Devil is in details of carbon cap system

John W. Schoen Senior producer • Profile • E-mail

As the utility industry moves toward an industry-wide solution to limit greenhouse gases, one leading proposal is a so-called “cap and trade” system similar to one already operating in Europe. The idea is simple: Companies that produce emissions below a mandatory cap earn carbon credits — which they can then sell to companies that don’t meet the cap. This rewards those who invest in ways of reducing pollution and penalizing those who don’t.

But while a broad consensus is developing over a plan for a mandatory carbon cap-and-trade system, various players in the industry — from owners of zero-emission nuclear stations to operators of carbon-spewing coal-fired plants – are divided on just how to set the rules of the game.

“One of the inevitable things about the democratic process is that everybody is going to look for their own version of fairness,” said David Yarnold, executive vice president of Environmental Defense.

Among the key questions:

• How will carbon credits be allocated?
• How restrictive should carbon caps be?
• Will there be rewards for early adopters?
• What level of emissions will be grandfathered?
• Should companies be rewarded for investments made years ago?

The utility industry already has experience with a cap-and-trade system to limit emissions of sulfur dioxide and nitrous oxide and control acid rain. Under the program, the Environmental Protection Agency issues allowances that can be traded in accounts set up in an EPA registry.

And U.S. companies already can trade carbon allocations under on the Chicago Climate Exchange, a voluntary carbon cap-and-trade market. But without mandatory caps, monitoring of emissions and clear penalties for exceeding caps, trading there will likely remain limited.

So one of the hardest tasks in creating a mandatory cap-and-trade market will be determining where to set the initial caps — and how tough to enforce them. The first round of a system set up by the European Union was only a partial success because caps were set so high that there was little demand for credits, undercutting their value.

That’s why proposed “escape clauses” — granting companies waivers if they can demonstrate economic hardship — could subvert the U.S. system, said Yarnold.

“The notion of a constantly tightening market for carbon emissions is what creates value (for  carbon credits), which is why the notion of a so-called escape valve won't fly as a real market,” he said.

But clamping down too hard and too quickly also could backfire. Tough restrictions on the dirtiest coal-fired plants, for example, could force power generators to lean more heavily on natural gas-fired plants, squeezing already-stretched supplies and further driving up prices, said Michael Morris, CEO of American Electric Power, one of the biggest operators of coal-fired plants.

“The timeline has to be right, and the reduction targets have to be achievable,” he said. “It will serve no purpose for Congress to ask the utilities of the world to run a three-minute mile because it won’t happen.”

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