By John W. Schoen Senior producer
msnbc.com
updated 4/24/2007 4:27:09 PM ET 2007-04-24T20:27:09

As the utility industry moves toward an industry-wide solution to limit greenhouse gases, one leading proposal is a so-called “cap and trade” system similar to one already operating in Europe. The idea is simple: Companies that produce emissions below a mandatory cap earn carbon credits — which they can then sell to companies that don’t meet the cap. This rewards those who invest in ways of reducing pollution and penalizing those who don’t.

But while a broad consensus is developing over a plan for a mandatory carbon cap-and-trade system, various players in the industry — from owners of zero-emission nuclear stations to operators of carbon-spewing coal-fired plants – are divided on just how to set the rules of the game.

“One of the inevitable things about the democratic process is that everybody is going to look for their own version of fairness,” said David Yarnold, executive vice president of Environmental Defense.

Among the key questions:

  • How will carbon credits be allocated?
  • How restrictive should carbon caps be?
  • Will there be rewards for early adopters?
  • What level of emissions will be grandfathered?
  • Should companies be rewarded for investments made years ago?

The utility industry already has experience with a cap-and-trade system to limit emissions of sulfur dioxide and nitrous oxide and control acid rain. Under the program, the Environmental Protection Agency issues allowances that can be traded in accounts set up in an EPA registry.

And U.S. companies already can trade carbon allocations under on the Chicago Climate Exchange, a voluntary carbon cap-and-trade market. But without mandatory caps, monitoring of emissions and clear penalties for exceeding caps, trading there will likely remain limited.

So one of the hardest tasks in creating a mandatory cap-and-trade market will be determining where to set the initial caps — and how tough to enforce them. The first round of a system set up by the European Union was only a partial success because caps were set so high that there was little demand for credits, undercutting their value.

That’s why proposed “escape clauses” — granting companies waivers if they can demonstrate economic hardship — could subvert the U.S. system, said Yarnold.

“The notion of a constantly tightening market for carbon emissions is what creates value (for  carbon credits), which is why the notion of a so-called escape valve won't fly as a real market,” he said.

But clamping down too hard and too quickly also could backfire. Tough restrictions on the dirtiest coal-fired plants, for example, could force power generators to lean more heavily on natural gas-fired plants, squeezing already-stretched supplies and further driving up prices, said Michael Morris, CEO of American Electric Power, one of the biggest operators of coal-fired plants.

“The timeline has to be right, and the reduction targets have to be achievable,” he said. “It will serve no purpose for Congress to ask the utilities of the world to run a three-minute mile because it won’t happen.”

Morris said that U.S. caps on carbon emissions also should take into account participation by developing countries like China and India. By not bearing the cost of controlling carbon emissions, he said, those countries would have an unfair price advantage when competing against American manufacturers. One solution would be a tariff on products produced by countries that don't impose mandatory carbon caps, he said.

Then there’s the question of how to apply credits to existing plants. One of the thorniest issues: Should existing nuclear and gas plants be given credit for producing less carbon per megawatt than older, coal-fired plants?

“If the nuclear and gas lobby gets their way and you tie it to megawatts of capacity. that is a windfall,” said David Crane, CEO of NRG Energy, which operates mostly coal and gas plants in Texas and the Northeast. “A nuclear plant that was built under a rate-based mechanism with full recovery (of construction costs), and now suddenly gets a carbon benefit, that is a windfall for the nuclear plant. What behavior in the nuclear plant are you going to influence by giving them this carbon allocation?”

Then there’s the question of how to determine carbon emission reduction targets. Various states have already set their own targets, with different deadlines for different reduction levels.

As Congress begins tackling the details, the task could be eased by an alliance of industrial energy consumers, producers and environmental groups called the U.S. Climate Action Partnership. Founding members include Alcoa, BP America, Caterpillar, Duke Energy, DuPont, FPL Group, General Electric, PG&E Corp. PNM Resources and environmental groups like the Natural Resources Defense Council, Environmental Defense, the Pew Center on Global Climate Change and the World Resources Institute.

(MSNBC.com is a joint venture of Microsoft and GE's NBC Universal unit.)

How will process unfold?
Earlier this year, USCAP laid out a set of proposals that includes a cap-and-trade system with mandatory targets. The targets includes phased-in, increasingly restrictive caps with an ultimate goal of cutting carbon emissions by 60 to 80 percent from current levels by 2050.

It remains to be seen how this process will unfold. As with the Energy Policy Act of 2005, a joint congressional committee could become the final battleground for details of a cap-and-trade market. Some of the rulemaking could be left to the EPA, especially in light of a recent Supreme Court ruling that the agency has the right — if not the duty — to regulate greenhouse gas emissions.

Bur for all the challenges of hammering out the details, some participants say they’re optimistic a compromise will be reached.

“There is a golden moment right now,” said Yarnold of Environmental Defense. “There is a confluence of public opinion, of political will, of a level of understanding. And so the question now is not whether there will be climate legislation, but whether there will be climate legislation that gets over a high enough bar to have actually the necessary environmental benefit."

“I have huge faith in this governmental process,” said Morris, the power company executive. “I would expect that between the House and the Senate sometime in the next year or so well come up with a plan that will work."

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