Catching Up to Kyoto: Obama and Cap-and-Trade

A central tenet of the energy policy of Barack Obama's presidential campaign was to "make the United States a leader on climate change." Will the United States now truly engage with the international community in addressing climate change?

How the Obama Administration approaches setting up a U.S. cap-and-trade system will determine whether the United States emerges as a true leader on climate change — or retrenches and focuses just on taking action domestically.

A key issue in the negotiations to replace the Kyoto Protocol, which expires at year-end 2012, is whether a post-2012 international framework to reduce GHG emissions will require developing countries to cap their emissions.

While the European Union countries and Japan have been taking action on climate change under the Kyoto Protocol, the United States has held out for a better deal. It insists that developing countries join industrialized countries in accepting firm commitments to reduce their emissions.

While developing countries are expected to account for two-thirds of the world's GHG emissions by 2030, the prospects would appear dubious that they will be prepared to cap their emissions in this next phase.

Leading developing countries such as China and India counter that industrialized countries have had a free ride since the onset of the industrial age — developing their economies at the expense of the world's climate.

Before developing countries pay the economic price for addressing climate change, they first want to catch up and lift their populations out of poverty.

Will the Obama Administration persist in the approach of prior U.S. administrations by insisting that leading developing countries cap their emissions in the immediate post-2012 phase?

In fact, to do so would be the equivalent of "shooting oneself in the foot" — by driving up the price of carbon under a U.S. cap-and-trade system.

In the first commitment period of the Kyoto Protocol, the European Union countries and Japan have benefited from "international offsets," by purchasing emission reductions from projects in developing countries at a lower cost than they could achieve domestically.

Kyoto projects representing potential emission reductions of 1.5 billion tons of carbon dioxide-equivalent and a market value of about $28 billion are now under development, with half originating from China.

Since a molecule of a greenhouse gas emitted anywhere on Earth has the same impact on the environment, international offsets from developing countries contribute to mitigating climate change just as emission reductions in industrialized countries, while driving down the cost of compliance for industrialized countries.

Italy's largest utility, ENEL, for example, expects to meet part of its emission reduction requirements by purchasing up to 35 million tons of emission reductions from Kyoto projects in developing countries, reducing its cost of compliance by at least $165 million.

If developing countries were to cap their emissions, they would then implement the most cost-effective projects themselves, taking these projects off the table for U.S. compliance buyers and leaving them with only the more costly emission reduction projects to implement domestically.

Alternatively, making these projects available for international offsets under a U.S. cap-and-trade system would involve the United States directly in efforts to take global action on climate change.

In setting up a U.S. cap-and-trade system, another key issue that will impact U.S. leadership on climate change is what to do with proceeds from auctioning emission allowances, which could total over $1.0 trillion over a ten-year period.

In the U.S. Congress, House Democrats have called for a federal cap-and-trade system where a portion of revenues would be returned to low- and moderate-income households. Such a "cap-and-trade dividend" may well be good politics and fair to consumers, who would bear the burden of increased energy costs.

However, it presupposes that the global fight against climate change will have already been won — when the United States is only just beginning to take action. Until each of the world's leading emitters have succeeded in bringing down their GHG emissions to sustainable levels, the United States must make every effort to deploy resources on a global scale, both in terms of people and capital.

While the plan of the incoming Obama Administration aims to invest $150 billion domestically to "catalyze private efforts to build a clean energy future," it falls short of directing capital toward projects that reduce GHG emissions in developing countries.

Under the Kyoto Protocol, public- and private-sector investment funds raised capital of over $9 billion to invest in projects that reduce emissions in developing countries and to purchase carbon credits that these projects generate. This is a start, but it is hardly enough.

Climate change is a global challenge — to reduce one's own emissions alone is not sufficient.

Cash accrued from auctioning allowances under a U.S. cap-and-trade system should be deployed to finance the efforts of U.S. companies and development banks to invest in projects that generate emission reductions in developing countries, where the carbon credits would then be purchased by compliance buyers in the United States and internationally.

The United States already has two institutions in place to deploy capital beyond its borders. First is the U.S. Overseas Private Investment Corporation, with its focus on providing financing and political risk insurance to help U.S. businesses invest in emerging markets.

Second is the U.S. Export-Import Bank which, in financing exports of U.S. goods and services, could deploy U.S. expertise and technology globally.

The "nuts and bolts" of taking action on climate change in emerging markets is a tough business: finding good projects and implementing them to generate a sufficient return to investors is no easy task. On a global scale, it will require the full engagement of U.S. ingenuity and business practices, backed by billions of dollars in capital, to succeed.

This international engagement is the essential path toward making the United States a true leader on climate change.