It isn't cheap being green.

We need to remember that as we search for the best way to limit greenhouse gas emissions in the U.S.

For most policymakers, the debate of whether to control emissions such as carbon dioxide is over. The question is how to pay for it.

In an attempt to bring financial incentives, rather than penalties, to environmental regulation, cap-and-trade markets are emerging to trade carbon credits. The latest is the Green Exchange, set up by the New York Mercantile Exchange, which had its first trade in March.

At the moment, it's catering to voluntary contracts by U.S. and European companies.

"If you want to make a real and significant reduction in emissions, you need innovation, and that can't happen without a cap-and-trade system," Nymex Vice President Tom Holleran said during a recent visit to Houston.

Here's how it works: The government sets a limit on the country's total carbon output, then issues permits to companies in 1-ton increments. Companies that emit more than they have permits for have to buy more. Companies that emit less could sell the extras.

In theory, the market would find the most efficient way to meet emissions standards, which the government would tighten over time.

It's supposed to be the best of both greens — money and the environment.

The biggest beneficiaries, though, may be the traders who buy and sell these credits.

Somewhere Grandma Millie, that fictional victim of Enron's electricity traders, is pulling her shawl close and holding on to her pocketbook.

There's an Enron-y feel to the whole cap-and-trade notion, which basically creates a market for companies to buy and sell the right to pollute.

Gaming the market

Markets bring the need for oversight and regulation, and yes, the opportunity for abuse. If traders could quickly learn to exploit regional markets for electricity, how long will it take them to game the hidden fortunes of cap and trade?

More important, why is it even necessary?

The goal is to reduce emissions as quickly as possible, not reduce them based on the gyrations of a market that, especially at first, will have little liquidity.

In other words, we don't need incentives, we need mandates. That means a carbon tax.

Unforeseen consequences

I raised the issue with Bruce Williamson, the chief executive of Houston-based Dynegy, which owns power plants, including coal-fired ones, around the country. It also used to have a sizable trading business.

"The best way to really reduce emissions is a straight carbon tax," Williamson said.

He supports a phased-in approach that would increase the taxes over time and force companies to lower their emissions.

Williamson worries that a cap-and-trade system will have unforeseen consequences, not just on generators, but on consumers.

"The volatility of cap and trade could lead to a consumer backlash without dealing with the issue," Williamson said.

Anticipating heavy electricity demand for summer, for example, companies may load up on carbon credits, causing the price of the contracts to spike.

Others could shift all their carbon credits to one region, increasing generation there while cutting back in another market, like some carbon-based version of Enron's Ricochet scheme.

Pricey contracts

When the European Union began trading carbon credits in 2005, most analysts predicted prices would stay at about $10. A year later, contracts were selling for $38, before they eventually plunged.

We're seeing something similar on the Regional Greenhouse Gas Initiative, a voluntary cap-and-trade market set up among Northeastern states. In anticipation of trading, prices last month traded well above the market's reserve price, according to the trade publication Climate Wire.

At the moment, most of the trades are being done by participants who want to test the market, to gain an understanding of how it works.

Keep in mind, those contracts can't be used for anything at the moment, so their value ought to be zero.

Hedge against policy

With no regulations in place, the contracts are little more than a hedge against future policy, a bet that Congress or the next president — and all the major candidates have said they favor cap and trade — will implement controls.

A recent study by the Congressional Budget Office found a tax would be five times more effective in reducing carbon emissions than a cap-and-trade market.

So why are we trying to create a complex system to make a tax appear as if it's something else? Why all the crunchy granola capitalism?

If we're serious about paying for this, we need a carbon tax.

No one likes taxes, but most people aren't fond of pollution, either, and reducing greenhouse gases isn't cheap.

It costs some green to be green.
