Selling Smoke

By Nina Sovich

When Dawn Schrepel, an environmental and energy consultant in Washington, wanted to thank her 10 interns for a job well done, she bought each of them an unusual gift--a ton of carbon dioxide. "They were pretty surprised," she says, laughing. "And it took a little explanation." Schrepel, 33, bought the carbon dioxide not in giant tanks but on paper, through Natsource, an energy brokerage based in New York City.

Natsource trades not only standard commodities like coal and natural gas but also a new currency known as greenhouse-gas credits. These credits represent, in effect, the right to emit a certain amount of carbon dioxide, methane or other gases thought to contribute to global warming. Such credits trade in earnest in nations like Britain and Denmark, which have capped emissions from such sources as factories and power plants. And the credits are trading on an experimental basis in the U.S., as industries anticipate the eventual imposition of similar emission limits here.

Natsource arranged for Schrepel to pay a retail price of $17 a ton for carbon dioxide that is part of the natural chemistry of a 1,200-acre patch of Illinois grassland in a nature preserve. In return for part of that payment, the land's owner agreed not to burn, pave over or otherwise release that carbon dioxide. Schrepel wryly explained to her interns that buying the credits would help offset the carbon dioxide they emitted by, among other things, breathing.

Schrepel's gift is but a tiny part of a global greenhouse-gas trading industry that is growing rapidly. Between 1996 and 2002, about $500 million worth of carbon dioxide was traded among companies in the U.S. and Europe. The World Bank's Prototype Carbon Fund, which helps countries preserve forest and reduce CO2 emissions, says the number of greenhouse-gas trades and the volume of gas affected will double this year. Experts predict that the right to emit a ton of carbon dioxide, which costs between $3.50 and $6 if purchased in bulk today, will cost between $7 and $12 by 2005. That would make the global market for greenhouse-gas credits worth well over $3 billion a year.

Two events drive this growth: the expectation that the Kyoto Protocol on Climate Change will go into effect this year and require many countries to reduce carbon dioxide emissions by 2008, and the emergence of government-backed emissions-trading schemes in Britain and Denmark. Despite President George W. Bush's assertion two years ago that Kyoto would wither, 2003 looks to be the year the treaty will come to life. Canada ratified it in December, and if Russia joins this year, as its President has promised, the treaty will have enough support to go into effect. It would not bind the U.S., but it could induce U.S. multinationals to reduce emissions by their plants in signatory countries.

Even in the U.S., there is a growing consensus that greenhouse-gas reductions are inevitable. In January, Senators John McCain of Arizona and Joseph Lieberman of Connecticut introduced legislation that would cap emissions and allow rights trading. Thirteen U.S. companies, including American Electrical Power, Dupont and Ford, have joined the new Chicago Climate Exchange. Members volunteer to reduce carbon dioxide emissions in a system that lets them practice trading greenhouse-gas credits while trying to deflect regulation and public criticism.

Jack Cogen, president of Natsource, couldn't be happier about this trend. Besides trading in energy and emissions credits, Natsource consults with firms that are weighing the idea of operating cleaner. Greenhouse-gas trading and consulting provide only 10% of Natsource's revenue, but the company expects that share to rise to 50% by 2007. "It's a fascinating business opportunity. Can you use market forces to effect environmental and societal goals?" asks Cogen, 46. "Can you put a cost on what was a free resource?"

Cogen thinks you can, and he's not alone. In 1990 the Clean Air Act capped emissions of sulfur dioxide, a major contributor to acid rain, and ordered that they be gradually reduced. The government issued "allowances" to companies and let them trade polluting rights on the open market. A power company that cut its emissions at relatively low cost could sell its leftover emission rights to another utility facing higher costs for pollution control.

Robert Stavins, an economist at Harvard's Kennedy School of Government, estimates that this cap-and-trade system, vs. a system of rigid caps on each firm's emissions, saves U.S. companies about $1 billion a year in compliance expenses. "It's the most cost-effective way to reduce emissions," he says, "and companies have an incentive to cut pollution so they can sell credits." The Environmental Protection Agency estimates that sulfur dioxide emissions have been halved since 1990 and that Americans save $50 billion a year in health and environmental costs associated with acid rain.

Expecting that international support for Kyoto will grow despite U.S. government opposition, companies around the world--including U.S.-based multinationals--want to be prepared. Cogen says today's nascent trading of CO2 credits forces executives to "sit in a room and figure out how to manage, market, verify and account for their emissions. We call it learning by doing."

Some U.S. companies are not just experimenting; they are buying carbon dioxide credits today, at relatively low prices, as insurance against future regulations. World wholesale prices of carbon dioxide credits have jumped more than 600% since 1996, but prices differ from country to country. Kyoto allows credit trading only among signatory countries, and when it became clear in 2001 that the U.S. would not adopt Kyoto in the first round, the price of U.S. credits fell.

Michael Intrator, a managing director at Natsource, believes that the U.S. should have led the way. "America had a massive information advantage," he says. "We understood how cap-and-trade worked because we traded sulfur dioxide. Now we are left in a sea of uncertainty because we didn't ratify Kyoto. The overarching belief is that sometime we will. But by then, we might be at a competitive disadvantage."

Melissa Carey, a climate-change analyst at the Environmental Defense Fund, says that despite all the greenhouse-gas trading under way, it won't reduce emissions until Kyoto takes effect. "Sulfur dioxide was successful," she says, "because there are huge penalties for failing to comply." One Kyoto provision lets industrialized countries fund carbon-reduction projects in developing countries that do not have emission caps. For example, a U.S. utility may find that cutting its emissions is more expensive than planting a carbon-trapping forest in Bolivia. But until Kyoto is ratified, there won't be any independent verification that the forest has been planted.

Another obstacle to wider trading of emissions is nature. Forests burn down. Hurricanes wash away fields. Then there are governments that ignore international agreements and change environmental policies in ways that can radically affect the value of existing emissions credits. Until financial instruments are developed to ensure credits against the ravages of politics and nature, trading greenhouse gases will be a risky business. But the traders at Natsource are betting that multinational firms are also learning about the risks of doing nothing in the face of regulations that they know are coming, sooner or later.