Air-Pollution Market's Debut Tests Cap-and-Trade Model for U.S.

By Jim Efstathiou Jr.

Sept. 23 (Bloomberg) -- Ten Northeastern states will open the first U.S. market for trading greenhouse-gas permits this week, a $1.1 billion pilot project whose success may serve as a nationwide model to stem global warming.

The state governments will begin auctioning permits on Sept. 25, supervised by the New York-based Regional Greenhouse Gas Initiative Inc. called ``Reggie.'' Under a 2005 agreement, power plants in the states will be required to buy an allowance for each ton of carbon dioxide they release, and unused permits may be sold in the market as an incentive to trim air pollution, according to documents on the group's Web site.

Reggie's organizers, including New York and New Jersey, will offer more permits than generators are likely to need during the program's first seven years. While that will initially reduce pressure to cut emissions, utilities have said the strategy encouraged them to support the so-called cap-and- trade market by ensuring permit prices begin low.

``They didn't want to stick their necks out too far,'' Louis Redshaw, head of environmental markets for Barclays Plc, said about the organizers in a Sept. 11 interview in New York.

Modeled on rules that reduced the air pollution causing acid rain in the U.S., Reggie's goal is to cut fumes from burning fossil fuels 10 percent by 2019. The other members are Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, Rhode Island and Vermont.

188 Million Tons

During the first three years, states will supply enough permits to release 188 million tons of carbon dioxide a year. That's about 9 percent more than 2007 emissions in the region, according to a Sept. 3 report from the consulting firm Environment Northeast, based in Rockport, Maine. Utilities may buy at auctions, or from third parties in the market, and must hold allowances equal to their emissions.

A market flop for Reggie may damage support in Congress for a U.S. cap-and-trade program, said Don McCloskey, director of environmental strategy for Public Service Enterprise Group Inc., owner of New Jersey's largest utility and based in Newark.

``Success would be that Reggie is implemented and that we're able to transition quickly from Reggie to a national program,'' McCloskey said in an interview Sept. 12 from Newark. ``If it does go awry, it certainly could affect the national program.''

Reggie prices may rise when the pool of allowances available to utilities is gradually reduced, making it more expensive over time to pollute. The number of permits will drop 2.5 percent a year from 2015 through 2018.

Surplus Permits

Giving polluters a surplus at the outset aims to avoid price or supply shocks that could undermine support for emissions markets, Redshaw said.

Permit prices in the U.S., as reflected by early trading in derivatives, have fluctuated between about $4.50 and $7 for a ton of emissions, making the annual supply worth about $1.1 billion using the average price. That compares with about 25.35 euros ($37) for a permit in Europe, manager of the world's biggest greenhouse gas-trading system.

The Sept. 25 auction in the U.S., which releases the first Reggie permits into the market, sets a floor price of $1.86.

``To me, having a modest start is not a failure,'' Judi Greenwald, director of innovative solutions for the Arlington, Virginia-based Pew Center on Global Climate Change, said in a Sept. 12 interview. ``It will actually give comfort to a lot of people that have fears on the other side that you'll go too far, too fast.''

Inaction in Washington led U.S. states to leapfrog federal officials to battle global warming. President George W. Bush, after taking office in 2001, said evidence of mankind's contribution to climate change was not conclusive. Bush now says burning fossil fuels does contribute to climate change.

`Freakish Evolution'

During that time the Northeastern states, along with California, Florida and groups of Western and Midwestern states, have taken steps to limit global-warming gases. Both candidates for president, Democrat Barack Obama, a senator from Illinois, and Republican John McCain, an Arizona senator, said they back a national cap-and-trade program to address climate change by regulating utilities and other industries.

``This is not a freakish or unnatural evolution of public policy development,'' Minnesota Governor Tim Pawlenty said Sept. 17 in Washington. ``The founding fathers and mothers of our country consigned the states to be laboratories of democracy.''

Reggie's cap-and-trade model copies the European Union Emissions Trading System, also for carbon dioxide. Around the world, cap-and-trade ``is emerging as the preferable solution'' to fight climate change, according to Robert Stavins, director of the Harvard Environmental Economics Program in Cambridge, Massachusetts.

Carbon Tax Alternative

``It appears that if not in 2009, then in 2010 or at the least in 2011 we are likely to see a cap-and-trade system in the United States,'' Stavins said at a Sept. 16 conference in Washington.

Critics say cap-and-trade lets polluters avoid real reductions by purchasing more permits. New York City Mayor Michael Bloomberg last week reiterated his preference instead for a tax on carbon emissions to reduce usage of fossil fuels.

``This is the approach nearly every economist prefers, as do I,'' Bloomberg said at a Sept. 18 hearing of the House Ways and Means Committee in Washington.

He added that a cap-and-trade system ``could also be effective.'' Bloomberg is founder and majority owner of Bloomberg News, parent Bloomberg LP.

Large polluters, such as Columbus, Ohio-based American Electric Power Co., the biggest U.S. producer of electricity from coal, favor cap-and-trade because it offers a choice between paying for pollution-control technology or for permits.

To contact the reporter on this story: Jim Efstathiou Jr. in New York at jefstathiou@bloomberg.net.