I recently sat in a meeting with a group of decision makers at a local university. They were deciding what improvements to make to their thermal distribution system. The tool that a large organization like this uses when deciding between two options for a large capital improvement expense is a Life Cycle Cost Analysis, or LCCA.

One of the people in the room asked me, the person who had done the LCCA, how environmental benefits of the project were figured in.

"Well, the university is currently paying for NOx credits. This project will reduce NOx emissions, so that cost savings was figured into the analysis."

"What about other reduced emissions?"

I shrugged. "While that might have some value to you from a marketing standpoint, no marketing analysis of green benefits was provided, and that is outside our scope, so there is no benefit given in the LCCA."

When we talk about cap and trade programs, this moment is what we are talking about. the moment where decisions are being made about energy projects. I don't know if the man I was talking to was able to put the following thoughts together, but I'm going to spell them out here.

There are already cap and trade programs around the country. Here's one in Texas - specifically, the one I referred to above, when I mentioned NOx credits. NOx - that'd be nitrous oxides - contribute to the formation of ozone in the atmosphere. The effect of high levels of carbon dioxide may be contentious, but nobody argues about the effect of high levels of ozone.

This cap and trade program is able to apply a specific dollar amount to the cost of the emissions. If you want to emit NOx, then you have to purchase credits on the open market. And the cap ensures that only a certain number of credits are available. This means only a certain amount of NOx will be emitted - and its an amount that can be reduced over time by reducing the number of credits available.

This allows the cost of environmental pollution to show up in an economic analysis of a project.

But no such mechanism for carbon exists. And despite all the incentives that exist for alternative energy technology, it turns out that not a single one of them applied to this project that would directly reduce fossil fuel consumption and carbon dioxide emissions. Incentives are just the wrong tool to use to get energy efficiency projects implemented. The only way to reduce carbon emissions is to include the externality cost of these emissions into the cost of energy.