Richard Sandor, chairman and C.E.O. of the
Making a market: BP, whose Whiting, Ind., refinery is shown here, participated in the design of the Chicago Climate Exchange but ultimately didn't sign on.
Sandor says that the commodities market is just the place for an environmental revolution.
But of course, green is also
the color of money. And Sandor, who has been called “the father of
financial futures” for his role in creating interest-rate futures in
the 1970’s and who made a fortune during the boom years of the 80’s at
Drexel Burnham Lambert, the firm of the junk-bond king
Not that there’s anything wrong with that. In fact, the trading
of greenhouse gas allowances, also known as carbon trading, may be
capitalism’s best answer to the problem of
Last year, the
For the time being, Sandor’s operation is somewhat more modest.
The exchange, also known as CCX, opened for business in December 2003,
after raising $25 million in a public offering on the Alternative
Investment Market, a part of the
What makes CCX exceptional, despite its small size, is that it’s a private, voluntary endeavor. In
Some analysts, including Sandor, contend that it’s just a matter
of time before the United States adopts some sort of national
emissions-trading scheme. Pressure is building on several fronts:
environmentalists are demanding action on global warming, investment
banks covet the arbitrage opportunities that a carbon market affords
and international corporations seek long-term regulatory certainty. “I
think it’s all but inevitable that a trading program will become the
tool of choice for managing emissions in the U.S.,”
Several players are taking steps to design and implement trading
schemes in the United States. In effect, they are jockeying for what
economists call “first-mover status,” hoping to create the prototype
for what might become a future national carbon market. A group of seven
Eastern states have banded together to create a regional greenhouse gas
initiative, known as R.G.G.I., which is scheduled to begin in 2009. In
the West, a number of states, led by
And then there’s Sandor. No one has done more than he has to get
a carbon market up and running in the United States. The World
Resources Institute, a private environmental research group and an
associate member of the exchange, has given Sandor an endorsement. “The
Chicago Climate Exchange is an important experiment in reducing
greenhouse gas emissions,” the institute’s president, Jonathan Lash,
told me.
But some observers are more wary. Mark Trexler, an industry consultant who is an advocate of emissions trading, told me that in Sandor’s rush to gain a foothold in this growing market, he may be undermining the integrity and effectiveness of the very system he presumes to advocate. It may be true that a market-based system is an indispensable means for combating global warming, but does it follow that an entrepreneur, no matter how well intentioned, can be trusted to design that system for the public good? “My fear is that if we aren’t rigorous enough in how we set up a trading system right now,” Trexler said, “we could end up discrediting trading as a tool to deal with global warming. If we’re not careful, people could get the idea that it’s all a fraud. And that would be a disaster, both for us and for the planet.”
On a recent morning, I visited Sandor in the CCX offices, which are housed in a skyscraper designed by
As we talked in his office, I noticed a green silicone band on
his right wrist. It was similar to the yellow Live Strong wristband
that
“It’s a CCX wristband,” he explained. “I never take it off. Want one?”
He opened a drawer in his desk, took out a wristband in a plastic bag and handed it to me. I opened it and read the slogan on the band: “CCX — To Save the Planet.”
“That’s a big job,” I said, poking fun at the immodesty of the slogan. “You’re serious about this, aren’t you?”
“Very serious,” he said, stone-faced.
Sandor began his career as an academic, teaching economics at the
Sandor’s interest was sparked by the Environmental Protection Agency’s 1990 Acid Rain Program, which sought to reduce sulfur dioxide emissions from coal-burning power plants in the United States. The design of the program was ingenious but simple. Instead of trying to regulate sulfur dioxide emissions the usual way, by dictating a certain kind of emissions-control technology on each power plant, the E.P.A. employed what is known as a cap-and-trade program. The agency set an overall limit, or cap, on the amount of emissions permitted from all power plants combined. Then it allotted a certain number of pollution allowances to each emitter and let the operators of individual plants figure out how they wanted to proceed. A company might install scrubbers or switch to lower sulfur coal in order not to exceed its quota, but if the company determined that polluting beyond its quota was necessary, it could buy additional allowances from companies that had not used up their allotments. Companies that reduced their emissions could bank their credits for later use or sell them for a profit.
Fascinated, Sandor joined the E.P.A.’s Acid Rain Advisory Committee, which was charged with helping to implement the new law. Among other things, Sandor persuaded the E.P.A. to hold the annual auction for sulfur dioxide allowances on the exchange run by his former employer, the Chicago Board of Trade. In the end, the cap-and-trade program reduced pollutants more quickly, and far more cheaply, than anyone anticipated and became the model for market-based environmental success. Best of all, it helped transform the problem of reducing pollution from a moral issue into a pragmatic one.
Not long after the acid-rain program began, Sandor and other
economists began thinking about how to apply the same market-based
strategies to an even bigger problem, with an even bigger potential
market: global warming. Whereas sulfur dioxide is a pollutant emitted
from a measurable number of specific smokestacks, greenhouse gases,
which are commonly measured in metric tons of carbon dioxide
equivalent, are emitted from millions of diverse sources, including
cars, jets, farm animal waste, factories and power plants. And unlike
sulfur dioxide, which is a regional pollutant, greenhouse gases are a
global problem: a metric ton of carbon dioxide emitted in
Despite these critical differences, in principle the same market-based approach could be used. First, set the overall limit of greenhouse gases that countries are collectively permitted to emit, then distribute (or auction off) allowances among various pollution sources within each country and sit back and watch the emitters trade those allowances as their needs and market strategies dictate. There would even be room for speculators to join in the market: if you think next summer is going to be a scorcher, you might buy up allowances on the theory that in hot weather, coal plants often run at maximum capacity to meet the power demand, dumping more carbon dioxide into the atmosphere and thus raising the demand (and the price) for carbon allowances.
A key innovation in the design of carbon markets was the idea of offsets. The basic concept was that polluters could earn emissions credits not only by cutting their own carbon emissions but also by assisting in efforts to reduce emissions from other sources elsewhere in the world: for instance, by paying farmers to reduce the emission of methane, a potent greenhouse gas, from animal waste. Another example of an offset was the so-called natural carbon sink — something like a forest, which absorbs carbon dioxide through photosynthesis. If you increase the absorption of carbon dioxide with plants, you create the same net effect on the atmosphere as cutting emissions from your car — so why not allow polluters to earn credits for, say, investing in reforestation?
The use of offsets also added the possibility for greater
profits and speculation by carbon traders. For instance, if the price
for carbon emissions credits is, say, $15 a metric ton, a company that
can buy or lease land in
Policy makers in the United States were excited by the idea of carbon trading, and during the mid-1990’s, American negotiators pushed hard to make sure the framework for a carbon-trading scheme was included in the Kyoto Protocol. Sandor, for his part, was eager to capitalize on a global carbon market and began dreaming up the idea for an all-electronic exchange for carbon trading. In 2000, with a $450,000 grant from the Joyce Foundation, a private organization with a history of financing environmental initiatives, he enlisted about 100 people — power-industry executives, environmentalists, lawyers — to study the feasibility of establishing a voluntary market in advance of what he assumed would eventually be a mandatory emissions-trading scheme in the United States. In theory, his market would give companies practice measuring and managing their greenhouse gas emissions, preparing them for life in a carbon-constrained world. It would also put him in a position to be the dominant trading platform when the American market opened in earnest.
Sandor’s first challenge was to recruit companies to join the exchange, and his ace in the hole was American Electric Power, or A.E.P. Sandor, it so happened, had joined A.E.P.’s board of directors at about the same time as the design process for CCX was getting under way. Not surprisingly, in 2000, A.E.P. enlisted in CCX and was joined by a number of other blue-chip corporations, including Ford and I.B.M.
In 2001, the Bush administration threw CCX a curve when it
declined to ratify Kyoto. As a result, when CCX opened for business in
2003, it became virtually the only carbon-trading game in town for the
foreseeable future. As with the trading scheme regulated by Kyoto, CCX
brokers trades for credits of the six main greenhouses gases; its
transactions are audited by N.A.S.D., a respected private securities
industry regulator; and it has links to the E.U. E.T.S., where Sandor
also runs an exchange. Unlike Kyoto, however, CCX has no teeth: it is
an entirely private effort. In the first full month of trading on CCX,
credits for about 82,000 metric tons of greenhouse gases swapped hands
at a price of about $1 per metric ton. “It was a little like the
ot everyone
was so upbeat about CCX. When the exchange first began recruiting
companies to join and soliciting environmental groups for endorsements,
several of those groups started to have reservations. The
Despite the claim that industry had a strong influence on the design of CCX, many of the biggest emitters — including companies with solid environmental credentials, like BP, the global oil and gas conglomerate, and Cinergy, the Midwestern electric-power company — declined to sign on. There were a variety of reasons given for this, but one of the most important issues very likely concerned something called the emissions baseline. In any trading scheme, picking a baseline — the point from which emissions increases and reductions are measured — is controversial. In the Kyoto Protocol, for instance, all reductions are measured against a baseline of emissions levels in 1990. For its baseline, CCX decided to use an average of emissions from 1998 to 2001. As it happened, one of the big nuclear plants of A.E.P. was mostly shut down during those years, meaning that A.E.P. had to burn more coal to make up for it, presumably inflating its carbon dioxide emissions. Thus, the choice of an artificially high 1998-2001 baseline was a benefit to A.E.P. (on whose board Sandor sits), since it could more easily remain below it.
Bruce Braine, vice president for strategic policy analysis at A.E.P. and a CCX board member, told me that “the question of establishing baselines is always difficult. No matter how you choose to set them, someone complains that it’s unfair.” But as I was told by one former executive for CCX, who was granted anonymity because the executive was not authorized to discuss CCX’s internal matters, “other big emitters had no interest in joining a program that seemed designed to help A.E.P. look like a good corporate citizen.”
In the three years that CCX has been in operation, criticisms from environmentalists have only grown. This is particularly the case with CCX’s standards for using agricultural offsets, in which carbon is sequestered in farmland soils and then sold for emissions credits. Agricultural offsets are notoriously difficult to measure and quantify, and a less-than-rigorous program is essentially a way of introducing overvalued emissions allowances into the trading system. Advocates of carbon trading like Environmental Defense have worked hard to develop stringent protocols for soil sequestration, while others, like David Doniger, the climate policy director at the Natural Resources Defense Council, remain skeptical of the whole concept. “The problem with these kinds of offsets is that we’ve never found a way to separate the wheat from the chaff,” Doniger told me. “There is a constant tension between quality control and high participation rate. And it’s usually quality that goes in the toilet.”
To check this out for myself, on a rainy afternoon this spring I drove a few hours southwest of Omaha to visit Steve Wiese, a 51-year-old farmer who earns extra money by sequestering carbon on his 2,500-acre farm and selling the carbon allowances on CCX. When I arrived, Wiese was going over some paperwork in his barn. On his desk was a check for $2,008.94. “It just came in the mail the other day,” Wiese said, waving it happily.
Wiese, like hundreds of other farmers who are getting paychecks from carbon emitters by way of CCX, practices a form of cultivation known as no-till. Instead of tearing up the fields each spring and releasing the carbon stored in the soil (mostly in the form of decomposing plant matter and roots), no-till farmers plant right over the previous year’s crop, leaving the soil undisturbed.
“How long have you been no-tilling?” I asked him.
“About 14 years,” he said, leaning back in his chair.
“How long have you been getting paid by CCX?”
“Just signed up last year,” he said.
Here was an instance of a major problem that critics of CCX have raised: Wiese is getting paid for storing carbon in his soil, even though he has done nothing to increase the amount of carbon that is being stored on his land — he’s just doing exactly what he’s been doing for the last 14 years. A polluter like A.E.P. or Ford can use a credit from Wiese’s farm to offset their greenhouse gas emissions, but the fact is, in cases like these the payments from CCX are having no net effect on the level of greenhouse gases in the atmosphere.
And Wiese is hardly alone. Of the half-dozen farmers I spoke to in
Environmentalists have also raised questions about another aspect of CCX: how it calculates emissions reductions. Sandor regularly notes that CCX members reduced carbon emissions by 14 million metric tons in 2003 and 30 million metric tons in 2004. (2005 numbers aren’t available yet.) That is, of course, a good thing. But it’s not clear that CCX should get the credit.
Consider the case of DuPont. Overall, DuPont’s carbon dioxide emissions are down 72 percent since 1990 — an example, according to Edwin Mongan, the director of energy and environment at DuPont, of “what a company can do if it sets its mind to it.” DuPont has beat its CCX baseline by more than 50 percent, cutting emissions by 8 million metric tons more than required. “We’re supportive of CCX because it has given us experience trying out selling, working in a carbon market,” Mongan told me. But he also suggested that being a member of CCX has not, in itself, led to reduced emissions. “I think CCX has been most valuable to us in helping to certify and validate the emissions cuts that we’ve already made,” he said.
The fact that companies like DuPont are reducing their carbon emissions does not mean that the emissions reductions trumpeted by CCX are necessarily unreal. But it may mean that these reductions are mostly the result of good corporate citizenship, not the power or efficiency of Sandor’s market.
Unfortunately, sorting out the real from the unreal is not
always easy with CCX projects. It was precisely this difficulty that
bothered David Littell, the commissioner of
Instead, Littell is now concentrating on the creation of R.G.G.I., the regional greenhouse gas initiative that also involves
If CCX has such troubling flaws, why has it attracted so much support, particularly in corporate America? One explanation, provided by Sandor and others who endorse CCX, is that by joining CCX, companies get valuable experience managing emissions in a functioning market. In addition, of course, there is the public-relations benefit that goes along with being part of an enterprise that is widely viewed as part of the solution, not part of the problem.
But what’s going on here may be more complicated than that, and it has to do with that other shade of green. The logic goes like this: in a few years, if a mandatory carbon-trading system is finally established in the United States, one of the most contentious issues in the design of that system will be how companies that have already made reductions in their emissions will be credited for those reductions — if indeed they are credited at all. In other words, should a company like DuPont or I.B.M., both good corporate citizens that have already made sizable cuts in emissions, be required to reduce greenhouse gas emissions just as much as a competitor who has done nothing? If they do get credit for those early reductions, how might that credit be measured? For DuPont and I.B.M., hundreds of millions of dollars could be at stake in how this question is resolved.
With CCX, Sandor has effectively played this uncertainty to his advantage. The bigger CCX gets, the more cities and states it can get to join, the more likely it will be that carbon credits on the exchange will be viewed as the de facto standard by politicians and others responsible for designing a national system — and the more likely it will be that credits on the exchange, which at the moment are only informally recognized among CCX participants, will be grandfathered into a national system and granted full legal status as property rights. “This is all about business,” one carbon-market veteran told me. “It has nothing to do with the environment.”
To Sandor, these criticisms of CCX are, if not trivial, then at least beside the point. “At a certain level, all this becomes a debate about how many angels can dance on the head of a pin,” he told me. “In the larger scheme of things, they are meaningless. Global warming is an extremely urgent problem. Is CCX perfect? Of course not. Neither was the U.S. Constitution — they forgot the 10 amendments, including freedom of the press and freedom of speech. The important point here is that markets work to solve problems. The sooner we admit that, and the sooner we get around to building those markets, the better.”
Not long ago, at the
If CCX were simply a giant
“Integrity is the linchpin to both public and investor confidence,” the emissions-trading pioneer Dan Dudek told me. “Without integrity, investors won’t commit serious capital either to generate the supply of reductions necessary for trading or to buy the reductions in the first place.”
Sandor doesn’t disagree. “This is just the beginning of a long journey,” he told me as we walked down the
