Just as many thought cap-and-trade was dead in the United States,
California –the eighth largest economy in the world– introduced a statewide carbon-trading program. Can one state put a whole nation back on track and send a message to major stakeholders around the world?

Prior to President Barack Obama’s election, cap-and-trade was on the tip of everyone’s tongue. It seemed a sure thing that legislation to curb carbon emissions would pass Congress and the green energy industry would blossom. But like the recent debt ceiling debate, all opponents had to do was label cap-and-trade “cap-and-tax” to stop the discussion in its tracks and send politicians running for cover. By the summer of 2009 cap-and-trade legislation was dead.

In the meantime, a nationwide voluntary market, the Chicago Climate Exchange, had opened its doors in 2003 in anticipation of cap-and-trade legislation passing. From the time it began, the exchange was North America’s only cap-and-trade system for all six greenhouse gases. The way it worked was that companies set targets for annual emissions of carbon dioxide. If they met or beat their targets the companies could sell surplus carbon credits to firms that hadn’t. Companies, such as Ford, Intel, and IBM, signed up believing that someday carbon trading would be mandatory and they’d be ahead of the game, able to profit from going green. 

It wasn’t just environmentally-minded companies that were eager to reduce their carbon footprint. The Big Three banks –Bank of America, JPMorgan Chase and Citigroup– saw carbon trading as big business and they rushed to set up carbon trading desks. College grads looking to jumpstart their careers and dive into a booming market set their sights on Wall Street where carbon trading was all the rage. 

Then reality sank in. As greenhouse gas reduction programs floundered under a lack of political will, the Chicago Climate Exchange announced last year it would end its voluntary cap-and-trade program. Earlier this month, Intercontinental Exchange Inc. announced it planned to shut down the Chicago Climate Futures Exchange at the end of the first quarter of 2012, citing the failure of the U.S. to pass cap-and-trade legislation as part of the reason. Without a regulatory obligation to deliver emissions reductions, there really was no market. The price of carbon on the exchange tumbled from $7.40 per ton in May 2008 when cap-and-trade legislation was anticipated, to 10 cents per ton in August 2010. Nonetheless, Intercontinental will still list OTC contract equivalents of all of its climate futures contracts on its over-the-counter trading system. 

Does that mean all hope is lost for the reduction of carbon emissions in the U.S.?

Not so fast.

California, the most populous U.S. state and the eighth largest economy in the world, voted in August to put its statewide carbon trading program back on track. California’s program would be North America’s biggest carbon market and would require a reduction in carbon pollution to 1990 levels by 2020. The program was originally scheduled for implementation in 2012, but because of legal wrangling and delays, compliance in the cap-and-trade program will now begin in 2013. By 2016, approximately $10 billion in carbon allowances are expected to be traded in the California market alone. In addition, California may also work with Canada under the Western Climate Initiative, a partnership involving the United States, Mexico and Canada, to reduce carbon emissions.

But the question remains: Can California lead the way in reducing carbon emissions and convince the rest of the nation to follow suit? 

“What we have to remember is that the U.S. is a federal republic and many initiatives, like seatbelts, began locally,” said Richard Sandor, who is known as the “father of financial futures” and is the chairman and CEO of Environmental Financial Products LLC. “California has a bottom up approach.  It doesn’t matter whether it’s Avatar, Facebook or emissions trading, California is often a place where trends start in America. A failure in California would be bad. A success there would send an enormous message to the Federal government and other states about what they could do in terms of reducing greenhouse gases.” 

If California’s carbon market succeeds, the hope is that other states will replicate its system and a national carbon market will be created. 

It hasn’t been easy, but California has been able to bridge the political gap that Congress hasn’t been able to bridge, Sandor explained: “The environmentalists who had been very stringent about punish the polluter have backed off intelligently. And the right wing that tried to kill the program have backed off.” 

Unfortunately, the U.S.’ failure to pass cap-and-trade legislation has meant that other countries have far outpaced it in creating their own carbon reduction programs. Sandor calls it “one of the great moments of irony” that the world leaders in emissions trading will be in China and that the U.S. “will become a follower not a leader.” Already China has carbon trading exchanges and programs in Shanghai, Beijing, and Tianjin and pilot emission trading programs in Jiaxing, Liuzhou, Baotou, Taiyuan, Pingdingshan, Guiyang, and Wuhan, as well as eight provinces. “Essentially China’s Communist economy will use a free market to solve their environmental problems and the U.S. with a capitalist economy is abandoning free markets and going to command and control,” Sandor mused. “It’s an interesting sign of the times.” 

Sandor believes that China and India will shock the world. While the West has lectured the developing world, one of the biggest surprises in the next decade will be when China becomes the leading producer in renewables like solar and wind, Sandor pointed out. 

“I think it’s interesting that we have lectured China and India in building robust economies and moving people out of poverty and some have criticized them for their environmental records, and yet their environmental record and economy has gotten better and our environmental record and our economy has gotten worse.” 

It’s not only China and India that have started emissions reduction programs. Last year, Kenya and Indonesia both announced carbon trading initiatives. The Nairobi Climate Exchange will be the first in Africa and will allow for trading of carbon credits with other African nations. The Australian government plans to introduce an A$23 per ton carbon tax on 500 of the country’s largest emitters, which will be replaced starting in 2015 by a cap-and-trade scheme modeled on the European Union’s exchange, which is the largest in the world. The EU’s mandatory program began in 2005 and so far has successfully reduced emissions within the most carbon-emitting sectors, such as steel, cement refineries, pulp and paper.

“With the exception of California, the U.S. is in a position where it will be playing catch up,” said Abyd Karmali, Bank of America Merrill Lynch’s Global Head of Carbon Markets. “The EU carbon emissions market has existed for six years and it has the trading expertise, carbon fund management expertise, and a whole array of emissions verification, monitoring, legal, accounting, and all those professional services built up around carbon finance, which is a relatively new area of expertise. By moving early, Europe gained this expertise early on. Regardless of what happens in the U.S. there are other countries that are likely to go ahead with their own emissions reduction programs.” 

The early success of the EU trading program reinforces the point that economic growth doesn’t have to be killed off to deliver environmental improvement. It’s possible to deliver innovation and growth in the economy and help transition to a green economy at the same time.

 In 2009, the World Bank estimated a global carbon market would be valued at $144 billion, despite the recession. If the rest of the world continues to move forward with their cap-andtrade programs, the U.S. will get left further and further behind. 

Meanwhile, the last few years have seen a leveling off in the growth of the carbon market because of significant policy uncertainty globally, particularly in the U.S. The first commitment period of the Kyoto Protocol, which was aimed at fighting global warming, expires at the end of 2012. Another commitment period could start in 2013 but it’s difficult to predict how well that would go given the political situation. The U.S. has never signed on to the protocol and Canada and Japan have indicated they do not want another commitment unless they see greater engagement from the U.S. and China. The EU is happy to continue, but the whole you-emit-more-than-me-soyou- should-engage-first mentality has threatened to derail the entire protocol. 

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by Ruthie Ackerman