Pumping Green

Arnold Schwarzenegger, a Hummer-driving republican, is setting the environmental agenda with California's global warming law. Wall Street traders and Silicon Valley VCs are clamoring to cash in.

By Edward Robinson
Bloomberg Markets December 2007

Arnold Schwarzenegger needed help. It was Aug. 9, 2003, three days after the Austrian-born actor had stunned Californians by announcing his bid to unseat Gray Davis, the Democratic governor, in a recall election. Overnight, Schwarzenegger had morphed from a gun-toting action star into a leading contender to become chief executive of the world's eighth-largest economy. Now, he was rushing to form a platform.

Near the top of his list: global warming. "I did not come into this campaign as an environmental expert," says Schwarzenegger, who read aloud the conservation speeches of President Theodore Roosevelt and pored over research reports on his Gulfstream jet as he traveled east that August.

He was spending the weekend at the Kennedy compound in Hyannis Port, Massachusetts, with his wife, Maria Shriver, a member of late President John F. Kennedy's clan. After dinner, Schwarzenegger discussed his nascent environmental ideas with Robert Kennedy Jr., Shriver's cousin and an outspoken environmentalist. Kennedy put Schwarzenegger in touch with Terry Tamminen, founder of Santa Monica Baykeeper, a group that combats water pollution in Southern California.

Tamminen was skeptical. He'd raised money for Vice President Al Gore's White House run in 2000 and was critical of the Republican record--especially the Bush administration's rejection in 2001 of the United Nations' Kyoto Protocol to curb greenhouse gases. Now Schwarzenegger, 60, a Hummer-driving Republican, was asking a tree-hugging Democrat for advice. "The Republican Party hadn't covered itself with environmental glory," says Tamminen, 55, author of Lives Per Gallon: The True Cost of Our Oil Addiction (Island Press, 2006). "Then I thought, this man could be the next governor, so don't we want to make sure he has the most progressive policies? I decided to dive in."

Four years later, the "governator" has ushered in the Global Warming Solutions Act, the first U.S. legislation of its kind. The law, which Schwarzenegger signed on Sept. 27, 2006, requires California's industries to cut greenhouse pollutants such as carbon dioxide 25 percent, to 1990 levels, by 2020. Five states-- New Jersey, Minnesota, Washington, Oregon and Hawaii--have passed look-alike global warming laws this year. Three bills in the U.S. Senate and two in the House of Representatives are pressing for 14 percent CO2 reduction targets by 2020.

"California is the model," says Daniel Esty, director of the Yale Center for Environmental Law & Policy in New Haven, Connecticut. "Governors in a dozen states are now taking the issue seriously, and the groundwork is being laid for a federal policy."

Other leaders rang the climate alarm long before Schwarzenegger did. There was Gore, who called for environmental changes when he was vice president and heightened the debate with his 2006 documentary An Inconvenient Truth and his Nobel Peace Prize, which was awarded in October. Tony Blair, U.K. prime minister from 1997 to June, championed Kyoto. Yet, in a strange twist of fate, it's Schwarzenegger, a former bodybuilding champion who conquered Tinseltown by playing an unstoppable cyborg called the Terminator, who's writing America's global warming script. "I was very determined to prove that you could create economic growth and protect the environment simultaneously," he says. "I knew that my strength was being a Republican. I could win the business community over."

U.S. policy will create huge ramifications for the rest of the world: America is the No. 2 source of greenhouse gases, after China. If average global temperatures rise 3-10 degrees Fahrenheit (1.1-5.5 degrees Celsius) by 2100, as many scientists predict, California's snowpack in the Sierra Nevada mountains could decline more than 70 percent, jeopardizing the water supply for a projected 60 million people, according to the California Environmental Protection Agency. Deteriorating air quality, coastal erosion, pest infestation and monster wildfires could also convulse the state, the 12th-largest emitter of greenhouse gases in the world. Similar scenarios could befall entire continents, according to a 2007 report by the United Nations' Intergovernmental Panel on Climate Change, which shares the 2007 Nobel prize with Gore.

"I love tackling big problems," the governor said at a town hall meeting in Chico, California, in June. "I don't like incremental steps. I like big things."

Schwarzenegger's critics suspect his crusade is more Hollywood razzle-dazzle than a hard-nosed policy that will succeed in cutting carbon. Jamie Court, president of the Foundation for Taxpayer and Consumer Rights (FTCR), an advocacy group in Santa Monica, says the governor is an opportunist who seized on global warming because going green has become a popular issue with voters. Unlike Gore, who has been calling for action since the early 1990s, Schwarzenegger didn't present himself as a global warming warrior until 2005. "He deserves credit for pulling off a massive show," Court says. "But when the public doesn't see results, they shouldn't be surprised."

Environmentalists who've worked with Schwarzenegger say he's not grandstanding, and that he's become an unexpected and influential ally. "He's serious about getting this right, and no one else could get the kind of media attention he can," says Fran Pavley, a Democrat and former legislator from Southern California who co- authored the global warming law and worked with Schwarzenegger on its passage last year. Schwarzenegger is precluded from a third term by the state's term limit law, according to the California Secretary of State's office. He'll leave office in 2010.

With results--and winners--to be determined, Schwarzenegger's agenda has spurred a gold rush. The venture capitalists who midwifed the Internet boom have poured funds into the governor's coffers as well as into startups making everything from so-called clean coal to ethanol derived from wood chips. Investments almost doubled in North America to $3 billion in 2006 from $1.6 billion in 2005, according to CleanTech Venture Network LLC, a research firm in Brighton, Michigan.

"Renewable energy is the next big growth cycle," says Vinod Khosla, founder of Menlo Park, California-based Khosla Ventures, who gave $20,000 to the governor's 2006 re-election bid. "I personally believe that because California has this global warming law, you will see the next 10 Googles emerge here."

Timothy Draper, founder and managing director of Menlo Park, California-based venture firm Draper Fisher Jurvetson, has contributed $318,000 to Schwarzenegger's committees since 2003, according to campaign finance records. Draper talks with the governor often on technology and his firm is the No. 1 clean-tech investor in the Silicon Valley. Last year, one of its affiliates, DFJ Element, closed a $284 million green technology fund.

Draper Fisher invests in startups such as Tesla Motors Inc., which makes zero-emission, electric-powered sports cars. Earlier this year, Schwarzenegger test-drove Tesla's $98,000 roadster, which goes from 0 to 60 miles (97 kilometers) per hour in less than four seconds. Elon Musk, Tesla's chairman and primary investor, donated $22,300 to the governor's 2006 re-election campaign.

Schwarzenegger's zeal for Tesla and other green ventures has prompted his staff to make controversial moves, according to Robert Sawyer, chairman from 2005 to June of the California Air Resources Board, the rulemaking agency charged with implementing the global warming law. In February, when word leaked that Tesla was searching outside California for an assembly plant site for its new luxury White Star sedan, Dan Dunmoyer, the governor's cabinet secretary, made an emergency call to Sawyer. To encourage Tesla to build the White Star in California, Dunmoyer directed Sawyer to allocate $5 million to the firm from a $25 million fund set up for alternative fuels.

Sawyer refused. He said the fund still had to go through a public request-for-proposal process before doling out grants. Sawyer didn't consider Tesla, a maker of luxury cars for the rich, to be a wise choice for special treatment. "Those funds should be awarded competitively," says Sawyer, a professor of energy studies at the University of California, Berkeley. "I just didn't think it was a proper use of public funds." Tesla wound up choosing a site near Albuquerque, New Mexico. (See "Clean Machine," also in this issue.)

Some regulators are concerned that in the frenzy to profit from the green boom, the law's main purpose--curbing global warming-- might get lost. "There are a lot of people who want to get rich on climate change, but is that what's best for the planet?" says Catherine Witherspoon, former chief executive officer of the Air Resources Board.

The governor, the most prolific political fundraiser in California history, has built close ties to corporate interests. Since 2003, his campaign committees have raked in $121 million from real estate developers, insurers, banks and other business and individual donors, according to a study of campaign finance records by the FTCR. The committees have spent most of that cash. The 2006 re-election committee, which paid for events, advertisements and staff, has $42,700 in its coffers, according to the Secretary of State's office. Schwarzenegger's California Recovery Team committee, which supports ballot initiatives proposed by the governor such as the $36 billion infrastructure bond propositions approved by voters in November 2006, had $2 million remaining as of July 31, 2007.

Wall Street traders are one group that's champing at the bit to cash in on the green agenda. The governor is overseeing the establishment of an electronic cap-and-trade market set to open in 2012 that will permit buying and selling of carbon emission credits like a commodity. Companies that emit carbon at a level below the cap will be able to sell emission credits to firms that want to emit more than the cap. Those higher-emitting companies can use the credits to cut emissions at a slower pace and absorb the costs of changing their operations over a longer period.

"We're looking to California to be the biggest pool of liquidity in the U.S. and a precursor to a national cap-and-trade system," says Paul Ezekiel, 42, New York-based head of carbon trading for Zurich-based Credit Suisse Group. Goldman Sachs Group Inc. and JPMorgan Chase & Co. are among the other firms eyeing California.

California's consumer advocates view cap and trade with trepidation. (For more on carbon trading, see "Cashing In on Pollution," also in this issue.) Angela Johnson Meszaros, director of policy at the California Environmental Rights Alliance near Los Angeles, says low- and middle-income Californians still have bitter memories of the last time the state turned to the financial markets for a policy fix--the deregulation of its power industry in the late 1990s.

In 2000 and '01, traders at Enron Corp. and other energy firms gamed the state's partially deregulated grid by withholding power to create artificial shortages. Electricity bills skyrocketed as rolling blackouts left hundreds of thousands of ratepayers in the dark. Three Enron traders pleaded guilty to manipulating California's electricity market and received two years probation each. One reason for Davis's recall--the first ever of a California governor--was the electricity crisis.

Johnson Meszaros, 43, fears that in similar fashion, market players will get rich trading carbon as utilities and oil producers pass the costs of compliance to consumers. "Industry loves the idea of the market because they have visions of dollar signs," she says. "For people who live in the real world, the market could cause misery from the middle class on down."

California's biggest companies have their own set of concerns about the law. Dorothy Rothrock, vice president of government relations at the California Manufacturers and Technology Association, says Schwarzenegger's contention that addressing climate change will be an economic boon isn't a sure thing. For old-economy industries such as agriculture, manufacturing and petroleum, the global warming push could trigger a wrenching period of economic disruption that slashes jobs if it's not handled right, says Rothrock, who represents AT&T Inc., Northrop Grumman Corp. and other big employers. Her group opposed the law. The global warming requirements could cost California as much as $500 billion in reduced consumption of its goods and services by 2050, according to a 2007 study by the Electric Power Research Institute, a Palo Alto, California-based group that studies the industry.

California companies already pay 23 percent more than the national average in wages, electricity and other expenses, according to the Milken Institute, a research group in Santa Monica. If the law imposes too many burdensome costs, companies might shift future investment and expansion from California to more-affordable states or even China, Rothrock says. That would just serve to move emissions to another region. "We have decided to make the atmosphere a scarce resource, and the consequences of this policy are overwhelming," she says. "This is not simply about energy or the environment: It's an economic policy that will affect jobs, the creation of wealth and our quality of life."

Holding court in his smoking tent outside his suite of offices in Sacramento's capitol on a hot July afternoon, Schwarzenegger appears relaxed as he talks about his approach toward governing in his second term. As light jazz plays softly in the background, an antique brass fan blows a breeze through the tent, where the governor likes to meet with political chieftains as he puffs on his beloved Montecristo cigars.

Dressed in a cream-colored sport shirt and tanned to a bronze hue, the former movie star looks like a jet-setter who took a wrong turn on his way to St-Tropez. Schwarzenegger stands 6 feet 2 inches (1.9 meters) tall and bears a sturdy physique for a man who just entered his seventh decade. Of course, in the 1970s, when he reigned as bodybuilding's Mr. Olympia, he used to bench-press 400- pound (181-kilogram) barbells.

When Schwarzenegger first came into office, Sacramento's pols deemed the movie star little more than a curiosity. During the past four years, Schwarzenegger has established a reputation as a deft political operator with a knack for co-opting the ideas of both parties, says Willie Brown, the Democratic speaker of the state Assembly from 1980 to '95 and a two-term mayor of San Francisco.

Schwarzenegger enjoys sparring with adversaries in the smoking tent before making decisions. "Don't ignore those who don't like your policies or don't like your movies," Schwarzenegger says in his unmistakable Austrian accent. "No, bring them in, and as long as they can add constructive criticism, you can only win. That's always been my style."

Establishing a cap-and-trade market is one area where Schwarzenegger's opponents almost got the better of him. The governor is such a strong proponent of carbon trading that on the day the global warming act landed on his desk for signature, he balked at one piece of it, according to Witherspoon, who was in the governor's suite of offices in the state capitol that day. The problem: The bill didn't guarantee that a "market-based mechanism" would be part of the solution; Assemblywoman Pavley and her fellow Democrats preferred to leave it as an option. After several anguished minutes of deliberation, Schwarzenegger signed the bill. "He got boxed into a corner," Witherspoon says. "He had to take that language."

Not for long. Within three weeks of signing the law, Schwarzenegger issued an executive order that formed a Market Advisory Committee to design a cap-and-trade market for California, ensuring his pet strategy wouldn't be sidelined. The committee would make recommendations to the Air Resources Board. Democrats were miffed. "The order is totally inconsistent with the intent of the law," Assembly Speaker Fabian Núñez said in October 2006. Schwarzenegger pressed ahead with his plan to introduce a carbon trading market.

From his first meeting with Robert Kennedy that August in 2003, Schwarzenegger says he was determined to pair the state's regulatory power with the profit motives of the marketplace. His GOP friends put him in touch with Robert Grady, a San Francisco- based venture capitalist at Washington investment firm Carlyle Group. Grady, 50, a policy aide in the administration of President George H.W. Bush, had helped design a mandatory cap-and-trade market for sulfur dioxide, which causes acid rain. It slashed emissions 35 percent from 1990 through 2005, according to the U.S. Environmental Protection Agency. Grady and Baykeeper's Tamminen became the main authors of Schwarzenegger's environmental policies. "He wanted to make sure the solutions were market based, not command and control based," Grady says.

The energy industry has contributed $4.3 million to the governor's campaign committees. Oil companies are adamant that a carbon market play a substantial role in meeting California greenhouse gas reduction targets under the law, says Catherine Reheis-Boyd, chief operating officer for the Western States Petroleum Association, Big Oil's lobbying arm in Sacramento, which opposed the governor's global warming law. Fossil fuels burned in cars and trucks are the No. 1 source of greenhouse gases in California, according to the state EPA.

Now that the law and the executive order are in place, Reheis-Boyd says, oil companies will cooperate rather than resist because they can use a carbon trading market to string out the cost of compliance rather than taking a hit all at once. Without a market, oil companies may have to pass costs on to consumers and fuel prices would jump in California and injure the economy, she says. That would scuttle the central tenet of Schwarzenegger's policy: curbing greenhouse gases and maintaining economic growth at the same time. "The governor doesn't believe that environmental regulation and economic prosperity are mutually exclusive," the lobbyist says. "Our goal is to point out that this is a core principle, and the governor cannot move away from that."

The European Union's Emissions Trading Scheme, the No. 1 carbon market in the world, has had a rough debut. Unveiled in January 2005 with little reliable emissions data and a windfall of free allowances for power plants, the market almost collapsed in 2006. So far, consumers are bearing the brunt of the rocky start: Electricity rates have soared by as much as 50 percent as utilities passed on expected new compliance costs.

California consumer advocates say the EU scheme shows that cap and trade is a false promise. "What we have to do is fundamentally change how we make and use energy," says Johnson Meszaros, who co- chairs the Global Warming Environmental Justice Advisory Committee, an advisory panel to the Air Resources Board. "That's the core issue here. Not the markets."

The governor's office plans on avoiding the EU's mistakes, says Winston Hickox, secretary of the state EPA from 1999 to 2003. The 15-member Market Advisory Committee, chaired by Hickox, shows a coalition of environmental, academic and industry players are backing the governor's market plan. Members include Dale Bryk, a senior attorney with the Natural Resources Defense Council; Steven Koonin, chief scientist at oil giant BP Plc; and Lawrence Goulder, a professor of environmental and resource economics at Stanford University.

The panel favors auctioning a portion--perhaps 20 percent--of the greenhouse gas allowances instead of giving them all away. If the panel lets participants instead of regulators set a price for allowances, the market will have more integrity and liquidity, says Credit Suisse's Ezekiel, who sat on the committee. Traders should also benefit from reliable emissions data. The state must impose tough reductions to make allowances valuable and the market viable, Ezekiel says. "We're going to want real base-line data in California and rigorous caps," he says. "We want industry to make meaningful reductions." That's one area where Wall Street and environmentalists can agree, he says.

Finding consensus has been Schwarzenegger's modus operandi since being swept into power in October 2003. That year, California was reeling from the dot-com bust and the electricity crisis, which both walloped the state from 2000 to '02. Voters were so angry with Davis's failure to lead the state out of the woods that they held an unprecedented, and bizarre, recall election.

Schwarzenegger wound up running against 134 other candidates, including former child actor Gary Coleman and pornographic film star Mary Carey. Schwarzenegger won with almost 49 percent of the vote.

Since then, he's assembled a diverse kitchen cabinet ranging from Warren Buffett, billionaire CEO of Berkshire Hathaway Inc. and a longtime counselor on business matters, to Alan Autry, the Republican mayor of Fresno. "Arnold likes to listen to people," Buffett writes in an e-mail. "Probably because he genuinely likes people to begin with, and also because he wants to do the smartest thing and realizes the value of listening in achieving that goal."

Having it both ways is part of Schwarzenegger's makeup. He still drives three Hummers, only they've been converted to hydrogen fuel cells and biofuels. His politics are equally alloyed. He's an anti-tax Republican with an immigrant's faith in America's entrepreneurial spirit. One time in the early '80s, Schwarzenegger, then an up-and-coming movie star, was so excited about an appointment that he was fussing over his appearance and searching frantically for a camera to take with him, says Bonnie Reiss, 50, an entertainment lawyer and friend of the governor and his wife. He wasn't meeting Steven Spielberg or some other hot- shot director. "Arnold was going to meet Milton Friedman for the first time, and he was acting like a kid," Reiss says, referring to the late Nobel Prize-winning economist who championed laissez- faire capitalism. "Arnold had these dreams of America, and he saw Friedman as the thought leader on free-market enterprise." In 2004, the governor appointed Friedman to serve on his council of economic advisers.

Schwarzenegger is also a pro-choice, social-issues liberal who married into a Democratic dynasty. Maria Shriver, who's been married to Schwarzenegger for 21 years, is the daughter of Sargent Shriver, founder of the Peace Corps, and Eunice Kennedy Shriver, the sister of JFK. Maria, 51, a former broadcast journalist who advises the governor on political strategy, says her husband is at heart a pragmatist who shuns ideology. "You can't be married to someone of the opposing party and start bashing what the other party stands for," says Shriver, who has four children with Schwarzenegger, aged 10 to 17.

Californians like the governor's centrist ways. He enjoys a 57 percent approval rating among registered voters, 24 percentage points better than the Democratically controlled legislature, according to an August poll by San Francisco-based Field Research Corp. Three out of four Californians, including most Republicans, approve of his global warming legislation, according to the Public Policy Institute of California in San Francisco. Yet tackling climate change is uncharted territory even for California, a state on the forefront of air pollution regulation ever since it began scrubbing its smog-choked skies in the '70s, says Mary Nichols, chairman of the Air Resources Board. "We are trying to make a transition from an economy where carbon dioxide is intertwined in everything we do," says Nichols, 62, an administrator with the U.S. EPA from 1993 to '97 who has worked on air pollution issues for 30 years.

For all of the attention showered on Schwarzenegger's green policy, not one gram of carbon dioxide has been erased from California's air under the law. The Air Resources Board is only one year into an unprecedented, six-year rule-making process of converting the law's intentions into enforceable regulations. This year, the board got off to a shaky start on implementing the law when chairman Sawyer and CEO Witherspoon broke with Schwarzenegger on the best way forward. The board was obliged to issue "early action" regulations by July 1 to cut gases, which will go into effect in 2010. The governor signed off on three, including the Low-Carbon Fuel Standard that will require petroleum producers to reduce the carbon content in fuel 10 percent by 2020. Sawyer tried to add a fourth item: a requirement that automakers use so-called cool paints on vehicles sold in the state. By reflecting more sunlight than traditional tints, cool paints can lessen the need for air conditioning and decrease fuel consumption.

Sawyer's move clashed with Schwarzenegger's policy of not dictating how companies should build their products. The governor fired Sawyer in a June 22 letter. Witherspoon resigned in protest days after. No sooner did Nichols replace Sawyer than she disclosed that she held shares in BP, Chevron Corp. and other polluters as part of her family's stock portfolio. Critics pounced. "Being an environmentalist isn't compatible with someone who depends on oil companies for their investment returns," the FTCR's Court says. Nichols says she has liquidated her oil company holdings.

The board's rough summer is a preview of the difficulties leading to 2012, when its rules will be enforced. By then, Schwarzenegger will be two years out of office and denied a run for the presidency because of his Austrian birth. Esty, at Yale, says it's possible that Schwarzenegger may use his celebrity and California credentials to carry on his global warming crusade as a private citizen.

From the moment he decided to run for governor, Schwarzenegger understood that fighting global warming would be the cause that secures his place in history, Reiss, his longtime friend, says. "Arnold wants to leave a legacy that stands the test of time," she says. "He truly believes that in 100 years, when the books are written, they will talk about his leadership in transitioning to renewable energy and averting global warming catastrophes." The environmental policies that Schwarzenegger started forming that weekend in Hyannis Port are setting corporations, politicians, bankers, VCs and traders on a tumultuous path. In the next decades, the world will see whether the governor's global warming crusade turns into good policy, big profits, smart politics--or just more Hollywood.

EDWARD ROBINSON is a senior writer at Bloomberg News in San Francisco. edrobinson@bloomberg.netWith reporting by Michael Marois in Sacramento.

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