Statement to the U.S. Senate Agriculture Committee

March 29, 2001 Hearing on Environmental Trading

Dr. Richard L. Sandor

Chairman and Chief Executive Officer, Environmental Financial Products L.L.C.

Visiting Scholar, Northwestern University

Good morning Mr. Chairman, members of the committee, staff, and guests.  Thank you for the opportunity to participate in today’s hearings.  Our company, Environmental Financial Products, is a small investment bank and consulting company that has dedicated the last three decades to designing, launching, and trading in new markets.  Our efforts cover many areas from financial futures to insurance and weather derivatives.  Our principal focus during the last decade has been environmental financial instruments.  

In 1990, we authored an early advocacy paper that advanced emissions trading as a cost-saving mechanism under the Clean Air Act Amendments.  In 1991, while serving as a director of the Chicago Board of Trade (CBOT) and Chairman of its Clean Air Committee, I encouraged the exchange to support the SO₂ emission allowance market on a pro bono basis.  The Environmental Protection Agency (EPA) ultimately selected the CBOT to administer its annual allowance auctions.  Our small company then registered the first trade under the program and acted as a principal for over $100 million of SO₂ allowances at the outset of the program. 

Yesterday, I chaired a press conference announcing the results for the eighth annual SO₂ auction at the Chicago Board of Trade.  The results continued to buttress the fact that emissions trading has been a milestone in environmental and financial history.  The success of that program has been realized despite the predictions of the nay Sayers.  We were told, “it will never work” and “it would cost too much.”  All of those criticisms have been proven wrong by empirical evidence and practical experience.  To date, the program has cost 75% less than many predicted and the emission reduction has been far beyond requirements. 

We continue to expand and explore new opportunities for low-cost solutions to environmental problems.  We believe that an emissions trading program for CO₂ can bring similar benefits for combating global climate change that SO₂ trading brought to combating acid rain.  We can begin managing the potential risks associated with climate change by providing financial incentives to our industrial and agricultural communities who are invariably linked to global climate issues. 

Emissions trading under the Acid Rain Program required three critical components.  Trading of greenhouse gases will require the same components, which we proposed in an article for the Earth Summit (UNCED) in Rio de Janeiro in 1992 (see record): 1) a viable legal infrastructure with a clearly defined tradable commodity, 2) monitoring and verification protocols, and 3) extensive market architecture in the private sector.  We firmly believe this committee can play a significant role in providing an opportunity in these three areas for the public sector to facilitate the development of this market.  These efforts will have a concomitant benefit for U.S. agriculture while providing a parallel track to current carbon market developments in the private sector. 

It is commonly accepted in the international community that efforts to create a market-based solution for mitigating greenhouse gas emissions have stalled in the United States.  But commonly accepted knowledge doesn’t apply in the Midwest. 

In June 2000, the Midwest-based Joyce Foundation announced a “Millennium grant” to the Kellogg Graduate School of Management at Northwestern University to be administered by Environmental Financial Products.  Under this grant, we are now completing the design phase of a voluntary greenhouse gas emissions trading market based in the Midwest.  The remainder of this statement will be devoted to describing the rationale for the research, its current status, and the role this committee can provide in assisting in the recordation, verification, and monitoring of soil carbon sequestration to benefit this voluntary private sector activity and the agriculture community within it. 

This Midwest initiative was recently named the Chicago Climate Exchange (CCX).  The website address and content have been included in the record.  Initially, the program will target emission sources and offset projects in seven midwestern states (Illinois, Indiana, Iowa, Ohio, Michigan, Minnesota, and Wisconsin).  To develop the infrastructure for an international component, limited carbon offset projects from Brazil will be included.  The second phase of the program, beginning in 2003, will include participants from the entire United States, Canada, and Mexico.  By 2004, international sources will be incorporated.  The initial emission baseline will be 1999 and a reduction of 5% from that baseline will be phased-in between 2002 and 2005. 

The Midwest is a logical location to start a pilot GHG emissions trading pilot.  The region has a diversity of emission sources including electric utilities, agricultural producers, forestry companies, refineries, steel plants, automobile manufacturers, and other large industries.  Its GDP of approximately $1.8 trillion would rank it among the top 5 economies in the world.  With a land area of one million square kilometers, it contains over 475,000 separate farms.  The economy of this region is representative of the entire United States, making the pilot scalable to a national level. 

We have assembled a blue-ribbon CCX advisory board that includes leading economists, lawyers, accountants, and scientists throughout the world.  Our public sector representation includes individuals who have served in the U.S. Senate and House, as well as governors, mayors, and leaders in the NGO community.  The list of advisory board members is included in the record.  

Industry and agriculture have expressed considerable interest in the Chicago Climate Exchange.  Specifically, we have positive indications of interest from electric utilities such as Cinergy and Alliant, various industrial corporations, and four agricultural cooperatives including Agriliance, Growmark, the Iowa Farm Bureau, and the National Council of Farmer Cooperatives.  With carbon sequestration in soil from no-till farming, and through other conservation practices, the Midwest farmer may now be responsible for selling two crops—one above the ground and one below it.  Agricultural offsets would be a cost-effective option for electric utilities, particularly coal-fired power plants, to mitigate their emissions without significantly affecting the affordability of energy.  The record contains a recent article we wrote, that provides a more complete discussion of this issue. 

How large are the potential benefits to the agricultural sector?  In an article we published in Choices, a publication of the American Agricultural Economics Association, we estimated that 200 million tons of CO₂ could be sequestered through soils and forestry in the United States per year (see record).  At the most conservative prices of $20-$30 per ton, this could potentially generate $4-$6 billion in additional agricultural income.  Our research suggests that the Midwest should enjoy its pro rata share with a national trading regime. 

An important caveat to this realization is that monitoring and verification protocols must be designed to minimize transaction costs.  A simple schematic that suggests such a process has been put in the record.  There is enormous opportunity for the USDA and its various programs to provide these services.  Many of the activities could be carried out through existing programs such as the Conservation Reserve Program.  This committee’s support could initialize a process that would minimize transaction costs by fostering recordation as well as least-cost monitoring and verification protocols. 

Parenthetically, this hearing provides us with an opportunity to announce the purchase of 50,000 tons of carbon offsets by Sustainable Forestry Management, a London-based company of which I am a director, from the Confederated Salish and Kootenai Tribes of Montana.  The proceeds from this transaction will be used to reforest land that was decimated by forest fires in 1994.  The trade was facilitated by the Montana Carbon Offset Coalition, which is helping to facilitate participation by farmers and foresters in the emerging carbon markets.  A national registry with uniform verification and monitoring protocols might help trigger other such transactions. 

In conclusion, we strongly encourage the Committee to take an active role in providing assistance to significantly affect the long-term income opportunities for American agriculture and forestry.  There is every reason to believe that their productivity could be used to generate significant environmental services, thereby providing a cleaner and safer future for our country and the world.