Beyond Kyoto

John Browne

From Foreign Affairs, July/August 2004

Summary:  Global warming is real and needs to be addressed now. Rather than bash or mourn the defunct Kyoto Protocol, we should start taking the small steps to reduce carbon dioxide emissions today that can make a big difference down the road. The private sector already understands this, and its efforts will be crucial in improving fossil fuel efficiency and developing alternative sources of energy. To harness business potential, however, governments in the developed world must create incentives, improve scientific research, and forge international partnerships.

Lord Browne of Madingley is Group Chief Executive of BP plc.

DOWN TO BUSINESS

The role of business is to transform possibilities into reality. And that means being practical, undertaking focused research, and testing the different possibilities in real commercial markets. The energy business is now global, which offers a tremendous advantage: international companies access knowledge around the world and apply it quickly throughout their operations.

But the business sector cannot succeed in isolation. Harnessing business potential requires fair and credible incentives to drive the process of innovation and change. In responding to global warming, that role must fall to the government. Neither prescriptive regulations nor fiscal interventions designed to collect revenue rather than to alter behavior provide the answer. Rather, governments must identify meaningful objectives and encourage the business sector to attain them by using its knowledge of technology, markets, and consumer preferences.

Recent experience suggests that emissions trading regimes -- whereby government sets a binding cap on total emissions, dividing the total into "emission credits" that are given to those who emit carbon dioxide -- are the best policy for encouraging business. Policymakers (notably in the United States) have demonstrated that it is possible to design such systems for other pollutants, such as sulphur dioxide, thereby harnessing the power of innovation and the flexibility of the market to protect the environment, while avoiding crippling costs. The same insights should apply to carbon dioxide. A well-designed trading regime would include a strictly enforced cap, which would make carbon dioxide emission credits scarcer (and thus more valuable) and would thereby increase the incentive for business to control emissions. Such a system would also allow firms and households the flexibility to apply resources where they have the greatest impact, which is essential, because the best measures for controlling carbon dioxide are hard to anticipate with precision and are widely dispersed across the economy. And a credible emission trading system would create incentives to invest in radical new technologies, the kind that will be crucial in building a carbon-free energy system in the future.

Emissions trading systems need not be identical in every country, nor be applied universally from day one. The political reality is that we are unlikely to see the sudden emergence of a single regime; in scope and ambition, that would be comparable to the emergence of a single global currency. Instead, progress is much more likely to come through the gradual process of knitting together diverse national and regional efforts on the basis of their track records of experience and achievement. The key task today is to find practices that will lead to a system that will enable today's diverse and fragmented reduction efforts to be valued on a common basis. The history of trade liberalization over the second half of the twentieth century shows that gradualism can yield impressive results.

At present, the nascent European emission trading system -- which will start running on a trial basis in 2005 -- is the most advanced example. Built on sound monitoring and verification policies, the system is the centerpiece of the European effort to implement the commitments adopted at Kyoto. Yet there are still hurdles to be cleared if it is to be fully operational by 2008, as planned. The process for allocating emission credits is not yet complete. And the system will cover only about 40 percent of Europe's emissions as it stands -- mainly those from industry. The potential for extending the scope of the trading base is indeed considerable, not least through the incorporation of effective incentives that will reward businesses whose investments reduce emissions outside Europe, such as in Russia and the emerging market economies of Asia -- where large and relatively low-cost reductions of emissions are possible.

Markets are emerging in other regions as well. The Chicago Climate Exchange, opened in December 2003, involves 19 North American entities that have agreed to reduce their emissions by one percent per year over four years. Canada may yet create a market for carbon dioxide as it aims to meet the Kyoto targets. And U.S. states have become laboratories for innovation and change. For example, Massachusetts, New York, and New Hampshire are adopting rules that will spur the creation of market-based emission trading systems. Voluntary systems for measuring emissions -- such as one being crafted in California -- may also provide further foundations for emission trading. There is a strong argument for linking these efforts. U.S. policymakers should also consider establishing a transatlantic partnership to work toward a common market-based trading system.

Offering positive incentives is one key contribution that government can make to stimulate business. Another is organizing research. It is crucial to extend our understanding of the science of climate change: monitoring key variables with sufficient precision to understand both natural variability and the climate's response to human activity. A key target of such work must be to understand the precise connection between the concentration of carbon dioxide in the atmosphere and changes in climate. Such research must also advance our knowledge of available choices: with the clock ticking, we cannot wait for definite answers before we take action.

Government intervention must take other forms too. Transforming the energy system will require new technologies with risks that will be too high (and benefits too remote) for private firms to provide all the needed investment. This is one area in which the United States, with its outstanding technical capacity, should take a leadership role. Innovation will require an across-the-board infusion of resources for basic science and technology, as well as the development of a portfolio of key demonstration projects. The priorities for such work might include photovoltaic cells (which convert sunlight into electricity), fission reactor technology, energy from biomass, and the use of hydrogen.

Given the costs and risks involved in such investment, governments with common interests and common views of the future have every incentive to combine their efforts and resources. Fortunately, there are many precedents of international partnerships in innovation -- from high-energy physics to astronomy and nuclear fusion. The global warming challenge is different, in that it involves not only basic science but also the application of novel techniques through products that must withstand the test of competition. But that is why the program of research and development work should involve collaboration not just between different countries but also between governments and business.