Global Climate Change: Economic Implications & Opportunities for the U.S. and Japan

December 5, 2007

J. Patrick Adcock
, Senior Vice President for Environmental Markets, World Energy Solutions, Inc.
Kevin Butt, General Manager and Chief Environmental Officer, Toyota Motor Manufacturing North America, Inc.
Takamitsu Sawa, Professor, Kyoto University & Ritsumeikan University

Howard Margulis
, Partner, Troutman Sanders LLP

A distinguished panel of environmental experts met to explore business solutions to global warming and the challenges of sustainable development.

At an international conference on Asia this past spring, then Prime Minister Shinzo Abe proposed that the world's countries aim to cut global greenhouse-gas emissions in half from current levels by 2050, observed panelist Takamitsu Sawa, Professor of Economics at Kyoto University and at the Graduate School of Policy Science at Ritsumeikan University. Under Mr. Abe's plan, unlike the 1997 Kyoto Protocol, all major GHG emitter countries, not just the developed world, would be required to participate. China, India and other developing countries would set a baseline year of 2010 and commit to restrain their emissions growth to some set percentage, not specified, in the decade running up to 2020.

In his speech, Mr. Abe argued for the creation of "a flexible and diverse framework" that would take into account the circumstances of each country, as well as a "new financial mechanism" to support the efforts of developing countries; he also urged that Japan launch a national campaign to reduce its own CO2 emissions by one kilogram per person per day, from current annual levels (including industrial-sector emissions) of 9.9 tons per person.

"It was the first time that a Japanese prime minister had made such in-depth remarks about GHG emissions reduction," Professor Sawa commented.

Can global emissions indeed be cut in half by 2050? The prospects for success are respectable, Professor Sawa suggested.

Because of forthcoming population declines, Japan can cut its own greenhouse gas emissions quite a bit just by keeping emissions per capita at current levels, he said. If existing technologies for carbon dioxide capture and storage, or CCS, are put to use on a global scale, that could slash worldwide emissions by 30 percent by the target date. The remaining 20 percent cut can be accomplished, in his view, through wide-ranging adoption of energy-efficient technologies already developed by the Japanese manufacturing sector.

"A serious problem is how we are going to secure sources of power supply," whether through nuclear plants, renewable sources like solar and wind energy, or coal-fueled power plants that use CCS to reduce their CO2 emissions to zero, Professor Sawa continued. Although oil now in the ground isn't likely to run out before 2050, "it is quite certain that the oil price will be at least more than doubled" by that date; because of this, gas- and diesel-fueled cars will become a thing of the past, he predicted, replaced by electric- or fuel-cell-powered vehicles, and airplanes and ocean-going vessels will use renewable bio-fuels.

The Kyoto Protocol set an overall target for the developed countries of a 5 percent emissions reduction by 2010, measured from a 1990 baseline, with separate targets for each country and region, he noted: 8 percent for the EU, 7 percent for the U.S., 6 percent for Japan, and 0 percent for the former Soviet Union and Eastern European countries. In his view, a post-Kyoto protocol is likely to set a developed-countries reduction target of at least 10 percent by 2020, again from the 1990 baseline.

"In order to have the U.S. 'return' to the protocol," he said, "it is essential to establish joint international research and development organizations for large-scale technologies against climate change," the International Thermonuclear Experimental Reactor being one example of the kind of joint effort that's needed.

China and India "still oppose aggressively" the inclusion of any restraint on their emissions, although China has said that it aims to lower its emissions-to-GDP ratio by 20 percent over the next five years, evidence of a growing concern for environmental issues there, he stated.

What are the incentives for China and India to participate in a protocol such as Mr. Abe outlined? One is the right to be a host nation for joint implementation, or JI, activities, Professor Sawa said.

Host nations receive foreign currency by selling emissions rights to investing countries, such as Japan, that aren't able to reach their required targets domestically, he explained. JI programs trade existing emissions rights, unlike clean development mechanism, or CDM, programs, which generate new emissions credits. Thus JI projects are simpler to set up than CDM projects; the latter must be approved as such by the United States CDM Board of Directors, whereas JI projects need only the agreement of the two nations involved.

Panelist Kevin Butt of Toyota Motor Manufacturing North America said his company aims for 100 percent compliance with EPA rules and a perfect record in the community: "no complaints from the neighbors," as he put it.

"I have to tell you that we had one noncompliance this last year," Mr. Butt said. "For a company our size, that's pretty incredible, except that I work for Toyota and it's unacceptable. When we have a noncompliance or a complaint, I get notified within 24 hours of the event and I have to notify the president of Toyota Motor Corporation within 24 hours. The response is a lot quicker than 24 hours coming back the other direction. So, it's taken very seriously."

To make sure everyone at Toyota is held accountable, "we publish targets for you to follow and watch for in all the major areas--air, water, waste, VOC reduction and so forth"; company audits check on progress, and Toyota ties a portion of employee bonuses and merit raises to whether targets are met, he said.

The introduction of water-borne paint has yielded tremendous reductions in emissions of VOC, volatile organic compounds, in the vehicle body painting process, he said, and cutting down on waste saves the company some $1.3 million to $2 million annually. The Georgetown, Kentucky plant produces over half a million Camrys, Avalons and Solaras each year, yet zero waste goes to landfills. Organic materials from the company's six cafeterias go to an onsite composter, and with the resulting compost, employees grow vegetables in a garden on the company's property.

Vehicles are being designed to make disassembly simpler, so that parts can be reused and recycled, he indicated. In the new Raum, currently sold only in Japan, Toyota has attached a dismantling belt to the electrical wiring network; pulling hard on the belt disengages the network from the grounding terminals for easy removal. "In Japan right now we have a site that actually will disassemble a car and actually pick the car up and drop it into a grinder," with the end products separated magnetically for recycling, Mr. Butt said, and he hopes to bring this system to the U.S.

It's not a foregone conclusion that energy reduction equals CO2 reduction, or vice versa, he said, but Toyota is making this work. Through measures such as turning off lights and improving efficiency, BTUs per vehicle used in the manufacturing process are down 17 percent, and CO2 emissions are down 20.5 percent from fiscal year 2002.

"The question that everybody likes to ask--whatever we do in manufacturing, our products still have a contribution to what CO2 goes out there," he said. "Since 1997, hybrids have emitted approximately 3.5 million fewer tons of CO2 than conventional vehicles of the same class," with additional savings achieved through variable valve timing, high-efficiency diesel systems and more aerodynamic designs.

Toyota puts its environmental know-how to use well beyond its own facilities, Mr. Butt noted. "One of the fun things in my job is that I get to work with the Galapagos Islands," 600 miles off the coast of mainland Ecuador. "Toyota has no manufacturing in the Galapagos, as you can imagine. We don't sell any cars--well, that's not true. I saw one Toyota truck on the island. We don't have a sales department down there. But what we're doing down there is helping the island" in partnership with the World Wildlife Federation.

"A lot of you don't know, but in the Galapagos there is a human element and they have an impact to the islands," he said. "They used to dump their oils in the bay when they changed it out of their boats. We recover all of the oil now. We are recycling that oil. We are also segregating waste" to limit the impact on the region's fragile ecosystem.

Long-term sustainability rests on the 6 Rs, Mr. Butt concluded: reduce, reuse, recycle, recover, redesign and remanufacture. "And hopefully as we progress in that area there is actually a way that we can improve our shareholder support as well, because it's simply the right thing to do."

During the 1970s, the key drivers of global energy markets were energy security and oil prices, said Rick Adcock of World Energy, an energy brokerage company based in Massachusetts. In the decade that followed, as investments in energy efficiency and new, non-OPEC oil supplies brought lower prices and reduced security concerns, environmental issues such as urban smog and acid rain came to the fore.

In the U.S., the Clean Air Act Amendments of 1990 integrated emissions trading for the first time; although the U.S. ultimately did not sign the Kyoto Protocol, "we were very active in the negotiating process in the '90s during the Clinton administration," and it was through American involvement that emissions trading became part of the Kyoto structure, he said.

With 9/11, energy security became a major concern again, he continued. In 2005, the EU launched its Emission Trading Scheme, which is the largest emissions trading market on the planet. Trading volume was $30 billion last year and is expected to reach $60 billion this year.

It now appears likely that the U.S. will join in a post-Kyoto regime for 2013 and beyond, he reflected, "and so we are at a point right now in this transition to a new energy economy that we've never been in before, and it's extremely exciting and a lot of things are going to happen."

"If you've got five years' worth of memory, you might sort of worry we're in a dotcomesque kind of bubble," and there are ongoing debates for example over the true value of recent investments in ethanol, he said. But this is a unique time, when all three forces, security, oil prices and the environment, are creating big pressures in energy markets--"and that is going to be affecting things for a while to come."

Carbon intensity, measured in units of CO2 per unit of GDP, declined between 1980 and 2005 in both Japan and the U.S., but total greenhouse gas emissions rose for both countries, though more for the U.S. than Japan. Japan generates about 60 percent of its electric power using fossil fuels, 30 percent from natural gas, 30 percent from coal and a small fraction from oil; in the U.S., some 70 percent of electric power comes from these fuels, 20 percent from natural gas and 49 percent from coal. With huge reserves of coal in the U.S., he said, "the U.S. in particular is looking at carbon-capturing storage as a way toward the future," but much research is needed to understand how long the carbon would actually remain sequestered underground and what will happen when it escapes: the U.S. Department of Energy is doing a lot of work on this, but "it's not really a well-understood science yet."

Two types of credits are traded in the EU emissions trading market, Mr. Adcock explained: allowances, meaning government-issued rights to pollute, and clean development mechanism (CDM) credits, which represent the monetization of emissions avoided through clean-energy and pollution-containment programs in the developing world.

A European Union allowance is the right to emit one metric ton of CO2 or equivalent greenhouse gas. "Everybody knows what that is. It's like a dollar bill. It's got the full faith and credit of the government that issued it behind it, so companies can trade those pretty freely," Mr. Adcock said, and about $25 billion in allowances traded in the EU market last year.

The first two years of the EU system, 2006 and 2007, were a practice period, and "the caps were set too high"--the allowances market literally collapsed. It's now recovered, and allowances to pollute during 2008 through 2012, which is the Kyoto Protocol compliance period, are trading now at about 22 or 23 euros a ton; "that's pretty high," he commented.

India got off to a quick start with CDM projects in 2004, although China has since surpassed India and is now the number one source of CDM credits, he said; project-based credits are currently trading in the EU system at 16 to 18 euros per ton, with about $5 billion worth traded in 2006. In Japan, NEIDO, the New Energy and Industrial Development Organization, is committed to buying some 100 million credits over the next few years at about 20 euros per credit.

Project quality varies, and buying project-based credits is more complicated than buying allowances, because CDM credits must be documented, approved and certified at national and international levels, Mr. Adcock noted.

"The Japanese industrials and energy companies are big buyers of these credits, and to the extent that there is a cap and trade program in the U.S., which is what the bills before Congress right now are talking about, we will be participating in these markets as well; when the U.S. comes on the scene, it's going to increase demand tremendously overnight," he said.

Worldwide, emissions markets are immature, with a churn rate--the number of times a credit trades before it is used up--of about four, versus a churn rate of 18 for a barrel of oil. They're also fragmented, with separate U.S. markets being established in the Northeast, the Rocky Mountain states and California, none as yet integrated with the EU or other systems. "Somewhere along the line, all of this is going to have to come together in a global market," Mr. Adcock concluded.


Presider Howard Margulis of Troutman Sanders began the Q&A:

I'd like to have each of you talk about your expectations for the Bali conference on climate change.

"I think what we expect out of Bali is a process--a roadmap for the path forward towards the post-2012 regime that will address the climate issue," responded Mr. Adcock. "It's not lost on anybody I think in this room, at the negotiating table, or anywhere else, but there's going to be an administration change in the middle of this in the U.S., and that's going to have a huge impact on the outcome."

"I don't think we're going to see any really significant conclusions," Professor Sawa cautioned. Getting India and China to participate, "that's the kind of direction I would like to see."

Mr. Butt expressed agreement with his colleagues on the panel, and added that he expects the parties to come up with a platform for sharing a broader knowledge base and to push for more data verification.

It's been suggested that the U.S., rather than creating an allowance target, should create a clean tech sector to solve our problems as the largest emitter country. How do you view this?

"It's probably one of the most exciting areas of development," Mr. Butt replied. Toyota has developed a fuel-cell vehicle that works in cold temperatures and under high vibration, and "the problem a little bit with that is we need the infrastructure to support that within North America. We have to catch up."

"My first job out of college was a place called the Solar Energy Research Institute," said Professor Sawa, and "we are still bringing the technologies along," with Sharp developing cheap, ultra-thin solar batteries. Tax incentives and other mechanisms are important, in his view, to ensure that new infrastructure has the best available conventional technologies. "You're building it today--it's going to be here 40 years from now," and in all likelihood emitting the same greenhouse gases then as now, he added.

What do you think will be the overall shape of carbon policy after the U.S. presidential election in 2008?

Cap and trade, said Mr. Butt; Mr. Adcock agreed.

The audience joined in the conversation:

In 2050, what will be the market share of the various energy sources--nuclear, coal, biofuels, solar and wind?

It will vary country by country, especially for nuclear energy, answered Professor Sawa. "We have a nuclear allergy in Japan," and thus "it's hard to envision it over 50 percent." As for solar and wind, "I would like to appeal to my government to really work hard. Let's be at least 20 percent renewable energy." Coal, of which Japan has about a 200-year supply, can be made much cleaner, and Japan should also work hard on mass transit.

Mass transit is something Toyota is working on in California, Mr. Butt noted. "I really can't tell you where I think the market share will be, although I think in the U.S. clearly nuclear and coal are going to dominate that market for a while."

"Speaking for myself, more nuclear," commented Mr. Adcock. "Less gas, because we're going to need the gas as a feed stock for industrial chemicals at that point in time. A lot of coal, but the coal is going to be liquefied and gasified"; more renewable energy; and "more liquid fuels derived from biomass resources, but a little more sensible resource than corn."

If the CAFE restrictions get tougher, will that have an impact on Toyota--positive or negative--and what will Toyota do relative to that impact?

Just last night, Congress agreed to a CAFÉ target of 35 miles per gallon by 2020, and "I think Toyota is currently in a position to meet that" and will balance increased customer demand for Tundra pickup trucks with increases in hybrids, Mr. Butt commented.

Will India and China have an opportunity to move closer to per capita energy use in developed countries? What might or should be a solution for these countries?

"Environment is a tool of economic statecraft. We all know that," said Mr. Adcock. "Somehow there will be a deal, and it will have to accommodate the simple fact that development must occur to increase the standard of living in those societies, while at the same time on a planetary scale we're going to have to decrease greenhouse gas emissions for everybody, including the future."

"By transferring Japanese technology, western technology, developed country technology to the developing countries," Professor Sawa reflected, it may be possible for the developing countries to raise their standard of living without increasing their greenhouse gas emissions as much as Japan has over the last 30 years and other industrialized countries over the last 100 years. This could yield perhaps a 20 percent improvement; "and Indian and Korea--if they put CCS technology into their coal-using facilities, we should see some improvement there."

"I don't think we can expect a developing nation to be able to afford the highest priced technology to reduce greenhouse gas," agreed Mr. Butt. "There needs to be a global assist in those developing countries, to give them subsidized improved technologies so that they don't have to start working their way from the lowest technologies to the highest technologies. I think that's clearly going to have to be part of the solution."

--Katherine Hyde

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