Carbon Trading Scam?—French Firm Rhodia Cashes In Under U.N. Warming Program

Source:  Copyright 2008, Wall Street Journal
Date:  July 23, 2008
Byline:  Charles Forelle
Original URL

Copyright 2008, Wall Street Journal

 

A French chemical maker is reaping a potential billion-dollar windfall under a United Nations program intended to spur climate-friendly investment in the developing world, highlighting the challenges of using market forces to tackle global warming.

The company, Rhodia SA, manufactures hundreds of tons a day of adipic acid, an ingredient in nylon, at its factory here. But the real money is in what it doesn’t make.

The payday, which could amount to more than $1 billion over seven years, comes from destroying nitrous oxide, or laughing gas, an unwanted byproduct and potent greenhouse gas. It’s Rhodia’s single most profitable business world-wide. Last year, destroying nitrous oxide here and at a similar plant in Brazil generated €189 million ($300.5 million) in sales of pollution “credits.”

The laughing gas is big money thanks to the U.N.-administered program in which polluters in rich countries buy credits like Rhodia’s, effectively paying for the privilege of continuing to emit greenhouse gases. The money is meant to flow to poorer countries to develop clean-air technology — for instance, an African nation would get a financial incentive to build windmills instead of a cheaper, but dirtier, coal-fired power plant.

Rhodia’s experience shows that even a major Western industrial company can cash in on the pollution-trading program. The Rhodia factory in Onsan alone is slated to bring in more money, under the U.N.-administered program, than all the clean-air projects currently registered on the continent of Africa.

The U.N. system is designed to use market mechanisms — the trade in credits — to curb emissions in the developing world without stunting those countries’ economies. Critics say the system is flawed. The money from selling credits reduces the incentive for a relatively wealthy country like South Korea to adopt voluntary cuts of its own, they argue.

“Markets are incredibly powerful institutions,” says David Victor, a Stanford University professor who studies climate policy. But in some cases, he says, “you cannot create the right kind of market forces.”

Some also question the logic of paying hundreds of millions of dollars to Rhodia for installing pollution-control equipment that cost a bare fraction of that, about $15 million or so, to install. Simply paying for the installation of the equipment “could have done this an awful lot more cheaply,” says Patrick McCully of International Rivers, an environmental group.

RELATED DOCUMENT

• Take a look at Rhodia’s U.N. filing describing its project in Onsan.Rhodia points out its Onsan project was approved by both local authorities in South Korea and administrators of the U.N. program. Its projects prevent tens of thousands of tons of nitrous oxide — which is 310 times more potent a greenhouse gas than carbon dioxide — from floating into the atmosphere, the company says.

Philippe Rosier, president of Rhodia’s Energy Services division, says the company is committed to environmental protection and has pledged to cut its own greenhouse-gas emissions in France voluntarily by 30% from their 1990 levels by 2010. The company says its efforts world-wide cut the equivalent of 37 million metric tons of carbon dioxide a year; for more than half of those reductions, it says, it receives no compensation.

The U.N. defends its pollution-trading system, saying it helps industrialized countries meet their obligations to cut greenhouse-gas emissions in a cost-effective way. Regarding windfalls for companies like Rhodia, Conor Barry, an official at the U.N.’s climate secretariat in Bonn, Germany, says the U.N.’s objective is mainly to determine that any emissions reductions are “additional” — that is, they wouldn’t have happened without the financial incentives provided by the U.N.’s pollution-trading program.

Mr. Barry declined to speak specifically about Rhodia. In granting approval to this or any project, the U.N. is in effect concluding it will be “additional.”

Rhodia can claim credits for pollution-cutting at the Onsan plant thanks to international climate negotiations, conducted in the 1990s, that categorize South Korea as a “developing” nation. Under the global agreement known as the Kyoto Protocol, developing nations don’t have to curb their greenhouse-gas emissions, but they get a nice bonus if they do: Each ton of emissions cut generates a credit that can be sold through the U.N. program. Rich countries (most of which are required to cut emissions under the Kyoto treaty) can buy the credits in lieu of cleaning up what comes out of their own smokestacks. Individual European companies can also buy credits to meet their caps under European Union rules.

The U.S. hasn’t signed on to Kyoto. But U.S. lawmakers are debating implementing a similar pollution-trading system.

Today, South Korea’s designation as a developing nation looks outmoded. The country is an industrial powerhouse and home to global brands like Samsung and Hyundai. Per capita gross domestic product is roughly $20,000, putting it on par with Portugal, which is considered a “developed” economy under Kyoto.

South Korea’s economic muscle, combined with developing-nation status, means it has plenty of pollution to profitably cut. That has transformed South Korea into a hotbed of pollution-credit sales. So far, South Korea has received about 18% of all the credits issued world-wide.

Koreans say the rules are the rules, and the world agreed to them. “I can’t say the critics are groundless,” says Jung Jaesoo, 48 years old, who runs a consulting firm that advises Korean companies on how to qualify for credits. “But the Kyoto Protocol is a multilateral agreement. It is impossible to make only South Korea an exception now.”

Mr. Jung’s company, Ecoeye Co., has shepherded about a dozen projects to U.N. approval, among them wind, tidal, solar and hydroelectric power plants.

In credits received so far, South Korea is behind only China and India, two much poorer countries that have per capita GDPs of about $2,500 and $1,000, respectively.

“I think South Korea has great potential,” Mr. Jung says. There are still a number of industries, including semiconductors and flat-panel displays, that can sell credits, Mr. Jung says. “These industries produce a lot of greenhouse gases.”

South Korea’s experience is spurring pollution-credit prospectors like Mr. Jung to scour other countries in Asia, including Thailand and Vietnam, for easy pollution reductions.

Michael Hennig, who works in South Korea for a German trading firm and helped set up a deal to sell credits from a fertilizer factory, says he, too, has been peppered with inquiries. “It’s a good business, because the Western world is basically desperate” to purchase these credits, says Mr. Hennig. “If I would have more [credits], I think I could sell them all.”

The U.N.’s pollution-trading system doesn’t directly reduce the amount of greenhouse gas emitted to the atmosphere, since each ton of carbon dioxide cut in a developing country allows someone in an industrialized country to pollute that same amount. Rather, the idea is to transfer money to poor countries to encourage construction of environmentally sensitive factories and spur alternative-energy use. Otherwise, the argument goes, global greenhouse-gas emissions would grow more quickly as developing nations like China expand their economies.

Looming Deadline

One factor that’s spurred the rush into South Korea is a looming deadline: Many expect the country will be reclassified a “developed” country after 2012, when Kyoto’s current requirements end. That means extra urgency for companies to get credits now. Park Chun-kyoo, director of the South Korean environment ministry’s climate-change policy division, says it is “much too early” to say what will happen at international climate talks.

Critics say the system that funnels money to companies in places like South Korea is partly to blame. It sends signals that “are exactly the opposite of what we should be sending,” says Mr. Victor, the Stanford professor. For South Korea — a relatively wealthy nation — emissions cuts should be an obligation, not a windfall, he says. “It’s just part of being a responsible citizen.”

Western nations are likely to press for South Korea to be recategorized as developed. At this month’s meeting of the Group of 8 nations, officials from the U.S. pressed for Asian countries to promise to cut their own emissions as a part of a new climate accord to take effect after Kyoto.

Until then, the current pollution-credit program is likely to balloon. At the summit, G-8 nations committed to major emissions reductions, and the EU passed a measure bringing airlines into Europe’s pollution-trading system in 2012. Both moves will spur demand for more pollution credits.

No one has mined South Korea for credits as successfully as Rhodia. The Paris-based company was spun off in 1998 from Rhône-Poulenc, a French chemical and pharmaceutical conglomerate.

The subsequent years were unkind. Rhodia creaked under heavy debt. The ballyhooed recall early this decade of the painkiller Vioxx, after reports of heart problems, crippled Rhodia’s contract-drug-manufacturing business.

But by 2003, Rhodia managers had figured out that two of its factories — the Onsan plant in South Korea and the Brazil facility — were jackpots. For reducing one ton of carbon dioxide, the U.N. issues one credit. One ton of the more potent nitrous oxide yields 310 credits.

These credits are currently changing hands at about €21 on European markets, although prices can vary wildly because the market is relatively new.

Many adipic-acid plants long ago slashed nitrous oxide emissions. Indeed, the technology to burn it off was developed in the 1970s. By the 1990s, most adipic-acid producers in the U.S. and Europe started to voluntarily cut their emissions under pressure from environmentalists. Rhodia itself did so in 1998 at its plant in Chalampé, France.

But it had left its then-smaller Brazil and Onsan plants unmodified. At the time, “there was no obligation to do it,” says Mr. Rosier of Rhodia, the executive in charge of the credit project.

A Good Investment

The advent of credit sales under the U.N. program in 2004 made nitrous-oxide abatement lucrative. In 2006, Rhodia turned on the furnace to destroy the gas at the Onsan plant. The furnace cost roughly $15 million to install. It was a good investment: The plant is projected to generate more than nine million credits a year, and Rhodia is initially authorized for seven years of credits.

The Onsan factory sits in an industrial park that runs for four miles up the Korean coast, wedged between evergreen hillocks and the open sea. The plant is a gurgling network of boilers and centrifuges. A metal pipe carries the waste gas outside, where it is stripped of other pollutants, fed with natural gas and then burned off. An outside auditor checks emissions data, and every few weeks the U.N. issues new credits.

In the case of some greenhouse gases, the U.N. imposes constraints to combat the “perverse incentives” to run a factory simply to generate pollution credits, says the U.N.’s Mr. Barry. A few years ago, the U.N. came under fire after some Chinese plants started reaping huge numbers of credits for relatively small changes to their manufacturing process.

There are no such U.N. constraints on adipic-acid production, Mr. Barry says, since there’s demand for the finished product, given its importance in manufacturing nylon. “With adipic-acid prices, it’s not considered economically viable to produce the product” simply to generate pollution credits for sale, he says. However, he adds, the U.N.’s panel examines the situation regularly as prices change.

Currently, if adipic-acid production is a profitable business, it’s only barely. The average cost of producing adipic acid was just over $1,750 a metric ton in June, while the sales prices in the benchmark Chinese market were barely higher, at around $1,800 a metric ton, according to industry consultant PCI Nylon GmbH. That works out to a slim profit of roughly $50 a metric ton. “The economics of adipic-acid production are currently pretty awful,” says PCI’s Robin MacDonald.

The figures suggest that Rhodia almost certainly makes more money from selling pollution credits than it does from producing adipic acid. If Rhodia’s adipic acid at Onsan generates a profit of $50 or so a metric ton, that’s worth $7.5 million a year. The company is making much larger sums from sales of pollution credits: According to U.N. figures, Rhodia was issued more than 11 million credits for cuts in 2007; at the €15 price Rhodia says it recently has been getting, they are worth some €173 million ($275.1 million).

Mr. Rosier declined to comment on the relative profitability of adipic acid and pollution credits. He played down the financial significance of credit sales, saying the price of credits is highly volatile and could fall.

As to whether it is sensible for his company to reap rewards for installing pollution-control technology in a highly industrial country like South Korea, Mr. Rosier says the rules of the U.N.’s system were set by the Kyoto negotiators.

“We were not part of these discussions, we didn’t make the rules of the game,” he says. “We know only to work with the rules as they were set down.”