FOILING EXPECTATIONS OF BOTH SUPPORTERS AND detractors, the Clinton Administration's proposed electric restructuring legislation offered no new policy on carbon-dioxide emissions, such as a cap-and-trade program similar to that already in place for sulfur dioxide.

But don't breath a sigh of relief. The debate has only begun.

Many observers see the Administration's tactics on CO2 as an obvious attempt to sidestep a highly sensitive political issue. They appear to agree that at some point the Administration must confront CO2 emissions. Any future domestic legislation likely will take the form of a cap-and-trade program, which would cap emissions and set up an allowance trading program as envisioned in the recently drafted Kyoto Protocol.

Congress has indicated that it will not approve the Kyoto Protocol as drafted; the global climate treaty caps U.S. CO2 emissions for the year 2008 at 7 percent less than 1990 levels %n1%n and doesn't include developing countries. Aware of the mood in Congress, President Clinton issued the details of his own domestic plan to meet U.S. obligations under the Kyoto Protocol. He also promised to set up a program to credit companies willing to take early action to cut emissions. %2%n This move further fleshed out the Administration's Global Climate Change Policy announced in late 1997, which included a plan to decrease domestic CO2 emissions through a cap-and-trade program.

For now, some utilities have chosen to ignore the rhetoric and plow ahead with their efforts to address what they feel is inevitable (em a CO2 emissions cap. They're just hoping they'll be rewarded eventually and that any regulation will contain a market-based tool, such as allowance trading. Others have chosen to wait and see. Both options offer their own risks.

Meanwhile, several groups have drawn up proposals on how to implement a CO2 allowance trading program, both domestically and internationally, while others are rubbing their hands together in anticipation of what could be the largest commodity market ever.

What Are the Odds?

According to data from the Energy Information Administration, carbon emissions from energy use should increase about 1.2 percent each year, reaching 1.9 billion metric tons by 2020. Electricity generation accounts for 35 percent of total carbon emissions in the U.S., at about 520 million metric tons in 1996. This share is expected to grow to 38 percent by 2020 (see Figures 1 and 2). Of that figure, coal generation would make up 80 percent; gas-fired plants would account for just below 20 percent.

Environmental groups and other supporters of climate change policy slammed the Administration's proposal for doing little to mitigate utility emissions of CO2, the compound cited as the primary greenhouse gas: %n3%n "This was the single best opportunity the Administration is likely to have to influence greenhouse gas emissions and to show that its commitment goes beyond rhetoric." %n4%n

Observers speculate the Administration backed off from including cap-and-trade provisions for CO2 at the last minute amid rumors of attempts by the EPA to slip Kyoto in "through the back door." %n5%n

"I'm guessing [a CO2 provision] was in there and pulled,"says Linda Schoumacher, Edison Electric Institute spokeswoman. "We had an internal memo from EPA saying that is what they wanted. I mean I'm glad it's not there but by no means do we think it's over with. This is just the starting point for the Administration."

Before release of the plan in late March, Elliot Diringer, representative for the White House Office for Environmental Quality, had confirmed that electricity restructuring legislation discussions did include some talk of a cap-and-trade system for CO2.

Environmental Protection Agency Administrator Carol Browner and Secretary of Energy Federico Peña defended the plan's lack of direct CO2 provisions. Peña claimed the plan would reduce carbon emissions by 25 percent to 40 percent by 2010 through such details as the $3-billion matching fund to finance energy efficiency and the 5.5-percent portfolio standard for renewable energy. %n6%n Asking for any more likely would have killed any chance of legislation.

"[The Administration's plan] will reduce greenhouse gas emissions in cost-effective ways," Browner said at a briefing on the proposal. "This Administration remains firmly committed to reducing greenhouse gas emissions on the timetable set out by the president's climate change strategy. And we will work with Congress to determine the appropriate legislative vehicle¼ including a cap-and-trade program for carbon dioxide. At this point in time, we did not believe that was the appropriate way to proceed."

Meanwhile, the Administration plans to make sure that information on CO2 emissions is readily available. It will ensure that the relevant federal agencies coordinate the data on utility emissions and then provide such data in annual reports to the president, according to the report.

Amber Jones, DOE spokeswoman, would neither confirm nor deny future plans on a cap-and-trade program for CO2, but acknowledged the president's global climate plan includes the idea.

A representative of the Department of State confirmed that several federal agencies (em including EPA and DOE, plus several state governments (em are involved in talks to come up with a plan for a carbon emissions allowance trading program, but it's only at the idea stage. The coalition hopes to have a proposal together in time for the next global climate talks in Bonn, Germany set for June 2-12.

The Ni-Mo/Suncor Deal

Kyoto or no, two North American energy companies took the initiative to create a trading plan for CO2 that the rest of the world might follow. Vice President Al Gore has lauded the idea as proof that such a market is feasible. Others have called it a well-meaning public relations coup. Either way, without an official program identifying exactly what credit will be awarded, utilities are taking a chance by acting now.

In early March, Niagara Mohawk Power Corp. sold 100,000 metric tons of greenhouse gas emission reductions to Suncor Energy with an option for 10 million more tons over the next 10 years. The deal has a potential value of $10 million (Canadian) if Suncor uses all options. Suncor will apply the credits toward its emissions reduction targets under Canada's voluntary Climate Change Challenge Program. Niagara Mohawk will use 70 percent of the proceeds to fund new projects. Both companies hope to receive official recognition for their early efforts.

"We need formal recognition by the governments of both countries before this transaction is likely to proceed any further" and remaining options are used, says Steve Schaefer, Niagara Mohawk Power Corp. spokesman. He says the companies began working on the transaction well before Kyoto.

If CO2 reductions are mandated, most utilities seem to prefer a cap-and-trade program. This type of program would offer an economical way to address environmental problems, Schaefer says. "Part of the goal is to prove [that] emissions reductions could be good for the environment and good financially. Companies will have some freedom to determine how to achieve the [emissions] levels they are pursuing."

Niagara Mohawk hopes that companies like itself that achieved early reductions will be recognized, a sentiment likely shared by other utilities. Some have more work ahead of them than others (see Figure 3).

According to Joe Goffman, senior attorney at the Environmental Defense Fund, a nonprofit organization that oversaw the trade, several other utilities are interested in pursuing similar deals. The transaction was conducted under an allowance trading program EDF put together as a model for future legislation.

But it isn't clear what types of ventures would qualify for credit. Utilities are involved in a variety of projects including carbon sinks, in which trees are planted or old-growth forests maintained to offset power plant emissions. If such activities do qualify, some question whether projects set up in developing nations will count.

At press time, Cantor Fitzgerald Environmental Brokerage Services was poised to close a deal with a U.S. utility for options on 7.5 million tons of CO2 offsets from a portfolio of projects. By including CO2 offsets from a variety of projects across technologies, the utility minimizes its risk of buying into any one project that could later be deemed ineligible, says Carlton Bartels, senior vice president at the company. The company is one of the largest dealing in environmental credits in the U.S. and the official broker under the EPA's Acid Rain Program.

This deal will mark the first CO2 trade Cantor Fitzgerald has conducted. "This could be one of the largest commodity markets in the world," says Bartels.

"It's a market that will blow the doors off every other market that we know of," agrees Josh Margolis, senior vice president at Cantor Fitzgerald.

Trading for a Better Hand

How would a domestic CO2 allowance trading program work? Three major issues arise: (1) who would regulate participants? (2) how to allocate allowances? (3) how to credit projects and early actions?

Several groups have put together or are working on proposals. One is the Center for Clean Air Policy, a consortium of utilities, environmentalists and academics. With partial funding from the EPA, the center has proposed a plan similar that designed by EDF.

"We're really trying to think through all of the design elements of a domestic carbon trading system," says Tim Hardgrave, senior policy analyst at the Center. "There's a presumption¼ that this will look a lot like the [EPA's] Acid Rain Program [for SO2], that you'll regulate at the boiler, but the acid rain model is not necessarily a great model for CO2. A lot of people gravitate to that model because we know how it works."

The Center has focused on one model that would target fuel producers rather than users. Under this model, fuel producers would have to go out and get allowances, he says. Users would see regulation reflected in prices.

This sort of "upstream regulation" would account for more than 80 percent of CO2 emissions since it would include transportation, industrial and residential users, instead of focusing solely on utilities, a tactic mirrored in other proposals (see Figure 2). The goal is to get beyond the utilities and look at all fuel use; all energy-related CO2, not just electricity, Hardgrave says.

An auction system likely would solve the second issue of how to allocate allowances, Hardgrave adds. Yet, for political reasons, such a system is unlikely to get adopted. It's more likely that allowances will be issued based on historic fuel-use records. Based on this usage information, a baseline would be created for a given company; if actual emissions were greater than the allocation, then a company would either have to purchase credits or reduce emissions.

"Our suggestion is, if you can picture this: Take whatever emissions are in 1998 for a company as a whole (em not looking just at a particular facility they want to report, but looking at where they need to be in 2007 (em and draw a line between those two points. If you're below the line, you get a credit. If you're above the line you don't have anything to sell."

Two issues are left to consider in awarding early reduction credits: whether credit should be project-based or budget-based. Project-based crediting would include many early attempts utilities are undertaking. This system could prove an "administrative nightmare" due to the difficulty in tracking offsets and carbon sinks, but would allow utilities greater flexibility in meeting targets. A budget-based system would prove much more limiting, but could provide greater certainty that emissions are actually being offset.

Monitoring sinks, for instance, is a real problem, according to David Harrison Jr., vice president of National Economic Research Associates Inc. "Suppose you give credits for someone planting trees; you don't know whether those trees are really substitutes for trees that would have been planted otherwise," he says.

NERA has put together a proposal for an international trading program. %n7%n

The danger of a CO2 program is if you don't develop an effective program, you run the risk of not creating benefits, Harrison says. For instance, an international program that does not include developing countries will prove neither effective nor cost-effective. "That's why it's so critical to develop some mechanism that will include those countries, if not initially, at least eventually."

According to NERA's report, while developed countries account for nearly half of current carbon emissions, that proportion is likely to change as developing countries, such as China, India and Brazil, progress (see Figure 4).

"These proposals are out there now and the EPA is looking at them, and other things as well," Hardgrave says.

To Bluff or Bid?

It appears likely that future domestic legislation will be linked intrinsically to the ultimate outcome of the Kyoto Protocol, which includes general language concerning an emissions trading program. %n8%n

The Kyoto Protocol calls for joint implementation of projects that reduce CO2 but restricts cooperation (for credit) to the 39 countries named in the appendix to the agreement, Annex I (which includes no developing countries and just a few former Soviet bloc nations). The Kyoto agreement also calls for the creation of a Clean Development Mechanism that would allow developed countries to participate in projects in developing countries that might generate CO2 reduction credits in the future, according to Lawrence Susskind, a professor at the Massachusetts Institute of Technology and an active participant in the Kyoto convention. The protocol will take affect when it is ratified by at least 55 nations representing 55 percent of CO2 emissions.

Participants say more details will be hammered out at the meeting this summer in Bonn; it's a work in progress.

While the official domestic plan remains ephemeral, utilities like PacifiCorp plow ahead toward an as-yet undetermined emissions target. PacifiCorp began developing projects about five years ago to identify the most efficient way to offset emissions, says Bill Edmonds, company public policy manager.

PacifiCorp is working under the premise that the United States eventually will sign the Kyoto Protocol, a position other observers have adopted despite debate over global warming effects and the veracity of carbon reductions. Edmonds acknowledges that by moving early the company is taking a big risk, but it also has the advantage of finding the most cost-effective way of meeting targets.

"Companies have to hedge their bets," says Alden Myer, government relations director for the Union of Concerned Scientists, one of the more vocal supporters of the protocol. There will be a binding treaty on the CO2 problem, he adds without doubt.

"If we wait too many more years¼ it's going to be virtually impossible for the U.S. to get where it's supposed to be under the Kyoto Protocol," says Mark Trexlar, president of Trexlar and Associates a climate change consulting firm.

The U.S. has several years before it needs to make a decision about Kyoto. But by then, it could prove tremendously expensive to meet targets. %n9%n Early experimentation helps to identify cost-effective remedies and could provide companies a much-needed head start. It is also possible the Administration will develop a domestic program before making any decision on the protocol.

"We will undoubtedly have a U.S. trading system," says Carlton Bartels, "that will be harmonious with an international trading system that's developed."

Elizabeth Striano is managing editor of Public Utilities Fortnightly.

1 This figure is about 36 percent below what emissions otherwise would have been based on current levels.

2 Katie McGinty, chairwoman of the Council on Environmental Quality: "The president will want to work in partnership with industry, affording them credit for taking early action to reduce emissions," Press Briefing, Oct. 22, 1997.

3 Other greenhouse gases: methane; nitrous oxide; hydrofluorocarbons; perfluorocarbons; sulfur hexafluoride.

4 The Washington Post, March 26, 1998.

5 Patrice Hill, The Washington Times, March 10, 1998.

6 U.S. DOE, Comprehensive Electric Restructuring Plan, Mar. 25, 1998.

7 NERA, Designing and Implementing an International Gas Trading Program, Aug. 4, 1997.

8 "Any certified emission reductions which a Party acquires from accordance with the provisions of Article 12 shall be added to the Party," Article 3.12, Kyoto Protocol to the United Nations Framework Convention on Climate Change, December 1997. See also, articles 3.10; 3.11; 6; 12 and 17.

9 A White House report estimates if ratified as is, the Kyoto Protocol will increase energy costs $70 to $100 per year per household, assuming an active allowance trading program for CO2 is in place.

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