrats.

Cap and trade, as the system came to be known, was a market-driven system, not the usual top-down “command and control” approach, with built-in financial incentives to cut pollution—a trading system that would have big polluters paying high-priced “allowances” in exchange for continuing to pollute. As for the vast regulatory establishment of the federal government? It was told, in effect, to butt out. The only role for the Environmental Protection Agency (EPA) in the so-called acid rain program was to keep score.

In Congress, both sides of the aisle jumped in to support the program. Amendments to the Clean Air Act, which established the cap-and-trade program to fight acid rain, passed the Senate 89-11 and the House of Representatives 401-21, with 87% of Republicans voting for the plan.

Cap and trade turned out to be surprisingly effective in reducing power plant emissions and their damage to the environment. Not only did the system cut SO₂ to manageable levels, but also it turned out to be a rare “green” program with seductive appeal, even for Bush's Republican base. The year was 1990.

That was then, and this is now. Nearly 25 years after Bush Sr. announced his campaign against acid rain, a cap-and-trade system for carbon dioxide (CO₂) is so unpopular on Capitol Hill that President Barack Obama barely mentioned it as an option in his new policy initiative addressing climate change.

In a speech unveiling his plan in June, the president said wistfully that he welcomed a “bipartisan, market-based solution to climate change,” urging Congress to come up with such a plan.

That, any member of Congress is likely to tell you, is not going to happen anytime soon. Political conservatives and global-warming skeptics have succeeded in demonizing cap and trade, critics say, dubbing it “cap and tax” and using it as a bludgeon against Democratic and moderate Republican candidates.

But the main criticism of cap-and-trade programs has been that they raise energy costs and harm the economy without having any significant impact on air quality or climate change.

Others Are Not Waiting

Still, the implementation of cap-and-trade systems persists, both in North America and around the globe.

Some U.S. states, such as California and nine in the northeast, have devised their own cap-and-trade systems, and the European Union recently strengthened its eight-year-old program. Most recently, Australia switched from a carbon tax, which was billing major polluters 24.15 Australian dollars per metric ton (1 metric ton equals 2,205 pounds) of CO₂ emitted, to an emissions trading system.

“Jurisdictions covering 10% of the world’s population and a third of its gross domestic product are implementing carbon caps,” economists Nathaniel Keohane and Gernot Wagner wrote in a Financial Times op-ed. That includes New Zealand, Quebec, South Korea and seven Chinese cities and provinces, as well as Australia and the EU.

The idea is simple enough. Establish the rate that a given emission—CO₂, in this case—is polluting the atmosphere, then come up with the amount that needs to be cut. The resulting level of atmospheric CO₂ is the “cap,” which becomes the ceiling on emissions. Major polluters then get their own caps, allocated limits on the amount they can emit. They are issued “allowances”—one per ton of CO₂. If they exceed their limits, they can either pay a penalty or buy an allowance from some other company.

The system, which in effect establishes a carbon market, just like a crude oil or pork belly market, offers emitters a considerable amount of operational flexibility. For example, nobody tells the polluters how to stop polluting; the programs just provide incentives to stop. Companies that perform especially well, reducing their emissions below cap levels, not only avoid penalties but also can profit from selling their unused allowances to others who are not performing as well.

According to a report last year by the Harvard Environmental Economics Program, the U.S. acid rain program reached its goal of slashing SO₂ emissions to 8.12 million metric tons a year by 2007 (a 50% reduction from 1980 levels) and went on to cut the number to 4.6 million metric tons by 2010. The EPA reported that the acid rain cap-and-trade program had saved $120 billion in pollution and health expenses, 40 times what the program had cost.

Europe Revises Its Program

The latest round of cap-and-trade programs varies by regional values and political willpower. There is no cookie-cutter approach.

The most ambitious is Europe’s Emissions Trading System (ETS), which includes 31 nations and seeks to regulate about 11,000 carbon-spewing power plants and factories. Launched in 2005, the program regulates CO₂ emissions from coal-fueled plants and energy-intensive industries, as well as commercial airlines—in all, about half of all EU emissions.

But the program has floundered since its inception. ETS’s sheer size and its network of diverse, sprawling jurisdictions have tended to blur the program’s focus, critics say, though ETS claims to have been responsible for reducing more than 480 million metric tons of CO₂ between 2005 and 2009. Some of that reduction may be attributed to the 2009 recession, which drastically reduced factory activity.

One ongoing problem for the ETS was that, during an early trial phase—when the program was determining how many allowances to issue for each plant—companies reported their own baseline levels of emissions, leading to some exaggerated claims. The excessive allowances that were then bestowed on those plants were, of course, floated on the market, adding to a glut of allowances and a degradation of their value.

But the European Parliament recently infused new life into the market by voting to approve a delay of some allowances, driving up the market price. European environmentalists saw the reduction in the number of shares as not only a means of raising the faltering value of carbon shares, but also as a signal the EU was renewing its commitment to cap and trade. Critics charged that the delay was meddling in the market. “But the world’s pioneering carbon market has a pulse again,” said The New York Times.

There is, however, still considerable skepticism about how strong that pulse is. The market price for EU carbon shares and industry participation in the market remain far too low to be a strong incentive for cutting emissions.

A less complex system, though one that still involves multiple jurisdictions, is the Regional Greenhouse Gas Initiative (RGGI), a federation of nine northeastern U.S. states that was launched in 2009. (Those states are Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island and Vermont.)

The RGGI states use a regional cap-and-trade system focusing on older-generation power plants that use fossil fuels and are responsible for about one-third of all greenhouse gases in the United States. A spokesman for the program, who asked not to be identified, says that with the help of cap and trade, carbon emissions in the nine states had decreased 30% from 2005.

As a mark of the program’s success, RGGI states recently announced new, ambitious goals for CO₂ reduction. Next year, the RGGI cap will fall from 150 million metric tons to 83 million metric tons, a 45% difference. The cap will then decline 2.5% annually through 2020.

The California Version

California, a longtime leader in clean air initiatives, potentially has one of the most rigorous and comprehensive programs in the world. In 2006, the state legislature approved and Gov. Arnold Schwarzenegger (another pro-cap-and-trade Republican) signed Assembly Bill 32, which established an array of goals for “global warming solutions.” Aside from directing the state’s Air Resources Board (ARB) to establish a market-based emissions trading system, the bill set 1990 levels of greenhouse gas emissions as a state baseline to be achieved by 2020.

The trading system launched in January 2013, but it will not be fully implemented for another year and a half. For now, the 400 or so companies involved (those that generate at least 25,000 metric tons of CO₂ a year) get a free ride for the first 90% of their emissions. In 2015, however, the full range of allowances and penalties apply, except for those companies or industries that can prove they have special hardships.

California’s current CO₂ cap is 162.8 million metric tons, or about 90% of the total amount emitted by the businesses currently targeted in the system. However, that will start shrinking as the cap is ratcheted downward, by between 2% and 3% a year, ARB officials say.

“What distinguishes California from RGGI,” says Alex Jackson, legal director of the Natural Resources Defense Council’s California climate program, “is that California’s [system] is truly economy wide. It covers transportation, natural gas producers, the industrial sector—85% of all [greenhouse gas] emitters. RGGI’s program applies only to the power sector.”

The cost so far to businesses has been about $1 billion for the purchase of allowances. Business groups worry about the increasing costs, which the California Chamber of Commerce estimates to reach about $6 billion in two years, when oil refineries, which so far have had a bye in terms of market participation, will start paying for their emissions. The refineries account for about 10% of the state’s CO₂ emissions.

The Chamber sued the ARB last November, charging it had exceeded its authority in imposing fees other than what is necessary for administrative costs. “What was not authorized by A.B. 32,” the complaint said, “is the board’s decision to withhold for itself a percentage of the annual statewide greenhouse gas emissions allowances and to auction them off to the highest bidders, thus raising from taxpayers up to $70 billion or more of revenue for the state to use.” The suit is still pending.

The Action in Other Countries

Other jurisdictions, such as New Zealand and Canada’s Quebec province, have had moderate success in curbing emissions from power plants with cap-and-trade programs, and a number of nations, including South Korea and Japan, are either considering emissions trading systems or are about to launch them.

China, the world’s greatest greenhouse gas polluter, recently launched its first cap-and-trade program in the southern city of Shenzhen, with six other cities to follow by the end of the year. The program will eventually cover 864 million metric tons of CO₂, about 7% of the nation’s total, The Washington Post reported in June.

But analysts are skeptical about China’s ability to make the program work. A report in the American scientific journal Proceedings of the National Academy of Sciences said major polluters are already relocating plants to the nonindustrial interior of the country to avoid regulatory restrictions.

Higher Costs, Without Environmental Impact

In the United States, companies—including those in the metals industry—have insisted that cap and trade places them at a disadvantage against foreign manufacturers. They argue heatedly that if carbon emission reductions are to have any impact on climate change, programs and restrictions must be global, and all major polluting countries, most notably China and India, must adopt them.

The U.S. metals industries poured 114 million metric tons of greenhouse gases into the atmosphere in 2011, according to the EPA. For the entire United States, the number is 5.5 billion. But for China, the national figure was an estimated 8.7 billion metric tons, and for India it was at least 1.7 billion metric tons, according to the U.S. Energy Information Administration.

Environmental groups say that even though most program goals are far too modest, they will eventually make a difference.

“California is not going to single-handedly address the global problems of climate change,” says the Natural Resources Defense Council’s Jackson. “But there’s a great potential for California to dispel some myths about cap and trade. When they see the success we’re having without necessarily damaging the economy, other jurisdictions will get off the sidelines.”

And it won’t take a lot of nations to have a significant impact, the Environmental Defense Fund’s Wagner adds.

“Take only six countries—the U.S., China, India, Brazil, Indonesia and Russia—plus the European Union, and you’ve got 60% of global pollution. Get them all to slash emissions, and the planet would surely notice.”