Firms Prepare for Federal CO2 Limits

Utilities, steel mills and petrochemical companies are among those trying to get ahead of the regulatory curve.

By Jim Ostroff, Associate Editor, The Kiplinger Letter

December 7, 2004

With several eastern states preparing to set limits on carbon dioxide (CO2) emissions next year, expect the federal government to follow suit by the end of this decade. Businesses around the country are going to take preemptive action, cutting their CO2 output and tapping a nascent futures market to buy and sell pollution rights. The early movers hope to spare themselves the pain of a future CO2 clampdown by Washington that forces the unprepared to scramble for compliance.

The six New England states plus New York, New Jersey, Pennsylvania, Maryland and Delaware are instituting CO2 rules next spring. They'll set emissions limits that a company can meet either by cutting CO2 output or purchasing emissions credits—allowances, in trader lingo. When the feds get around to it, they're likely to control CO2 in the same way, just as they have limited sulfur pollutants for the past two decades.

Electric utilities, steel mills and petrochemical companies are by far the biggest producers of CO2, but manufacturers in many other fields also need to prepare for federal regulations. Interface Inc. of Atlanta, a manufacturer of carpets and modular floor coverings from recycled materials and plant fibers, senses which way the wind is blowing. "By taking actions now to reduce [CO2] emissions, we'll have the technology in place and preserve [pollution emissions] credits, should a regulation be issued in a few years [limiting carbon effluents]," says Erin Kelley, an environmental research analyst with Interface Research Corp., a subsidiary that Interface set up to guide its environmental activities.

Meanwhile, Interface has joined American Electric Power (AEP), DuPont, Dow Corning, Bayer, International Paper and about 70 others as members of the Chicago Climate Exchange. Formed last year to create a national market to trade allowances for controlled pollutants, it will begin listing futures contracts for sulfur dioxide on Friday through a subsidiary, the Chicago Climate Futures Exchange.

CO2 contracts are a year or so down the road, pending regulatory approval, even though the gas won't be regulated at the federal level by then. Companies in the East will use the contracts actively while firms in other regions can trade CO2 credits on the assumption that they will be honored when Washington begins national regulation. The trading activity will be based in part on industry assumptions about the limits the feds are likely to impose.

The futures market is a boon for smaller polluters, which generally have a hard time arranging private trades for emissions credits. The futures market also will create transparency in credit pricing trends. Membership on the exchange costs between $1000 and $10,000 annually, depending on the company's volume of greenhouse gas emissions.

The exchange also binds members to cutting their emissions of greenhouse gases, such as CO2 and methane, by at least 1% annually from 2003 to 2006, in part to create sufficient volume in the emissions markets. Compliance is certified by the National Association of Securities Dealers, which sets each company's benchmark based on its average emissions from 1998 to 2001. Businesses that joined this year must meet the 2003 reduction requirement as well as those for 2004 to 2006.

Polluters with publicly traded stock have another good reason to cut their emissions: heightened diligence expected of these companies in the post-Enron shareholder environment. "There's the belief that if a company can make [CO2] cuts and [profit from] the value of these reductions, they have an obligation to do so in order to increase shareholder value," says Richard Sandor, the Climate Exchange's founder and president.

This isn't a hypothetical worry, says Brent Dorsey, director of environmental programs for Entergy Corp., a national electric utility. "There have been a number of suits against AEP, TXU Energy, Cinergy Corp. and Southern Co. in which shareholders [alleged these utilities] use large amounts of coal and other fossil fuels and have a significant carbon risk should any carbon regulation be issued," Dorsey says.

Companies are exploring various ways to get a jump on CO2 emissions regs and shield themselves against possible litigation. Entergy, for example, has pledged to limit through 2005 the CO2 output of its power plants at 2000 levels and is considering an extension beyond 2005. Entergy also has planted millions of trees to absorb the CO2 that it produces and is buying emissions credits from Blue Source, a firm trading in CO2 emissions reductions that businesses have achieved by trapping the gas in geological formations.

CO2 trapping—known as carbon sequestration—is spawning a hot new industry. The Department of Energy (DOE), for example, is tracking about 370 projects by companies, research firms and universities aimed at sequestering CO2 in trees, under the oceans and in geologic formations. AEP, for example, recently landed a $4.2-million DOE contract to bore a 10,000-foot-deep hole where it will inject and trap the CO2 emitted by one of its power plants in West Virginia.

DOE also is involved in a mammoth project to create a regional CO2 dump at the 10,000-acre Teapot Dome oil field in Wyoming. Oil wells will probably become a favored venue for CO2 storage, and for good reason. Injecting the gas increases oil production up to 50% from older fields by ferreting out thicker oil that generally has been uneconomical to recover.