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March 1, 2012

Cap and Trade Goes Local

Absent any federal restrictions, state, provincial and regional carbon emissions limits in recent years have proliferated across North America.

WITH U.S. AND CANADIAN FEDERAL —not to mention global—climate change programs shelved for the time being, the state of California and province of Quebec are going it alone, establishing their own cap-and-trade programs and adding to a growing patchwork of pollution markets in North America.

Starting Jan. 1, 2013, big emitters like electric utilities and large industrial facilities in California will be required to meet new carbon standards, or buy permits to keep polluting, from a market supervised by the California Environmental Protection Agency's Air Resources Board. The new greenhouse gas (GHG) emissions trading program received final regulatory approval in October. It is a byproduct of the Global Warming Solutions Act of 2006, a law championed by then-Gov. Arnold Schwarzenegger designed to reduce California's GHG pollution output to 1990 levels during the next decade.

On Dec. 15, Quebec's Minister of Sustainable Development, Environment and Parks, Pierre Arcand, rolled out a similar system. Like California, Quebec's new system gradually phases in different industrial sectors based on output. Energy-intensive industries, like mining companies, utilities and manufacturers, that spew 25,000 metric tons or more of carbon dioxide annually, are required to comply first. Quebec's move echoed California's because the Canadian federal government, like the U.S. federal government, has declined to take any national or international action to curb GHGs and is unlikely to do so for the foreseeable future.

Quebec's decision to debut its carbon market, in fact, came less than a week after Canadian Minister of the Environment Peter Kent announced at the United Nations Climate Change Conference in Durban, South Africa, that it was pulling out of the Kyoto Protocol, a 1997 agreement designed to reduce GHG emissions worldwide.

“Kyoto, for Canada, is in the past,” Kent said following the U.N. conference. For the United States, of course, Kyoto has always been something to largely ignore even though it does attend the global GHG conferences. “Canada's obviously a sovereign country and can make its own decision,” said Todd Stern, the U.S. envoy to the Durban talks, on a conference call with reporters. “The U.S. is not, as you know, in Kyoto so [Canada's withdrawal is] not something certainly that we're going to criticize or take a position on.”

Unlike their Canadian counterparts, Stern and his colleagues shied away from the limelight at Durban and immediately following, preferring to play a supporting role at the conference; as Stern describes it, “working with a lot of the parties on how to find a way to bridge gaps.”

The timing of Canada's Kyoto withdrawal in late 2011, the debut of Quebec's carbon market only days later, and the United States' relative indifference to carbon controls, highlight an increasingly decentralized environmental policy landscape in North America. This hodgepodge of state, provincial and regional programs promises to bring no shortages of headaches to energy-intensive industries up and down the manufacturing supply chain.

The first time U.S. officials started a federal cap-and-trade system they seem to have gotten it right. Still in operation, the U.S. Environmental Protection Agency's (EPA) sulfur dioxide market-based program was the first of its kind when it launched more than two decades ago.

While it seems now like a distant memory, news reports of “acid rain” created an environmental agenda in the United States in the 1980s. Public outrage over the environmental effects of excess sulfur dioxide and nitrogen oxide concentrations in the atmosphere forced Congress to rewrite the Clean Air Act. The law was signed in 1990 by President George H.W. Bush and created a pollutant trading system for power plants that has few mainstream detractors to this day. Heavy emitters like coal-fired power stations are allocated allowances that permit them to release a specific amount of pollution into the atmosphere. If a facility's pollution levels exceed the amount allotted by regulators, they must purchase offsets in the open market, either directly from another allowance holder, through a broker or in an EPA auction.

An Auspicious Start

The EPA's latest progress report on its acid rain reduction program, published in October, showed that sulfur dioxide levels in 2010 from domestic power plants were one-half of those in 1980. “The first cap-and-trade program to reduce acid rain was successful,” Brookings Institution Senior Policy Analyst Devashree Saha says.

The decade after the EPA's successful acid rain program launched saw the introduction of a number of high-profile cap-and-trade experiments in the Western Hemisphere. The voluntary Chicago Climate Exchange was formed in 2003 by major players such as Ford Motor Co., Waste Management Inc., the City of Chicago, Motorola, Inc. and International Paper Co. Within less than a decade, however, the exchange had closed, shuttering its doors in 2010 on account of too many sellers and not enough buyers for pollution contracts.

Across the Atlantic Ocean, the European Commission launched its Emissions Trading System in 2005, a mandatory program that to date includes 11,000 power plants, refineries, steel mills and factories that churn out cement, glass and paper products. While still intact, Europe's carbon market has struggled periodically since its launch seven years ago. By its own admission, the European Commission during the first years of the program overestimated the pollution output of its member states and thus allocated far too many pollution permits. This miscalculation led to low prices in the trading pits and little reduction in GHGs.

European Union (EU) officials say that its second phase, 2008 to 2012, will be much more productive than the first two years. The number of permits and corresponding emission allowances have been recalculated and are now more attractive to traders and potentially more effective at promoting pollution control. EU market officials say the continent-wide cap-and-trade program, which includes 30 member countries, is now on track to lower emissions 21% by 2020.

Coming to America

On the heels of the EU climate market's 2005 launch, the first large, mandatory cap-and-trade market designed to reduce carbon emissions in the United States began in 2009. The Regional Greenhouse Gas Initiative (RGGI), whose members put rules on the books requiring their individual state's participation in the program, set out to curb carbon emissions from fossil fuel-fired power plants in 10 Mid-Atlantic and Northeastern states, including Connecticut, Maryland, Massachusetts, New Jersey and New York.

Under RGGI, individual states auction off their allotted slice of the overall regional carbon dioxide pie to roughly 200 power plants that burn fossil fuels. According to RGGI, 90% of the pollution allowances are sold this way and 80% of auction proceeds are used to finance energy efficiency projects and lower utility bills for consumers. The 2012 RGGI carbon dioxide cap for participating states is 165 million short tons, with each 1-ton allowance auction price starting at $1.93.

Since it began, auction proceeds for the regional program have totaled more than $950 million. A report released in November by the Analysis Group, a North American consultancy, concluded that the three-year-old program created 16,000 “job years”—defined by RGGI as “full-time jobs that last one year”—and saved consumers more than $1 billion on their utility bills. It also added $1.6 billion-plus to the regional economy.

According to the Analysis Group, the job growth and savings came from “the complex ways that RGGI dollars interact with local economies: the states' use of RGGI auction proceeds on programs leads to more purchases of goods and services in the economy (e.g., engineering services for energy audits, more sales of energy efficiency equipment, labor for installing solar panels, dollars spent to train those installers and educators, and so forth).”

But not everyone agrees RGGI has been successful and skeptics include even some in the environmental community. Luis Martinez, a Natural Resources Defense Council energy policy analyst, says on the one hand the program has worked, particular in the creation of a “green-jobs” sector.

But has it produced a positive impact on the environment? That's “hazier,” he says. The recent drop in regional carbon emissions, as Martinez tells it, has more to do with a sluggish economy, equipment investments and the uptick in national gas usage in the United States, rather than carbon restrictions mandated by RGGI. “The actual emissions reductions have happened through efficiency and not through the caps,” Martinez says. “The limit hasn't driven reductions but the investments in energy efficiency have achieved emissions reductions.”

Still, RGGI as of press time had not released figures showing how it has directly reduced carbon emissions in the region.

Steve Miller, president and chief executive officer of the American Coalition for Clean Coal Electricity, agrees that RGGI is having a negligible direct impact on carbon emissions reductions. For one, he says low carbon dioxide allowance prices offer little punitive reason for participation. As of press time, the latest RGGI auction on Dec. 7 sold about 65% of its offerings at $1.89 per allowance, a dramatic change from the program's initial auction in 2008, when all carbon dioxide allowances were scooped up.

Miller's group represents large energy producers like Ameren, Southern Company and Peabody, as well as manufacturers and transportation companies such as GE Energy, Caterpillar, CSX and BNSF Railways. Of these, only GE Energy's parent, General Electric Co., is listed by RGGI as a participant in the regional cap-and-trade program.

“We don't see RGGI as a program that's significantly reducing greenhouse gases in the region,” Miller says. “RGGI is there, but it's our view that it's limping along.”

It is a view shared by New Jersey Gov. Chris Christie, who in May dropped out of RGGI. Participation in RGGI is self-imposed by laws enacted in the individual states. In the case of the Garden State, the governor's office was given considerable wiggle room whether to take part in the program. Christie told reporters at the time: “RGGI has not changed behavior and it does not reduce emissions. RGGI does nothing more than tax electricity, tax our citizens, tax our businesses, with no discernible or measurable impact upon our environment.”

Undaunted by the uneven reception and results of RGGI, the Golden State rolled out the nation's first state-administered cap-and-trade program in October. In the next decade, the program will grow to include more than 350 businesses and plans to reduce emissions to 1990 levels, according to the California Environmental Protection Agency's Air Resources Board.

Designed to reduce GHG emissions 15% over current levels by 2020, utilities and industrial facilities are required to comply by 2013, while non-consumer gasoline, natural gas and diesel distributors have until 2015 to meet the new guidelines.

The province of Quebec's similar program is in response to the Western Climate Initiative (WCI), a pact signed in 2007 by then-California Gov. Schwarzenegger, as well as the governors of Arizona, New Mexico, Oregon and Washington. Of the original WCI quintet that signed on to the pact five years ago, however, only California remains affiliated with the program, which now includes the Canadian provinces of British Columbia, Manitoba, Ontario and Quebec.

'The Million-Dollar Question'

While the Natural Resources Defense Council's Martinez says RGGI proves non-federal cap-and-trade programs “can be very painless,” industry groups are preparing for the worst. Gino Dicaro, a California Manufacturers & Technology Association spokesman, says his organization's members expect an increase in energy prices and layoffs to coincide with cap-and-trade's introduction next year. But what's likely to be the exact economic damage? “That's the million-dollar question,” Dicaro says.

In Quebec, the economic impact of the program is uncertain as well. Arcand's office has a goal of reducing the province's GHG levels to 20% of the 1990 output by 2020. Still, environmentalists say it is too lax to have much impact.

“We obviously wanted something stricter, but what we realized is that we're not in an isolated world. This is a good starting point,” says Patrick Bonin, the climate and energy director at the Association Québécoise de Lutte Contre la Pollution Atmosphérique. “What we see now is quite disappointing in Canada on the federal scene. We need provinces to step up.”

The Need for 'Clarity'

While cap and trade in California survived a 2010 state ballot measure to abolish it, the new program is expected to face a rigorous challenge in federal court once it's up and running. Robert Lawrence, an environmental lawyer at the law firm Marten Law in San Francisco, California, says the most likely plaintiff is a combination of in-state consumer groups and out-of-state energy companies, which could challenge the program for attempting to keep out cheaper electricity from neighboring states like Nevada because it imposes a tax on imported voltage.

A federal judge could interpret rigging the system for in-state energy producers by taxing out-of-state electricity as a violation of the Constitution's Commerce Clause, Lawrence says. “It's a red flag when a state tries to impose a cost on goods and services between states to keep an advantage to their industries,” Lawrence says. “When you peel away all the layers, that's what you get.”

Legal challenges to California's program at both the state and federal level could take years to wind their way through the court system. Unlike California, Quebec's new system is not expected to face a court challenge, Bonin says. “Public opinion in Quebec is widely for a cap-and-trade [system], and I believe whoever contests it won't be welcome by the population and this could be problematic for their image,” he says.

In the meantime, Miller says companies that do business in any number of U.S. states and Canadian provinces are left contending with an evolving system. And while an absence of a federal cap-and-trade system would seem to delight industry heavyweights, Miller and members of his coalition, in fact, say quite the opposite is true.

“Our position is that we're for national climate policy rather than a patchwork of state-based programs. Everybody recognized the danger that in not having a federal program, state programs might come up in their place,” Miller says. “This is something that ought to be handled on the federal level, so that there's more clarity and not be so subjected to legal challenges.”