In the spring of 2006, well before he launched his presidential campaign, Sen. Barack Obama delivered a keynote address on climate change at the Associated Press' Annual Luncheon in Chicago. Among a myriad of potential remedies for America’s dependence on fossil fuels, the Illinois senator made sure to highlight the Chicago Climate Exchange (CCX), a local institution that had only been in operation for three years. “To deal directly with climate change, something we failed to do in the last energy bill, we should use a market-based strategy that gradually reduces harmful emissions in the most economical way,” he said. “Right here in Chicago, the Chicago Climate Exchange is already running a legally binding greenhouse gas trading system.”
The name check was gratifying for leaders of the burgeoning CCX, many of whom had spent the market’s early days trying to establish its legitimacy in both environmental and financial circles. Although balancing the demands of both greens and venture capitalists is tricky -- and the exchange has generated plenty of criticism from the two camps -- the CCX has undergone serious growth in five short years and has solidified its role as the nation’s premiere carbon trading market. Now, with politicians and environmentalists clamoring for increased carbon regulation, it’s well situated to become a crucial player on the national stage.
“Cap-and-trade” is born
CCX was devised by Chairman and CEO Richard Sandor, an eccentric former economics professor at the University of California – Berkeley, who also played a central role in developing financial futures, instruments that allow banks and investors to hedge against the risk of future interest rate fluctuations. Following financial gigs at the Chicago Board of Trade and on Wall Street, Sandor caught the green fever in 1990, sparked by the Environmental Protection Agency’s Acid Rain Program.
As he learned about this initiative, which aimed to quell the forest-killing acid rain triggered by rising levels of sulfur dioxide emissions, Sandor was floored by the agency’s novel approach to regulation. In short, the program required companies to acquire credits for the sulfur dioxide gases they emit and then steadily reduce the amount of credits available. At the same time, firms that cut their emissions below the required level would be allowed to sell their available credits to high-polluting businesses that exceed their caps, thereby netting a profit through conservation.
Impressed by the possibility of cost-effective pollution reduction strategies and interested in creating a profitable market where none had existed, Sandor joined the program’s advisory committee. Once on board, he convinced his colleagues to auction sulfur dioxide allowances at the Board of Trade. As a result, acid rain pollutants dropped precipitously with little financial effect on polluting businesses.
Convinced about this so-called “cap-and-trade” model, Sandor decided greenhouse gas emissions could be tackled in a similar manner.
After years of planning, the CCX launched as a voluntary exchange in 2003. Companies, municipalities, utilities, and public institutions enter (under their own volition) into legally-binding contracts that force them to reduce their emissions at least six percent below a prescribed baseline. Those that exceed the minimum reductions can sell their credits to other polluters on the exchange or to offset companies, intermediaries who purchase emissions rights and then retire them, thus lowering the overall cap.
Over 300 members have joined the CCX since its inception, including Fortune 500 companies like DuPont, Ford, and Dow, the states of Illinois and New Mexico, cities like Chicago and Portland, and three Big 10 universities.
Why would these institutions choose to self-regulate? More often than not, it’s a matter of dollars and cents. Companies that anticipate future government action on climate change can hone the skills they will need to manage greenhouse gas emissions resourcefully. In the process, these companies can earn a profit if they manage to reduce emissions below the cap. Moreover, shareholders and potential clients tend to look kindly upon self-imposed green initiatives. For businesspeople ethically concerned about their company’s carbon footprint, CCX membership is a productive way to focus a corporation’s conservation efforts as well. Between 2003 and 2006, the CCX reports that participants of the exchange reduced their greenhouse gas emissions by 180 million tons.
A tough sell to environmentalists
But can a market created by a successful financial services entrepreneur help save the environment and protect the public good? That’s the central question underlying much of the criticism heaped upon the CCX since its foundation.
For one, environmentalists have lamented the industry-friendly nature of the exchange. Until 2006, when the reduction schedule was raised to a level Sandor calls in an email “demanding and significant,” participating members were only required to reduce emissions by one percent annually. That cap was less stringent than even the modest requirements of the Kyoto Protocol and one many corporations and municipalities could achieve without any focus on green initiatives. These loose requirements affected the credits companies sold as well. The environmental publisher Environmental Data Services warned offset buyers in April to avoid purchasing the credits produced by CCX emitters because they do not adhere to the most vigorous offset criteria.
There’s also the concern that entering into a voluntary carbon-trading market will distract participating members from more substantial conservation efforts. In August 2006, a coalition of 19 public interest and environmental advocacy groups -- including giants like the Natural Resources Defense Council and Environmental Defense -- advised states and cities against joining the CCX. Their concern was that these governments would be less likely to implement climate legislation or create their own mandatory emissions trading programs if they could placate eco-minded constituents through membership in the market.
The voluntary nature of the CCX also means that companies attracted to the exchange are already interested in reducing their carbon footprint, in part undercutting the necessity of the market itself. “What’s basically the problem with carbon dioxide emissions is that one person’s emissions affect another person’s well-being. That’s the basic story of an externality,” says Joshua Linn, an assistant professor of economics at the University of Illinois-Chicago. “But if you have a situation where it’s in the firm’s own interest to reduce their emissions -- and we really don’t have an externality problem -- there’s really no reason to regulate.” That’s why critics have raised questions about CCX’s stated reductions achievements; it’s not clear whether the emissions drops are the result of good corporate citizenship or the carbon market’s efficiency.
But absent a mandatory cap-and-trade system at the national level, CCX is a valuable learning tool that provides tangible benefits for its members and the environment. For market-oriented business, it institutionalizes the notion that environmental protection can be pragmatic and profitable as well as moral. CCX membership puts the impetus on companies and municipalities to make their operations more energy-efficient by implementing or developing low-cost emissions control technology. And once participating bodies sign on, the emissions cap is mandatory, meaning there is a direct financial penalty for backtracking on promises to shareholders or constituents.
Waiting for 44
Much to the delight of Sandor and his colleagues, 2008 has been a banner year for the exchange. Since the beginning of January, CCX members have traded the equivalent of 44.25 million tons of carbon dioxide, a giant leap in activity since 2005, when participants traded only 1.5 million tons throughout the year. Since the presidential primary season got underway, Chicago carbon prices jumped from $1.90 a ton to $5.75 as well, including a 60¢ boost on February 6 when it became clear that all three presidential front-runners favored some form of cap-and-trade. “[Cap-and-trade] is certainly more likely than it was a couple of years ago,” says Linn. “I’d say it is likely there’s going to be something but it’s unclear how strict the policy is going to be.”
Under an Obama administration, odds are a policy would be substantive. In his climate plan released last October, the presumptive Democratic nominee advocated an ambitious, economy-wide cap-and-trade program that would require all credits to be purchased at auction, rather than allocated by industry. He would also call for the nation to lower its carbon emissions 80 percent below 1990 levels by 2050, a commitment long advocated by environmentalists.
John McCain proved his environmental policy chops need tuning when he told reporters in June that he believed in a nationwide cap-and-trade system as long as it did not impose a mandatory cap. Despite the blunder, the Arizona Republican has been on record since 2003 in support of mandatory cap-and-trade and such a proposal -- requiring emissions to drop 60 percent below 1990 levels by mid-century -- sits at the center of his energy plan.
Either candidate would please CCX executives, who believe they've created the dominant American trading platform for carbon, one the federal government could use as a reference model if legislation was enacted nationally. "CCX is already complementary, synergistic, and reinforcing of all emerging public policy, whether regional, state-based or national," says Sandor over email. CCX members could have an easier time than other companies transitioning to a mandatory market, as Congress could potentially grandfather their credits into a national system. Meanwhile, the market growth necessitated by a mandatory cap-and-trade system could net Sandor some serious dollars while reducing carbon emissions significantly.
According to Point Carbon, a Norwegian consulting firm, the total global trading volume for carbon products last year was 2.7 billion metric tons. That figure would swell by an additional 6 billion metric tons if the United States joined in.
Until then, the CCX will continue to expand its operations. At the end of May, they teamed up with the Montreal Exchange to create the Montreal Climate Exchange, an operation they hope will become the leading market for publicly traded environmental products in Canada. And in early 2009, they will be ready to capitalize on the departure of our 43rd president.
By utilizing the power of the market to protect the planet, Sandor and his Chicago-based colleagues have found their niche.
