Climate change. Welcome to Kyoto-land

TWO hundred and fifty thousand tonnes of carbon dioxide is an exceedingly tiny amount compared with how much is released by mankind's burning of fossil fuels every day. But consider that those 250,000 tonnes were traded on October 5th as forward contracts on Europe's fledgling market for carbon-emissions credits, and suddenly the number seems more impressive. After all, a few years ago the very notion of carbon trading seemed fanciful. Indeed, that recent daily amount was more than twice the volume traded in the whole month of August.

A big reason for the surge in trading was Russia's decision to ratify the United Nations' Kyoto treaty on climate change. Now, a long-running uncertainty is over. The treaty will soon come into force and remove the cloud that has hung over the domestic rules on carbon emissions that European Union countries have introduced. Industries in most rich countries, notably in the EU, can no longer hope they will ever again be allowed to vent carbon dioxide freely into the atmosphere, as they have done in the past.

That will be good for the atmosphere, but what does it mean for industry? After all, while the manufacturing sector in rich countries has become less carbon-intensive since the oil shocks of the 1970s, it is still the biggest contributor to carbon emission. Because George Bush confirmed his country's rejection of the treaty in 2001, American businesses are not subject to Kyoto rules. That has led Europe's businessmen to ask with increasing urgency whether firms in Kyoto-land, which also includes Japan and Canada, will suffer against rivals in America and in the often overlooked, but energy-guzzling Australia, which also has not ratified the Kyoto treaty.

At first it seems obvious that firms facing a “carbon price” must suffer a heavy burden compared with rivals that do not. But look closer, and there is reason to think that EU industry may not have such a heavy load to lift after all.

Benedikt von Butler of Evolution Markets, a greenhouse-gas broker, points to one reason not to worry: price. If a firm cannot stay under its government-allocated quota for carbon emissions (and every sizeable EU firm received such a quota earlier this year), then it must purchase carbon allowances at the going price. Following the informal carbon market already under way, pan-EU carbon trading starts next year. A few years ago, observes Jorund Buen of Point Carbon, a European carbon consultancy, most experts had expected businesses to be confronted with a price of €20-25 ($25-31) per tonne. In practice, prices have been a lot lower than that - and they are not expected to rise much above €10-15 per tonne.

There are two reasons for this. The first is the potential overhang of “hot air”. Russia was given an over-generous allowance of credits, to persuade it to join the treaty. Some worried that it would, over time, depress prices on the EU market. In fact, self-interest will discourage this: the Russians do not want a price collapse. Indeed, argues Mr von Butler, they are more likely, eventually, to join Ukraine and Bulgaria in a cartel to try to prop up prices. The most likely outcome, reckons David Victor of Stanford University, is that overhang of Russian credits will allow EU governments to use the hot air as a “safety valve” to ensure the long-term price of EU carbon credits does not rise much above €10. The second reason is that, despite all the rhetoric, the EU is doing rather less than it appears on climate, and America rather more.

Europe has all the regulations of Kyoto in place, but the straitjacket on industry is pretty loose. When the national allocation plans for carbon were issued earlier this year, the greens complained that they were toothless and amounted to “business as usual”. Industry had successfully lobbied EU governments not to hobble its competitiveness. And in America, where Mr Bush has unshackled corporations from Kyoto, many industries are confronting a carbon challenge nonetheless and, in some cases, making voluntary cuts.

One example is DuPont, which has slashed its emissions of greenhouse gases (which include gases other than carbon dioxide) by a breathtaking 65% compared with its 1990 levels. One reason has been to gain favourable publicity. But multinationals like DuPont are convinced that carbon constraints are coming anyway in America, and they want to make global preparations. Since they have operations inside Kyoto-land, many are pursuing low-carbon strategies at home, even in the absence of regulation.

There is also a grassroots rebellion taking place in America. Many states have, in defiance of the Bush administration, introduced carbon restrictions. States in New England have imposed curbs on carbon emissions from power plants, and are developing a common trading system for emissions with Canada's eastern provinces. California has the nation's first law limiting greenhouse-gas emissions from cars. New York and others may adopt similar rules.

So, Kyoto need not place a carbon millstone around the neck of Europe's businesses. Indeed, even concerns about developing countries stealing a competitive edge may be overblown. China, which has no obligations under the treaty, is imposing de facto constraints on local industry through seemingly unrelated policies such as tough new fuel-efficiency laws for cars.

European economies might even gain some advantages. Anthony Hobley of Baker & McKenzie, an American law firm, argues that Britain's early embrace of the Kyoto protocol gives it a chance to dominate a sector that benefits: the legal profession: “English law is likely to be the major legal system of this new international market. The fact the US has ruled out ratifying Kyoto takes New York law out of the running for the time being.”

Another sort of edge lies in the pan-EU trading system. It formally covers 25 countries, but may set the global standard. Already, notes Mr Hobley, Norway, Switzerland and Canada have had formal discussions about linking to the system. Japan, a Kyoto signatory, may also announce a linking scheme. Most intriguingly, rumours suggest that California might unveil a carbon-trading system in December - and it too might be linked to the European scheme.

The emerging carbon market already feels more like the dizzying early days of Silicon Valley than the state capitalism of Europe's past. Jos Delbeke, of the European Commission, certainly sounds more like a free marketeer than a Eurocrat: “We have created a new currency, the carbon allowance, but only the market can set its price.” The commission has already chastised eastern European governments for over-generous carbon allowances, which it insists add up to unfair state aid.

The emerging carbon-emissions industry in the EU counts dozens of small and medium-sized consulting firms, technology start-ups and the like. The big accounting firms are scrambling to train “carbon accountants”, and venture capital is pouring into clean energy. London is quickly emerging as the carbon-finance capital. It is home to Climate Change Capital, the first merchant bank dedicated to carbon issues, and the Carbon Trust, an innovative public-private partnership that aims to boost clean energy, in part by funding promising technologies considered a little too risky for private financiers.

If any industry should be hostile to Kyoto, then it should be energy. Yet in 1997, Lord Browne, the boss of BP, the world's second-largest oil company, broke ranks and called for action on global warming. Hoping to encourage a market-friendly approach by the EU, he vowed that his company would reduce its emissions to 10% below 1990 levels by 2010. He turned to Environmental Defence, a market-minded green group that helped design America's successful sulphur-dioxide trading system. Together, they implemented a cap-and-trade carbon scheme for BP's various divisions worldwide.

The result? The firm met its targets eight years ahead of schedule through a combination of higher efficiency, new technology and better management of energy. Most impressive, Lord Browne explains, is the price tag: “We've met it at no net economic cost - because the savings from reduced energy inputs and increased efficiency have outweighed all the expenditure involved.” The costs of tackling climate change, he concludes, “are clearly lower than many feared. This is a manageable problem.” By embracing Kyoto, the EU might just have given its businesses an edge in the race towards clean energy.

Why European companies may not lose out to their American rivals under the Kyoto treaty on greenhouse-gas emissions

Why European companies may not lose out to their American rivals under the Kyoto treaty on greenhouse-gas emissions.

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