By Martin Smith and Gord Lambert

The use of private market mechanisms, such as emissions trading, has been viewed by many economists and policy makers as a means for achieving difficult environmental goals in an efficient manner. Already employed in some countries to help meet pollution reduction targets for air quality problems like acid rain and urban smog, trading has also been proposed to help in the reduction of greenhouse gas emissions that many scientists believe are contributing to changes in global climate, or what is often referred to as global warming.

The new international agreement negotiated in Kyoto, Japan, in December of 1997 establishes emissions limitations (or "budgets") applying to 39 nations (or "parties") during the period from 2008-2012 and applies these limitations to a number of major greenhouse gases such as carbon dioxide (CO2). The Kyoto Protocol also specifically provides for the buying and selling of greenhouse gas "emission reduction units" among the parties to the protocol.

However, rules governing such emissions trades have yet to be developed, and substantial uncertainty remains as to whether trading in greenhouse gases will be supported by the major emitters themselves, namely industrial corporations, some of whom oppose action on global warming at this time. There is also uncertainty as to whether trading, particularly international trading, will prove administratively feasible and politically acceptable between nations, considering the significant differences that exist in governmental institutions and regulatory systems.

Against this backdrop, two firms -- an American electric utility and a Canadian integrated oil and gas company -- announced on March 5, 1998, an agreement for a major greenhouse gas emissions reduction trade. While there have been at least two prior publicly announced international trades involving a modest amount of greenhouse gases (e.g., 10,000 metric tons), the magnitude of this agreement, over 10 million tons of CO2, and the potential value of the agreement, about $6 million, was seen by the Canadian and American governments as a major demonstration and test case for the future role of emissions trading.

Likewise, the two companies involved in the transaction, Niagara Mohawk Power Corporation of Syracuse, New York, and Suncor Energy Incorporated of Calgary, Alberta, hope the agreement will be an important first step toward the creation of a global market and an international trading system for reductions in this area.

OVERVIEW OF THE TRADE AGREEMENT

Under the terms of the agreement, Suncor Energy will make an initial purchase of 100,000 metric tons of CO2-equivalent greenhouse gas emissions reductions from Niagara Mohawk. In addition, Suncor will obtain an option on up to 10 million tons of reductions, to be delivered over a 10-year period beginning in 2001. Finally, Niagara Mohawk will reinvest a minimum of 70 percent of any proceeds from the sale of reductions into new projects, activities, or measures that further reduce emissions of greenhouse gases. The two trading partners may work together on such projects.

The reductions to be traded under the agreement fall into two major categories. The first includes emissions reductions achieved through projects and measures undertaken by Niagara Mohawk since 1990, the baseline year against which emissions increases or reductions are typically measured. To qualify for trading purposes, such reductions must be "surplus," that is, emissions reductions must be below the 1990 baseline emissions level, minus 7 percent (the emissions level used to establish emissions budgets for both Canada and the United States in the Kyoto Protocol).

Niagara Mohawk activities that have created such reductions include power plant performance improvements, energy efficiency improvements, and use of less-polluting fuels. The second category or source of reductions reflects new reductions to be achieved by Niagara Mohawk in the future, such as reductions resulting from development of new renewable wind, solar, and biomass energy resources.

Documentation of the emissions reductions to be used in the trade is being undertaken in several ways. First, Niagara Mohawk has been and will continue to report its total greenhouse gas emissions and emissions reduction activities to the U.S. Department of Energy under the voluntary reporting program established in Section 1605(b) of the Energy Policy Act. Suncor Energy will continue to report its annual greenhouse gas emissions performance as part of its participation in Canada's Climate Change Voluntary Challenge and Registry Program.

In addition, the Environmental Resources Trust (ERT), a not-for-profit institution founded by the Environmental Defense Fund, will further qualify and quantify Niagara Mohawk emissions reductions to be applied in the trade. ERT will also create accounts for the two companies into which the verified emissions reductions can be deposited and later transferred.

PERSPECTIVES AND INTERESTS OF THE TRADING PARTNERS

Niagara Mohawk Power Corporation and Suncor Energy share a number of perspectives and interests that helped to make this international trade possible. Both Niagara Mohawk and Suncor believe potential climate change is a serious environmental issue which, recognizing the many remaining scientific uncertainties, nonetheless warrants prudent, cost-effective and early action to reduce or offset greenhouse gas emissions

Both companies have set targets for greenhouse gas emissions reductions that were publicly communicated to their respective governments, and both companies believe that market-based mechanisms, such as emissions trading, are crucial to meeting these targets.

Equally important, both companies initiated deliberate internal programs in the early 1990's to undertake, coordinate, and track projects and activities resulting in reductions of greenhouse gas emissions. Suncor, for example, has committed to actions in seven areas that address the risk of climate change. These areas include such things as internal mitigation, alternative energy sources, and domestic and international offsets.

Through these efforts, Suncor projects its greenhouse gas emissions per unit of production will be 32 percent lower in the year 2000 than they were in 1990. Similarly, Niagara Mohawk has been active in a dozen program areas, resulting in a reduction in its current greenhouse gas emissions of about 25 percent below 1990 levels.

Results to date and targets for 2000 notwithstanding, both Niagara Mohawk and Suncor recognize in the Kyoto Protocol a clear signal that national and international efforts to limit greenhouse gas emissions can be expected to continue and intensify after the year 2000. Furthermore, Suncor expects to experience emissions increases shortly after the new century begins due to significant increases in production and facility expansion. Thus, the company determined it was necessary to intensify its efforts to reduce or offset emissions after the year 2000.

While continued pursuit of internal energy efficiencies remains Suncor's first priority, a complementary component of Suncor's strategy to deal with the challenge of projected emissions increases, combined with increased government pressure for emissions reductions, is to explore opportunities for obtaining offsetting emissions reductions elsewhere in the world where additional reductions may be achieved at a lower cost.

Along with seeking greater internal company emissions reductions, Suncor has, therefore, also cosponsored a forestry conservation project in Belize, Central America, invested in a wind power project in southern Alberta, and negotiated the international trade with Niagara Mohawk. In the words of Suncor Chief Executive Officer Rick George, "One idea that we fully support is creating a system of domestic and international credits to encourage greenhouse gas reduction efforts around the globe."

Niagara Mohawk, for its part, strongly endorses Suncor's view that the climate change issue is a global problem that requires a global solution, with maximum flexibility regarding where reductions can be obtained, and close cooperation between nations. Niagara Mohawk also supports the U.S. government's position that national and international emissions trading is a vital component of any program to combat global warming. If properly structured, trading can lead to net environmental benefits as well as benefits in economic efficiency.

For example, as a result of an earlier domestic greenhouse gas trade with the Arizona Public Service Company (APS), Niagara Mohawk was able to fund development of a biomass project in its New York service territory and invest in an international "joint implementation" wind and solar renewable energy project with APS in Mexico. The reinvestment provision of the trade with Suncor Energy will continue this pattern of obtaining additional environmental benefits beyond the value of the trade itself.

Finally, Niagara Mohawk believes efforts to mitigate potential climate change need to go forward sooner rather than later, and early reductions of greenhouse gas emissions should be encouraged by government policy. Companies that have made early reductions should be given credit for their actions. The trade with Suncor was designed to demonstrate that early reductions can create financial value and stimulate the emergence of market trading, in turn encouraging broader participation by private sector corporations in emissions reduction activities and leading to further reductions that would otherwise not have occurred.

As stated by Niagara Mohawk's Chief Executive Officer Bill Davis, "By making this international trade, we hope to help forge a new marketplace that will make economically efficient options to reduce the risk of global climate change more viable."

CONDITIONS FOR FULL IMPLEMENTATION OF
THE TRADE AGREEMENT

Since there are as yet no formal mechanisms in place for international trading in greenhouse gas emissions, full implementation of the trade will require recognition and sanction by the governments of the United States and Canada. Niagara Mohawk and Suncor will work together to pursue such approvals as an international trading system is developed and put into place. Also, the agreement is contingent upon proper verification and depositing of Niagara Mohawk emissions reductions to be used in the trade in an account with ERT, a process which is already moving forward.

Finally, because most of the reductions for the trade will be created prior to the beginning of the first emissions budget period (2008), implementation will require a government program that gives credit for voluntary early reductions.

The Kyoto Protocol does not specifically address credit for early reductions, other than a provision allowing credit for certain Clean Development Mechanism projects in developing countries undertaken between the years 2000 and 2008 (Article 12). However, nations with emissions budgets can decide to set aside or "reserve" a portion of their future budget to stimulate and reward early reduction efforts. The United States and Canada are currently considering early reduction credit programs. Suncor and Niagara Mohawk are contributing to the deliberations.

Global warming is a global issue that will require global solutions. Niagara Mohawk and Suncor hope their trade agreement will serve as a useful and beneficial test case of what can be accomplished when two companies and two nations work together.

----------

Martin Smith serves as chief environmental scientist for Niagara Mohawk Power Corporation in Syracuse, New York. Gord Lambert is corporate director for Environment, Health, and Safety at Suncor Energy Incorporated in Calgary, Alberta, Canada.

Global Issues
USIA Electronic Journal, Vol. 3, No. 1, April 1998