The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
April 14, 2008
Kevin Poloncarz
The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Overview
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Market Mechanisms in General
Offsets
• Concepts/ Criteria/ Additionality
Case Studies
• Enhanced Oil Recovery
• Long Lived Wood Products
Federal Trade Commission’s (FTC) and State Attorneys’ General
Interest
Voluntary Standards
• CCAR The Climate Action Reserve
• SCAQMD SoCal Climate Solutions Exchange
Why participate in voluntary (i.e., pre-compliance) markets?
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Market Mechanisms
• Cap-and-Trade
• Sets a cap and declining
balances on emissions
• Allocation and/or
auction of allowances
• Trading occurs
• Trued-up periodically
with agency
• vs. command-and-control
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Market Mechanisms
• Cap-and-Trade
• US SOx/NOx Acid Rain Program trading system
• SCAQMD’s RECLAIM program
• US delegation prevailed upon international community to
accept market mechanisms during Kyoto negotiations.
• European Union Emission Trading Scheme (EU ETS)
• Phase 1 2005-2007: learning phase: over-allocation; fuel
switching; price for allowances crashed
• Phase 2 2008-2012: 1st Kyoto Commitment Period
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As of April 3, price for delivery of ton of carbon in 12/08 at
$36; expectation that will rise to $37-54 by 2010 (which is $915 higher than estimated one year ago).
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Market Mechanisms
• Post-Kyoto?
• AB 32’s goal and even longer-term 2050 goal sent signal
of carbon price in future.
• Start-date for program coincides with end of first Kyoto
commitment period in 2012.
• Massachusetts v. EPA, 127 S. Ct. 1438 (2007)
• Citigroup, JPMorgan Chase and Morgan Stanley: “The
Carbon Principles”
• Commodities Future Trading Commission (CFTC) now
says carbon credits poised to become “leading global
derivates product” in next four or five years.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Market Mechanisms
• Why oppose market mechanisms?
• Problems with paying to pollute
• Localized impacts of carbon, but co-pollutants
• CARB must consider whether market-based mechanism
will result in “direct, indirect, and cumulative... localized
impacts within communities that are already adversely
impacted by air pollution” and design mechanism “to
prevent any increase in emissions of toxic air contaminants
or criteria air pollutants.” Cal. Health & Saf. C.
§38750(b)(1), (2).
• Obstacles and opposition are not insignificant.
• Safety valve/ linkage/ offsets
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Offsets
• Expected to play supporting role in any comprehensive
market-based solution.
• Reductions would not occur under business-as-usual (BAU).
• April 4: CARB says considering allowing offsets both in capand-trade and command-and-control (i.e., direct) regulation.
• Kyoto credits: created through Bonn and Marrakech COPs:
• Clean Development Mechanism (CDM) certified emission
reductions (CERs) in developing nations
• Joint Implementation (JI) emission reduction units (ERUs) in
Annex I, post-Soviet transitional economies
• EU Linking Directive
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Offsets
• Voluntary (pre-compliance) markets
• Participation to enhance “green” image, respond to
shareholder or consumer demand, or undertake serious “precompliance” reduction measures outside of own footprint.
• Learn-by-doing: inventorying, evaluating reductions, verifying
them, participating in registration process, trading platform.
• Media exposé: voluntary carbon markets plagued by a
number of high-profile instances where value of reductions
called into question.
• Project never occurs; double sales
• Lowest hanging fruit was high GWP pollutants in China.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Offsets
• Criteria: Reductions must be real, verified,
permanent, and additional.
• Recent maturity, but...
• Perceptions shaped by voluntary carbon markets
may stand as obstacle to development of
regulatory scheme incorporating offsets.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Additionality
Baseline Emissions
Volume of
CERs
Emissions of the CDM project
(to be monitored along crediting period)
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4 5 6 7 8 9 10 11 12 13 14 15
Years of operation of the project
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Additionality
• How to demonstrate difference between project and BAU?
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WBCSD and WRI: “While the basic concept of additionality may be easy
to understand, there is no common agreement about how to prove that
a project activity and its baseline scenario are different.”
• CDM EB Methodological Tool for the demonstration of
additionality
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“Legal, regulatory or institutional test” = surplus
“Technology test”, “barriers analysis”, and “common practice test =
performance standard?
“Investment test”
• Decisive reason for implementing project
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Not necessarily that project would fail but for offsets revenue..
But need to point to significant costs or risk-taking.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Additionality
• Project-by-project vs. performance standard
“Best in practice”
RGGI model rules
Market Advisory Committee
CCAR’s Climate Action Reserve
AB 32 requires that offsets must be “in addition to any
greenhouse gas reduction otherwise required by law or
regulation, and any other greenhouse gas emission
reduction that would otherwise occur.” (Cal. Health & Saf.
C. § 38562(d)(2).)
• Ultimately, a question of policy.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Case Study #1: Enhanced Oil Recovery
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EOR experimenting with geologic sequestration for decades.
• Supercritical carbon injected into depleted oil basins.
• Produces substantial amount of oil (10-15% more), which
“floats” on heavier carbon.
• Geologic reservoirs successfully confined oil.
• IPCC special report stressed need for geological sequestration.
CDM EB referred decision to UNFCCC MOP.
• Permanence and additionality questions
• “But-for” investment test creates preference for projects with
inherently low IRR.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Case Study #1: EOR
• Wrong incentives?
• Why not support technologies with marginally better
prospects of widespread adoption and implementation?
• Like making loan to debtor least likely to repay?
• What are goals of offsets program?
• Development/ promotion of technologies likely to succeed
on broad-scale without credits revenue?
• Increasing liquidity/ learning regarding carbon markets?
• Establishing integrity/ confidence in role of markets?
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Case Study #2: Chicago Climate Exchange (CCX)
Long-Lived Wood Products (LLWP) Credits
• Tradable Carbon Financial Instruments (CFIs)
include both Exchange Allowances and Offsets.
• Voluntary commitments of CCX members:
• Phase I (2003-2006): 4% below baseline
• Phase II (2007-2010): 6% below baseline
• Offsets may be used to satisfy some portion of cap.
• Registered by members or aggregators.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Case Study #2: CCX LLWP Credits
• Exchange Forestry Offsets (XFOs)
• Reforestation/ conservation management results in
net carbon sinks.
• Total carbon stock sequestered within standing live
and dead wood, lying dead wood, etc., is measured
by forester; represents “baseline” scenario.
• Net increase in carbon stock from implementation of
“project” verified over time results in XFOs.
• Aggregators bundle together small pools.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Case Study #2: CCX LLWP Credits
• All harvested carbon “emitted” to atmosphere.
• Calculation of net carbon sinks should be able to
credit amount of carbon remaining sequestered in
long-lived wood products (LLWP) after 100 years.
• Continued use as furniture or in construction
• Sequestered within landfills
• Typically not registered and only reported as
secondary effect or “optional” pool.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Case Study #2: CCX LLWP Credits
• Sub-Prime Credits?
• As of December 2007, CCX now has protocol allowing
members and aggregators to report and register carbon
sequestered by LLWP.
• CCX to issue XFOs even where underlying timberlands
not registered as conservation management project.
• Contract limits downstream rights to credits.
• Verifier confirms that meets sustainable harvesting
standards and sales receipts.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Case Study #2: CCX LLWP Credits
• Additionality?
• Potential “double-counting” issues?
• When market forces converge with GHG reductions, how
do you disaggregate environmental benefits?
• So what? Shouldn’t we motivate parties up and down
supply chain to make choices limiting climate change
impacts?
• Real risk is that undermines confidence in not only the
subprime players, but the standard bearers as well.
• Once XFOs issued = CFIs.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
The Federal Bail-Out
• FTC’s Update to Green Guides on Environmental Marketing
Claims (16 CFR§260 et seq.)
• To address claims of being “green”
• To address market in carbon offsets and RECs
• FTC Act makes unlawful deceptive acts and practices in or
affecting commerce (15 USC § 45, 52).
“Safe-harbor” for environmental marketing claims if:
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clearly qualify statements,
clarify whether claim applies to product or packaging,
not overstate environmental benefit, and
make basis for comparative claims clear (16 CFR § 260.6).
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
The Federal Bail-Out
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Carbon offsets raise issues, both in the sale of the offset itself and in
the marketing claims made by purchasers (who claim the offset to
promote “carbon neutrality” of products or operations).
FTC raises questions, not only regarding double-counting and
verification standards, but regarding importance of “additionality”.
Attorneys General of VT/ CA have taken active role in comments.
Legislative proposals in CA:
• AB 1851 (Nava): Process for assuring voluntary offsets meet
consistent standards.
• AB 3001 (Hancock): Voluntary Carbon Offset Commission;
donations invested in environmentally sound offset projects.
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Can the Market Fix Itself?
• FTC/ AGs could stifle nascent markets and chill
participation.
• Lack of credibility undermines compliance markets.
• Voluntary Certification Schemes:
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CDM Gold Standard for Voluntary Offsets
Voluntary Carbon Standard
Center for Resource Solutions’ “Green-e” Climate
CCAR’s Climate Action Reserve
SCAQMD’s SoCal Climate Solutions Exchange
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The “Credit” Crisis
Growing Pains within the Emerging Carbon Markets
Should Consumers Avoid Voluntary Markets?
• Depends on goals
• To stockpile credits before prices rise?
• To support claims of carbon neutrality?
• To gain valuable experience in trading platform and
inventorying/ evaluating emissions reductions?
• Learn by asking questions of offsets providers:
• Should avoid offsets providers who cannot or are
unwilling to answer questions.
• Might favor un-aggregated projects where consumer can
conduct due diligence.
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