The scientific consensus, widely reported, is that global warming is proceeding at an alarming pace and that the generation of greenhouse gases, or GHG, through human activity is the main culprit.
Carbon dioxide emissions from burning fossil fuels like coal and oil pose the most serious risk because of the enormous amounts that are spewed into the atmosphere, mostly by the world's industrialized nations. More than 25 billion metric tons of carbon dioxide are emitted globally each year, with the United States alone contributing more than 20 percent of the total.
The Kyoto Protocol, designed as the international community's response to global warming, has been ratified by 163 countries and entered into force in February 2005. Its objective is to curb emissions of carbon dioxide and five other greenhouse gases (methane, nitrous oxide, sulfur hexafluoride, HFCs and PFCs), mainly by imposing binding limits on GHG emissions by the world's industrialized countries. The goal is that by 2012 they will reduce their collective emissions of GHG by 5.2 percent below 1990 levels. Kyoto sets caps for each industrialized country, and those that emit less than their "quota" of GHG will be able to sell emissions credits to others who exceed their limits. Kyoto envisages that to meet the caps set by treaty, the countries involved will establish internal cap-and-trade systems for their own domestic industries. The idea is that market forces inherent in "cap and trade" will drive a reduction in GHG emissions because the most efficient in reducing GHG will be rewarded financially for their efficiency, while the less efficient will have to buy emissions credits to continue polluting. Most industrialized countries have ratified the treaty and accepted its emissions limits -- the only notable holdouts being Australia and the United States.
Why the United States dropped out
Our rejection of Kyoto is due, some say, to the opposition of the U.S. oil and gas industry and its close ties to the Bush administration. The Bush administration asserts, however, that scientific evidence for human activity as the cause of global warming is as yet inconclusive, that the costs of Kyoto to the U.S. economy would outweigh its benefits, that more research is needed to understand global warming and the best ways to counter it, that we should rely more on economic incentives -- principally tax breaks, which would of course add to the deficit -- and use more flexible and voluntary measures to address the problem. The administration also argues that because China and India, among several other rapidly-industrializing countries, are not required to reduce their GHG emissions under Kyoto, industries in those countries would gain an unfair competitive advantage relative to U.S. companies.
Our competitive position
But our keenest competitors in the world economy are not China or India, but Japan and the industrialized countries of Europe. And while the United States sits on the sidelines, Japan has ratified Kyoto -- as have all 25-member states of the European Union, which have forged ahead with caps on GHG and the largest multinational emissions trading system in the world. The European Union Emission Trading Scheme, which began operations in January 2005, has engendered a thriving European market, centered mainly in London, for trading emissions credits. Volume is reported to have hit $10 billion in 2005 and by some estimates may reach $30 billion in 2006.
Cap and trade in the United States
U.S. companies that want to trade GHG emissions credits must for now join the system operated by the Chicago Climate Exchange, or CCX, which has been trading them since 2003. Although joining the system is voluntary, CCX sets binding rules and standards enforceable by contract for its over 120 members, employs independent verification and covers all six greenhouse gases. Members include major corporations such as Ford (NYSE: F) and Motorola (NYSE: MOT); states and municipalities such as New Mexico, Oakland and Chicago; several major universities; and also farmers and the Iowa Farm Bureau. Each CCX participant agrees to reduce its GHG emissions by 1 percent a year, using average output from 1998 to 2001 as a baseline. The aggregate CCX baseline for its participants of 226 million metric tons a year amounts to about 4 percent of annual U.S. emissions of greenhouse gases.
Some states are moving ahead with their own cap-and-trade systems for GHG, most notably the seven Northeastern states (Connecticut, Delaware, Maine, New Hampshire, New Jersey, New York and Vermont) that have signed a regional compact called the Regional Greenhouse Gas Initiative, or RGGI. The RGGI plan calls for implementation of a regional cap-and-trade system by 2009, which in its first stage will apply only to carbon dioxide emissions by electric power generators. The goal is to stabilize these emissions at their current levels over the period 2009 to 2015, followed by a 10 percent reduction in emissions by 2019.
In California, Gov. Schwarzenegger announced last year the goal of cutting our GHG emissions to 2000 levels by 2010, with much greater reductions later on. His proposals include cap-and-trade, among other measures, but there is no telling at this stage whether or not, and in what form, any of the proposals will survive the legislative process.
Global warming presents "hard dollar" risks for individual U.S. companies. Those viewed as environmentally unfriendly risk damage to their reputations and brands. For companies that are heavy GHG emitters, the potential for future regulation at federal, state and local levels introduces uncertainty and a possibly confusing or shifting regulatory environment that would slow corporate decision-making and halt new investments. Companies that postpone action to curb their GHG emissions may suddenly have to recognize new liabilities if stringent caps are placed on emissions in the future, or suddenly incur major increases in capital spending to make production facilities work "cleaner." Companies also face a litigation risk and potential liabilities at some future date, as was the case with asbestos. Moreover, a growing number of institutional and other investors are increasingly aware of the need to factor in environmental risks and liabilities in assessing corporate performance, with all the implications that follow for financial markets and share prices of individual companies.
On the other hand, companies that reduce their emissions in a cap-and-trade system will gain a competitive advantage over companies that do not. And there will be worldwide business opportunities for U.S. companies that can develop new products, methods of production and technologies to reduce GHG emissions in a global economy that may soon be clamoring for them. But European and Japanese companies may already be gaining the competitive edge over U.S. companies in this respect. The longer we wait for a national cap-and-trade system in the United States, the harder and more costly it will be for U.S. companies to catch up.