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September 1, 2008

COOL IT

Cap and trade is coming to the United States, like it or not.

Make no mistake about it. The United States will impose some kind of cap-and-trade system on industry to control greenhouse gas (GHG) emissions and establish a market price for carbon emissions.

Despite the defeat earlier this year in the U.S. Senate of a first, almost-exploratory cap-and-trade bill, the concept’s future is about as secure as anything can be in American politics these days. Both presidential candidates endorse the idea, as has a plurality in the existing Congress, including many Republicans. If the Democratic majority in Congress increases as widely as predicted, the Senate and House holdouts will be unable to turn back this effort. More than that, since the issue of GHG emissions is global, it has sparked considerable international interest in persuading the two largest emitters, the United States and China, to offer their own abatement programs.

It’s not likely that the next U.S. cap-and-trade bill will be exactly like the Lieberman-Warner Climate Security Act of 2008 that died in the Senate in June. But the basic structure of the idea—one that is widely embraced globally—will remain the same. GHG emission limits—the cap—would be set for corporations and their polluting facilities, and emission permits would be allocated, either free, auctioned or both, for emissions up to those limits. Companies that don’t meet the limits would have to buy permits—the trade—from companies with permits to spare or from a market created for that purpose. The cap-and-trade system would put a price on carbon emissions, creating an economic incentive for GHG emitters, such as steel companies, to control those emissions or spend money on permits that allow them to exceed their limits. The European Union (EU) has just completed the first three years of a pilot project to create such a system.

From that framework, however, the new Congress and the new president should be expected to propose a number of ways to structure a carbon trading system. But it seems unlikely at this point that any approach will be acceptable to the steel industry—the aluminum industry, which emits fewer GHGs, favors cap and trade—unless it acknowledges the progress the industry has already made in this area and its position as a global competitor. The American Iron and Steel Institute (AISI), for example, opposes cap-and-trade programs because it says they will unfairly penalize the environmental successes of North American steelmakers and necessarily shift more production to nations such as Brazil, Russia, India and China (BRIC) that are among the larger GHG producers. In place of cap and trade, AISI says, the United States should focus on carbon intensity standards, which set production limits per unit, based on how much carbon dioxide (CO2) and other GHGs are emitted by production of individual steel products.

Environmentalists, however, oppose carbon intensity standards as the only solution because they don’t place a limit on total GHG emissions and thus would sanction greater emissions, albeit emission levels reached at a slower rate. In other words, while intensity or efficiency standards would produce lower levels of GHGs per widget, if the world produces vastly more widgets, total GHG emissions would continue to increase.

“On average, steel producers around the world emit 1.7 tons of greenhouse gases, directly and indirectly, for every ton of steel they produce,” said Jim Slattery, counsel to Nucor Corp. and lead witness for AISI at Congressional hearings in March. “American steel producers are among the most efficient in the world. … [They] emit on average only a little over 1.2 tons of greenhouse gases per ton of steel. Although some international statistics indicate that China emits nearly 2.5 tons of greenhouse gases for every ton of steel produced, the real number is almost certainly higher, perhaps four to five tons.”

In 1990, the U.S. steel industry emitted 86.2 million tons of CO2 and equivalent gases, Slattery reports. By 2005, total process-related emissions fell sharply to 46.2 million tons.

“The U.S. iron and steel sectors are presently emitting GHGs at levels approximately 40% below 1990 levels while maintaining or adding to 1990 production levels,” says Steve Rowlan, director of environmental affairs at Nucor in Charlotte, North Carolina. “That record is unmatched anywhere in the world. Strong growth in recycling and efficiency has created this industry in the U.S. that is able to compete globally, despite being highly regulated on many fronts, including environmental.”

The aluminum industry’s record is even better. The Aluminum Association reports that as of 2005, reduction in direct process emissions of GHGs per ton of production was 56% from a 1990 baseline. The industry’s goal under its voluntary program was a 53% total carbon equivalent reduction on direct CO2 emissions from 1990 levels by 2010.

Possible Scenarios

The new version of cap and trade seems likely to take account of this metals industry record and include some intensity standards and other bells and whistles to improve energy-efficiency. It seems likely, say industry and environmental lobbyists, to retain the fund in Lieberman-Warner created from the proceeds of auctioned permits that could be spent on crash programs to develop alternative energy sources and to transfer energy-efficiency technologies to emerging economies. That is, of course, if Congress doesn’t gobble up the money for pet projects, as is its habit, and as some metals and other industry critics predict.

Energy-efficiency standards for everything from appliances and office buildings to steel furnaces and coal-fired power plants are certainly on the agendas of coalitions that include such strange bedfellows as the U.S. Chamber of Commerce and environmental groups.

There are plenty of indications that Congress understands the metals industry’s GHG reduction record and the need to keep core industries healthy and competitive. The original Lieberman-Warner bill gave the steel, cement and chemical industries free emission permits for a 20-year phase-in period. That feature likely will remain in place, contend environmental and business lobbyists, including David Doniger, policy director of the Natural Resources Defense Council’s (NRDC) Climate Center; William L. Kovacs, vice president for environmental, technology and regulatory affairs for the U.S. Chamber of Commerce; and Sarah Ladislaw, energy and national security fellow in the Energy and National Security Program at Washington, D.C.-based Center for Strategic and International Studies.

The metals industry’s push to include intensity standards in a GHG strategy is also receiving a sympathetic ear. A major force will be Congressman John Dingell (D-Michigan) and his House Committee on Energy and Commerce, which publishes white papers on global warming legislation issues. One of those gives intensity standards a favorable review. From the think-tank side, the McKinsey Global Institute (MGI), a research arm of the international consulting firm, also endorsed the idea in a lengthy June research report that received a lot of attention on Capitol Hill and from K Street lobbyists, advocacy groups and the like. “Increasing carbon productivity is the key to tackling the twin challenges of mitigating climate change and maintaining economic growth,” the MGI report concluded.

The report singles out the steel industry as an ideal candidate for a program to transfer manufacturing efficiency technology elsewhere. “India and China use approximately 20% more energy to manufacture a ton of steel than do Western Europe or Japan,” the report said. “Likewise, given China’s dependence on coal, it will be in the world’s interest to ensure China has access to the most advanced and cost-effective [carbon abatement] technology.”

Says Ladislaw, of the Center for Strategic and International Studies, “People knew [Lieberman-Warner] was a trial run, but the real significant things were the areas of agreement and what wasn’t debated. They did not debate whether something should be done or whether global warming was happening or what its causes are. Or even whether there should be a cap-and-trade solution. That is very significant.” (See “What’s True, and Does it Matter?”)

“I think that companies in the United States and elsewhere see the writing on the wall,” says Andrew J. Hoffman, associate director of the Erb Institute for Global Sustainable Enterprise at the University of Michigan in Ann Arbor. “It is not a matter of if, but when carbon controls will be instituted in the United States and abroad. Both candidates support such controls. The statements by the G-8 [in June at the last meeting of the richest industrial powers—Japan, Germany, France, the United Kingdom, Italy, Canada, Russia and the EU, in addition to the United States], while vague, not terribly aggressive and non-binding, suggest action around the world is coming, as well. So while legislation in the United States is stalled, it can be seen only as breathing room for companies to make preparations for the eventuality of controls.”

One Debate Ends, Another Begins

Still, the political and policy drama—what to do about climate change—remains a major challenge for the American political system.

The chief executive of Exxon Mobil, Rex Tillerson, nailed the core of the problem in a July interview: “The reason the United States has never had an energy policy is because an energy policy needs to be left alone for 15 to 20 years to take effect. But our policymakers want a two-year energy policy to fit with the election cycle because that is what people want.”

Indeed, adds Kovaks, “long-term planning has never been the strong suit of the U.S. government. Congress is deaf to technology. It’s very hard to get Congress to even understand the issues.”

A number of organizations—McKinsey, the Pew Center on Climate Change, the Center for Strategic and International Studies and the United Nations Intergovernmental Panel on Climate Change (IPCC) included—recommend multi-step strategies, including a combination of approaches that evolve over time. Steps would include establishing GHG emissionreduction targets, imposing a cost on carbon emissions to induce markets to respond to reducing those costs, developing energy- and carbon-efficient technologies, transferring those technologies to emerging economies and last, but hardly least, persuading the business community and public in general to embrace all of it.

McKinsey says there are five areas for action to drive the necessary microeconomic changes: capturing available opportunities to increase energy efficiency in a cost-effective way, de-carbonizing energy sources, accelerating development and deployment of new low-carbon technologies, changing the behaviors of businesses and consumers, and preserving and expanding the world’s carbon sinks, most notably forests.

The McKinsey agenda might find enthusiastic advocates in the halls of Congress and industrial and environmental activist boardrooms across the world, but only if it can also be applied to the elephant in the room: China. Its fast-growing economy gobbles so much energy and belches so much GHGs that it is now a crucial player in any program to address global climate change.

Only this year, the Netherlands Environmental Assessment Agency reported that China passed the United States in 2007 as the world’s No. 1 GHG emitter. It is now putting out more than 6,200 megatons a year, increasing at a nearly 9% annual rate. The United States, in contrast, produced some 5,800 megatons in 2006, a 1.5% decrease from the year before.

In percentage terms, the International Energy Agency reports that in 2004, the United States, China and the EU’s 25 countries were producing half the world’s GHGs. The eight largest emitters when that last ranking was issued were the United States with 19% of the world’s total, China (17%), the EU25 (13%), Russia and India (5% each), Japan (4%), and Germany and Brazil (3% each).

Canada, a signatory to the Kyoto Accords, reported total GHG emissions in 2006 of 721 megatonnes of CO2 equivalent, a decrease of 1.9% from 2005 levels and down 2.8% from 2003 levels, says the latest annual inventory submitted by Environment Canada. The reduction has come so far primarily from cutting coal use as fuel for electric power plants and an increase in hydro and nuclear generation. It also has cut its energy use for heating because of warmer winters in 2004, 2005 and 2006, the government reports.

These emissions, however, remain nearly 30% above the national Kyoto target of 558.4 megatonnes. But the national government has announced a new program, “Turning the Corner,” which includes its own version of a cap-and-trade scheme, called the Offset System for Greenhouse Gases. The goal is a 20% cut in emissions by 2020.

The metals industry and others, including the U.S. Chamber of Commerce, say only a cap-and-trade system applied globally—unlikely in the near term given China’s and India’s reluctance—will have any significant impact, other than making U.S. goods less competitive.

But China and India have been quite clear. They say they are being asked to reduce emissions, slow their own economic growth and endanger their competitive trade positions in ways never required of the industrialized countries as they evolved into less-polluting manufacturing and trade powers. As a political bargaining chip, McKinsey, the U.S. Chamber of Commerce, the United States Climate Action Partnership—a coalition of industry and environment groups—and others have urged that nonproprietary, energy-efficient, low-pollution technologies be shared with the high-polluting BRIC countries.

As Hoffman at the University of Michigan puts it, “I really think that the developed world will go first, but not without mechanisms for the developing world to make controls of their own. Without some involvement by the developing world, nothing will happen. I don’t think developing countries will be forced to abide by similarly strict rules as the developed world. Their involvement will be through mechanisms that help them achieve the economic growth they deserve and use some of the latest technologies to do it.”

To be clear, all the big GHG emitters are on record as wanting to reduce their contributions to global warming. China and India, particularly, have national programs and proposals to do so. But they take a more gradual approach to these reforms. They have not participated fully, along with the United States, in the United Nations Kyoto Protocol, which aims to keep global CO2 concentrations in the atmosphere below 450 parts per million. Concentrations are now at 425, reports the IPCC. Short of war, no country, of course, can be compelled to participate in this global effort.

“If it is a global problem, we must use global mechanisms to accomplish the goal,” says Nucor’s Rowlan. “We believe the goal is to reduce global concentrations of GHGs. With that in mind, we have proposed using carbon intensity standards for any product sold in any given country. That way, the markets of a given country begin to affect goods manufactured in other countries.”

EU’s Cap-and-Trade Position

U.S. industry points to cap and trade’s most notable experiment to date—the EU’s three-year-old system—as a good reason to steer clear of such a program. Under the EU system, individual carbon traders and companies have made money. But the EU, based on poor emissions data and heavy industry lobbying, handed out carbon credits that exceeded the expected and actual pollution of most industries. These were all free at the beginning, which collapsed the price and handed substantial profits to those who sold their free credits early, or that raised prices to recover carbon credit costs they did not incur.

There is also some question whether there was any reduction in GHG emissions. The EU initially reported a 2% or so increase. But when later-audited emission numbers came in, they showed a drop of as much as 5% in some industry sectors, says MIT Sloan School of Management professor Denny Ellerman, an expert on cap-and-trade systems.

Ellerman, Ladislaw and others say the initial criticism of the EU missed the point. “The system was a definite success,” Ellerman says in his report, “The European Union’s Emission Trading System in Perspective.” “It was a pilot program to begin with and was not expected to achieve significant emission reductions in just three years.” But he notes that the EU now has an active trading system in place, with exchanges in London, by far the biggest, but also Vienna, Austria, Paris and Leipzig, Germany. It is improving its data, tightening emission standards and auctioning a higher percentage of credits to eliminate the windfall-profit criticism.

The EU is still working on other aspects of the system, but will almost certainly build in exemptions and allowances tailored for industries, such as steel, that face international competition. Ellerman says this is one of the important lessons from the EU system that should be carefully considered as the United States and the Kyoto community attempt to craft a market system. Certainly, the EU itself is already getting plenty of advice from European steelmakers, as the market system continues to be fine-tuned.

“The European steel industry is committed to the EU objective to reduce carbon emissions and is willing to share the burden to meet the EU target of a reduction of CO2 emissions by 20% in 2020 compared to 1990,” said the European Confederation of Iron and Steel Industries (Eurofer) in an open letter to the EU Trading System in February. “We have already done a lot. Over the past 30 years, emissions per tonne of steel produced have been cut by more than 60%. Even if available CO2 mitigation technologies for steelmaking are reaching their maximum potential, we are prepared to do more. We are investing massively in ambitious research and development projects with the aim to produce better and lighter steels.”

“Steel is infinitely recyclable so that the life-cycle CO2 impact is very positive compared to other materials,” the Eurofer letter said, echoing a similar position among U.S steelmakers. “This should be taken into account in any regulatory systems. However, our ability to invest in Europe depends on the correct policy framework.”

That framework, the organization said, should “adopt internationally agreed benchmarks of CO2 intensity as a means of determining allocations. Auctioning [of permits] for steel would be extremely damaging and counterproductive. Until an international agreement sets the rules globally, [we urge] free allowances to the steel industry but tailored to sector performance indicators.”

“Europe is trying to make a symbolic effort, even without the United States,” says Blas Pérez Henríquez, director of the Center for Environmental Public Policy at the Goldman School of Public Policy at the University of California at Berkeley. “They’ve decided that an emissions trading system was the most flexible mechanism to reach their goal.”

Cap and trade is the most viable alternative, says Hoffman. “Economists prefer a carbon tax. The latter is simpler to apply. But it is stuck with the stigma of being a ‘tax.’” Hoffman and others say that a cap-and-trade system, imposing costs on carbon emissions, is really a tax in disguise. “It gets the cost of carbon into the marketplace,” says Ladislaw. “Call it what you will.”

Both Hoffman and the McKinsey study point to the cap-and-trade system the United States successfully used, beginning in 1995, to sharply reduce sulfur dioxide and other components of acid rain in the Northeast. The market responded well: Cutting these pollutants to healthful levels has cost $1 billion to $1.4 billion per year instead of the $3 billion to $25 billion per year originally estimated. Nucor’s Rowlan and others emphasize this was a far more localized problem than GHGs and thus more easily addressed with a single cap-and-trade system.

But backers of a U.S. carbon market say it is an opportunity to innovate and expand on the EU model, lead by example and convince the rest of the world that this global industrial power is serious in its commitment.

However, even if Europe and the United States agree on designing compatible systems to better take advantage of cost-reducing strategies on emissions, “If China doesn’t play, then we’re still doomed in terms of the ultimate goal of reducing GHGs,” says Henríquez.

How Soon? How Much?

In any case, there seems little likelihood, say lobbyists and congressional staff, that a new administration and a new Congress will be sufficiently together on this issue before 2009 ends. So we will not be running down to our friendly local cap-and-trade store any time soon to buy and sell emission credits. That also means the United States will probably not have a specific plan to offer when parties to the Kyoto Protocol meet in Copenhagen, Denmark, in September 2009 to work on GHG targets beyond 2012, when the Kyoto agreement expires.

“We think we can get a bill by the end of 2009,” says Doniger of the Natural Resources Defense Council’s Climate Center. “But it is clear that the global negotiations cannot succeed without knowing what the United States will do.”

“I can’t see anything moving if the Lieberman-Warner bill comes back in anything close to what it was,” says Kovacs at the U.S. Chamber of Commerce. “There are plenty of things to do about GHG emissions that do not involve the expense and complexity of Lieberman-Warner. And I would be shocked if either an Obama or a McCain administration pushed anything that complex.”

The chamber’s agenda calls for a strong technology transfer program to improve global energy and carbon-use efficiency. It would develop alternative energy sources like solar and wind, but says that must be coupled with increased use of nuclear power, as well. And it talks about phased-in energy-efficiency standards for appliances and buildings, with an emphasis on “practical and phased in,” as Kovacs puts it. “There are a lot of things we could be doing right now that we are not doing,” he says.

The remarkable thing is how close this agenda is to those of the NRDC and other environmental groups that will help shape the issue in a new administration and Congress. Kovacs says that either an Obama or a McCain administration will be more likely to be in a mood for compromise than the previous one.

There remains a tremendous concern about rendering American industry uncompetitive by burdening it alone with increased carbon costs. Some estimates—Britain’s Stern Review, for instance—put the cost of reaching and maintaining “safe” GHG levels at 1% of global gross domestic product (GDP) a year, recently revised to 2% of GDP. Others, such as MGI, say it could be done with 0.6% of GDP a year. But both emphasize these costs will be coupled with the creation of huge new economic opportunities from technology transfer, development of state-of-the-art carbon-use efficiencies and new markets for alternative energy sources and retrofitting existing users.

Both, as well, estimate that the cost of doing nothing about climate change could be 5% of global GDP at a minimum, the result of rising sea levels, drought, extreme weather and other disruptions. Ladislaw says no one has tried to put a cost on the possible threats to the security of nations. “These too are not national problems,” she says. “That is where the security issues will emerge across borders. Populations that can’t feed themselves will cross borders; there will be political unrest.”

Certainly the magnitude of the change required is a showstopper. MGI estimates the need for a tenfold increase in carbon productivity. The last time we made an equivalent jump was during the Industrial Revolution. “However, the ‘carbon revolution’ must be achieved in one-third of the time that economic transformation took in the Industrial Revolution if we are to maintain current growth levels while keeping CO2 levels below 500 parts per million by volume, a level that some scientists believe is the maximum that can be allowed without significant risks to the climate,” the MGI report says.

“There is all this talk about political will and whether the world has or we have the political will to solve this climate change challenge,” says Ladislaw. “But one question still is, ‘The will to do what?’ No one has ever had to do anything like this before.”

What's True, and Does it Matter?

THE DEFINING SCIENTIFIC AND ECONOMIC work for the current debate on climate change is in two current documents.

The first is The Stern Review of the Economics of Climate Change, written by Sir Nicholas Stern and a team of scientists and economists working out of Britain’s Office of Climate Change and released by the British government late in October 2006. It concluded that 1% of global gross domestic product (GDP) needs to be invested annually to avoid the worst effects of climate change, and failure to do so could risk a global GDP that is 20% lower than it otherwise might be. The report further suggests that climate change threatens to be the greatest and widest-ranging market failure ever seen “on a scale similar to those associated with the great wars and the economic depression of the first half of the 20th century.” In June 2008, Stern increased the estimate to 2% of GDP to account for faster-than-expected climate change.

The second is the report issued by the Noble Prize-winning United Nations Intergovernmental Panel on Climate Change (IPCC). IPCC was established by the World Meteorological Organization and the United Nations Environment Programme. Its latest report, issued last fall, is a compendium of research reviewed by panels of hundreds of independent scientists from all over the world. The report, non-partisan and endorsed almost universally by the scientific community, is also now the most quoted on the subject. It concluded that the evidence for human-induced climate change is “unequivocal,” and the rise in greenhouse gases (GHGs) in the atmosphere thus far will result in an average rise in sea levels of up to 4.6 feet.

There is other work from the McKinsey Global Institute (MGI), an arm of the wellknown international consulting firm; from the Center for Strategic and International Studies, a D.C. think tank that has testified extensively before Congress on this issue; from the United States Climate Action Partnership; and from the Pew Center on Global Climate Change. This last is particularly noteworthy because the partnership’s more than three dozen members include not only environmental activists such as the Natural Resource Defense Council, but also major corporations and energy producers such as Alcoa, Rio Tinto, Shell, General Motors and Duke Energy.

A GROUP CONSENSUS

“An overwhelming body of scientific evidence now clearly indicates that climate change is a serious and urgent issue,” the Stern report found two years ago. “The Earth’s climate is rapidly changing, mainly as a result of increases in greenhouse gases caused by human activities.”

Its conclusion: “Most climate models show that a doubling of pre-industrial levels of greenhouse gases is very likely to commit the Earth to a rise of between 2 to 5 degrees Celsius in global mean temperatures. This level … will probably be reached between 2030 and 2060. A warming of 5 degrees Celsius on a global scale would be far outside the experience of human civilization and comparable to the difference between temperatures during the last ice age and today.”

A year later the IPCC declared, “Greenhouse gas emissions have risen by 70% since 1970, and will rise by between 25% and 90% over the next 25 years under ‘business as usual.’”

“The current atmospheric concentrations are equivalent to about 425 parts per million of CO2,” the IPCC said. “The IPCC suggests that concentrations between 445 and 490 parts per million would keep the temperature rise to 2.0 to 2.8 degrees Celsius. European Union policy is to avoid a rise greater than 2 degrees Celsius.” The Lieberman-Warner cap-and-trade plan that failed in the U.S. Senate earlier this year was designed to reduce U.S. emissions by an estimated 65% below 2005 levels by 2050 in an attempt also to help keep CO2 levels within “safe” concentrations.

The IPCC joined Stern stating, “Most of the observed increase in global average temperatures since the mid-20th century is very likely due to the observed increase in anthropogenic [human-caused] GHG concentrations.” The IPCC uses the term “very likely” when, according to its report, there is a 90% certainty.

THE CRITICS

As any serious student of this subject understands, the significant objections to existing cap-and-trade proposals and to devising an effective curb on GHG emissions revolve tightly around who or what’s to blame for the warming planet. To be sure, there have been a few IPCC panel members who have broken with the group and criticized the panels’ methodology and conclusions. John Christy, a contributing author to IPCC and professor of atmospheric science at the University of Alabama, among others, says global meteorological models remain inadequate to conclude that humans are causing climate change. The most vociferous politician in this area has been Sen. James Inhofe (R-Oklahoma), who says there is no need for action on climate change, since the issue is “a hoax.”

One of the frequently quoted skeptics is Richard S. Lindzen, the Alfred P. Sloan professor of meteorology, Department of Earth, Atmospheric and Planetary Sciences at MIT and an early IPCC author. “We simply do not know what relation, if any, exists between global climate changes and water vapor, clouds, storms, hurricanes and other factors, including regional climate changes,” he told the Ottawa Citizen a few years ago. “Nor do we know how to predict changes in greenhouse gases. This is because we cannot forecast economic and technological change over the next century, and also because there are many man-made substances whose properties and levels are not well known, but which could be comparable in importance to carbon dioxide.”

Another skeptic, Dr. Vincent R. Gray, retired, with a degree in physical chemistry from Cambridge University, and an IPCC articles reviewer, says, “The science is selected, distorted and occasionally fabricated. Their reports have to be approved by the politicians who set them up, and the lead authors are all chosen because they are willing to carry out their orders. It is impossible to measure the average temperature of the Earth and even more difficult to find out whether it is increasing or decreasing.”

These views, however, have not been accepted by the world’s scientific community and have been rejected by the world’s political community. From the European Union to the U.S. Congress, even among the heretofore sticky, resistant Chinese and Indians, the IPCC conclusions now control the debate. The primary question has shifted from, “Are humans doing it?” to “Assuming they are, what can we effectively do about it?”

“GHG regulations should be global, as it is a global problem,” says Nucor Director of Environmental Affairs Steve Rowlan, explaining the major industry position and most serious objection to single-country solutions. “As presently considered, cap and trade will act as nothing more than a mechanism to transfer jobs, wealth and emissions from one country to another without impacting global emissions.”