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Climate Change and the Law

The upside of regulated emissions is a market for credits.
By George B. Murr

Imagine a world without abundant and readily available power. Imagine—if you can—conducting business, com- muting to and from work—even simple living—without ready access to as much power as you want. Although prices have increased for electricity and gasoline, we have not yet experienced regulation of actual supply. Such a world might not be so difficult to imagine, however, given what scientists (and even a grow- ing number of energy companies) have to say about the impact our unabated use of electricity and hydrocarbons has in the form of carbon emissions. If the current policy trend on the state and local level toward limiting carbon emis- sions by businesses continues, it may not be surprising eventually to see federal regulations. Such regulations may reach not only business use, but consumer and personal use as well.

Although the federal government has not yet implemented mandatory limitations on carbon emissions, the Environmental Protection Agency tracks the efforts made nationwide at the state and local government levels. Given the trend towards legislation regulating carbon emissions, and that the absence of regulation has generated litigation to address the issue, it may be inevitable that such emissions controls eventually become law throughout the nation. If regulation is on the horizon, it may be more successful in allocating the social costs associated with restricting carbon emissions by being rooted in economic incentives and by being market-driven. Additionally, to minimize the size of the bureaucracy needed to enforce the regulations, legislatures and Congress can provide for private causes of action as a viable enforcement mechanism. This article examines the increasing trend in regulating carbon emissions, how carbon emission markets work, and the impli- cations and potential problems arising from operation of a carbon emissions market.

Trend of Legislation

While the federal government has not set carbon emission limits for industry, it did pass the Clean Air Act, 42 U.S.C. §§ 7401, et seq., in 1977 and its subse- quent amendments. This act does specifi- cally seek "to protect and enhance the quality of the Nation's air resources so as to promote the public health and welfare and the productive capacity of its popu- lation," "provide technical and financial assistance to state and local governments in connection with the development and execution of their air pollution prevention and control programs," and "encourage and assist the development and operation of regional air pollution prevention and control programs." Taking advantage of the private cause of action under the Clean Air Act, private litigants have used the act as a means of challenging vari- ous types of emissions by industry. For example, citizens have recently sued a power company under the Clean Air Act seeking injunctive relief to prevent the construction of a coal-fired electric plant in Texas. Additionally, various states have also sued industry in an attempt to restrict carbon emissions based on the common law cause of action for nuisance as well as other claims.

Currently, there are no carbon emis- sion limitations in effect on the federal level and in many states. However, the trend at the state and local level through- out the country is to regulate carbon emissions. One traditional means of regulating carbon emissions is through the use of permits and caps or limits on the volume of emissions allowed per year. For example, just last year, California Governor Arnold Schwarzenegger signed California legislation imposing a first-in-the-nation emissions cap on utilities, re- fineries and manufacturing plants, with a goal of cutting greenhouse gases to 1990 levels by 2020. Another emerging means of regulating carbon emissions is through the increasingly popular use of a market in which carbon emissions "credits" are bought and sold by those that generate carbon emissions.

The European Union has operated a market for the trade of carbon emission credits since January 1, 2005. Also in 2005, a group of seven Northeastern states—Delaware, Connecticut, Maine, New Hampshire, New Jersey, New York, and Vermont—agreed to enter into a market-based system to curtail harmful carbon dioxide emissions and, in the words of New York Governor George Pataki, to "take meaningful steps in the fight against climate change."

In the U.S., at least one voluntary carbon emissions market has been estab- lished. The Chicago Climate Exchange claims to be "the world's first and North America's only voluntary, legally binding rules-based greenhouse gas emission reduction and trading system."

In addition to passing regulation providing for carbon emission caps, California has been active in the forma- tion of carbon emission trading markets. Governor Schwarzenegger and British Prime Minister Tony Blair announced plans to work toward a possible joint emissions-trading market.

Further, on February 26, 2007, Gov- ernor Schwarzenegger was one of five governors of Western states who agreed to create the Western Regional Climate Action Initiative, forming a consortium to allow companies to buy and sell carbon "credits" on a carbon emissions market. Meanwhile, in a different vein, market "greenhouse gas credits" have been issued to farmers in the hopes of imple- menting an efficient means of allocating the atmosphere as a limited resource.

More and more, nascent carbon emis- sions policy at the state and local level is impacting the law and economics of the energy industry, and how it goes about its business. As experience has shown under existing laws and regulations restricting atmospheric emissions, litigation will likely be a companion of any new regulations or laws restricting carbon emissions, impacting and ultimately shaping the underlying emissions policy of such laws and regulations.

Carbon Emissions Markets

The Trend Towards Carbon Emission Markets. As noted above, the overwhelm- ing trend in regulating carbon emissions has been in the form of carbon emission markets. Under the California Health and Safety Code, the California Legislature has stated that:

"While traditional command and control air quality regulatory programs are effective in cleaning up the air, other options for improvement in air quality, such as market-based incentive programs, should be explored, provided that those programs result in equivalent emission re- ductions while expending fewer resources and while maintaining or enhancing the state's economy. . . ."

The program will result in an equiva- lent or greater reduction in emissions at equivalent or less cost compared with current command and control regulations and future air quality measures that would otherwise have been adopted as part of the district's plan for attainment.

In concluding that markets may more efficiently implement the emissions limita- tion, California seeks with its emissions market to set an example for the rest to follow.3 Given the activity in the United States and the European Union, the es- tablishment of carbon emission markets appears to be a forgone conclusion,4 rais- ing the question as to how these markets will function.

How Emissions Markets Work

In a carbon emission market, the regu- lating body sets a cap on overall carbon emissions by all participants. The cap is based on scientific analyses and policy considerations regarding the acceptable amount of carbon emissions, and can be established by agreement among the participants or mandated by government. In addition, the market may impose fees or taxes to pay for its own operation.

Once the overall cap is in place, the regulating body issues a permit and allocates an amount of acceptable emis- sions to each participant in the form of

"credits." A participant is limited in the amount of carbon exhaust it may emit to the amount of its registered credits, and violating that limit subjects the participant to a penalty. Once the permits and credits are issued to the participants, each may buy or sell them on the market to other participants. Any credits purchased allow the participant to increase its carbon emissions in direct proportion to its in- crease in credits. Conversely, any credits sold decrease the allowable emissions for that participant.

The operation of the market should result in the allocation of the credits in such a way as to maximize the use of the carbon emissions in the manner that society values most. For example, the price that a carbon emitter can command for its product or service, in part, is a reflection of the value that society places on it. That is, generally, the higher or more inelastic the price, the greater the demand relative to supply.

Therefore, carbon emitters that com- mand high prices or that can easily pass on the costs of buying emissions credits will be more likely to aggregate credits and supply those goods or services that society prefers. Conversely, those car- bon emitters that do not command high prices or have products or services that have high price elasticity are less likely to aggregate credits and will be forced to reduce emissions either by reducing production or becoming more efficient. Further, the market would also reward carbon emitters that generate less carbon on a per unit basis than their competitors by requiring them to purchase fewer cred- its or providing them a surplus of credits to sell. This would simultaneously require their competitors to become more ef- ficient in their carbon emissions so thatthey can remain competitive.

Thus, allowing participants to compete with each other for the emissions credits ensures that the emissions are used to generate those products and services that have the highest and best use from society's point of view. This results in the market efficiently allocating the cost to the environment.

Enforcing, Exchanging Credits

As noted above, each participant is limited to emitting the amount of carbon for which it has credits. In the event a participant exceeds that limit (without obtaining additional credits) from the market, it will be assessed a penalty. In addition, other market participants may have a cause of action against that market participant. In this way, the market may be regulated without the high cost of having an administrative body engaging in enforcement. In the event a participant breaches its agreement to sell credits, it may also be subject to liability in breach of contract. The aggrieved participant may assert a cause of action against the breaching participant.

Carbon market credits may qualify as intangible interests under the property law. As intangible property interests, such credits may be exchanged for other property. If two market participants are engaged in an unrelated transaction

—for example, the purchase of rights to explore for and develop oil and gas on real property, or the purchase of elec- tricity or natural gas—those two market participants may seek to include, as consideration for the deal, carbon credits on the carbon emissions market. Carbon market credits may be traded for other things and become part of the economy independent of the carbon emissions trading market itself. Buying and selling such intangible rights will integrate the value of the carbon emission credits into the larger economy. In this way, it will obtain a more accurate value and the market will more efficiently allocate it as a resource.

Potential Problems

Establishing and enforcing a carbon emissions market may significantly im- pact the energy industry. The allocation, regulation and trading of what was once a free resource, i.e., use of the atmo- sphere to receive carbon emissions, will be assigned a price. Questions regard- ing whether to charge such a price, as well as the need to charge it, are largely questions of policy. Nevertheless, the increase in costs of operation will burden the energy industry and may lead to cost cutting elsewhere, even the possible loss of jobs.

If indeed there is a limit placed on the overall emissions allowable, the market would most likely be the most efficient means of implementing such a limit. The market ensures that the resource is most efficiently allocated among its potential users. In addition, to the extent the overall limit of carbon emissions is too oppressive to the market participants, it may be adjusted. The market may be adjusted by the regulating body to increase (or decrease) the overall carbon emissions limit. The market may also be adjusted by allocating the carbon credits to participants unequally, based on external factors or for other policy reasons. Whether to increase the overall carbon emissions limit becomes part of the political process.

Conclusion

As markets are called upon to regulate carbon emissions in the energy industry, and as markets become a tool to regulate other industries as well, a world where personal or consumer use of electricity or gasoline is subject to such markets becomes quite conceivable. Most im- portant, however, as the legislative and industry trend toward carbon markets escalates, businesses and their legal coun- sel must be aware of possible dramatic changes in the energy industry and be prepared to adjust the operation of their businesses accordingly.

Catalyst May Revolutionize Biodiesel Production

Line up 250 billion of Victor Lin's nanospheres and you've traveled a meter. But those particles—and just the right chemistry filling the channels that run through them—could make a big difference in biodiesel production.

They could make production cheaper, faster and less toxic. They could produce a cleaner fuel and a cleaner glycerol co-product. And they could be used in existing biodiesel plants.

"This technology could change how biodiesel is produced," said Victor Lin, an Iowa State University professor of chemistry, a program director for the U.S. Department of Energy's Ames Laboratory and the inventor of a nanosphere-based catalyst that reacts vegetable oils and animal fats with methanol to produce biodiesel.

"This could make production more economical and more environ- mentally friendly." Lin is working with Mohr Davidow Ventures, an early stage venture capital firm based in Menlo Park, Calif., the Iowa State University Research Foundation and three members of his research team to establish a startup company to produce, develop and market the biodiesel technology he invented at Iowa State.

The company, Catilin Inc., is just getting started in Ames. Catilin employees are now working out of two labs and a small office in the Roy

J. Carver Co-Laboratory on the Iowa State campus. The company will also build a biodiesel pilot plant at the Iowa Energy Center's Biomass Energy Conversion Facility in Nevada.

Lin said the company's goal over the next 18 months is to produce enough of the nanosphere catalysts to increase biodiesel production from a lab scale to a pilot-plant scale of 300 gallons per day.

Lin will work with three company researchers and co-founders to de- velop and demonstrate the biodiesel technology and production process. They are Project Manager Jennifer Nieweg, who will earn a doctorate in chemistry from Iowa State this summer; Research Scientist Yang Cai, who earned a doctorate in chemistry from Iowa State in 2004 and worked on campus as a post-doctoral research associate; and Research Scientist Carla Wilkinson, a former Iowa State post-doctoral research associate and a former faculty member at Centro Universitario UNIVATES in Brazil. Larry Lenhart, the president and chief executive officer of Catilin, said the company is now up and running. It has a research history. It has employees. It has facilities. It has money in the bank.

And he said the company has proven technology to work with. The technology allows efficient conversion of vegetable oils or animal fats into fuel by using Lin's nanospheres with acidic catalysts to react with the free fatty acids and basic catalysts for the oils.

All that makes biodiesel production "dramatically better, cheaper, faster," Lenhart said. The technology replaces sodium methoxide—a toxic, corrosive and flammable catalyst—in biodiesel production. And that eliminates several production steps including acid neutralization, water washes and separations. All those steps dissolve the toxic catalyst so it can't be used again.

Catilin's nanospheres are solid and that makes them easier to handle, Lenhart said. They can also be recovered from the chemical mixture and recycled. And they can be used in existing biodiesel plants without major equipment changes. Lin said the catalyst has been under development for the past four years. The company will market the third generation of the catalyst—a version that's much cheaper to produce than earlier, more uniform versions. The technology was developed with the support of grants from the U.S. Department of Agriculture, the U.S. Department of Energy's Office of Basic Energy Sciences and the state's Grow Iowa Values Fund. Patents for the technology are pending. Catilin has signed licensing agreements with Iowa State's research foundation that allows the company to commercialize Lin's invention.