Getting Started With A Pilot:

The Rationale for A Limited-Scale Voluntary International Greenhouse Gas Emissions Trading Program

  Testimony Presented by

  Dr. Richard L. Sandor
Chairman and Chief Executive Officer
Environmental Financial Products L.L.C.

to the

White House Conference on Climate Change
October 6, 1997

and the

U.S. Senate

Energy and Natural Resources Committee
September 30, 1997

 

In 1991 we began working with United Nations Conference on Trade and Development (UNCTAD) to design an international system of tradable greenhouse gas (GHG) emission allowances as a contribution to the "Rio process" and its search for workable mechanisms to deal with climate change.  At that time, there was little support for the idea.  Some felt that it was premature and should not detract from efforts to introduce more conventional measures such as carbon taxes and new regulations, or from the newly launched effort to gather support for a bilateral offsets program (or "joint implementation").  However, in just a few short years the idea of using tradable permits to combat global warming appears to be gaining widespread acceptance.

Several factors have influenced the evolution of perceptions towards tradable permits. One of the most important is the success of the U.S. sulfur dioxide (SO2) allowance trading program.  Responding to incentives, participants in this program have reduced emissions ahead of schedule and    at a cost far lower than even the most optimistic forecasts.   This major success has piqued the interests of both the environmental and business communities because it reflects the win-win nature of emissions trading.  Pollution is strictly limited and precisely measured, and industry is allowed to be creative in its compliance.

Other less well known resource and emissions trading programs have emerged in the U.S. and elsewhere, including the introduction of new trading schemes in such diverse places as Poland, New Zealand and Chile.  In addition, carbon taxes are often politically infeasible and suffer from having an unpredictable quantitative effect on emissions.  While joint implementation is a movement in the right direction, it is understood to be a step on the path to a clearly defined emissions trading program

With an agreement to reduce GHG emissions potentially emerging from Kyoto, we must now prepare for the challenge of moving from the drawing boards to implementation.  A wealth of lessons is available to us from inventive processes ranging from aircraft to computers to new commodity markets.  The evolutionary development pattern observed for many international treaties and, as well, for cooperative compacts such as European Community, is also pertinent. 

The lessons leave us convinced that the best approach to the realization of a large-scale GHG trading system is to begin with a simple, pilot, limited-scale voluntary program.  National governments that participate voluntarily would agree to enforce a system where their domestic emission sources can reach emission limits jointly by trading with emission sources in other participating countries.  Other governments can choose a more limited “opt-in” by agreeing to monitor emissions and certify emission reductions for industries or individual firms that voluntarily choose to participate in the international pilot. Provisions to add additional participants, gasses, and emission sources and sinks should be included to assure the market’s structured evolution over time.  A coalition of "market leaders" is now being formed consisting of leading governments, energy companies, insurance companies and financial institutions.  The first step is to agree a on plan for the operationalization of the program.

A limited-scale GHG trading program is an essential step on the path to a larger international trading system, so we must to act now.  But pioneers will be needed to face the challenge of innovation.  It is in the interest of the major emission sources to assume the pioneering role.

The search for new innovative mechanisms to finance the post-Rio sustainable development program (Agenda 21) has revealed the remarkable "double dividend" capability of tradable emission permits.  An international trading system can achieve the emissions reduction target at minimum cost, mobilize private capital to protect the environment and provide strong incentives for technological innovation.  As it expands, a trading system has the potential to act as a powerful mechanism for transferring clean energy technologies and financial resources to developing countries.

The Economic Significance of Lower Cost Emission Reductions

The economic benefits of driving down the cost of cutting greenhouse gas emissions are impressive.  We have considered some simple cost scenarios for lowering total U.S. emissions to 10% below 1990 levels starting in year 2000.  Using the latest U.S. numbers, such a cut would require a reduction of 323 million metric tons carbon equivalent (mmtce) to go from projected 2000 level of 1,757 mmtce to 10% below the 1990 level of 1,594 mmtce.

At a reduction cost of US$100 per ton the annual U.S. cost would total $32.3 billion.  On the other hand, consider a US$20 per ton cost, a price in the range of many proposed offset transactions and a level which many analysts believe would generate very large emission reduction quantities.  If a market system succeeds in driving the cost down to US$20 per ton, the annual U.S. cost would total US$6.5 billion.  This total cost figure is less than 0.09% of U.S. national income (1996 GDP), or 1.3% of the 1993 U.S. final energy bill (US$493 billion).  Similar numbers arise for Canada, but costs as a fraction of national income are far lower for Japan and the European Union.  The bottom line is the industrialized world can take very meaningful steps to bring down GHG emissions at a cost that is rather small, provided we use methods that help drive down compliance costs.

Prior to launch of the U.S. sulfur dioxide emissions cap-and-trade program, forecasts put compliance costs in the range from $600 to as high as $1,500 per ton.  The first trades were executed in 1992 at around $300 per ton, and in 1993 the price from the first EPA/Chicago Board of Trade auction was $131 per ton.  In 1996 the auction price drop to $66, and in 1997 the auction price was $107.  To summarize, emissions came down ahead of schedule (in 1995 and 1996 total emissions were more than 34% below allowed levels), and the market tells us that national current per-ton cost of lowering emissions is a small fraction of the original projections.  If a greenhouse gas trading program can bring the same sort of cost-lowering effect, it would move us from facing a potentially significant drag on our economies to one that is for practical purposes economically imperceptible.

How Do We Get Started?

To date we have treated our atmosphere as an unlimited resource, available to all, in unlimited quantities, at no charge.  It is no wonder we have managed to fundamentally alter its chemical composition!  To respectfully treat the atmosphere as the limited resource it truly represents, we must place limits on its consumption, and institute a process for treating it responsibility.  Nobody owns the atmosphere now, so nobody takes account.  Enforcing legal ownership will help usher in an era of responsibility and care.  The zero price now being charged for use of the atmosphere tells us a market is missing and must be introduced. 

The first step in developing the missing GHG market is to define the commodity.  This requires an international agreement among market participants that limits total emissions and delineates the basis for the creation of the property right or commodity.  Other key ingredients needed to implement the market include participants' baseline emission rates, initial allowance allocations and protocols for monitoring emissions and calculating the benefits of emission avoidance or sequestration programs.

The lessons from introduction of new markets tells us the following steps are needed:

 

1.        Clearly define the tradable commodity for greenhouse gas emissions.

2.        Establish a market oversight body.

3.        Establish emission baselines.

4.        Clearly specify allocation and monitoring procedures.

5.        Establish uniform, non-segmented allowances.

6.        Launch an international allowance clearinghouse and registrar.

7.         Employ existing exchange and trading systems.

8.        Use allowance auctions to assist the market.

9.        Develop standardized trade documentation.

10.    Require cooperation among trade forums, including provisions for information sharing and mutual offset.

11.    Use existing expertise to design bookkeeping and accounting systems.

12.    Provide assistance to market forums in emerging economies.

Conclusion

Emissions trading is an environmental and economic winner.  Trading must be near the top of the full menu of policies that will be needed to prevent the costly threat of climate change.  We must act now to exploit this opportunity to make the vital first step in the direction of protecting the environment with firm emission limits achieved through incentives and the creativity of the private sector.  Leaders are needed now to send a clear message that this is the best way forward.  And the skills possessed by innovative private entities and leading government and non-government organizations must be brought to bear on this exciting and promising challenge.

Appendix A: 

Annual Cost to Cut GHG Emission 10% Below 1990, Using Tradable Permits With Assumed Price of $20/Ton of Carbon

 

Required Cut (mmtce)

Total Cost

Percentage of Year 2000 National Income (Nominal GDP)

USA

323

$6.45 billion

0.072%

EU

68

$1.35 billion

0.015%

Japan

43

$0.87 billion

0.014%

Canada

27

$0.54 billion

0.073%

TOTAL

461

$9.22 billion

0.037%

*  Assumes allocation and compliance parameter analogous to the U.S. sulfur dioxide allowance system.  Projections of year 2000 emissions are based on latest available estimates for the U.S. (1,758 million metric tons carbon equivalent) and Canada (166 mmtce).  Projects for Japan (340 mmtce) and the EU (1,083 mmtce) are from FCCC projections.  GDP projections assuming nominal (current price) GDP grows 5% per year from 1993 through 2000.

 

Cost of Offsetting 25% of Carbon Emissions at $20 per Metric Ton Carbon

 

1 Gallon of Gasoline

1 Megawatt Hour U.S. Electricity

Carbon Emissions

5.33 Pounds

436 Pounds

25% Carbon Offset

1.33 Pounds

109 Pounds

Cost to Offset at $20/Mt

$0.012

$0.99

U.S. Retail Price

$1.25

$69.00

% Price Increase

1.0%

1.4%

*  Assumes use of tradable permits system with allocation and compliance parameters analogous to the U.S. sulfur dioxide allowance trading program.

 

Appendix B:  Costa Rican Carbon Emission Offsets

The government of Costa Rica seeks to sell for the first time an asset, termed Certifiable Tradable Offset (CTO), that conveys to the bearer the rights to pre-specified carbon dioxide emission reductions over the next twenty years, in denominations of one thousand metric tons of carbon per year.  The tranche currently available is equal to one million ton-years over 20 years, or 50,000 tons per year.  The asset is priced at $20 per ton-year of carbon captured and is transferable.

The government of Costa Rica has asked Environmental Financial Products LLC. to manage the issuance and marketing of the initial tranches of CTOs.

The carbon dioxide reductions that are conveyed through the CTO come from the Protected Areas Project.  This project will consolidate over half a million hectares (about 1.25 million acres) of land as national parks, regenerate tropical forests, and protect land that is currently at risk of deforestation, thus guaranteeing its preservation in perpetuity.

The World Bank has agreed to underwrite the efforts of Société Générale de Surveillance (SGS), a world leader in inspection, testing and verification, to provide initial and ongoing certification of Costa Rica’s CTOs.

While there is no mandate compelling current sources of carbon emissions to offset their pollution ownership of CTOs provides important benefits to the purchaser.

·           CTO purchasers can tie the carbon offsets to the production of their good or services and thus market them as “carbon neutral.”

·           CTOs allow the purchaser to manage the public’s perception regarding the environment through visible, direct involvement in the most advanced ameliorative action in the world today.

·           Purchasers can demonstrate their support of market solutions to global warming to key U.S. and international policy makers.

·           Naming opportunities may be available for the world’s first “Earth Centre,” an environmental science, education, and tourism facility to be built with proceeds from the sale of CTOs.

·           Eventually CTOs may be one means of complying with regulations limiting greenhouse gas emissions.