From yesterday's Washington Post.  Please see highlighted section on OPG.  

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Trading Futures in Dirty Air 
Here's a Market-Based Way to Fight Global Warming 
By Ricardo Bayon

Sunday, August 5, 2001; Page B02 
Gary Payne and Jeremy Taylor are two Wall Street types who work for trading companies in, respectively, Kansas City and Houston. Their daily routine is familiar to speculative traders everywhere: They wake up early to get a jump on the markets, read the industry papers, take a look at their companies' trading portfolios, and log onto their Bloomberg terminals to see who's buying and who's selling. But they do not trade in stocks, bonds, currencies or even pork bellies. Instead, what Payne and Taylor trade is the right to pollute -- specifically, the government-given right to emit sulfur dioxide (SO2) and nitrogen oxides, the two gases chiefly responsible for acid rain.
In a classic example of doing well by doing good, successful traders such as Payne and Taylor buy pollution credits low, sell them high and make money -- all the while playing an integral role in a system that has reduced annual emissions of SO2 by U.S. utilities by 29 percent since 1990. Their experience offers a valuable lesson for U.S. policy makers seeking solutions to the problem of global climate change. The sulfur dioxide market provides a business-friendly, market-oriented, cost-effective model for reducing emissions of carbon dioxide, the gas generally considered to be the main culprit behind global warming. 
The market is based on the same theory as the country-to-country emissions trading program envisioned in the Kyoto Protocol signed by 178 countries and rejected by President Bush. But the president should not be put off by this. Pollution-credit trading is an inherently capitalist approach to the global warming problem that can be set up nationally (or regionally, with Canada and Mexico) and can be tailored to U.S. needs. 
Perhaps the administration needs to be reminded of the successes of the SO2 program. It was created to combat acid rain, one of the major environmental issues of the 1980s. Acid rain is caused when sulfur dioxide and nitrogen oxides are emitted into the atmosphere, mostly by power generators. In 1990, Congress amended the Clean Air Act to set national targets for emissions of those gases; it then instructed the Environmental Protection Agency (EPA) to allocate the rights to these limited emissions among major U.S. utilities, and to create a mechanism for the utilities to buy and sell those rights. Note that the government did not tell utilities how to reduce their emissions of SO2. It merely set targets and let the market determine how best to achieve this goal. So, under the EPA plan, a power plant that was emitting too much sulfur dioxide had several options: It could install less polluting technology, it could switch its fuel from coal to natural gas (which produces less SO2), or it could purchase excess emission credits from another utility. A utility that upgraded its technology or switched fuels might even cover some of the costs by selling emission credits it no longer needed.
Trading in sulfur dioxide rights got fully underway in 1995 (and in nitrogen oxides some years later). Today, the right to emit SO2 sells for around $200 a ton and is sold in lots of 2,500 tons, which means it is available to anyone with half a million dollars to spare. The big buyers and sellers are utilities and energy companies, but there are exceptions. The venerable Wall Street brokerage firm Cantor Fitzgerald once helped a wealthy benefactor purchase the right to emit one ton of SO2 as a wedding present for a pair of environmentalists; and it brokered a deal for an environmental group that wanted to give its retirees emission rights instead of gold watches. 
Taylor, who tracks the market closely, says that in the past year about $668 million worth of SO2 credits changed hands. He points out, however, that if the trading in SO2 options and futures is included, the total market is several times that size. "You can buy SO2 puts, calls, straddles, call spreads, whatever you need," he says. 
And this robust and liquid market is not just profitable; it also has been remarkably effective at controlling acid rain. According to the EPA, which tracks the emissions of 263 of the largest power plants in the country, they emitted 8.7 million tons of SO2 in 1990, when Congress first mandated a cap. That figure dropped to 7.4 million tons by 1994. But in 1995, when trading in SO2 credits began, emissions plummeted to 4.5 million tons, even though power generation continued to increase. In the Northeast and Mid-Atlantic regions of the United States, where acid rain and lake acidification were particularly problematic, acid rain levels declined by 25 percent between 1995 and 1999. 
The cost to businesses of this environmental benefit was barely more than a tenth of what had originally been predicted. Before Congress mandated the sulfur dioxide cap, the Edison Electric Institute estimated that it would cost $7.4 billion a year for industry to meet its targets; over the ensuing decade, successive studies by a variety of groups have shown that the real figure is likely to be closer to $870 million a year. 
In other words, the SO2 market is doing what markets do best: It has wrung inefficiencies out of the system and allocated scarce resources (in this case, pollution rights) very cost-effectively. 
Markets can do the same thing for carbon dioxide. But this will require of President Bush and Congress at least one act of political courage: They will need to cap CO2 emissions. Bush pledged to do so during his 2000 campaign, but later reversed his stance. Now he would have to reverse the reversal -- but he can find inspiration in his father, the first President Bush, whose administration launched the successful SO2 trading program.
Besides, the gesture might not be as difficult as it looks -- because when it comes to greenhouse gases, business is way ahead of government. A quiet "gray market" already exists in carbon dioxide. Individual companies, expecting some kind of government regulation in the not-too-distant future, have been buying and selling CO2 credits for more than three years. 
"If you are a large power company spending millions of dollars building plants that you expect to operate for 20 or 30 years," says CO2 trader Carlton Bartels, "you are not happy when government comes along and tells you not to worry about global warming, at least not for the next four years. That doesn't decrease the risks your company faces as a result of climate change. It may actually increase them." 
Bartels is chief executive officer of CO2e.com, a carbon dioxide trading firm that was spun off from Cantor Fitzgerald six months ago. The new company helps businesses prepare for what Bartels calls the inevitable "carbon-constrained" future -- when public pressure will force governments to regulate emissions of the gases that cause climate change. 
In the meantime, CO2e.com is busy arranging trades for companies that want to stay ahead of the curve. For example,Houston-based Petro Source Carbon Co. has constructed a pipeline that takes the carbon dioxide produced by four U.S. power plants and pumps it into new oil wells in west Texas, where it enhances oil recovery. Since the CO2 it uses would otherwise be vented into the atmosphere, Petro Source figures it will have carbon credits to spare if and when the United States puts a cap on CO2 emissions. Meanwhile, Ontario Power Generation of Toronto, whose plants emit carbon dioxide, expects Canada to institute a similar cap. In a deal brokered by CO2e.com, Ontario Power recently bought 1.3 million tons of Petro Source's credits. Both parties expect their governments to honor the deal in the future. 
Bartels estimates that in its short lifetime, CO2e.com has been involved in trades for the equivalent of 3.5 million tons of CO2 emissions rights, each ton selling for between $1 and $5a ton. (A ton of carbon dioxide is much cheaper than a ton of sulfur dioxide, in part, because trade in CO2 is still highly speculative. If governments institute CO2 emissions caps, these prices should skyrocket.) Even before CO2e.com was created, he said, Cantor Fitzgerald helped move between 20 million and 30 million tons of CO2 emissions rights.
By the end of this decade, Bartels believes that the CO2 market could be worth tens of billions of dollars. "Given the amount of global emissions," he says, "this could become the largest commodity market in the world." 
As President Bush seeks a coherent policy on climate change, he would do well to realize that Wall Street, power companies and emissions traders have for years been sitting on an elegant -- not to mention profitable -- solution to his problems. The 1980s may have taught us that greed is not always good, but the decade to come is likely to show that it can sometimes be green.
Ricardo Bayon is a fellow of the New America Foundation, a nonpartisan think tank based in Washington.
? 2001 The Washington Post Company 


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