Sunday, September 23, 2007

Opportunity out of thin air=The Carbon Trade

From The Daily Report

(The Daily Report, often referred to as the Fulton County Daily Report, is Fulton County's official legal newspaper and Georgia's leading source for legal news and information. The newspaper was established in 1890.)

ATLANTA ATTORNEY John R. Varholy went to London six years ago for the primary purpose of helping clients trade an invisible, intangible—and at that point, worthless—commodity on a market that didn’t exist.

Speculative? You bet. But thanks to a Gordian knot of international, European Union and nation-specific regulations that, quite literally, created a multibillion-dollar market out of absolutely nothing, Varholy, now the managing partner of Troutman Sanders’ London office, and the three other lawyers there now focus their practices on various aspects of the market for trading carbon emission allowances—essentially, the right to pollute.

The market, which in 2006 was valued at $30 billion, now spans Europe, where some 12,000 factories and power plants must comply with limits on how much carbon dioxide they can produce. It has tentacles in developing countries such as China, India and Pakistan, where speculators can earn and sell credits for, among other things, installing technology to reduce pollution.

To be sure, the market has its problems. So far, it hasn’t reduced emissions as hoped. An over allocation of allowances caused carbon prices to plummet, and some related investment products have proven vulnerable to fraud. Electricity rates are on the rise—a 2007 report by Britain’s Department for Environment, Food and Rural Affairs estimates that prices will rise 10 percent for consumers and 20 percent for industry over the next few years, depending upon carbon prices.

Still, this nascent monetization of the right to emit greenhouse gases is turning out to be big business in Europe, particularly for lawyers, and deserves some serious analysis by attorneys on this side of the pond. That’s because it may one day serve as a model for what could happen here, where at least nine bills contemplating a domestic cap-and-trade market in CO2 and other greenhouse gases are now before Congress, and the U.S. Senate Committee on Energy and Natural Resources already has held a roundtable with European officials and executives to discuss how the United States could adapt Europe’s system—without suffering some of the same ills.

Varholy is the rare American energy-trading attorney with European experience who understands how it all works. He went to London to assist a client interested in the market—which hadn’t even launched yet—and ended up staying to help open the firm’s office there. He’d already spent years working to deregulate U.S. utilities; because deregulation is the first step toward a wholesale trading market, his experience was both valuable and uncommon in the European Union back in 2001, when few member states had liberalized their power sectors and few lawyers had any idea how to prepare their clients for what was coming.

This meant many countries went into the market without any experience for trading energy commodities. The mandatory nature of the market, however, prompted some companies and trade groups to begin exploring the issue with their lawyers early on.

“It was very analogous to the state of the U.S. right now, in the sense that there was a lot of talk, a lot of speculation,” says Varholy. “I think it’s fair to say there was a whole lot of perceived uncertainty.”

Though the potential for a carbon market was little more than a gleam in the European Commission’s collective eye, Varholy says he knew something was likely to happen. The question was what, exactly.

A potential structural precursor to a market was in place, because the Kyoto Protocol to the United Nations Framework Convention on Climate Change—the international agreement that sparked the whole idea of a carbon-trading market—had been adopted in 1997. But European Union member states, which as industrialized nations would be required by Kyoto to reduce their greenhouse gas emissions, wouldn’t even ratify it until 2002—the year after Varholy got to London. And the agreement itself wouldn’t come into force for another three years.

Even then, the Kyoto Protocol was just a structural framework; no actual monetized market existed. Varholy says people didn’t understand the complex technology needed to set up such a market—creating carbon registries, launching computer systems for each country and the European Union that would interconnect and facilitate trading. There were also political issues related to how many emissions allowances each country would get.

“There were just so many questions as to how it would actually hold together, whether it would work, how the allocations at the country level would work, whether it would get bogged down in politics,” Varholy says now.

But after substantial political wrangling, in January 2005, just one month before the Kyoto Protocol went into force, the European Union Emissions Trading Scheme was born.

Operating under the theory that who emits CO2 is less important than the total amount emitted, the European Union’s plan caps emissions by allocating a set number of free allowances—each equaling the right to produce one metric ton of CO2 per year—to each participating member state. The member states then may apportion those allowances among companies in select, heavily polluting industries, including the power, oil refining, steel, cement, pulp and paper sectors.....MORE