Shop Talk: Environmental Markets

The decade-old global trade in pollution credits, poised to skyrocket in the near future, began as an idea that didn't please either side of the debate over environment and development.

When the first emissions market opened in Chicago in 1993, some utilities complained that government was imposing too heavy a burden on their industry and hurting consumers.

Environmentalists, on the other hand, considered emissions trading a loophole that would enable business to continue polluting.

As it turned out, they were both wrong.

The Chicago Board of Trade began emissions trading with credits for sulfur dioxide (SO2), the gas largely responsible for acid rain. According to a year-2000 report by the Environmental Protection Agency, emissions of SO2 by the largest power plants in the US went from 8.7 million tons in 1990 (when the US Congress first mandated a cap), to 7.4 million tons in 1994, and to 4.5 million tons in 1995. Acid-rain levels in the Northeast and Mid-Atlantic regions of the US -- where the problem was most severe -- have declined by 25 percent between 1995 and 1999.

The markets have also turned out to be relatively inexpensive. When SO2 standards were first proposed, the electric utilities, through the Edison Electric Institute, estimated that it would cost the US about $7.4 billion a year to meet these new SO2 targets. More recent studies have shown that the real cost is likely to be closer to $870 million a year, almost a tenth of what was originally predicted. These investments are estimated to have saved Americans about $50 billion a year in pollution-related health care costs.

SO2 trading is now conducted all over the world. In the US, companies trade not only in SO2, but also in nitrogen oxide (NOx), wetland mitigation credits, particulate matter, volatile organic compounds, and even endangered woodpeckers.

Meanwhile, the spot markets in SO2 now trade around $1 billion a year, and have derivative markets (markets in futures, swaps, and options) that traders say are worth two or three times that amount. Most major brokerage firms, including NatSource and Cantor Fitzgerald, have created divisions dedicated to serving these "environmental markets."

The biggest emissions market, though, is still in its earliest phases: carbon dioxide (CO2), the gas believed to be most responsible for global climate change.

While the trade in SO2 and NOx generally takes place within nations, carbon dioxide is rapidly becoming a global market. As such it has the potential to be worth tens of billions of dollars, according to the World Bank. Traders say the market eventually could be worth ten times as much as the bank estimates. Indeed, some traders predict that CO2 will one day become the world's largest commodity market, eclipsing coffee, soybeans, pork bellies, or even oil.

Driving this new carbon market is the UN Framework Convention on Climate Change and its so-called Kyoto Protocol. Kyoto commits its signatories (particularly those in the developed world) to drastic reductions in their emissions of CO2 and other greenhouse gases. It sets out rules by which countries can engage in CO2 trading. Though Kyoto is not yet in force (it still needs to be ratified by countries representing 55% of global emissions of greenhouse gases), it has given traders hope that a global CO2 market is in the offing.

Meanwhile, trading in CO2 has already begun. The UK and Denmark, for instance, have this past year set up official markets in greenhouse gases. Similar moves are being planned by the European Union and Japan. Even in the US, where ratification of Kyoto is not expected, companies are trading CO2 in unofficial grey markets or in deals sponsored by individual state governments. Both Cantor Fitzgerald and NatSource have established divisions that concentrate solely on CO2 markets.

"Every day that passes," says Michael Walsh, a former senior economist at the Chicago Board of Trade,"the CO2 market becomes more real. The buzz around these issues is becoming tangible."

Walsh, who was on hand for the first day of sulfur dioxide trading in 1993, says the carbon dioxide market now reminds him of the early days in SO2 trading, when deals were being struck far in advance of the first official market.

"I remember meetings where there were essentially 27 lawyers sitting around a table trying to hammer out an SO2 deal. The markets were so new that everyone was taking extra precautions. That is where we now stand on CO2," Walsh says.

Even at this early, speculative stage, though, millions of dollars of CO2 change hands each month.

Walsh, now Senior Vice President at Environmental Financial Products LLC, is part of an effort to establish a "Chicago Climate Exchange" or CCX -- a voluntary market and trading forum for Midwestern companies interested in cutting their CO2 emissions.

The CCX has already heard expressions of interest from Dupont, American Electric Power, Calpine, Cinergy, the Ford Motor Company, and many other companies. According to Walsh, their hope is that this Midwestern market might one day go national, then become a transnational regional market, and then link up to the growing global markets in greenhouse gases.

CO2 trading on the CCX is slated to begin in early 2003, ten years to the day after SO2 trading began on the Chicago Board of Trade. One day, Walsh hopes, the real-time price of CO2 on the CCX will come spewing from Bloomberg terminals around the world.

Until then, this column will keep an eye on these nascent environmental markets, highlighting major deals signed, important policy developments, and possibly even updating readers on the global price of pollution.