Attorney David Hayes looks back at first year of European Emissions Trading Scheme

A market for carbon dioxide (CO2) trading has been active for nearly one year, with European businesses starting to reduce their greenhouse gas emissions. David Hayes, former deputy secretary at the Interior Department and the Global Chair of the Environment, Land and Resources division at Latham & Watkins, examines the effect of emissions trading thus far, and how it could affect U.S. companies. Hayes also discusses ongoing Kyoto Protocol negotiations in Montreal, regulations that allow countries to get credit for reducing CO2 in developing nations and regional climate efforts in the United States.


Brian Stempeck: Hello and welcome to OnPoint. I'm Brian Stempeck. Joining us today is David Hayes, former deputy secretary at the Interior Department, currently an attorney with Latham & Watkins who chairs the firm's Environment, Land and Resource Department. David thanks a lot for being here today.

David Hayes: My pleasure Brian.

Brian Stempeck: Now I hear today we have the COP [Conference of Parties] meetings coming up next month at the United Nations, basically dealing with global warming. I wanted to talk to you today about emissions trading. It's been in effect in Europe for almost a year and Latham & Watkins has been pretty involved tracking what's going on. How have you been advising the American companies in terms of what they're doing under this scheme?

David Hayes: Well Brian I've been advising American companies to watch very closely what's happening here in the international marketplace because it is frankly quite stunning in the speed at which the trading system has developed under the Kyoto Protocol. I think no one expected this much pressure this early to get carbon credits for the signatories of the Kyoto Protocol. And its meaning that a lot of dollars are chasing credits in a way that is leaving the United States out of the equation frankly, but it's very important for the U.S. to see what's happening because I suspect that before too long the U.S. companies will be part of this somewhere, one way or another.

Brian Stempeck: Now so far, use of the market has grown very quickly, about 200,000,000 tons of carbon have traded hands so far. Is there a sense yet on who the winners and losers are?

David Hayes: It really varies tremendously. Let me set the stage a little bit Brian. The Kyoto Protocol requirements really kick in, in earnest, in 2008. And the 2008 to 2012 period is when you're going to see companies and countries really entering the marketplace in a big way to make up for the deficits that they have for their carbon equations if you will. In terms of who are going to be winners, who are going to be losers, many of the Annex One countries of the European Union, Canada, Japan, it looks like they're going to have a big deficit in terms of the carbon credits they need, even with lots of in country investment in energy efficiency of projects, renewables, etc. Morgan Stanley came out with a report within the last week or two that suggests there'll be a 1.5 billion ton deficit from the three major geographies, Canada, Japan and the E.U., per year, that's going to have to find credits somewhere. And the developing world is probably the likely place where they're going to come from.

Brian Stempeck: Are we just looking at a massive transfer of wealth from those countries to developing nations?

David Hayes: Well it's interesting, there's certainly a lot of investment in the developing country under the clean development mechanism, the CDM mechanism, which is now also getting under way and developing steam, although there's some bureaucratic issues that we can talk about, about that. But yes, a lot of investment. Transfers of wealth? Well many of the projects will stand on their own in terms of the economics. So they're actually, we think, investment opportunities for countries and investors including traditional project finance type opportunities in developing countries to develop renewable power, to develop methane from landfills, etc.. Projects that may make sense and are certainly not the traditional just hand over of dollars to a developing country.

Brian Stempeck: Now I was going to ask about these projects, the CDM projects as they're called. It's a very bureaucratic process. It's very complex. Give us a sense so far what's been happening in the past year? Where have these projects been going into effect? Basically the idea here is the developed country builds a project, a hydropower or wind power project in a developing nation, and then gets credit for it for its own emissions. Where has that been working so far?

David Hayes: Well we're very early in the process. The CDM executive board in Geneva, which is an arm of the United Nations under the Kyoto Protocol, has the final say on certifying projects and the emissions reductions that come from them. It is very bureaucratic as we talked about. What are we seeing so far? Well an incredible avalanche of new applications going in. To date we've had only a handful, actually less than five projects actually certified. About 30 are registered with the board. There are 400 in line. There's a Reuters report here, within the last few days, that said that within the last two weeks 200 more were added. What are these projects? They vary a lot. There are a lot of small hydro projects. Methane is popular, methane from landfills because the greenhouse power of methane is about 21 times that of carbon dioxide. So you get a lot more bang for your buck if you will. And I also think you're going to see more renewable energy, etc. Just within the last week, for the first time, it looks like an afforestation project, a natural carbon sequestration project, may get approved in the Pearl River Basin in China. So it's a very vibrant time for CDM projects. We're right at the front end of it.

Brian Stempeck: First it seemed like it was the countries who were pushing those. Now we're seeing more private investment get involved.

David Hayes: Right.

Brian Stempeck: The big question here is who's actually making money off this so far? Emissions trading has been in effect for about a year. And as you said the harder targets don't come into effect until 2008, but before then, who are we going to see a stepping up and really making money off this scheme so far?

David Hayes: Well I think you're going to see entrepreneurs. There is an enormous amount of activity in the project finance market and a lot of examination of potential CDM opportunities. Now these CDM projects tend to be much smaller in terms of capital intensity than your traditional project finance project. So there's an open question about whether and how much the big investment houses will get involved in CDM projects. However, there's a lot of interest and funds are developing to basically try to replicate small projects that have similar characteristics, back them with big dollars through investment funds that are backed by some of the big investment houses. And go with it. And then have developers who are quick on their feet, who are skilled in the developing world of Latin America, India, China, whatever, implement them. And that is happening. We are advising clients all the time on this, many times through our European lawyers, through our Asian lawyers who are the first stop because that's what the activity is right now.

Brian Stempeck: Looking domestically at what's been the response of some of your clients, I mean we've seen some of these regional plans go into effect, the regional greenhouse gas initiative in the Northeast.

David Hayes: Right.

Brian Stempeck: Talking about capping emissions there. California has its own plans, as do other Western states. How are you advising your clients in the United States and what kind of advice are they looking for right now?

David Hayes: Well there are two different types of clients here in the U.S. There are clients who have subsidiaries or parents that are in Kyoto nations, signatory nations, and therefore they're part of it. And we're helping them in terms of dealing with the obligations that are arising for those subs and parents. In terms of indigenous U.S. companies and their U.S. operations we're suggesting that they track their emissions, that they start getting their house in order because this is coming. And I think the sophisticated U.S. companies, in terms of what they're feeling about this, I would say the word that comes to mind is anxious. They know its coming. And there's a sense and I think there's a good reason for the sense that perhaps the Kyoto countries are getting a leg up because the early projects are going to be the ones that perhaps deliver the best bang for the buck. The low hanging fruit if you will. The early projects are going to chase after the easily obtained carbon reduction credits. And the U.S. is not in that game.

Brian Stempeck: At the same time though, is there a sense of the Kyoto Protocol is not going to keep on going? I mean with this conference coming up at the U.N. there's a lot of talk about what's going to happen after 2012, after Kyoto runs its course. And there seems to be a lot of skepticism that the world is really ready for another treaty or another step.

David Hayes: Right. And I agree with that Brian actually. And as your listeners probably know the Kyoto Protocol has not yet decided if you will, the nations signing it, have not decided what will happen after 2012. We know the overall reductions through 2012, but then there's a cliff. So that's one major open question. It will be very interesting to see in Montreal, in the meetings that are coming up, if there's any progress on that issue. I suspect there won't be for a while. There also are problems with the bureaucracy that's developed under the Kyoto Protocol. And I refer to the CDM executive board and the five step process that you have to go through between project design and finally getting certified emissions reductions credits will make anyone blanch, even the U.S. companies that are used to some tough regulatory environments. I think there will be a lot of opportunities for fixing. And frankly that playing field suggests to me that the combination of the 2012 cliff and the fact that the system is going to need to be retooled, suggests there may be an opportunity for a newer, different, better, international response to climate change that will probably have some of the fundamental features of Kyoto, the cap and trade system, but perhaps in a way that's palatable to the United States and that is new and improved. My speculation.

Brian Stempeck: Taking that step further, in the coming year what do you see happening from Congress on climate change? That seems to be the big question right now.

David Hayes: Well, it will be interesting to see what happens next year, an election year. Obviously we saw a significant shift this year with climate change going from a verboten topic to one that everyone's talking about basically. And that the Senate came very close to endorsing, with Senator Domenici showing a lot of interest in it, among others, and Ted Stevens, etc. You've got the dynamics, the assumption that the Bush administration will be able to keep a lid on all of this I think is fading. And next year, I don't know what it will bring, but I'm sure by watching E&ETV we'll find out.

Brian Stempeck: All right. We're going to stop there with a little plug for our own TV show. David thanks a lot for being on the show.

David Hayes: My pleasure.

Brian Stempeck: I'm Brian Stempeck. This is OnPoint. Thanks for watching.

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