Warming Trend Is Hatching a Business

Stockholm-based Vattenfall, Europe's fourth-largest utility, is building a pilot zero-emissions coal-fired plant in Germany using sequestration, which injects carbon dioxide into the earth instead of releasing it into the air. Vattenfall chief executive Lars G. Josefsson says removing the carbon dioxide will cost more than $25 a metric ton, but he says, "If we're going to have a problem with carbon dioxide, this is a good investment."

While the E.U. carbon trading scheme has given birth to an industry, it has also created controversy over how quotas are assigned and who gets stuck paying the bills. In Germany, utilities raised electricity rates, treating carbon emissions as a cost to pass along. Four utilities made $3 billion to $5 billion in windfall profits, Bugnion says.

There are disputes between countries as well as within them. Britain and Germany are cutting their greenhouse emissions sharply, while Spain's are still growing. Sweden relies mostly on hydro- and nuclear power for electricity; Germany relies overwhelmingly on coal. Countries are currently drawing up new caps for 2008-2012.

Setting baselines for emissions has been tough. Quotas are based on a company's emissions over the five years before the program began. Firms have sought higher baselines to get more allowances. In most nations, utilities were squeezed while industrial firms were given more than enough.

The numbers didn't add up the way people expected. In May, the E.U. revealed that actual emissions were well below the quotas, suggesting that baseline levels were set too high. That shocked the carbon trading market. The price of a ton of carbon dioxide crashed, dropping by two thirds and erasing $36 billion of value. Prices crept back up but tumbled in recent days.

The credits bought in developing countries pose other challenges. So far, companies find it cheapest to cut the most potent greenhouse gases, mostly in the developing world. A ton of methane, common in landfills and farms, equals 21 tons of carbon dioxide; a ton of hydro-fluorocarbons, a refrigerant byproduct, is worth as much as 11,700 tons of carbon dioxide.

Independent firms and investors are getting into the act. Ecosecurities, whose chief executive Bruce Usher is a former Wall Street derivatives trader, has become a broker and developer of projects in 26 countries, ranging from one to capture methane at a Chinese landfill to small hydropower dams in Honduras.

A London firm called Climate Change Capital has raised $830 million to reduce greenhouse gases for credits to be sold in Europe. AES is putting $325 million into a joint venture to produce 50 million tons of credits by 2012.

These credits need the blessing of the Clean Development Mechanism (CDM), a United Nations agency in Bonn. That process could get messy, and political. One criterion: "additionality," the buzzword for a project that wouldn't have happened without the credit system. That can be hard to figure out when high oil prices make conservation and alternative energy attractive. In July, the CDM rejected four projects, including two proposed by Ecosecurities, without saying why.

Not surprisingly, most credits are generated in countries with the worst environmental track records. China accounted for 62 percent of the CDM credits sold during the first half of this year. That raises a sensitive question: Should Europe be effectively subsidizing investments in pollution control that its economic competitor China hasn't bothered to make? Moreover, China is collecting a 65 percent tax on the sale of credits.

"Scientifically, it makes sense to take [greenhouse gases] out wherever you can do it most cheaply, but politically, it might be better to do it in your country," said AES chief executive Paul Hanrahan.

There is one functioning U.S. carbon market. On Earth Day 2005, Richard Sandor founded the Chicago Climate Exchange, but participation is voluntary. Member companies must trim 6 percent of their emissions by 2010. "The only ones who opt in know they'll meet the targets," says Point Carbon's Bugnion. Members include Ford Motor Co., DuPont Co., Motorola Inc., International Business Machines Corp., American Electric Power Inc. and half a dozen municipal governments.

Mandatory carbon trading may still be adopted in the United States. Cap-and-trade measures have been drafted by a handful of lawmakers. Sen. John McCain (R-Ariz.) co-sponsored an earlier bill.

"This is a big global problem, and we have a deficit in global governance," says Vattenfall's Josefsson. "If we could solve this, it could be a model for global governance."