Energy Q&A Climate-Exchange Founder Richard Sandor

Barack Obama and John McCain agree on one thing: the need to cut carbon emissions. With both candidates backing that idea, smoke-spewing factories and power plants can expect big changes soon. Some have prepared by joining the Chicago Climate Exchange, a voluntary market that functions like the NASDAQ but trades emission rights instead of Google stock. Richard Sandor, an economist who's spent decades at the intersection of environmentalism and finance, founded the CCX—the world's first, and America's only, carbon market—in 2003. NEWSWEEK's Fareed Zakaria spoke with him about the exchange and the world's up-and-coming carbon emitters, China and India. Excerpts:

How does the climate exchange work?
The CCX is what is called a cap-and-trade system: there is a cap on the total amount of emissions. In our case, companies have to reduce emissions in the aggregate by 6 percent between 2000 and 2010. If any particular company reduces emissions more than that, they are free to sell those extra credits on the market. Companies that can't make the necessary reductions can buy somebody else's excess.

Why not just mandate that everyone individually cut emissions by 6 percent?
Let's say you're particularly good at reducing emissions—you can change technologies or switch fuels easily. And let's say I can't—I don't have the acreage around my plant [to make renovations], or it will take three years to get permits. I can buy your reductions until I'm capable of doing it. You get the same systemwide reduction, but it's done by those who can do it most cost-effectively and quickest.

Who's involved with the CCX?
We have 17 percent of the Dow Jones industrial average, including IBM, DuPont, United Technologies, Intel. We have 11 percent of the Fortune 100, including Ford Motor Co., Honeywell and International Paper. We have about 25 percent of the top power companies in America, including AEP, the biggest burner of coal in the Western hemisphere. We also have eight cities, from Chicago to Portland, and eight universities from Tufts in the east to UC San Diego in the West.

Why are they agreeing to cut emissions when there's no law requiring it?
Some do it because they see an easy way to make reductions [beyond the minimum 6 percent]. They can then sell the credit and make extra money. There are also many companies who just want to be involved in the process—if you're not at the table, you're on the menu. If there's going to be legislation, they want to get an early start.

They're betting America will institute a mandatory cap-and-trade system.
Exactly. Some companies, like Ford, joined because they knew they were going to be involved in other cap-and-trade systems around the world—they have manufacturing plants in Manchester and Marseilles and Japan, and they were operating in countries that were subject to the Kyoto Protocol [whose signatories must start cap-and-trade systems by 2008].

What has happened to the price of carbon in the United States?
The price of carbon started out at a dollar a ton. It hung around there for a while, but the world changed on Super Tuesday. When it became clear that all three candidates—Clinton, Obama and McCain—all favored a national cap-and-trade system, the price of carbon went from $1.90 to $7.

Economists like Joseph Stiglitz and Greg Mankiw say cap-and-trade is inherently susceptible to corruption.
They're very capable men, but I think they don't understand the on-the-ground reality.

Which is?
The first cap-and-trade program done on a massive scale came after the Clean Air Act of 1990, and required a 50 percent reduction in sulfur dioxide over a 10-year period. [Thanks to the economics of cap-and-trade,] the EPA estimates the current system costs $1 [billion] to $3 billion a year, as opposed to an initial estimate in the tens of billions. And the medical benefits associated with reduced health-care costs due to less lung disease will reach $120 billion a year in 2010. I know of no other program that has achieved this kind of cost-benefit ratio.

Wouldn't a straightforward tax be simpler?
I'd rather have the price set by the participants on a daily basis. I also think the cost of administering and collecting taxes would far outweigh the costs associated with the market. And the impact of a carbon tax will depend on how good your accounting firm is.

Most of the growth in carbon emissions is going to be in China and India. Will they have carbon trading soon? Companies there seem much less interested in the idea.
We have five Chinese members [on the CCX], and we have biogas projects in the poorest sections of India, in Kerala—

But can you get the Chinese and Indian governments to impose cap-and-trade?
I think it's going to happen the other way around: the private sector will lead and the government will ratify. We're now in the process of forming an Indian climate exchange. We've signed a memorandum of understanding with the China National Petroleum Corp. I don't think that India and China are quite as behind as many would have us believe, and I don't think Europe is quite as far ahead.

How can you be sure companies are making the necessary reductions?
We haven't had a problem. The monitoring technology is there. Will you find abuses? Yes, of course. Will there be people who put out misguiding earning statements, like Enron? Yes. Are there people who violate commodities laws? Yes. Does the [current financial] system still create efficiency and access to capital? Yes. So many tell you what can go wrong, instead of building things and learning by doing, as we have done in the capital markets over the last couple of hundred years. The European Union started as a steel and coal agreement; it took 50 years to become the European Union. I believe that's the model for a worldwide solution to global warming. I think it will follow the examples of past industrial and financial innovation, and that within 20 years it will have evolved into a worldwide system.