Imagine a time in the not-so-distant future, when countries trade the value of the carbon locked up in healthy rain forests as easily as a barrel of crude oil.

With no intention of ever cutting down their rain forests, the carbon value locked up in the trees could provide national income for countries in the global commodities markets of tomorrow.

Some countries have already taken steps toward such a system by evaluating their forests, in anticipation of a global carbon trading market that is already being established.

This vision of economic empowerment based on atmospheric pollution trading may be the next chapter in economic and environmental history.

Trading this commoditized carbon is done through a “futures contract” — an agreement to buy or sell a commodity sometime in the future.

Previously, futures trading was limited to the physical, deliverable and easily comprehensible: cattle, pork bellies, wheat, soybeans etc. This allowed farmers to secure favorable prices for crops still in the fields. In return, farmers gave up some of the potential profit — or loss — the unharvested crops might have realized at market.

But now atmospheric pollution futures trading in the U.S. also exists for carbon dioxide (CO2) and sulfur dioxide (SO2) in a system gathering steam among environmental groups and corporations alike.

No Longer Free Goods

The foundation for today’s pollution futures market was laid by policymakers who believed that by extending property rights to environmental goods and making them sellable, new markets would be created.

Instrumental in realizing the potential of pollution futures is Richard Sandor, currently the Chairman and CEO of the Chicago Climate Exchange.

“Air and water are simply no longer the ‘free goods’ that economists once assumed,” Sandor said in a 1992 interview with the Wall Street Journal. “They must be redefined as property rights so they can be efficiently allocated.”

At a 2005 Milken Institute Conference, Sandor said, “The right to use water or air is more valuable than food, and we can use the price system to allocate that right.”

Changing of the Guard

Under the previous “command and control” system of regulations, all polluters had ambient air quality standards imposed on them. Failure to comply brought fines and legal penalties. Environmentalists often complained that this system made it cheaper for polluters to pay the fines and keep polluting, rather than invest in cleaner technologies.

Sanctioned by the Environmental Protection Agency, a new era began in 1993 when the first annual auction of air emission allowances, or pollution rights, was held at the Chicago Board of Trade. On that day, 150,000 sulfur dioxide allowances were sold for $21.4 million.

With the new “cap and trade” system, firms (mostly electric power plants) are allocated annual pollution allowances. The total number of these SO2 pollution allowances is capped. Allowances are allocated only by the EPA on a per-plant basis based on emissions rates and previous levels of fuel (coal, oil, etc.) use. As a result, polluting companies may either purchase more allowances on the open market from less polluting companies or reduce their own emissions. At year’s end, total emissions for any one polluter must be accounted for by all their SO2 allowances, either unused or purchased on the open market. Unused allowances may be sold on the open market for a profit or “banked” for future use.

“A Major Environmental Achievement”?

Currently, the Environmental Defense Fund is a strong supporter of cap and trade pollutions futures trading. And according to a CBS News story in 2005, Greenpeace has acknowledged that atmospheric futures trading would allow Japan, Canada and Australia, among others, to meet Kyoto emissions-reduction targets.

Still, some environmentalists criticize that pollution trading systems do not actually reduce pollution. Since pollution levels are set byregulatory mandate and not by the trading itself, that analysis may have some truth to it.

In the current system, markets do not encourage industry to reduce emissions. The role of the market is to provide an efficient and cost-effective mechanism for trading to occur. In the U.S., the government mandates limits and reductions on emissions. The market is one tool to help industry meet those goals.

The establishment of the Chicago Climate Exchange (CCX) in 2004 requires its members to adhere to legally binding emissions reduction targets. According to the exchange, this reduction in CO2 represents a total emissions baseline of 226 million metric tons of carbon dioxide — equivalent to the United Kingdom’s annual allocation under the European Union’s trading system. That would make the Chicago Climate Exchange one of the largest “countries” in the EU’s CO2 market.

“Our goals are not modest,” said Sandor in U.S. News and World Report, referring to the Chicago Climate Exchange’s CO2 reduction commitments. They are “a major environmental achievement.”

Part of the 1990 Clean Air Act Amendments also called for the establishment of a sulfur dioxide emission trading program. SO2 is a major component of acid rain associated with emissions from coal-fired electric power plants. The Clean Air Act says that electric utilities are required to reduce SO2 emissions by roughly half from their reported 1980 levels by the year 2010, with a permanent national cap just below 9 million tons of SO2 annually. More than 3,200 plants and utilities are now regulated under the Clean Air Act.

Corporate Compliance

“Corporate involvement in the Chicago Climate Exchange has been driven partly by the expectation of some future, government-imposed emissions-reduction programme in America,” according to a 2002 article in The Economist.

One expert estimates that the financial potential of the U.S. carbon trading market is somewhere between $100 to $500 billion, according to an editorial by Roger East in the UK magazine Green Futures.

“Trading is going to make the costs of reducing greenhouse gas emissions cheaper and easier. That’s what markets do best and forward-looking companies are realizing this,” said Jonathan Lash, president of the World Resources Institute in Washington, D.C. and a former member of the Chicago Climate Exchange’s advisory board.

A subsidiary of the Chicago Climate Exchange, the European Climate Exchange, established two affiliated branches in Europe that trade CO2 futures, giving atmospheric futures trading an international reach. European factories have had to comply with emission-reduction mandates that began in January 2005. The European Union rules are expected to lower CO2 emissions by 3 percent annually and are expected to create additional demand for CO2 futures.

It doesn’t take much for the market to have an impact. “We’re the biggest emitter in the world by far,” Sandor told The Economist. “So even a small percentage change becomes significant.”