07/27/2011 02:11 pm ET | Updated Sep 26, 2011

The Fall and Rise of the Carbon Coalition

Since the Kyoto Protocol was developed in 1997, an unlikely new global partnership of bankers and environmentalists has emerged. I call it the Carbon Coalition, and while it seems like a very 21st century development, I actually trace its emergence back to the arrival of Reaganism in the 1980s.

Under Ronald Reagan, Americans began to see the market itself as a potential tool of government, something politicans could work with, rather than simply against (on the left) or for (on the right). With this shift, Reagan made it possible for Democrats, and their traditional constituencies, to change: It's safe to say that it was Reagan who begat Bill Clinton, who then begat Tony Blair. For better or worse, the political right, through success, made the left become more attendant to the values of market capitalism. This affected everyone in the Democrats' tent, including environmentalists.

Prior to Kyoto, the environmental movement in America could be divided into two groups: the hardcore legislative and regulatory wing, whose bearded wonks and crusading attorneys labored to use government to beat back corporate polluters; and the radical wing, who tried to call attention to environmental problems by disrupting the status quo, often adopting confrontational techniques, such as chaining themselves to trees.

Kyoto galvanized a third way: the environmentalist as financier. At Kyoto, the goal was reducing global greenhouse gas emissions, and its participants stressed the advantages of market-based solutions. The new world economy, they realized, needed to find ways to grow while not destroying the planet. Greenpeace and Wall Street finally had something in common: a potentially trillion-dollar international trade in emissions offsets. The Carbon Coalition was born. It immediately attracted the idealistic policy wonks who were uncomfortable with the stubborn intellectual limitations of the hardcore Greens and the cynical dreariness of Boomer Beltway insiders. Their work was cut out for them: They needed to create a brand-new international commodity marketplace for carbon emissions, convincing skeptical investors that this could be a multibillion dollar adventure. They also needed to lobby for legislation to establish the scheme.

Last year, thirteen years after Kyoto, the coalition endured its greatest defeat, when the climate bill that would have established a U.S. cap-and-trade system was defeated in the Senate after passing the House. At Carbon TradeEx America, a carbon-trading conference held in Chicago (before the Chicago Climate Exchange officially shut down), the sense of confusion and disarray was palpable. Various members of the Carbon Coalition blamed the Senate, the Obama administration, the Tea Party, and corporate lobbies that had, largely through the GOP, branded cap-and-trade as a recovery-killing carbon tax.

It would be easy now for the Carbon Coalition to disband, with the bankers jettisoning the frustrations of dealing with government entities and moving on to renewable energy investments and the environmentalists focusing their energy on international forest-preservation schemes for the developing world, such as REDD. The European Union's carbon market -- the world's only truly large emissions exchange -- is now under tremendous stress, after millions in emissions allowances were stolen from a Czech registry.

However, this would be short-sighted. There are still efforts underway to price and trade carbon, albeit without the dramatic creation of a national cap-and-trade scheme. A "backdoor" regulatory solution is being engineered by the Environmental Protection Agency, in the face of significant political headwinds. California is currently in the midst of working out the implementation of A.B. 32, a climate law that will enable the creation of a large regional carbon-trading scheme. In the Golden State, a classic standoff between environmentalists and corporate interests is taking shape -- a negotiation that's right in the Carbon Coalition's wheelhouse.

As a result of these and other developments, the Carbon Coalition needs to see itself not as a brief tryst between pragmatic Greens, rebellious but forever tied to the apron strings of government to make anything happen, and innovative investment bankers, always evading government to find their true home in some ideal unregulated market. Rather, the Carbon Coalition needs to persist as an alliance, one that will play an essential role in an overall American cultural transition away from segregation of interests and toward synthetic policy and market-making.

The temptation will be to focus on regulatory, rather than market-driven, responses to the U.S. cap-and-trade defeat. (The continued slow progress of international discussions, highlighted by the fairly quiet achievements of the UN talks in Cancun, will also drive this.) The EPA's efforts are Exhibit A.

But this is all antiquated thinking, a rollback to the years when the environmental movement looked to government to bolster its efforts, rather than making its case to the markets. In the past decade, sustainability has become a business reality. Consumers are demanding that companies aspire to a higher environmental standard, and this is compelling big players, even the likes of Wal-Mart, to actively participate in enhancing America's environmental equity. These days, business is actually taking an active role in defining sustainability -- because their customers are demanding it, even through the worst economic downturn since the Great Depression.

Multinational business leaders now need to step up. Many of them recognize that rising global competitors, especially China, are pushing aggressively toward carbon-constrained economies. Assuming that the United States does eventually take part in some kind of global agreement to reduce emissions, many businesses understand that the U.S. could become an importer of carbon credits, effectively running an offsets deficit with a greener developing world.

Their foresight has to be supported by the sophisticated bilateralism of a unified Carbon Coalition. Paradoxically, the Coalition must stay together by not defining itself around carbon exclusively. Some members of the coalition are moving in the right direction, transitioning away from a narrow reliance on carbon and stressing their commitment to "environmental services," such as water or forests. Like carbon, these natural resources carry with them untapped environmental value that can be assessed, monetized and subjected to financial innovation and introduced to new markets. A forest, for example, soaks up carbon, so could be traded in its capacity as a carbon sink.

The idea of the environment as an asset, something that can be quantified in terms of wealth and then shared with investors, may horrify those who consider the great outdoors and all that's in it to be a collective human trust. But the fact is that most of what counts as an environmental asset is owned by someone. The problem is that ownership may not imply that the asset has been properly valued. This is what the Carbon Coalition, version 2.0, can now bring to the table. It assessed the worth of a negative that we wanted to reduce -- CO2 -- and then devised ways for that negative to be transformed into a positive by the reliable magic of markets. Regrettably, it did not succeed. But there's opportunity now to use the same kind of thinking to create environmentally beneficial markets based on the the ecosystem itself, and in the process surge toward a dynamic second act.