A Price Tag on Carbon as a Climate Rescue Plan

By JUSTIN GILLISMAY 30, 2014

KEWAUNEE, Wis. — Bryan T. Pagel, a dairy farmer, watched as a glistening slurry of cow manure disappeared down a culvert. If recycling the waste on his family’s farm would help to save the world, he was happy to go along.

Out back, machinery was breaking down the manure and capturing a byproduct called methane, a potent greenhouse gas. A huge Caterpillar engine roared as it burned the methane to generate electricity, keeping it out of the atmosphere.

The $3.2 million system also reduces odors at Pagel’s Ponderosa Dairy, one of the largest in Wisconsin, but it would not have been built without a surprising source of funds: a California initiative that is investing in carefully chosen projects, even ones far beyond its borders, to reduce emissions as part of the battle against climate change.

“When they came out here and told us they were willing to send us checks, we were thrilled,” Mr. Pagel said.

California’s program is the latest incarnation of an increasingly popular — and much debated — mechanism that has emerged as one of the primary weapons against global warming. From China to Norway, Kazakhstan to the Northeastern United States, governments are requiring industries to buy permits allowing them to emit set levels of greenhouse gases. Under these plans, the allowable levels of pollution are steadily reduced and the cost of permits rises, creating an economic incentive for companies to cut emissions.

The Big Fix

This is the first in a series of articles examining potential solutions to climate change.

The system encourages companies to find the least expensive ways to make the cuts, either by adopting cleaner energy technology or by investing in outside emission-control projects, like the Pagels’ methane digester.

Congress rejected a national plan of this type during President Obama’s first term, but 10 states, including most of those in the Northeast and mid-Atlantic, have developed their own programs. And the approach is expected to get a huge lift on Monday when Mr. Obama unveils a long-awaited national plan requiring states to lower their power plant emissions. One likely effect will be to encourage more states to adopt systems like California’s.

Already, the approach is spreading worldwide, with the number of people living in places that have such a system nearing one billion, or 14 percent of the world’s population, including about 80 million Americans.

“The point now is to say, look, this can work, it can be scaled, and please join,” said Frank A. Wolak, an economist at Stanford University.

Yet in the decade it has been used to tackle global warming, this approach has had a turbulent history. The world’s largest such system, in Europe, has had severe problems, including gyrations in the prices that polluters have to pay. Given a lack of evidence that the system can actually solve the emissions problem, some environmental groups and scientists have developed serious reservations.

“The reason I don’t support what we’re doing is not that I don’t think something needs to be done,” said Myles R. Allen, a leading British climate scientist at Oxford University. “I just don’t think it’s effective, and I don’t see it ever being effective.”

Drought-plagued California, which Gov. Jerry Brown recently called the “epicenter” of climate change, hopes to prove that capitalism can work in the fight against global warming. The state took great care in setting up its system, which is now being seen as a global test case.

Eighteen months into the venture, it is still too soon to tell how well it will work. But the state has so far managed to avoid some of the mistakes that have plagued efforts in other parts of the world. Hundreds of industrial facilities have been brought under the plan, prompting those businesses to study how to use less energy, and fuel suppliers will be pulled into it next year.

By the end of the decade, the state is expected to collect about $5 billion a year in permit fees, with the bulk of the money being recycled into clean-energy projects.

Worldwide, other approaches to global warming are also being considered. A more ambitious push could be made on renewable energy, like solar and wind. Power companies might be ordered to capture their carbon emissions and bury them underground. Forests could be preserved or allowed to regrow to absorb more carbon dioxide from the air.

But all those methods have drawbacks, and interviews by The New York Times with more than 80 experts in nine countries revealed sharp disagreements about which to embrace.

How a Carbon Market Works

Governments around the world are experimenting with issuing permits that allow industries to emit carbon dioxide and other greenhouse gases, then restricting those permits to rein in carbon emissions.

Experts say that limiting the effects of the human-induced warming will almost certainly cost trillions of dollars over generations and require an unprecedented level of cooperation across states and nations — if it can be done at all.

“How do we deal, as a global civilization, with a problem that is decades in the making and is caused by everything we do?” asked Peter Miller, a senior scientist with the Natural Resources Defense Council in San Francisco. “It’s the challenge of our time, and there is no road map.”

Drought, Rain and Fire

The Intergovernmental Panel on Climate Change, a body of scientists and other experts appointed by the United Nations, found last year that total emissions of carbon into the atmosphere must be kept below one trillion tons if global warming is to be held to tolerable levels. More than half that amount has been emitted since the beginning of the industrial era, and at the rate emissions are going up, the limit will be reached in 30 years or less.

Already, the effects are being felt far and wide. A recent report, the National Climate Assessment, found that every corner of the United States was being hit hard, with more droughts in some regions, more torrential rains in others, worsening forest fires, melting land ice, and the deaths of millions of acres of trees from heat-loving insects.

This month, the global stakes were made clear yet again when researchers reported that ice sheets in the western section of Antarctica had begun an irreversible breakup that could ultimately raise the level of the sea by 10 feet or more.

“Climate change, once considered an issue for a distant future, has moved firmly into the present,” the National Climate Assessment said.

Some environmental groups have contended that the best way to combat climate change would be for governments to impose tight regulations on businesses that produce greenhouse gases.

Economists have argued, instead, that governments should put a price on emissions. The simplest way to do that would be a tax — the same sort of sin tax applied to liquor and cigarettes, albeit on a vastly larger scale.

In the 1960s, economists in Canada and the United States developed an alternative concept: a market in pollution rights, which they believed would allow companies to decide for themselves how to limit their emissions at the lowest cost.

That approach got its first major tryout in 1990 when the administration of George Bush embraced it to battle acid rain, persuading reluctant congressional Democrats to go along. It reduced emissions of sulfur dioxide far more cheaply than expected, and it was seen as a triumph of conservative thinking about the environment.

Grates are the first step in capturing cow manure to remove methane, a greenhouse gas, and use it generate electricity, keeping the gas out of the air. Credit Sally Ryan for The New York Times

The strategy, called cap and trade, is now being applied to greenhouse gases. Governments impose a limit, or cap, on the amount of the gases that can be spewed into the atmosphere by polluters like power plants and refiners. It then issues permits, often called carbon allowances, equal to the level of the cap, with each permit representing a ton of emissions.

The government requires industries to acquire enough permits to equal their emissions. Companies that need permits buy them, either from the government or on a commodity market, with the value set by supply and demand. Over time, the government reduces the cap and the number of permits, driving up their value.

The system is intended to ensure that polluters reduce their emissions, but do it in a way that makes the most financial sense. A company might spend money to upgrade to more efficient equipment, for instance, if that is less expensive than buying permits at the market price at that time. The sale of permits also creates a flow of funds to reduce emissions in economic sectors not covered by the permit system, such as farming or forestry.

Over the past decade, carbon allowances have become the world’s newest commodity. Thousands of people — in small offices in San Francisco, on trading floors in Houston, at power stations all over Europe — now buy and sell the permits every day. They are not all representing polluters; some are simply speculators placing bets on what will happen to carbon prices over time. Thomson Reuters Point Carbon, a research firm, expects permits representing more than nine billion tons of emissions to trade hands this year, with a transaction value of nearly $90 billion.

Yet a few of these government-created markets have been seriously flawed, and some experts argue that time is being wasted on an effort that could, ultimately, fall short.

Problems in Europe

While the United States has been embroiled in a political argument over the past decade about whether climate change is even real, the European Union has largely embraced the science and moved forward. The European Emissions Trading System, which went into operation in 2005, has proved that a market in pollution permits can be made to work across barriers of language and national interest. Yet the European Union has also come to be seen as a case study in what can go wrong if such a system is not set up carefully.

Early on, instead of scrutinizing data on emissions, European regulators trusted companies to tell them how much greenhouse gas they were emitting. Since those numbers would be used in setting the initial emissions cap, the companies had an obvious incentive to exaggerate. When it finally became clear in 2006 that they had done so, and emissions were actually lower than traders had been led to believe, permits suddenly became less valuable and their price crashed in a matter of hours.

Then, just as Europe was tightening its rules, the global financial crisis hit in 2008 and 2009. “You produced less electricity, less steel, less toilet paper — less of everything that was included in the system,” said Stig Schjolset, chief carbon markets analyst with Thomson Reuters Point Carbon in Oslo.

The European Union had put no mechanism in place to respond to these changing economic conditions, so governments kept cranking out carbon permits even as the decline in output meant that fewer were needed. Carbon prices tanked yet again.

Recently the European Union adopted changes that have firmed up prices somewhat. But at just over $7 per ton of carbon dioxide, they are still far below their peak, and below the $30 level that many analysts believe is needed to spur investment in cleaner energy sources.

Liquid is removed from the manure and the remaining material is cleaned of bacteria. Credit Sally Ryan for The New York Times

Moreover, the Europeans have yet to agree on long-term emission targets that would drive up carbon prices and reward investors in clean energy, though proposals are under discussion. “Through the 2020s, there is no clear signal about how the cap will tighten,” said Adrian Gault, chief economist with Britain’s national Committee on Climate Change, which advises the government on the problem.

Europe’s broader goals have by no means been a complete failure. The European Union set a target of lowering emissions 20 percent by 2020, and that appears likely to be met — but several studies suggest that is less a result of the carbon market than of economic weakness, as well as subsidies for renewable power. Many experts in Europe fear that later, more ambitious goals will prove unattainable if companies have too little incentive to invest in clean technology. The experts believe emissions throughout the developed world need to fall 80 percent or more by 2050.

“Even if we’re fine to meet the emissions target for 2020, it will be very challenging to meet Europe’s long-term targets,” Mr. Schjolset said. “For that, you need a higher carbon price now.”

California as Pioneer

Mary Nichols cut her teeth as a young lawyer by successfully suing the California state government for violating the federal Clean Air Act. She has long since become an insider, running the most powerful state environmental agency in the country, California’s Air Resources Board.

Ms. Nichols — chosen by a Republican governor and kept on by the Democrat who succeeded him — said that when her agency set out to create a carbon market, her European counterparts were candid in advising the state how not to repeat their mistakes. “It was an act of great generosity on their part,” she said.

California’s Global Warming Solutions Act, signed in 2006 by Gov. Arnold Schwarzenegger, set a goal of lowering California’s greenhouse gases in 2020 to the 1990 level, a cut of 28 percent from the level they had been expected to reach in 2020 without the law.

Even after it was signed, the law was the subject of political and legal battles, with oil companies and other polluters fighting to overturn it. When voters were asked whether they wanted the state to tackle global warming in 2010, they voted 62 percent to 38 percent to move forward with the law, which requires more efficient cars, more renewable power on the state’s electric grid and many other steps. A centerpiece was a provision capping emissions from big polluters, including power generators and gasoline refiners, and setting up a permit-trading system.

California spent several years developing regulations, then began its cap-and-trade system in 2013. The project is taking hold gradually. California adopted rules shielding companies vulnerable to out-of-state competition, as well as residential electricity customers, from the full impact of the costs. In the early days, it is giving away many of the required carbon permits for free to ease companies into the system.

Nonetheless, at just over $11 a ton, the carbon price in California is now the highest in any cap-and-trade market, 60 percent above the price in Europe.

In setting up the market, California took measures to prevent the wild price gyrations seen in Europe. The state spent years getting accurate emissions data, for instance. And it established de facto floor and ceiling prices for its permits. The price so far has been highly predictable, trading in a range from $11 to $14 a ton.

A Caterpillar engine roars as it burns the methane to generate electricity. Credit Sally Ryan for The New York Times

As part of its plan, the state decided to allow emission-lowering projects in sectors not covered by the cap-and-trade system, such as forestry and farming. These “offset projects,” which can be located anywhere in the United States, are subject to strict auditing. The projects create credits that can be sold in the California market.

New companies have sprung up to serve as middlemen, helping farmers, forest owners and others set up eligible offset projects. One of those companies, TerraPass of San Francisco, matched the Pagel dairy farm in Wisconsin with California’s money.

John T. Pagel, the owner, said that he had thought for several years about installing a system to reduce odors and capture methane emissions from the manure of thousands of cows. But he could not figure out how to make the economics work. “It’s the right thing to do, but it has to support itself, too,” Mr. Pagel said.

Then he met a TerraPass representative at an agricultural fair several years ago and learned he could receive payments totaling tens of thousands of dollars a year.

On a tour of his farm near Kewaunee, Mr. Pagel proudly showed off the gear. A 20-cylinder Caterpillar engine, powered by methane from cow manure, throbbed in a large building behind his barns. As it turned a generator, it was pumping enough renewable power into the local electric grid to supply about 1,200 homes.

“I love that thing!” Mr. Pagel said.

One of his sons, Bryan, described meticulous oversight from California, including instruments that send a stream of data back to TerraPass headquarters to verify that the system is working properly. Otherwise, said Peter Freed, a former TerraPass employee who helped set up the deal, the state might disallow the carbon credits. “The California system doesn’t have a real tolerance for error,” he said.

Still, it will not be clear for years how successful the state’s carbon market has been in lowering emissions, or in spurring investment in clean energy. In the meantime, the Obama administration must decide how hard to push other states toward copying California’s program.

“What’s good for California, and what others will ultimately look to, is success,” said Richard Corey, chief executive of the Air Resources Board. “The ultimate test of success is going to be: Did it work?”

Questioning Cap and Trade

Some environmental groups and academics have never reconciled themselves to the idea of a market in pollution rights, and Europe’s problems have heightened their doubts. So far, they point out, global emissions are still rising.

A trading floor in London where carbon permits are bought and sold, part of an attempted market solution to reining in global warming. Credit Andrew Testa for The International Herald Tribune

“I would throw the markets out and start over with something different,” said Doreen Stabinsky, a professor of global environmental politics at the College of the Atlantic in Bar Harbor, Me. “I think we can’t be sidetracked by playing around with a market, because this objective is so important, so pressing and so difficult.”

Economists and analysts who support cap and trade say they are confident the problems can be worked out, and they believe California is in the process of proving it. The key issue now, they say, is whether governments that adopt these systems will tighten the emissions caps, driving up carbon prices — and do it soon enough to make a real dent in global warming.

A second carbon market operating in the United States shows that the gradual lowering of emissions targets can have an impact. That system, known as the Regional Greenhouse Gas Initiative, started with far more modest goals than California’s, covering a smaller segment of the economy, and for much of its history carbon prices were below $2 a ton.

But the system has worked smoothly for several years, generating $1.7 billion that nine state governments in the Northeast have used largely to support clean-energy projects. Those investments, as well as utilities’ switch to cleaner natural gas, have sharply reduced carbon emissions in the region.

Recently, the nine states decided to cut their emissions cap by 45 percent and to let carbon prices rise. They have nearly doubled, to $4 a ton, and the revisions are expected to spur still more clean-energy investment.

Some experts believe that in the long run, carbon markets will make a substantial contribution only if they can be tied together across political boundaries. That would allow polluters to search the world for the cheapest ways of cutting emissions.

To a limited extent, such networking has already begun. Europe has allowed billions to flow abroad to developing countries, underwriting projects that have, for example, helped poor families switch to more efficient coal-burning stoves. California and Quebec have tied their markets together, and trading between them began early this year.

The world’s biggest carbon polluter, China, has begun experimenting with markets in seven cities and provinces, with a view toward forming a national carbon market this decade. Both California and Europe are tentatively speaking to the Chinese about future linkages.

As such developments take hold, the once unthinkable has begun to seem plausible, if by no means inevitable: a linked global carbon price high enough to accelerate the transition to a low-carbon economy.

“We might be witnessing the birth of a new system, without quite realizing it,” said Glen P. Peters, a climate researcher at the Center for International Climate and Environmental Research in Oslo. “When you think of all these bottom-up initiatives around the world, maybe we are living through the transformation right now.”

Experts who support cap and trade contend that a market mechanism can reach more deeply into the economy than any other approach, changing the behavior even of people and companies that might not necessarily care about global warming.

The Wisconsin dairymen perhaps serve as an example of that.

Even as the methane-powered generator roared on his property, John T. Pagel said he was not convinced that the climatic changes happening in the United States were a result of human emissions. He suspects they might be part of a natural cycle. But with Californians dangling cash in exchange for his willingness to cut emissions, he jumped at the chance to build his digester.

“We are doing exactly what they asked us to do to get paid to reduce carbon,” Mr. Pagel said. “If somebody else believes in it enough to put up the money, that’s all I need to know.”

Reporting was contributed by Mark Scott from London, Keith Bradsher and Chris Buckley from Hong Kong, and Felicity Barringer from San Francisco.

As the Climate Changes, So Does the Language
Climate change has created its own vocabulary of concepts and institutions. Here are a few of the terms that often come up in discussions of the problem and its proposed solutions.
Carbon market: A financial market where government-issued permits that regulate greenhouse-gas emissions are traded as a commodity.
Cap and trade: A government-created system to restrict emissions by imposing a limit, or cap, on the amount of pollution that can be spewed into the atmosphere by certain industries. The government issues permits or carbon allowances to industries for the amount of greenhouse gases they are allowed to emit, then gradually reduces the cap and the number of permits, providing a financial incentive for those companies to pollute less. Companies that need fewer permits can trade with those that need more permits on a financial commodities market, with the price driven by supply and demand. The higher the price of the permits, the greater the incentive to reduce emissions.
Greenhouse gas: A type of pollutant that scientists say contributes to global warming. The primary pollutant is carbon dioxide, but there is also methane, nitrous oxide and many refrigerants.
Carbon allowances: Government-issued permits to industries that allow them to pollute up to a certain limit.
Carbon offsets: Projects that lower carbon emissions in nonregulated industries, such as forestry or farming. These projects produce “offset credits” that can be traded on the carbon market and used by polluters to comply with emissions limits. Governments usually set limits on how many of these types of credits polluters can use.
Carbon price: The cost to industries or companies for each ton of greenhouse gas that is emitted in a given period. The cost can be established directly by the government, in the form of a tax or a set price for permits, or indirectly through carbon markets, where permits are traded freely and supply and demand sets the price.
Carbon pricing: A system that requires polluters to pay for their carbon emissions.
Pollution rights: Permission given by a government to an industry or company to pollute up to a certain controlled level. Such a system leaves it up to the company or industry to figure out the best way to stay within the limit.
Emissions Trading System: A financial market created by the European Union to trade the carbon allowances issued to industries to control carbon emissions. The system has been in effect since 2005 and covers about 11,000 power plants, industrial facilities and airlines in 31 countries.
Intergovernmental Panel on Climate Change: A body of scientists and other experts appointed by the United Nations to periodically assess and issue reports about the status and impact of climate change on the planet.
National Climate Assessment: A report issued periodically by the federal government and prepared by a panel of scientists and other experts, including representatives of fossil-fuel companies, to assess the status and impact of climate change on the United States.
Regional Greenhouse Gas Initiative: A cap-and-trade system limiting emissions in nine states in the Northeast and mid-Atlantic regions. The system has raised $1.7 billion for the governments, which have mostly put the money back into clean-energy projects.

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