Taking pollution to market: America looks to make real climate change progress

The US is preparing to adopt a cap and trade system to limit carbon emissions and hopes to avoid the pitfalls that the EU encountered. Stephen Foley reports

The US has just taken several big steps towards capping carbon emissions and there is optimism that its proposed "cap and trade" scheme might avoid the disastrous debut that afflicted the European scheme earlier this decade.

The country – a Kyoto Treaty refusenik whose previous president, George Bush, declined to sign up to the emissions reductions in that international agreement – looks set to have some real progress to boast of when diplomats assemble to draft a new climate change treaty in Copenhagen at the end of this year.

Some optimists from the environmental lobby are whispering that Barack Obama might by then even have authorised a cap and trade law that commits the US to cut carbon emissions by 17 per cent by 2020.

The powerful House of Representatives energy committee passed a draft bill last week and while that still puts it at the very early stages of the legislative process, the committee is made up of such a diverse bunch of politicians, representing states reliant on a range of different industries that could be affected by cap and trade, that its passage represents the emergence of a remarkable consensus.

Republicans are still largely opposing the measure, calling it "the biggest energy tax in the history of the US", and the green groups Friends of the Earth and Greenpeace have peeled away from their support, expressing disappointment that the targeted reductions are not larger and that there have been too many concessions handed to the owners of coal-fired power plants and other polluters.

But, as Tony Kreindler, a spokesman for the Environmental Defence Fund, a moderate green group, said: "When folks on either end of the spectrum, when groups on the left and on the right, are raising objections, that suggests the bill sits somewhere in the centre, and that is a good place to be if your aim is to enact a law."

So what exactly is being proposed? The principles of the legislation are the same as the emissions trading system set up by the European Union in 2005, namely that by turning carbon emissions into a finite – and ever more scarce – commodity, traded on the financial markets, you set a market price for pollution and therefore create big economic incentives for polluters to offset or slash emissions.

The details of how the initial set of US carbon emissions permits are likely to be allocated differ substantially from the European model. The EU staged a free giveaway of the permits, and because power producers passed on the new notional price of carbon to consumers, that in effect handed polluters a multibillion-euro windfall. Worse, it gradually became clear that the EU had handed out too many permits, sending the carbon price crashing to zero two years ago, and nullifying the hoped-for economic incentive to cut emissions, at least in the first phase of the scheme.

As the EU is picking up the pieces, the US is learning from the mistakes – or trying to. Mr Obama, on the election campaign trail last year, reflected the consensus that permits should be auctioned off, rather than given away, with the proceeds funnelled into schemes to compensate consumers for the cost of higher energy bills and to promote clean energy and energy efficiency.

The purity of that scheme has been sullied somewhat by the grubbiness of the US political process, as polluter industries have thrown themselves into massive lobbying and public relations campaigns aimed at limiting the cost of cap and trade to them. The pragmatic President has not insisted on auctions, and has acquiesced instead in the energy committee's horse-trading, which allocates 85 per cent of the value of carbon credits for free, with only 15 per cent being auctioned. But there is a big difference from the EU.

It is not the polluters, in the main, who are being allocated the free permits. Instead they are being handed out as if they were subsidies for favoured causes, allocated to a rainbow selection of companies and groups and schemes. The coal-fired power generators are getting some free, thanks to their lobbying, so that they are not initially as severely punished for their carbon output as they would be in an auction. There is the whiff of protectionism in the bill, too, since "trade-vulnerable" industries, such as steel, will get free allocations to compensate them for the increased cost of production. The biggest chunk of free credits will be handed to electricity distributors, with regulators instructed to ensure they are passed on to consumers as compensation for the increased cost of electricity. And 5 per cent by value of the credits will be allocated to projects preventing deforestation in the tropical rainforests.

For unfavoured industries not fully covered by these "subsidies", they will have to buy their permits in auctions or on the open market.

Lisa Zelljadt, an analyst at Point Carbon, which researches the emerging carbon market, said: ""The US is learning from Europe. Although the allocation of allowances to power sector emitters is free, those allowances are not being handed out directly to the power plants but rather to local distributors, which are closer to the consumer. Also unlike Europe, whose cap and trade scheme covers only power generators and industrial facilities, the US programme would cover a greater proportion of the economy – including transportation."

Power plants, oil refiners and other fuel producers all fall under the US caps. There is also going to be a "strategic reserve" of credits kept back from the open market for sale to polluters, to make it more difficult for financial speculators to manipulate the market and to prevent the carbon price from swinging too wildly.

The legislation could be on the floor of the House of Representatives by the end of summer, and there is optimism even for the much tougher task of getting it through the Senate.

"The House energy committee has had to bridge a lot of regional divides to this through," said Mr Kreindler, saying that the committee is made up of representatives from coal producer states, oil producer states, and headed by the long-time green campaigner, Henry Waxman of California. "They have produced something that looks to have a high comfort level for getting through the rest of Congress."

Also in its favour is the reaction of high-profile business leaders, whose public comments range from positive down to acquiescent. The Climate Action Partnership, a group of US company chief executives, including from powerhouses such as General Electric, General Motors and the American subsidiaries of British oil giants BP and Shell, has come out in favour, saying Mr Waxman's compromise reflects a lot of what their own coalition has been pressing for.

Some of those same business leaders were in Copenhagen over the weekend to broaden support and add momentum to the process towards a new climate change treaty later this year. About 500 chief executives, business experts and campaigning celebrities said at the conclusion of the three-day World Business Summit on Climate Change that "immediate and substantial" emissions cuts were needed by 2020, followed by cuts of at least 50 per cent of 1990 levels by 2050. They said governments should use the marketplace to set a global price on carbon instead of taxing it – and it looks increasingly likely that the US will be able to say it is signing up to that principle.