Carbon Trading Law

Carbon Trading Law and Practice

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Carbon Trading Law and Practice

Scott D. Deatherage

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Library of Congress Cataloging-in-Publication Data Deatherage, Scott. Carbon trading law and practice / Scott D. Deatherage. p. cm. Includes bibliographical references and index. ISBN 978-0-19-973221-0 (pbk. : alk. paper) 1. Emissions trading—Law and legislation. 2. Emissions trading—Law and legislation—United States. 3. Carbon off setting—Law and legislation. 4. Carbon off setting—Law and legislation—United States. I. Title. K3593.5.C37D43 2011 344.04’634—dc22 2010045984 ___________________________________________________________________________________

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To Violet, my wife, and my two children, Brett and Ashley


Contents

Acknowledgments xxiii

Preface xxv

Introduction xxix

PART ONE The Emergence of Carbon Markets

1 Prelude to Regulation—Th e Development of Climate Change Science 3 A. Typical Process of Regulation Following Science 4 B. Th e Greenhouse Eff ect 5 C. Th e Science of Climate Change 5

1. Conclusions of Scientifi c Institutions 5 a. Th e International Panel on Climate Change 5

i. Africa 7 ii. Asia 7iii. Latin America 7 iv. North America 8 v. Europe 8

b. National Academies of Science of the Major Emitting Developed and Developing Countries 8

c. In the United States: the National Research Council and the National Academy of Sciences 11

D. Th e Policy Impact of the Conclusions of the National Academies of Science 12

E. Controversy over Climate Science 12 F. Future Policy Development Based on Climate Science 15

viii | CONTENTS

2 Th e Emergence of Emissions Trading Concepts 16 A. Economics vs. the Environment 16 B. Evolution of Environmental Regulation and Emergence

of Environmental Markets 17 C. Emissions Trading as a Means of Bridging the Divide

between the Economy and Environment 17 D. Basic Concepts of Emissions Trading 18 E. Cap and Trade “Made in America”—Th e Advent of U.S.

Emissions Markets with Sulfur Dioxide and Other Emissions 20

F. Examples of Working Carbon Markets 211. Th e Kyoto Protocol 222. Th e European Union Emissions Trading Scheme 24

G. Environmental Markets Are Alive and Well 243 Fundamentals of Cap and Trade 25

A. Defi ning the Regulated Gases 25 B. Determining the Th reshold Amount of Emissions

to Be Regulated 28 C. Determining the Regulated Sources 28 D. Setting the Cap 30 E. Permitting Emissions of Greenhouse Gases 30 F. Emission Allowances 31 G. Allocation of Emission Allowances 31 H. Trading Allowances 33 I. Banking Allowances 33 J. Borrowing Allowances 33 K. Safety Valve and International Competitiveness 34 L. Off sets 34 M. Additionality 35 N. Supplementarity and Linkage to Other National

and International Trading Systems 35 O. Early Action 36 P. New or Expanded Facilities 36 Q. Regulatory Agency or Agencies 37

1. Regulation of Greenhouse Gas Emissions 372. Regulation of Trading of Allowances and Off sets 37

R. Enforcement 38

CONTENTS | ix

PART TWO Regulatory Structures

4 International Law 41 A. Th e UN Framework Convention on Climate Change 41

1. Conference of the Parties 42 B. Th e Kyoto Protocol 42

1. General Principles 422. Th e Clean Development Mechanism 433. Joint Implementation 444. Emissions Trading and Trading in Assigned

Amount Units and Removal Units 455. Kyoto Units 46

C. Th e Marrakesh Accords 46 D. Bali, Copenhagen, and Cancun: Negotiations for a

Post-Kyoto Treaty 471. Th e Bali Action Plan 472. Th e Copenhagen Accord 483. Cancun 48

E. Alternatives to the UNFCCC 495 Th e European Union Emissions Trading Scheme 52

A. Th e EU Policy on Climate Change 52 B. Phase I—2005 to 2007 53 C. Phase II—2008 to 2012 53 D. Phase III—2013 to 2020 54 E. Fundamentals of the EU ETS 54

1. Defi ning the Cap 54 2. Defi ning the Regulated Sources 55 3. Permitting Emissions of Greenhouse Gases 55 4. Emission Allowances 55 5. Allocation of Emission Allowances 55 6. Trading Allowances 56 7. Banking Allowances 56 8. Borrowing Allowances 56 9. Safety Valve and International Competiveness 5610. Off sets 5611. Additionality 5712. Supplementarity and Linkage to Other National and

International Trading Systems 5713. Early Action 5714. New or Expanded Facilities 5715. Enforcement 58

x | CONTENTS

6 Emissions Programs among Other Kyoto Countries 59 A. New Zealand 59 B. Canada 60 C. Australia 61 D. Japan 61 E. China 63

7 Th e Emergence of National and International Carbon Markets 64 A. Compliance or Mandatory Markets 64 B. Voluntary Markets 64

1. Voluntary Carbon Standards and Markets 642. Source of Demand for Voluntary Carbon Credits 653. Development of Voluntary Standards, Registries,

and Exchanges 65 a. Chicago Climate Exchange 66 b. Voluntary Carbon Standard 66 c. American Carbon Registry 68 d. Climate, Community, and Biodiversity Alliance 69

C. Pre-Compliance Markets and the Transition from Voluntary to Compliance Markets 69

D. Survival of Voluntary Markets aft er Establishment of Compliance Systems 70

E. Th e Current State of the Voluntary Market 70 F. Th e European Market 71 G. Th e Kyoto Protocol and the Clean Development

Mechanism Market 728 Developing Laws in the United States—State Laws 74

A. State Climate Change Programs 74 B. Individual State Programs 74

1. California 74 a. Regulated Gases 75 b. Regulated Sources 75 c. Th e Cap 77 d. Permitting Emissions of Greenhouse Gases 77 e. Emission Allowances 77 f. Allocation of Emission Allowances 77 g. Trading Allowances 79 h. Banking Allowances 79 i. Borrowing Allowances 79 j. Safety Valve and Competitiveness 80 k. Off sets 80

CONTENTS | xi

l. Additionality 82 m. Supplementarity and Linkage to Other

Trading Systems 82 n. Early Action 83 o. New or Expanded Facilities 83 p. Regulatory Agency or Agencies 83 q. Enforcement 83

2. Florida 843. New Mexico 84

C. Multi-State Programs 851. Regional Greenhouse Gas Initiative 85

a. Regulated Gases 85 b. Regulated Sources 85 c. Th e Cap 85 d. Permitting Emissions of Greenhouse Gases 86 e. Emission Allowances 86 f. Allocation of Emission Allowances 86 g. Trading Allowances 86 h. Banking Allowances 86 i. Borrowing Allowances 86 j. Safety Valve and Competiveness 87 k. Off sets 87 l. Additionality 87

m. Supplementarity and Linkage to Other Trading Systems 87

n. Early Action 87 o. New or Expanded Facilities 88 p. Regulatory Agency or Agencies 88 q. Enforcement 88

2. Western Climate Initiative 88 a. Regulated Gases 90 b. Regulated Sources 90 c. Th e Cap 90 d. Permitting Emissions of Greenhouse Gases 91 e. Emission Allowances 91 f. Allocation of Emission Allowances 91 g. Trading Allowances 92 h. Banking Allowances 92 i. Borrowing Allowances 92 j. Safety Valve and Competitiveness 92

xii | CONTENTS

k. Off sets 93 l. Additionality 93

m. Supplementarity and Linkage to Other Trading Systems 94 n. Early Action 94 o. New or Expanded Facilities 95 p. Regulatory Agency or Agencies 95 q. Enforcement 95

D. Midwestern Greenhouse Gas Reduction Accord 95 E. Cooperation and Potential Linkage among the

Multi-State Programs 969 Developing United States Law—Th e Courts 99

A. Federal Statutory Litigation 1001. Th e U.S. Supreme Court Landmark Decision in

Massachusetts v. EPA 1002. Background—How Did the Matter Reach the

U.S. Supreme Court? 1013. Standing—Could the Court Hear the Matter When the

Emissions and Eff ects of Climate Change Are Global and Infl uenced by Emissions from Other Countries? 102

4. Th e Merits of the Case—Does the EPA Have the Authority to Regulate, and, if so, the Ability to Defer Regulation of Greenhouse Gases under the Clean Air Act? 104

5. Implications of the Court’s Decision—Regulation under the Clean Air Act and Other Federal Statutes, Corporate Environmental Disclosure, and Litigation Alleging Climate-Related Damages 106 a. Symbolic or Political Signifi cance 106 b. Greenhouse Gases Are Air Pollutants and the

EPA Has the Authority to Regulate Th em 106 c. Eff ect on Other Vehicle-Related Greenhouse

Gas Lawsuits 107 d. Eff ect on Challenges to the EPA’s Decision

Not to Regulate Greenhouse Gases from Power Plants 107

e. Eff ect on Cases Filed under the National Environmental Policy Act, Challenging Governmental Action Th at Causes or Leads to Greenhouse Gas Emissions 107

f. Eff ect on Tort Suits Filed by Individuals Claiming Damages from Greenhouse Gas Emissions 108

CONTENTS | xiii

g. Broadening Standing for States to Challenge Federal Administrative Agency Action 109

B. State Statutory Litigation 109 C. Federal Common Law Litigation to Impose Emission

Reductions on Greenhouse Gas Emitters 109 D. State and Federal Common Law Litigation to Obtain

Damages from Greenhouse Gas Emitters 11110 Developing United States Law—Th e Environmental

Protection Agency 114 A. Federal Greenhouse Gas Reporting Program 115

1. What Gases Are Covered? 1172. What Facilities Are Covered? 117

a. Specifi c Source Categories 118 b. Other Facilities Th at Emit 25,000 Tons per

Year or More of CO2e of Combined Emissions from Listed Source Categories 118

c. Facilities Th at Do Not Meet the First Two Source Categories, But Th at Emit 25,000 Tons of CO2e per Year from Stationary Fuel Combustion Sources 119

d. Entities Th at Sell, Import, or Export Fossil Fuels, Industrial Greenhouse Gases, and CO2 119

e. Entities Th at Manufacture or Sell Vehicles or Engines in the United States 120

3. Monitoring and Measurement 1214. Certifi cation and Verifi cation 1215. Information Th at Must Be Reported 121

a. Facilities Th at Emit Greenhouse Gases 121 b. Suppliers of Greenhouse Gases or Materials

Th at Produce Greenhouse Gases When Used 1226. Public Availability of Information Submitted

to the EPA 1227. Exiting the Reporting Regulation Requirements 1238. Enforcement Actions and Penalties for Failure to

Comply with the Greenhouse Gas Reporting Rule 123 B. EPA Regulation of Greenhouse Gas Emissions

under the Clean Air Act 1241. Th e EPA’s Endangerment Finding 1242. Th e EPA’s “Johnson Memo” 1253. Th e EPA’s Mobile Source Rule 126

xiv | CONTENTS

4. Th e EPA Tailoring Rule 126 a. Application of the Prevention of Signifi cant

Deterioration to Regulation of Greenhouse Gas Emissions 127

b. Covered Gases 129 c. Phases of Coverage, Beginning with Larger Sources 129

i. Step 1: January 2, 2011 to June 30, 2011 129(a) PSD applicability 129(b) Title V permitting applicability 130

ii. Step 2: July 1, 2011 to June 30, 2013 130(a) PSD applicability 130(b) Title V permitting applicability 130

iii. Step 3: July 1, 2013 to April 29, 2016 131 d. Best Available Control Technology 131 e. State Implementation Plans 132

11 Developing United States Law—Congress and Proposed Federal Climate Change Legislation 133 A. Defi ning the Regulated Gases 133 B. Emission Th resholds for Facilities Th at Emit

Greenhouse Gases 135 C. “Covered Facilities”: Determining What Emission

Sources Would Be Regulated 1361. Emitters of Greenhouse Gases 1362. Producers or Importers of Greenhouse Gases or

Materials Th at Emit Greenhouse Gases When Used or Burned 138

D. Setting the Cap 138 E. Permitting Emissions of Greenhouse Gases 139 F. Emission Allowances 139 G. Allocation of Emission Allowances 140 H. Auctions 141

1. Main Allowance Auction 1412. Market Stability Reserve 1423. Small Business Refi ner Reserve 143

I. Auctioning Allowances for Other Entities 144 J. Carbon Registry 144 K. Off sets 145

1. General Issues Relating to Off sets 1452. Carbon Off set Creation—Rules Relating to Off set

Methodologies and Projects 147 a. Basics of Off set Creation 147

CONTENTS | xv

3. Eligible Off set Project Types 1484. Methodologies 150

a. Additionality 151 b. Activity Baseline 152 c. Quantifi cation Methods 152 d. Leakage 152

5. Accounting for Reversals 1536. Crediting Periods 1537. Approval of Projects 1538. Monitoring, Reporting, and Verifi cation 1549. Issuance of Credits 155

10. Early Off sets 15511. Environmental Considerations for Forestry or

Land-Management Projects 15612. Recordkeeping 15713. International Off sets 157

a. General Issues 157 b. Sectoral Credits 158 c. Credits Issued by an International Body 159 d. International Forest Off sets 160

i. National Programs 160 ii. State- or Province-Level Programs 162iii. Program for Low-Emitting Countries 162 iv. Project-based Deforestation Reduction Credits 163 v. Forested Wetlands and Peatlands 163

L. Compliance with Greenhouse Gas Emission Requirements 1631. Compliance Obligations 1632. Phase in of Compliance Obligations for Certain

Covered Entities 164 M. Trading Allowances and Off sets 166 N. Banking Allowances 166 O. Borrowing Allowances 167 P. Safety Valve International Competitiveness 167

1. Program to Provide Additional Allowances for Industrial Sources Facing International Competition 168

2. Use of Sectoral Approach for the Importation of International Off set Credits 168

Q. Supplementarity and Linkage to Other National and International Trading Systems 169

xvi | CONTENTS

R. Early Action 170 S. New or Expanded Facilities 171 T. Regulatory Agency or Agencies 171

1. Regulation of Greenhouse Gas Emissions 1712. Regulation of Trading of Allowances and Off sets 171

U. Enforcement 172

PART THREE Carbon Project Development

and Carbon Finance

12 Carbon Credit Project Types and Methodologies 175 A. Introduction to Carbon Credit Project Types and

Methodologies 175 B. Methodologies for Developing Carbon Credit

Project Types 176 C. Carbon Credit Project Types 177

1. Renewable Energy 1772. Energy Effi ciency 1783. Landfi ll, Oil and Gas, and Other Methane Projects 1784. Natural Gas Production and Distribution Projects 1795. Fuel Switching 1806. Agriculture, Forestry, and Land Use 180

a. Avoided Deforestation and Reforestation 180 i. Th e Voluntary Carbon Standard Agriculture,

Forestry, and Other Land Use Guidance 183(a) Th e baseline 185(b) Additionality 185(c) Leakage 186(d) Permanence and Related Carbon Buff er 186(e) Monitoring 186

ii. Climate Action Reserve Forestry Methodology 187(a) Th e baseline 188(b) Additionality 188(c) Leakage 189(d) Permanence and Related Carbon Buff er 189(e) Monitoring 190

iii. CDM Reforestation/Aff orestation Methodology 1907. Carbon Capture and Storage 190

13 Carbon Credit Project Development 193 A. Project Development Generally 193

CONTENTS | xvii

B. Basics of Carbon Credit Project Development 194 C. Feasibility Study 194 D. Th e Carbon Credit Approval Process 196

1. Th e Process under the Clean Development Mechanism 196 a. Project Feasibility Study 196 b. Project Idea Note 196 c. Project Design Document 196 d. Stakeholder Participation 197 e. Host Country Approval 197 f. Validation by a Designated Operational Entity 197 g. Registration 197 h. Implementation and Monitoring 198 i. Verifi cation and Certifi cation 198 j. Issuance of Credits 198

2. Th e Voluntary Carbon Standard Process 198 E. Carbon Credit Project Risks 199 F. Examples of Projects 200

1. Landfi ll Methane 2012. Solar Projects 201

a. Solar Projects Generally 201 b. Free-Standing or Utility-Scale Solar Projects 201 c. Non-Utility-Scale Solar Projects 202

3. Forest Carbon Projects 20314 Carbon Finance 207

A. Financing Carbon Projects 207 B. Project Finance 207

1. Equity 2092. Debt 2093. Types of Agreements Typically Involved in

Project Finance 2104. Managing Political Risk with International Projects 211

C. Carbon Finance 2111. Basic Elements of Carbon Finance 211

D. Carbon Credit Project Lenders and Investors 2141. Multilateral Banks and Associated Carbon Funds 2142. Private Banks 2173. Private Carbon Funds, Private Equity Firms, and

Hedge Funds 2174. Utilities and Other Compliance Investors 217

xviii | CONTENTS

PART FOUR Other Credits That May be Generated

From Carbon Credit Projects

15 Other Environmental Attributes, Including Renewable Energy Credits and Energy Effi ciency Credits 221 A. Environmental Attributes and Other Credits

Th at May Enhance Carbon Credit Projects 221 B. Renewable Portfolio Standards 222 C. Renewable Energy Credits 224 D. Energy Effi ciency Credits 225 E. Credits for Traditional Pollutants 225 F. Forward Capacity Markets 225 G. Contractual Issues in Selling RECs Outside California 226

1. Type of Credit 226 2. Vintage of Credit 227 3. Quantity Being Sold 227 4. Pricing 227 5. Transfer Mechanism 227 6. Payment 227 7. Delivery 228 8. Representations and Warranties 228 9. Eff ective Date and Termination 22810. Remedies and Damages 22811. Change in Law 228

H. Contractual Issues in Selling RECs Inside California 22916 Ecosystem Services: Wetlands and Biodiversity Credits 230

A. Wetlands Credits and Banking 231 B. Biodiversity Credits 232 C. Credit Stacking 234

17 Water Credits 236 A. Increasing Water Demand and Decreasing Water Supply 236 B. Why Water Is Becoming a Potential Tradable Commodity 236 C. Water Credits and Markets as a Means of Conserving a

Scarce Resource 2371. Water Quantity Trading 2372. Water Quality Trading 237

D. Carbon Credit Projects and Water Credits 238

PART FIVE Government Incentives—Stimulating

Carbon Projects

18 Government Incentives for Renewable Energy and Other Types of Projects Th at Generate Carbon Credits 243

CONTENTS | xix

A. Th e Use of Government Incentives to Enhance Carbon Credit Projects 243

B. Government Incentives 2451. Government Grants 2452. Government Tax Incentives 245

a. Th e EESA 246 i. Renewable Energy 246 ii. Energy Effi ciency and Conservation 246iii. Carbon Capture and Storage 246 iv. Transportation and Domestic Fuel 247

b. Th e ARRA 2473. Grants in Lieu of Tax Incentives 2484. Government Loan Guarantees 2505. Property-Assessed Clean Energy Programs 2506. Development Bonds 251

C. Utility Incentives 251

PART SIX Carbon Trading—Selling Credits

and the Carbon Markets

19 Fundamentals of Carbon Trading 255 A. A Regulatory “Commodity” 255 B. Th e Various Types of Carbon Credits 255 C. Primary or “Over-the-Counter” Markets and Bilateral

Agreements 256 D. Secondary Markets and Exchanges 256 E. Future vs. Spot Markets 257 F. Off -Take Agreements 257 G. Carbon Indexes 257 H. Fungible Commodity vs. Diff erentiation 258 I. Voluntary and Compliance Buyers 258 J. Investors and Speculators 258 K. Carbon Credit Risk and Price 259 L. Other Price Drivers 259 M. State of the Global Carbon Markets 259

20 Contractual Issues in Carbon Trading in the Primary Market 261 A. Defi nitions 261 B. Conditions Precedent 261 C. Price 262 D. Quantity and Delivery 262 E. Payment 262 F. Obligations of Seller 263

xx | CONTENTS

G. Obligations of Buyer 263 H. Representations and Warranties 264 I. Share of Proceeds and Taxes 265 J. Default 265 K. Termination 266 L. Remedies 266 M. Choice of Law and Venue 266 N. Dispute Resolution 267 O. Force Majeure 267 P. Limitation of Liability 267 Q. Miscellaneous Issues 267

PART SEVEN Carbon Accounting—Carbon

Assets and Liabilities

21 Th e “Carbon Ledger” and Carbon Credit Accounting 271 A. Carbon Accounting 271 B. Defi ning Carbon Assets and Liabilities 272 C. Forming a Carbon Ledger as Part of a Carbon Strategy 273 D. Financial Accounting Treatment of Carbon

Assets and Liabilities 27522 Climate Risk Disclosure 279

A. Corporate Climate Change Liabilities 279 B. Securities and Exchange Commission Regulations

Governing Environmental Financial Disclosure 2811. Item 101 2822. Item 103 2823. Item 303 2834. Item 503(c) 283

C. Accounting Rules 283 D. Th e Sarbanes-Oxley Act 284 E. SEC Enforcement 284 F. SEC Guidance Regarding Disclosure Related to

Climate Change 2851. Overview of Existing Disclosure Requirements 2862. Climate Change-related Topics Th at May Require

Disclosure 287 a. Impact of Legislation and Regulation 287 b. International Accords 289

CONTENTS | xxi

c. Indirect Consequences of Regulation or Business Trends 289

d. Physical Impacts of Climate Change 289 G. Voluntary Climate Change Disclosure Protocols 291 H. Voluntary Standards Evolving into Legal Requirements 292 I. Offi cer and Director Liability Environmental and

Climate Risk Management 293 J. Conclusion 295

Acronyms and Abbreviations 297

Index 299


Acknowledgments

Th is book could not have been written without the support of certain people. My wife Violet Deatherage has supported me in my career and business endeavors for these last 25 years, and supported me throughout the long process of conceiving and writing this book. My children Brett and Ashley have sup-ported me in the excitement of their father writing his fi rst book. Without my family’s encouragement, this book would not have been possible.

I would also like to acknowledge the support of friends such as Greg Rogers and Ted Benn who have supported me in my endeavor to develop a practice in the areas of climate change, greenhouse gas regulation, renewable energy, and energy effi ciency. Others I would like to thank are my friends and clients at Incenergy, primarily Barry McConachie, Jeff Smith, and Liz Cunningham, who have also supported me and encouraged me in this endeavor and inspired me with their development of a demand response company that will become a sig-nifi cant player in this space. I would like to acknowledge the assistance of Jane Peck Hay, Head of the Commodities Legal Team for Direct Energy, who pro-vided guidance and review of the chapter on renewable energy certifi cates, which was very helpful to me in preparing the important discussion of such an impor-tant element of renewable energy projects.


Preface

Th e origins of this book date back to my attendance of Carbon Expo, a carbon credit conference in Cologne, Germany in 2006. My goal was to learn about the the European Union’s Emissions Trading Scheme and the activities surrounding the Kyoto Protocol. I wanted to understand the development of emissions markets for greenhouse gases. I was expecting a conference of a few hundred, but to my surprise found a large conference of several thousand people in atten-dance. In attendance were regulated industries, banks, investment houses, and entrepreneurs as well as government agencies and ministers focused on the European and international carbon markets and a for-profi t mechanism for reducing greenhouse gas emissions. It appeared at that time, that international developments and the science—as stated by the national academies of science of the major— were leading developed and developing nations supported the view that anthropogenic greenhouse gas emissions were leading to climate change and potentially devastating results. It appeared that in time some form of greenhouse gas regulation would evolve in the United States, and the international trading of carbon credits would continue. My conclusion was that opportunity existed to those who understood carbon markets because states in the United States had or were developing greenhouse gas regulatory systems based on an emissions trading scheme, or what we refer to as “cap and trade.”

During the writing of this book, the U.S. Congress fi rst moved toward adopting climate change legislation, and then the legislation stalled in the Senate and appeared to have little chance of passage in the short term. Th e course of the political debate took several strange turns. As a group of politicians developed their attacks on regulation of greenhouse gases, an unfortunate

xxvi | PREFACE

strategy evolved. Th ey began to attack the concept of emissions markets, that is, the concept of cap and trade. Th e issues of whether or not to regulate greenhouse gases, and what method would be best to carry out such regulation once the decision to regulate was made, were not separated.

It does not appear that a national emissions trading market for greenhouse gases will be instituted in the United States, but the concept of emissions markets has and continues to invade various aspects of environmental regulation, and has spread around the world to both developed and developing countries. It has become a part of ongoing economic evolution. Markets that have grown in so many areas, from commodities to fi nance, and have reached global propor-tions, have now become part of regulatory programs.

What I have discovered is that market-based programs are in fact for the most part considered benefi cial and preferable to regulated industries once the decision is reached by governments to regulate a particular environmental issue. While industry likely will try to avoid regulation in the fi rst instance, once the regulatory decision is made to regulate greenhouse gases, industry will likely favor using market-based systems in jurisdictions around the world, rather than a command and control style system where little fl exibility exists among industry and third party carbon credit project developers through emissions markets. Even where mandatory regulation does not apply, the development of voluntary systems for trading voluntary reductions has already spread globally, with devel-opment of international voluntary standards for carbon credits and carbon credit exchanges in China and Brazil among other countries around the world.

Th us, this book is focused on the foundation of greenhouse gas emissions markets and what has occurred at the federal and state level in the United States and internationally. Th e decision of whether to regulate in a sense precedes the discussion in this book. My interest is focused, once the regulatory decision is made by governments in a particular jurisdiction, in the fundamental structural aspects of greenhouse gas emissions markets and how diff erent jurisdictions have addressed these fundamental aspects, and how the markets have functioned. Since the markets are products of the evolution that occurs once the legal or regulatory structure is established, the legal aspects are of critical importance in terms of the statute and regulations that are issued by regulatory agencies once the general law is established.

What I have discovered in researching and writing this book is that the use of market-based systems as a means of regulating emissions and other environ-mental pollution or degradation is a growing phenomenon. As nations and states appear to be responding to scientifi c pronouncements regarding the existence and causes of climate change, environmental markets appear to be one of the main tools that will be used to address greenhouse gas emissions. I have been

PREFACE | xxvii

amazed as to the power of environmental markets to lead to the emergence of private entrepreneurs who create new technologies, new business plans and com-panies, and develop new projects to reduce greenhouse gases all with a for-profi t motive—a sort of greenhouse gas and energy entrepreneurialism. I have discov-ered that if these systems are created with enough profi t potential, private capital in terms of angel investors, venture capitalists, private equity, and banks and other lenders will fi nance these new entrepreneurs. Th e incredible self-organizing power of the marketplace can make great strides in energy effi ciency, renewable energy, and other means of reducing greenhouse gas emissions—all without gov-ernment planning or control, but merely the establishment of general rules that then result in the emergence of a private system of greenhouse gas reductions. Adam Smith would be proud of such a system.

As a result of the power of environmental markets in lieu of the traditional command and control regulatory systems, carbon trading will continue in some form at the state level in the United States and at an even larger scale in the European Union, Japan, New Zealand, and perhaps China, which will drive an international carbon market for off sets. It appears that both a voluntary carbon market and a carbon market based upon regulatory obligations will continue in the coming decade. Whether the international system will be focused on a United Nations program or bilateral arrangements, or perhaps the G20 and “plus fi ve,” meaning China, Brazil, India, Mexico, and South Africa, will form their own trading program remains to be seen. Th e UN negotiations for a successor to the Kyoto Protocol continue, but an agreement seems unlikely in the short term.

However the international, national, and subnational developments play out in terms of the reach of carbon markets, it is intended that this book will provide a fundamental explanation of the underlying legal systems that serve to create and sustain carbon credit creation and the trading of these credits, as well as a discussion of a series of related practical and business issues.


Introduction

“Carbon trading” is a term that has come to be used to refer to trading of greenhouse gas emission allowances needed in jurisdictions that require they be submitted by regulated entities for each ton of greenhouse gases emitted under a regulatory program, or, alternatively off sets from reducing greenhouse gas emis-sions, whether under a mandatory regulatory system or a voluntary program. Th is book is designed to provide a discussion of the fundamental legal and busi-ness issues that relate to the regulatory and voluntary programs driving green-house gas reductions and the trading of allowances and off sets under both regulatory systems and voluntary programs. It is hoped that it will provide the reader a basic understanding of the climate science that is driving emissions reduc-tions, whatever controversy exists, the basic elements of emission markets and cap and trade programs, and the concepts underlying carbon credits and carbon trading.

Th is book is not intended as a “science book,” but it is important to lay out the science that is driving the regulations that have been evolving over the last twenty years or more regarding international treaties, national regulatory pro-grams in most of the industrialized countries, and evolving programs at the state or provincial level. Th e chapter on climate science attempts to lay out the conclusions of the national academies of science, including the U.S. academy, and the International Panel on Climate Change, the United Nation’s group of scientists enlisted to provide reports regarding climate change and its potential impacts. Not surprisingly, all scientists do not necessarily agree with all of these conclusions or studies. Controversy has erupted at the political and business association level as to the potential economic impacts.

xxx | INTRODUCTION

Th e reality is that science issues are addressed by the national academies, and their conclusions tend to drive public policy. As many in various industries have concluded, it is probable that in time all developed countries will have some form of national regulation of greenhouse gases. Even though no legislation has been passed at the national level in countries such as the United States or Australia, programs have been established at the state or subnational level. Th us, regulation exists or is developing in both countries. In the United States, the U.S. Environmental Protection Agency has issued regulations governing greenhouse gas emissions following a Supreme Court decision interpreting the current fed-eral Clean Air Act. Historically, when the scientifi c academies reach conclusions regarding environmental matters, then in time, regulation to address those conclusions tends to follow. Whatever the ultimate decisions by local, state, national, and international entities may make regarding climate change and greenhouse regulation, this book is intended to provide an explanation of how environmental markets can be used to reduce the costs of greenhouse gas regula-tion if in fact regulations are established in any particular jurisdiction to regulate these emissions.

Th is book is dedicated to reviewing the regulatory systems that have emerged and continue to emerge to address climate change and greenhouse gas emissions. Emission markets, and how they evolved and then were applied to greenhouse gas emissions, is a fundamental background that needs to be explored. Initially, environmental regulation focused on setting reductions in emissions or environmental degradation. In the United States, this led to thou-sands of pages of state and federal regulations across all fi ft y states that proscribed actions and prohibited other actions mostly of business and industry to reduce environmental impact. Th is approach has come to be known as “command and control.”

Over time, economists and lawyers began formulating concepts that applied market principles to environmental regulation. One of the most famous of which is the emission market for sulfur dioxide emissions from coal-fi red power plants established in the United States under the Clean Air Act. Th is pro-gram has largely been seen as a success in achieving the emission-reduction goals at lower cost than either industry or the government predicted. Emission markets have been applied to air pollutants of other types such as volatile organic com-pounds and nitrogen oxides that are the precursors to ground-level ozone that creates smog and particulates that can cause health problems and that are usually problematic in urban environments.

Environmental markets have been established for other environmental con-cerns as well. Wetlands, water quality and quantity, species, habitat, and biodiver-sity are some of the markets that have emerged or that are beginning to emerge

INTRODUCTION | xxxi

and evolve. Markets for renewable energy and energy effi ciency credits have emerged to increase the percentage of electricity produced from renewable energy sources. Th us, in addition to carbon credits, a variety of other environmental credits known as “environmental attributes” can be produced and sold and, thus, through a market system, drive the increased environmental performance and achieve the goals of environmental regulation with more fl exibility than the traditional command and control approach.

When the international community began developing an international treaty to address greenhouse gas emissions, it is not surprising that the United States that had pioneered the use of emission markets to address sulfur dioxide emissions in the 1990 Clean Air Act Amendments would argue for a cap and trade system and emission markets as a critical part of addressing climate change and reducing greenhouse gases on a global basis.

Th e Kyoto Protocol was draft ed to meet these goals, and emissions trading was a central part of the treaty. Since its beginning, billions of dollars in trading has occurred. Th e European Union established the European Trading Scheme that was designed to implement the Kyoto Protocol in Europe. Th is program has resulted in hundreds of billions of dollars in carbon trading.

Other nations are considering emissions trading programs and exchanges, including Australia, Japan, China, Brazil, and South Korea. Th us, the concepts of emissions trading have spread throughout the global economy. Th e adoption of these programs still face opposition as a concern about costs and global competi-tiveness have led to many companies and industry associations opposing their adoption.

On the other hand, many groups that would manufacture energy equip-ment that drives a low carbon energy source, such as solar photovoltaic panels, wind turbines, LED lights, and other renewable and energy-effi cient projects, are advocating for legislation to drive a low carbon economy.

In any event, the current legal systems that impose a cap and trade program are explained in the book. Th e elements of a cap and trade program are explained generally and then specifi c adopted or proposed systems internationally and in the United States. Th ese chapters will orient the reader to the fundamentals of the legal requirements applying to regulated entities and the establishment of the parameters of an allowance and off set market.

For greenhouse gas emission off sets, the necessities of established off set methodologies governing the ability to obtain off sets for particular types of projects are explained. Forest projects are explained in particular detail as they provide the largest potential source of carbon off sets and provide a means of reducing the deforestation and degradation of the world’s forests, particularly the remaining rainforests of the Amazon, Asia, and Africa. Th e fi nancing of these

xxxii | INTRODUCTION

projects is outlined with discussion of the particular challenges in attracting both debt and equity fi nancing for carbon credit projects.

Once projects are fi nanced, they must go through a rigorous process from governmental or nonprofi t standards boards in order to obtain approval of the project as meeting a particular established methodology and then obtaining approval of the amount of greenhouse gases reduced and then the number of carbon credits issued. Th e challenges of the existing programs of the Kyoto Protocol and the United Nations’ implementation of the off set programs are discussed.

Th e purchase and sale of carbon credits is explained. In particular, the contracts and the provisions typically included in those contracts are detailed. Th e bilateral nature of initial sales of credits along with the secondary market for trading carbon credits on a spot basis and in terms of futures contracts are presented.

Both before and aft er the recent economic recession, government incen-tives have been provided for projects that reduce greenhouse gas emissions. Renewable energy and energy effi ciency receive much of these incentives, but other activities such as carbon capture and storage below ground are discussed as well. Many of these projects may qualify for governmental or utility incentives in the United States and potentially other countries.

Accounting for greenhouse gas emissions and carbon credits has become a signifi cant issue for companies with operations in jurisdictions with green-house gas regulatory systems. Th e state of the still evolving accounting standards of U.S. and international accounting boards is discussed. A strategic approach of preparing a “carbon ledger” is proposed for consideration by aff ected companies.

Financial disclosure related to climate change and greenhouse gas regula-tion has become a critical issue to companies as well. Th e U.S. Securities and Exchange Commission has recently issued guidance for companies in applying the agency’s rules to climate change and greenhouse gas issues in terms of how legislation impacts the physical and fi nancial operations of the company, to corporate reputation. In the European Union and the United States, mandatory greenhouse gas monitoring and reporting programs have been instituted. Many companies participate in voluntary disclosure in environmental, sustain-ability, or greenhouse gas programs. Climate change disclosure has likely become a permanent fi xture in corporate disclosure, both in terms of mandatory fi nancial disclosure and voluntary disclosure protocols.

Th e development of a cap and trade program in the United States presents uncertainty for U.S. and global carbon markets, and the availability of debt and equity investment as a result of this uncertainty and the general state of domestic

INTRODUCTION | xxxiii

and international economies presents challenges to carbon credit project developers and the market for credits they produce. Prices have fallen signifi -cantly for carbon credits in the European market, the largest market for carbon credits. Th ese prices refl ect uncertainties to some extent in future regulatory pro-grams but also the general economic, business, and fi nancial uncertainty facing national and global economies and markets.

One of the remarkable developments in the context of economies and mar-kets related to greenhouse gas emissions and carbon credits is that industries and businesses in the United States, where a national carbon credit program has not yet emerged, are still looking for a means of monetizing reductions in greenhouse gas emissions that they are asked to implement by customers, share-holders, or corporate reputation, and as entrepreneurs they are accomplishing this through renewable energy, energy effi ciency, and other products or services that reduce greenhouse gas emissions. Th is is one of many indications that carbon trading has spread into the economy, and businesses are looking for opportunities to obtain fi nancial reward for their emission reductions. Th e con-cept of environmental markets and of carbon credits specifi cally has in a sense entered the marketplace. It is diffi cult to remove these concepts from the market once they have been introduced. In the future, whether emissions of greenhouse gases, sulfur dioxide, mercury, or nitrogen oxides, environmental markets provide a means of achieving the regulatory goal of reducing emissions at the lowest cost and giving industry the greatest fl exibility.

Carbon credits and emission markets as a means of addressing climate change and greenhouse gas emissions appear to be a fi xture in current and future economies. Th e extent of the application of cap and trade programs and emission markets to greenhouse gas emissions appears to be growing, but elections and votes in state and national legislatures will determine to what extent these pro-grams expand around the globe. It appears clear that Europeans will continue their Emissions Trading Scheme, and a $100 billion market or more will continue to grow and evolve over the next fi ve to ten years. At least some state carbon market programs in the United States appear to be set to begin in 2012. Th us, this book will hopefully serve to educate those who are looking for a fundamental understanding of carbon trading law and business.


P A R T O N E

The Emergence of Carbon Markets


1

Prelude to Regulation — The Development of Climate Change Science

To understand the purpose of carbon trading, one fi rst has to understand the basic science underlying the concern with climate change. Carbon markets evolved as a response to a policy decision to reduce the impact of climate change. It is important to keep in mind the eff ort to engage governmental organi-zations, whether at the international, national, or subnational level, to develop a regulatory system, to reduce GHG emissions, and to fi nd alternative means of producing energy, fueling vehicles, and increasing energy effi ciency, derives from scientifi c institutions that caution these governments that action is necessary to reduce the risk of potentially signifi cant damage to people, economies, and societies.

While there is much controversy over climate science, as will be discussed below, the scientifi c academies of the major developed and developing nations are largely in agreement on climate change and its causes. Th e actual climate trends over the coming decades and further scientifi c research of what it causing these trends will eventually show whether current views of scientifi c academies are correct. In the near term, the question is to what extent the conclusions of the national academies and other scientifi c institutions will impact policy such that the United States at the national or state level will enact climate change statutes and GHG regulations, and the countries of the United Nations will adopt an international treaty to follow on or as an extension of the Kyoto Protocol, and what actions other major emitters in the developed and developing world will take as a result of the conclusions of the major scientifi c institutions.

4 | THE EMERGENCE OF CARBON MARKETS

If a decision is made to regulate and reduce GHG emissions, then the best means of reducing the impact on industry, the economy, and consumers is a critical issue. Much of the controvery over GHG regulation centers on the eco-nomic impact of climate change and GHG legislation. Th us, the use of emissions markets can provide a major contribution to reducing these impacts. Th is chapter will address the scientifi c issues and controversies as an introduction, but in the remaining chapters will mainly focus on carbon trading law and trading systems, and their use to reduce economic impacts of GHG regulation.

A. Typical Process of Regulation Following Science In human systems, whether political, social, or economic, change through adap-tation and innovation occurs as a result of a change in the surrounding circum-stances. Here, substantial change has occurred as a result of the conclusions of the scientifi c institutions that the emission of GHGs is causing signifi cant changes to the climate. Th e process has followed the evolution of other areas of environmen-tal regulation over the last forty or fi ft y years.

Historically, in the United States, evolution of a new environmental law typically occurs as follows:

A scientifi c discovery leads to a specifi c environmental concern; • Th e scientifi c discovery is reviewed by multiple scientists and peer-reviewed •by scientifi c journals and state and national scientifi c academies; A social or political movement regarding the issue emerges and lobbies •for state and federal action; Legislative activity at the state level leads to state laws governing the issue; and • Aft er some period of time, congressional action in the form of an •environmental bill leads to a new federal statute or signifi cant amendment to an existing statute.

Th e concern over climate change and the impact to people, ecosystems, agricul-ture, society, and the economy have generated the same general pattern. To understand how this has come about, it is important to understand the science that underlies the movement for new GHG legislation at the US and interna-tional level. Th is chapter will review the science that has served as the starting point for the emergence of regulatory programs to reduce GHGs, and ultimately the topic of this book will be the use of a cap and trade system and carbon credits to attempt to harness the power of the marketplace to reduce the GHG emis-sions, which the scientifi c academies, as explained below, have concluded are causing climate change.

PRELUDE TO REGULAT ION—THE DEVELOPMENT OF CLIMATE CHANGE SCIENCE | 5

B. The Greenhouse Eff ect Th e fi rst step to understanding climate science is to understand the greenhouse eff ect. Th e greenhouse eff ect is the basis for identifying and reducing emissions of gases that contribute to an increased greenhouse eff ect.

To understand the greenhouse eff ect, it is fi rst necessary to comprehend that the Earth’s surface would be expected to be about –19 ° C on average. Actually the Earth’s surface (the global mean surface temperature) is about + 14 ° C. “Th e reason the Earth’s surface is this warm is the presence of GHGs, which act as a partial blanket for the long wave radiation coming from the surface. Th is blanket-ing is known as the natural greenhouse eff ect.” 1 Th e greenhouse eff ect allows life as we know it to exist on Earth; without it, the surface would be too cold for current life to have evolved and survived.

Th e two most important natural GHGs are water vapor and carbon diox-ide. Carbon dioxide is the most signifi cant GHG emitted from human activity. Methane and nitrous oxide are GHGs that are both emitted by human activity and occur in nature, while other GHGs such as perfl uorocarbons and sulfur trifl uoride are now being emitted by human activity that may not occur in nature or are uncommon in nature.

C. The Science of Climate Change Scientists have been measuring temperature in the atmosphere for many decades. According to the national academies of science and other scientifi c institutions, observations and measurements show that the climate is in fact changing, from melting glaciers, to other eff ects that could have signifi cant impacts on cities, states and provinces, and national governments, as well as the people who inhabit these areas.

1. Conclusions of Scientifi c Institutions a. The International Panel on Climate Change Th e International Panel on Climate Change (IPCC) is the international institu-tion created by the United Nations to study climate change and its causes. It has concluded that climate change is in large part being caused by human emissions of GHGs.

Over the last hundred years the concentration of carbon dioxide in the environment has steadily risen. Th e IPCC in its 2007 report stated, “Human activities intensify the blanketing eff ect through the release of GHGs.

1. Intergovernmental Panel on Climate Change, Fourth Assessment Report, Chapter 1: Historical Overview of Climate Change Science, at 97 (2007) (hereinaft er Climate Change Science).


For instance, the amount of carbon dioxide in the atmosphere has increased by about 35 % in the industrial era, and this increase is known to be due to human activities, primarily the combustion of fossil fuels and removal of forests. Th us, humankind has dramatically altered the chemical composition of the global atmosphere with substantial implications for climate.” 2

Th e IPCC concluded that most of the observed increase in global average temperatures since the mid-twentieth century very likely is caused by the observed increase in GHG concentrations resulting from human emissions. Th e IPPC further concluded that it is likely that signifi cant warming in global average tem-peratures over the past fi ft y years averaged over each continent (except Antarctica) is caused by human GHG emissions. 3

Th e IPPC evaluated other potential causes for global warming and areas of uncertainty. With respect to the impact of solar and volcanic activity over the last fi ft y years, which has been one of the potential causes of global warming asserted by parties who do not accept the conclusions of the IPCC and other scientifi c institutions, the IPCC determined that these phenomena would likely have produced cooling, rather than warming. Issues still remain in terms of the ability of climate scientists to evaluate all aspects of climate change and its causes. For example, the IPPC stated that diffi culties remain in simulating and attributing observed temperature changes at smaller than continental scales. 4

Th e IPPC has concluded that discernible human infl uences extend beyond average temperature to other aspects of climate. Th e scientists of the panel stated that human infl uences have very likely contributed to sea-level rise during the latter half of the twentieth century, likely contributed to changes in wind pat-terns, aff ecting extratropical storm tracks and temperature patterns; likely increased temperatures of extreme hot nights, cold nights, and cold days; and more likely than not increased risk of heat waves, areas aff ected by drought since the 1970s, and frequency of heavy precipitation events. Anthropogenic warming over the last three decades has likely had a discernible infl uence at the global scale on observed changes in many physical and biological systems. 5 Spatial agree-ment between regions of signifi cant warming across the globe and locations of

2. Climate Change Science, at 97.

3. Intergovernmental Panel on Climate Change, Fourth Assessment Report, Chapter 9: Understanding and Attributing Climate Change at 665 (2007) (hereinaft er Attributing Climate Change).

4. Id.

5. IPCC 2007: Climate Change 2007: Synthesis Report, Contribution of Working Groups I, II, and III to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change [Core writing team, R. K. Pachauri and A. Reisinger (eds.)]. IPCC, Geneva, Switzerland, at 30–33, available at http://www.ipcc.ch/publications_and_data/ar4/syr/en/contents.html .

http://www.ipcc.ch/publications_and_data/ar4/syr/en/contents.html


signifi cant observed changes in many systems consistent with warming is very unlikely to be due solely to natural variability. 6

Th e IPCC has predicted future likely impacts due to climate change on the various continents. 7 Th ese impacts are stated below.

i. Africa By 2020, between 75 and 250 million people are projected to be exposed to increased water stress due to climate change. By 2020, in some countries, yields from rain-fed agriculture could be reduced by up to 50 percent. Agricultural pro-duction, including access to food, in many African countries is projected to be severely compromised. Th is would further adversely aff ect food security and exacerbate malnutrition. Towards the end of the twenty-fi rst century, projected sea-level rise will aff ect low-lying coastal areas with large populations. Th e cost of adaptation could amount to at least 5 to 10 percent of gross domestic product (GDP). By 2080, an increase of 5 to 8 percent of arid and semi-arid land in Africa is projected under a range of climate scenarios.

ii. Asia By the 2050s, freshwater availability in Central, South, East, and South-East Asia, particularly in large river basins, is projected to decrease. Coastal areas, especially heavily populated mega delta regions in South, East, and South-East Asia, will be at greatest risk due to increased fl ooding from the sea and, in some mega deltas, fl ooding from the rivers. Climate change is projected to compound the pressures on natural resources and the environment associated with rapid urban-ization, industrialization, and economic development. Endemic morbidity and mortality due to diarrhea disease primarily associated with fl oods and droughts are expected to rise in East, South, and South-East Asia due to pro-jected changes in the hydrological cycle.

iii. Latin America By mid-century, increases in temperature and associated decreases in soil water are projected to lead to gradual replacement of tropical forest by savanna in eastern Amazonia. Semi-arid vegetation will tend to be replaced by arid-land vegetation.

Th ere is a risk of signifi cant biodiversity loss through species extinction in many areas of tropical Latin America. Productivity of some important crops is projected to decrease and livestock productivity to decline, with adverse

6. Id. at 39.

7. Id. at 50–52.


consequences for food security. In temperate zones, soybean yields are projected to increase. Overall, the number of people at risk of hunger is projected to increase. Changes in precipitation patterns and the disappearance of glaciers are projected to signifi cantly aff ect water availability for human consumption, agri-culture, and energy generation.

iv. North America Warming in western mountains is projected to cause decreased snowpack, more winter fl ooding, and reduced summer fl ows, exacerbating competition for overallocated water resources. In the early decades of the century, moderate cli-mate change is projected to increase aggregate yields of rain-fed agriculture by 5 to 20 percent, but with important variability among regions. Major challenges are projected for crops that are near the warm end of their suitable range or which depend on highly utilized water resources.

Cities that currently experience heat waves are expected to be further chal-lenged by an increased number, intensity, and duration during the course of the century, with potential for adverse health impacts. Coastal communities and habitats will be increasingly stressed by climate change impacts interacting with development and pollution.

v. Europe Climate change is expected to magnify regional diff erences in Europe’s natural resources and assets. Negative impacts will include increased risk of inland fl ash fl oods and more frequent coastal fl ooding and increased erosion (due to stormi-ness and sea-level rise).

Mountainous areas will face glacier retreat, reduced snow cover, and winter tourism, and extensive species losses (in some areas up to 60 percent, under high emissions scenarios, by 2080). In southern Europe, climate change is projected to worsen conditions (high temperatures and drought) in a region already vulnera-ble to climate variability, and to reduce water availability, hydropower potential, summer tourism, and, in general, crop productivity. Climate change is also projected to increase the health risks due to heat waves and the frequency of wildfi res. 8

b. National Academies of Science of the Major Emitting Developed and Developing Countries In addition to the IPCC, the national academies of sciences of the G8 nations, which consist of Canada, France, Germany, Italy, Japan, Russia, the United Kingdom,

8. Id. at 50.


and the United States, 9 and the national academies of science of the + 5 — Brazil, China, Mexico, South Africa, and India, fi ve of the largest developing nations and economies — have considered the climate change and causation evidence and issued joint statements on these issues. Th e national academies of science from these countries have issued statements calling on national governments to take action to reduce GHGs and to develop means of adapting to climate change.

In 2005, the national academies from the G8 + 5 signed a document declar-ing that there is “strong evidence” that climate change is occurring and that human activity is likely the cause of that change.

Th ere will always be uncertainty in understanding a system as complex as the world’s climate. However there is now strong evidence that signifi cant global warming is occurring. Th e evidence comes from direct measurements of rising surface air temperatures and subsurface ocean temperatures and from phenomena such as increases in average global sea levels, retreating glaciers, and changes to many physical and biological systems. It is likely that most of the warming in recent decades can be attributed to human activities (IPCC 2001). Th is warming has already led to changes in the Earth’s climate. 10

Th e 2005 statement called on the nations of the world to take action to reduce GHG emissions, to prepare for the adverse consequences of climate change that cannot now be avoided and to mitigate and adapt to such changes, and to develop and deploy clean energy technologies and approaches to energy effi ciency, and to share this knowledge of technologies and approaches with other nations.

Th ese national academies issued two more statements in 2007 and 2008 regarding climate change. In 2007, the national academies concluded in a joint statement that the countries of the world should take the following actions:

Set standards and promote economic instruments for effi ciency, and commit •to promoting energy effi ciency for buildings, devices, motors, transportation systems, and in the energy sector itself; Promote understanding of climate and energy issues and encourage necessary •behavioral changes within our societies; Defi ne and implement measures to reduce global deforestation; •

9. Th e European Union is part of the G8, but cannot host or chair the G8 meetings.

10. Joint Science Academies’ Statement: Global Response to Climate Change (2005).


Strengthen economic and technological exchange with developing countries, •in order to leapfrog to cleaner and more effi cient modern technologies; and Invest strongly in science and technology related to energy effi ciency, •zero-carbon energy resources, and carbon-removing technologies. 11

In addition, these scientifi c academies advocated that national governments develop new sources for energy supply, including clean use of coal, carbon capture and storage, unconventional fossil fuel resources, advanced nuclear sys-tems, advanced renewable energy systems (including solar, wind, biomass, and geothermal energy), smart grids, and energy storage technologies.

In 2007, the InterAcademy Council, which consists of numerous national academies, issued a report entitled, “Lighting the Way: Toward a Sustainable Energy Future.” 12 Th is report was commissioned by the governments of Brazil and China. Th e report provided what it considered a scientifi c consensus framework for directing global energy development, in terms of a science, tech-nology, and policy road map for developing energy resources to drive economic growth in both industrialized and developing countries while also securing climate protection and global development goals. Th e report was prepared by a study panel of fi ft een world-renowned energy experts, and co-chaired by Nobel Laureate Steven Chu, formerly the Director of the Lawrence Berkeley National Lab in the United States, who later became the U.S. Secretary of Energy, and José Goldenberg, former Secretary of State for the Environment for the State of São Paulo, Brazil.

In 2008, the G8 + 5 academies issued another statement. In this statement, the academies called for mitigation to reduce further change in the climate and adaptation to address climate change that is already set to occur.

Responding to climate change requires both mitigation and adaptation to achieve a transition to a low carbon society and our global sustainability objectives. We urge all nations, but particularly those participating in the 2008 G8 Summit in Hokkaido, Japan, to take the following actions:

Call on G8 + 5 governments to agree, by 2009, a timetable, funding, •and a coordinated plan for the construction of a signifi cant number of CCS demonstration plants.

11. Joint Science Academies’ Statement on Growth and Responsibility: Sustainability, Energy Effi ciency and Climate Protection (2007).

12. InterAcademy Council, “Lighting the Way: Toward a Sustainable Energy Future” (October 2007).

PRELUDE TO REGULATION—THE DEVELOPMENT OF CLIMATE CHANGE SCIENCE | 11

Prepare for the challenges and risks posed by climate change by •improving predictive and adaptive capacities at global, national and local level and supporting the developing world in carrying out vulnerability analyses and addressing their fi ndings. Take appropriate economic and policy measures to accelerate transition •to a low carbon society and to encourage and eff ect changes in individual and national behavior. Promote science and technology co-operation, innovation and •leapfrogging, e.g., by transfer of some basic critical low-carbon and adaptation technologies. Urge governments to support research on greenhouse gas reduction •technologies and climate change impacts.

As national science academies, we commit to working with our governments to help implement these actions. 13

In reviewing the statements of these national academies of science from the most signifi cant nations in terms of GHG emissions, it is clear that a con-sensus exists among these academies in terms of climate change science and the actions they believe their respective governments should take in terms of climate mitigation and adaptation.

c. In the United States: the National Research Council and the National Academy of Sciences In May 2001, the White House asked the National Research Council, which is a part of the National Academy of Sciences, to assess our current understanding of climate change by answering some key questions related to the causes of climate change, projections of future change, and critical research directions to improve understanding of climate change. In a report entitled “Climate Change Science: An Analysis of Some Key Questions,” the Academy concluded that “changes observed over the last several decades are likely mostly due to human activities.” 14 Th e National Research Council and the National Academy of Sciences have not varied from the conclusion over the last nine years that the climate is changing and that the cause is largely human GHG emissions.

13. Joint Science Academies’ Statement: Climate Change Adaptation and the Transition to a Low Carbon Society (2008).

14. Climate Change Science: An Analysis of Some Key Questions (2001).


D. The Policy Impact of the Conclusions of the National Academies of Science Th e national academies of sciences of the developing world and the largest devel-oping countries have issued these joint statements on the occurrence and casues of climate change. Th e extent to which these views will be borne out over the coming years remains to be seen. Th e conclusions of these scientifi c academies has and will continue to exert pressure on public policy development. As so many other scientifi c academies’ conclusions about particular empirical matters relat-ing to pollution and human health and the environment have driven public policy and eventually led to the adoption of federal legislation by Congress, in time we may see some federal legislation, but it does not appear likely in the short term. As will be discussed in this book, climate change and GHG regulation is continuing to evolve in the United States, at a local, state, and federal level, and in other countries. Other aspects of climate policy from potential economic impact to political views on climate science may be more infl uential at the federal level over the next several years.

E. Controversy over Climate Science Th e conclusions in the reports and statements by the IPCC, the national acade-mies of science of the G8 + 5, and the U.S. National Academy of Sciences and various other U.S. science entities, are not without controversy among the public and certain scientists, whose opporsition is vociferous to say the least. Beyond scientists, representatives of industry and business groups, politicians, and certain media have attacked not only the conclusions of those who have published scientifi c papers and participated in the academies, universities, and the IPCC, but their character as well, asserting that the conclusions were based on fraud, not legitimate science. Th us, the debate among the public and policy-makers has been extreme in certain countries, particularly Australia and the United States, the only industrialized country not to ratify the international climate agreement known as the Kyoto Protocol.

An example of a strong advocate against climate science is Richard S. Lindzen, a professor of meteorology at the Massachusetts Institute of Technology. He has argued that in fact the climate is not changing in any way that refl ects a warming trend. 15 Other scientists have reached similar conclusions, or that if climate change is occurring that the cause is not in fact GHG emissions from human activities.

15. Richard S. Lindzen, Th e Climate Science Isn’t Settled: Confi dent Predictions of Catastrophe Are Unwarranted , The Wall Street Journal, Nov. 30, 2009.


Th e U.S. Chamber of Commerce has issued somewhat inconsistent state-ments about climate science and GHG regulation. Aft er the U.S. Environmental Protection Agency (EPA) issued what is known as an “Endangerment Finding” (which will be discussed in a later chapter) saying that GHGs are endangering human health and welfare, William Kovacs, the Vice President for Environment, Technology, and Regulatory Aff airs of the U.S. Chamber called for “the Scopes monkey trial of the 21st century” that would include witnesses, cross-examina-tions, and a judge who would determine if anthropogenic GHG emissions were causing climate change. Mr. Kovacs stated, “It would be evolution versus creationism. It would be the science of climate change on trial.” 16 Later, Mr. Kovacs revised his response to a question posed on the National Journal Energy and Environment blog. He said, “My ‘Scopes monkey’ analogy was inap-propriate and detracted from my ability to eff ectively convey the Chamber’s posi-tion on this important issue.” 17 Mr. Kovacs reiterated his call for a trial of the EPA’s Endangerment Finding and the science underling the conclusions in the fi nding.

One of the most signifi cant controversies over climate science arose over what some have called “Climate Gate.” In November of 2009, computer hackers of unknown origin hacked into computers of climate scientists at the Climate Research Unit at the University of East Anglia in Great Britain. Subsequently, e-mails and documents obtained illegally from these computers were posted on the Internet. Some reviewers considered statements in these documents and e-mails to reveal scientifi c misbehavior, and that these climate scientists had conspired to overstate the science on climate change. 18 Th e head of the program actually resigned pending investigations of the allegations.

Th e criticism of East Anglia scientists and those who worked with them was blistering. Th e criticism grew to even challenging the credibility of “science” itself. Daniel Henninger, an editorial writer for Th e Wall Street Journal wrote an editorial that stated the following:

What is happening at East Anglia is an epochal event. As the hard sciences — physics, biology, chemistry, electrical engineering — came to dominate intellectual life in the last century, some academics in the

16. Jim Tankersley, U.S. Chamber of Commerce Seeks Trial on Global Warming , L.A. Times, Aug. 25, 2009.

17. National Journal Experts Blog: Energy & Environment (Aug. 31, 2009), available at http://energy.nationaljournal.com/2009/08/should-epa-bow-to-chambers-dem.php#1349896 (last vis-ited Sept. 3, 2010).

18. Andrew C. Revkin, Hacked E-Mail Is New Fodder for Climate Dispute , N.Y. Times , Nov. 20, 2009.

http://energy.nationaljournal.com/2009/08/should-epa-bow-to-chambers-dem.php#1349896

http://energy.nationaljournal.com/2009/08/should-epa-bow-to-chambers-dem.php#1349896


humanities devised the theory of postmodernism, which liberated them from their colleagues in the sciences. Postmodernism, a self-consciously “unprovable” theory, replaced formal structures with subjectivity. With the revelations of East Anglia, this slippery and variable intellectual world has crossed into the hard sciences.

* * * If the new ethos is that “close-enough” science is now suffi cient to achieve political goals, serious scientists should be under no illusion that politicians will press-gang them into service for future agendas. Everyone working in science, no matter their politics, has an [sic] stake in cleaning up the mess revealed by the East Anglia emails. Science is on the credibility bubble. If it pops, centuries of what we understand to be the role of science go with it. 19

Several investigations were conducted regarding these scientists’ activities. Th e conclusions were that the science was not in question, but criticisms were lodged against some of the scientists that were involved in terms of openness and transparency and certain other behaviors. 20 Th e IPCC issued statements that hundreds of scientists across the world work on the scientifi c issues and that the lines of multiple lines of evidence support the work of the scientifi c community on climate change. 21 Th e American Association for the Advancement of Science and the American Meteorological Society issued similar statements. 22

As a result the political controversy over climate science and its conclusions remain at high levels. Th ese are only some of the controversies and criticisms of climate science, and there are scientists who question whether climate change is occurring, or if it is occurring, whether human activity is a cause of that change.

19. Daniel Henninger, Climategate: Science Is Dying , The Wall Street Journal , Dec. 3, 2009, avail-able at http://online.wsj.com/article/SB10001424052748704107104574572091993737848.html .

20. Ron Oxburgh, Huw Davies, Kerry Emanuel, Lisa Graumlich, David Hand, Herbert Huppert, & Michael Kelly, “Report of the International Panel Set Up by the University of East Anglia to Examine the Research of the Climatic Research Unit,” University of East Anglia (April 14, 2010); Th e Pennsylvania State University, “Final Investigation Report Involving Dr. Michael E. Mann” ( June 4, 2010).

21. International Panel on Climate Change, “IPCC Chairman Statement on News Reports Regarding Hacking of the East Anglia University Email Communications” (Dec. 4, 2009), available at http://www.ipcc.ch/pdf/presentations/rkp-statement-4dec09.pdf .

22. American Association for the Advancement of Science, “AAAS Reaffi rms Statements on Climate Change and Integrity” (Dec. 12, 2009), available at http://www.aaas.org/news/releases/2009/1204climate_statement.shtml ; American Meteorological Society, “Impact of CRU Hacking on the AMS Statement on Climate Change” (Nov. 25, 2009), available at http://www.webcitation.org/5lnFDGhdZ .

http://online.wsj.com/article/SB10001424052748704107104574572091993737848.html

http://www.ipcc.ch/pdf/presentations/rkp-statement-4dec09.pdf

http://www.aaas.org/news/releases/2009/1204climate_statement.shtml

http://www.aaas.org/news/releases/2009/1204climate_statement.shtml

http://www.webcitation.org/5lnFDGhdZ

http://www.webcitation.org/5lnFDGhdZ


Th e public debate on climate science is likely to continue, which will likely eff ect in some states and at the national level any attempt to impose GHG regulations.

F. Future Policy Development Based on Climate Science While the controversy may not end any time soon, climate science will continue to serve as the foundation of evolving climate change regulation. Th at the U.S. National Academy of Science and the National Research Council have pro-vided conclusions on the issues will likely serve as the basis for future climate change and GHG regulation at the state and federal level in the United States. Elected offi cials will determine to what extent any legislation and regulations will be developed to regulate GHGs, or, once government agencies initiate regu-latory programs, whether the legislators will act to block such programs.

It is beyond the purview of this book to attempt to resolve any controversy or disagreement over the conclusions of the IPCC, scientifi c academies, or indi-vidual scientists. Th e point of this chapter is to note the scientifi c conclusions outlined above, and recognize the trends in environmental regulation over the last forty or fi ft y years. On this basis, climate science has led to GHG regulation in many countries at the national and international level, and at the state and provincial level, and even among local governments both in the United States and in other countries. Th us, climate science, like prior environmental science, has and likely will continue to drive GHG regulation. To what extent a particular jurisdiction will reject or adopt regulation remains to be seen.

2

The Emergence of Emissions Trading Concepts

A. Economics vs. the Environment In the early 1970s, in the United States, Congress began adopting environmental statutes as it became clear that the economic development brought on by industrialization was creating very damaging environmental and public health issues, as well as signifi cant degradation of our natural ecosystems. Statutes designed to reduce air pollution and water pollution were the fi rst ones passed. In the following decades, statutes were passed to regulate solid and hazardous waste treatment storage and disposal and to cleanup abandoned hazardous waste dis-posal sites. Over the last fi ft y years, Congress has amended and strengthened these environmental statues.

Th e initial approach to environmental protection was to set specifi c stan-dards and procedures to govern air and wastewater emissions from specifi c sources of those pollutants. In other words, the regulated party has to comply with technology standards. Each facility also must obtain a permit that dictates specifi c limitations that apply to that facility, in addition to the more general requirements that the regulations impose on all facilities. Th is model resulted in hundreds of federal regulations being created by the U.S. Environmental Protection Agency (EPA). Failure to follow these regulations could result in civil and criminal sanctions.

Th e model of the early environmental protection approach has been known as the “command and control” model. Under this model, the government sets out the specifi c standards in great detail that each regulated party must follow,

THE EMERGENCE OF EMISS IONS TRADING CONCEPTS | 17

and uses the threat of civil and criminal sanctions to motivate the industrial sources to comply. Th e model is based on a concept that, left to their own devices, companies will pollute without regard to the environmental impact, in order to avoid the costs of pollution that are “externalized” to society and the environ-ment at large. Th us, government regulations are needed to force companies to “internalize” these costs and thereby reduce the level of pollutants released to the society and the environment.

Inherent in this model is a fundamental view that the economy and eco-nomic development are damaging to the environment, and regulation is needed to force through government fi at economic actors to reduce this impact.

B. Evolution of Environmental Regulation and Emergence of Environmental Markets Th e concept of markets as a form of government regulation is based initially on the basic principles of economic markets, as described above. Th e evolution is the combining of concepts of economics and environment, which have been and oft en are in confl ict. On the one hand, economics and economists could not put a value on ecosystems or their component parts, such as habitat, species, water bodies, or the various living, physical, or chemical parameters, the change of which can have signifi cant damaging eff ect on ecosystems and the fl ora and fauna that make up an ecosystem. On the other hand, ecologists could not com-prehend economics — fi nancial value and preservation of ecosystems were not consistent. No price could be put on the value of a habitat or a species.

Th ese two disciplines have been hybridizing at the margins in signifi cant ways over the last few decades. In part, as the human agents making up human society and economies have begun to recognize the problems with having two systems that do not work in any harmonizing way, and that tend to work against the success of the other. Concepts of ecological or environmental value have evolved as governments attempt to impose the costs of damages to ecosystems on private parties or fi rms that have caused these damages.

C. Emissions Trading as a Means of Bridging the Divide between the Economy and Environment Th e particular relevance for emissions trading is the need in the climate change context to make millions of decisions about taking actions in millions of places all over the world, or even at the state or national level. No governmental or centralized process can possibly manage such a system or even attempt to manage such a system in any effi cient way, both in terms of cost or time. To think a


United Nations program to identify and fund hundreds of thousands of projects around the world or to ask national governments to identify and fund thousands of projects in any one country, particularly the developed and larger developing countries, is simply not workable. Th us, a system that can allow individual agents acting on their own to search out the space of possibilities and fi nd the most effi cient and fi nancially viable projects requires another approach.

Emissions markets — or in the case of greenhouse gas emissions, carbon markets — serve to allow a complex system to allow adaptive agents, that is entrepreneurs and private capital, to search out projects fi rst identifi ed by the entrepreneurs or carbon credit project developers and then fi nanced if the capital markets, international development banks — largely originally the World Bank — and then private equity, private banks, new organisms called “carbon funds,” and other capital providers to decide the projects are viable and can return suffi cient profi ts. Th rough setting up this private market via the Kyoto Protocol, that will be discussed in more detail in Chapter 4, and the European Union Emissions Trading Scheme, that will be discussed in more detail in Chapter 5, an interna-tional system of greenhouse gas emission reductions and a carbon market emerged from the “primordial soup” of entrepreneurs and capital providers based on the simple regulatory and market rules that were set up and the activities of thou-sands of “adaptive agents.”

Th eory and reality, thus, show that emissions markets and a cap and trade system actually work. Under the Kyoto Protocol’s Clean Development Mechanism alone, approximately 431,090,634 tons of greenhouse gas reductions have occurred largely through private project developers and private capital investment. 1 No central governmental system was used to select the projects or to fund the projects, but the origin of the projects was largely through carbon credit project developers seeking out and fi nding funding for the projects — an environ-mental market in action.

D. Basic Concepts of Emissions Trading To comprehend how this decentralized and self-organizing system or systems work, the fi rst step is to understand “cap and trade.” Th is concept confuses many people who are not familiar with environmental regulation in general or the cap and trade programs developed under the U.S. Clean Air Act that were then incorporated in the Kyoto Protocol and the European Union Emissions Trading

1. United Nations Framework Convention on Climate Change, Clean Development Mechanism, available at http://cdm.unfccc.int/Statistics/Issuance/CERsRequestedIssuedBarChart.html (last visited Sept. 3, 2010).

http://cdm.unfccc.int/Statistics/Issuance/CERsRequestedIssuedBarChart.html


Scheme (EU ETS) specifi cally. Th e concept derives from a principle known as emissions trading, generally discussed above, through which “pollution rights” may be bought and sold between emitters of pollution. Under such a system, a company may reduce emissions at its facility or purchase “emission rights” from a party that has reduced its own emissions beyond those required by pollution regulations. Th is system of trading of allowances between polluting facilities per-mits less effi cient pollution-reducing facilities to purchase allowances from more effi cient pollution-reducing facilities. What emerges from this market system is a self-organizing system.

Th e pollution rights are usually referred to as emission allowances and form what is oft en referred to as a “cap and trade” system. Th e “cap” is the limit placed on a state or country for a relevant type of emission of air pollution. Th e “trade” is the market for pollution allowances between regulated polluting facilities, in addition to purchases of another regulated facility’s allowances.

Th e cap and trade systems typically also allow the use of what are known as pollution off sets. Off sets are generally reductions of emissions from activities that are not part of the regulated industry. Th e off sets can be used to meet the reductions required by a regulated polluting facility.

In a cap and trade system where allowances are granted to a facility in a regulated industry, a particular facility may meet its reductions in emissions by reducing its emissions, buying another regulated facility’s allowances or buying off sets from a party in another industry or business.

Th e system must also impose substantial fi nes for failing to meet the emission limits. Th e fi nes must be much higher than the cost of reducing its emis-sions and/or buying allowances or off sets to make the system work. Otherwise, the regulated facility would simply pay a fi ne rather than reducing its emissions or buying allowances or off sets.

In other words, a cap and trade system is basically a market of emission allowances and off sets, where industry is forced to participate in the system by continually lowering allowed emissions generally and by each regulated facility. An example may provide the best way to understand the concept.

Assume that two coal-fi red power plants are required to reduce their emis-sions by 10,000 tons of carbon dioxide (CO 2 ) each in order to meet a permitted limit on emissions. Let’s say the fi rst power plant, Plant A, can either install equipment to reduce the emissions or may buy allowances or off sets to meet that 10,000-ton limit. Plant B has the ability to reduce its emission by 15,000 tons for less than the market to sell its allowances for emitting CO 2 . Plant B off ers to sell its excess allowances to Plant A. Plant A purchases these allowances, but must decide whether to reduce its emissions by 5,000 tons or purchase other allow-ances. Another party determines that it can reduce greenhouse gas emissions by


installing a wind farm to off set electricity produced from a coal-fi red power plant. Th e wind farm produces 5,000 off sets. Plant A negotiates with the wind farm owner to purchase the 5,000 off sets.

In the above example, 20,000 tons of carbon dioxide emissions are elimi-nated. Th e cost to reduce the emissions are far less than if Plant A would have been required to reduce its emissions by 10,000 tons by installing expensive control systems. Th e outcome is a reduction of emissions at a far lower price.

Th is is the basic concept behind cap and trade systems — a market-based system that allows the market to function and allows the parties in the emissions market to “fi nd” the least-cost approach to reduce emissions. Such systems have to have several aspects to actually work.

Th e aspects of systems that actually work include several necessary elements or traits. First, the reductions imposed on an industry or industries must be real, signifi cant, and continue to decrease over time. Second, a substantial penalty must be imposed if a facility fails to meet its mandated emission reductions. Without real, mandated reductions, the reductions in pollution sought by the regulations do not occur, and the market for allowances and off sets is very low or zero. In such a situation, the environmental goals are not met and the market does not function. Where both are in place, the environment is enhanced and the economics emerge for a functioning emissions market.

E. Cap and Trade “Made in America” — The Advent of U.S. Emissions Markets with Sulfur Dioxide and Other Emissions Cap and trade concepts were invented in the United States. Th e most prominent of these systems is the sulfur dioxide emission markets that developed under Title IV of the 1990 Clean Air Act Amendments. 2 Acid rain was a signifi cant problem in the United States. Sulfur dioxide emissions from coal-fi red power plants would transform in the atmosphere into sulfuric acid and fall in the rain, making it more acidic. Th e acidity caused damage to trees and other plants and rivers and streams.

Th e implementation of the cap and trade system to address sulfur dioxide emissions from coal-fi red power plants and the resulting damage from acid rain proved very successful both in terms of reducing acid rain and by reducing the costs of sulfur dioxide emission reductions. According to a report prepared by the Environmental Defense Fund (EDF), “‘Cap and trade’ harnesses the forces of markets to achieve cost-eff ective environmental protection. Markets can achieve

2. 42 U.S.C. §§ 7651–7651o.


superior environmental protection by giving businesses both fl exibility and a direct fi nancial incentive to fi nd faster, cheaper and more innovative ways to reduce pollution.” 3 Th e EDF website provides two fi gures that demonstrate how the emissions of sulfur dioxide were reduced, and compares the estimate costs and the actual costs — the actual costs were dramatically less than the esti-mated costs to achieve the emission reduction goals. 4 On the eve of legislation, the EPA estimated that the program would cost $6 billion (in 2000 dollars) annually once it was fully implemented. Th e Offi ce of Management and Budget has estimated actual costs to be $1.1–1.8 billion — just 20 to 30 percent of the forecast. 5

Th e EDF off ers two main reasons why cap and trade programs work:

1. Markets provide greater environmental eff ectiveness than command-and-control regulation because they turn pollution reductions into marketable assets. In doing so, this system creates tangible fi nancial rewards for environmental performance.

2. Because cap-and-trade gives pollution reductions a value in the marketplace, the system prompts technological and process innovations that reduce pollution down to or beyond required levels. Th is point is not theoretical; experience has shown these results. 6

Th e empirical results show that cap and trade can be used to direct resources more effi ciently than a command and control system by marrying economics in the form of a market-based system for emission rights and an environmental regula-tory system in the form of an emissions-reduction program.

F. Examples of Working Carbon Markets Th ese concepts led to the formation of an international carbon market that much of this book will discuss. Before moving into more detail, understanding the basic concepts will provide context for the chapters that follow. At the interna-tional level, the Kyoto Protocol along with the EU ETS serve as the carbon market that has grown to over $100 billion. Th e two systems create a set of

3. Environmental Defense Fund, Th e Cap and Trade Success Story, available at http://www.edf.org/page.cfm?tagID=1085 .

4. Id .

5. Id .

6. Id .

http://www.edf.org/page.cfm?tagID=1085

http://www.edf.org/page.cfm?tagID=1085


national markets involving numerous countries supplemented with carbon off -sets largely derived from developing nations.

1. The Kyoto Protocol International negotiations led to the fi rst climate change treaty in Rio de Janeiro 1992. Th e countries of the United Nations entered into the UN Framework Convention on Climate Change (UNFCCC). Th is treaty stands as the basis for all other climate change negotiations since then. In 1997, the parties to the UNFCCC negotiated the Kyoto Protocol. Th e Kyoto Protocol stands as the basis for the current international climate change law and the bedrock of the international carbon credit trading system.

Various other meetings of the parties have occurred over the last eleven years aft er the treaty was ratifi ed by suffi cient countries to allow it to go into eff ect. Various other related agreements through the Conference of the Parties are negotiated and issued several times a year.

At present, the Kyoto Protocol imposes certain restrictions on developed countries. Developed countries are required to reduce their emissions to 1990 levels by establishing their own national greenhouse gas emissions reduction programs. Ranging from 8 percent reductions for the European Union to 7 per-cent for the United States (the United States did not submit to the agreement), 6 percent for Japan, 0 percent for Russia, and permitted increases of 8 percent for Australia and 10 percent for Iceland. Developing countries have no limits, including China and India.

Th e Kyoto Protocol ironically included cap and trade concepts — whereby one party may purchase and use another party’s emission reduction allowances or off set credits to meet their own compliance obligations — at the insistence of the U.S. delegation. Th e United States then did not ratify the agreement. Th e European Union took it into account by setting up the EU Emissions Trading Scheme, which will be discussed below.

Th e fi rst process by which countries may trade among themselves is out-lined in Article 6 of the Kyoto Protocol, which is known as the Joint Implementation. Th is program involves trading between those countries on Annex I, or the developed countries that generally must reduce emissions under the agreement. Th us, European countries can develop projects, such as wind energy, fuel switching, or energy effi ciency, and seek certifi cation of those emis-sions. Once the reductions are verifi ed, the credits known as Emission Reduction Units (ERUs) may be bought and sold among developed countries.

Th e program that is best known for carbon trading is the Clean Development Mechanism (CDM) under Article 12 of the Kyoto Protocol. Th is program allows


parties in developed countries with emission reduction commitments to invest in projects in developing countries that have no reduction commitments. Th e carbon credits produced through the CDM are known as Certifi ed Emission Reductions (CERs). To administer this program and to review and approve projects and to issue credits, the United Nations formed the CDM Executive Board. A fairly rigorous process for establishing methodologies for measuring and verifying emissions reductions has been developed.

Th e gases that may be reduced to generate CERs under the CDM are shown in Table 2.1, with the equivalent greenhouse gas aff ect of each ton in carbon dioxide equivalents.

As you can see, a reduction in methane or other greenhouse gases other than CO 2 produces a multiplier eff ect in terms of carbon credits, which are measured in carbon dioxide equivalents (CO 2 e). Each reduction in a ton of meth-ane produces 21 tons of CO 2 e and 21 CERs. 7

One of the qualifi cations that has caused many projects to be rejected by the Executive Board is the requirement that the project proves “additionality.” CDM projects must lead to “additional” emission reductions that are “beyond business as usual.” Additionality is a complex concept.

Once the project meets the additionality requirement and is approved by the host country where the project is located and by the Executive Board, the project is then constructed or implemented. A third-party verifi er, known as a Designated Operational Entity (DOE), must then verify completion of the project and the reductions in greenhouse gas emissions. Once the DOE report is submitted to the Executive Board, the Board reviews the submission and, if approved, the CERs are issued.

7. Th e use of the word ton throughout this book is to metric tons.

TABLE 2.1 Relative Greenhouse Gas Eff ect

Carbon dioxide, CO 2 1

Methane, CH 4 21

Nitrous oxide, N 2 O 310

Hydrofl uorocarbons, HFCs 140 – 11,700

Perfl uorocarbons, PFCs 6,500 – 9,200

Sulphur hexafl uoride, SF 6 23,900


2. The European Union Emissions Trading Scheme Th e European Union established the EU ETS with a fi rst phase in 2005 to 2007 and a second phase from 2008 to 2012 to coincide with the Kyoto Protocol period. Th e EU ETS is the largest emissions trading system in the world, covering over 10,000 installations. It includes combustion plants, oil refi neries, coke ovens, iron and steel plants, and factories making cement, glass, lime, brick, ceramics, and pulp and paper. Other industries are to be added to the ETS, such as aviation, aluminum, and ammonia. Th e legislation covers CO 2 initially, but other greenhouses gases (GHGs) may be added. At this time, the allowances are assigned without charge and not auctioned. In the future, the European Union will be auctioning some of the allowances.

One of the criticisms lodged at the EU ETS is the problem with the First Phase, from 2005–2007, which was plagued with overallocation of allowances. Th e countries and companies applied for more allowances than there were emissions — driving the price of allowances to near zero. Without scarcity, no market works.

Th e European Union is working in the Second Phase to limit allowances, which has resulted in litigation by countries and companies against the European Union to try to increase the allotment of allowances. Nonetheless, the European Union has implemented a more robust emissions trading scheme to cap and begin reducing greenhouse gas emissions. Th e carbon market under this system is active and functioning well.

G. Environmental Markets Are Alive and Well Th e emergence of such a large environmental market, by means of government set-ting up the process and letting entrepreneurs and capital providers fi gure out on their own — in a distributed and noncentralized process — how to solve environ-mental concerns, is a testament to self-organizing systems. Markets can serve to play a role in environmental regulation. Th e details of the system in terms of the laws, regulations, and guidance from legislatures and governing agencies must be devel-oped and experimented with over time, but the ultimate goal can work. Cap and trade has received much scorn from some portions of the U.S. political and busi-ness circles. However, many in the potentially regulated industries, particularly utilities with coal-fi red power plants, recognize that if there is to be greenhouse gas regulation, cap and trade is preferred to a command and control regulatory system or a pollution tax. For direct emitters of greenhouse gases, an environ-mental market system provides the fl exibility and effi ciencies that these industries require to reduce the cost of achieving the environmental regulatory goals.

3

Fundamentals of Cap and Trade

Th e emerging environmental emissions markets for greenhouse gases, as stated in the prior chapter, all arise primarily through government fi at. Voluntary systems arise as well, as certain business entities and even some local or state/provincial governmental entities have decided to off set their greenhouse gas emissions. In establishing both compliance systems and voluntary systems for emissions trading, a series of standards and regulations must be established. Th is chapter will focus on the compliance or mandatory cap and trade systems.

All of the state or national governments establishing cap and trade programs face a complex set of issues and concerns. How these issues and concerns are addressed infl uence the eff ectiveness of the emissions trading markets and ultimately the goal of reducing emissions, as well as the economic impact on the regulated industry and the general consumer. In this chapter, the major issues that arise in the formation of legislation and regulations to establish a cap and trade system for greenhouse gas emissions will be discussed.

A. Defi ning the Regulated Gases In order to establish an emissions market for air pollutants, the fi rst step is to defi ne the gases or materials that will be regulated. As discussed above, carbon dioxide constitutes the greatest mass of greenhouse gases emitted to the atmosphere, largely through the burning of fossil fuels. Studies indicate that


carbon dioxide accounts for approximately 80 percent of the mass of greenhouse gases emitted by human activity in the United States each year. 1

Carbon dioxide, however, is not the only greenhouse gas and does not cause the most signifi cant amount of global warming of the greenhouse gases regulated at this time. Th ere are fi ve other greenhouse gases that are typically regulated:

methane, CH • 4 nitrous oxide, N • 2 O hydrofl uorocarbons, HFCs • perfl uorocarbons, PFCs • sulphur hexafl uoride, SF • 6

Th e relative greenhouse gas eff ect can be measured through comparing the impact of carbon dioxide to the other greenhouse gases.

Figure 3.1—provides a comparison of these gases. For example, under the Kyoto Protocol, methane is considered twenty-one times more potent as a greenhouse gas than CO 2 . Because of this disparity, regulators decided to convert greenhouse gases into a common unit. Not surprisingly, they selected CO 2 as the common unit. Th e unit is expressed in CO 2 equivalents and abbrevi-ated as “CO 2 e.” If one is emitting one ton of methane, it would be expressed as 21 tons of CO 2 e.

Th e European Union Emissions Trading Scheme (EU ETS), which will be discussed in more detail in a later chapter, initially regulated only carbon dioxide. 2 Similarly, the Regional Greenhouse Gas Initiative (RGGI) involving ten of the northeastern states in the United States, which will be discussed in

1. U.S. EPA, 2007. Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990–2005, EPA 430-R-07–002, EPA: Washington, DC, available at http://epa.gov/climatechange/emissions/usin-ventoryreport.html .

2. EU Emissions Trading Directive, Annex I.

TABLE 3.1 Relative Greenhouse Gas Eff ect

Carbon dioxide, CO 2 1

Methane, CH 4 21

Nitrous oxide, N 2 O 310

Hydrofl uorocarbons, HFCs 140 – 11,700

Perfl uorocarbons, PFCs 6,500 – 9,200

Sulphur hexafl uoride, SF 6 23,900

http://epa.gov/climatechange/emissions/usinventoryreport.html

http://epa.gov/climatechange/emissions/usinventoryreport.html

FUNDAMENTALS OF CAP AND TRADE | 27

more detail in a later chapter as well, addressed only carbon dioxide. 3 On the other hand, the California Global Warming Solutions Act (AB 32) addresses all six greenhouse gases, 4 as does the developing program under the Western Climate Initiative and the Midwestern Greenhouse Gas Reduction Accord. 5 Th e legislation that was voted out of the U.S. House of Representatives and was considered by the U.S. Senate would have regulated all six greenhouse gases. Th e European Union is considering regulating the other greenhouse gases as well. Th us, the developing trend is toward regulating all six greenhouse gases (GHGs).

Other compounds and substances have been identifi ed as being poten-tially regulated as GHGs. In the Waxman-Markey Bill passed by the House of Representatives, nitrogen trifl uoride was included in the list of regulated greenhouse gases. Nitrogen trifl uoride is used in the etching of silicon wafers, and for cleaning parts used in the manufacture of fl at panel displays and thin fi lm solar cells. Th is addition would make seven regulated greenhouse gases.

Another compound being considered is actually not a gas, but a particulate. Black carbon is a material generated from burning wood and other materials. Th is material was included in some of the bills proposed in the U.S. Congress. Th e defi nition under this proposal was “the light absorbing component of carbonaceous aerosols.” 6 Black carbon falls on snow and ice in the poles and absorbs sunlight, thereby heating the ice and contributing to the melting of the ice. Th e ice would otherwise refl ect the sunlight and not be heated to the same extent. Some argue that reducing anthropogenic emissions of black carbon would be the most rapid way of reducing climate change. 7 Some of the bills proposed in Congress called for the U.S. Environmental Protection Agency (EPA) to develop programs to mitigate black carbon emissions and to develop plans to mitigate international emissions of black carbon. One of the sources of black carbon is the millions of wood-burning stoves in the developing world. Cutting the use of such stoves would reduce black carbon emissions and reduce deforestation and degradation, and the associated ecological, biodiversity, and climate damages associated with Reducing Emissions from Deforestation and Forest

3. Regional Greenhouse Gas Initiative Memorandum of Understanding, at 2.

4. AB 32, 38550.

5. Midwestern Greenhouse Gas Reduction Accord (2007).

6. Waxman-Markey Discussion Draft , § 333(a).

7. IPCC, Changes in Atmospheric Constituents and in Radiative Forcing , in Climate Change 2007: The Physical Science Basis. Contribution of Working Group I to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change 129, 136, 163 (2007), available at http://www.ipcc.ch/ipccreports/ar4-wg1.htm .

http://www.ipcc.ch/ipccreports/ar4-wg1.htm


Degradation (REDD). It would also reduce the work largely placed on the women of populations for gathering and hauling the wood to their homes.

B. Determining the Threshold Amount of Emissions to Be Regulated Aft er the specifi c gases are selected, the next step is to determine if there is a threshold amount of emissions of these gases a facility must emit before it will be regulated. In some cases, a threshold will not apply, as the governing body has determined that the facility emits suffi cient greenhouse gases that no threshold is necessary. In other types of facilities, the governing body will establish a thresh-old in order to avoid regulating what may be considered too many facilities with small amounts of emissions to feasibly regulate. Th is level is usually referred to as the “emissions threshold.” In the United States, in bills passed or considered by Congress, 25,000 tons of CO 2 e per year was emerging as the emissions thresh-old under which a facility would not be required to monitor and report its emis-sions and would not generally be required to be regulated under a cap and trade system. Th e emissions threshold allows certain sources of emission to avoid regu-lation and any mandated reductions in their emissions.

Small sources are typically too numerous to eff ectively regulate. Government environmental regulatory agencies would fi nd themselves overwhelmed with permitting and otherwise regulating the sheer number of sources of emissions. In addition, certain small businesses and even household emissions could fall within the regulations and agencies typically avoid regulating small business and personal emissions directly.

C. Determining the Regulated Sources Th e next step is the selection of those types of facilities that will be regulated. Tremendous political lobbying arises as the industries that would be regulated attempt to be excluded from any regulation or to reduce the impact of the regulations on their industry. Th e industry that is typically the main target of regulation involves electric utilities that operate coal-fi red power plants. Coal-fi red power plants are the largest single industrial source of greenhouse gas emissions, primarily in the form of CO 2 .

Th e EU ETS initially regulated CO 2 emissions from the following sources:

Combustion installations with rated thermal input exceeding 20 megawatts •(except hazardous or municipal waste installations); Mineral oil refi neries; •


Coke ovens; • Metal ore (including sulfi de ore) roasting or sintering installations; • Installations for the production of pig iron or steel (primary or secondary •fusion), including continuous casting, with capacity exceeding 2.5 tons per hour; Installations for the production of cement clinker in rotary kilns with a •production capacity exceeding 500 tons per day or lime in rotary kilns with a production capacity exceeding 50 tons per day or in other furnaces with a production capacity exceeding 50 tons per day; Installations for the manufacture of glass including glass fi bre with a melting •capacity exceeding 20 tons per day; Installations for the manufacture of ceramic products by fi ring, in particular •roofi ng tiles, bricks, refractory bricks, tiles, stoneware, or porcelain, with a production capacity exceeding 75 tons per day, and/or with a kiln capacity exceeding 4 m 3 and with a setting density per kiln exceeding 300 kg/m 3 ; and Industrial plants for the production of (a) pulp from timber or other fi brous •materials, or (b) paper and board with a production capacity exceeding 20 tons per day. 8

Th e European Union has begun to focus on other industries as well, such as aluminum, ammonia, and aviation.

Th e types of facilities that could potentially be regulated include two types: those that emit greenhouse gases and those that produce or import gases or materials that when burned or used produce greenhouse gases. Th e fi rst category would include the following types of source categories:

Electricity generation: fossil-fuel-fi red power plants (coal, natural gas, etc.) • Adipic acid production • Primary aluminum production • Ammonia manufacturing • Cement production, excluding grinding-only operations • Hydrochlorofl uorocarbon production • Lime manufacturing • Petroleum refi ning • Nitric acid production • Phosphoric acid production • Silicon carbide production • Soda ash production •

8. EU Emissions Trading Directive, Annex I.


Titanium dioxide production • Coal-based liquid or gaseous fuel production •

A second group of emitters would include those that emit more than the emis-sions threshold of 25,000 tons of CO 2 e per year. Th ese facilities would be a very long list of facilities.

Other facilities that could be regulated are those that produce or import materials that when burned or used would release greenhouse gases. Included in this group would be fuel producers (e.g., petroleum refi ners) and importers of petroleum-based or coal-based liquid fuel (e.g., gasoline, diesel, jet fuel, etc.), natural gas liquid, or petroleum coke the combustion of which would cause the emission of GHGs above a threshold in tons of CO 2 e per year or more. Natural gas distribution companies have been proposed to be regulated if they deliver above a threshold amount of cubic feet or more per year of natural gas to non-covered entities.

D. Setting the Cap In order to eff ectively reduce greenhouse gas emissions, the cap must be set in the fi rst year and then over time decreased to meet the intermediate and fi nal green-house gas reduction goals. In addition, the baseline year is critical as well, as it becomes the year regions or countries and individual facilities must use to measure their progress and to determine the baseline for their individual permit-ted levels of emissions.

An example can be found in one of the bills considered by Congress. Th e following goals were set based on a 2005 baseline year: 3 percent below 2005 levels by 2012; 17 percent below 2005 by 2020; 42 percent by 2030; and 83 per-cent below 2005 by 2050.

Under the Kyoto Protocol, the baseline year was set as 1990. Developed nations were required under the treaty to reduce their emissions based on what they were in 1990. As U.S. emissions have risen signifi cantly from 1990 to 2005, the U.S. goals in bills that were fi led in Congress were adjusted to 2005 levels in order to attempt to make the reductions politically palatable.

E. Permitting Emissions of Greenhouse Gases Emission limits for individual facilities are typically set in the form of a permit issued by the relevant governing agency. Th e permit serves to proscribe the vari-ous obligations of the regulated facility in terms of operations, monitoring,


reporting, and the specifi c levels of greenhouse gases that may be emitted by the facility. Th is is the individual cap for a particular facility, such as a coal-fi red power plant, oil refi nery, or manufacturing plant.

F. Emission Allowances In order for a cap and trade system to work, there must be a “commodity” to trade. In emissions markets, the tradable commodity is an emission allowance, sometimes referred to as an emission permit or credit. Emission allowances are the “pollution rights” that allow a source of air emissions to emit a unit of a pol-lutant into the air. In the context of a greenhouse gas cap and trade system these allowances are oft en referred to as a “carbon credit.” Th e term “carbon credit” oft en also refers to emission “off sets” that will be discussed later in this chapter. Th ese off sets diff er from allowances in that they are not the rights to pollute issued by a governmental agency to regulated facilities, but are the emission reductions from unregulated facilities that are not legally required to reduce their emissions as will be discussed later in this chapter.

Emission allowances are distributed to individual facilities in terms of the amount of emissions that the particular facility may emit for a particular time period, which is typically an annual emissions rate in terms of tons per year. In order to achieve compliance with an air emissions statute that implements a cap and trade system, the facility must turn in the prescribed number of allow-ances alone or in combination with a permitted amount of off sets into the gov-ernment at the end of the regulated period to cover each ton of emissions emitted by the facility during that period. If they fail to submit an adequate amount of allowances or off sets, then the government will charge a substantial penalty, as discussed later in this chapter.

G. Allocation of Emission Allowances Allocation of the emission allowances can have a profound impact on the emis-sions trading system, the companies that own regulated facilities, and the market for allowances and off sets. Th e debate over allocation started as government and nongovernmental organizations (NGOs) began, because obviously the allow-ances have economic value. As explained in more detail in Chapter 21, compa-nies are required to refl ect a value for emission allowances on their balance sheet and fi nancial statements. Governments and NGOs further saw the sale of the allowances as a way to raise funds for investment in renewable energy and other means of reducing greenhouse gas emissions, the impact of climate change, and the economic costs on citizens of higher electricity and other costs as


a result of requiring the reductions in greenhouse gases from power plants and other industries. Industry opposes substantial auctions of allowances as they impose costs that, depending on the industry, they may not be possible to pass on to consumers.

Governments also see emissions sales as a means of raising money for gov-ernment projects unrelated to greenhouse gas emissions, climate change, and alternative energy sources that do not emit greenhouse gases.

Th e allocation methods that have developed are basically threefold, although other methods are certainly possible and may evolve over time. First, governments, as the European Union did in its fi rst two phases of its Emissions Trading Scheme, may issue the allowances without charge to the regulated facili-ties. Free allocation avoids costs incurred by regulated industries and indirectly by consumers. Th e problem is that some industries or facilities within industries may benefi t by being less effi cient as no cost is incurred initially to purchase the allowances necessary to operate. Moreover, the government loses an opportunity to raise funds to address greenhouse gas emissions, climate change, and the costs of a greenhouse gas reduction program on society and economies. Th ese trade-off s have been debated in the U.S. Congress and the European Commission.

Th e second method of allocating emission allowances is to auction emission allowances to the highest bidder. Th e sale of the allowances by the government addresses the concerns over forcing an immediate internalization of pollution costs or at least some part of those costs by the regulated industries. On the other hand, it places an immediate cost on those industries during a transition to a lower greenhouse gas emitting economy. Depending on their fi nancial state and place in international competition, the impact on domestic industry may be signifi cant, and, therefore, on the country implementing greenhouse gas regulations.

A third method is a hybrid of the fi rst two approaches. It is a partial auction in which only a percentage of the allowances required by the regulated industries are auctioned. Th is approach reduces the cost of a complete auction on indus-tries, while at the same time allows the government to raise new revenue to fi nance renewable energy and other means of reducing greenhouse gas emissions and reducing the impact of the emissions caps.

Many northeastern states are auctioning 100 percent of allowances under the RGGI program. Th e EU Emissions Trading Scheme distributed allowances largely without cost to the regulated facilities, but the European Union is cur-rently considering implementing an auction. Th e Waxman-Markey Bill passed by the House of Representatives produced a mixed approach, starting with a certain amount of allowances that would be auctioned, with the amount of allow-ances auctioned per industry varying to some extent. By doing so, the bill would


favor certain entities, such as coal-fi red power plants, over others, such as oil refi neries that would receive fewer free allowances.

H. Trading Allowances Th e other half of cap and trade — “trade” — involves the ability to buy and sell allowances in order to set up a market that may set a price for “carbon,” or the cost of emissions of greenhouse gases. Th is is measured by the price for a ton of CO 2 e or carbon dioxide equivalent. GHG off sets may also be allowed to meet compliance obligations and be traded within the cap and trade system.

I. Banking Allowances Th e concept of “banking” is an important concept for cap and trade systems. Th e term arises from the ability to use emission allowances or off sets in the year that they are issued or created, or to hold them, that is, “bank” them, for another future compliance year.

In the initial EU ETS trial phase from 2005 to 2007, the emission allow-ances issued by the European Union had an expiration date at the end of 2007. Th us, once the expiration date passed, the allowances could not be used for the second phase of the ETS. Combined with what turned out to be an overal-location of allowances, the price for the 2007 allowances approached zero.

Banking of emission allowances as well as off sets allows greater fl exibility to facilities as to how they will make reductions in emissions, sell or purchase allowances, or hold allowances for a future compliance year. Banking also reduces the fi nancial impact of emission-reduction regulations by allowing a party to hold allowances and use them in future years as opposed to potentially paying higher prices in future years. Th e ability to hold allowances generally increases the market value of the allowances, as they have value for more than one compliance year.

J. Borrowing Allowances Another important concept that has arisen under proposed legislation in the United States is a concept known as “borrowing.” Borrowing is a concept whereby regulated fi rms may request from the regulating government agency additional allowances in a particular compliance year in order to provide the necessary allowances for retirement, and pay them back to the government in future years. Th e concept includes the payment of “interest” through turning in a certain percentage of higher allowances to the government than were borrowed.


K. Safety Valve and International Competitiveness Th e term “safety valve” refers to a price cap or other means of preventing the price of allowances from rising beyond a certain point. Th e process for reducing the economic impact of high carbon credit prices varies. Many industries sup-port a safety valve in order to protect their fi rms from paying high prices for allowances and international competition.

Th e fi nancial community and off set developers oppose a safety valve and want to allow the market to determine the price for carbon. Some bills pro-posed in Congress did not have a specifi c safety valve, but would have created a sort of “Carbon Fed” that would have stepped in under certain circumstances to reduce a high price of carbon that may have emerged in a carbon market.

L. Off sets A cap and trade system could exist with emission allowances alone. Th e fi rms would be given or purchasing these allowances in auctions or from the govern-ment at some fi xed price. Th e emissions market would consist of parties who have more allowances than they need and those that need to purchase allowances as they are short on allowances, while the seller is long. Depending on the system, investors or speculators could buy and sell allowances as well.

In order to drive the price of compliance down, and to create maximum fl exibility, compliance fi rms may be allowed in the design of the specifi c cap and trade system to purchase the off sets produced by those who are not required to reduce their emissions, or perhaps go beyond what they would otherwise do. “Off sets” refer to the use of emission reductions from activities or facilities that are not required to reduce their emissions under a greenhouse gas regulatory regime. Th e off sets may arise from activities in the United States or in foreign countries.

Studies, some of which are prospective models, demonstrate that off sets provide a means of lowering the cost of emission reductions. International off sets are generally the least expensive means of meeting compliance deadlines and obligations.

One of the critical issues is the percentage of domestic and international off sets allowed under a particular emissions scheme. In one bill proposed in Congress, a 30 percent limit was placed on the use of off sets, and up to 15 percent of the total permitted emissions for a particular facility could have been met with international off sets.


M. Additionality Additionality may be one of if not the most challenging aspect of developing a carbon off set project. Th is concept was designed to ensure that a project that is being submitted for carbon credits — off sets — would actually achieve a reduction in greenhouse gases that would have occurred without the carbon credits or the revenue that would be derived from the sale of carbon credits. Th e concept is expressed as “Beyond Business as Usual” or “BBU.”

While simple in concept, in its application it can be quite complicated — challenging lawyers, technical consultants, and fi nancial experts.

N. Supplementarity and Linkage to Other National and International Trading Systems Carbon off sets present many issues with respect to the “import” of those off sets into a developed country. One of those concerns is that if an unlimited amount of inexpensive off sets can be purchased by a regulated facility under a cap and trade regime, then the facility will simply buy suffi cient off sets and avoid any pressure to reduce their own emissions. In the European Union, for instance, an “import quota” was imposed on the number of off sets that could be used to meet the carbon allowance requirement under the EU ETS.

Th e concept of a limit on the amount of international carbon off sets that may be purchased and utilized by a domestic facility is known as “supplementar-ity.” Th e derivation of this term is that the use of international off sets will supplement domestic actions to reduce greenhouse gas emissions from a facility or faculties in the regulated country. Th us, it is intended that international off sets do not play a dominant role in the domestic reduction eff orts. Supplementarity in theory will limit the amount of international off sets, proba-bly cheap off sets, and thereby raise the price of off sets and allowances in a devel-oped country. Th is increase in price, in theory, will encourage facilities to reduce their emissions. As stated above, one of the bills proposed in the U.S. Congress allowed up to 15 percent of the total permitted emissions for a particular facility to be met with international off sets.

“Linkage” is a concept that relates to the ability of a governing body of one regulated jurisdiction to allow trading of allowances, off sets, or both produced within that jurisdiction with another jurisdiction. For example, assume that the United States establishes a cap and trade system, and the European Union continues its Emissions Trading Scheme. Both jurisdictions would be operating a


cap and trade system, which could either permit allowances to be traded between an EU country and the United States, or they could keep their systems isolated and separate. Th e step of linking the two trading systems allows commerce in carbon credits between the countries. Th ere are a variety of legal and economic complexities associated with this linkage. How these issues play out in interna-tional negotiations of a post–Kyoto Protocol treaty remain to be seen, as well as the bilateral negotiations between countries if a treaty to follow Kyoto is adopted.

O. Early Action Early action consists of activities, retrofi tting of equipment, boilers, etc., and other operational changes that reduce the emissions of greenhouse gases in advance of regulations that require GHG reductions. Companies have been encouraged to take early action before a regulatory program goes into eff ect. Th e diffi culty with taking such action is that one’s baseline may be reduced, and then the company would have to cut its emissions further when a cap and trade program requires reductions in GHGs. Such a circumstance may put that com-pany at a competitive disadvantage to its domestic competitor that did not take early action and kept its baseline higher, and an even greater competitive disadvantage with an international competitor in a country that is not required to cut its emissions at all.

Th e bills that have been off ered in the House and Senate in the United States typically provide early action provisions that would eliminate or reduce the impact on companies that have taken early action. An example might be to provide additional allowances to companies that reduce their emissions before mandatory emissions are imposed.

P. New or Expanded Facilities One of the great challenges, and one that raises opposition among industry and business groups, is the concern about the cap not on emissions, but on domestic economic growth. Consider a country and economy where greenhouse gases are capped. How does a new factory ever get built? Will not the cap prevent the new emissions from that plant?

Th e way that these issues would have to be addressed would be to reserve carbon allowances for future growth, or to require that entity to purchase allow-ances and off sets to allow for the construction of the new facility that will be a new emissions source of greenhouse gases.


Th e same issue arises for the expansion of a facility. Th e increased emissions must be addressed in the cap and trade regime.

Q. Regulatory Agency or Agencies In establishing a cap and trade system, the jurisdiction for regulating various aspects of the system must fall on one or more governmental agencies or bodies. Th e regulatory responsibilities may be divided simply into two general roles: regulation of greenhouse gas emissions and regulation of the trading of allow-ances and off sets. It may be that these responsibilities are divided among two or more agencies and some overlap occurs.

1. Regulation of Greenhouse Gas Emissions Th e fi rst aspect of a cap and trade system requires the setting of emissions limits and addressing reporting of emissions and granting of permits to allow those emissions. Th e enforcement of these regulations would typically be managed by the agency setting up the regulations that must be promulgated under a statute and the various administrative responsibilities that derive from such a system. Th e agency would set up the reporting requirements, measurement methodolo-gies, permit application, and operating requirements, review and issue permits, and address the issue of methodologies for off set projects, the extent to which international off sets are approved or allowed to be used.

Th e type of regulatory knowledge and expertise for this type of regulation would typically be found in an environmental regulatory agency that regulates wastewater discharges, hazardous waste, and air pollutant emissions.

2. Regulation of Trading of Allowances and Off sets One of the other major roles is to regulate the trading of allowances and off sets, in other words, the fi nancial aspects of the transactions. Carbon credits become, to some degree, like a commodity that is traded, like a stock or agricultural or petroleum or oil commodity. To some extent the credits will be fungible and traded on an exchange. For other credits, the so-called “charismatic credits,” they may be traded between two parties in an “over the counter” transaction, not on an exchange.

Th is type of regulation usually falls to a securities or commodity trading agency, not an environmental agency. Regulation of trading, trading markets, and fi nancial instruments would not be an area of expertise of an environmental agency.


R. Enforcement Th e costs of purchasing any additional allowances or off sets required to meet a facility’s cap might be avoided if a penalty or other sanction did not accrue to the facility’s owner or operator. Th e country or state creating a cap and trade system generally enacts a civil enforcement process and establishes civil penalties to punish those parties that fail to submit suffi cient allowances or off sets. In the European Union, the penalty per ton of CO 2 e was set at 200 euros so that com-panies would not be tempted to ignore the potential for reducing greenhouse gases, and, instead, to pay penalties rather than buying allowances or off sets.

P A R T T W O

Regulatory Structures


4

International Law

A. The UN Framework Convention on Climate Change Th e evolution of international climate change law in terms of the laws we work with today began in the 1980s with the adoption by the General Assembly of the United Nations (UN) of a resolution entitled, Protection of the Global Climate for Present and future Generations of Mankind. 1 Th e Resolution called on coun-tries of the UN to address climate change, and endorsed a prior decision by the UN Environment Program and the World Meteorological Organization to establish the Intergovernmental Panel on Climate Change (IPCC). Th e next step was the negotiation of the UN Framework Convention on Climate Change (UNFCCC). In June 1992 in Rio de Janeiro, Brazil, the UNFCCC was pre-sented to the nations attending the UN Conference on Environment and Development for signature. Th us was born the convention that has served as the point of formation of UN treaties and polices on climate change issues ever since.

Th e UNFCCC acknowledged that human activities are increasing the concentrations of greenhouse gases (GHGs) in the atmosphere and that this would lead to increasing warming of the Earth and to climate change. 2 Th ese changes would then lead to adverse eff ects on natural ecosystems and human beings. Th e objective of the UNFCCC was stated as follows:

to achieve, in accordance with the relevant provisions of the Convention, stabilization of greenhouse gas concentrations in the atmosphere at a level

1. UN General Assembly, Protection of Global Climate for Present and Future Generations of Mankind (New York: United Nations) (A/RES?43/53), 70th plenary meeting, Dec. 6, 1988.

2. UN Framework Conventions on Climate Change (adopted May 9, 1992, entered into force March 21, 1994) 1771 UNTS 107 (hereinaft er UNFCCC).

42 | REGULATORY STRUCTURES

that would prevent dangerous anthropogenic interference with the climate system. Such a level should be achieved within a time frame suffi cient to allow ecosystems to adapt naturally to climate change, to ensure that food production is not threatened and to enable economic development to proceed in a sustainable manner. 3

In terms of actual commitments, Article 4 of the Convention discusses what the nations of the UN are supposed to accomplish. One of the most important is that developed countries are to adopt national polices and take measures to miti-gate climate change through the limitations of GHG emissions and protecting GHG sinks and reservoirs. 4 Th e UNFCCC established a Conference of the Parties to the Convention to carry out is work and to adopt and make the deci-sions necessary to promote the eff ective implementation of the Convention. 5

1. Conference of the Parties Th e fi rst meeting of the Conference of the Parties (COP) was held in Berlin, Germany. At this meeting, the parties reached agreement on developing a schedule for developed countries to reduce their GHG emissions. Th e outcome of this fi rst COP meeting was the “Berlin Mandate.” From this mandate, the parties began work that led to the negotiation of the Kyoto Protocol, so named as the COP 3 meeting was held in Kyoto, Japan.

B. The Kyoto Protocol 1. General Principles Th e Kyoto Protocol was actually issued on December 11, 1997. Th e actual eff ec-tiveness of the Protocol did not occur until February 16, 2005, when a suffi cient number of nations ratifi ed the agreement. Th e rules for implementing the Protocol occurred in 2001 at the COP 7. Th ese rules are known as the “Marrakesh Accords.” Th e general principles of the Kyoto Protocol address GHG reductions by developed countries and the ability to develop credits for emissions reductions and the trading of allowance and off sets internationally. Th ese provisions led to the emergence of the international “carbon market,” named aft er the trading of credits that are measured in carbon dioxide equivalents, thus the term carbon credits.

3. UNFCCC, Art. 2.

4. Id. Art. 4(2)(a).

5. Id. Art. 7(2)(a).

INTERNAT IONAL LAW | 43

In the document, goals were set for developed countries, listed in Annex I of the UNFCCC and Annex B of the Kyoto Protocol. Th ese “Annex I” countries that ratifi ed the treaty were supposed to meet specifi ed targets for GHG emis-sions from a 1990 baseline of the estimate emissions for that country for that year. Th e goal was to reach these targets by 2012. Many of the nations will not reach these goals.

2. The Clean Development Mechanism Th e mechanism of the Protocol that has resulted in the greatest growth in the international carbon market is the Clean Development Mechanism (CDM). Th is mechanism was established by Article 12 of the Protocol, and provides for a market mechanism to allow developed countries to obtain GHG off sets that help them meet their compliance obligations in their own country and the goals set out in the Protocol, and, at the same time, result in GHG reductions in developing countries and clean technology transfer to those countries from devel-oping countries with developed country fi nance. 6 Th e CDM is administered through an Executive Board established under the Protocol. 7

Th e Protocol calls for third-party verifi ers, known as “Designated Opera-tional Entities” (DOEs), to validate the emissions reductions projects to be reviewed and approved by the Executive Board under the CDM. 8 Subsequent to Executive Board approval of the project, DOEs also verify the actual GHG emission reductions from a project once it is installed or otherwise becomes operational.

Two critical issues that evolved in more detail with the policies adopted by the Executive Board were set forth in Article 12: fi rst, the reductions must provide “real, measurable, and long-term benefi ts;” and, second, that the reduc-tions must be “additional to any that would occur in the absence of the certifi ed project activity.” 9

One of the critical issues, as discussed in a prior chapter, is proving addition-ality. Th e concept is fundamentally that the reduction is beyond business as usual. Th e reductions in GHG (GHG) emissions were not required by law and would not have occurred even without the issuance of carbon credits. Th e Executive Board has issued a document that provides a guide to how additionality may be proven, called “Tool for the demonstration and assessment of additionality.”

6. Kyoto Protocol, Art. 12(3).

7. Id. Art. 12(4).

8. Id. Art. 12(5).

9. Id. Art. 12(5)(b), (c).


Th e process provided in this Executive Board document to prove addi-tionality involves the following steps:

Identifi cation of alternatives to the project activity — identifi cation of •alternatives to the project activity consistent with mandatory laws and regulations; Investment analysis to determine that the proposed project activity is not •the most economically or fi nancially attractive — whether sensitivity analysis concludes that the proposed CDM project activity is unlikely to be the most fi nancially attractive or is unlikely to be fi nancially attractive; or Barrier analysis to determine what barriers would prevent the •implementation of the type of project activity — whether at least one alternative scenario, other than the proposed CDM project activity, is not prevented by any of the identifi ed barriers; and Common practice analysis — no similar activities can be observed, but •essential distinctions between the proposed CDM project activity and similar activities can reasonably be explained.

A developer must be able to demonstrate additionality to obtain the off set credits from the CDM.

Parties to the Protocol may transfer carbon credits that are known as Certifi ed Emission Reductions (CERs). With permission of the party countries, private entities may transfer CERs as well. 10 Th e CDM provides a mechanism for projects to be implemented in developing countries and the reductions in GHG emissions to be incorporated into a kind of currency of carbon credits and CERs, and then monetized through the transfer process of the Kyoto Protocol from developing country to developed country, where they can be used as a percentage of the off sets needed to meet compliance obligations in that country.

Th e CDM has thus become the international trading mechanism for carbon credits in the form of off sets. Th e EU Emissions Trading Scheme that will be discussed in Chapter 5 is a bigger market, but it is limited to the EU.

3. Joint Implementation Article 6 of the Protocol allows trading of a certain type of carbon credit among the countries listed in Annex I of the Protocol. Th is program is referred to as “Joint Implementation” ( JI). Again, these credits, known as Emission Reduction Units (ERUs), may be traded among Annex I countries for projects that have

10. Id. Art. 12(9).


achieved GHG reductions. 11 Th e countries involved in a transfer must be in compliance with their obligations under the Protocol, and must be implementing an active program to reduce their emissions to meet their Kyoto obligations to reduce GHG emissions. 12 Private parties may engage in the trading of ERUs as well. 13

4. Emissions Trading and Trading in Assigned Amount Units and Removal Units Th e Protocol provides one other type of carbon credit and trading mechanism. Th e trading of credits is limited to Annex B countries, which are those that are part of the Annex I to the UNFCCC, and these credits are the Quantifi ed Emission Reductions and Limitation Commitment which the countries in Annex B have committed to and are set out in Annex B. Article 17 of the Protocol provides for the Conference of the Parties to defi ne “the relevant principles, modalities, rules and guidelines, in particular for verifi cation, reporting and accountability for emissions trading.” 14

Th e parties included in Annex B of the Protocol can then participate in the trading of emissions credits as one means of meeting their obligations under the Protocol. 15 Th e trading of credits must be supplemental to the domestic programs in these countries to reduce their emissions, which must be the main process of reducing emissions. 16

In addition to CERs and ERUs, countries that are parties to the Protocol and Annex B, may actually sell the assigned amount of GHGs to their country. 17 Th ese units are known as Assigned Amount Units (AAUs). Th us, one country’s GHG limits would decrease and one would increase. Generally, this has only been accomplished where the AAUs are “greened” by devoting the sales proceeds of the selling country to GHG reduction activities. 18 Another little known unit is the Removal Unit (RMU) that on the basis of land use, land-use change, and forestry (LULUCF) activities such as removals by sink. Th ese sinks

11. Id. Art. 6(1).

12. Id. Art. 5 and 7.

13. Id. Art. 6(4).

14. Id. Art. 17.

15. Id.

16. Id.

17. See id. Art. 3.

18. Sander Simonetti & Rutger de Witt Wijnen, International Emissions Trading and Green Investment Schemes , in Legal Aspects of Carbon Trading: Kyoto, Copenhagen, and Beyond 157–175 (David Freestone & Charlotte Streck eds., 2009).


may be land-use change and forestry activities, limited to aff orestation, reforesta-tion, and deforestation. 19

Because these are generally state-to-state transactions, they may have little direct relevance to private carbon trading, but may aff ect the market for private carbon credit transactions. If states buy credits for their domestic industries or other domestic purposes, the demand of industries in those countries may be reduced, and the credit price may fall.

5. Kyoto Units Several types of carbon credits established under the Protocol have been intro-duced above, CERs, ERUs, and AAUs. In 2003, the Ninth COP created two additional types of units, Temporary CERs (tCERs) and Long-Term CERs (lCERs). 20 Both of these units are associated with land use and forestry projects under the CDM.

C. The Marrakesh Accords As stated above, the meeting of the parties to the UNFCCC is referred to as the COP. Th e meetings also include the Meeting of the Parties to the Kyoto Protocol (MOP). Th us, these meetings are known as the COP/MOP. Th e meeting at Marrakesh of the COP/MOP was particularly signifi cant for the development of the Kyoto Protocol, which resulted in agreements, known as the Marrakesh Accords. Th e Marrakesh Accords was a lengthy document of more than two hundred pages, and included modalities and procedures for the CDM.

One of the critical aspects of the CDM was the establishment of its gov-erning body, known as the Executive Board. Th e members of this board are appointed through the COP/MOP. Since the formation of the Kyoto Protocol, various decisions have been made by the COP/MOP governing the CDM, JI, and emissions trading. Th ese decisions established through the Marrakesh Accords and COP/MOP are too numerous to enumerate or discuss in this book.

Some of the more important issues have been decided by the Executive Board of the CDM. Th ese range from approval and disapproval of methodolo-gies to be used to formulate design documents for GHG reduction projects and measuring their actual reductions, additionality guidance, and approval and suspension of DOEs that validate and verify projects and GHG emission reductions under the CDM.

19. See Kyoto Protocol, Art. 3(3)–(4).

20. Decision 4/CMP.1.


Some of these issues will be discussed in later chapters in more detail. One of the decisions that is worth mentioning here is that the Marrakesh Accords provided that land use changes under the CDM would be limited to aff orestation and reforestation, and that avoided deforestation would not be permitted to qualify as a CDM off set project. 21 In later COP/MOP meetings, allowing Reducing Emissions from Deforestation and Forest Degradation (REDD) to produce carbon credits through off sets has become an important part of these discussions of a post-Kyoto treaty.

D. Bali, Copenhagen, and Cancun: Negotiations for a Post-Kyoto Treaty 1. The Bali Action Plan Th e Kyoto period was set for 2008 to 2012, and at the end of this period the Protocol is set to expire. Two major meetings of the countries of the United Nations were set to attempt to negotiate a post-Kyoto treaty, or to extend the Kyoto Protocol. Th ese meetings were held in Bali, Indonesia, in December 2007 and in Copenhagen, Denmark, in December 2009. Neither resulted in a treaty, but some progress was made in each toward what may follow Kyoto.

Th e fi rst meeting held in the Bali meeting resulted in what has come to be known as the “Bali Action Plan.” Under this Action Plan, the parties to the document agreed that developing nations for the fi rst time would consider mea-suring, reporting, and verifying nationally appropriate mitigation actions, in other words a program to control their emissions in some manner. Th is is impor-tant as the GHGs emissions of several “developing” countries such as China and India have become signifi cant, with China now being the largest global emitter. Countries such as Brazil and Indonesia are in the top group of emitters because of deforestation. What actual programs these countries may agree to continues as an ongoing debate, and will be discussed below. Funding for technology trans-fer, capacity building for mitigation activities, adaptation to climate change that occurs despite mitigation activities, and other activities in developing countries is a major area of negotiation and discussion. Th e Bali Action Plan, or what also has been called the “Bali Road Map,” was to lead to a fi nal negotiation and agreement in Copenhagen in 2009.

21. Marrakesh Accord, 3. Modalities and procedures for a clean development mechanism as defi ned in Article 12 of the Kyoto Protocol, 7. Decision -/CP.7 (Article 12).


2. The Copenhagen Accord In December 2009, the UN convened again to attempt to negotiate a new treaty to extend or to replace the Kyoto Protocol. Th e negotiations were diffi cult and controversial. Th e outcome was only an unenforceable agreement on several points.

One of the major points was that developed countries commit to emissions targets for 2020 by January 31, 2010. Th e reductions once agreed to, were then subject to the issue of verifi cation, which China opposed in its country. Some language was placed in the agreement that emissions reductions would meet standards for monitoring, reporting, and verifi cation (MRV) under COP guidelines.

One of the more diffi cult negotiating points was emissions in developing countries as China and India did not want to commit to caps on emissions. Th e agreement was that developing nations were to “implement mitigation actions,” known as Nationally Appropriate Mitigation Actions (NAMAs) to reduce growth in their carbon emissions. Th e NAMAs were to be submitted by January 31, 2010. China has committed to reducing its carbon intensity, that is the amount of emissions per unit of economic activity and slowing growth of emissions, but not caps. Th e least-developed and smaller nations were allowed to reduce emissions voluntarily and with international fi nancial support.

China did not want to be subject to mandatory reporting. Th e agree-ment reached was that developing countries would report their emissions and activities to meet the NAMAS every two years under their domestic MRV.

Th e agreement also recognized the importance of reducing emissions from deforestation and forest degradation and “the need to enhance removals of GHG emission by forests.” Th e agreement also recognized that a program known as Reducing Emissions from Deforestation and Forest Degradation (REDD) should be established “to enable the mobilization of fi nancial resources from developed countries to help achieve” this goal.

3. Cancun UNFCCC meetings have continued over 2010 to attempt to work out agree-ment on further development of the Copenhagen Accord and the development of a post-Kyoto treaty. Th e next major meeting is scheduled in December 2010 in Cancun, Mexico. Th e potential for an international treaty seems low as of the writing of this book. What progress may be made toward agreement remains to be seen in Cancun. How countries such as the EU and Japan will address the issue in the absence of an international treaty aft er Kyoto remains a signifi cant question. Th e ability of the United States to participate and ratify a treaty is in serious question.


E. Alternatives to the UNFCCC As the negotiations for a treaty to replace or extend Kyoto appear to face a risk of failure, countries are beginning to consider alternatives. As will be discussed in Chapter 6, Japan is moving forward with a bilateral approach to GHG off sets. Bilateral carbon trading agreements outside of UN treaties may have been possible under bills proposed in Congress. It is possible that the Kyoto Protocol will not be extended through the UNFCCC process. Th is raises questions of future CDM viability.

Th e CDM has been criticized by some NGOs for purportedly being too lax and letting projects slip through the review process without much oversight and that do not produce real GHG emission reductions. In reality, those involved in the process, including project developers, investors, and buyers of carbon cred-its seeking approval through the CDM, oft en see the process as being bureau-cratic, slow, and overly concerned with matters that make little diff erence in the verifi cation of real GHG reductions.

Criticism of the CDM process has been growing as it has become increasingly ineffi cient and bureaucratic. Th e International Emissions Trading Association (IETA) has issued a report with fairly strong criticisms of the CDM process and how the Executive Board and its staff manage the process. 22 IETA listed four structural inadequacies that prevent eff ective management:

1. part-time governing bodies; 2. inappropriate division of responsibilities; 3. inadequate standardization; and 4. neglect of due process. 23

Th e report identifi ed fi ve “enduring challenges” that are “nearly strangling the CDM today”:

1. unrelenting time constraints; 2. ineff ective communication practices; 3. lack of transparency; 4. slow policy development and inadequate resolution of issues; and 5. inadequate number and expertise of Secretariat staff . 24

22. International Emissions Trading Association, State of the CDM 2009: Reforming for the Present and Preparing for the Future.

23. Id.

24. Id.


Th ese issues may have played a role in Japan’s decision to initiate a bilateral approach that could serve as an alternative to the CDM process for reviewing, issuing, and trading carbon credits.

Japan is moving forward with preparing for more bilateral agreements whereby Japan would work with developing countries directly and form its own monitoring, reporting, and verifi cation (MRV) process and methodologies for diff erent types of project activities in order to encourage GHG reduction proj-ects in developing countries. Th e program would be supported by a 500 billion yen (US$5.6 billion) loan facility. Japan Bank for International Cooperation ( JBIC) is recruiting fi rms to study how to transfer Japan’s clean-energy tech-nology to developing countries, how to measure the scheme’s eff ectiveness in cutting emissions, and how to fi nance the program. Th e Europe Union, which has pledged to continue its Emissions Trading Scheme with or without an extension of the Kyoto Protocol, is also reportedly considering a bilateral program for GHG off sets.

Th e political wrangling and the requirement for a unanimous decision in the post-Kyoto negotiations may lead to the development of an alternative. It would seem that developed countries, project developers, investors, and corpo-rate purchasers of carbon credits are looking for a more effi cient system than the United Nations may be able to provide. For countries that are frustrated with the UN carbon credit system, the bilateral approach has considerable merit. Particularly where a group of developed countries formed an entity to take the place of the CDM and the CDM Executive Board, a greater effi ciency in a GHG off set program could be established. Th e protocols of the CDM could be adopted. Many of the problems with the CDM could be more readily addressed without going through the Kyoto or UNFCCC process and votes by well over a hundred nations of the UNFCCC.

Another country may be considering a CDM alternative. Th e Russian gov-ernment could consider entering into bilateral agreements for purposes of selling carbon credits. 25 A representative of Gazprom Marketing & Trading Ltd. advocated that Russia follow the developing policy of Japan in seeking bilateral agreements for carbon trading. Japan has taken steps toward a bilateral approach as a buyer of credits, while Russia could move in this direction as a seller of carbon credits.

Th e problems of the UN’s CDM process may not be curable. If not, then countries will continue to pursue alternatives. Th e G20 and the + 5 countries — China, Brazil, India, Mexico, and South Africa — could form their own carbon

25. Bilateral Deals Could Be Solution for Russia: Investors, Point Carbon, Sept. 7, 2010, available at http://www.pointcarbon.com/news/1.1472590 .

http://www.pointcarbon.com/news/1.1472590


credit standards board and protocol, borrowing the protocols of the CDM, and creating their own. Th is would be an opportunity to make reforms, including those advocated by IETA. Promotion of programs of activities that aggregate lots of smaller projects so that it does not make economic sense to go through the validation and verifi cation process, would greatly increase the effi ciency of the system and reduce costs for smaller emissions reduction projects.

5

The European Union Emissions Trading Scheme

A. The EU Policy on Climate Change Th e European Union established the EU Emissions Trading System (ETS) with a fi rst phase from 2005 to 2007 and a second phase from 2008 to 2012 to coincide with the Kyoto Protocol period. Th e EU ETS is the largest emissions trading system in the world, covering over 10,000 installations. It includes com-bustion plants, oil refi neries, coke ovens, iron and steel plants, and factories making cement, glass, lime, brick, ceramics, and pulp and paper. Other industries are to be added to the ETS, such as aviation, aluminum, and ammonia. Th e legis-lation covers CO 2 initially, but other greenhouse gases (GHGs) may be added. At this time, the allowances are assigned without charge and are not auctioned. In the future, the European Union may be auctioning some of the allowances.

One of the criticisms lodged at the EU ETS, is the problem with the First Phase, 2005–2007, which was plagued with overallocation of allowances. Th e countries and companies applied for more allowances than there were emissions — driving the price of allowances to near zero. Without scarcity, no market works.

Th e European Union is working in the Second Phase (2008–2012) to limit allowances, which has resulted in litigation by countries and companies against the European Union to try to increase the allotment of allowances. Nonetheless, the European Union has implemented a more robust emissions trading scheme to cap and begin reducing greenhouse gas emissions. Th e carbon market under this system is active and functioning well.

Th is chapter will discuss the fi rst three phases and basic elements of the EU ETS.

THE EUROPEAN UNION EMISS IONS TRADING SCHEME | 53

B. Phase I — 2005 to 2007 Th e implementation of the EU ETS in Phase I from 2005 to 2007 was in essence an experimental phase prior to the implementation of the Kyoto Protocol that began in 2008. In any ramp-up of such a large regulatory and environmental market, certain aspects of the trading system required signifi cant improvement in Phase II. However, Phase I served the purpose of a transitional process into a more eff ective program for controlling greenhouse gas emissions and establish-ing a carbon trading program and an emissions trading market of unprecedented size and scope.

One of the chief challenges in Phase I was the overallocation of allowances. Data on emissions from facilities in each member state was not complete. Th us, the allowances requested by the facilities and the members states turned out to be quite conservative in terms of protecting against underallocation. Th e result was allocation of more allowances than the total emissions of the regulated facilities under the scheme, and a drop in the price for European Union Allowances (EUAs) in the latter part of Phase I to almost zero.

While some critiques of the EU ETS see this as a failure of cap and trade as a concept, one should consider that Phase I was an experimental stage designed to allow a start-up process and identifi cation of issues and problems to be resolved in Phase II. Th e success of Phase I was the creation of the EU ETS, the world’s largest emissions trading market, and the development of a monitoring and reporting system and of a compliance process in terms of the European Union as a whole, the EU ETS members states, and the regulated industries within these countries.

C. Phase II — 2008 to 2012 Implementing Phase II of the EU ETS required a much stricter control of the allowances each country in the scheme was allocated. Th e allocation to each country became a central challenge for setting up Phase II. Unlike Phase I, in which banking of allowances was not allowed into Phase II, Phase II allowances may be banked and used in Phase III. Th e banking decision means that allow-ances will not go to zero value at the end of Phase II, and regulated entities and investors in EUAs will have more fl exibility in terms of use or sales of these credits. Phase II covers CO 2 and no other GHGs; however, individual countries may regulate other GHGs.

In terms of allocation, 90 percent of the allowances are given freely to regulated entities, and 10 percent is auctioned. Th e Linking Directive permits entities to use Joint Implementation ( JI) and Clean Development Mechanism


(CDM) credits up to a maximum amount of 10 percent of a country’s total allo-cated number of allowances. Th ree non-EU countries joined the ETS — Iceland, Norway, and Liechtenstein.

Currently, the economic recession has resulted in lower energy use and less demand for EUAs or off sets. As a result, EUAs have dropped in price.

D. Phase III — 2013 to 2020 Phase III will last from 2013 to 2020. Th e EU Council in March 2007 decided that it would pursue a 20 percent reduction in greenhouse gas emissions from 1990 levels by 2020 and by 30 percent if a suffi cient number of other nations committed themselves to comparable reductions. 1 On January 31, 2008, the EU parliament called for more stringent caps, if necessary to obtain agreement on an international climate change agreement. 2 Th e actual emissions target will be a reduction in 2005 levels by 21 percent by 2020.

From 2013 to 2020, during Phase III, the quantity of emission allowance issued each year will decline 1.74 percent compared to the average annual total issued by member states in accordance with the EU Commission’s decision on their national allocation plans (NAPs) for Phase I. 3 Th e allocation system will shift from NAPs to a more centralized EU allocation process. In addition, in Phase III all allowances not allocated for free must be auctioned. Full auctioning will occur by 2027, as discussed below. Monitoring and reporting rules have been amended and will be more stringent.

E. Fundamentals of the EU ETS 1. Defi ning the Cap Since the EU system is a grouping of nations, each nation within the alliance must develop its own cap and allocation of EU allowances (EUAs) for the emis-sion of greenhouse gases. Th e cap is essentially set by the allocation of EUAs, or what are referred to as the national allocation plan for each country (NAP). Th e NAP includes other aspects of the greenhouse gas regulatory system for the country, including, the allocation to each regulated operating facility, how

1. See Directive 2009/29/Ec of the European Parliament and of the Council o f April 23, 2009, amending Directive 2003/87/EC so as to improve and extend the greenhouse gas emission allow-ance trading scheme of the Community, Art. 1(1) (hereinaft er EU ETS Amendment).

2. See id.

3. See id. Art. (9).


allocation will be managed for those facilities, and what amount will be reserved for new facilities. 4

2. Defi ning the Regulated Sources Th e EU ETS started with regulation of large greenhouse gas emitters, including electric power plants, oil refi neries, coke ovens, glass manufacturers, iron and steel plants, cement plants, lime producers, ceramics plants, and pulp and paper facilities. 5 Th e European Commission (EC) is adding other emitters, including the airline industry — a decision that has been quite controversial — and facilities producing aluminum, ammonia, chemicals, and petrochemicals.

3. Permitting Emissions of Greenhouse Gases Th e EU ETS requires that regulated facilities obtain a greenhouse gas emissions permit. 6 Such a permit is necessary to operate and to emit greenhouse gases. Th e EU member state issues the permit for the types of regulated facilities in that country.

4. Emission Allowances As stated above, the emission allowances in the EU ETS are known as EU allow-ances, or EUAs. Every operating facility that has obtained a permit must have suffi cient EUAs to meet the amount of greenhouse gases emitted in the previous year, and must submit those allowances to the EU member state in which the facility operates under the NAP for that country.

5. Allocation of Emission Allowances As in every emissions market, emission allowances must be allocated to the regulated facilities. A variety of methods are available, from free allocation based on prior years’ emissions to auctioning allowances to a mix of the two systems. Under the EU ETS, member states could choose to allocate EUAs without charge to regulated facilities or to auction them. Initially, few nations auctioned the allowances, and those that did, auctioned a very small fraction.

However, in Phase III of the EU ETS, starting in 2013, the allocation system will be moving toward auctioning of all allowances over the coming years. At that time, full auction will begin for electrical power producers, and other sectors will gradually increase from 20 percent auctioning to full auctioning by 2027. 7

4. EU ETS Directive, Art. 9.

5. Id. Annex I.

6. Id. Art. 6(1).

7. EU ETS Amendment, Arts. 10 and 10(a).


6. Trading Allowances Th e EU ETS is founded upon the concept of an emissions market. Th e EUAs may be used for compliance purposes or sold by the facility that has received them to a third party. In other words, the EUAs are fully tradable.

Th e EUAs are registered on an EU-wide registry. Trading must be accom-plished through transfer through this registry to track title to the EUAs.

7. Banking Allowances Th e ability to hold allowances issued in year one for future years, increases the liquidity of the market and balances out the emissions prices. Th e banking of allowances has been limited to each respective phase of the ETS initially. Starting in Phase II, EUAs may be banked for use in Phase III and any subsequent phases.

8. Borrowing Allowances Borrowing is permitted. Th e ability to borrow against future issued EUAs is limited to the phase in which the facility it operating, and cannot be borrowed from future phases.

9. Safety Valve and International Competiveness At this point, no safety valve is provided for controlling the prices of EUAs. Th e main mechanism for reducing the economic costs of the ETS is the use of off sets from the Kyoto Protocol, as described below.

10. Off sets Off sets may be used for compliance purposes in the ETS. CDM credits or Certifi ed Emission Reductions (CERS) may be purchased and Joint Implementation credits or ERUs may also be used to turn in for meeting the compliance obligations of a particular country’s NAP. In addition to the limit on the quantity of CERs or ERUs that may enter and be used by countries and facil-ities in the EU ETS, restrictions were imposed on the types of projects that gener-ate credits. Forestry and land use credits are not permitted at this time to be used in the EU ETS. 8 Certain limitations are also imposed on hydro projects with a capacity of over 20 megawatts 9 and nuclear facilities. 10

8. Directive 2004/101/EC of the European Parliament and of the Council of October 27, 2004 amending Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowance trad-ing within the Community, in respect of the Kyoto Protocol’s project mechanisms, Art. 11a(3)(b).

9. Id. Art. 11b(6).

10. Id. Art. 11a(3)(a).


11. Additionality Additionality is mainly a key criteria for obtaining approval of greenhouse gas off sets. Th e additionality requirements are met through the Kyoto Protocol’s CDM and JI programs as approved by the respective United Nations boards. As a result, there is no specifi c additionality requirement under the ETS.

12. Supplementarity and Linkage to Other National and International Trading Systems On the other hand, supplementarity is a key aspect of the ETS. Th e use of off sets from the Kyoto programs must supplement the use of EUAs to meet a regulated facility’s compliance obligations and lead to the country’s compliance with its NAP approved under the EU ETS. Th e ETS requires that each country provide for a maximum level of off sets that may be used in any one year within the country’s NAP, and that specifi c facilities are only able to use a maximum amount for their compliance obligations. Generally, this amount is set at 10 percent for each facility. 11 For Phase II of the EU ETS, the maximum is set at 11.4 percent or 1.4 billion tons CO 2 e.

Th e EU ETS was formed with compliance with the Kyoto Protocol as a central aspect of the scheme. Th us, the relationships between the two programs are critical to understand in forming an idea of how the ETS works. In order for the EU ETS and the Kyoto Protocol to work together, and allow trading of CERs and ERUs, a linking directive was necessary.

Th e linking directive limited the amount of off sets that could be used in the ETS and set limits on certain types of project activities, as discussed above.

13. Early Action Credit for early action or the reductions of greenhouse gas emissions before the regulatory system goes into eff ect it less important now, as the program has been in eff ect for several years now.

14. New or Expanded Facilities Of course each country would like to see expanding economies, which oft en leads to new sources of greenhouse gas emissions. In order to not prohibit the construction of such new sources, a reserve is created in each country for these new sources. In Phase III of the EU ETS, 5 percent of the EUAs for the ETS will be reserved for new facilities.

11. EU Emissions Trading Scheme Com (2006) 725 fi nal, Nov. 29, 2006.


15. Enforcement By April 30 of each year, each EU member state must ensure that the regulated greenhouse gas emitting facility turns in suffi cient EUAs to cover its emissions for the prior year. In the event the facility fails to turn in suffi cient EUAs, the member state must collect a fi ne for each metric ton of greenhouse gases emitted that is not covered by an allowance. Th e amount of the fi ne charged was set at 40 euros for Phase I and 100 euros for Phase II. Th e fi ne must be higher than the cost of purchasing an EUA in order to encourage compliance with the EU ETS and NAP.

6

Emissions Programs among Other Kyoto Countries

Other countries outside of the European Union have struggled with establishing a cap and trade system. Concerns over international competiveness of domes-tic industries have been a strong driver for hesitancy in adopting domestic cap and trade programs along the Kyoto Protocol and European Union Emissions Trading Scheme (EU ETS) models. Th is chapter will provide an overview of some of the developments in both developed and developing countries.

A. New Zealand Th e New Zealand Emissions Trading Scheme (NZ ETS) started in January 1, 2008, initially only covered forestry. Th e NZ ETS was expanded in 2010 to include about one hundred emissions sources in the power generation, industrial, and liquid fuel sectors. 1 No specifi c caps are imposed under the system. By May 31, 2011, regulated facilities must turn in New Zealand Units (NZUs) for the emissions for the second half of 2010. 2 Electricity generators must sub-mit allowances for their total emissions, and other industrial sectors that are regulated must submit 60–90 percent of the NZUs that are provided from the government.

1. New Zealand Expands Carbon Scheme, Point Carbon News, Carbon Market Australia-New Zealand, 1 ( July 2, 2010), available at http://www.pointcarbon.com/news/1.1459607 .

2. See id.



Th e bulk of NZUs are being supplied from forest carbon projects in New Zealand, whereby forests are protected and the carbon emissions avoided are producing carbon credits under the ETS. 3

Th e carbon market in New Zealand is still small and not terribly liquid. Forest carbon developers were hanging onto their carbon credits in the hope of a rising price. In July 2010, the spot market for allowances was around NZ$18.00–18.50, and some parties were predicting that regulated entities could purchase allowances for NZ$25, which at the time was the equivalent of about US$17. 4

Th e New Zealand government is undergoing pressure to not implement a strict program until other countries, such as the United States, Japan, China, and Australia, adopt climate change legislation and greenhouse gas regulations and caps.

B. Canada Canada is a signatory to the Kyoto Protocol, but has not established a greenhouse gas reduction plan that successfully reduced greenhouse gas emissions to meet its Kyoto commitment. Greenhouse gas emissions in Canada have risen over the relevant Kyoto period.

According to Environment Canada, the national environmental agency, the current government has set a national target of 20 percent reduction in greenhouse gas emissions from 2006 levels by 2020, a reduction of approximately 610 megatons of greenhouse gas emissions. 5 Th e stated federal program would focus on energy intensity rather than caps, and reduce energy intensity by 18 percent from 2006 to 2010, and 2 percent per year thereaft er. Carbon capture and storage would be required of oil sands and coal-fi red power plants by 2018. Th e program would also implement renewable and energy effi ciency measures, such as transportation fuel effi ciency, renewable fuels, and energy effi ciency standards for appliances and equipment.

Th e federal program would also rely on the greenhouse gas reduction programs being developed by various Canadian provinces, including, Alberta, British Columbia, Quebec, and Ontario. Th ese goals range broadly from 50 per-cent reductions of business-as-usual reductions by 2050 in Alberta to 33 percent reductions of 2007 levels by 2020 in British Columbia.

3. See id.

4. See id. at 2.

5. Environment Canada, Turning the Corner: Detailed Emissions and Economic Modelling, avail-able at http://www.ec.gc.ca/doc/virage-corner/2008-03/571/Annex1_eng.htm

http://www.ec.gc.ca/doc/virage-corner/2008-03/571/Annex1_eng.htm

EMISS IONS PROGRAMS AMONG OTHER KYOTO COUNTR IES | 61

In May 2010, the House of Commons passed a climate bill that would require a reduction of 25 percent below 1990 levels by 2020. 6 Th e bill would require the Canadian government to establish an emissions trading program with allowances and off sets. Th e Canadian government had agreed to reduce its emissions by 17 percent based on 2005 levels by 2020. Th is is a very large disparity, and it would be very diffi cult for Canada to meet the greater reductions in the House of Commons bill.

Canada has also been awaiting any action at the federal level in the United States, and would likely meet a national reductions imposed by Congress. Th us, the requirements of the United States and Canada would be generally harmonized if Congress takes action.

C. Australia Australia has similarly struggled with enacting a climate bill. Th e Labor Party attempted to pass what is known as the Carbon Pollution Reduction Scheme (CPRS), but failed to garner the necessary votes to pass the bill. Kevin Rudd, who was the Labor Party leader and Prime Minister of Australia, lost his role as the Labor leader to Julia Gillard. Gillard made climate change a central plank in her election platform. 7 Th e 2010 elections have been concluded and a clear majority did not occur; however, a coalition government has been formed with the Labor Party in control. Th e Green Party is part of the coalition and is sup-porting a carbon tax until the terms of a cap and trade system can be negotiated, with reports a statute can be passed in the coming years. 8

D. Japan Japan signed the Kyoto Protocol, but operated much in the vein of an industry voluntary greenhouse gas reduction programs for many years. Starting in 2008, a trial program was initiated whereby 528 fi rms participated in a voluntary pro-gram to test the eff ectiveness of a carbon trading program in Japan. 9 Of these

6. Climate Bill Passes Canada’s House, PointCarbon News, May 6, 2010, available at http://www.pointcarbon.com/news/1.1442718 .

7. Gillard Mulls Climate, Tax Policies that Doomed Rudd , Business Week , June 24, 2010, available at http://www.businessweek.com/news/2010-06-24/gillard-mulls-climate-tax-policies-that-doomed-rudd.html

8. Labor Holds on to Power in Australia, PointCarbon News, Sept. 7, 2010, available at http://www.pointcarbon.com/ news/1.1472418.

9. Cap-and-Trade: Does It Fit Japan?, available at http://www.gov-online.go.jp/pdf/hlj_ar/vol_0021e/16-17.pdf



http://www.businessweek.com/news/2010-06-24/gillard-mulls-climate-tax-policiesthat-doomed-rudd.html

http://www.businessweek.com/news/2010-06-24/gillard-mulls-climate-tax-policiesthat-doomed-rudd.html



http://www.gov-online.go.jp/pdf/hlj_ar/vol_0021e/16-17.pdf

http://www.gov-online.go.jp/pdf/hlj_ar/vol_0021e/16-17.pdf


fi rms, 455 set emission quota targets. Many companies have relied upon Certifi ed Emission Reductions (CERs) generated through the Kyoto Protocol Clean Development Mechanism to meet their greenhouse gas reduction goals.

On March 12, 2010, the Japanese cabinet endorsed a draft law that would create a cap on greenhouse gas emission in Japan and create a market for trading carbon credits. 10 Th e goal of this law would be to cut greenhouse gas emissions by 25 percent by 2020. Th e covered entities would include electric-power genera-tors, steel, and other industry groups. Th e goal would be to launch a carbon market by 2012 or 2013.

In June 2010, the cabinet was proposing to try to move a climate bill through the upper house of the Japanese parliament by late 2010. Th e Japanese Environment Ministry proposed an emissions trading scheme in November of 2010 that would initially cover CO 2 , which would include 95 percent of GHGs emitted in Japan. 11 On the other hand, the Japanese Ministry of Economy, Trade and Industry has proposed a voluntary program.

One of the more signifi cant aspects of the Japanese approach to carbon trading is how it is considering addressing international off sets. Th e Clean Development Mechanism has been criticized for its bureaucracy, slow processing of applications, changing rules, and methodologies, among other problems. Combined with the uncertainty of an international treaty aft er the Kyoto Protocol expires at the end of 2012, planning for countries such as Japan that are evaluating the formation of a cap and trade program for greenhouse gases raises concerns about the ability to obtain lower cost greenhouse gas off sets in developed countries to reduce the impact on domestic industries and the overall economy becomes diffi cult.

With respect to international greenhouse gas off sets, particularly from developed countries, Japan has apparently decided to “go it alone,” in the sense that it is developing a program to enter into bilateral agreements with individual developing countries. Th e process would entail a treaty or agreement with a developing country, and the Japanese government would establish a program and protocols for evaluating and approving off set projects from that country and the issuance of carbon credits. Japan has reportedly already initiated a test pro-gram with certain countries and domestic corporations. According to one press

10. Japan’s Cabinet Endorses Cap-and-Trade Climate Bill , Bloomberg , Mar. 12, 2010, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=adciuCGMBEw8 .

11. Japanese Ministry Unveils Final Draft of ETS, PointCarbon News, Nov. 16, 2010, available at http://www.pointcarbon.com/news/1.1486296.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=adciuCGMBEw8


EMISS IONS PROGRAMS AMONG OTHER KYOTO COUNTR IES | 63

article, Japan has entered into initial discussion with China to develop an off set program. 12

E. China China has not embraced a cap and trade system, and has negotiated against mandatory cuts in greenhouse gas emissions in developing countries. At the same time, voluntary carbon markets may be springing up in China. China has been the leader in generating off sets in the form of CERs under the Clean Development Mechanism. Th us, the concept of emissions trading, at least with respect to off sets, is well understood and encouraged in China.

Another development is the formation of environmental trading exchanges in China. In 2002, China set up a sulfur dioxide trading program, and a water pollution trading program for Lake Tai. In the City of Tianjin, a carbon market is being developed. Th e exchange is a joint venture among the China National Petroleum Corp. — the country’s largest oil and gas company — the Tianjin Property Rights Exchange, and the Chicago Climate Exchange. 13

China is reportedly attempting to make fairly major strides through its developing fi ve-year energy plan. China reportedly may take steps to generate 30 percent of its energy from noncarbon sources by 2015, cut energy use by 346 million tons of standard coal consumption per year, with the ultimate goal of reducing its carbon intensity by 40–45 percent by 2020 based on 2005 levels, and may develop a pilot carbon trading scheme for the electricity generation, petroleum, and petrochemical industry sectors. 14

While the development of carbon trading programs in these countries remains in the developmental stage, as it does in the United States, it appears that if these countries pursue greenhouse gas reductions, some level of carbon trading will play a role in all of these programs as they develop and are implemented. Th e use of market-based emissions control programs is defi nitely a concept that is spreading across the globe. It does seem apparent that a carbon market will endure in any event; the question is the structure and the size of the market.

12. Japan’s Big Business Pushes for Rival to CDM, PointCarbon News, Nov. 17, (2010), available at http://www.pointcarbon.com/news/1.1486550 .

13. China May Start Its First City-Wide Carbon Market , Bloomberg, Mar. 5, 2010, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=arHr7BXpQIfQ .

14. China to Cut Coal Dependence, Point Carbon News ( June 20, 2010), available at http://www.pointcarbon.com/news/1.1459344 .


http://www.bloomberg.com/apps/news?pid=newsarchive&sid=arHr7BXpQIfQ



7

The Emergence of National and International Carbon Markets

A. Compliance or Mandatory Markets Environmental markets as mentioned in prior chapters in a sense appear to be an evolving aspect of modern economies. Th e use of emissions markets in par-ticular to address air pollution issues is a preferred industry approach as it is more cost eff ective and allows more fl exibility to industrial sources of air emissions, whether volatile organic compounds, sulfur dioxide, particulates, nitrous oxides, or greenhouse gases, it really does not matter. As the concept of environmental markets is permeating the globe where national and subnational governments are reviewing the mechanisms to control greenhouse gas emissions, we should expect that carbon trading will grow internationally.

B. Voluntary Markets 1. Voluntary Carbon Standards and Markets One of the most interesting, if not surprising, markets for greenhouse gas off sets is the voluntary carbon market or markets. Th ese markets exhibit an organic growth without any government mandate, thus the term “voluntary” markets. Various businesses and industries have sought to acquire carbon off sets generated from projects throughout the world in order to off set their greenhouse gas emissions and/or those of their customers in order to reduce their carbon footprint or those of their customers.

In order to meet the demand for these voluntary carbon credits, standards boards and reviewers or validators/verifi ers were required. One of the key

THE EMERGENCE OF NATIONAL AND INTERNAT IONAL CARBON MARKETS | 65

problems with carbon credits is the concern or discovery that the credits do not refl ect real, additional changes in behavior or changes in activities that lead to actual reductions in greenhouse gases. Stories have proliferated in the press regarding off sets that turned out not to reduce any greenhouse gas emissions at all. Th us, standards-setting boards were established to provide confi dence that the carbon off sets are real and verifi able. Th ese standards will be discussed below.

2. Source of Demand for Voluntary Carbon Credits So why did these markets emerge? How is it possible that companies would actually spend hard-earned profi ts to reduce net emissions without any govern-ment mandate? It does not seem possible under a traditional view of economics or corporate behavior.

Th e explanation may be best explained by the science of climate change and the causes of climate change discussed in Chapter 1. In order to expand on those concepts, as the public has become more aware of the current science on climate change and its causes, demand for action by consumer product and service companies to reduce greenhouse gas emissions or to off set them has grown dramatically.

Hotel chains, airline companies, retail stores, and a variety of other con-sumer companies have been setting up programs to purchase carbon off sets and even selling them to their customers. Th ese buyers are purchasing credits for “green” marketing programs or corporate policies.

Other buyers are what are referred to as “pre-compliance” buyers. Th ese buyers may be buying for marketing or public relations reasons but may also or solely be purchasing voluntary credits in order to amass a certain volume of credits before a mandatory program is instituted. Th e pre-compliance market will be discussed later in this chapter.

Some buyers are purchasing options or forward sales or entering forward sale contracts with carbon credit project developers. Th us, these contracts look more like hedges on other commodities, and may be regulated as fi nancial derivatives under any new climate legislation. We will discuss these issues in more detail in later chapters.

3. Development of Voluntary Standards, Registries, and Exchanges As stated above, as the demand for voluntary carbon credits evolved, the emergence of standards boards, registries, and exchanges emerged to address the demands of the new market. New ones have emerged over the years and investors and entrepre-neurs seized on the opportunities that emerging carbon markets created.


a. Chicago Climate Exchange While the name Chicago Climate Exchange (CCX) would at fi rst blush imply an exchange alone, it really functions as a standards board and registry as well. Th e founder of the CCX is Dr. Richard Sandor, an economist who seized on the concepts of carbon trading in the very early days of the development of programs to address climate change.

One of the main aspects of the CCX is that members of the exchange enter into legally binding agreements to meet certain greenhouse gas emissions from their operations. Th ose who exceed their voluntary goals, bank or sell the diff erence in terms of surplus allowances. 1

With respect to off sets, the CCX establishes protocols for project activities. A program for parties who want to propose new off set protocols is available to allow new forms of greenhouse gas reductions. Guidance is provided for verifi cation of the projects and off sets.

Once projects and off sets are verifi ed and allowances created, they are registered on the CCX carbon registry. Th e registry account holders use the reg-istry to manage, register, and trade their allowances or off sets.

For trading off sets, the CCX provides a trading platform as well. Th is is an electronic system for posting and accepting bids and off ers much like any other commodity exchange used for buying and selling. Th e CCX provides a clearing and settlement program through the electronic trading platform. Th e movement of ownership occurs on the CCX carbon registry, which is linked to the exchange.

b. Voluntary Carbon Standard While the CCX, and its sister companies in Europe, were part of the early movers in terms of initiating a voluntary carbon market, several other standards organizations for carbon credit review and issuance have emerged. We will focus on the more well-known standards boards for purposes of this chapter.

One of the leading voluntary carbon standards organizations goes by a rather obvious name, the Voluntary Carbon Standard Association (VCSA) that administers the Voluntary Carbon Standard (VCS). Th e organization was formed by the Climate Group, the International Emissions Trading Association, and the World Economic Forum in late 2005. Version 1 of the VCS was released on March 28, 2006, as both a consultation document and a pilot standard for use

1. For more information regarding the CCX, see their website at http://www.chicagoclimatex.com/ .

http://www.chicagoclimatex.com/

http://www.chicagoclimatex.com/


in the market. Th e VCS is designed to serve as a global standard for issuing voluntary carbon credits. Th e self-stated objectives of the VCS are as follows:

Standardize and provide transparency and credibility to the voluntary off set •market; Enhance business, consumer, and government confi dence in voluntary •off sets; Create a trusted and tradable voluntary off set credit; the Voluntary Carbon •Unit (VCU); Stimulate additional investments in emissions reductions and low carbon •solutions; Experiment and stimulate innovation in emission reduction technologies and •off er lessons that can be built into future regulation; and Provide a clear chain of ownership over voluntary off sets that prevent them •being used twice. Th is is achieved through multiple VCS registries and a central project database that is open to the public. 2

Th e VCS works by adopting methodologies that serve as the protocols for developing carbon credit projects. Some of these methodologies are created through the VCSA, and the VCSA also accepts methodologies adopted by the Executive Board of the Clean Development Mechanism (CDM) created under the Kyoto Protocol.

In order to obtain approval of a carbon project and the issuance of VCUs, a third-party validator/verifi er must validate the project design document submitted by the project developer, and verify the amount of greenhouse gas emissions actually reduced and, therefore, how many VCUs should be issued. Th e VCSA relies on third-party registries to actually issue the credits and main-tain them on their registries. Th e VCSA does not take a direct role in the issuance of carbon credits for individual projects.

Projects must be validated within two years of their start date. Th e VCSA believes this is necessary to ensure that the projects intend to pursue carbon fi nance from the outset and that the reductions meet the additionality tests.

New methodologies are developed through the “Double Approval Process.” A project proposing a new or amended methodology must have two VCS-approved validators independently assess the methodology and provide a positive assessment of the methodology.

2. See the Voluntary Carbon Standard website at http://www.v-c-s.org/about.html . Various infor-mation, programs, methodologies, registry system, guidance documents, and other documents can be found on the website.

http://www.v-c-s.org/about.html


Th e VCSA allows for “Grouped Projects,” which is similar to the CDM’s “Project of Activities.” A Grouped Project allows developers to bring a number of similar project activities into one Project Description, whereby these projects can be monitored under a centralized system. Th is allows the addition of new projects to the same program and the aggregation of smaller projects together for purposes of validation and verifi cation.

Th e VCS Registry System allows the tracking of all VCUs that are issued through the VCS-approved carbon registries. Currently the three approved carbon registries are APX Inc. (a leading environmental market infrastructure provider in North America), Caisse des Dépôts (a leading French fi nancial institution and developer of carbon registries in Europe), and Markit (a leading international fi nancial markets meta-registry in the United States, United Kingdom, and Asia-Pacifi c). VCUs must be registered on one of these three reg-istries, and all issuance, holding, transferring, and selling of VCUs will be man-aged through these registries. An exchange per se is not necessary to be utilized under the VCS. Typically, the trading of VCUs is managed through “over-the-counter trades” or bilateral agreements, rather than through clearing through an exchange.

c. American Carbon Registry Like the VCS, the American Carbon Registry (ACR) serves as a means of vali-dating, verifying, and issuing carbon credits in the form of greenhouse gas off sets. Th e ACR was formed by Environmental Resources Trust (ERT), now a business unit of Winrock International (Winrock), in 1997. Winrock is a nonprofi t orga-nization whose stated mission is working “with people in the United States and around the world to empower the disadvantaged, increase economic opportu-nity, and sustain natural resources.” 3 ERT is a leader in the fi eld of environmental markets. 4 Th e ACR was the fi rst private voluntary greenhouse gas registry in the United States and “off ers the entire spectrum of carbon technical services for greenhouse gas accounting, verifi cation, registration, over-the-counter (OTC) transactions and off set retirement.” 5

Th e unit established by the ACR for greenhouse gas off sets is the Emission Reduction Tons (ERTs). Th ese carbon credits are registered, and the purchase, sale, and retirement is tracked on the ACR’s registry.

3. See Winrock International website at http://www.winrock.org/about_us.asp .

4. See id. , http://www.winrock.org/feature_ert_200802.asp .

5. See id.

http://www.winrock.org/about_us.asp

http://www.winrock.org/feature_ert_200802.asp


d. Climate, Community, and Biodiversity Alliance With the advent and growing demand for carbon credits from avoided deforesta-tion and reforestation projects, standards for these types of projects and carbon credits evolved under the CCX, VCS, and ACR. One of the growing trends was the concern that the local communities and the biodiversity related to the preserved or regrown forests were addressed. Th e Climate, Community, and Biodiversity Alliance (CCBA) was born out of these concerns. Th e objectives of the CCBA are summarized as follows:

“Th e Climate, Community and Biodiversity Alliance . . . is a partnership of international NGOs and research institutes seeking to promote integrated solutions to land management around the world. With this goal in mind, the CCBA has developed voluntary standards to help design and identify land management activities that simultaneously minimize climate change, support sustainable development and conserve biodiversity.” 6

Th e early draft s of the CCBA’s standard (CCB Standard) were issued in 2004 and 2005, and the fi nal standard was issued in May 2005. Th e standards were revised in 2008, and the second edition relaunched in December 2008. Th e CCBA issued new Rules for the use of the CCB Standard on June 21, 2010, which prescribe the requirements for the evaluation of projects against the CCB Standard and is intended to be used by project proponents and the independent auditors that evaluate the conformance of projects to the CCB Standard. 7

Th is standard will be discussed in a later chapter addressing forest carbon projects.

C. Pre-Compliance Markets and the Transition from Voluntary to Compliance Markets Some buyers of voluntary carbon credits are obtaining credits in order to amass a certain volume before a mandatory program is instituted. Th us, the term “pre-compliance” was coined. Th ese purchases are made under the presumption that the cost of credits aft er a mandatory cap and trade program goes into eff ect

6. See CCBA website at http://www.climate-standards.org/ .

7. Rules for the Use of the Climate, Community & Biodiversity Standards ( June 21, 2010), avail-able at http://www.climate-standards.org/pdf/CCB_Standards_Rules_Version_June_21_2010.pdf .

http://www.climate-standards.org/

http://www.climate-standards.org/pdf/CCB_Standards_Rules_Version_June_21_2010.pdf

http://www.climate-standards.org/pdf/CCB_Standards_Rules_Version_June_21_2010.pdf


will rise several fold. Th e pre-compliance buyers tend to be electricity generators, petroleum refi ning, steel, chemical, and other industries or businesses that anticipate potentially being required to reduce their emissions and that a cap and trade program will likely be the form of regulatory program that would be passed at some point in the future. Th ese purchases are in eff ect a “hedge” against higher prices for credits in the future. Th e pre-compliance market demand increases as the potential for legislation is perceived to be likely and decreases as it as seen as less likely.

D. Survival of Voluntary Markets after Establishment of Compliance Systems One of the current questions is the extent to which voluntary markets will con-tinue in existence if mandatory systems are created in a particular country — the primary country of interest being the United States. One thought is that once mandatory markets are created, the pre-compliance market would cease to exist as regulated entities would purchase off sets or allowances approved under the relevant governmental system. Th e other thought is that the mandatory market would serve to provide off sets or allowances for use by the volunteer, public relations market.

What has been seen in Europe is that a voluntary market continues to survive. Th is may be that non-compliance purchasers fi nd a more ready and less expensive source of off sets in the voluntary market, rather than purchasing in the mandatory market.

E. The Current State of the Voluntary Market At least two reports are published annually that provide a study and analysis of the voluntary carbon markets. Th e fi rst of these is entitled “Th e State of the Voluntary Carbon Markets Report” and was developed by Ecosystem Marketplace and Bloomberg New Energy Finance. In 2010, the report was issued and entitled “Building Bridges: State of the Voluntary Carbon Markets 2010.” 8 Th e report reviews the prior market for the year prior to the year of issuance and compares it to the preceding years.

8. Katherine Hamilton, Milo Sjardin, Molly Peters-Stanley, & Th omas Marcello, Ecosystem Marketplace and Bloomberg New Energy Finance, Building Bridges: State of the Voluntary Carbon Markets 2010 ( June 14, 2010).


In the 2010 Report, the authors report a “tumultuous year” for the voluntary carbon markets, as a result of the severe economic recession and the unpredictable nature of climate legislation in the United States. 9 Th e report concludes that about one-half of the buyers were “pure” voluntary buyers, as opposed to pre-compliance buyers.

Th e supply in 2009 was 93.7 million tons of CO 2 e, compared to 126.6 mil-lion tons in 2008 — a 26 percent decline, but still 39 percent above 2007 levels. 10 Almost half the market was traded on the CCX in the form of Carbon Financial Instruments; however, exchange-traded deals dropped 40 percent in 2009. Th is indicates a shift to the over-the-counter market. Compared to the regulated markets, the voluntary markets were small, about 1 percent of the regulated markets. 11

Th e total value of trades transacted were $387 million in 2009, as compared to $787.1 million in 2008. 12 Th e OTC market constituted 84 percent of the market, and the CCX exchange market formed 14 percent of the market value. Th is may refl ect lower prices for CCX credits. Average prices on the OTC market declined by 12 percent from $7.3/tCO 2 e to $6.5 per ton CO 2 e, while the CCX suff ered a large price reduction of 73 percent from an average $4.4/tCO 2 e in 2008 to $1.2 per ton CO 2 e in 2009. Th ese changes resulted in a market value decline in the CCX market of 84 percent. Voluntary credits sales price varied dramatically for as low as $0.3 per ton CO 2 e and as much as $111.0 per ton CO 2 e during 2009.

F. The European Market Th e European Market is by far the largest carbon market. Th e EU Emissions Trading Scheme (ETS) has created a market that has grown to over $100 billion dollars per year in 2009. Total transactions in European Union Allowances (EUAs) have increased by about 18 percent to $118.5 billion. 13 Trading volume increased by 105 percent. However, the average EUA prices fell 42 percent to $18.70 in 2009 compared to $32.50 in 2008. 14 Futures trades constituted 73 per-cent of all transactions. Spot market trades grew in volume to 1.4 billion tons.

9. Id. at i.

10. Id. at ii.

11. Id. at iii.

12. Id.

13. World Bank, State and Trends of the Carbon Market 2010 5 (May 2010).

14. Id.


Th e World Bank report states that EU companies monetized their excess allowances to raise capital. 15 In general, the economic recession and reduced demand for electricity and decreased greenhouse gas (GHG) emissions were signifi cant factors aff ecting the EU carbon market.

In considering the EU carbon market, the World Bank report concludes that the carbon market is actually functioning well:

As a market mechanism, the EU ETS should be evaluated according to how accurately it has refl ected macro-economic trends. Th e fact that carbon prices fell along with the prices of mature energy commodities as the global economic crisis deepened, and rebounded amidst signs of recovery, suggests the market is both effi cient and rational. Th e price of carbon refl ected expectations for the amount of abatement required to limit emissions under a changed economic scenario. 16

Th e evidence as reviewed by the World Bank analysts demonstrates that emis-sions markets and carbon markets in particular can work well to address reduc-tions in emissions of air pollutants. Much like the SO 2 market for coal-fi red power plants in the United States, the GHG markets in the European Union have achieved reductions in emissions while allowing industry more fl exibility in determining how to meet mandated reductions and in seeking the lowest cost reductions.

G. The Kyoto Protocol and the Clean Development Mechanis Market Trading of Certifi ed Emission Reductions (CERs) under the CDM of the Kyoto Protocol has grown dramatically since the inception of the CDM. Th e market value grew from nothing to $6.5 billion in 2008. 17 CERs played a signifi cant role in the EU ETS market as compliance buyers and investors and banks bought CERs.

Th e fi nancial crisis has a marked eff ect on the CER market. Th e volume and market value both declined signifi cantly in 2009. Volume decreased from 401 to 211 million tons, and total value of the market trades dropped from $6.5 to

15. Id. at 2.

16. Id. at 6.

17. Id. at 37.


$2.7 billion. 18 Prices for CERs dropped as well from an average of $12.7 per ton from $16.1 in 2008. 19

Compliance buyers did not purchase as many credits as demand for elec-tricity and other economic activity decreased. Financial entities with their own fi nancial challenges reduced their purchases of credits. Financial institutions reduced their lending and investment in project development as well, so fewer credits were being generated. 20

As the economy recovers, these trends may reverse themselves, depending on how countries with a demand maintain their legislation on climate change and cap and trade as the regulatory system to use to address climate change concerns. Th e ability to obtain fi nancing for carbon credit projects will be essen-tial to the market.

18. Id.

19. Id. at 39.

20. Id. at 37.

8

Developing Laws in the United States — State Laws

A. State Climate Change Programs In the United States, the fi rst regulation of greenhouse gases (GHGs) began in the states, and the developing laws at the state level was one of the signifi cant factors in pushing Congress to act. While Congress has enacted only require-ments and funding for the Environmental Protection Agency (EPA) to require GHG monitoring and reporting, and climate change legislation has been passed by the House of Representatives, but not the Senate, the states have moved forward with a signifi cant degree of development of GHG regulatory systems. Cap and trade is a part of all of those enacted or developing systems, as will be described below.

One of the interesting aspects of these multi-state programs is that Canadian provinces and Mexican states are also working with these programs and may participate in the regional GHG regulatory programs at some point in the future, making these programs cross-border, international programs.

B. Individual State Programs 1. California California, a long-established leader in developing environmental initiatives that spread across the country at the state level and eventually become federal law, has enacted a climate change statute. Th e statute is known as the California Global Warming Solutions Act, also known as “AB 32” from of its legislative number, Assembly Bill 32.

DEVELOP ING LAWS IN THE UNITED STATES—STATE LAWS | 75

Th e California Air Resources Board (CARB) is the agency given the responsibility of developing the programs to implement AB 32. In developing a climate change and GHG regulatory program and cap and trade system, CARB is required to analyze many factors, including economic impacts, environ-mental impacts, public health impacts, equity between regulated entities, elec-tricity reliability, conformance with other environmental laws, and potential disproportionate impacts on low-income communities.

In November of 2010, CARB issued a proposed regulation to establish a cap and trade system (Proposed Rule). Under AB 32, the program must be adopted by January 1, 2011, and must go into eff ect by 2012. In developing this program, CARB is working with other states and developing the Western Climate Initiative, discussed below, and its cap and trade program for the participating states and provinces. Th us, CARB intends that the California program be part of a larger, regional cap and trade system.

Since CARB is establing the cap and trade system through regulations as provided under AB 32, CARB is receiving public comments on the proposal. 1 CARB set a hearing on the regulations on December 16, 2010.

a. Regulated Gases Th e gases listed in the Rule in the defi nition of greenhouse gases are as follows:

Carbon dioxide (CO • 2 ); Methane (CH • 4 ); Nitrous oxide (N • 2 O); Hydrofl uorocarbons (HFCs); • Perfl uorocarbons (PFCs); • Nitrogen trifl uoride (NF • 3); Sulfur hexafl uoride (SF • 6 ); and Other fl uorinated gases. • 2

b. Regulated Sources “Covered Entities” would include the following:

Cement production; • Cogeneration; • Glass production; •

1. California Air Resources Board, Proposed Regulation for a California Cap-and-Trade Program (Oct. 19, 2010) (hereinaft er “Proposed Rule”).

2. Id. § 95810.


Hydrogen production; • Iron and steel production; • Lime manufacturing; • Nitric acid production; • Oil and natural gas systems; • Petroleum refi ning; • Pulp and paper manufacturing; • Self-generation of electricity; and • Stationary combustion. • 3

Covered entities would also include the following:

Electricity deliverers, meaning electricity generators located in California, •and parties importing electricity into California; 4 Natural gas deliverers, meaning a public utility gas corporation operating in •California; a publicly owned natural gas utility operating in California; or the operator of an intrastate pipeline not included in section 95811(c)(1) or section 95811(c)(2) that distributes natural gas directly to end users; 5 Fuel deliverers, including California reformulated gasoline (RBOB), diesel •fuel, distillate fuel oil, natural gas liquids, and biomass fuels; and Suppliers of CO • 2 . 6

Th e emissions threshold would generally be 25,000 tons per year. 7 Th e cap and trade program would be developed in three compliance peri-

ods. Th e fi rst compliance period would begin in 2012 and end in 2014, and apply to the list of covered entities, regulate electricity generating plants and importers of electricity generated in other states, and suppliers of CO 2 that emit in excess of 25,000 tons CO 2 e. 8

Th e second compliance period would begin in 2015 and end in 2017, and would expand the cap and trade program to suppliers of natural gas, suppliers of

3. Id. § 95811(a).

4. Id. § 95811(b).

5. Id. § 95811(c).

6. Id. § 95811(d)-f.

7. Id. § 95812(b).

8. Id. § 95840(a), 95851(a).


RBOB and distillate fuel oils, and suppliers of liquefi ed petroleum gas generally above 25,000 tons. 9

Th e Th ird Compliance Period would begin in 2018 and end in 2020. Any additional source types to be included in the regulatory system would have to be added by CARB through regulatory amendment.

c. The Cap Th e program would implement a cap on GHG emissions to reach 1990 levels by 2020. Th e program would allow a market-based system and other alternative compliance programs to achieve this reduction goal. Th e program to achieve the 2020 cap is required to be adopted by January 1, 2012.

CARB would set what it calls an Allowances Base Budget for specifi c time periods in millions of allowances. Th e periods would correspond to three-year compliance periods — First Compliance Period 2012 to 2014, Second Compliance Period 2015 to 2017, and Th ird Compliance Period 2018 to 2020. Th e number of allowances would start in 2012 at 165.8 million allowances and decline to 159.7 million in 2014. With the increase in Covered Entities and the reach of the Second Compliance Period to other sectors of the economy, the allowances would be raised to 394.5 million allowances and decrease to 334.2 allowances in 2020. 10

d. Permitting Emissions of Greenhouse Gases A permit would be required for each facility that governs the allowed GHG emissions and future reductions. Th e permitting program is outside of the cap and trade program and not addressed by the Proposed Rule.

e. Emission Allowances Emission allowances would be created and used as the foundation of the cap and trade program. In order to enforce the cap, fewer total allowances would be issued each year. Allowances must be submitted and retired on an annual basis by each Covered Entity to meet their compliance obligations. 11 Failure to do so would result in substantial penalties.

f. Allocation of Emission Allowances Th e Proposed Rule provides for both free allocation and auctioning of allowances. Th e approach proposed is to have an initial percentage of the allow-ances being auctioned and then increasing to a higher percentage of auctioning

9. Id. § 95840(b), 95851(b).

10. Id. § 95841, Table 6-1.

11. Id. § 95856.


of allowances in later years. 12 In the Proposed Rule, CARB is allocating allow-ances in part based on the risk of the reductions in California resulting in increased emissions in other jurisdictions. Th e term used for this is “leakage.” For a group of entities, this means 100 percent of allowances would be directly allo-cated. A certain amount of allowances would be set aside to assist these industry types. Th e goal being to reduce the economic impact and reduce the competitive impact from international or domestic entities from jurisdictions that do not regulate GHGs. Th e allowances for certain entities would be allocated annually using a product output-based methodology and formula, while others would be based on a thermal energy methodology and formula. 13 Th e regulation of the following types of sources are considered a high risk of leak-age, and would get 100 percent of their industry assistance allowance:

Oil and gas extraction; • Natural gas liquid extraction; • Soda ash mining and manufacturing; • Reconstituted wood product manufacturing; • Paper manufacturing; • Paperboard manufacturing; • All other basic inorganic chemical manufacturing; • Flat glass manufacturing; • Glass container manufacturing; • Cement manufacturing; • Lime manufacturing; and • Iron and steel mill. • 14

Other industries would be allocated 100 percent in the First Compliance Period, and decline to lower percentages in the Second and Th ird Compliance Periods. 15 Certain industries would be allocated allowances based on a thermal effi ciency formula. Th e leakage percent is plugged into the product or thermal effi ciency formula depending on the industry type. Th e goal would be to use the allocation process to reduce economic impacts.

If suffi cient allowances are not directly allocated, then the covered entity would need to purchase additional allowances through the allowance auction. As discussed below, purchasing off sets may also serve to fi ll some portion of that need.

12. See id. § 95870-95893.

13. Id. § 95891.

14. Id. § 95870, 95890-91.

15. Id .


In the auction process, CARB is proposing to use “soft collars,” by which the CARB could adjust the supply of allowances or off sets in the emissions market once price triggers are reached through reserve allowance accounts. CARB is also proposing to use a reserve price below which no allowances would be sold to attempt to maintain a fl oor price for allowances, and by association, off sets. For calendar year 2012 the reserve price would be set at $10 per metric ton of CO2e for vintage 2012 allowances, and $11.58 per metric ton of CO2e for vintage 2015 allowances, and the reserve price would increase in auctions aft er 2012 by increased annually by 5 percent plus the rate of infl ation. 16

Th e Allowance Price Containment Reserve would be allocated one percent of the allowances from budget years 2012–2014, four percent of the allowances from budget years 2015–2017, and seven percent of the allowances from budget years 2018–2020. 17

g. Trading Allowances Allowances may be sold freely to third parties. Covered Entities, entities volun-tairloy submitting to regulation, and third party traders may register and seek approval to trade allowances under the program. 18 Th e CARB is planning in the Proposed Rule to regulate trades and traders to ensure the integrity of the trading system and allowance and off set markets. 19

h. Banking Allowances Allowances may be used to meet compliance obligations if the allowance has been issued for a current or previous compliance period. 20 Off sets may be held or used for a compliance obligation. 21

i. Borrowing Allowances Borrowing would not be allowed under the Proposed Rule. 22

16. Id. § 95111(b)(6).

17. Id. § 95870(a).

18. Id. § 95812-14, .

19. Id. § 95831(b).

20. Id. § 95922.

21. Id.

22. Id.


j. Safety Valve and Competitiveness CARB does not propose a price cap on allowances. To reduce costs of compli-ance with the program, CARB has proposed as discussed above to allocate a certain amount of free allowances and a reserve of allowances for sale to covered entities that would increase the supply of allowances and reduce allowance prices. Off sets are another mechanism to reduce compliance costs by providing a less expensive means of meeting compliance obligations by submitting off sets in lieu of allowances that tend to be more expensive than off sets.

k. Off sets Th e off set program under development in California has faced challenges. A vol-untary program was created by CARB in the California Climate Action Reserve (CAR). Voluntary GHG emissions reductions were intended to be registered with CAR, and it was intended that those off sets would be qualifi ed for use in a future CARB cap and trade program. Unfortunately, aft er the methodologies were created, CARB determined that public notice and comment procedures had not been followed and the credits created under the CAR system could not be accepted in a future compliance system. CARB has identifi ed certain CAR methodologies it will accept, as discussed below, but apparently may not neces-sarily adopt all of the CAR methodologies. CARB may adopt other project types and methodologies at later dates.

In the Proposed Rule, a program for monitoring and issuing GHG off sets is proposed. Th e proposal contains a general set of requirements for off set credits, approval of off set methodologies, requirements for off set methodologies, addi-tionality requirements, baseline emission calculations, requirements for opera-tors of off set projects, verifi cation, reporting, ownership and transferability, off sets issued by non-Carb programs, sector-based programs, and many other issues related to off sets. 23

In addition to the Proposed Rule and the issues raised in the text of the Proposed Rule regarding off sets and the off set program, on July 29, 2010, CARB issued a letter aft er public workshops were conducted to gather public comment on the off set program. 24 Th e workshops were held to development discussions on the role of off sets in the compliance program for addressing GHG emissions. Some of the conclusions of the letter were:

Off sets can serve to reduce the costs of compliance; •

23. Id. § 95940–95997.

24. California Air Resources Board, Update Regarding the Proposed Off set Component of the California Cap-and-Trade Program ( July 29, 2010).


Quality of the off sets is critical to maintaining the integrity of the cap and •trade program, and therefore, CARB plans to

Conduct analyses to ensure that compliance-eligible off set credits meet all •AB 32 requirements; Ensure the cap-and-trade program meets all California Environmental •Quality Act requirements; Take a conservative approach to ensure that all off sets used in the program •are real, additional, permanent, verifi able, and enforceable; and Propose that all emission reductions from off set projects be verifi ed by •third-party verifi ers accredited by ARB.

Th e off set program contained in the Proposed Rule would include verifi er accreditation, requirements for verifi er services, and confl ict of interest provisions, among other provisions regulating the off set program. Th e Proposed Rule includes a process for allowing other qualifi ed off set programs to be used in California. 25

Th e off set types that CARB would include immediately are ozone deplet-ing substances projects, livestock projects, urban forest projects, and U.S. forest projects. 26 Other protocols may be approved in the future. In addition to CARB off sets, sector-based off sets may be allowed into the system from developing countries or from subnational jurisdictions within developing countries, the one provided for specifi cally in the proposed rule being from international reduced deforestation and degradation (REDD) projects. 27 In what is known as a “nested” approach, project-based sector projects, currently only REDD projects, may be allowed within a jurisdiction and sector-based set of baseline emissions and reductions. 28 Other sectors may be approved by CARB in the future.

Th e Proposed Rule does provide for a limitation on the number of off set credits that can be used by a covered entity to meet its compliance obligations as will be discussed below under the section on supplementarity.

CARB has made a a commitment to off sets. Th e rule, however, has limited the use of off set credits to four protocols. Th e rules allow the use of off set credits from other off set programs that may lead to acceptance of those off sets issued under the Voluntary Carbon Standard, the American Carbon Registry, and other voluntary standard programs, as well as other state programs from the Western Climate Initiative and potentially the Midwestern Greenhouse Gas

25. Proposed Rule § 95941.

26. Id. § 95973(a)(2)(C).

27. Id. §§ 95991, 95993(a).

28. Id. § 95994(a)(6).


Reduction Accord. Th e need for an increased supply from other off set programs to reduce the cost impact of the cap and trade program is recognized by CARB.

l. Additionality Th e defi nition and application of additionality requirements for off sets is still under development. Th e current proposed defi nition for the term “additional” is: “greenhouse gas emission reductions or removals that exceed any greenhouse gas reduction or removals otherwise required by law, regulation or legally binding mandate, and that exceed any greenhouse gas reductions or removals that would otherwise occur in a conservative business-as-usual scenario.” 29 In the California program for off sets, there has been discussion about “performance tests” for additionality that would apply across the board to off set project types, and not require project by project analysis of additionality. Sectoral programs also have been discussed by which industries or businesses would have to show reductions in overall emissions before reductions in greenhouse gases at a specifi c facility could be credited.

m. Supplementarity and Linkage to Other Trading Systems Th e Proposed Rule would address supplementarity by limiting the use of off sets for compliance obligations for covered entities to ensure reductions are made at emissions regulated facilities, rather than off sets alone being used to meet com-pliance obligations. Th e formula provided in the Proposed Rule is that O/S cannot be less than L. Th e term O refers to off set credits subject to the limitation, which are off set credits issued by CARB under its protocols, early action credits under programs existing before the beginning of the new program, and sector-based off sets these sector-based credits being limited to REDD projects currently by the Proposed Rule. Only 25 percent of sector credits may be included in the calculation of O for this formula in the First and Second Compliance Periods, but up to 50 percent for subsequent compliance periods. S is the covered entities annual or triannual compliance obligation. L equals the quantitative off set credit usage limit of 0.08. “Early action” off set credits may arise from cer-tain types of projects that are approved under third-party off set programs. Th e Early action project’s GHG reductions must have occurred between January 1, 2005, and December 31, 2014, and the off set project must have commenced before January 1, 2012. 30

29. Id. § 95802(a)(3).

30. Id. §§ 95991-95997.


Linkage to other allowance and off set programs would be permitted under the Proposed Rule. 31 A fairly detailed set of requirements have been proposed to ensure the integrity of the California program.

n. Early Action One of the requirements of AB 32 was to protect facilities that reduced their GHG emissions prior to a regulatory system going into eff ect. Th e Proposed Rule would allow third party off sets that were issued prior to the eff ective date of the fi nal rule if the off sets were issused under the four off set protocols approved by CARB and discussed above or if an executive order is issued approving the program and off sets or if certain criteria listed in the rule are met. 32

o. New or Expanded Facilities Th e Proposed Rule provides for facilities that are newly regulated by establishing a phase in of their compliance obligations. 33 Newly constructed covered entities of facilities that were not in operation before 2011 may estimate emissions to obtain free allocation under the relevant provisions of the Proposed Rule. 34 Under the thermal energy-based methodology, entities shall be assessed baseline annual steam and/or thermal energy use values based on expected activity levels. No specifi c provision is included for expanded facilities as to how these expan-sion activities will be allowed to go forward in the cap and trade system. Th ese facilities would appear to be required to purchase additional allowances or off sets to meet their complianee obligations for any increased emissions. Increases in emissions would likely require approval from the permitting authority prior to the construction of the expansion.

p. Regulatory Agency or Agencies CARB will be the main state agency regulating greenhouse gas emissions and the cap and trade program, as well as regulation of allowance and off set trading.

q. Enforcement CARB has proposed enforcement provisions in the Proposed Rule. Th ese provi-sions include the authority to suspend, revoke, or modify a Holding Account that contains allowances or off sets, to place restrictions on the account, to seek injunctions and penalties under the California Health and Safety Code, and

31. Id. § 95940–95943.

32. See id. § 95990.

33. Id. § 95853(e).

34. Id. § 95891(c)(3).


other actions for failure to comply with the Proposed Rule or submit the neces-sary number of allowances or off sets for a compliance year. 35

2. Florida In June 2008, the current governor signed House Bill 7135 that provided for a comprehensive energy and climate change program. 36 Th e Florida Climate Protection Act authorizes the Department of Environmental Protection to develop an electric-utility greenhouse gas cap and trade program. Th e agency is in the process of developing regulations to implement the cap and trade program. With a governor’s race in the fall of 2010, like many other state climate programs, the future of the program likely depends on the outcome of the election.

Florida has considered joining one or more of the multi-state programs in more detail below. 37 While Florida is not adjacent to any of the other states participating in a multi-state greenhouse gas program, participation is possible as it may gain the value of work of the analysis and program development completed by the other states. In addition, the consistency of a Florida program with one or more of the multi-state programs may allow the state to participate in off set trading with the other U.S. states and the potential for trading with participant provinces and states in Canada and Mexico.

3. New Mexico Th e State of New Mexico has adopted through the New Mexico Environmental Improvement Board and the New Mexico Environment Department a cap-and-trade program. 38 Th e rule was adopted on November 10, 2010. Th e rule may be challenged in court by opponents of a cap and trade program in the state. With the election of a new governor, the administrative agencies may alter their approach to greenhouse gas regulations. Th us, the longevity of this program is somewhat uncertain.

35. Id. §§ 96010–96013.

36. Florida Action Team on Energy and Climate Change, Florida’s Energy and Climate Change Action Plan 4–2 (Oct. 15, 2008).

37. Florida Decision on Regional Greenhouse Gas Initiative Still Up in the Air, Environmental News Service (Sept. 7, 2009), available at http://www.ens-newswire.com/ens/sep2009/2009-09-08-092.html

38. New Mexico Environmental Improvement Board, Order and Statement of Reasons for Adoption of New Regulations, In re. Proposed New Regulation: 20.2.350 NMAC—Greenhouse Gas Cap and Trade Provisons, EIB No. 10-4 (R) (Nov. 10, 2010), available at http://www.nmenv.state.nm.us/cc/documents/SOR_20_2_350_NMAC.pdf ; New Mexico Environment Department, Greenhouse Gas Cap-and-Trade Provisions, to be codifi ed at 20.2.350 NMAC, available at http://www.nmenv.state.nm.us/cc/documents/20_2_350_NMAC_fi nal.pdf .

http://www.ens-newswire.com/ens/sep2009/2009-09-08-092.html

http://www.ens-newswire.com/ens/sep2009/2009-09-08-092.html

http://www.nmenv.state.nm.us/cc/documents/SOR_20_2_350_NMAC.pdf

http://www.nmenv.state.nm.us/cc/documents/SOR_20_2_350_NMAC.pdf

http://www.nmenv.state.nm.us/cc/documents/20_2_350_NMAC_final.pdf

http://www.nmenv.state.nm.us/cc/documents/20_2_350_NMAC_final.pdf


C. Multi-State Programs 1. Regional Greenhouse Gas Initiative Th e fi rst of the multi-state programs to develop a GHG regulatory system was the Regional Greenhouse Gas Initiative (RGGI), which was established in 2005 with seven northeastern and mid-Atlantic states, and has grown to ten states. Th e participating states are Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, and Vermont. Th is pro-gram involved fi ve years of development and the adoption of a model rule to govern the participating states programs so that they would be compatible. Other states and Canadian provinces in the region are serving as “observers” in that they are working with the participating states, but have not yet joined RGGI or adopted the model program in their own state or province. Th e observer states and provinces are Pennsylvania, Québec, New Brunswick, and Ontario. Th e participating states developed program that was modest and designed not to have a signifi cant impact on electricity prices.

Th e RGGI program includes a cap and trade system. Th e participating states developed a Model Rule, and each state adopts the Model Rule and imple-ments and enforces the greenhouse gas regulatory program in their respective jurisdictions. 39

a. Regulated Gases RGGI currently only regulates CO 2 , and not any of the other greenhouse gases.

b. Regulated Sources Th e regulated entities are fossil-fuel power plants that generate 25 megawatts (MW) or more of electricity. 40 Approximately 225 facilities in the region are regulated.

c. The Cap A cap is set for the region and allotted for each state. Th e cap was set at 188 mil-lion tons of CO 2 with the reduction of 10 percent of 1990 emissions levels by 2018. Th e reductions will be timed by a stabilization of emissions through 2014, and then a 2.5 percent reduction from 2015 to 2018. Th e fi rst compliance period is 2009 to 2011.

39. Regional Greenhouse Gas Initiative Model Rule (Dec. 31, 2008) (hereinaft er Model Rule).

40. Id. at XX-1.4.


d. Permitting Emissions of Greenhouse Gases A permit is required for each facility that governs the allowed GHG emissions and future reductions. 41 Th e permitting program implements the cap and reduc-tions at the facility level.

e. Emission Allowances Allowances are required by each regulated facility. Each facility must submit a compliance certifi cation report that states the emissions from the facility and the number of allowances required to cover the emissions for the prior year. 42

f. Allocation of Emission Allowances Allowances for the regulated facilities are sold at quarterly auctions, with a very low reserve price of $1.86 initially, and then 80 percent of the most recent auction price. Th e program thereby is designed to keep carbon prices low. Allowances are allocated through auctions, with many states auctioning 100 per-cent of allowances. Prior to the beginning of the program in 2009, “pre-compliance” auctions were held in September and December 2008. Th e auctions are limited to compliance buyers and structured so that the prices are held to a low a price and to avoid speculation. Th e goal was to avoid signifi cant increases in electricity prices.

g. Trading Allowances Allowances may be sold freely traded to parties who have established CO 2 Allowance Trading Accounts (COATs). 43 An allowance registry or tracking system has been established in order to track purchases and trades of allowances. 44

h. Banking Allowances Allowances may be held for future compliance years, and are not required to be used in the year they are purchased. 45

i. Borrowing Allowances Borrowing is not currently permitted, but the prices have remained so law, that this is really not a necessary aspect of the trading program.

41. Id. at XX-3.

42. Id. at XX-4.

43. Id. at XX-1.5, XX-7.

44. Id. at XX-6.

45. Id. at XX-6.6.


j. Safety Valve and Competiveness Th e low cap and auction system keep the prices of allowances low. As a result, no safety valve to control prices is necessary, and little concern exists regarding competiveness of the power plants, which are diffi cult to close and obtain power outside of the region. Since the regulatory program has not been applied to industry, there is little impact on the manufacturing sector, other than perhaps slightly higher electricity prices.

k. Off sets Off sets are permitted, 46 but with such low prices for allowances, there has not been and may not be a signifi cant demand for off sets among power plants regu-lated under RGGI.

l. Additionality Additionality as it applies to off sets has not been a critical issue, since, as stated above, off sets are not in demand at present.

m. Supplementarity and Linkage to Other Trading Systems A limit on off sets has been established, but the use of off sets is not attractive under this system because the prices for allowances have been so low. As to linkage, the various interstate programs discussed below are evaluating trading between the three systems. A white paper on off set markets has been developed by the three regional programs. Potential problems with integrating the RGGI system with other state and regional systems is that the market prices for RGGI allowances are low and the system is limited to only CO 2 and the electrical power industry. If the other systems are more economy-wide and cover all or most of the GHGs, then the programs may be diffi cult to integrate as prices for allowances will vary signifi cantly, and other incompatibilities and negative eff ects may arise.

n. Early Action Since the system is in eff ect, early action would be relevant only if RGGI were expanded beyond electricity production. 47

46. Id. at XX-10.

47. Id. at XX-3.


o. New or Expanded Facilities Th e RGGI Model Rule provides for submission of permits and CO 2 budgets for new sources. 48 However, the process by which a new source obtains allow-ances or how this fi ts in the facility or state cap is not discussed.

p. Regulatory Agency or Agencies Each of the participating states enforces the cap and trade and regulatory program through their environmental agencies. Th ere is an RGGI entity that works with these agencies, but each state manages its own enforcement of the program. A GHG monitoring and reporting program has been established in each state.

q. Enforcement As stated above, each state enforces the greenhouse gas regulatory program developed under the model rule. Th e environmental agency for each state is generally assigned by the state to implement and enforce the RGGI program in that jurisdiction.

2. Western Climate Initiative Th e Western Climate Initiative (WCI) consists of western U.S. states and certain Canadian provinces and Mexican states developing a multi-state and potentially multi-national cap and trade program that would be economy wide and cover all of the greenhouse gases. Th e WCI is developing perhaps the leading pro-gram for a cap and trade program that would cover a signifi cant part of the United States. Th e proposed start date of the WCI cap and trade program is January 2012.

Th e membership of the WCI consists of partners who have pledged to par-ticipate in the program of greenhouse gas reductions, and observers who are have not yet committed to participation, but are involved in the meetings and following the developments of the WCI. California is a leading state in the WCI. Th e other states that are members are Arizona, Montana, New Mexico, Oregon, Utah, and Washington. Four Canadian provinces are also partners in the WCI: British Columbia, Manitoba, Ontario, and Quebec. Th e other U.S. states that are observers are Alaska, Colorado, Idaho, Kansas, Nevada, and Wyoming. Canadian provinces now acting as observers are Saskatchewan and the Yukon. Th e Mexican states that border the United States, Baja California, Chihuahua, Coahuila, Nuevo Leone, Sonora, and Tamaulipas, are observers.

48. Id. at XX-3.2.


Th e WCI has progressed in the development of a greenhouse gas regulatory system. On July 27, 2010, the WCI issued a design document 49 for this system. Th e design document resulted from two years of development by the seven U.S. states and four Canadian provinces that make up the WCI. Th e stated emis-sions goal of these states and provinces is to reduce regional GHG emissions to 15 percent below 2005 levels by 2020. 50

Th e stated general goals of the WCI program are:

Creating a market-based system that caps GHG emissions and uses tradable •permits to incent development of renewable and lower-polluting energy sources; Encouraging GHG emissions reductions in industries not covered by the •emissions cap, thus reducing energy costs regionwide; and Advancing policies that expand energy effi ciency programs, reduce vehicle •emissions, encourage energy innovation in high-emitting industries, and help individuals transition to new jobs in the clean-energy economy. 51

Th e WCI cites an economic analysis performed by the “Partner jurisdictions of the WCI” that indicates the WCI Design “can achieve the regional GHG emissions reduction goal and realize a cost savings of approximately US$100 bil-lion by 2020” and “underscores that mitigation of GHG emissions and the move to a clean energy economy is aff ordable, and can be achieved without negatively impacting the regional economy.” 52 Th e WCI concluded that its “eco-nomic analysis underscores that mitigation of GHG emissions and the move to a clean-energy economy is aff ordable, and can be achieved without negatively impacting the regional economy. Th is result is consistent with other recent state and federal analysis of climate mitigation programs.” 53 Th us, these states believe that the program they have designed can accomplish the green-house gas reductions sought, avoid detrimental economic eff ects, and result in economic benefi ts.

49. Western Climate Initiative, Th e Design for the WCI Regional Program ( July 27, 2010), avail-able at http://www.westernclimateinitiative.org/designing-the-program (hereinaft er WCI Design).

50. Id . Design Summary, at 1.

51. Press Release, Western Climate Initiative, Th e WCI Partners Release Th eir Comprehensive Strategy to Address Climate Change and Spur a Clean-Energy Economy ( July 27, 2010) (hereinaf-ter WCI Press Release).

52. Id.

53. Id.

http://www.westernclimateinitiative.org/designing-the-program


a. Regulated Gases GHGs that will be regulated are carbon dioxide, methane, nitrous oxide, hydrofl uorocarbons, perfl uorocarbons, and sulfur hexafl uoride. 54

b. Regulated Sources Th e regulated sources in general will include the following:

Electricity generation, including emissions from electricity generated outside •the WCI jurisdictions (or generated by a federal entity or on tribal lands) delivered into a WCI Partner jurisdiction; Combustion at industrial and commercial facilities; • Industrial process emission sources, including oil and gas process emissions; • Residential, commercial, and industrial fuel combustion at facilities with •emissions below the WCI thresholds, which will be covered upstream of the emissions from use; and Transportation fuel combustion, which again will be covered upstream of the •emissions form use. regulated through imposing the cap and trade program on the distributor of the fuels. 55

Th e last two sets of emissions in the list will be covered upstream of the actual emissions from use. Coverage of these emissions will begin at the start of the second compliance period in 2015. Th e emissions threshold will be 25,000 tons CO 2 e per year.

c. The Cap Emission allowances may be traded within that jurisdiction and the jurisdictions of the other participating jurisdictions — creating a seven state and four province carbon market. 56 Th e total allowances will be reduced over time to achieve the emissions reduction goal. Th e WCI is designed to work by each state or province adopting a cap and trade program through its own legislation or regulations. Each jurisdiction will issue its own allowances, forming the cap for that jurisdiction. Th e initial regional cap will be determined by calculating the best estimate of expected actual emissions for sources regulated during the fi rst year of the program. 57

54. Western Climate Initiative, Design Recommendations for the WCI Regional Cap-and-Trade Program at 1 (2008) (hereinaft er Design Recommendations).

55. Id. at 12-14.

56. WCI Design, Design Summary, at 6.

57. Id. at 4.


For the second compliance period beginning in 2015, the best estimate of transportation fuels, residential, commercial, and industrial fuels, and any other sources included in the coverage of the program for the fi rst time in 2015. 58 For the cap in 2020, the regional cap will be set so that reductions achieved by the sources under the cap plus reductions from uncapped sources will meet the regional goal set for 2020. For the period aft er 2020, the participating juris-dictions will the regional cap at least three years before 2020.

d. Permitting Emissions of Greenhouse Gases As in other programs, a permit would be required for each facility for the GHG emissions allowed initially and then the reductions required over time.

e. Emission Allowances Each jurisdiction will issue allowances under its GHG regulatory program.

f. Allocation of Emission Allowances In order to allocate allowances to each jurisdiction, an annual allowance budget will be determined for each jurisdiction by the WCI that will fi t within the regional cap that will decline from 2012 to 2020. Each allowance budget for each year from 2012 through 2020 will be set prior to the start of the program in 2012.

Within each jurisdiction, the state or province will determine how the allo-cation of allowances will be made to regulated sources. Th e allocation for each year will be provided to the WCI. Th e WCI may determine that allocation to particular sectors of regulated sources should be made in a consistent manner. Th e WCI will particularly consider competitive issues among jurisdictions. Industries that will be considered specifi cally will include “process (non-combustion) emissions where the greatest emission reduction potential is associated with large technology changes and high GHG emission intensity, such as aluminum, steel, cement, lime, pulp and paper, and oil refi ning.” 59

Th e WCI current plan is to have each jurisdiction allocate allowances for the following purposes:

Energy effi ciency and renewable energy incentives and achievement; • Research, development, demonstrations, and deployment (RDD&D) with •particular reference to carbon capture and sequestration (CCS); renewable energy generation, transmission and storage; and energy effi ciency;

58. Id. at 5.

59. Id. at 8.


Promoting emission reductions and sequestration in agriculture, forestry, and •other uncapped sources; and Human and natural community adaptation to climate change impacts. • 60

Th e participants may also consider allocating some of the allowances for these purposes:

Reducing consumer impacts, especially for low-income consumers; • Providing for worker transition and green jobs; • Achieving emission reductions in communities that experience •disproportionate environmental impacts; Supporting community-wide eff orts funded by local governments to reduce •GHG emissions; Providing transition assistance to industries; • Recognizing early actions to reduce emissions; and/or • Promoting economic effi ciency. • 61

Auctions may be conducted by each jurisdiction of allowances. Th e extent of the use of auctions and the percent of allowances each regulated source must purchase to meet their compliance obligations will be determined by each jurisdiction.

g. Trading Allowances Allowances received in the allocation process may be sold freely to other covered facilities or third parties.

h. Banking Allowances Banking will be permitted for allowances.

i. Borrowing Allowances Borrowing of allowanced from future years will not allowed under the WCI.

j. Safety Valve and Competitiveness No safety valve or price controls are currently planned, other than a minimum reserve price for auctions. Th e auction system proposed may reduce prices in quarterly auctions. Allowance reserves may be used to sell into the market at

60. Id. at 7.

61. Id.


lower prices if market prices rise to high levels. 62 Use of allowances from future periods may be sold early to assist in reducing costs regulated parties may have to pay.

k. Off sets Th e WCI will provide for an off set program. Th e use of off sets by regulated parties will be limited to “no more than 49 % of the total emission reductions from 2012–2020.” 63 Off set projects must have commenced aft er January 1, 2007, in order to be eligible for WCI credits. 64 Off sets may be used by covered facilities up to a limit set by the WCI. Th e off sets may be generated through the WCI and other standards approved by the WCI.

Certain types of off sets will be favored by the WCI. Th ese project types are:

Agriculture (soil sequestration and manure management); • Forestry (aff orestation/reforestation, forest management, forest preservation/ •conservation, forest products); and Waste management (landfi ll gas and wastewater management). •

Th e crediting period for nonsequestration WCI off set projects will be ten years. At the end of a crediting period a project proponent may renew a project subject to the current WCI off set protocol for that project type. Renewal of a project at the end of a crediting period will include a reevaluation of a project’s addition-ality and a reevaluation of how the reductions are quantifi ed and verifi ed. Th us, the baseline scenario will be reevaluated at each renewal.

l. Additionality Additionality guidance will be developed by the WCI for the off set program. Th e WCI guidance recommends that “a sector-specifi c or activity-specifi c perfor-mance standard” be developed for “WCI off set protocols based on a regional assessment of project performance or common practice.” 65 Performance stan-dards provide a much more effi cient and predictable means of determining addi-tionality as opposed to the project specifi c analysis that makes it diffi cult for a project developer and its investors to predict if credits will be issued by a stan-dards board. Th e Clean Development Mechanism (CDM) process has proven

62. Id. at 11–12.

63. Design Recommendations at 10–11.

64. Western Climate Initiative, Off set System Essential Elements Final Recommendations Paper 5 ( July 2010).

65. Id. at 10.


how this process may be somewhat unpredictable and changing over time even for project types and methodologies used many times.

m. Supplementarity and Linkage to Other Trading Systems Th e WCI will set a limit on the use of off sets by covered sources of emissions. Th e jurisdictions of the WCI will be linked and trading of allowances and off sets among the jurisdictions will be permitted. Linkage with other non-WCI compliance systems and off set programs will be pursued, but until an agreement is reached with those programs, allowances and off sets from those programs cannot be used to meet compliance obligations under the WCI or its participants. 66

n. Early Action Early action is specifi cally addressed under the current plans for the WCI. Th e early reductions must occur aft er January 1, 2008, and before January 1, 2012. 67 Early action allowances will be reserved for certain parties. In order to qualify for early action credits, the annual averages of absolute emissions and emission intensity must be below the annual averages of absolute emissions and emission intensity for 2005 to 2007. 68 Part of the challenge may be the ability to demon-strate the baseline emissions from 2005 to 2007 and the actual emissions from 2008 to 2012. Some sources may not have measured their emissions in a way that the emissions can be documented.

Th e WCI in June 2010 issued a guidance document on early action credits. 69 Th e reductions must be voluntary, additional, real, verifi able, perma-nent, and enforceable.

Th e early action allowances will be issued in each WCI Partner jurisdiction for reductions occurring prior to the regulatory system going into eff ect. Th ese allowances will be in addition to the allowance budget for each jurisdiction.

A jurisdiction issuing early action allowances to facilities may either identify those it believes have engaged in early reductions or ask them to submit an application, or establish an application program where sources chose to apply for early action allowances. 70

66. Design Recommendations at 14.

67. WCI Design, Detailed Design, at DD-23.

68. Western Climate Initiative, Guidance to Partners for Distributing Early Reduction Allowances ( June 22, 2010).

69. Id.

70. Id . at 1.


o. New or Expanded Facilities Th e allocation system for each jurisdiction must include provisions for allocating allowances for new entrants into the regulatory system, as well as the treatment of sources that shut down. 71

p. Regulatory Agency or Agencies Each participating state or province will assign an agency to oversee the program.

q. Enforcement Th e agencies assigned by each jurisdiction will enforce the program and address situations where covered sources fail to comply with applicable legislation and regulations. Specifi cally, the Detailed Design document provides that each jurisdiction establish in its program enforcement mechanisms that:

Provide general market surveillance, identify suspect transactions, and •provide for investigations and enforcement actions; Ensure consequences for noncompliance are comparable between the systems •to be linked, and in particular that the consequences of failing to meet compliance unit surrender requirements are automatic; Respond in a timely manner to requests by enforcement agencies in the •partner jurisdiction and all jurisdictions approved by the Partner jurisdiction for relevant and necessary information on market participants under investigation; and Transfer between systems in a timely manner relevant and necessary notice •and information concerning all relevant enforcement actions undertaken by the system’s jurisdictional enforcement authority. 72

D. Midwestern Greenhouse Gas Reduction Accord Th e third multi-state program would be established in several midwestern states. Th e U.S. states and one Canadian province that are currently members of the Midwestern Greenhouse Gas Reduction Accord (MGGRA) are Iowa, Illinois, Kansas, Manitoba, Michigan, Minnesota, and Wisconsin. Observers are Indiana, Ohio, Ontario, and South Dakota. Again, gubernatorial elections in 2010 will determine how many states remain as participants in the program.

71. Detailed Design at 28.

72. Id . at DD-45.


Th e purpose of the MGGRA is to reduce GHG emissions in the participat-ing states, and to jointly endeavor to:

1. establish GHG reduction targets and timeframes in the accord that are consistent with those established by the MGGRA member states and provinces; and

2. develop a market-based and multi-sector cap and trade mechanism to help achieve GHG reduction targets; and

3. join the Climate Registry to enable tracking, management, and crediting for entities that reduce GHG emissions; and

4. develop and implement other associated mechanisms and policies as needed to achieve the GHG reduction targets, such as a low-carbon fuel standard and regional incentives and funding mechanisms. 73

Th e advisory group for the MGGRA has developed a model rule and a set of recommendations for the governors to consider. Th e model rule is very similar and follows almost the same format for the subcategories of the RGGI model rule. Th e coverage of the MGGRA as proposed by the advisory group would include the GHGs and sources of GHG emissions similar to the California and WCI programs with a threshold of 25,000 tons per year based on a three-year rolling average. 74

Th e similarities of the form of the MGGRA and RGGI model rule and the coverage of the MGGRA and the WCI being similar may allow the systems to engage in linkage and trading of allowances and off sets across the three multi-state systems. Th e eff orts of the three programs to cooperate and achieve similar goals are discussed below.

E. Cooperation and Potential Linkage among the Multi-State Programs Th e three multi-state greenhouse gas regulatory programs have initiated coopera-tive activities to develop some degree of consistency across the programs. Th e outcome of the model rule of the MGGRA that follows the pattern of the RGGI model rule and the similarity of the coverage to the WCI program reveal growing cooperation among and an attempt to harmonize to a great extent the three programs.

73. Midwestern Greenhouse Gas Reduction Accord 3 (Nov. 15, 2007) (hereinaft er Midwestern Accord).

74. Midwestern Greenhouse Gas Reduction Accord, Model Rule XX-1.4 (April 2010).


Recently, the three groups issued a document on off set quality and the design and implementation of an off set program. 75 Th e paper issued by the multi-state programs contains fairly typical off set criteria. One of the signifi cant aspects of the paper is the discussion of the alternative to project-level analysis of additionality and the use of a standard approach, discussed above under the WCI program, for project types. Th e paper identifi es two types of standard approaches:

A benchmark is a qualitative eligibility criterion for a category of projects •that ensures that a project is unlikely to occur under standard market practice. A benchmark could include a technology or practice standard and could also be a qualitative market evaluation criterion; for example, a criterion that addresses the stacking of multiple project incentives based on typical project economics for a category of projects, considering other available noncarbon economic incentives. A performance standard is a quantitative eligibility criterion that establishes a •metric for determining if categories of projects are unlikely to occur under standard market practice. Th e criterion is usually established in relation to the performance level achieved through standard market practice for the category of activities eligible under a certain off set category. Projects that meet or surpass the standard qualify as additional. Examples of performance standards include:

Emission rate; • Energy effi ciency criteria; and • Market penetration rate. • 76

Th e paper explains this standardized process as follows:

It should be noted that this process is more straightforward than a project-by-project analysis of fi nancial additionality, as it involves evaluating actual market practices and project economics in a defi ned market, based on projects that have already occurred and evidenced trends, rather than a counterfactual assessment of future alternative project-level investments. It also reduces transaction costs for project proponents, as

75. Regional Greenhouse Gas Initiative, Midwestern Greenhouse Gas Reduction Accord, and Western Climate Initiative, Ensuring Off set Quality: Design and Implementation Criteria for a High-Quality Off set Program (May 2010).

76. Id. at 19–20.


they do not need to conduct such an analysis to support the development of project-specifi c evaluation assumptions. 77

* * * If a project exceeds standard market practice, it is assumed to be fi nancially additional and is assumed to be implemented in response to the fi nancial incentive provided through the receipt of off set compliance units that have a market value. 78

Th e use of benchmarks and performance standards for additionality has the potential to greatly increase the effi ciency of review and approval decisions of application for off set projects. Th ese standards would create more certainty in the off set process and allow developers a better chance of obtaining investment or investment under better terms than using the project-by-project approach. Th e use of such standards may enhance the ability of project developers to use forward sales, discussed in a later chapter, to help fi nance greenhouse gas reduction projects designed to capture carbon credits and, thereby, to monetize the reductions.

Th e cooperative eff ort of the three multi-state programs may lead to a link-age between the programs and trading of off sets between the programs and the respective participating states and provinces. Such a result would produce a signifi cant North American carbon credit market. Elections in 2010 may result in some states pulling out of the programs. Th us, the future of these programs or at least participation by all of the states and thereby the size of the market is uncertain.

77. Id. at 19 n. 12.

78. Id. at 19 n. 13.

9

Developing United States Law — The Courts

From the U.S. Supreme Court opinion in Massachusetts v. EPA 1 :

A well-documented rise in global temperatures has coincided with a signifi cant increase in the concentration of carbon dioxide in the atmosphere. Respected scientists believe the two trends are related. For when carbon dioxide is released into the atmosphere, it acts like the ceiling of a greenhouse, trapping solar energy and retarding the escape of refl ected heat. It is therefore a species — the most important species — of a “greenhouse gas.” 2

In sum — at least according to petitioners’ uncontested affi davits — the rise in sea levels associated with global warming has already harmed and will continue to harm Massachusetts. Th e risk of catastrophic harm, though remote, is nevertheless real. Th at risk would be reduced to some extent if petitioners received the relief they seek. We therefore hold that petitioners have standing to challenge the EPA’s denial of their rulemaking petition. 3

Because greenhouse gases fi t well within the Clean Air Act’s capacious defi nition of “air pollutant,” we hold that EPA has the statutory authority to regulate the emission of such gases from new motor vehicles. 4

1. 549 U.S. 497 (2007).

2. Id. at 504.

3. Id . at 526.

4. Id. at 532.


Under the clear terms of the Clean Air Act, EPA can avoid taking further action only if it determines that greenhouse gases do not contribute to climate change or if it provides some reasonable explanation as to why it cannot or will not exercise its discretion to determine whether they do. To the extent that this constrains agency discretion to pursue other priorities of the Administrator or the President, this is the congressional design. 5

U.S. laws relating to climate change and greenhouse gases have evolved dramati-cally from 2007 to the present. In this period, the courts have played a signifi cant role in the evolution of climate change law. Th e courts have become a forum for states and environmental groups to attempt to impose restrictions through permits under state and federal statutes or to seek to have a court determine the level of reductions that signifi cant emission sources must achieve under the public nuisance doctrine or other tort theories. In addition, plaintiff s have sued greenhouse gas emitters, asserting they are liable for damages allegedly caused by climate change.

A. Federal Statutory Litigation 1. The U.S. Supreme Court Landmark Decision in Massachusetts v. EPA In a landmark case issued on April 2, 2007, from which the quotations above are taken, the U.S. Supreme Court ruled in Massachusetts v. EPA 6 that the U.S. Environmental Protection Agency (EPA) acted in contravention of the federal Clean Air Act in deciding not to regulate greenhouse gas emissions from auto-mobiles. In remanding the decision back to the EPA, the Court waded into a controversy that Congress and the Executive Branch were battling at the time, with numerous bills fi led in Congress and the President expressing his opposition to mandatory limits on greenhouse gas emissions. In a sharply divided opinion, the majority voted 5 to 4 that Congress had provided the Court the power to review EPA decisions regarding greenhouse gas regulation of automobiles and that a causal link existed between the greenhouse gas emissions from new auto-mobiles and the rise in sea levels that the Court concluded was harming and threatened to continue to harm the State of Massachusetts. 7

5. Id. at 533.

6. 549 U.S. 497 (2007).

7. See supra notes 1–4.

DEVELOP ING UNITED STATES LAW—THE COURTS | 101

Th e implications of this case were and continue to be signifi cant, and allowed the EPA under the Obama administration to begin developing regula-tions under the Clean Air Act to regulate greenhouse gas emissions at the federal level, even if Congress did not pass climate change legislation. On the general policy front, the U.S. Supreme Court recognized not only that climate change was occurring, but that human emissions from greenhouse gases were a major cause of climate change. Moreover, it concluded that the EPA and the Bush administration in power at the time did not contest the impact of anthropogenic emissions greenhouse gases on the Earth’s climate.

Th is decision gave substantial recognition at legal level from the highest court in the country to the conclusions discussed in Chapter 1 of the fi ndings of the National Academies of Science and the American Association for the Advancement of Science, as well as other governmental entities, on of the most important being the National Oceanic and Atmospheric Administration.

With respect to future legislation, the decision and the subsequent change in presidential administrations created the basis for the EPA to put pressure on Congress to pass a climate change bill, and aff ected industries to engage their lobbyists to address the issues and to seek a legislative alternative to the EPA rulemaking that industry general perceived would be much more strict than a statute that Congress may pass. 8

2. Background — How Did the Matter Reach the U.S. Supreme Court? Th e origins of the decision by the EPA not to regulate greenhouse gas emissions provides an interesting review of a process largely ignored in rulemaking — the process of petitioning a government agency for the promulgation of new regula-tions. Th e controversy, or dispute in this case, began on October 20, 1999, when a group of nineteen private, nongovernmental organizations fi led a petition with the EPA for a rule under the Clean Air Act to require automobile manufacturers to control the emissions of greenhouse gases from new automobiles.

Th ese organizations sought promulgation of a new rule under Section 202(a)(1) of the Clean Air Act that provides the EPA administrator shall regu-late “the emission of any air pollutant from any class or classes of new motor vehicles or new motor vehicle engines, which in his judgment cause, or contribute

8. Letter from the U.S. Chamber of Commerce to Senator Barbara Boxer, Chairman, and Senator James Inhofe, Ranking Member, Senator Committee on Environment and Public Works, dated November 3, 2009, advocating a climate bill be passed by Congress to avoid the EPA regulating greenhouse gas emissions.


to, air pollution which may reasonably be anticipated to endanger public health or welfare . . .” 9

Th e term “air pollutant” is defi ned under the Clean Air Act as “any air pol-lutant agent or combination of such agents, including any physical, chemical, biological, radioactive . . . substances or matter which is emitted into or otherwise enters the ambient air.” 10 “Welfare” is defi ned as “among other things . . . weather . . . and climate.” 11

Th e EPA requested public comment on the issue and received over 50,000 comments over a fi ve-month period. 12 Aft er the comment period closed, the EPA decided not to regulate greenhouse gases emitted from automobiles under Section 202(a)(1).

3. Standing — Could the Court Hear the Matter When the Emissions and Eff ects of Climate Change Are Global and Infl uenced by Emissions from Other Countries? Th e global nature of the eff ect of greenhouse gas emissions on global warming and climate change placed the issue of standing directly before the Court, and presented a potential major legal obstacle for the State of Massachusetts and the other petitioners in the case to convince the Court that it should hear this issue at all. Th e question was whether the plaintiff could show that the harm it sought to remedy would be directly and causally related to the greenhouse gas emissions from vehicles that could be reduced if the EPA had acted to regulate them.

In demonstrating one has standing to challenge an administrative agency decision, it is necessary to show an injury, causation, and redressability — the abil-ity of the court to remedy the injury of the plaintiff . Otherwise, a court cannot eff ectively address the plaintiff ’s complaint or injury, and to hear the case would be of no avail and would waste scarce judicial time and resources. 13

In considering the issue of standing, the Court concluded that states have special role and, therefore, face a reduced level of scrutiny in establishing standing in the federal courts. Th e Court, looking back to an opinion from 1907, Georgia v. Tennessee Copper Co. , 14 concluded that states have a special interest in cases that

9. 42 U. S. C. § 7521(a)(1).

10. Id. at § 7602(g).

11. Id. at § 7602(h).

12. Mass. v. EPA, 547 U.S. at 511(citing 68 Fed. Reg. 52,924 (2008)).

13. Id. at 517–18.

14. 206 U.S. 230 (1907).


involve a “quasi-sovereign” power, “[in] that capacity the State has an interest independent of and behind the titles of its citizens, in all the earth and air within its domain.” 15 In the 1907 case, Georgia sued Tennessee Copper Company for its emissions from its copper smelting operations that were having a devastating eff ect from sulfur dioxide air pollution on the surrounding land and forests. Th e Court in Massachusetts v. EPA concluded that Massachusetts, similar to Georgia’s right to protect its land and air, had special standing to protect the lands within its borders from rising sea levels that the Court concluded were occurring as a result of global warming. 16

In addition, Justice Stephen Breyer, who wrote the opinion, pointed out that a party to whom Congress has provided a procedural right can assert that right without meeting all the normal standards for redressability and immedia-cy. 17 In this instance, the Court ruled that Congress had aff orded the right to challenge in court a decision by the EPA whether to regulate pollution from vehicles.

In deciding that Massachusetts in fact had standing to challenge the EPA’s decision on regulating greenhouse gas emissions, the Court relied upon the evidence it had been presented in terms of scientifi c reports and affi davits fi led by the petitioners. Th e Court concluded that Massachusetts owns coastal lands that are currently being swallowed — and are predicted to be more so in the future — by rising sea levels.

One of the more fascinating debates between the majority and the dissent-ing Justices in an opinion authored by Chief Justice John Roberts and Justice Antonin Scalia was whether the reduction of greenhouse gases from U.S. vehicles would in fact reduce any fl ooding of coastal land owned by the State of Massachusetts, if China and India continued to increase their emissions. Th e majority concluded that, regardless of the emissions from China and India, any signifi cant reduction in greenhouse gas emissions would reduce coastal fl ood-ing — in essence identifying, apparently, an almost linear relationship between emissions and the harm caused. 18 Th e majority opinion concluded that it was suffi cient to establish a proportional reduction in greenhouse gas emissions and, therefore, a proportional reduction in climate change and its related harm on Massachusetts’ shoreline. 19

15. Mass. v. EPA, 547 U.S at 537, quoting Georgia v. Tennessee Copper Co. , 206 U.S. 230, 237 (1907).

16. Id . at 519.

17. Id. at 517–21.

18. Id . at 523–24, 545–46.

19. Id . at 524–27.


4. The Merits of the Case — Does the EPA Have the Authority to Regulate, and, If So, the Ability to Defer Regulation of Greenhouse Gases under the Clean Air Act? Having decided that Massachusetts has the right to challenge the EPA’s decision to not regulate greenhouse gas emissions, the Court then turned to a review of the basis of the EPA’s decision not to regulate greenhouse gas emissions. As stated above, the EPA had refused to promulgate limits on greenhouse gas emis-sions from vehicles aft er receiving a petition from private parties requesting that the EPA act to limit such emissions. In reviewing this decision, the Court applied the “arbitrary and capricious standard.” Th is standard of review under the Clean Air Act provides that the Court “may reverse any such actions found to be . . . arbitrary, capricious, an abuse of discretion, or otherwise not in accor-dance with the law.” 20

Th e provision at issue in this case involved the EPA’s role in regulating pollution from vehicles. Th e Clean Air Act states in Section 202(a)(1) that the EPA “shall by regulation prescribe . . . standards applicable to the emission of any air pollutant from any class or classes of new motor vehicles or new motor vehicle engines, which in the [Administrator’s] judgment cause, or contribute to, air pollution which may be reasonably anticipated to endanger pubic health or welfare.” 21

As stated above, the EPA’s logic in its decision not to regulate greenhouse gases was fi rst that greenhouse gases do not fi t within the defi nition of an “air pollutant” under the Clean Air Act. To the contrary, the Court interpreted the defi nition of air pollutant to include any air pollution agent, and that any physical or chemical substance emitted into the ambient air could be considered an air pollutant. 22 Th e defi nition was deemed broad enough to include carbon dioxide and other greenhouse gases that cause global warming. 23 Th e EPA also stated in its explanation for its decision that even if it could regulate greenhouse gas emissions, it would not be appropriate to do so for two reasons. First, the President had decided to use voluntary standards to accomplish the reduction of

20. 42 U.S.C. § 7607(d)(9)(A).

21. Id. § 7521(a)(1).

22. Mass. v. EPA, 549 U.S. at 528–29.

23. Id . at 529.


greenhouse gases. 24 Second, the issuance of regulations by the EPA would detract from the President’s negotiations with developing nations to reduce their greenhouse gas emissions. 25 Th e Court ruled that the EPA’s explanation did not constitute a reasoned basis for refusing to form a scientifi c judgment on the question of whether greenhouse gas emissions contribute to climate change. It further ruled that the EPA cannot avoid its statutory duty to reach a decision whether greenhouse gases cause global warming based on scientifi c uncertainties about certain aspects of climate change. “If the scientifi c uncertainty is so pro-found that it precludes EPA from making a reasoned judgment, it must say so.” 26 Th e court ruled that the EPA’s action was “arbitrary, capricious, or otherwise not in accordance with law.” 27

In developing its opinion, the majority of the Court appeared to be infl u-enced by certain EPA decisions. One of the primary issues aff ecting the decision was that historically the EPA, under a previous President, had concluded that it in fact did have the authority under the Clean Air Act to regulate greenhouse gases. 28 Th e other issue was the fact that the EPA and the President have taken the position that greenhouse gases and climate change were serious issues, but voluntary measures should be taken to reduce these emissions. 29 Th e fact that the EPA and the White House acknowledged the human contribution to global warming and the need to take action, albeit voluntary, appeared to inform the Court’s decision that there was a suffi cient causal link between greenhouse gas emissions and the harm currently being caused by global warming and future predicted harm.

Ultimately, the Court reversed the court of appeals decision upholding the EPA decision not to regulate emissions from vehicles, and remanded the case to the lower court for further proceedings consistent with its decision regarding the EPA’s power under the statute and the requirement that the EPA provide a “reasoned explanation for its refusal to decide whether greenhouse gases cause or contribute to climate change.” 30 Th e result of the Court’s decision was that the EPA did not necessarily have to decide to regulate greenhouse gas emissions

24. Id . at 533.

25. Id. at 533–34.

26. Id. 549 U.S. at 536.

27. Id .

28. Id . at 521.

29. Id. at 526.

30. Id . at 535.


from vehicles, but it was required reconsider its decision and base it on the legislative requirements set forth in the Clean Air Act.

5. Implications of the Court’s Decision — Regulation under the Clean Air Act and Other Federal Statutes, Corporate Environmental Disclosure, and Litigation Alleging Climate-Related Damages Supreme Court decisions in landmark cases like Massachusetts v. EPA oft en have implications that range far beyond the specifi c issues decided by the Court. Th e potential implications of the case included the following.

a. Symbolic or Political Signifi cance Th e symbolic or political signifi cance of the case derives from the ruling of the highest court in the United States that “the harms associated with climate change are serious and well recognized.” 31 Th e Court further agreed with Massachusetts that “[a] reduction in domestic emissions would slow the pace of global emissions increases, no matter what else happens.” 32 Such a ruling of cause and eff ect by the U.S. Supreme Court may signifi cantly increase public support for congressional action to regulate greenhouse gas emissions and embolden members of Congress to enact climate change legislation. Once a Democratic president was elected fol-lowing this decision, it certainly emboldened the EPA to begin issuing green house gas regulations under the Clean Air Act with the full legal cover of the U.S. Supreme Court. Even the dissenting opinions gave cover to the EPA, as for example, the Chief Justice chided the majority for stepping into this area that he believed should have been left for the other political branches of government to resolve. 33 Th at is in fact what the EPA has done under the Obama administra-tion, reached decisions under the Act regarding the endangerment of human health and the environment and begun to develop regulations to address those stated harms by controlling greenhouse gas emissions in the U.S. economy.

b. Greenhouse Gases Are Air Pollutants and the EPA Has the Authority to Regulate Them Th e Court’s ruling that greenhouse gases are “air pollutants” under the Clean Air Act, and the narrow room left to the EPA not to regulate the emissions of these gases from automobiles, puts the matter squarely in the EPA’s hands to decide how it will address greenhouse gases. With the historical objection of the

31. Id. at 521.

32. Id. at 526.

33. Id. at 535.


Bush administration to mandatory restrictions on greenhouse gases and the multitude of greenhouse gas bills reviewed by Congress, the Bush administration delayed addressing the issue of an “endangerment fi nding” before the George W. Bush presidential term was up — leaving the issue to the next president. Th e Bush administration EPA did issue a Notice of Advance Rulemaking, as will be discussed below.

Upon appointment of its new Administrator of the EPA by President Barack Obama, the EPA began pursuing an endangerment fi nding and taking other steps to regulate not only vehicles, but other sources of greenhouse gas emissions. Th ese regulatory developments will be discussed in Chapter 10.

c. Eff ect on Other Vehicle-Related Greenhouse Gas Lawsuits California, Vermont, and Rhode Island enacted their own limitations on vehicle emissions and these regulations were challenged by automakers. Th e cases were stayed pending the decision in Massachusetts v. EPA . Based on the Court’s ruling, the challenges to the states’ greenhouse gas limits on cars faces an uphill battle, and had little chance to succeed.

d. Eff ect on Challenges to the EPA’s Decision Not to Regulate Greenhouse Gases from Power Plants In addition to the challenge of the EPA’s decision not to regulate greenhouse gas emissions, ten states, including Massachusetts, three environmental groups, and two cities, at the time of the issuance of the opinion in Massachusetts v. EPA , had sued the EPA for its refusal to regulate emissions from certain utility and industrial power plants in its promulgation of New Source Performance Standards under the Clean Air Act. 34 In that case as well, the EPA determined it did not have the authority to regulate greenhouse gas emissions under the Clean Air Act. It would appear likely the Supreme Court would not agree with the EPA on that issue. Once the presidential election occurred, the EPA proceeded down the path of regulating these sources as well.

e. Eff ect on Cases Filed under the National Environmental Policy Act, Challenging Governmental Action That Causes or Leads to Greenhouse Gas Emissions Several lawsuits had been fi led under the National Environmental Policy Act (NEPA) against federal agencies for approving or funding projects in the United

34. Coke Oven Environmental Task Force v. EPA, No. 06-1131 (D.C. Cir. fi led Apr. 7, 2006).


States and in foreign countries that emit greenhouse gases. 35 Th ese cases were aff ected by the Supreme Court’s decision in Massachusetts v. EPA . Th e plaintiff s were able to argue that the causation issue has been resolved by the Supreme Court, and that regulation of greenhouse gases is required by federal statutes. Th us, the case certainly raised new opportunities for concerned citizens or neighbors to fi ght projects in their backyard or overseas, asserting that projects that release greenhouse gases must be reviewed under NEPA.

f. Eff ect on Tort Suits Filed by Individuals Claiming Damages from Greenhouse Gas Emissions A variety of tort suits have been fi led claiming that the emissions of greenhouse gases have resulted in climate change that has damaged the plaintiff s in those cases. For example, in a case known as Comer v. Murphy Oil , 36 fi led in Mississippi by Hurricane Katrina victims against defendant classes of oil, coal, chemical, and insurance companies, the plaintiff s claim that the emissions contributed to the force of Hurricane Katrina. In another case, eight states, the City of New York, and three land trusts have sued the utilities that are the fi ve largest carbon dioxide emitters in the United States. 37 Th e plaintiff s assert that the emissions of green-house gases constitute a nuisance. Th e perceived challenge in these cases is one of causation, which was a central issue in the dissenting opinions of Massachusetts v. EPA . Th e question is: How do you connect emissions from specifi c sources into a global atmosphere to global warming, and then further establish that injuries alleged by specifi c plaintiff s are linked to the incremental global warming caused by those sources? Despite this proof problem, plaintiff s’ attorneys have appar-ently been considering the future opportunities in this area for some time. Th ese attorneys may see the decision on standing in the Supreme Court’s climate change opinion in Massachusetts v. EPA to open the door to arguing that parties emitting greenhouse gas emissions are causing global warming and thereby damaging their clients. As will be discussed later in this chapter, the case did lead to an opening for plaintiff s in climate change tort cases and federal common law

35. Center for Biological Diversity v. NHTA, No. 06-71891 (9th Cir. fi led Apr. 12, 2006) (suit challenging failure to consider impacts of 2006 CAFÉ standards on global warming under NEPA); Friends of the Earth v. Mosbacher, 2005 WL 2035596 (N.D. Cal. Aug. 23, 2005); Mayo Foundation v. Surface Transportation Board, No. 06-2031 (8th Cir. fi led Apr. 14, 2006); Natural Resources Defense Council v. Reclamation Board, No. 06CS01228 (California Superior Court of Sacramento County, fi led Aug. 18, 2006) (challenging California Reclamation Board for approval of a develop-ment project without considering the potential impacts of rising seal levels caused by global warming under the California Environmental Quality Act).

36. 2006 WL 1066645 (S.D. Miss. 2006).

37. Connecticut v. American Electric Power, 406 F.Supp.2d 265 (S.D.N.Y. 2005).


nuisance cases to overcome challenges of standing and political questions and the resulting dismissal of their claims.

g. Broadening Standing for States to Challenge Federal Administrative Agency Action Th e majority in Massachusetts v. EPA adopted a new view of standing for the ability of states to challenge federal administrative action. Responding to this standing analysis, Chief Justice Roberts scathingly criticized the majority’s view in his dissent, joined by Justices Scalia, Samuel Alito, and Clarence Th omas, as exceeding any previous Supreme Court opinions. Th e degree to which this reduced standard for state standing will thrive and prosper is unclear. To the extent the notion of a reduced standard for state standing develops in future Supreme Court cases, it could lead to a new level of state power in our federal system.

B. State Statutory Litigation At the state level, cases have been fi led to impose controls under state air pollu-tion states. An example is a case fi led in 2009 in Texas, which is the largest green-house gas–emitting state in the United States and, if Texas were a country, would be the seventh largest greenhouse gas emitter in the world. In the Texas case, Public Citizen, Inc., a citizens group, or NGO, fi led a lawsuit against the Texas Commission on Environmental Quality (TCEQ) alleging that the agency had violated the Texas Clean Air Act by not regulating CO 2 from permitted sources. 38 Th e suit seeks to require the TCEQ to impose CO 2 emission limits on several proposed coal-fi red power plants whose proponents were seeking permits to construct. Th e case is apparently modeled aft er the Massachusetts v. EPA case, but bases its claims on the Texas Clean Air Act rather than the federal Clean Air Act.

C. Federal Common Law Litigation to Impose Emission Reductions on Greenhouse Gas Emitters In a case that opened the door for litigation to impose court-based emission reductions on industry, the U.S. Court of Appeals for the Second Circuit issued an opinion in State of Connecticut, et al. v. American Electric Power Company Inc.,

38. No. D-1-GN-09-003426 (Dist. Ct., Travis County, Tex. Filed Oct. 6, 2009).


et al. ( Connecticut v. AEP ) 39 that allows eight states, New York City, and three land trusts to continue nuisance claims against fi ve electrical power companies, including American Electric Power Company Inc. Th e district court had dis-missed the case, concluding that setting emission caps was “an undertaking for the political branches, which were charged with the identifi cation and balancing of economic, environmental, foreign policy, and national security interests.” 40 Th e Second Circuit concluded that the plaintiff s did not bring a claim that constitutes a political question, but rather had simply presented a claim of common law nuisance that “does not establish a national or international emissions policy.” 41

A substantial portion of the Second Circuit’s opinion was devoted to whether the plaintiff s had standing to bring their claims of nuisance. Th e court ultimately concluded that they had standing because they had alleged an injury in fact, presented a causal connection between the injury and the conduct complained of, and established that their injury will likely be redressed by a favorable decision. 42

In terms of redressability, the Second Circuit compared the prospect of the plaintiff ’s request that the utilities reduce their carbon dioxide emissions to the prospect of reducing motor vehicle emissions (considered by the Supreme Court in Massachusetts v. EPA 43 ) for support of its conclusion that the plaintiff s’ injury was redressable. In doing so, the Second Circuit cited the Supreme Court’s reasoning in Massachusetts v. EPA that although “regulation of motor vehicle emissions would not by itself reverse global warming, . . . it was suffi cient for the redressability inquiry to show that the requested remedy would slow or reduce it.” 44

Th e utilities also argued that the plaintiff s’ claims were displaced by federal statutes. Th e court acknowledged that the EPA may have statutory authority under the Clean Air Act to regulate greenhouse gas emissions, but determined that the EPA had not yet done so at the time with respect to stationary sources (as opposed to mobile sources, for which the EPA has already proposed an

39. 582 F.3d 309 (2d Cir. 2009).

40. Id. at 320 (internal quotation marks omitted).

41. Id. at 325 (emphasis in original).

42. Id. at 346–49.

43. 549 U.S. 497 (2007).

44. Conn. v. AEP, 582 F.3d at 348 (quoting Mass. v. EPA 549 U.S. at 525).


endangerment fi nding, a preliminary step to regulation of greenhouse gases from these sources). 45

Th e case has been appealed to the U.S. Supreme Court. Interestingly, the Obama administration has fi led a brief with the court arguing that the public nuisance action is prohibited because the EPA has now issued regulations gov-erning greenhouse gas emissions from stationary sources. 46 Th e federal defendant, the Tennessee Valley Authority, a federal entity that operates coal-fi red power plants, is represented by the solicitor general that asked the Supreme Court to vacate the Second Circuit’s opinion and to remand it for consideration as to whether “prudential” standing considerations would argue for the court to withhold entering the issue, and whether the EPA’s regulations would displace the court’s power to consider addressing greenhouse gas emissions through a public nuisance claim.

D. State and Federal Common Law Litigation to Obtain Damages from Greenhouse Gas Emitters In 2009, the U.S. Court of Appeals for the Fift h Circuit, Comer v. Murphy Oil , found that residents and owners of land and property along the Mississippi Gulf Coast have standing to pursue their public and private nuisance public and private nuisance, trespass, and negligence claims and that these claims do not present nonjusticiable political questions. 47 Th e plaintiff s sought monetary dam-ages for destruction of both private property and public property useful to them due to rising sea levels and to the increased ferocity of Hurricane Katrina, which they claimed defendants contributed to through their greenhouse gas emission.

To arrive at its decision, the Fift h Circuit cited the Supreme Court’s holding in Massachusetts v. EPA , 48 which alluded to the existence both of a causal link between man-made greenhouse gas emissions and global warming, and between a warmer climate and rising ocean temperatures with the strength of hurricanes. Regarding the traceability test for purposes of standing, the court acknowledged that plaintiff s must show only that “injuries may be fairly traceable to actions that

45. Id. at 379.

46. Gabriel Nelson, Obama Admin. Urges Supreme Court to Vacate Greenhouse Gas “Nuisance” Ruling , N.Y. Times, Aug. 25, 2010.

47. 585 F.3d 855 (5th Cir. 2009).

48. 549 U.S. 497 (2007).


contribute to, rather than solely or materially cause, greenhouse gas emissions and global warming.” 49

Th e Fift h Circuit also ruled that the claims do not present political ques-tions. Th e common law tort claims of nuisance, trespass, and negligence were determined to be justiciable because “they have plainly not been committed by the Constitution or federal laws or regulations to Congress or the President.” 50

Th is case took an interesting turn, when the matter was appealed to the full court of judges rather than the panel of three judges who issued the decision discussed above. Numerous judges recused themselves and a quorum of the full court was not available. Th e court decided the case could not be heard and denied the appeal and let the lower court ruling stand, eff ectively reversing the panel decision discussed above. 51 A judge dissenting with the decision to take this approach wrote, “[F]ederal courts lack the authority to abstain from the exercise of jurisdiction that has been conferred.” 52 Th e procedural twists this case went through create a result without an eff ective appeal. Th e appeal of the case to the Supreme Court may occur, and it may be years before the procedural and substantive issues are resolved.

In another case, the Village of Kivilina, Alaska has sued eighteen energy companies, alleging that greenhouse gas emissions led to climate change that has melted ice around their village and causing the inhabitants of the village to have to move. Th e federal district court dismissed the cause of action, concluding that the plaintiff s’ claims presented nonjusticiable political questions and the plaintiff s did not have standing, because their harm was not fairly traceable to the defendants’ conduct. 53 Th e case has been appealed to the Ninth Circuit Court of Appeals.

Questions of causation still would appear to present signifi cant barriers to recovery against individual defendants in cases like Comer v. Murphy Oil . Th e links between individual corporate emissions to climate change, that climate change to increased hurricanes, and those increased hurricane strength to particular damages would appear to be tremendous causal hurdles for plaintiff s’

49. 585 F.3d at 866.

50. 585 F.3d at 870.

51. Comer v. Murphy Oil USA, 607 F.3d 1049 (5th Cir. 2010).

52. Id. at 872, quoting New Orleans Pub. Serv., Inc. v. Council of the City of New Orleans , 491 U.S. 350, 358, 109 S. Ct. 2506, 105 L. Ed. 2d 298 (1989) (quoting Cohens v. Virginia , 19 U.S. 264, 404, 5 L. Ed. 257 (1821)), and United States v. Will, 449 U.S. 200, 215, 101 S. Ct. 471, 66 L. Ed. 2d 392 (1980).

53. Native Village of Kivalina v. ExxonMobil Corporation, 663 F.Supp.2d 863 (2009).


attorneys and the experts they may hire to pursue these cases. It would also appear that in taking into account all of the other global emissions from indus-trial, deforestation, farming, electrical generation, transportation, and other sources would make the percentage each defendant would pay somewhat diffi cult to prove and, if proved, potentially very small.

10

Developing United States Law — The Environmental Protection Agency

As will be discussed in Chapter 11, the U.S. House of Representatives passed a climate bill, but no action was taken in the Senate. Even before it was clear Congress was not going to pass a climate bill in 2010, the EPA under the Obama administration took action to regulate greenhouse gas emissions. Th us, even without congressional action, a federal greenhouse gas (GHG) reduction program is being pursued by the EPA.

Th e regulatory program can be divided into two parts. Th e fi rst GHG program adopted consists of a monitoring and reporting regulatory system for GHG emissions. Th e second step taken was the issuance of decisions and regulations that form an actual federal regulatory system designed to require emission sources to reduce their GHG emissions. Th e EPA took this action under the Clean Air Act (CAA) following the decision to allow GHG regulation under the CAA by the Supreme Court in Massachusetts v. EPA in 2007, discussed in Chapter 9. Th e issuance of regulations to control GHG emissions was predicated on the election of a president in 2008 who would urge the EPA to move forward with issuance of GHG regulations. Th ese two events have led to the promulga-tion of a climate change program in the United States. Th e system as adopted by the EPA, however, does not allow a market for trading emissions credits, but is a traditional command and control system that requires reductions through site-specifi c determinations of the best technology to control emissions at that source. It is not clear that if Congress does not take action during the

DEVELOPING UNITED STATES LAW—THE ENVIRONMENTAL PROTECTION AGENCY | 115

current presidential administration, whether the EPA will attempt to adopt a cap and trade program under the CAA for GHG emissions.

Th e current system adopted by the EPA is of course not without contro-versy. Objections to the EPA action are numerous. Legal challenges to the EPA’s decisions and regulations have been fi led by industry groups, business associations, congressmen, states, and other plaintiff s. Th e lawsuits seek a stay of the regulations and ultimately a judicial decision striking down or ordering changes in the regulations adopted by the EPA.

Th is chapter will provide a summary of the regulations adopted by the EPA and the lawsuits fi led by various interest groups challenging their adoption.

A. Federal Greenhouse Gas Reporting Program Under the Obama administration, the fi rst step by the EPA in regulating GHGs was the development of the reporting rule. On September 22, 2009, the EPA issued its fi nal greenhouse gas monitoring and reporting rule that requires approximately 10,000 facilities in the United States to measure their greenhouse gas emissions and start reporting them in early 2011 (Greenhouse Gas Reporting Rule). 1 A congressional amendment to the Omnibus Spending Bill in December of 2007 appropriated funds and required the EPA to issue a proposed rule by September 2008, and a fi nal rule by June 2009. 2 While the EPA had authority under that appropriations bill to promulgate the Greenhouse Gas Reporting Rule, it took the position that it had the power to issue the regulations requiring the reporting of greenhouse gas emissions under the existing Clean Air Act.

Th e EPA relied upon Sections 114 and 208 of the CAA on the basis that these provisions allow the EPA to require that the information be gathered and reported as the information is relevant to the EPA’s regulatory activity under various provisions of the CAA. 3 Th e EPA relied upon Section 114 for sources of emissions from stationary sources, and Section 208 for mobile sources such as vehicles, boats, and aircraft .

Some industry groups asked the EPA for a delay until 2011 to start monitoring and until 2012 to start reporting their greenhouse gas emissions,

1. Mandatory Reporting of Greenhouse Gases; Final Rule, EPA, 74 Fed. Reg. 56,260 (Oct. 30, 2009) (hereinaft er Greenhouse Gas Reporting Rule).

2. Consolidated Appropriations Act, 2008, R.R. 2764, Public Law 110–161, 121-Stat. 2128 (Dec. 26, 2007).

3. Greenhouse Gas Reporting Rule, 74 Fed. Reg. at 56,264–65.


but the EPA chose not to delay implementation of the rule. 4 Regulated facilities had only two and one-half months to prepare for the monitoring that they were required to begin January 1, 2010. Th is imposed certain challenges for many companies that were required to install or modify continuous emission monitors or that have numerous facilities that are regulated. However, the EPA allowed regulated parties to use “best available monitoring methods” for param-eters that “cannot be reasonably measured” under the relevant sections of the rule for the regulated source until March 31, 2010, and the ability to request an extension until December 31, 2010. 5

Under the Greenhouse Gas Reporting Rule, the EPA has adopted a substantial program of greenhouse gas monitoring and reporting with a publicly available registry. Th e program is “economy wide” and covers 85 percent or more of greenhouse gas emissions in the United States. 6 Th e EPA is in part imple-menting the Greenhouse Gas Reporting Rule to gather information for future regulatory and policy decisions. Th us, many of those sources that will be required to report under the Greenhouse Gas Reporting Rule may be regulated under a federal greenhouse gas system developed under the Clean Air Act following the Massachusetts v. EPA decision issued by the Supreme Court, or if Congress passes a climate bill at some point in the future.

While the Greenhouse Gas Reporting Rule does not impose any reduction obligations, prior “reporting only” rules, such as the Toxic Release Reporting of SARA Title III, 7 have shown that companies reporting emissions “manage what they measure.” In other words, once companies are required to publicly report their emissions, they generally begin to identify ways to reduce those emissions. 8

As stated above, the monitoring of greenhouse gas monitoring began on January 1, 2010. Th e fi rst reports are required to be submitted to the EPA by March 31, 2011, and annually thereaft er.

Th e EPA has issued subsequent changes to its rules and proposed adding GHG reporting requirements to other sources of emissions.

4. Id . at 56,273–74.

5. Id . at 56,274.

6. Id. at 56,264.

7. 42 U.S.C. §§ 11001–50 (known as the Emergency Planning and Community Right-to-Know Act, or Title III of the Superfund Amendments and Reauthorization Act of 1986).

8. A survey of companies in certain regulated industries published in a 1994 report found that 94 percent of their facilities reduced or eliminated hazardous wastes, reportable releases to the envi-ronment, or stored chemicals. S. Santos, V. Covello, D. McCallum, & E. David, “Industry Response to SARA Title III: Pollution Prevention, Risk Reduction and Risk Communication,” at 3 (May 1994).


1. What Gases Are Covered? Th e EPA has identifi ed the traditional greenhouse gases for reporting: carbon dioxide (CO 2 ), methane, nitrous oxide, sulfur hexafl uoride, hydrofl uorocarbons, chlorofl uorocarbons, perfl uorocarbons, and certain other fl uorinated gases. 9 For each emission source type, the regulations provide the types of greenhouse gases that must be reported. 10 For purposes of comparing emissions of the various gases using a single unit, the gases are converted into the equivalent greenhouse gas impact of CO 2 .

11 Th e conversion is based on the principle discussed elsewhere in this book that gases other than CO 2 have a greater impact in terms of causing the greenhouse eff ect and thereby global warming. For example, one metric ton of methane emissions expressed in carbon dioxide equivalent (CO 2 e) units would be reported as 21 metric tons of CO 2 e. Th is is critical in understanding the threshold levels for application of the reporting requirements, as the non-CO 2 greenhouse gas emissions must be converted to CO 2 e before determining whether the greenhouse gas reporting obligations apply to a particular facility. It is also important to keep in mind that reporting will be in metric tons.

2. What Facilities Are Covered? Four categories of facilities are required to measure and report their greenhouse gas emissions. In addition, vehicle manufacturers would be required to report the greenhouse gas emissions of their vehicles. Research and development activi-ties (as defi ned in 40 C.F.R. 98.6) are not considered to be part of any source category subject to the rule.

Th e EPA deferred several source categories. Th ese source categories are as follows: electronics manufacturing, ethanol production, underground coal mines, oil and natural gas systems, food processing, industrial landfi lls, and wastewater treatment facilities. Subsequently, the EPA has proposed rules cover-ing some of these deferred sources. Th e source category for manure management was deferred as Congress had passed a bill preventing the EPA from expending funds to regulate this source.

9. Greenhouse Gas Reporting Rule, 74 Fed. Reg. at 56,388 (to be codifi ed at 40 C.F.R. § 98.6).

10. For example, the facilities that fall within the General Stationary Fuel Combustion Source Category, must only report CO 2 , CH 4 , and N 2 O emissions. Id. at 56,397 (to be codifi ed at 40 C.F.R. § 98.6)

11. Id . at 56,377 (to be codifi ed at 40 C.F.R. § 98.2(b)).


a. Specifi c Source Categories Th e fi rst category of facilities required to report under the Greenhouse Gas Reporting Rule are facilities that fall under a list of source categories identifi ed by the EPA. 12 Th ese sources include the following:

Electricity generating facilities that are subject to the Acid Rain Program •(ARP) or otherwise report CO 2 mass emissions year-round through 40 C.F.R. part 75; Adipic acid production; • Aluminum production; • Ammonia manufacturing; • Cement production; • HCFC–22 production; • HFC–23 destruction processes that are not co-located with a HCFC-22 •production facility and that destroy more than 2.14 metric tons of HFC-23 per year; Lime manufacturing; • Nitric acid production; • Petrochemical production; • Petroleum refi neries; • Phosphoric acid production; • Silicon carbide production; • Soda ash production; • Titanium dioxide production; • Municipal solid waste landfi lls that generate CH • 4 in amounts equivalent to 25,000 metric tons CO 2 e or more per year, as determined according to 40 C.F.R. part 98, subpart HH; and Manure management systems that emit CH • 4 andN 2 O (combined) in amounts equivalent to 5,000 metric tons CO 2 e or more per year, as determined according to 40 C.F.R. part 98, subpart JJ.

b. Other Facilities That Emit 25,000 Tons per Year or More of CO 2 e of Combined Emissions from Listed Source Categories Th e second category of sources required to report are facilities that emit 25,000 or more metric tons of CO 2 e per year of combined emissions from stationary fuel combustion units, miscellaneous uses of carbonate, and all source categories

12. Id . at 56,266–67.


that are listed and located at the facility in any calendar year. 13 Th ese sources are as follows:

Ferroalloy Production. • Glass Production. • Hydrogen Production. • Iron and Steel Production. • Lead Production. • Pulp and Paper Manufacturing. • Zinc Production. •

c. Facilities That Do Not Meet the First Two Source Categories, But That Emit 25,000 Tons of CO 2 e per Year from Stationary Fuel Combustion Sources Th e third source of facilities required to report are those that meet all of the following conditions:

(1) the facility does not contain any source category designated in the fi rst two groups of categories;

(2) the aggregate maximum rated heat input capacity of stationary fuel combustion units at the facility is 30 mmBtu/hr or greater; and

(3) the facility emits 25,000 metric tons of CO 2 e per year or more from all stationary fuel combustion sources.

For 2010 only, the facilities falling under this group were allowed to submit an abbreviated GHG report according to 40 C.F.R. 98.3(d). 14

d. Entities That Sell, Import, or Export Fossil Fuels, Industrial Greenhouse Gases, and CO 2 Th e fi nal category of entities required to submit greenhouse gas emission reports under the Greenhouse Gas Reporting Rule are suppliers of coal, coal-based liquid fuels, petroleum products, natural gas and natural gas liquids, producers of industrial GHGs as listed in the Greenhouse Gas Reporting Rule, importers and exporters of industrial GHGs and CO 2 , and importers and exporters of industrial greenhouse gases and CO 2 exceeding 25,000 metric tons of CO 2 e per year. Th e entities covered are any supplier (as defi ned in 40 C.F.R. Part 98,

13. Id . at 56,267.

14. Id .


subparts LL through PP) of any of the products as listed below in any calendar year starting in 2010: 15

Coal-based liquid fuels: All producers of coal-to-liquid fuels; importers and •exporters of coal-to-liquid fuels with annual imports or annual exports that are equivalent to 25,000 metric tons CO 2 e or more per year; Petroleum products: All petroleum refi ners that distill crude oil; importers •and exporters of petroleum products with annual imports or annual exports that are equivalent to 25,000 metric tons CO 2 e or more per year; Natural gas and natural gas liquids: All natural gas fractionators and all local •natural gas distribution companies; Industrial GHGs: All producers of industrial GHGs; importers and •exporters of industrial GHGs with annual bulk imports or exports of N 2 O, fl uorinated GHGs, and CO 2 that in combination are equivalent to 25,000 metric tons CO 2 e or more per year; and CO • 2 : All producers of CO 2 ; importers and exporters of CO 2 with annual bulk imports or exports of N 2 O, fl uorinated GHGs, and CO 2 that in combination are equivalent to 25,000 metric tons CO 2 e or more per year.

e. Entities That Manufacture or Sell Vehicles or Engines in the United States Th e types of engine manufacturers or importers that are required to report are as follows:

Highway heavy-duty (engine and vehicle); • Nonroad diesel; • Marine diesel (other than C3); • C3 marine; • Locomotives; • Small spark-ignition; • Large spark-ignition; • Marine spark-ignition; • Snowmobiles; • Highway motorcycles; • Off -highway motorcycles/ATVs; and • Aircraft . •

15. Id .


3. Monitoring and Measurement Th e EPA reviewed several monitoring or measurement options in developing the Greenhouse Gas Reporting Rule. Th e EPA selected the option of combined direct emission measurement and facility-specifi c calculations. Facilities that already have installed continuous emission monitors (CEM) are generally required to add a greenhouse gas measurement capability to that CEM so that GHGs are measured on a continuous basis. Th ose that do not have CEM devices would have the choice to install them or to use facility specifi c calculation methods.

4. Certifi cation and Verifi cation Th e EPA reviewed several options regarding certifi cation and verifi cation of the greenhouse gas emissions reported to the EPA. Th e agency decided to require certifi cation by a designated representative of the facility submitting the report and to have the EPA verify the emissions report. No third-party verifi cation is currently required.

5. Information That Must Be Reported Th e critical question is what information must be submitted in the reports to the EPA for the prior reporting year. Th e information varies between the emitters of greenhouse gases and suppliers of greenhouse gases or materials when used emit greenhouse gases. In addition to the address of the facility and the year for which the report is submitted, the facility must provide the following:

a. Facilities That Emit Greenhouse Gases For facilities that are direct emitters of greenhouse gases, the following informa-tion must be provided to the EPA:

Annual facility emissions (excluding biogenic CO • 2 ), expressed in metric tons of CO 2 e per year, aggregated for all GHG from all source categories in 40 CFR part 98, subparts C through JJ that are located at the facility; Annual emissions of biogenic CO • 2 (i.e., CO 2 from combustion of biomass) aggregated for all applicable source categories in subparts C through JJ located at the facility; Annual GHG emissions for each of the source categories located at the •facility, by gas. Gases are: CO 2 (excluding biogenic CO 2 ), biogenic CO 2 , CH 4 , N 2 O, and each fl uorinated GHG; Within each source category, emissions broken out at the level specifi ed in •the respective subpart (e.g., some source categories require reporting for each individual unit or each process line);


Additional data specifi ed in the applicable subparts for each source category. •Th is includes activity data (e.g., fuel use, feedstock inputs) that were used to generate the emissions data and additional data to support Quality Assurance/Quality Control (QA/QC) and emissions verifi cation; and Total pounds of synthetic fertilizer produced through nitric acid or ammonia •production and total nitrogen contained in that fertilizer. 16

b. Suppliers of Greenhouse Gases or Materials That Produce Greenhouse Gases When Used For suppliers of GHGs, the following information must be submitted to the EPA: 17

Annual quantities of each GHG that would be emitted from combustion use •of the products supplied, imported, or exported during the year. Report this for each applicable supply category in 40 C.F.R. part 98 subparts KK through PP, by gas. Also report total quantity, expressed in metric tons of CO 2 e, aggregated for all GHGs from all applicable supply categories; and Additional data specifi ed in the applicable subparts for each supply category. •Th is includes data used to calculate GHG quantities or needed support QA/QC and verifi cation.

6. Public Availability of Information Submitted to the EPA Th e information provided by the regulated facilities will be made available to the general public by a website developed by the EPA. Th e EPA in the preamble to the rule stated that it would protect information claimed as confi dential business information (CBI) in accordance with its rules relating to CBI in 40 C.F.R. part 2, subpart B. 18 It did caution that it viewed general emission date submitted under Sections 114 and 202 of the Clean Air Act not to qualify as CBI. Th e EPA noted that it would promulgate another rule to address con-cerns of some of the regulated community regarding information reported under the rule and CBI protection determinations by the EPA with respect to that data. 19

16. Id . at 56,268.

17. Id .

18. Id .

19. Id . and n. 10.


7. Exiting the Reporting Regulation Requirements Once subject to this reporting rule, a regulated facility must continue to submit GHG reports annually unless the emissions fall below thresholds for a certain number of years. 20 A reporter can cease reporting if the required annual GHG reports demonstrate that reported GHG emissions are either

(1) less than 25,000 metric tons of CO 2 e per year for fi ve consecutive years, or (2) less than 15,000 metric tons of CO 2 e per year for three consecutive years.

Th e entity reporting for the facility must notify the EPA that the facility intends to stop reporting under the rule and explain the reasons for the reduction in emissions that result in the facility falling below the relevant threshold for the stated time frame. Th e EPA clarifi ed that the opt-out provision applies to all facilities and suppliers subject to the rule, regardless of their applicability category (i.e., whether rule applicability was initially triggered by an “‘all-in’” source category, those for which a threshold was not provided, or a source category with a 25,000 metric tons CO 2 e threshold). Records must be kept for the years that a party is claiming that it may opt out of the rule.

8. Enforcement Actions and Penalties for Failure to Comply with the Greenhouse Gas Reporting Rule Th e EPA states in the preamble to the rule that it will take enforcement action against those facilities that fail to monitor or report greenhouse gas emissionsor quantities supplied, to collect data as required by the rules, to maintain records, to calculate data as required by the provided methodologies, to continu-ously monitor emissions, and falsifi cation of records. Such enforcement actions could be brought under Sections 113 or 203–205 of the Clean Air Act, which provide for administrative, civil, or criminal sanctions. Th e relief could include injunction or civil penalties up to $37,500 per day of violation. 21 Falsifi cation of records or tampering with monitoring equipment or testing may lead to criminal prosecution.

20. Id .

21. Id . at 56,360 and n. 31.


B. EPA Regulation of Greenhouse Gas Emissions under the Clean Air Act 1. The EPA’s Endangerment Finding Th e “Endangerment Finding,” serves as the EPA’s determination on the impact of greenhouse gas emissions on human health and environment has come to be known, arose out of the U.S. Supreme Court decision in Massachusetts v. EPA (discussed in Chapter 9), which required the EPA to make a decision on the health and environmental impact on GHG emissions based on legal challenges to its prior decision on whether to regulate emissions from light-duty vehicles (LDVs).

In considering the level of emissions from LDVs, the EPA estimated that on-road vehicles, which LDVs are a subset, contribute more than 23 percent of GHG emissions in the United States. Th e EPA estimated that its LDV rule would reduce GHG emissions by approximately 950 million metric tons and conserve 1.8 billion barrels of oil over the lifetime of model year 2012 to 2016.

Th e level of interest in this fi nding was enormous because of the extent of the regulation that would ultimately be imposed on GHG emissions sources. Aft er the proposed endangerment fi nding was published, approximately 380,000 public comments were fi led with the EPA.

Th e endangerment fi nding covered six greenhouse gases: carbon dioxide, methane, nitrous oxide, hydrofl uorocarbons, perfl uorocarbons and sulfur hexafl uoride. Th e EPA reviewed what it concluded were the relative scientifi c reports and concluded that a scientifi c consensus demonstrates that human activities are contributing GHG concentrations in the atmosphere at such a level that they have caused the Earth to warm over the last one hundred years. Th e agency concluded that the reports show the steepest increase in warming occurred in recent decades, and cited increases of

average surface temperatures; including melting ice in the Arctic, • melting glaciers around the world, • ocean temperatures, • rising sea levels, • acidifi cation of the oceans due to excess carbon dioxide, • changing precipitation patterns, and • changing patterns of ecosystems and wildlife. • 22

22. On December 15, 2009, the fi nal fi ndings were published in the Federal Register. Cause or Contribute Findings for Greenhouse Gases under Section 202(a) of the Clean Air Act; Final Rule, 74 Fed. Reg. 66,495 (Dec. 15, 2009). Th e decision was eff ective January 14, 2010.


President Barack Obama and EPA Administrator Lisa Jackson stated that in proposing and adopting the endangerment fi nding and the LDV vehicle rule that they preferred a solution enacted by Congress in the form of a climate bill, particularly one that sets a price on carbon through a cap and trade program. However, the administration stated that in the absence of congressional action, the EPA would move forward with greenhouse gas regulation under the CAA pursuant to the Supreme Court’s opinion in Massachusetts v. EPA .

Th e EPA administrator actually signed two fi ndings on December 7, 2009, under section 202(a) of the CAA:

Endangerment Finding: Th e Administrator fi nds that the current and •projected concentrations of the six key well-mixed greenhouse gases — carbon dioxide (CO 2 ), methane (CH 4 ), nitrous oxide (N 2 O), hydrofl uorocarbons (HFCs), perfl uorocarbons (PFCs), and sulfur hexafl uoride (SF 6 ) — in the atmosphere threaten the public health and welfare of current and future generations. Cause or Contribute Finding: Th e Administrator fi nds that the combined •emissions of these well-mixed greenhouse gases from new motor vehicles and new motor vehicle engines contribute to the greenhouse gas pollution which threatens public health and welfare.

While the fi ndings alone do not impose any requirements on LDV vehicles, they form the basis for adopting the LDV rule.

Ten petitions for reconsideration of the endangerment fi nding were fi led with the EPA aft er it was issued. On July 29, 2010, the EPA denied all ten Petitions for Reconsideration of the Endangerment and Cause or Contribute Findings on July 29, 2010. 23 Lawsuits by various industry and political groups have been fi led challenging the endangerment fi nding.

2. The EPA’s “Johnson Memo” During the Bush administration, the EPA responded to the Supreme Court’s Massachusetts v. EPA decision issued by then EPA Administrator Stephen Johnson, which has become known as the “Johnson Memo.” Under the Obama administration, the EPA has modifi ed parts of the Johnson Memo, and has repub-lished it in the Federal Register. 24 Th e EPA’s conclusions in that publication

23. EPA’s Denial of the Petitions to Reconsider the Endangerment and Cause or Contribute Findings for Greenhouse Gases Under Section 202(a) of the Clean Air Act, available at http://epa.gov/climatechange/endangerment/petitions.html .

24. Reconsideration of Interpretation of Regulations that Determine Pollutants Covered by the Clean Air Act Permitting Programs; Final Rule, 75 Fed. Reg. 17,004 (Apr. 2, 2010).

http://epa.gov/climatechange/endangerment/petitions.html

http://epa.gov/climatechange/endangerment/petitions.html


address issues of when the LDV rules will go into eff ect, how this initial regula-tion of greenhouse gases will trigger other aspects of the CAA, such as the Prevention of Signifi cant Deterioration (PSD) Program and Title V permitting, and a variety of other aspects of how the EPA will proceed with respect to regulating greenhouse gas emissions.

Th e Johnson Memo was issued on December 18, 2008, and its main topic was the EPA’s interpretation regarding which pollutants were “‘subject to regula-tion’” for the purposes of the PSD permitting program. Th e EPA under both administrations concluded that is permissible to construe sections 165(a)(4) and 169(3) of the CAA to fi nd that a pollutant, here greenhouse gases, becomes “‘subject to regulation’” at the point that a regulatory restriction or control “‘takes eff ect.’” 25

3. The EPA’s Mobile Source Rule As stated above, the Mobile Source Rule or LDV Rule was proposed aft er the decision in Massachusetts v. EPA . Th e regulation of LDVs was designed to reduce emissions from these vehicles as a starting point to reduce greenhouse gas emissions within the U.S. economy.

For stationary sources, the most important aspect of the rule is that it trig-gers regulation of stationary sources under Section 165(a)(4) and 169(3) of the CAA under the EPA’s re-publication of the Johnson Memo, as amended.

4. The EPA Tailoring Rule On May 10, 2010, the EPA announced its fi nal “Tailoring Rule.” 26 Th is rule was developed to address regulation of greenhouse gas emissions under the CAA through EPA or state programs (most states are delegated responsibility to implement the CAA). Th e EPA’s concern was that using the general emission thresholds under the CAA — for example, 250 tons of emissions per year for certain pollutants — would apply permitting requirements to hundreds of thousands of facilities, which would be unmanageable for the EPA and costly to regulated parties.

Th e import of this rule is that it imposes the CAA’s Prevention of Signifi -cant Deterioration and Title V Operating Permit programs on sources that emit 75,000 tons or more of CO 2 e per year. Sources subject to the Tailoring Rule will be required to install Best Available Control Technology to reduce green-house gas emissions. Th e answer to the question of what technology to control

25. Id. at 17,017.

26. Prevention of Signifi cant Deterioration and Title V Greenhouse Gas Tailoring Rule; Final Rule, 75 Fed. Reg. 31,513 ( June 3, 2010) (hereinaft er Tailoring Rule).


greenhouse gas emissions would be available for particular types of industry sources remains unclear at this time. Th e EPA is holding meetings to consider this question.

Th us, the rule as adopted would create a greenhouse gas regulatory system under the CAA. Th e approach being taken by the EPA is a “command and control” regulatory system, rather than the “cap and trade” system that provides a much more fl exible approach and a market-based system for addressing green-house gas emissions. While the House of Representatives passed a bill in 2009, the Senate has yet to vote on a climate change bill with a cap and trade system as of the publication of this book. Without such a bill, under the Tailoring Rule, the EPA would regulate greenhouse gas emissions without any potential for trad-ing emission rights between facilities and would reduce the potential for cost reductions and effi ciency in a systemic reduction in greenhouse gas emissions. Th e EPA has discussed the potential for developing a cap and trade system for GHG emissions under the current provisions of the CAA, but has not taken steps as yet to implement a market-based system. At least two prior market-based programs adopted by the EPA for other pollutants have been remanded by the Circuit Court of Appeals for the District of Columbia. 27

Th e current approach under the Tailoring Rule is a typical command and control system. Th e regulatory system under the Tailoring Rule would cover approximately 70 percent of the national GHG emissions from stationary sources and subject them to permitting requirements under the CAA. Th e facili-ties covered would include power plants, refi neries, and cement plants, among others.

a. Application of the Prevention of Signifi cant Deterioration to Regulation of Greenhouse Gas Emissions Th e Prevention of Signifi cant Deterioration Program (PSD) discussed generally above was created under Sections 160 to 169B of the CAA. It is designed to pre-vent areas that have not fallen below the National Ambient Air Quality Standards (NAAQS) from approaching those concentrations. 28 Permits are required if

27. See NRDC v. EPA , 489 F.3d 1364 (D.C. Cir. 2007) (vacating the Clean Air Mercury Rule); North Carolina v. EPA , 531 F.3d 896 D.C. Cir. 2008) (vacating the Clean Air Interstate Rule). Th e D.C. Circuit later reinstated the Clean Air Interstate Rule, including the cap and trade program, until the EPA issued a new rule in accordance with the court’s opinion. North Carolina v. EPA , 531 F.3d 896, 901 (D.C. Cir. 2008). On July 6, 2010, the EPA reissued a new rule meant to replace the prior CAIR with a less ambitious emissions market program than the prior version of CAIR. Th e response of the court in any subsequent litigation will remain to be seen.

28. 42 U.S.C. § 7470–7492.


certain thresholds of pollutants are exceeded, which are classifi ed as a “major source” for a new source or a “major modifi cation” for an existing source.

First, to understand the PSD program it is important to identify those pol-lutants that are regulated. Th e regulated pollutants are those for which an NAAQS has been established by the EPA. Th ese pollutants are as follows:

Nitrogen oxides; • Volatile organic compounds; • 29 Sulfur dioxide; • Fine particulate; • Carbon monoxide; and • Lead. •

In general, the threshold amount of emissions of for these pollutants for a Major Source or Major Modifi cation is 250 tons per year. Th is measurement is based on the “potential to emit,” not actual emissions. For 28 specifi ed sources, the threshold is 100 tons per year. Th ese sources of emissions include the following:

Power plants (fossil-fuel fi red); • Refi neries; • Cement plants; • Lime plants; and • Iron and steel plants. • 30

Th e process by which the PSD will be applied to major sources and major modifi cations in the context of GHG emissions will be discussed below.

Under the PSD Program, regulated sources must adopt and install the Best Available Control Technology (BACT) to control air emissions. Th e analy-sis of what is BACT for a particular source is generally carried out on a facility-specifi c basis. Environmental, economic, energy, and other impacts are evaluated in this process. Th e permitting authority, whether the EPA or the state, deter-mines through this process what emission controls must be installed to reduce emissions of the relevant pollutants. Th e EPA will implement GHG emissions regulation and reductions through the PSD program. While the PSD program is more complicated and its application to GHG emissions is complex as well, this discussion is intended to provide a basic understanding of both the PSD

29. Nitrous oxides and volatile organic compounds are precursors for ozone and, thus, are the pol-lutants regulated as emissions from sources. 40 C.F.R. § 52.21(b)(1)(ii).

30. Th e list of sources are found at id. § 52.21(b)(1)(i)(a).


program and the application of the program to GHG emissions through the Tailoring Rule. In November 2010, the EPA issued guidance regarding BACT analysis for control technologies to guide permitting authorities, whether the EPA or states, in implementing the BACT requirements for GHGs under the PSD program. 31

b. Covered Gases Under the Tailoring Rule, the GHGs that would be covered under the PSD program would be as follows:

Carbon dioxide (CO • 2 ); Methane (CH • 4 ); Nitrous oxide (N • 2 O); Hydrofl uorocarbons (HFCs); • Perfl uorocarbons (PFCs); and • Sulfur hexafl uoride (SF • 6 ). 32

To determine the amount of emissions for regulatory purposes, the sum of the six gases are estimated and converted to CO 2 e, and then compared to the thresh-olds of emissions established in the rule. 33 Th us, the EPA will use a common metric for GHGs of CO 2 e to measure and determine thresholds for GHG emissions.

c. Phases of Coverage, Beginning with Larger Sources

i. Step 1: January 2, 2011 to June 30, 2011

(A) PSD APPLICABIL ITY As discussed above, the regulation of station-ary sources will begin with larger sources and the program will be phased in over time. From January 2, 2011 to June 30, 2011, GHG emissions alone will not trigger PSD requirements. Th e trigger will be two-part for GHG emissions. First, a major modifi cation or major source must be part of the permit application. Th e GHG regulation will only be triggered if a source triggers PSD regulations

31. EPA, PSD and Title V Permitting Guidance For Greenhouse Gases (Nov. 2010), available at http://www.regulations.gov/search/Regs/home.html#docketDetail?R=EPA-HQ-OAR-2010-0841 .

32. Tailoring Rule, 75 Fed. Reg. at 31,522.

33. Id.

http://www.regulations.gov/search/Regs/home.html#docketDetail?R=EPA-HQ-OAR-2010-0841

http://www.regulations.gov/search/Regs/home.html#docketDetail?R=EPA-HQ-OAR-2010-0841


and is required to address other air pollutants. 34 Second, once other pollutants require PSD permitting, then GHG emissions will be regulated only if the new source or major modifi cation increases GHG emissions by 75,000 tons of CO 2 e or more per year. 35

(B ) TITLE V PERMITTING APPLICABIL ITY Title V permitting will apply only to those sources that already have been required to obtain Title V permits. Th e facility will only be required to address GHGs in the permit if the facility is applying for, renewing, or revising its Title V permit. 36

Th e EPA estimates that this phase will cover sources accounting for approximately 65 percent of GHG emissions from stationary sources in the United States.

ii. Step 2: July 1, 2011 to June 30, 2013

(A) PSD APPLICABIL ITY In the second step or phase, the EPA will begin to regulate sources on the basis of GHG emissions. Th e prior sources in Step 1 will continue to be regulated. Sources that emit 100,000 metric tons or more of CO 2 e begin to be regulated. A major modifi cation will be regulated if it results in a net emissions increase of 75,000 tons or more.

(B ) TITLE V PERMITTING APPLICABIL ITY A source that is not already subject to a Title V permit will not be subject to Title V unless its emis-sions are 100,000 tons of CO 2 e per year or more. 37 For sources that must apply for a Title V permit once they meet or exceed the threshold, they will have one year aft er becoming subject to Title V to submit a permit application, absent a requirement by the permitting authority, such as a state, to apply within a shorter time period. 38 For those sources that emit more than 100,000 tons per year as of July 1, 2011, a Title V permit application must be submitted by July 1, 2012. 39

Th e EPA expects that this step will include the largest industrial sources from energy-intensive source categories, the largest landfi lls, the largest coal mines, and the largest oil and gas production operations.

34. Id. at 31,523.

35. Id.

36. Id.

37. Id. at 31,523–24.

38. Id.

39. Id.


iii. Step 3: July 1, 2013 to April 29, 2016 During the implementation of Step 2, the EPA will evaluate the potential reg-ulation of additional smaller sources, but the EPA does not intend to regulate sources that emit less than 50,000 tons per year during the six-year period leading up to 2016. A Step 3 regulation would become eff ective on July 1, 2013.

Th e EPA committed to conduct a study as to how to address smaller sources and to complete that study within fi ve years that it pledges to complete by April 2015. Th e EPA would then issue a rule on these smaller sources by April 2016. 40 Th is action would be in addition to Step 3 in the EPA’s rule-making program for GHG emissions under the CAA.

d. Best Available Control Technology Th e applicability provisions lead to the most challenging aspect of the rule: What control technologies must be implemented to reduce greenhouse gas emissions? Th e EPA stated in the preamble to the Tailoring Rule that defi ning Best Available Control Technology for controlling greenhouse gas emissions would take time. Th e agency stated that it anticipated issuing guidance by June 2010, and policy guidance by the end of 2010 on BACT for GHG emissions. 41

Some of the documents that the EPA plans to issue are:

Initial technical data and information concerning available and emerging •GHG control measures; GHG Mitigation Strategies Database; • RACT/BACT/LAER Clearinghouse enhancements; • GHG technical white papers on control techniques and measures for the •largest GHG emitting industrial sectors (e.g., power plants, industrial boilers, cement plants, refi neries, and iron and steel, pulp and paper, and nitric acid plants); General guidance for applying the PSD requirements, including BACT, •for GHGs; and Training workshops with example BACT analyses for EPA regions •and states. 42

One of the more signifi cant issues is what BACT would be for controlling GHG emissions from coal-fi red power plants. One view is that it would be

40. Id. at 31,524–25.

41. Id. at 31,526.

42. J. Mangino, EPA Offi ce of Air Quality Planning and Standards, Prevention of Signifi cant Deterioration and Title V Greenhouse Gas Tailoring Rule ( June 2010).


switching to natural gas. Another is that carbon capture and sequestration would be required. Other sources such as petroleum refi neries, Portland cement plants, and lime plants, for example, will face similar critical questions as to what would be required to reduce GHG emissions and to what extent reductions would be required. Energy effi ciency or fuel effi ciency may be another approach the EPA may take in proscribing control technologies to GHG emission sources.

e. State Implementation Plans Current State Implementation Plans (SIPs) that are the roadmap by which the EPA approves delegation to the states the power to implement the CAA in that state, may not provide for GHG regulation. Th is raises questions as to how states will exercise jurisdiction over GHG emissions. Th e EPA’s position is that to the extent state law has similar language regarding “subject to regulation,” states may adopt the EPA’s approach by interpreting the phrase in the same way as the EPA in the amendments to the Johnson Memo and the Tailoring Rule. How states will address the issue of GHG emissions regulation will perhaps vary and depend on a variety of factors. Some have objected to any participation in green-house gas regulation and fi led lawsuits challenging the Tailoring Rules. 43 Th e EPA is preparing to take over state programs if they do not enforce the green-house gas regulations. 44

43. Th e State of Texas has fi led a lawsuit challenging the EPA’s power to require the state to regulate greenhouse gases, joining seventeen other lawsuits fi led against the EPA over the Tailoring Rule by other states, business groups, and advocacy groups. Th e EPA also sent a letter to EPA Regional Administrator Al Armendariz. Texas Joins Challengers to EPA’s Greenhouse Gas “Tailoring” Rule , N.Y. Times , Aug. 5, 2010.

44. Id.

11

Developing United States Law — Congress and Proposed Federal Climate Change Legislation

Th e development of federal legislation on climate change in the United States began in 2008 with proposed legislation and proposed bills in the Senate in 2010. Th e provisions of the legislation were to be codifi ed in Title VII of the federal Clean Air Act, which, as discussed in previous chapters, is the U.S. statute govern-ing air pollution regulation and permitting. While legislation was passed in the U.S. House of Representatives, no legislation had passed the Senate as of the writing of this book, and it did not appear that the legislation would pass the Senate in 2010.

Th e nature of the proposed legislation is of interest in terms of structure and coverage. Th e discussion below follows the Senate bill off ered by Senators John Kerry and Barbara Boxer.

A. Defi ning the Regulated Gases Under the proposed bill, there would be seven types of greenhouse gases that would be regulated:

Carbon dioxide (CO • 2 ) Methane (CH • 4 ) Nitrous oxide (N • 2 O)


Sulphur hexafl uoride (SF • 6 ) Hydrofl uorocarbons (HFCs) • Perfl uorocarbons (PFCs) • Nitrogen trifl uoride (NF • 3 ) 1

In addition to these types of gases, the Environmental Protection Agency (EPA) would be able to designate other gases as greenhouse gases under the criteria provided under the statute. 2

Once a gas has been determined to be a greenhouse gas, then the EPA would be required to determine whether the gas would be regulated under Section 619, which governs hydrofl uorocarbons. 3

Another compound being considered is actually not a gas, but a particulate. Black carbon is a material generated from burning wood and other materials. Th is material was included in the statute. Th e defi nition was “the light absorbing component of carbonaceous aerosols.” 4 Th e EPA would be required to develop programs to mitigate black carbon emissions and to develop plans to mitigate international emissions of black carbon.

Th e EPA would be required to make a determination as to the relative con-tribution to global warming over a one-hundred-year period and determine the CO 2 e value for each greenhouse gas. 5 Because the gases have diff erent relative contributions to global warming, a unifi ed measure or unit is required in order to regulate the emissions and to have a common unit for emission allowances and off sets. Since CO 2 is the main greenhouse gas emitted from human activities, and the least in terms of relative greenhouse gas eff ect, the other gases would be converted to a carbon dioxide equivalent, or CO 2 e. In order to convert the mass of emissions of the other greenhouse gases to CO 2 e, a multiplier is provided for each greenhouse gas.

An example of a conversion that would be performed is the emissions of methane. If 1,000 tons of methane were emitted by a particular source for any given time period, the multiplier that would be used under the federal statute

1. Clean Energy Jobs and American Power Act, to have been codifi ed at 42 U.S.C. § 711(a) (here-inaft er Proposed Legislation).

2. Id . § 711(a)(8).

3. Id . § 619.

4. Id . § 333(a).

5. Id . § 711(b)(1)–(2).

DEVELOP ING UNITED STATES LAW | 135

would be 25. Th e carbon dioxide equivalent, therefore, for the emissions of 1,000 tons of methane would equal 25,000 tons CO 2 e.

B. Emission Thresholds for Facilities That Emit Greenhouse Gases For certain large sources of emissions there would not be an emissions threshold, based on the assumption that those types of sources will always exceed the minimum emissions to be regulated. 6

Th e multiplier eff ect for greenhouse gases other than CO 2 , discussed above, is a dual-edged sword. For emission sources that would be regulated, the multi-plier eff ect creates greater liability for that facility in terms of creating an obliga-tion to obtain the necessary allowances and off sets to submit to the EPA for each year of operations. In other words, a facility that emits 1,000 tons of CO 2 may not be regulated as it falls below a regulatory threshold of 25,000 ton per year of CO 2 e, as discussed below. A facility that emits 1,000 tons of methane on the other hand, as explained above, must convert the methane emissions into CO 2 e, which equals 25,000 tons CO 2 e per year. Depending on the source type, the emission of 25,000 tons per year of CO 2 e may cause the facility to be a “Covered Facility,” as discussed below, and, therefore, be subject to all of the regulations under Title VII of the proposed Act.

Since some of the multipliers or conversion factors are even higher — for example, nitrous oxide is 298 and the highest one is HFC-23, which is 14,800 — a few tons or even less than two tons for HFC-23 could put a facility over the regulatory threshold.

For those facilities that would not be regulated, the multiplier eff ect may create an opportunity. For example, an unregulated facility, such as a landfi ll, that emits 1,000 tons per year over ten years of methane could convert the meth-ane emissions to CO 2 e by multiplying by 25, which would be 25,000 tons CO 2 e per year. If the methane were burned for electricity use, the emissions of the 25,000 tons CO 2 e of methane would largely be averted by using another conver-sion factor, because it would be converted for the most part to CO 2 in the com-bustion process, although as combustion is not complete some would still be emitted as methane. Th e actual emissions aft er combustion would be CO 2 and perhaps a few tons of methane that did not combust as the combustion is not likely 100 percent effi cient. Th us, the CO 2 e equivalent aft er installing and

6. Id.


operating the project would be signifi cantly fewer tons of CO 2 e with respect to the CO 2 emitted (a 1-to–1 measure) and a few tons of CO 2 e for the methane emitted (a 1-to-25 conversion). Th us, the diff erence for which carbon credits or off sets could be claimed would be somewhat under 25 times in terms of tons of CO 2 e.

Th e conversion factor for other greenhouse gases is a “curse” for regulated emitters and a “blessing” for the carbon credit project developer. It is important to note, that the destruction of HFCs has become very controversial. Th e reason is that for a small investment in a destruction system for HFCs, millions of dollars in carbon credits may be generated. As a result of the controversy of this quick-wealth generation for what is perceived as doing not that much for reducing climate change, the ability to continue to utilize the reduction of HFCs for carbon credits may be in doubt over time.

C. “Covered Facilities”: Determining What Emission Sources Would Be Regulated Th e types of facilities that would be regulated include two types of what are defi ned as Covered Entities: 7 those that emit greenhouse gases and those that produce or import gases or materials that when burned or used produce or emit greenhouse gases or are greenhouse gases themselves and are released to the environment when used.

1. Emitters of Greenhouse Gases Th e fi rst category of emission sources involves source categories that emit green-house gases and to which a minimum threshold of greenhouse gas emissions does not apply. Th e list of these emission sources would be as follows:

Electricity Source: Fossil-fuel-fi red power plants (coal, natural gas, etc.); • Geologic Sequestration Sites: any site where CO • 2 is geologically sequestered in subsurface formations for purposes of permanent storage; Adipic Acid Production; • Primary Aluminum Production; • Ammonia Manufacturing; • Cement Production: excluding grinding-only operations; • Hydrochlorofl uorocarbon Production; • Lime Manufacturing; •

7. Id . § 701(13).


Petroleum Refi ning; • Nitric Acid Production; • Phosphoric Acid Production; • Silicon Carbide Production; • Soda Ash Production; • Titanium Dioxide Production; and • Coal-based Liquid or Gaseous Fuel Production; •

Th e next group of emissions sources that is regulated includes those that emit 25,000 tons of CO 2 e per year and would be specifi cally identifi ed in the defi ni-tion of “covered entity.” Th is group of sources is identifi ed as follows:

Ethanol production; • Ferroalloy production; • Fluorinated gas production; • Food processing; • Glass production; • Hydrogen production; • Iron and steel production; • Lead production; • Pulp and paper manufacturing; • Zinc production; • Any chemical or petrochemical source that produces acrylonitrile, •carbon black, ethylene, ethylene dichloride, ethylene oxide, or methanol; and Nitrogen trifl uoride sources. •

In addition to the specifi cally identifi ed sources, there is another source to which the emissions threshold applies. Th is group is made up of those sources that operate fossil-fuel-fi red combustion devices that are not electricity sources but that individually or as a group emit 25,000 tons CO 2 e or more per year, and that fall within these categories:

Almost any type of manufacturing, food, textile, apparel, wood products, •pulp and paper, printing, pharmaceutical, concrete, metals production and forming, coating, engraving, furniture, semiconductors, electronics, vehicle and machine manufacturing, etc.; and Facilities that recover liquid hydrocarbons from oil and gas fi elds, natural gas •processing plants, or natural gas pipelines.


2. Producers or Importers of Greenhouse Gases or Materials That Emit Greenhouse Gases When Used or Burned In addition to those entities that emit greenhouse gas emissions, the statue regulates those entities that produce or import materials that when burned or used release greenhouse gases. Included in this group would be:

Fossil fuel producers (e.g., petroleum refi ners) and importers of petroleum- •based or coal-based liquid fuel (e.g., gasoline, diesel, jet fuel, etc.), natural gas liquid, or petroleum coke the combustion of which would cause the emission of 25,000 tons of CO 2 e per year or more. 8 Producers of petroleum-based, coal-based liquid fuels, petroleum coke, or •natural gas liquid. Th is includes all facilities that produce these materials if the combustion of those materials would generate 25,000 tons or more per year of CO 2 e. Any stationary source that produces and any entity that imports for sale •or distribution in bulk, or in products designated by the EPA, 25,000 or more tons of CO 2 e per year of:

fossil-fuel-based carbon dioxide; • nitrous oxide; • perfl uorocarbons; • sulfur hexafl uoride; • any other fl uorinated gas (except for nitrogen trifl uoride) that is •designated by the EPA as a greenhouse gas; or any combination of greenhouse gases described above. • Natural gas distribution companies that deliver 460,000,000 cubic feet or •more per year of natural gas to noncovered entities.

D. Setting the Cap Th e following greenhouse gas emission reduction goals were set for regulated sources based on a 2005 baseline year: 3 percent by 2012; 20 percent by 2020; 42 percent by 2030; and 83 percent by 2050. 9 Th ese reductions would apply to Covered Entities described above. Th e legislation uses 2005 as the baseline year. As seen in the Chapter 4 discussing the Kyoto Protocol, the baseline year interna-tionally has been 1990 for reductions in Annex I nations under the Kyoto

8. Id . § 701(13)(B), (C), and ( J).

9. Id. § 703.


Protocol, like Europe, Canada, and Japan. Using this baseline year, the reductions would be 7 percent by 2020.

E. Permitting Emissions of Greenhouse Gases Under the Clean Air Act (CAA), emission limits for individual facilities would be typically set in the form of a permit issued by the EPA or a state envi-ronmental agency, where the program has been delegated by the EPA to the state. 10 Th e permit serves to proscribe the various obligation of the regulated facility in terms of operations, monitoring, reporting, and the specifi c levels of pollutants that may be emitted by the facility.

Under the new statute, Section 727 provides that a stationary source cov-ered by Title V of the CAA, which governs sources of regulated air pollutants other than greenhouse gases, and that qualifi es as a covered entity under the new Title VII of the CAA must obtain or amend its existing Title V permit to address greenhouse gas emissions. 11 Th e permit would require that the owner or operator of such covered entity hold emissions allowance or off set credits at least equal to the total annual amount of CO 2 e for its combined emissions attributable greenhouse gas emissions to which Section 722 applies, and a representation to this eff ect be fi led. 12 Unless the designated representative of the owner or opera-tor has fi led such a representation, a permit cannot be issued and no emission allowances or off set may be issued to that covered entity. 13

F. Emission Allowances Th e EPA administrator establishes the quantity of emission allowances to be distributed each year, beginning in 2012. 14 In order to track the allowances issued each year, each allowance would have its own unique number. 15 Th e number of emission allowances in tons of CO 2 e is set in the statute, starting at 4.627 mil-lion tons of CO 2 e (MtCO 2 e), and increases until 2018 to 5.482 MtCO 2 e, and

10. Id. §§ 7661–7661f.

11. Id. § 727(a).

12. Id . § 727(a).

13. Id . § 727(b).

14. Id . § 721(a)–(b).

15. Id.


then declines to 4,873 in 2020, 3,533 MtCO 2 e in 2020, and 1,035 MtCO 2 e in 2050. 16

G. Allocation of Emission Allowances Emission allowances under the statute would be distributed in two ways: by free allocation and by auction. In addition to allocating allowances to specifi c industries, the EPA is required to allocate allowances to certain specifi c pro-grams to achieve a reduction economic impact to certain segments of the econ-omy or society. Th ese allocations may change over time but now include the following:

Program for electricity consumers; • Program for small • local distribution companies ( LDCs), which deliver in any given year less than 4 million megawatt hours of electricity to electricity consumers; Program for natural gas consumers; • Program for home heating oil consumers; • Program for domestic fuel production, including petroleum refi ners and •small refi ners; Program for commercial deployment of carbon capture and sequestration •technologies; Program for early action; • Program for Clean Vehicle Technology; • Program for state and local investment in energy effi ciency and renewable •energy; Program for energy effi ciency in building codes; • Energy Innovation Hubs; • ARPA-E research; • International Clean Energy Research; • Additional reserve for international climate change adaptation and security; and • State greenhouse gas reduction and climate adaptation; •

Th e EPA would be required to auction for each calendar year the allowances allo-cated to the respective programs outline above, as well as a variety of other pro-grams to fund those programs.

Th e states developed greenhouse gas programs in advance of a federal system. As a result some states have issued and continue to issue emission

16. Id . § 721(e)(1).


allowances before the statute goes into eff ect. Th e EPA is required to issue regulations allowing the exchange of state greenhouse gas allowances issued before December 31, 2011, or the date that is nine months aft er the fi rst auction of federal allowances. 17 Th e states whose allowances may be exchanged include California and those that are members of the Regional Greenhouse Gas Initiative and the Western Climate Initiative. 18 Th e exchange may not be a one-to-one exchange, but the amount of federal allowances provided would be in the amount to compensate for the cost of obtaining and holding the state allowances. 19 Th us, proof of purchase price or value of the state allowances would need to be provided and proof of ownership or title to the allowances.

Th e total amount of state allowances exchanged would be deducted from the federal allowances to be auctioned, 20 thereby not adding to the size of the cap of greenhouse gas emissions allowed by the statute.

H. Auctions 1. Main Allowance Auction Th e main allowance auction would be conducted in order to allow the sale of initial allowance to covered entities in order for them to obtain a portion of the allowances or off sets necessary to meet their compliance obligations. Th ese auctions would be held quarterly starting on March 31, 2011, and would include allowances for vintage years of 2012 and later years in the 2011 auction, and staring tin 2012 would include vintages for the year in which the auction is being conducted and future years. 21

Th e auction would be a sealed bid auction in a single round of bidding in a uniform price format. 22 Th e bill does not explain in any detail what is meant by a uniform price format. In general, auctions would be conducted as “multiple-price auctions” and “single-price auctions.” Multiple price auctions would be generally where bidders submit competitive bids and specify the price they would be willing to pay. Successful competitive bidders pay the price equivalent to their bid. Single-price auctions similarly involve bidders submitting competitive bids specifying the price they would be willing to pay. Successful bidders pay the

17. Id. at § 777(a).

18. Id.

19. Id. at § 777(b)(1).

20. Id. at § 777(b)(2).

21. Id. at § 778(b)(1).

22. Id. at § 778(b)(1).


price equivalent to the highest accepted price regardless of the price they bid. For example, all Treasury securities auctions are now single-price auctions. 23 Th us, it would appear the auction sets the price for all bidders, and that the bidder receives allowances if it bids at the selected price or above. If a covered entity bid too low, below the selected allowance price through the auction, it is not clear whether they would receive any allowances at all. Th e actual approach to the auction would be developed and clarifi ed by the EPA through promulgation of regulations.

Th e minimum auction price was established as $10 (in constant 2005 dol-lars) for the 2012 auction, and for years aft er 2012, the auction price would increase 5 percent plus infl ation. 24 No restriction was placed on these allowances in terms of use for any compliance year or banking, trading, or borrowing. No person could purchase any more than 5 percent of the allowances off ered for sale at any particular quarterly auction. 25

Bidding is open to any person, but such bidders must disclose their repre-sentation and the party who would benefi t from the winning bid, and must provide fi nancial assurance to demonstrate the party can consummate the purchase of allowances from any winning bid. 26

2. Market Stability Reserve One of the price control mechanisms is the auction of allowances through the “Market Stability Reserve” auction. Th is auction is restricted to those covered entities that would be required to comply with the requirement of Section 722 the following year. 27 Th e auction would be held quarterly and allowances that would be sold would be those that would be allocated to the various governmen-tal or other entities under Section 771 of the statute as discussed above; those allowances, if any, previously off ered for auction but not sold; and allowances created by using the auction proceeds to purchase domestic and international off sets and retiring them and creating new domestic allowances to replace them. 28 In addition, parties holding off sets may request that the EPA sell their off sets in this auction and obtain the proceeds of the sale of those off sets, which would

23. Http://www.treasurydirect.gov/indiv/research/indepth/auctions/res_auctions_faq.htm#single.

24. Proposed Legislation, at § 778(d).

25. Id. at § 778(b)(6).

26. Id. at § 778(b)(4), (5).

27. Id. at § 726(a)(2).

28. Id . at §726(b)(1)–(2).

Http://www.treasurydirect.gov/indiv/research/indepth/auctions/res_auctions_faq.htm#single

Http://www.treasurydirect.gov/indiv/research/indepth/auctions/res_auctions_faq.htm#single


be retired and allowances established in their place to provide to the winning covered entity bidder. 29

Th e minimum reserve auction price was established as $28 (in constant 2005 dollars) for the 2012 auction. For years aft er 2013–2017, the reserve auction price shall increase 5 percent plus infl ation, until 2028, when the price would increase 7 percent from the previous year’s price, plus infl ation. 30 Th ese allowances must be used for the calendar year for the year purchased, and only for compliance purposes. Th ese allowances cannot be banked, traded, or borrowed.

Limits on purchases would be 20 percent of the covered entity’s emissions allowance or off set credits retired in the most recent year, except for 2012, where the limit would be the amount of greenhouse gas emissions reported by that entity in 2011 and that would be subject to regulation under the greenhouse gas cap and trade system. 31 No person may purchase any more than 20 percent of the allowances off ered for sale. 32

Bidders must disclose their representation and the party who would benefi t from the winning bid, and must provide fi nancial assurance to dem-onstrate the party can consummate the purchase of allowances from any winning bid. 33

3. Small Business Refi ner Reserve In order to reduce the impact of the greenhouse gas emission restrictions on small petroleum refi ners, the statute provides a program to sell a certain percent-age of the allowances at a reduced price to small refi ners. Th e EPA must set aside the amount of allowances to be sold to small petroleum refi ners pursuant to Section 771 in an amount equal to:

For each of the vintage years 2012 and 2013, 6.2 percent of the emission allowances established under section 721(a);

For each of the vintage years 2014 and 2015, 5.4 percent of the emission allowances established under section 721(a); and

29. Id . at § 726(h).

30. Id . at § 726(c).

31. Id . at § 726(e).

32. Id . at § 726(i)(5).

33. Id . at § 726(i)(3), (4).


For each of the vintage years 2016 through 2024, 4.9 percent of the emission allowances established under section 721(a). 34

Th e allowances would be made available to the small refi ners for purchase from January 1 of the vintage year of the allowance to January 14 of the following year. 35 Th e price of each allowance is not determined by auction directly, but by the average price for allowances of the same vintage year for the auction conducting during the twelve months preceding the small refi ner’s purchase of allowances from this program. 36

Th ese allowances must be used for the calendar year for the year purchased, and only for compliance purposes. Th ese allowances cannot be banked, traded, or borrowed. 37

Th e EPA would required to set by regulation the amount of allowances any one person may purchase in terms of percent of the allowances off ered for sale, based on a fair allocation between all small refi ners. 38

I. Auctioning Allowances for Other Entities In addition to auctioning allowances under its other programs, the statute pro-vides that other parties may arrange to have their allowances auctioned off in the EPA auctions, and set a price they would accept in such auction. 39 Th us entities could sell their allowances on consignment through the government auction. As there would be secondary exchanges and brokers that currently auction other carbon credits, parties holding allowances that they wish to sell should consider these other options and whether a better price would likely be obtained through these other sales options and mechanisms.

J. Carbon Registry A carbon registry may have two meanings, and under the statute there would be two registries that the EPA would to set up. Th e fi rst registry discussed under

34. Id. at § 778(f )(1).

35. Id. at § 778(f )(2).

36. Id. at § 778(f )(3).

37. Id. at § 778(f )(4).

38. Id. at § 778(f )(5).

39. Id. at § 779.


the Act serves to track the measured and reporting greenhouse gas emissions from those parties required to measure and report such emissions. 40 Th ese emissions become the basis for the regulation of the covered entities, whereby they must hold and retire an equivalent number of tons of CO 2 e in allowances or off set credits.

Th e second registry relates to carbon credits, including both allowances and off set credits. In order to track allowances and off sets, the statute requires the EPA to develop a registry on which all allowances and off set credits would be registered. Th e EPA would to develop by regulation a system for “issuing, system for issuing, recording, holding, and tracking allowances, off set credits, and term off set credits.” 41 Th e registry would set out the necessary procedures and require-ments “for an orderly and competitive functioning of the allow ance and off set credit markets.” 42 Th e information in the registry must be published on the Internet. Each ton of CO 2 e of an allowance or carbon off set credit issued by the EPA or the Department of Agriculture, as the case may be for domestic land use or forestry, or exchanged for a state allowance or off set or international allowance or off set would be assigned a unique number. Th e registry would also serve as the database to determine which allowances or off set credits have been retired, cancelled, or transferred in order to achieve compliance by the covered entities whose emissions would be regulated under the Act. Th e two databases then would be a central part of the U.S. cap and trade program.

K. Off sets 1. General Issues Relating to Off sets Th e fi rst step to understanding the off set program under the statute is to review the defi nition of “off set” under the Act. Th e actual term is “off set credit” and is any such credit issued under part D, the off set section, of the Act. 43 “Th e term ‘off set project’ means a project or activity that reduces or avoids greenhouse gas emissions, or sequesters greenhouse gases, and for which off set credits would be or may be issued under part D.” 44

40. Id. at § 713.

41. Id. at § 724(d).

42. Id.

43. Id. at § 700(39).

44. Id. at § 700(40).


Th e critical aspect of the off set credit is that the credit may be used in lieu of an allowance to comply with the cap and trade program. 45 Th e statute estab-lished a program for using such off sets. Th e number of off sets that covered enti-ties may use system side is capped at a maximum of two billion tons CO 2 e annually. 46

A covered entity may use one ton of domestic off set credits or one ton of international off set credits, up to 2018, at which time 1.25 tons of international off sets may be used, to off set its emissions for the relevant compliance year. 47 For any covered entity, the amount of off sets that it may use to meet its annual compliance obligations is determined by taking the amount of greenhouse gas emissions, unless excluded by the Act, from the year before the relevant com-pliance year and dividing that number by the total number of greenhouse gas emissions, unless excluded by the Act, by all covered entities in that time frame, and multiplying that quotient by two billion tons CO 2 e. 48

Th e amount of off sets allowed per each covered entity may be three-fourths domestic off sets, and one-fourth international credits. 49 Th e EPA, however, is required increase the percentage of international off sets that may be used if the amount of domestic off sets available for use for a particular compliance year is likely to off set less than 900,000 tons of CO 2 e; this increase may be up to 750 million tons per year of additional international off sets that may be used by cov-ered entities to meet their compliance obligation in a particular year. 50 Th e President would be allowed to recommend to Congress that the two billion tons of off sets be increased or decreased.

Term off sets may be used as well. Th ese off sets have an expiration date, at which time other off sets must be used to continue to meet the compliance obligation. Term off sets have not been favorably welcomed under the Clean Development Mechanism of the Kyoto Protocol. Th ey would not be expected to be a signifi cant part of a cap and trade program in the United States.

Once turned into the EPA to meet compliance obligations, the allowances and off sets would be retired. “Retire” under the statute means

with respect to an allowance, off set credit, or term off set credit established or issued under this title, means to disqualify such allowance or off set

45. Id. at § 722(d).

46. Id. at § 722(d)(1)(A)(i).

47. Id. at § 722(d)(1)(A)(ii), (D).

48. Id. at § 722(d)(1)(B)(i).

49. Id. at § 722(d)(1)(B)(iii).

50. Id. at § 722(d)(1)(B)(iii).


credit for any subsequent use under this title, regardless of whether the use is a sale, exchange, or submission of the allowance, off set credit, or term off set credit to satisfy a compliance obligation. 51

By retiring an allowance or off set, the EPA ensures the numbered ton of CO 2 e cannot be used again by any covered entity and cannot be bought or sold or otherwise traded or transferred. Th e retirement, thus, takes that permitted emis-sion out of the system and serves to eff ectively cap the emissions of the emissions control regulatory system.

2. Carbon Off set Creation — Rules Relating to Off set Methodologies and Projects Th e means to create carbon credits in the form of off sets will be discussed in more detail in Chapter 13. Th e basics of the off set program under the statute would be outline below.

a. Basics of Off set Creation Th e EPA is required to develop and issue regulations to develop a program for issuing off set credits under part D of the Act. 52 An Off sets Integrity Board would be established within thirty days aft er passage of the Act. 53 Th e EPA is required to consult with the Advisory Board and other federal agencies in formu-lating these regulations. Th ese regulations would be required to accomplish the following:

authorize the issuance of off set credits with respect to qualifying off set •projects that result in reductions or avoidance of greenhouse gas emissions, or sequestration of greenhouse gases; ensure that such off set credits represent verifi able and additional greenhouse •gas emission reductions or avoidance, or increases in sequestration; ensure that off set credits issued for sequestration off set projects would be •only issued for greenhouse gas reductions that would be permanent; provide for the implementation of the requirements of this part; • include as reductions in greenhouse gases reductions achieved through the •destruction of methane and its conversion to carbon dioxide, and reductions achieved through destruction of chlorofl uorocarbons or other ozone depleting substances, if permitted by the President under section 619(b)(9)

51. Id. at § 700(47).

52. Id. at § 732(a).

53. Id. at § 731.


and subject to the conditions specifi ed in Section 619(b)(9), based on the carbon dioxide equivalent value of the substance destroyed; and establish a process to accept and respond to comments from third •parties regarding programs established under this part in a timely manner. 54

Th e EPA must designate the Department of Agriculture to be the lead agency in terms of agriculture and forest projects.

In order to function, the Act requires that the President establish within the registry established to track allowances an Off set Registry.

3. Eligible Off set Project Types Th e EPA would develop and amend from time to time a list of eligible off set project types that may generate domestic and international off set credits, under the advisement of the Off sets Integrity Advisory Board. 55 Th e Act established the following project types as the initial list that may qualify for off sets if all criteria would be met:

methane collection at mines, landfi lls, and natural gas systems; • fugitive emissions from the oil and gas sector that reduce greenhouse gas •emissions that would otherwise have been fl ared or vented; nonlandfi ll projects that involve collection, combustion, or avoidance of •emissions from organic waste streams that would have otherwise emitted methane into the atmosphere, including manure management, composting, or anaerobic digestion projects; projects involving aff orestation or reforestation of acreage not forested as of •January 1, 2009; forest management resulting in an increase in forest carbon stores, including •harvested wood products; projects that capture and geologically sequester uncapped greenhouse gas •emissions with or without enhanced oil or methane recovery in active or depleted oil, carbon dioxide, natural gas reservoirs or other geological formations; recycling and waste minimization projects; • projects to abate the production of nitrous oxide at nitric acid production •facilities and other stationary sources; projects for biochar production and use; •

54. Id. at § 732(b).

55. Id. at § 733(a).


projects that destroy ozone-depleting substances that have been phased out •of production; projects in communities reliant on small, isolated electricity grids involving •conversion from diesel to renewable sources of energy, including electricity generation facilities with emissions below required levels for compliance with any limitation on district or home heating in those communities; projects relating to agricultural, grass land, and rangeland sequestration and •management practices, including — (a) altered tillage practices, including the avoided abandonment of

conservation practices; (b) winter cover cropping, continuous cropping, and other means to increase

biomass returned to soil in lieu of planting followed by fallowing; (c) the use of technology or practices to improve the management of

nitrogen fertilizer use, including slow and controlled-release fertilizers (including absorbed, coated, occluded, or reacted fertilizers) and stabilized nitrogen fertilizers (including urease, nitrifi cation inhibitors, and nitrogen stabilizers) that are recognized by State regulators of fertilizers;

(d) reduction in methane emissions from rice cultivation; (e) reduction in carbon emissions from organically managed soils and

farming practices used on certifi ed organic farms; (f ) reduction in greenhouse gas emissions due to changes in animal

management practices, including dietary modifi cations and pasture-based livestock systems;

(g) resource-conserving crop rotations of at least 3 years; and (h) practices that will increase the sequestration of carbon in soils on crop

land, hayfi elds, native and planted grazing land, grassland, or rangeland; projects for changes in carbon stocks attributed to land management change, •including — (a) improved management or restoration of cropland, grassland, rangeland

(including grazing practices), and forest land; (b) avoided conversion that would otherwise release carbon stocks; (c) reduced deforestation; (d) management and restoration of peatland or wetland; (e) urban tree-planting, landscaping, greenway construction, and

maintenance; (f ) sequestration of greenhouse gases through management of tree crops; (g) adaptation of plant traits or new 11 technologies that increase

sequestration by forests; and (h) projects to restore or prevent the conversion, loss, or degradation of

vegetated marine coastal habitats;


projects that reduce emission reductions from manure and effl uent, •including — (a) waste aeration; (b) biogas capture and combustion; and (c) improved management or application to agricultural land; and projects that reduce the intensity of greenhouse gas per unit of agricultural •production. 56

Any person would petition the EPA to add project types to the list of acceptable projects, and the EPA would have twelve months to either grant or deny the petition. 57

4. Methodologies For each of the project types listed above and any others that the EPA, in consul-tation with the Department of Agriculture and the Off set Integrity Advisory Board, may permit to be used to produce off sets, the EPA would be required to develop what are known as “methodologies” to establish baselines if the project were not developed and then the tracking of greenhouse gas emission reductions aft er implementation of the project. 58 Th e methodologies must provide for several aspects:

Additionality, to show real emissions reductions; • Activity Baselines, to show the business as usual baseline if the project had •not been implemented; Quantifi cation Methods; • Leakage, to address the emissions from other operations or locations if the •project is implemented. 59

Th ese methodologies and the calculations and documents generated by them that would be submitted to the EPA would form the foundation of ensuring the integrity of the off set project and the off sets generated by the project. Review and validation and verifi cation by independent, third-party verifi ers of these docu-ments would provide another layer of assurance of the validity of the projects and the actual greenhouse gases off set, thereby, ensuring that the system is reducing emissions.

56. Id. at § 733(a)(3).

57. Id. at § 733(c).

58. Id. at § 734.

59. Id. at § 734(a).


Th e EPA is required by the statute to “give due consideration” to those methodologies that exist as of the time of enactment of the Act. 60 For example, the Executive Board of the Clean Development Mechanism under the Kyoto Protocol has established numerous greenhouse gas project type methodologies. Th e Climate Action Reserve created under the California climate statute and the Voluntary Carbon Standard has developed methodologies as well. Th e use of these methodologies by the EPA allows the agency to avoid reinventing the methodologies and allows the carbon market more effi ciency and continuity as once a methodology is developed and accepted, the market knows the issues and the requirements for developing a project and the rules for obtaining carbon credits in the form of off sets. Th e use of the preexisting methodologies would be a tremendous benefi t to the off set industry and the covered entities.

a. Additionality Additionality may be one of if not the most challenging aspect of developing a carbon off set project. Th is concept was designed to ensure that a project that is being submitted for carbon credits, off sets, would actually achieve a reduction in greenhouse gases that would have occurred without the carbon credits or the revenue that would be derived from the sale of carbon credits. Th e business as usual approach would not qualify as additional, but the greenhouse gas reduc-tions must be beyond business as usual.

Th e statute defi nes “additionality” as follows: “the extent to which reduc-tions or avoidance of greenhouse gas emissions, or sequestration of greenhouse gases, would be additional.” Th e term “additional” is defi ned as follows:

when used with respect to reductions or avoidance of greenhouse gas emissions, or to sequestration of greenhouse gases, means reductions, avoidance, or sequestration that result in a lower level of net greenhouse gas emissions or atmospheric concentrations than would occur in the absence of an off set credit.

Th is defi nition for purposes of establishing an off set project and the resulting off sets is actually a much longer test provided under the Act. Any greenhouse gas reduction, avoidance, or sequestration qualifi es as being additional only to the extent it results from activities that —

are not required by or undertaken to comply with any law, including any •regulation or consent order;

60. Id. at § 734(e).


were not commenced prior to January 1, 2009, except in the case of — • off set project activities that commenced aft er January 1, 2001, and were •registered as of the date of enactment of this title under an off set program with respect to which the President has made an affi rmative determination under section 740(a)(2); or activities that are readily reversible, with respect to which the President •may set an alternative earlier date under this subparagraph that is not earlier than January 1, 2001, where the President determines that setting such an alternative date may produce an environmental benefi t by removing an incentive to cease and then 5 reinitiate activities that began prior to 6 January 1, 2009;

are not receiving support under section International Clean Energy •Deployment Program of the statute, which provides funding for greenhouse gas reduction, avoidance, and sequestration projects in developing countries; 61 and exceed the activity baseline established for the project type, as discussed •below. 62

b. Activity Baseline In developing a methodology for a particular off set type, the EPA would include a standard protocol to set a conservative estimate of the business as usual perfor-mance or practices for the relevant type of activity, with an adequate margin of safety to ensure that the greenhouse gas reductions are real and the off sets have environmental integrity. 63

c. Quantifi cation Methods Each methodology would provide that the quantifi cation methods and equations for each project type exceed the activity baseline and provide the protocols for monitoring and verifi cation, which includes accounting for uncertainty in these quantifi cation methodologies. 64

d. Leakage As discussed previously in Chapter 3 (“Fundamentals of Cap and Trade”), the issue of leakage is that the reductions in one project are moved to another place or activity, such that no real reductions actually occur. “Leakage” is defi ned in the

61. Section 323 of the Proposed Legislation.

62. Id. at § 734(a)(1).

63. Id. at § 734(a)(2).

64. Id. at § 734(a)(3).


Act as “a signifi cant increase in greenhouse gas emissions, or signifi cant decrease in sequestration, which is caused by an off set project and occurs outside the boundaries of the off set project.” 65

Each methodology must provide for a means of accounting for and mitigat-ing against potential leakage from the specifi c project type and account for uncertainty in that process. 66

5. Accounting for Reversals Another potential concern with off set projects is the potential for the emissions to be reversed in terms of the emissions being emitted aft er all. “Reversal” is defi ned in the Act as “an intentional or unintentional loss of sequestered green-house gases to the atmosphere.” 67 Th e statute requires that the EPA develop mechanisms to account for, discourage, and to provide a means of compensating for any reversal. Th e President may establish off set reserves, insurance, or other mechanisms to compensate for and protect against reversals from sequestration activities. 68

6. Crediting Periods A “crediting period” is defi ned as “the period with respect to which an off set proj-ect is eligible to earn off set credits as” under the Act. 69 Th e number of years of a crediting period is set forth generally, but would be determined specifi cally by EPA regulation. 70 For most project types, the crediting period may not be less than fi ve years or more than ten. For forestry projects, the period shall not exceed twenty years. For term off sets, the crediting period may not exceed fi ve years. Th ese crediting periods would be of immense importance as the project devel-oper earns income from the greenhouse gas project based on the amount of credits generated from the project on an annual basis times the years the project generates credits.

7. Approval of Projects Th e EPA would issue regulations proscribing the requirements for submitting a petition for approval of an off set project. Th e statute provides little guidance

65. Id. at § 700(34).

66. Id. at § 734(a)(4).

67. Id. at § 700(48).

68. Id. at § 734(b).

69. Id. at § 700(14).

70. Id. at § 734(c).


as to what must be contained in a petition to approve an off set project, but requires the EPA to respond and either approve or reject the project within ninety days. 71 Th e Act provides that the EPA may establish through issuance of regulation for a voluntary preapproval review that is nonbinding on the agency. 72 As discussed in Chapter 13, under the Clean Development Mechanism (CDM) of the Kyoto Protocol, a party must submit a Project Design Document (PDD) and a third-party validation of the PDD to the Executive Board for a review and approval. A project developer would not initiate the project unless a project receives suffi cient review and approval to give the project developer enough confi dence that the carbon credits would be issued upon completion and submission of the verifi cation of the greenhouse gas reductions achieved by the project. Th e preapproval process may be helpful, but it should be binding to be of more assistance to the project developer and to assist in obtaining fi nancing for the project.

Th e Act provides for an appeal of determinations made by the EPA regard-ing approval of the project. 73 One of the problems under the CDM is that there initially was no appeal process, and once a project was denied approval by the Executive Board, no process was available to clarify or to attempt to change a potentially errant denial of a project.

8. Monitoring, Reporting, and Verifi cation Th e integrity of an emissions off set program depends in large part on the moni-toring, reporting, and verifi cation (MRV) requirements and their reliability. Th e fi rst step is the development of adequate methodologies for each project type, and then the MRV program determines whether the project actually results in any additional greenhouse gas reductions over time.

Th e statute requires that a project developer submit a report prepared by a third-party verifi er accredited by the American National Standards Institute or the EPA to verify the amount of greenhouse gases reduced or avoided through carbon credit projects. 74 Regulations would be required to be developed to pro-vide the components of the report, which at a minimum shall include the desig-nated representative of the project developer, the quantity of greenhouse gases reduced, avoided, or sequestered, the applicable methodologies, a certifi cation

71. Id. at § 735(c)–(d).

72. Id. at § 735(f ).

73. Id. at § 735(e).

74. Id. at § 736.


that the project meets applicable requirements, and a certifi cation that the confl ict of interest requirements of the verifi er have been met. 75

9. Issuance of Credits Issuance of credits under the process requires the submission of the verifi cation report as to greenhouse gas reductions, avoidance, or sequestration, and the President, probably through either the EPA for most project types or the Department of Agriculture for land use, agriculture, and forestry projects. Th e agency reviewing the verifi cation report must make a decision as to the veri-fi cation report within ninety days, which must

make the report publicly available, • determine the quantity of emissions reduced, avoided, or sequestered by the •project, notify the off set developer in writing of the decision and make such decision •publicly available. 76

Once the agency approves the verifi cation report, it must issue one off set credit for each ton of CO 2 e reduced, avoided, or sequestered,

which has already occurred, that is • ex post , not ex ante , which has occurred aft er January 1, 2009, • and issue such credits within two weeks aft er the determination has been •made as to the verifi cation report. 77

Th e agency may audit projects on an ongoing basis, off set credits, and of third-party verifi ers. 78

10. Early Off sets Since the statute follows carbon trading programs established by the states and would eff ectively take over the role of those programs, it was necessary for Congress to address the off sets created pursuant to those programs. Th e Act pro-vides that the President may through a public notice and comment process issue federal off set credits under the Act in the amount of one off set credit for

75. Id. at § 736(c).

76. Id. at § 737(a).

77. Id. at § 737(b), (d).

78. Id. at § 738.


each ton of CO 2 e reduced, avoided, or sequestered, that has not expired or been retired, and that meets the following requirements:

Derives from a project initiated aft er January 1, 2001, • For greenhouse gas reductions or avoidance occurring aft er January 1, 2009, •up to three years aft er the date of enactment of the Act or the date regulations establishing an off set program would be issued, Was issued under a regulatory or voluntary program the President determines •

was established under a State or tribal program initiated before January 1, •2009, and that program is approved by the President, in which standards, methodologies, and protocols have been developed •through public consultation or peer review process and made publicly available, established those standards, methodologies, and protocols requiring •off sets to be permanent, additional, verifi able, and enforceable, that the off sets are verifi ed by a state regulatory party or accredited •third party, credits are registered in a publicly accessible registry., • where the issuing entity, administrator, or representative was not involved •in the funding of the project;

Th e credit is transferred to the President in order to have a federal off set •credit issued in its place (the President will attempt to have the original credit retired under the program under which it was issued). 79

Other programs not established under a state or tribal program or not established prior to January 1, 2009, but that meet the requirements above may be approved as well. Th is provision would apparently apply to review of voluntary programs, such as the Voluntary Carbon Standard, the Chicago Climate Exchange, or the American Carbon Registry. Any petition to approve such a program must receive a decision within 180 days. 80

11. Environmental Considerations for Forestry or Land-Management Projects Th e Act provides specifi c environmental considerations that must be applied to domestic forestry or land-management projects through regulations that

Ensure native species are given primary consideration, •

79. Id. at § 740(a).

80. Id. at § 740(e).


Enhance biological diversity, • Prohibit the use of federally or state-designated noxious weeds, • With respect to forestry project, are conducted under widely accepted, •environmentally sustainable forestry practices, Ensure that the project area was not converted from native ecosystems, such •as forests, grassland, scrubland, or wetland that took place at least ten year prior to the enactment of the Act or January 1, 2009, whichever is earlier, and To the maximum extent practicable, ensures that the use of off set credits •would satisfy emission reduction commitments made by the United States under the United Nations Framework Convention on Climate Change. 81

Land use and forestry projects would likely provide a substantial percentage of off sets for trading and for compliance by covered entities.

12. Recordkeeping Records would be required to be kept by both project developers and third-party verifi ers. Th e following records must be kept for not less than the crediting period for the project plus an additional fi ve years:

any off set project approval petition submitted to the appropriate offi cials •under the off set approval process; any reversals which occur with respect to an off set project; • any verifi cation reports; and • any other aspect of the off set project that the appropriate offi cials determine •is appropriate. 82

13. International Off sets a. General Issues Th e EPA is required to issue regulations within two years of enactment of the statute governing the importation and use of international off sets for use in meeting compliance obligations under the Act, in consultation with the Department of State and the Agency for International Development (AID). 83 As discussed above in this chapter, the amount of international credits that may be imported into the United States and the amount covered entities may use to meet compliance obligations is limited.

81. Id. at § 741.

82. Id. at § 744.

83. Id. at § 744(a).


International off sets would be issued by the EPA. Th e regulations must proved that international off sets be issued by the EPA only if

the United States is a party to a bilateral or multilateral international •agreement or arrangement that includes the country of origin of the project that generated the emissions off set; the country of origin is a developing country; • the international agreement or arrangement including that country •

ensures that the requirements for off sets under the statute apply to the •issuance of international off sets; provides for the appropriate distribution of international off sets; • provides that the off set project developer is eligible to receive service of •process in the United States for all civil and criminal actions in Federal courts. 84

Th e criteria for international credits would be strict and the ability to serve the project developer would require that a project developer that intends to sell credits into the U.S. carbon market plan ahead and submit to such jurisdiction or this may force many of the project developers to be either U.S. entities or U.S. subsidiaries of foreign entities. Th is requirement may drive a substantial portion of project development offi ces to the United States.

As discussed above, the number of international off sets is limited in terms of the total amount per year that all covered entities may use and the amount any one covered entity may use. However, the EPA is permitted by the Act to allow more international off sets into the U.S. carbon market.

Th e EPA may not include in any international off set program any credits issued for the destruction of hydrofl uorocarbons. 85

b. Sectoral Credits Th ree categories of international off set credits may be allowed into the U.S. carbon market, sector based credits, credits issued by an international body, and forest-relaated credits. Th e category to be discussed in this subsection is sector-based credits. “Sectors” are industries or businesses that generate green-house gases from which off sets are developed. Th e Act defi nes the term “sectoral basis” as follows:

Th e issuance of international off set credits only for the quantity of sector-wide reductions or avoidance of greenhouse gas emissions, or

84. Id. at § 744(b).

85. Id. at § 744(h).


sector-wide increases in sequestration of greenhouse gases, achieved across the relevant sector or sectors of the economy relative to a baseline level of emissions established in an agreement or arrangement [entered into with one or more countries] for the sector. 86

Th e EPA shall identify sectors or combination of sectors within developing countries in which the issuance for the industrial or business sector is appropriate, and issue credits only on a sectoral basis for those activities. 87

For those countries that have relatively high comparative emissions, such as China, India, Brazil, Mexico, and South Africa (although these countries are not identifi ed in the Act), the sectors would be established if that industry or business sector if located in the United States generally would be subject to compliance obligations for greenhouse gas emissions. 88 Th e Act sets forth the cri-teria on which the EPA would determine, in consultation with the Department of State and the AID, for which sectors in which countries only sectoral credits would be issued. Th ese criteria include the gross domestic product, national greenhouse gas emissions, whether the sector would be regulated in United States, whether the sector sells products in the international markets, risk of leakage within the sector if off set credits were issued on project level versus a sectoral basis, capacity to monitor, measure, report, and verify emissions from the sector, ability to encourage countries to make national greenhouse gas reduc-tions, among other factors that the EPA may fi nd appropriate. 89 Specifi c criteria would be used to determine the baseline emissions for a particular sector. 90

c. Credits Issued by an International Body For international off set credits issued by an international body, the EPA again would exchange those credits for a U.S. credit, and seek to extinguish the interna-tional credit with the international body established under the UN Framework Convention on Climate Change (UNFCCC), if such program meets the requirements discussed above for international off set for imported into the U.S. carbon market and provides equal or greater integrity as the off set programs established under the Act. 91

86. Id. at § 744(c)(3)(A).

87. Id. at § 744(c).

88. Id. at § 744(c)(2)(A).

89. Id. at § 744(c)(2).

90. Id. at § 744(c)(3)(B).

91. Id. at § 744(d).


d. International Forest Off sets Th e statute allows international off set credits to be imported into the United States if they meet the other requirements for international off set credits for activities to reduce deforestation only if the activity occurs in

a country listed by the EPA in consultation with the State Department and •AID and which has entered into an appropriate international agreement or arrangement, as discussed above, that have the capacity to aff ect deforestation reduction activities at a national level and is taking part in deforestation activities, a state or province (of a country) listed by the EPA in consultation with the •State Department and AID and which has entered into an appropriate international agreement or arrangement, as discussed above, and is not part of the lower emitting countries listed by the EPA, that has the capacity to aff ect deforestation reduction activities at a national level and is taking part in deforestation activities; or a country listed by the EPA in consultation with the State Department and •AID and which has entered into an appropriate international agreement or arrangement, as discussed above, and emits less than 1 percent of total anthropogenic global greenhouse gases, and less than 3 percent of global greenhouse gas emissions from deforestation. 92

i. National Programs Th e fi rst category applies to most nations. Under this category, the quantity of international off set credits that may be issued by the EPA is based on the comparison of the national emissions from deforestation in that country to the national deforestation baseline that is established under an international agreement or arrangement, and that meets the baseline requirements of the Act.

To be eligible and be placed on the list established by the EPA, the country must demonstrate capacity to participate in deforestation reduction activities at a national level based on the following criteria:

Th e capacity to monitor, measure, report, and verify forest carbon fl uxes; • Th e institutional capacity to reduce emissions from deforestations, including, •among other things, independent third-party verifi cation and transparent and equitable distribution of off set revenues for local actions;

92. Id. at § 744(e).


Have a land use or forest sector strategic plan that • assesses national and local drivers of deforestation and forest degradation •and identifi es reforms to national policies needed to address them; estimates the country’s emissions from deforestation and forest •degradation; identifi es improvements in and a timeline for data collection, monitoring, •and institutional capacity necessary to implement an eff ective national deforestation reduction program (including a national deforestation baseline); establishes a timeline for implementing the program and transitioning •forest-based economies to low-emissions from forests and land use; institutes a program to provide for consultation and participation by •indigenous and forest-dependent communities; distributes revenues from activities to reduce deforestation transparently, •publicly, and overseen by independent third parties; includes a national registry for information relating to deforestation and •degradation policy. 93

In addition to meeting these national criteria, to be eligible for the deforestation credits, the countries must establish a national deforestation baseline that meets several criteria:

Is national in scope; • Is consistent with nationally appropriate mitigation commitments or actions •with respect to deforestation, based on average annual historic deforestation rates for at least fi ve years; Has a trajectory that would result in net zero deforestation in twenty years, •with a land use plan that identifi es intact and primary forests; Can be adjusted over time to refl ect changing circumstances; • Is designed to account for all signifi cant sources of greenhouse gas emissions •from deforestation; Is consistent with the national deforestation baseline, if any, under the •Deforestation Assistance Program for developing countries established under the Act. 94

93. Id. at § 744(e)(4).

94. Id. at § 744(e)(2).


ii. State- or Province-Level Programs Off sets generated from state and province level programs may be exchanged for U.S. credits if the state or province is listed by the EPA. Th e criteria would be as follows:

Th e country is not one of the developing countries with low-level emissions •in total and from deforestation listed by the EPA; Th e state or province is undertaking deforestation reduction activities; • Th e state or province has the capacity to engage in deforestation reduction •activities; including

Th e capacity to monitor, measure, report, and verify forest carbon fl uxes; • Th e institutional capacity to reduce emissions from deforestations, •including, forest governance and mechanisms to deliver forest conservation resources for local actions;

Th e country demonstrates eff orts to transition to a national program within •fi ve year and is making a good faith eff ort to develop a land use or forest program that meets the requirements for a national program under the Act, discussed above.

Th e issuance of credits would be based on the reductions compared to the state or provincial baseline established under the criteria for the national baseline discussed above.

Th e program would phase out aft er fi ve years from the fi rst calendar year for which a covered entity must demonstrate compliance under the Act. 95

iii. Program for Low-Emitting Countries Th e program for low-emitting countries allows the EPA to list those countries eligible for the exchange of avoided deforestation credits if the country is making a good faith eff ort to develop a land use or forest sector strategic plan and a monitoring plan for major forest areas in the country. 96 A project-level or program-level deforestation baseline may be used, and either project-level or program-level off set credits may be exchanged as U.S. off set credits. 97 Th e low-emitting country deforestation program would phase out aft er eight years from the fi rst calendar year for which a covered entity must demonstrate compliance

95. Id. at § 744(e)(5)(D).

96. Id. at § 744(e)(6).

97. Id. at § 744(e)(6)(B)–(C).


under the Act. 98 Th e EPA may extend this program for up to fi ve years for least-developed countries where the country lacks capacity to develop a deforestation reduction program and the country is receiving assistance under the Act to develop such capacity. 99

iv. Project-based Deforestation Reduction Credits Th e statute primarily discusses national or state/province-level off set credits for deforestation reductions. Th e Act provides that the EPA may issue a portion of the total quantity of available credits under the national or state/provincial pro-gram directly to a project developer for activities that contributed to a reduction in emissions. 100 Th e issuance must be authorized by the international deforesta-tion program under the relevant international greenhouse gas reduction agreement or arrangement with the United States, and the credits must be issued under a state/provincial program by a state/provincial government. 101 What is unclear is whether the project-level credit process would be phased out with the state/provincial program as provided under the Act, and discussed above.

v. Forested Wetlands and Peatlands Th e EPA may be rule expand the scope of the deforestation programs to include forested wetlands and peatlands. Wetlands and peatlands may contain large amounts of sequestered greenhouse gases, and when disturbed or burned may release CO 2 and methane in large quantities. Protection of these ecosystems, therefore, is critical to reducing greenhouse gas emissions in the same way as preserving forests.

L. Compliance with Greenhouse Gas Emission Requirements 1. Compliance Obligations Th e compliance obligations in terms of the cap on the emissions and the require-ment to hold emission allowances or off set credits that equal the annual emissions in a particular year would be phased in for various types of covered entities over time. Th e covered entity may not in combination emit greenhouse gases and have greenhouse gas emission attributable to it in excess of its allowable

98. Id. at § 744(e)(6)(D)(i).

99. Id. at § 744(e)(6)(D)(ii).

100. Id. at § 744(e)(7).

101. Id. at § 744(e)(7)(A)–(B)


emissions level, which is the number of emissions allowances or off set credits it holds as of 12:01 a.m. on April 1 of a compliance year. 102

2. Phase in of Compliance Obligations for Certain Covered Entities Generally, all covered entities must be in compliance by 2013. 103 Some categories of covered entities would not be required to be incompliance the fi rst year, but would be phased into the program over time.

One group of covered entities known as “Industrial Stationary Sources” must comply by 2014. Th is group encompasses the following categories of covered entities:

Any stationary source that has emitted 25,000 or more tons of carbon •dioxide equivalent of nitrogen trifl uoride in 2008 or any subsequent year; Adipic Acid Production; • Primary Aluminum Production; • Ammonia Manufacturing; • Cement Production: excluding grinding-only operations; • Hydrochlorofl uorocarbon Production; • Lime Manufacturing; • Petroleum Refi ning; • Nitric Acid Production; • Phosphoric Acid Production; • Silicon Carbide Production; • Soda Ash Production; • Titanium Dioxide Production; • Coal-based Liquid or Gaseous Fuel Production; • Any chemical or petrochemical source that produces acrylonitrile, carbon •black, ethylene, ethylene dichloride, ethylene oxide, or methanol; or emits 25,000 tons of CO 2 e or more per year. emissions sources that is regulated includes those that emit 25,000 tons of •CO 2 e per year and would be specifi cally identifi ed in the defi nition of Covered Entity. Th is group of sources is identifi ed as follows:

Ethanol production • Ferroalloy production • Fluorinated gas production • Food processing •

102. Id. at § 722(a).

103. Id. at § 722(b).


Glass production • Hydrogen production; • Benefi ciation or other processing (including agglomeration) of metal ores; • Iron and steel production • Lead production • Pulp and paper manufacturing • Zinc production •

Any fossil fuel-fi red combustion device (such as a boiler) or grouping of such •devices that —

is all or part of an industrial source not specifi ed in the categories of the •covered entities above, and has emitted 25,000 or more tons of carbon dioxide equivalent in 2008 or •any subsequent year.

Certain other categories would be phased in over time as well. Small business refi ners must comply by 2015. Natural gas local distribution companies must comply by 2016.

For certain entities, the emissions or those attributable to them would be net of certain emissions from fuels for which allowances or off set credits have already been purchased, for example, if a supplier of petroleum-based or coal-based liquid fuel has already assigned allowances for the emissions from the future burning of the fuel, then the party burning it would not need to hold allowances for the emissions the actual burning of the fuel. 104

Th e degree to which emissions would be regulated from biomass fuel derives from the source of the CO 2 the plants convert through photosynthesis into biomass. Generally, allowances would not be required for the burning of biomass or gas derived from biomass, as the CO 2 originates from the atmosphere and is then returned to the atmosphere so no net increase in greenhouse gas emissions in the atmosphere occurs. When the source of the CO 2 uptake by plants is from a covered entity that would add net greenhouse gas emissions the outcome is diff erent. Allowances must be obtained to address the emissions of CO 2 from the burning of algae that is made into a fuel if the CO 2 is derived from emissions from a covered entity. Th ose allowances must be obtained for the CO 2 at the point emitted from the covered entities or at the CO 2 is generated by burning the algal fuels. 105

“Fugitive emissions” generally would be excluded from cap and trade pro-grams. Th is term is defi ned under the Act as “emissions from leaks, valves, joints,

104. See, e.g. , id. at § 722(b)(6).

105. Id. at § 722(b)(10).


or other small openings in pipes, ducts, or other equipment, or from vents.” 106 Th ese emissions initially would not be covered under the Act, although the EPA may enact regulations to cover them if the EPA determines the CO 2 e value of emissions can be adequately measured “to ensure the integrity of emission allowances, the allowance tracking system, and the limits on emissions.” 107

No allowances or off set credits would be required if the fuels are exported for sale or use. 108

M. Trading Allowances and Off sets Th e statute provides that the holder of an allowance or off set “may, without restriction, sell, exchange, transfer, hold for compliance . . . or retire” such allow-ance or off set. 109 Generally, such ability is not restricted under the Act, except in certain situations such as the Market Stability Reserve or the Small Business Refi ners Reserve, so that any party may own and trade allowances and off sets. 110 Th e actual legal transfer of an allowance or off set is not eff ective until the certifi cation of the designated representative of the transferor is received and recorded by the EPA in accordance with the regulation promulgated by the EPA. 111 Th is is a critical aspect of the trading system and title to such allowances and credits as would be discussed in more detail in Chapter 14 (“Carbon Finance”).

N. Banking Allowances Th e concept of banking of emission allowances and off sets is that the emission credits do not expire in the year they would be issued, but may be used in future years. Banking may be for a few years or be unlimited. Th e allowances issued under the statute have unlimited banking potential, and may be used in any year aft er they would be issued. 112 Th e EPA by regulation, however, may establish expiration dates if necessary “to ensure the authenticity of allowances or credits

106. Id. at § 700(25).

107. Id. at § 722(b)(11).

108. Id. at § 722(b)(12).

109. Id. at § 724(a)–(b).

110. Id. at § 724(b).

111. Id. at § 724(c).

112. Id. at § 725(a).


or the allowance tracking system.” 113 It must be recalled that some allowances — for example, those that would be purchased pursuant to the Market Reserve and the Small Business Refi ners Reserve — may not be banked, but must be turned into the EPA for retirement for compliance purposes in the year purchased.

O. Borrowing Allowances Another important concept of the statute is “borrowing.” An allowance may be used in the calendar year preceding the vintage year without “interest,” and may be used for one to fi ve years prior to the vintage year up to 15 percent of the allowances needed for compliance, but in such circumstances an 8 percent interest rate is charged in terms of additional allowances that must be paid for each year the allowance is borrowed. 114 Th ree key issues must be kept in mind in borrowing. First, the allowances must be those issued by the EPA — they cannot be international allowances or off sets. Second, the allowances being borrowed from future years must be owned by the borrower, not a third party. Here the allowances could be transferred from say a related entity, a sort of inter-company transfer, or purchased from a third party, but the price might be too high for such a transaction to make sense, depending on the market price for allowances at the time. Th ird, as with banking, some allowances, as mentioned above, that would be purchased pursuant to the Market Reserve and the Small Business Refi ners Reserve, may not be borrowed, but must be turned into the EPA for retirement for compliance purposes in the year purchased.

P. Safety Valve International Competitiveness Th e term “safety valve” refers to a price cap or other means of preventing the price of allowances from rising beyond a certain point. While sought by covered entities, no safety valve was provided for under the Act. However, the Market Stability Reserve to allow additional credits to be bought provides for a sort of loose cap on prices as the minimum price is $28 per ton. As a result, it may be possible for covered entities to always purchase allowances at this price, thus cre-ating a form of cap on prices. Th e Small Business Refi ners Reserve provides another means for that group of entities to reduce their costs of compliance.

113. Id. at § 725(b)(1).

114. Id. at § 725(b)(2).


1. Program to Provide Additional Allowances for Industrial Sources Facing International Competition Other programs under the Act would be designed to address the potential for leakage in the form of greenhouse gas–emitting industries and activities of moving from the Untied States to China or other countries without greenhouse gas regulatory systems that cap facility emissions. One of these programs is entitled “Ensuring Real Reductions in Industrial Emissions.” Th is program allows the granting of additional allowances for industrial sources of greenhouse gas emissions where the energy or greenhouse gas intensity of the product would create an international competitive advantage to those manufacturers in coun-tries that do not have similar greenhouse gas reduction requirements. 115

Covered entities that may take advantage of this program would be those the EPA identifi es out of a group referred to as the “Industrial Sector.” Th is group is the manufacturing sector as defi ned in the industrial codes NAICS 31, 32, and 33, or is part of, or an entire, sector that benefi ciates or otherwise processes (including agglomeration) metal ores, including iron and copper ores, soda ash, or phosphate, but does not include any part of a sector that extracts metal ores, soda ash, or phosphate. 116 Petroleum refi ning is excluded from this group. Th e EPA must identify an initial list of “Eligible Industrial Sections” by June 30, 2011. 117

Covered entities that would be part of an Eligible Industrial Sector may receive additional allowances for each vintage year based on their direct and indirect (such as electricity consumption from fossil fuel electric power plants) carbon factors. 118 Th e method for deriving the carbon factors and, thereby, the number of allowances a covered entity in an Eligible Industrial Sector may obtain for any particular vintage year is set forth in the Act. 119

2. Use of Sectoral Approach for the Importation of International Off set Credits Th e program to allow the importation of international off set credits into the United States on a sectoral basis, as discussed above in section K (“Off sets”), is another means of addressing the international competitiveness concern.

115. Id. at § 761.

116. Id. at § 762(3).

117. Id. at § 763(a).

118. Id. at § 764.

119. Id. at §§ 763-64.


Th e sectoral approach only allows off sets of emissions from entities in a sector if the overall industrial sector is reducing its total emissions from a projected baseline. Th us, a developing country that has signifi cant emissions, such as China, India, Brazil, Mexico, or South Africa, would only be able to take advantage of off set projects and off set credits for importation into the United States if the country implements a program to reduce greenhouse gas emissions from its industrial sectors.

Q. Supplementarity and Linkage to Other National and International Trading Systems Carbon off sets present many issues with respect to the “import” of those off sets into a developed country. One of those concerns is that if an unlimited amount of inexpensive off sets can be purchased by a regulated facility under a cap and trade regime, then the facility would simply buy suffi cient off sets and avoid any pressure to reduce their own emissions. Th e concept of a limit on the amount of international carbon off sets that may be purchased and utilized by a domestic facility is known as “supplementarity.”

Th is issue is discussed above in this chapter. Th e amount of international off set credits that would be allowed into the United States is capped in total. In addition, the amount of international off set credits that may be used by any one entity is capped as well. Th us, the use of international off set credits is capped, and they serve only as a supplement to the cuts that would be supposed to be made by the covered entities.

Th e ability to trade emission allowances between developed countries is another aspect of greenhouse gas cap and trade programs. Th is term, as discussed in Chapter 3, is called “linkage.” Linkage allows two trading systems to engage in international commerce in carbon credits between the countries. Th e term linkage relates in part to the linking of the two computer databases or registries of the two countries such that the trading can occur.

Th e statute would allow the EPA to allow linkage with certain international climate change programs to reduce greenhouse gas emissions. In order to do so, the Act requires that the other program be operated by a national or suprana-tional foreign government (meaning the European Union, as an example of multiple countries) that imposes a mandatory absolute tonnage limit on green-house gas emissions or one or more economic sectors and is at least as stringent as the U.S. program. 120 To operate eff ectively, if an allowance is retired in the

120. Id. at § 728(a)(1)–(2).


United States, there must be a program to retire the allowance in the country of origin. 121 Th e EPA may in the implementing regulations or subsequently issue modifying regulations that limit the percentage of international emission allowances that may be used. 122

R. Early Action Companies have been encouraged to take early action before a regulatory program goes into eff ect, and the concern is that these companies should not be punished, but rather rewarded for their action prior to the statute going into eff ect. Th e Act addresses this issue through provision of additional allowances to the companies that have engaged in early action.

Th e program addresses early action in two ways. First, entities that have obtained state or voluntary allowances or off set credits may apply for allowances under the Act. 123 Under the fi rst scenario, the allowances granted would be for an amount refl ecting the average monetary value of the credits between January 1, 2006, and January 1, 2009. 124 Second, an entity that did not obtain allowances or off sets, may apply for allowance credits if:

the entity publicly stated its greenhouse gas reduction goals and publicly •reported actual emissions; the entity demonstrated entity-wide net greenhouse gas reductions; and • the entity demonstrates the actual projects or process improvements resulting •in reductions and provides documentation of those reductions. 125

Emission allowances for early action demonstrations without state or voluntary carbon credits would be provided allowances equal to the approximate CO 2 e value received by entities that received credits in the fi rst group that held state or voluntary credits. 126

A few other provisions apply to this program. 127 Th e exchange for allow-ances may only occur if the credits have not been retired, used to meet a voluntary

121. Id. at § 728(c)(2).

122. Id. at § 728(d).

123. Id. at § 782(a)(1).

124. Id. at § 782(b)(1).

125. Id. at § 782(a)(2).

126. Id. at § 782(b)(2).

127. Id. at § 782(b)(3)–(6), (c).


or mandatory commitment, or have expired. Once issued, the credit must be retired for purposes of use for which it was originally issued. Th e exchange must occur within a deadline set by the EPA. Participation in this early action program does not preclude an entity in participating in an off set program discussed above.

S. New or Expanded Facilities One of the great challenges, and that raises opposition among industry and business groups, is the concern about the cap not on emissions, but on domestic economic growth.

Under the program for industrial sectors that may be aff ected by interna-tional competition from countries that do not have a greenhouse gas regulatory system, the Act provides for the distribution of emission allowance rebates for the fi rst and second years of operation of a new entity in an eligible industrial sector, and other distributions consistent with the program for existing entities. 128

T. Regulatory Agency or Agencies 1. Regulation of Greenhouse Gas Emissions Under the Act, the EPA is the main entity regulating greenhouse gas reporting, permitting, and issuance of allowances and off sets. Th e Department of Agriculture would serve to establish the program for off sets for land use, agriculture, and forestry.

2. Regulation of Trading of Allowances and Off sets Regulation of trading of allowances and off sets, in other words, the fi nancial aspects of the transactions, would be fi rst managed by the EPA in terms of maintaining registries of the carbon allowances and off set credits, tracking own-ership and title to credits, and retirement of credits, and international trading of credits into the United States.

Regulation of trading in terms of fraud or misfeasance, trading markets, and fi nancial instruments would not be an area of expertise of an environmental agency, would be managed by the Commodities Futures Exchange Commission.

128. Id. at § 764(b)(1)(C).


U. Enforcement Facilities that fail to submit adequate carbon allowances or off sets would face potential sanctions by the EPA. Under the statute, parties would face up to $25,500 per day per violation administrative proceedings, civil, and criminal sanctions, as Section 113 of the Clean Air Act that contains the enforcement sec-tions have been amended to provide for enforcement under the new Title VII of the Act. 129 Th us, facilities would have an incentive to turn in carbon allowances or off sets in order to avoid these penalties that would by design cost the facility more than the price of an allowance or off set.

Specifi cally, the statute provides for a penalty for failure to hold suffi cient allowances or off sets for a covered entities’ emissions for the prior year. Each ton of CO 2 e that the covered entity fails to hold would be a separate violation, and the amount paid shall be equal to the product of the tons of CO 2 e emitted or attributable to the covered entity that the owner or operator failed to hold on the relevant deadline and twice the fair market value of the emissions established for the emissions allowances for the calendar year for which the emis-sions allowances were due. 130 In addition, the owner or operator of the covered facility would remain liable for any other fi ne, penalty, or assessment arising under the Act, and would be required to off set the emissions emitted by or attributable to the covered entity’s excess emissions the following calendar year. 131

129. 42 U.S.C. 7413.

130. Proposed Legislation, § 723(a)–(b).

131. Id. at § 723(b)–(c).

P A R T T H R E E

Carbon Project Development and

Carbon Finance


12

Carbon Credit Project Types and Methodologies

A. Introduction to Carbon Credit Project Types and Methodologies Th e general description of carbon credit standards and issues is important, but the creation or generation of carbon credits arises from the type of project actually implemented. Th e application of the general standards, whether under the European Union Emissions Trading Scheme (EU ETS), the Clean Development Mechanism (CDM), or a voluntary standard to a specifi c project, is where the real challenge for the project developer arises. To the novice, the creation of carbon credits appears somewhat easy: reduce greenhouse gases and the credits are generated. Th is is simply not the case. Th e generation of carbon credits through developing a project and applying for validation by a third party and the carbon standards board or entity is by no means an easy, straight-forward, or necessarily guaranteed process.

Th e fi rst challenge is that if there is no established methodology for a project, then no carbon credits can be generated. A methodology must fi rst be developed and approved by the relevant carbon standard entity. Fortunately, the Voluntary Carbon Standard Association (VCSA), for example, accepts the methodologies of the CDM. One of the questions of the U.S. system is whether the CDM methodologies or state methodologies will be accepted by the U.S. agencies that will be approving and issuing U.S. carbon credits and off sets. Th e other problem is that generation and approval of methodologies, at least within the CDM, has been a very slow process, taking a year or more to be approved. Th e streamlining of this process would greatly enhance the development of proj-ects that reduce greenhouse gas emissions at international and national levels.

176 | CARBON PROJECT DEVELOPMENT AND CARBON F INANCE

Th e second challenge is that even where a methodology exists, not all projects will be validated by a third-party verifi er or approved by the CDM Executive Board or by other standards entities. Projects may be disapproved for a variety of reasons. One of the most common reasons is the failure to estab-lish additionality — that the carbon credit generation and revenue were necessary to enable the project to go forward. Th e failure to show the project was beyond business as usual can cause a project to fail to obtain approval.

Th e development of the project design document is thus critical for each carbon credit project. Demonstrating the greenhouse gas (GHG) reductions is only one part of this process. A variety of other factors will play a role in obtain-ing the validator’s and verifi er’s approval and then the approval, in some cases, of the carbon credit standards crediting board.

B. Methodologies for Developing Carbon Credit Project Types As explained above, a carbon credit project has no value in terms of generating carbon credits if there is no approved methodology for that specifi c type of project. For example, if one were to reduce greenhouse gases from a landfi ll, but there was no methodology by which a party could prove the baseline and demonstrate the reduction of greenhouse gases initially and over time through monitoring, then there would be no means to develop the project and have a standards board issue carbon credits.

Methodologies are the protocols by which the project developer “proves up” his or her project. Th e CDM methodologies provide the currently most advanced system for demonstrating this process. Under the CDM, the Executive Board has fi rst approved various tools to use in developing baselines and monitoring projects. Th e tools approved so far are as follows:

Tool for the demonstration and assessment of additionality; • Combined tool to identify the baseline scenario and demonstrate •additionality; Tool to calculate project or leakage CO • 2 emissions from fossil fuel combustion; Tool to determine methane emissions avoided from disposal of waste at a •solid waste disposal site; Tool to calculate baseline, project, and/or leakage emissions from electricity •consumption; Tool to determine project emissions from fl aring gases containing •methane;

CARBON CREDIT PROJECT TYPES AND METHODOLOGIES | 177

Tool to calculate the emission factor for an electricity system; and • Tool to determine the mass fl ow of a greenhouse gas in a gaseous stream. •

One or more of these tools may be cited in the methodologies that have been developed and approved by the Executive Board.

Each methodology generally addresses several issues. First, the specifi c defi nitions will be stated that may apply to the project types that the method-ology will address. Second, the applicability of the standard to specifi c projects will be explained. Th ird, a baseline methodology procedure to determine the greenhouse gas emissions that would be emitted in the absence of the imple-mentation of the project will be described. Fourth, the means by which addition-ality will be shown is provided. Fift h, equations to calculate the baseline and project reductions in greenhouse gases will be included. Th e potential for leakage, where emissions move from the project to some other location, may be discussed, and how it must be addressed in order to prove the existence and amount of reductions. A monitoring methodology will then be provided, and the data and parameters to be monitored will be described.

Other standards boards, such as the Voluntary Carbon Standard Association (VCSA) and the American Carbon Registry will oft en accept the methodologies established under the CDM. Th e other standards boards will also allow for the creation of new methodologies or the modifi cation of existing methodolo-gies, such as CDM methodologies. Th e VCSA allows for a double-approval process whereby one validator reviews both the new or modifi ed methodology and the Project Design Document (PDD), and a second validator also reviews and comments on the new or modifi ed methodology. Th e two validators must both approve the new methodology.

C. Carbon Credit Project Types Th ere are numerous types of carbon credit project types. Th is chapter will discuss some of the more prominent or interesting of these project types.

1. Renewable Energy Renewable energy may take several forms. Wind, solar, biomass, geothermal, wave and tidal, landfi ll gas, and hydro are some of the main types of renewable energy. Th ose for which a methodology has been approved under the CDM include the following;

biomass; • landfi ll methane recovery; •


wind; • solar; • geothermal; and • hydropower. •

With the growth of renewable energy, this project type has the potential for substantial expansion. One of the challenges with the sector growth is with addi-tionality. Questions have arisen with the CDM Executive Board with wind energy projects in China and whether they are truly additional or the project would have been built without carbon credits, as there has been a signifi cant expansion of wind energy in China. Th e additonality challenge to these projects raises questions to some with the concept of additionality or how it is applied. Clearly, wind energy that replaces coal reduces greenhouse gas emissions. To not grant carbon credits once the industry gets off the ground and starts to grow would suggest only the early-entry projects will get credits in a country, and the later entrants will be denied credits. Th is may to some seem counterintuitive and counter to the goal of reducing greenhouse gas emissions and switching a signifi cant percentage of power production to renewable energy sources.

2. Energy Effi ciency Energy effi ciency provides one of the more intriguing project types. Under the CDM, methodologies for energy effi ciency projects have been established. Th ese projects evaluate the reduction in electrical usage for a particular facility or groups of facilities. Th e greenhouse gas emission reductions are “indirect” in the sense that they account for the reductions not at the location where energy effi -ciency is increased, but through the reduction of the power produced from the electrical grid from which the facility obtains its electricity.

Th e calculations involve both the reduction in power produced, and the loss of electricity along the transmission and distribution lines to the facility. Th is accounts for the total electricity that must be produced to provide the fi nal received power at the particular location. In general, these calculations are made through factors for carbon or greenhouse gases produced by the grid in the respective state or country, and the line losses for that particular area. Th ese are calculated by third-party entities or government agencies, such as the Energy Information Administration in the United States for U.S. states.

3. Landfi ll, Oil and Gas, and Other Methane Projects Landfi ll methane gas recovery projects have been one of the most popular forms of carbon credit projects. Landfi lls that serve as the disposal point for municipal


waste produce a signifi cant amount of methane from the degradation of organic material, such as food waste, in the garbage received by the landfi ll and buried underground. Th e methane migrates up through the soil and is emitted into the atmosphere. As methane is a greenhouse gas, the reduction of its emissions serves as a potential carbon credit project.

Th e projects are attractive, as has been discussed above, because methane is considered a much more potent greenhouse gas than CO 2 — resulting in a 21 times multiplier for methane in terms of carbon credits that may be produced for each ton of methane reduced.

Th e CDM developed methodologies for this type of project early on in the program. Th e projects may address methane reductions in several ways. First, the methane may be fl ared so that the methane is burned and converted into CO 2 . Second, the methane may be burned in turbines that in turn produce electricity. Th ird, in some cases, the methane may be processed so that contami-nant gases are removed and the methane placed in a pipeline to a distribution system or directly to a point of use, such as a nearby factory, or, in some cases, some of the methane may be used as a transportation fuel where buses, trucks, or other vehicles are able to burn the gas in their engines.

In terms of carbon credits, since CO 2 is formed from burning the methane, a complete 21 times multiplier may not be available because the emissions of the CO 2 must be deducted from the emissions of methane avoided. Despite this reduction, landfi ll gas projects and other methane reduction projects provide signifi cant opportunities for higher profi t carbon credit projects as a result of the multiplier eff ect.

4. Natural Gas Production and Distribution Projects As pointed out, a landfi ll has a 21 times multiplier for carbon credits when the emissions are reduced. Methane reduction projects as a result are sought-aft er projects. Th e production and transportation and distribution of natural gas pro-vide a signifi cant opportunity for carbon credit project. Th e reason is that some degree of natural gas leaks out of the systems for producing and transporting natural gas to the ultimate end user. Steps to reduce these leaks result in less meth-ane being emitted to the atmosphere and provide an opportunity to obtain carbon credits from those reductions.

Another opportunity arises from fl ared or vented natural gas. An astound-ing amount of natural gas is either vented directly to the atmosphere or fl ared as there is no feasible market or transportation system available to transport the gas to a market. To the extent the gas can be captured and piped to a market for use, documentation of a reduction in greenhouse gas emissions may be possible.


One of the largest amounts of carbon credits issued from a single project under the CDM resulted from the Rang Dong off shore oil fi eld in the waters off of Vietnam. Th e project involved the capture of the methane that had been fl ared and then piping it into the shore for burning as a heating fuel. Th e project was submitted to the Executive Board for approval as a carbon credit project. Th e Executive Board granted 4.43 million Certifi ed Emission Reductions (CERs). Th e value on at the time was approximately 15 euros per CER, which would have been 66 million euros or US$103 million.

As is clearly evident, methane reductions in the oil and gas industry have a tremendous potential for producing carbon credits through established methodologies.

5. Fuel Switching Methane plays a role in another carbon credit project type called fuel switching. Th is project type is fairly broad. Th e idea is that when a lower carbon fuel is sub-stituted for a higher carbon fuel, the diff erence may be used to calculate the reduction in greenhouse gas emissions. Methodologies exist for these fuel switching projects. For methane, it can be used to substitute for coal or diesel in electricity production and reduce greenhouse gas emissions, or for gasoline or diesel in vehicles to again reduce greenhouse gas emissions.

One of the other fuel switching opportunities is in the form of biomass use in place of fossil fuels. A specifi c example is the substitution of wood pellets pro-duced from waste wood for coal in a coal-fi red power plant. Since the carbon in the wood is pulled from the atmosphere by trees, the emission of carbon from the burning of the wood does not add to net atmospheric carbon. Of course, if you were to cut down the rainforests to produce the wood, this may not be a net reduction. Th e discussion below will describe avoided deforestation projects to produce carbon credits.

6. Agriculture, Forestry, and Land Use a. Avoided Deforestation and Reforestation Forest projects are a much more complicated type of project for a number of reasons. Th e discussion of this area will be more detailed as the potential source of credits is so large. Forests are a signifi cant storing house for carbon and when burned, release a large amount of carbon dioxide and other greenhouse gases into the atmosphere. As a result, forests provide the low-cost approach for the fi rst tranche in anthropogenic greenhouse gas reductions as we seek the “low hanging fruit” in terms of low-cost, large-volume off sets. Forest preservation and regrowth provide the potential for the larger-volume and lower-cost source of greenhouse gas reductions and off sets for greenhouse gas emissions. As carbon


capture and storage by which CO 2 from coal-fi red power plants and other sources is injected underground for long-term storage takes several years to bring on line, Reducing Emissions from Deforestation and Forest Degradation (REDD) can serve to make a signifi cant step toward emissions reduction to be achieved by 2020 as is being discussed in Congress for a U.S. climate change and cap and trade program, and in terms of international negotiations for a treaty to follow the Kyoto Protocol.

Th e size of the emissions from forest destruction is startling. In gross and relative terms, it is rather astounding. Th e destruction of forests actually accounts for somewhere between 17 and 22 percent of human greenhouse gas emissions. Th us, controlling the greenhouse gas emissions from deforestation is critical to any global plan to reduce climate change, particularly in the fi rst few years as costlier reductions are developed, and perhaps ways to reduce those costs. Th e amount of greenhouse gas emissions from deforestation exceeds the amount of emissions from all transportation activities.

A second aspect of deforestation relates to the areas that have already been lost or signifi cantly degraded. For example, farmland that was previously what we call “primary forest” — forest that existed in its natural state prior to being deforested or degraded. In these areas, opportunities exist for reforesting the land through tree planting. Two types of reforestation are possible. First, the forest can be replanted with native species that would have been present prior to the destruction of the forests. Th e second involves the planting of non-native species or otherwise planting for the purpose of harvesting some or all of the trees. Th e second approach has the goal of using trees to absorb or sequester CO 2 , and then using the harvested wood in ways that maintain the carbon in building or other products for a signifi cant period of time.

In understanding the challenges of private development of forest carbon projects, it is important to comprehend the issues of these projects. First, let us consider avoided deforestation projects. One of the fi rst issues is simply measur-ing the amount of carbon in the forests that would be released if destroyed. Th ere are certain protocols that can be used now developed by the Voluntary Carbon Standard Association (VCSA), which has become the main standards-setting organization for forest-related off set projects internationally, or the Climate Action Reserve (created by the State of California), which is the primary standard for domestic forest projects in the United States.

Another issue is the question of permanence . For growing forests, a signifi -cant risk is permanence, that is, to what extent will the forest be preserved over a very long period, as opposed to short-term preservation with destruction to follow. If the forest is logged or it burns or dies from disease, then the carbon sequestered in the trees, plant life, and soil, largely will be emitted to the


atmosphere and future sequestration of carbon dioxide will not occur. Th e carbon credits that are generated would be without substance if aft er fi ve years the forest is destroyed. Forestry projects are largely long-term projects, lasting twenty to one hundred years in most cases. Parties must show the registration entity and the verifi ers that review the Project Design Document that the forest will not be cut down, burned, or harvested within the relevant project period. One approach used by the VCSA to address permanence concerns is to hold back a percentage of the verifi ed credits and to release them back over time, say the thirty-year life of the project, to the project developer.

One of the other major concerns for forest projects is leakage . For forest projects, leakage involves the question of whether the reduction in deforestation or degradation in one area results in that activity moving to a nearby property or one a signifi cant distance away. As an illustration, burning forests for soybean farming, which is such a signifi cant problem in Brazil, moves from one part of a state in a country where actions have been taken to stop such burning to another area in that state or to another state. Measuring and addressing these issues is required by the VCSA.

Th ough the real game right now for REDD and reforestation projects lies with the VCSA, Climate Action Reserve (CAR), and voluntary carbon credits, it appears fairly clear that forest carbon projects will play a role and be a large part of future compliance markets. Current U.S. federal legislation that has passed the House of Representatives, California legislation, and the three multi-state climate change regulatory programs that are evolving will include forest carbon as an off set type. Th us, even if Congress does not act to pass climate change legisla-tion, a signifi cant number of states will implement programs that include forest carbon off sets.

Th e discussions at the international level appear to be moving toward accepting forest-based off set credits. Th e Kyoto Protocol as implemented by the United Nations allows a limited use of forest carbon from reforestation. Discussions are moving forward in terms of expanding the use of forest off sets from avoided deforestation through a REDD mechanism to be implemented under the Kyoto Protocol or its successor treaty.

Th e greenhouse gas emissions from forest destruction are so massive, that we cannot avoid taking on the need to reduce this destruction dramatically. More and more major greenhouse gas emitters in the United States are beginning to review this opportunity and to look at investing in project-based REDD opportunities. Th e thinking is that investment in a project or entering into emission-reduction purchase agreements that allow a company to have a right to purchase REDD credits once approved and verifi ed, provides a good hedging mechanism for future off set prices. More and more companies are looking at


both domestic and international forest carbon projects either as project develop-ers or as investors to ensure that they take advantage of the opportunities that forest carbon projects provide. For utilities and refi ning companies that face signifi cant risk in a compliance system governing GHG emissions and need to purchase signifi cant amounts of allowances or off sets, carbon credits generated from avoided deforestation have the potential to supply large amounts of credits at lower prices. As a result, many of these companies have been evaluating invest-ment in forest carbon projects.

Th is section of the book will explore in more detail the standards that have emerged for projects that are designed to allow the development of carbon credits from forest preservation and protection.

i. The Voluntary Carbon Standard Agriculture, Forestry, and Other Land Use Guidance Th e Voluntary Carbon Standard (VCS) has emerged as the leading international standard on forest carbon credits. Th e VCS has invested signifi cant amounts of time to develop the guidance for Agriculture, Forestry, and Other Land Use (AFOLU) projects. In this guidance, four types of activities are covered.

Aff orestation, Reforestation, and Revegetation; • Agricultural Land Management; • Improved Forest Management; • Reducing Emissions from Deforestation and Degradation. • 1

Th is subchapter will focus on the three forest-related projects. Other land use projects will be discussed in a separate subchapter.

Reducing Emissions fr om Deforestation and Forest Degradation (REDD) can be broadly defi ned, as the name implies the destruction of natural forest or the degradation of those forests. For example, the burning of forests for crop land would be considered destruction and the logging of a signifi cant number of the trees in a particular forest tract would be considered degradation. Th e VCS AFOLU standard further divides REDD into three subcategories:

1. Avoiding planned deforestation (APD), where the plans have been authorized by the relevant governmental body;

1. Voluntary Carbon Standard, Tool for AFOLU Methodological Issues, at 2–3, Nov. 2008 (here-inaft er VCS AFOLU Tool).


2. Avoiding unplanned fr ontier deforestation and degradation (AUFDD), where the deforestation or degradation is moving in the direction of that land and will likely occur in the future;

3. Avoiding unplanned mosaic deforestation and degradation (AUMDD), where the deforestation or degradation likely will occur under a “mosaic confi guration.” Th e VCS AFOLU Guidance describes this as “where human populations and associated agricultural activities and infrastructure (roads, towns, etc.) are spread out across the landscape and most areas of forest within such a confi gured region or country are accessible.”

Aff orestation, Reforestation, and Revegetation (ARR) projects entail areas that have already been deforested or signifi cantly degraded. Projects that may qualify for ARR are those that establish, increase, or restore a tree cover through the planting, sowing, or other human-assisted natural regeneration of woody vegeta-tion to increase carbon stocks in woody biomass and, in certain cases, soils. Enrichment planting and thinning are considered Improved Forest Management (IFM) project activities, rather than ARR.

Improved Forest Management (IFM) activities are those where parties change the forest management practices for forests that are used for cutting trees for wood products, such as saw timber, pulp wood, and fuel wood. Th e forest lands must meet the elements of the International Panel on Climate Change (IPCC) category “forests remaining as forests.” 2 In addition, these lands must have received legal approval as required in a particular jurisdiction, such as areas that have been designated, sanctioned, or approved for the tree removal actions, such as logging concessions or plantations. Absent these legal authorizations or permits, the project is not eligible for crediting by the under the IFM category.

Examples of projects types that may qualify for IFM are provided in the AFOLU Methodology and Guidance. Moving from “conventional logging” to “reduced impact logging” (RIL) resulted in fewer trees being harvested. Second, one may cease logging of logged forests or prevent logging of forests that would otherwise be logged, resulting in forest conservation, which is know as “conver-sion of logged forests to protected forests” (LtPF). Th ird, a change in logging practices by extending the cutting rotation in managed forest where diff erent plots have the same-age trees planted at the same time. Fourth, a project could consist of increasing the productivity of forests (LtHP).

Th e number of options to produce carbon credits from forests thus is quite wide ranging. For purposes of this discussion, we will focus on Reduced Emissions from Deforestation and Degreation (REDD) and Aff orestation, Reforestation,

2. IPCC AFOLU 2006 Guidelines.


and Revegetation (ARR) projects as they tend to be the most attractive projects because they reduce the destruction to forests or replace previously existing forest and REDD project may produce the largest number of carbon credits.

(A) THE BASELINE Th e critical fi rst step is establishing the baseline from which all future calculations of estimated and monitored reductions in GHG emissions will be compared. Th e VCS requires that the project baseline address the changes in the use of the land and the land cover and the resulting emissions of GHGs. Th e baseline must be calculated in diff erent ways, depending on whether the project involves avoided planned deforestation, avoided unplanned frontier deforestation and degradation, or avoided unplanned mosaic deforesta-tion and degradation. Th e baseline net GHG emissions and the reductions in emissions must be estimated every year during the crediting period. Th e baseline must be developed and approved by the VCS, and must be reassessed at least once every ten years.

Th e VCS standard and Guidance require that the project proponent account for CO 2 , nitrous oxide, and methane. Th e “carbon pools” are those sources of GHG sequestration in the forest. Th e pools that the VCS suggests be estimated are above-ground biomass, belowground biomass, dead wood, litter, and soil carbon. Oft en, these calculations and analyses take much of the time in studying a particular forest tract. Long-lived wood products removed from the forest may act as another pool. Not all pools must be evaluated or included if the exclusion would make the calculation of carbon credits more conservative, meaning include less carbon sequestered. For REDD projects, all pools that would result in a fi ve percent or more decrease in carbon stocks must be included.

Th e crediting period, or that period of time over which the project would last, is set at a minimum of twenty years and a maximum of one hundred years. Periods of thirty years are common in projects submitted to the VCS for approval thus far.

(B ) ADDITIONALITY Additionality follows a similar approach to the process proscribed for CDM projects. 3 For REDD projects, the project devel-oper must demonstrate in the documents submitted to the VCS that the land would have been converted to a use other than forests “if not for the REDD project.” 4 Th us, the risk to the forest must be demonstrated both in terms of a risk that actually exists and the extent of that risk.

3. UNFCCC/CCNUCC CMD Executive Board, “Tool for the Demonstration and Assessment of Additionality.”

4. VCS AFOLU Tool, at 6–7.


(C ) L EAKAGE Under the AFOLU guidelines, leakage is defi ned as any increase in greenhouse gas emissions that occurs outside a project’s boundary (but within the same country), but is measurable and attributable to the project activities. 5 For small projects, leakage does not need to be assessed. Small projects are considered to be those that are less than 10,000 hectares in size. 6 Th e approach to measuring leakage will vary, depending on the type of REDD project.

(D ) PERMANENCE AND RELATED CARBON BUFFER Th e VCS Guidance provides signifi cant discussion regarding determining permanence and the risk of potential future losses of GHG emissions from REDD projects. A documented risk analysis must be prepared by the project proponent. Th e baseline calculation and risk analysis are reviewed by the third party VCS verifi er at both validation and verifi cation.

Based on the risk analysis, a buff er must be set up by the project proponent to provide a means of addressing the risk. Th us, if the risk is considered to be 20 percent of the overall carbon credit potential that may be validated and veri-fi ed, the project proponent would be required to set aside 20 percent of the over-all carbon credits. To account for potential losses during the project period, the project manager must submit periodic reports, verifi ed by a third party, to show that the forest has not been degraded or destroyed during that period. Fortunately, the project developer does not need to wait until the end of the crediting period to receive the carbon credits in the buff er. Over time, if the developer can demonstrate the project is maintaining its carbon off sets, a portion of the credits in the buff er can be released by the VCS.

(E ) MONITORING Monitoring is a major part of all carbon projects, but it is more complex under a forest carbon project. For VCS AFOLU projects, the monitoring must be conducted and a monitoring plan presented that includes both the baseline case and the result of the project on GHG emissions. 7 Leakage must also be monitored. 8 In order to conduct this monitoring, the VCS AFOLU Tool requires that the IPCC 2006 Guidelines serve as the basis for estimating CO 2 and non-CO 2 emissions; forest regrowth and the CO 2 sequestered from the atmosphere from avoided forest degradation; and reductions in the carbon in the forest arising from removal of biomass that exceeds the regrowth of

5. Id. at 7.

6. Id.

7. VCS AFOLU Tool, at 4.

8. Id. at 7.


the forests. 9 Finally, the IPCC Guidelines must be used to provide evaluation of quality assurance and control and to analyze the degree of uncertainty in the estimating and monitoring process.

ii. Climate Action Reserve Forestry Methodology Th e State of California, as discussed in this section, has established climate change and GHG regulations and is working with the Western Climate Initiative to develop a multi-state GHG regulatory program. As part of the California program, the state has developed the Climate Action Reserve (CAR, formerly the California Climate Action Registry or CCAR) that serves as a registry for carbon off set projects. As all such programs, much like the VCS and the CDM, methodologies are required to determine the GHG reductions and the number of credits in the form of tons of CO 2 e to be awarded to the project developer.

In the forest area, CAR has developed a Forest Project Protocol (FPP). Th e FPP provides “eligibility rules, methods to calculate reductions, procedures for assessing risks, and approaches for long term monitoring and reporting. Th e goal of this protocol is to facilitate the creation of GHG emission reductions and ensure that they are calculated in a complete, consistent, transparent, accu-rate, and conservative manner.” 10 For these projects, CAR establishes a process and documentation requirements for project developers that are applying for validation and verifi cation of forest-based carbon off sets. Initially, the FPP cov-ered only projects in California, but it has been expanded to cover forest projects anywhere in the United States.

CAR has issued the Reserve’s Forest Verifi cation Protocol (FVP), which provides guidance to carbon off set verifi ers who verify the project has been initi-ated and the quantity of GHG emission reductions that have occurred. Th ese verifi ers provided the necessary transparency and validity of the GHG projects and the off sets and carbon credits that then are available for sale.

As provided under the VCS AFOLU Guidance, the CAR Forest Protocol provides for three types of forest projects: (1) Reforestation, (2) Improved Forest Management, and (3) Avoided Conversion. Th e “Avoided Conversion” project type is similar to the REDD project type under the VCS. While these project types are similar in description, the standards for the types of projects and the qualifi cations for these projects to be accepted as valid projects vary quite a bit with respect to some of the project types.

9. Id. at 9.

10. Climate Action Reserve, “Forest Project Protocol,” Version 3.0 (hereinaft er CAR Forest Protocol).


(A) THE BASELINE Under the CAR Forest Protocol, the baseline for Avoided Conversion is determined by calculating what would have happened in the absence of the project. Th e calculations involve estimating the carbon stock losses that would have occurred as a result of the conversion of the forest to a nonforest use. Two steps are involved:

1. characterizing and projecting the baseline; 2. discounting for the uncertainty of the probability of conversion. 11

Th e baseline calculation is diff erent from the VCS AFOLU process for REDD.

1. specifying the highest-value land use for the Project Area, using an appraisal;

2. estimating the rate of conversion and removal of forest carbon stocks; 3. using a compute simulation to project the changes in carbon stocks over the

next one hundred years.

Th e rate of conversion must be calculated using planning documentation for the Project Area or identifying a default annual conversion rate based on a table provided in the Forest Protocol. 12

Th e next steps involved calculations for other aspects of the carbon as changes would occur over time. One step is estimating the carbon in harvested wood products. Th us, the carbon sequestered in wood products that would have been removed from the forest must be estimated. 13 Actual carbon stocks must be estimated and updated on a regular basis. Th e actual carbon in harvested wood products for harvested wood must be calculated.

Secondary Eff ects must also be estimated. Secondary Eff ects are those that may not be intended, and include for Avoided Conversion projects the shift of conversion to other areas. 14

(B ) ADDITIONALITY Additionality is a prerequisite for any CAR forest project. Th e “business as usual” test applies. Th e baseline, as discussed above, must be rigorously analyzed using quantitative analysis and that analysis must be reviewed and approved by CAR. Th e actual GHG reductions must be

11. Id. at 31.

12. Id. at 31–32.

13. Id. at 32–33.

14. Id. at 34.


demonstrated again using quantitative analysis and providing suffi cient docu-mentation. Th e actual defi nition provided in the CAR Forest Protocol states, “Forest project practices that exceed the baseline characterization, including any applicable mandatory land use laws and regulations.” 15

(C ) LEAKAGE Under the CAR Forest Protocol, leakage is referred to as one part of the potential “Secondary Eff ects” of a forest project. As mentioned above in discussing the baseline and calculation of the results of the forest carbon project, Secondary Eff ects must be estimated. For Avoided Conversion projects, the “shift of conversion activities” or leakage to another area other than the project area must be calculated. 16

(D) PERMANENCE AND RELATED CARBON BUFFER As with the VCS protocol, permanence is a key concern with respect to forest carbon projects. Th e means by which the CAR Forest Protocol addresses permanence issues diff ers from the VCS, where a buff er serves as the main mechanism to address permanence risk. Th e CAR Forest Protocol uses three mechanisms to address permanence.

1. Th e requirement for all Forest Owners to monitor on-site carbon stocks, submit annual monitoring reports, and submit to annual third-party verifi cation of those reports along with periodic verifi er site visits for the duration of the Project Life;

2. Th e requirement for all Forest Owners to sign a Project Implementation Agreement with the Reserve, which obligates Forest Owners to retire CRTs to compensate for reversals of GHG reductions and removals; and

3. Th e maintenance of a Buff er Pool to provide insurance against reversals of GHG reductions and removals due to unavoidable causes (including natural disturbances such a fi res, pest infestations, or disease outbreaks). 17

Th e Buff er Pool is one by which multiple projects contribute, not a buff er for a particular project as with the VCS AFOLU protocol. Th e contribution to the Buff er Pool will vary based on each project’s reversal risk. 18 As insurance products evolve to cover these risks through insurance carriers, they may be

15. Id. at 41.

16. Id. at 15.

17. Id. at 35.

18. Id. at 36.


allowed to take the place of the Buff er Pool and other permanence risk manage-ment tools.

Th e Buff er Pool only serves to address “unavoidable” reversals that are not planned, such as fi re, insects, or disease. Logging would not be compensated from the Buff er Pool. Instead, the Forest Owner would be required to address these “avoidable reversals” by retiring Climate Reserve Tons (CRTs) to address the reversal. 19 If the reversal causes the carbon stocks to fall below the baseline, then the project will be terminated.

(E ) MONITORING Under the CAR Forest Protocol, monitoring must occur every year and the results must be report to CAR over the one-hundred-year life of the project. Th e Forest Owner must develop a monitoring plan in accordance with the CAR Forest Protocol, which must be submitted to and approved by CAR. 20

iii. CDM Reforestation/Aff orestation Methodology Th e CDM based on decisions of the UN Framework Convention on Climate Change (UNFCCC) meetings originally limited forest projects to aff orestation where trees are replanted. Avoided deforestation or REDD projects have not been permitted, but signifi cant discussion has occurred about allowing REDD projects to obtain carbon credits under the Kyoto Protocol, or any treaty signed to follow the Kyoto Protocol.

Only a few projects have been approved under the CDM. Th e main chal-lenge for project developers is that the credits are temporary. Th ey can be used for a period of a few years and then new credits have to be obtained to replace them. Th is makes their value and usefulness to compliance buyers limited. Th e price and desirability of the credits is lacking, and so these projects have not been pursued under the CDM, but rather the other voluntary standards, such as the VCS, American Carbon Registry (ACR), and the CAR have been used instead.

7. Carbon Capture and Storage Carbon capture and storage (CCS) involves the injection of CO 2 into the ground for long-term storage or sequestration. Th e main goal of CCS is to capture greenhouse gases from coal-fi red utilities and inject it underground. However, other sources of CO 2 can serve as the source for CCS. For example, natural gas

19. Id. at 37–38.

20. Id. at 38–39.


processing plants must remove excess CO 2 from natural gas to meet specifi ca-tions for natural gas pipelines. Th is rather pure CO 2 may serve as a good source for injection, particularly if located in areas where it may be used to enhance oil or natural gas recovery. Carbon credits can contribute to the ability to fi nance these projects; even carbon credit sales alone may not be suffi cient at this time, based on the price of carbon currently to fi nance the costs of CCS.

Th e International Emissions Trading Association (IETA) on May 31, 2007, sent a letter to the UNFCCC Cooperative Mechanisms Programme supporting the adoption by the UN body methodologies for approving CCS carbon credits generated under the CDM. Th e IETA noted several issues the UN body was concerned about in reviewing CCS as a carbon-credit-generating technol-ogy. Th e concerns were as follows:

Long-term physical leakage levels of risks and uncertainty; • Project boundary issues and projects involving more than one country; • Long-term responsibility for monitoring the reservoir and any remediation •measures aft er the crediting period; Long-term liability for storage sites; • Accounting options for any long-term seepage from reservoirs; • Criteria and steps for the selection of suitable storage sites; • Potential leakage paths and site characteristics and monitoring •methodologies for physical leakage from the storage site and related infrastructure, for example, transportation; Operation of reservoirs, dynamics of carbon dioxide distribution within the •reservoir and remediation issues; and Any other relevant matters, including environmental impacts. •

Th e IETA in its letter pointed out that signifi cant advancement has been made in terms of developing CCS projects and addressing regulatory issues related to CCS from the date of the International Panel on Climate Change Report from 2006. Th e Sleipner fi eld has operated in the North Sea continental shelf since 1996, where CO 2 is separated from natural gas produced from the fi eld, and then the CO 2 is injected into a sandstone layer, a deep saline aquifer, about 800 meters below the North Sea. In Norway, a new CCS project was about to begin opera-tion to inject CO 2 stripped from the natural gas stream back for injection into a subsea geological formation. In 2006 production of liquid natural gas (LNG) from the Sn ø hvit fi eld will start. Th e CO 2 produced with the gas on the Sn ø hvit fi eld is to be captured and stored 2,600 metres beneath the seabed at the edge of the reservoir. A total of 700,000 tons will be stored annually.


Th e IETA letter notes that various European countries and the European Union are working to develop regulatory systems and modifying the EU Emissions Trading System to permit the use of CCS to produce carbon credits.

In the United States, CCS has been promoted by various groups, including certain oil and gas interests that can use the CO 2 for enhanced oil recovery (EOR). Natural sources of the gas have been used for EOR in Texas for several decades. Th e potential for the use of CCS to redice CO 2 emissions may be a critical step in controlling GHG emissions.

A report prepared by Alliance Bernstein, 21 a Wall Street investment fi rm, concludes that one of the activities that will be required to meet global green-house reduction goals is CCS.

Th e report estimates that CCS could be used to inject CO 2 to produce an increased yield of natural gas of 7 billion cubic feet (bcf ) by 2015, 70 bcf by 2020, 500 bcf by 2030, and thereby sequester 60 gigatons of CO 2 by 2030. Th e injection for enhanced oil and gas recovery could increase yield by 11 million barrels of oil per day. Th e injection for coal-bed methane recovery could increase the yield of natural gas by 3,000 trillion cubic feet. Enhanced oil and gas recovery would off set a signifi cant portion of the cost for capturing and injecting the CO 2 .

An enormous number of carbon credits could be generated for use or sale if the CDM and other boards approved methodologies for this project type. Th e American Carbon Registry is developing a methodology for this project type in addition to the consideration by the CDM. Under proposed U.S. legislation, emission allowances would be granted for these projects in addition to other government incentives that would be available, with certain total caps and other limitations, for CCS projects. Th e U.S, Department of Energy has already awarded grants to projects under the economic stimulus funding legislation.

How the potential for CCS will evolve in the United States and interna-tionally is still uncertain. If CCS becomes a more widely-used technology, the ability to capture carbon credits for GHGs sequestered may become an impor-tant aspect of CCS funding. Th is will depend on the development of methodolo-gies for obtaining carbon credits for CCS.

21. Alliance Bernstein, Changing Climate, Changing Opportunities: Winners and Losers in the Global Eff ort to Control Carbon Emissions, available at http://www.google.com/search?q=alliance + bernstein + climate&rls=com.microsoft:en-us&ie=UTF-8&oe=UTF-8&startIndex=&startPage=1 .

http://www.google.com/search?q=alliance+bernstein+climate&rls=com.microsoft:en-us&ie=UTF-8&oe=UTF-8&startIndex=&startPage=1



13

Carbon Credit Project Development

A. Project Development Generally Carbon credit projects face many of the same issues and risks that other domestic and international projects face. Some of the same issues that arise in other areas of project development arise with respect to carbon credit projects. Many other issues are specifi c to carbon projects. Review of general project develop-ment is appropriate. We will generally discuss renewable energy projects as back-ground as many carbon credit projects also involve renewable energy.

Renewable projects fall mostly into two types. Most are built by developers and operated by the project developer. Th ese types of projects are known as “BOOM” projects — build, own, operate, and maintain. However, there are “BOT” projects as well — build, operate, and transfer. Th e second type involves the project developer building and operating the project until a third party is prepared to purchase the project and then take over operations. We will discuss mainly the BOOM project types. Th ese projects must demonstrate fi nancial viability to lenders and equity investors as they typically need to show the ability to generate revenue, cover costs, fi nance debt, return equity, and generate a profi t suffi cient to attract lenders and equity investors to the project.

Th e fi nancial issues and challenges that these projects face are several fold. First, the project must obtain the funds for construction. Th is funding may be a short-term construction loan of, say, six to twelve months. Long-term fi nancing must be available to pay the construction loan. Where grants are available, there may be an opportunity to fi nance the amount of the grant until it is paid by the government agency. In the United States for example, until the end of 2010,


30 percent of the capital expenditures for certain renewable energy projects may be obtained in the form of a grant in lieu of production tax credits or investment tax credits. If a project developer can obtain a loan for this amount, it makes fi nancing the project much easier. More discussion on carbon fi nance will be provided in Chapter 14.

For projects that are renewable energy, the revenues from the project will mainly be the electricity purchased by a utility or other third party. Th ese are generally long-term power purchase agreements (PPAs) of fi ve to twenty years. Th e project developer and their lenders and investors prefer as long a term of PPA as possible to guaranty payment of debt and equity, interest, and return on investment. Other possible revenues include tax credits sold to third-party tax investors, local, state, and federal incentives, utility incentives, renewable energy credits (RECs), and, depending on the location of the project, carbon credits.

B. Basics of Carbon Credit Project Development Chapter 12 describes various carbon credit project types and methodologies. Th e point to remember is that there must be an approved project methodology in order to obtain carbon credits from a type of project. If a methodology does not exist, then the developer who wants to pursue that project type would have to obtain approval of a new methodology. At times, one can use an existing methodology in a similar area and modify it for the new project type.

Projects include renewable energy (wind, solar, hydropower, biomass, and geothermal), energy effi ciency, methane capture (landfi lls, vented and fl ared natural gas from oil and gas production, and natural gas capture from pipelines), and a variety of other project types. Each of these project types presents unique challenges to project developers.

Financing the project, discussed in Chapter 14, requires project developers to plan the project and develop feasibility studies to convince investors and lenders that the risks inherent in these projects can be managed.

C. Feasibility Study Project developers developing greenhouse gas reduction projects or companies taking action within their facilities or selling products or installing them need to fi rst ask the question: Are the steps taken to reduce greenhouse gases and to create carbon credits going to generate more revenue than the costs of generating the

CARBON CREDIT PROJECT DEVELOPMENT | 195

carbon credits? We generally refer to this as a carbon credit feasibility study. It is wise to fi rst conduct a feasibility study to determine if the approach to reduc-ing greenhouse gas emissions will generate suffi cient income or net profi t to make the endeavor worthwhile from a business perspective, or to what extent the project will produce suffi cient rate of return to garner investment from third parties.

Examples of costs that the feasibility study should evaluate include the following:

equipment to reduce greenhouse gas emissions; • installing or constructing the equipment or other aspects of the physical •project; preparing a project design document (PDD) and other documents necessary •to obtain carbon credits through review by the validator and potentially the standards boards; third-party validator and verifi er of the PDD and actual greenhouse gas •reductions; taxes and Clean Development Mechanism (CDM) (or other standards •board) charges; and legal fees in entering contracts to implement the project, sell the carbon •credits, and other advices and counsel.

Th e feasibility study should then utilize the tools and methodologies that apply to the project to estimate the annual carbon credits generated over the rel-evant crediting period. Th e current and future estimated carbon credit price should then be applied with an appropriate discount rate to produce the amount of money that may be generated by the sales of carbon credits over the crediting period.

Applying the costs and revenue in the economic model developed will indicate the net revenue generated. From there the present value and the internal rate of return of the project may be generated for both the project developer and company and any relevant investor or lender that may be evaluating invest-ment or lending to the project.

Th ese feasibility studies and economic models are developed using spreadsheets and equations from the relevant methodologies.

Other steps in a feasibility study may include, and probably should include, an evaluation of additionality standards to attempt to determine whether the relevant standards body will likely consider the project and the greenhouse gas emission reductions to be additional.


D. The Carbon Credit Approval Process 1. The Process under the Clean Development Mechanism A project under the CDM must occur in a country that is a signatory to the Kyoto Protocol. Countries are participants in the program. As will be described below, the project must receive approval from the host country. Th e process for obtaining approval and issuance of Certifi ed Emission Reductions (CERs) is described below.

a. Project Feasibility Study As discussed above in more detail, a project developer generally will evaluate a potential project to determine if it is economically feasible and if it is likely to qualify for CERs under the CDM. Once the project developer has made this determination, then the developer will follow the process for attempting to obtain carbon credits.

b. Project Idea Note Th e project developer may then develop a project idea note (PIN) to gauge potential carbon credit buyer interest or investor interest in the project. Th e PIN will generally describe the project, the location of the project, the amount of carbon credits that are estimated to be generated, the fi nancing structure, the proposed crediting period in terms of the years that credits would be generated, the cost of the project, and the estimated price for the credits.

c. Project Design Document Th e Project Design Document (PDD) is required by the CDM in order to apply for carbon credits. Th e elements of a PDD are as follows:

general description of project activity; • application of a baseline and monitoring methodology; • duration of the project activity/crediting period; • environmental impacts; and • takeholders’ comments. • 1

Th e PDD is a critical document in terms of getting approval for carbon credits. It is reviewed by the third-party validator, as discussed below, and the CDM staff

1. Clean Development Mechanism Project Design Document Form (CDM-PDD) Version 03 ( July 28, 2006).


before approval is given to a project. It is also important for obtaining investment in a project by third-party investors, and, if a market exists, for sale of some or all of the credits on a forward basis, either as a fi nancing mechanism by receipt of some payment in advance, or to be paid on delivery, which acts as an off -take agreement, and may assist the developer in obtaining equity investment or debt fi nancing.

d. Stakeholder Participation Under the local stakeholder participation requirement, the project developer must seek comments on the project design document from local stakeholders, and provide a summary of the comments received and a report reviewing these comments to demonstrate how they were addressed. Th is report must be submitted for validation by an approved third-party validator, known as a Designated Operational Entity (DOE). DOEs are entities approved by the Executive Board of the CDM (EB) that review PDDs and validate them prior to submission to the EB.

e. Host Country Approval Th e host country where the project is to be implemented must provide approval of the project. Th e agency that reviews these requests and determines if the project will be approved is known as the Designated National Authority (DNA). A “letter of approval” must be obtained from the DNA in order to proceed with the process to obtain approval for the project by the EB.

f. Validation by a Designated Operational Entity An independent third party must review the PDD and other documents to be submitted to the CDM Executive Board before submission for approval. Th e DOE must review the PDD and local stakeholder report and determine if they meet CDM requirements. Without approval from the DOE, the project developer may not submit the PDD to the EB.

Th e DOE makes the validation report available to the public and receive public comments for thirty days. Th e DOE must then submit the report to the EB.

g. Registration Th e DOE then submits the project for registration to the EB. Th is body will make the validation report publicly available and receive comments for thirty days. Th e EB is supposed to register the project, unless review is requested by a member of the EB based on an issue related to registration requirements. Th is is where a project may receive comments and questions that can take some period


of time to be reviewed. Th e project must meet the requirements of the methodologies for that project type. Th e additionality requirements must be met as well. Th is is another area where projects may face delay or denial of registration.

h. Implementation and Monitoring Aft er the project is registered, then the project developer will implement the project. At this point, the project developer must begin monitoring the performance of the project and measure the reductions in greenhouse gases (GHGs). Other parameters such as leakage or environmental eff ects may have to be monitored as well. Th e monitoring must follow the monitoring plan submitted in the PDD.

i. Verifi cation and Certifi cation Th e monitoring results will then be submitted to a diff erent DOE than the one that performed the validation for verifi cation and certifi cation, which is required to request issuance of CERs. Th e DOE reviews the monitoring report and evaluates the reduction in greenhouse gases and issues a verifi cation report and certifi es the amount of GHG reductions. Once the DOE submits its veri-fi cation and certifi cation to the EB, the DOE becomes responsible for any underperformance in terms of GHG reductions. Th e DOE must carry adequate liability insurance to cover this risk.

j. Issuance of Credits Once the verifi cation is received, the EB will issue the amount of CERs set forth in the verifi cation and certifi cation into a designated account. A charge is deducted from the amount of CERs verifi ed to pay for the operation of the CDM. Th is charge is known as the “share of proceeds,” and amounts to 2 percent of the CERs that were verifi ed and certifi ed. At this point, the credits become available to the project developer and may be sold and transferred to a third party.

2. The Voluntary Carbon Standard Process Some of the steps for obtaining approval under the CDM are similar to those required under the Voluntary Carbon Standard (VCS). Th e Voluntary Carbon Standard Association (VCSA) relies more on the validator and verifi er for approving certain aspects of projects. Projects seeking registration under the VCS Program must be validated and verifi ed by a validator and verifi er accredited under an approved carbon credit standards board or the International Standards


Organization under standard ISO 14065:2007. 2 Validation and verifi cation can be carried out by the same accredited entity. Validation must occur at the time of or before the fi rst verifi cation.

Th e verifi cation statement shall state the actual amount of Voluntary Carbon Units (VCUs) associated with the project specifi c monitoring report that has been verifi ed. Th e validation or verifi cation statement shall:

be addressed to the VCS Board; • describe the level of assurance of the validation or verifi cation statement; • describe the objectives, scope, and criteria of the validation or verifi cation; • describe whether the data and information supporting the GHG assertion •were hypothetical, projected, and/or historical in nature; be accompanied by the responsible party’s GHG assertion; and • include the validator or verifi er’s conclusion on the GHG assertion, including •any qualifi cations or limitations. 3

To register credits, the developer must submit a request for issuance of credits to a VCS-approved registry.

E. Carbon Credit Project Risks A variety of risks arise in attempting to develop carbon credit projects. A list of some of the more signifi cant risks is as follows:

Project Risk: In essence there is the risk the project is never completed •because of a variety of factors, such as management failure. Regulatory Risk: Regulatory risk involves the potential that a project is not •approved or some aspect regarding meeting a methodology in terms of baseline or actual GHG reductions is questioned or disapproved by the standards board.

Additionality Risk: Th is is perhaps the most signifi cant risk, and the basis •for denial of most projects that fail to achieve regulatory approval. Validation/Verifi cation Risk: One of the critical aspects of the project risk •is the failure to meet the third-party verifi er’s expectations and review of the application of a particular methodology to a project.

2. Voluntary Carbon Standard Association, Voluntary Carbon Standard 2007.1 21–22 (Nov. 18, 2008).

3. Id. at 23.


Financial Risk: Th e ability to obtain funding to complete the project. • Political Risk: Projects in other countries face the risk that the government in •that country may not approve a project, may confi scate or nationalize a project, may not make payments under a contract, such as a power purchase agreement with a national government, or may otherwise take action to stop a project, take title to or possession of a project, or make the project less or completely fi nancially unviable. Purchase of political risk insurance may be appropriate, depending on the particular project and its location. Project Completion Risk: Th e ability to avoid a political decision or action •that would impede the completion of the project, such as a takeover of the relevant property, denial of any approvals for the project, or the taking or taxing of the credits that may be produced. Land Title Risk: In implementing projects in developing countries, it is •important to determine if the party with whom you are negotiating an agreement to develop a project has the rights to the land where the project will be implemented. Otherwise, one risks the potential for construction and ownership of the project to be placed in a party who has not been paid and with whom one had no binding or enforceable agreement. In some countries, title insurance can be purchased in addition to title review by local counsel to assist with addressing title risk. Carbon Credit Title Risk: Title to the carbon credits generated from a •project in part fl ows from land title. In other cases, the title of carbon credits may fl ow from the issue of who is the owner of the project or of the reductions in greenhouse gases. In some instances, such as energy effi ciency projects, it is important to obtain an assignment of the rights to carbon credits if the project developer is installing the energy effi ciency project on another party’s land, manufacturing plant, refi nery, building, or other structure that the project developer does not own. Currency Fluctuation Risk: Th e risk of the fl uctuation of currency can be a •signifi cant risk in terms of purchasing or buying land or operations, or engaging in future carbon credit or other revenue transactions, where currency from one country is to be expatriated to another country. How currency is set in transaction and purchasing currency hedges may be means of managing these risks.

Th ese are some of the more signifi cant risks carbon credit project developers face.

F. Examples of Projects Th e discussion of project types in Chapter 12 revealed an array of potential projects. Each type of project raises unique challenges in terms of development


and proving additionality — as mentioned above, one of the more signifi cant barriers in terms of obtaining approval of carbon credit projects from the CDM EB or other carbon standards organizations.

1. Landfi ll Methane One of the most common types of carbon credit projects has been capturing methane produced by municipal waste landfi lls. Th is project type, as mentioned in Chapter 12, has been attractive because of the multiplying eff ect of capturing one ton of methane resulting in 21 tons of CO 2 e or 21 CERs. Th ese projects are also common in developing countries and are not generally required to capture methane under any laws in the country, so additionality can be met for these projects. In the United States and some developed countries, air pollution laws may already require that the methane be captured to reduce air pollution, even if not for climate-related reasons.

In the early days of the CDM, the amount of methane that could be gener-ated was overestimated. Projects were capturing perhaps 30 percent of what was estimated. Th us, the projects were underperforming for the project devel-oper, investors, and buyers of the CERs that were to be produced. Th e engineer-ing estimation process was altered in order to attempt to better predict the amount of gas — a gas curve — that would be produced from the landfi lls. Th is type of project remains of high interest to developers because the process to capture the gas is well known, the prediction of CERs that may be generated is better known, and the multiplier eff ect remains in eff ect, resulting in signifi cant profi ts from these projects.

2. Solar Projects a. Solar Projects Generally Solar involves two general types of technologies: solar thermal and solar photo-voltaic (PV). Solar thermal is the use of mirrors or other means to heat water or other liquid that is then used to drive a turbine and produce electricity. Solar PV uses silicon or other material that is excited by photons and transfers that energy into electrons to produce electricity. We will focus on solar PV in this section.

b. Free-Standing or Utility-Scale Solar Projects Utility-scale solar projects involve many of the issues that wind and even some fossil fuel electricity plants face. Th ese projects involve constructing large solar PV instal-lations generally of 10 megawatts (MW) or more. Th e project is designed to sell the electricity into an electrical grid, generally to an electric utility that in turn sells the electricity to its customers on a wholesale or retail level. At times, large con-sumers of electricity will purchase the electricity, but the power still enters the grid.


c. Non-Utility-Scale Solar Projects Non-utility-scale solar projects are distinguished from a project — an example of which will be discussed below — where the power is sold in whole or substan-tial part to one entity or small group of entities, and the electricity is not trans-ferred into the grid. In the case of a solar rooft op project, the electricity is sold to the tenant, or if the owner and party using the building are the same then the owner of the building. Th us, the off -taker is a smaller entity and the installation is much smaller than a utility-scale solar project. Th e size of the project would likely be less than 5 MW, some less than 1 MW.

Th e discussion below regarding the legal issues associated with a solar rooft op project is based on U.S. laws. Similar concerns would apply to projects in other countries, but the potential solutions and laws that apply would vary.

One of the key concerns is protecting the ownership of the solar equipment that is installed. A fi xture fi ling may be necessary to record in county deed records to ensure that the solar installation is not considered part of the real property and subject to liens of lenders not actually providing funding for the solar PV, but for the building or other fi xtures.

A nondisturbance arrangement may be needed such that the senior interest permits the less senior interest to install the solar equipment and to retain ownership and again avoid it becoming collateral to the building owner’s or tenant’s fi nancing.

A lease or sublease may be the means of achieving these goals. Th e solar developer will be entering a PPA with the building owner or tenant, but a separate lease outside of the PPA should be entered into with the appropriate party. In order to ensure protection and notice to buyers and other lenders, it may be appropriate to fi le a memorandum of lease in the local deed records.

In any transaction like this, a risk may arise to the project if the owner of the building or property is subject to a bankruptcy proceeding. Under the bank-ruptcy code, bankrupt entities may reject executory contracts, which a lease is typically considered. Th e value of the lease, however, is that while the bankrupt entity could reject the lease, it would still be required to pay damages and allow the tenant, here the solar project developer, to continue to maintain the solar PV installation on the property. If there is a utility interconnection to the grid, an agreement may be entered with a party or the utility to purchase the electricity generated from the solar PV. If connected to the grid, the solar project developer could continue to operate and sell its electricity to the grid.

One of the key issues in this context is a net metering agreement with the utility. A net metering agreement is one in which the solar PV owner may sell excess electricity back into the grid. For example, if a party installs solar PV on its


roof and at certain times during the day is generating more electricity than it is using, then the meter actually turns backwards and the amount of the charges are netted from the electricity otherwise purchased by the owner.

One challenge here is that the local public utility regulations may limit the size of a solar PV project that is able to have net metering rights. For example, in some states the size may not exceed 2 MW. Th e other challenge is that the credit is usually given to the electricity customer, which presents challenges when that party is in bankruptcy. A lien may be necessary, if it can be achieved, against those credits in the event the owner fails to pay.

Other regulatory issues arise. One is the risk of being regulated by the Federal Energy Regulatory Commission (FERC). One exemption applied to a “qualifying facility” (QF), and facilities under 20 MW of solar PV allows self-certifi cation to the FERC. Th ere may also be state public utility rules that apply, and those should be addressed as well before entering into an agreement with a landowner/customer.

Th ese projects may benefi t from the forward capacity market that will be discussed in Chapter 15. Th is market involves the trading or sale of credits arising from reduction of peak electrical demand on the electrical grid. Certain FERC and state public utility commission regulations allow parties to take advantage of activities that reduce the demand at peak times, usually during the day in the summer months from, for example, May or June through September. Since solar power generation is highest in the summer months and during peak heat times, demand response provides a relief from the power that must be generated from fossil-fuel-burning and other plants during peak demand.

3. Forest Carbon Projects As climate change laws have been adopted at the state level in the United States, and as Congress and the U.S. Environmental Protection Agency (EPA) have considering climate change legislation or regulations, the potential impact on industries, particularly coal-burning utilities and oil refi neries, may be substantial. In the European Union, companies are already struggling with these issues. Forest carbon projects could provide the large number of off sets needed to reduce international competitiveness concerns of nations such as the members of the European Union, the United States, Australia, and Japan. Although forest carbon credits are not yet allowed as off sets in the European Union Emissions Trading Scheme (EU ETS), this may change in the coming years. Forest carbon projects are probably the most complicated and diffi cult to validate and verify.

If climate change legislation is adopted in the future in the United States, or forest carbon credits are allowed in other countries to serve to meet mandatory


compliance obligations, such as the European Union or Japan, some companies may consider acquiring large numbers of forest credits as off sets. If this were to occur, the demand could be as much as hundreds of millions of metric tons of forest credits. In considering the potential source of these carbon credits, many of these companies have concluded that the only source of a large volume of these credits arises from the preservation of the world’s forests.

Avoided deforestation projects provide a critical pivot point for reducing global greenhouse gas emissions while reducing the economic impact of such reductions. If 17 to 20 percent of greenhouse gases can be reduced just by ending the logging and cutting and burning for subsistence agriculture, we will be that much further ahead with respect to addressing the greenhouse gases from fossil fuel use. Th e emissions from deforestation are larger than the emissions from the transportation sector.

Th e goal of this section is to briefl y discuss forest-derived carbon credits and the role they may play in climate change regulatory programs and how major GHG emitters may evaluate the opportunities and risks that may arise from investing in these projects.

Th e role of forest carbon in compliance systems has been limited. As stated above, the EU ETS does not currently permit the use of forest carbon to off set greenhouse gas emissions in the European Union. Th e international program under the Kyoto Protocol referred to as the Clean Development Mechanism (CDM) did not originally allow forest carbon into the system, and then limited it to reforestation alone, not avoided deforestation. In addition, the credits were limited to “temporary credits” that only last for a short period and then have to be replaced by new carbon credits. Not surprisingly, the investment in these CDM forest credits has been very limited.

Since the regulatory programs initially did not permit at all or only a very limited role for forest carbon, the development of forest carbon shift ed to a “voluntary” program. Th e “voluntary” programs arose from the demand by those who were not required to invest in carbon credits but for their customers or public relations or corporate social responsibility or sustainability programs that decided to invest in these projects.

Scientists, nongovernmental organizations, governmental entities, and others invested signifi cant time developing methods to measure the carbon in existing forests and replanted forests. Th ese led to nonprofi ts establishing standards for parties who engage in these projects to obtain verifi ed and validated carbon credits.

As discussed in Chapter 12, several programs for forest carbon credits exist today, such as the Chicago Climate Exchange (CCX), the American Carbon Registry, Social Carbon, and the VCS. Other benefi ts may arise from


preserving forests, if managed in a particular way that extends beyond green-house gas reductions. Biodiversity and species can be protected and preserved, and communities that live in and around the forests may have their economic condition improved through planning of the projects that takes these com-munities into account. Th e Climate, Community, and Biodiversity Alliance provides a standard for certifying that both community and biodiversity are taken into account in forest carbon projects. Th e Social Carbon standard addresses community issues as well.

Forest carbon credit projects present some of the same risks faced by other carbon off set projects. Certain other risks may be of particular importance in forest carbon development or may be unique to forest carbon credit projects. Some of the risks are as follows:

Project Risk: In essence there is the risk the project never is completed •because of a variety of factors, such as management failure. Th is may include failure to obtain landowner purchase or lease, or failure to gain local government approval, as may be required. Validation/Verifi cation Risk: One of the critical aspects of the project risk is •the failure to meet the third-party verifi er’s expectations and review of the application of a particular methodology to a project. In the forest context, since methodologies are just now being developed, the project developer generally has to prepare and present a methodology for the particular project by which the baseline carbon emissions and monitoring of actual emissions would be completed under the project. Under the VCS Guidance, a dual approval is required of fi rst the proposed methodology and then the project design document that applies that methodology to the project being developed. Financial Risk: Th e ability to obtain funding to complete the project. • Political Risk: Th e ability to avoid a political decision or action that would •impede the completion of the project, such as a takeover of the relevant property, denial of any approvals for the project, or the taking or taxing of the credits that may be produced. Land Title and Land Tenure Risk: Land title is a critical issue that must be •addressed before moving forward with a particular forest tract. Title in developing countries can be diffi cult to prove. Squatters and other people claiming title to land creates another risk that must be resolved. Permanence Risk: Permanence concerns arise from the risk of fi res, drought, •or pests destroying or degrading the forests. Leakage Risk: Leakage results from parties moving to another nearby forest •and harvesting trees or burning the forest for agricultural purposes so that the net reduction in forests is of concern.


Currency Fluctuation Risk: Currency risk arises from fl uctuations in •exchange rates, say from the U.S. dollar to the Brazilian Real. Purchase prices or lease prices quoted in one currency may change for the developer over time. Currency hedges, where available, may be a means of attempting to address this risk.

All of these risks must be managed in order to obtain funding for a project, and some of them are necessary to discuss and address in order to obtain approval from third-party validators to have a project approved by a standards board and then verifi cation in order to have credits actually issued.

Th e challenge of obtaining funding for these projects is probably the most diffi cult of the various carbon credit project types. Managing the risks to make the project feasible is diffi cult. Th e ability to fi nd a market for the credits is hampered by the regulatory uncertainty surrounding the EU ETS and the UN Framework Convention on Climate Change (UNFCCC) negotiations over Reducing Emissions from Deforestation and Forest Degradation (REDD) and reforestation.

However, a group of developers are pursuing forest carbon projects. Most of these developers are seeking a lease or easement to enter into with forest land-owners in developing countries that would require the landowners to preserve the forest in exchange for payments derived from forest carbon credit sales. Th e investment in the project is lessened and the risk is shared with the landowner to some extent. Th e developer typically pays the development costs for forest studies, preparation of project design documents, and third-party validators, as well as other costs. Th e developer may be allowed to recoup these costs before any payment is made to the landowner. Aft er costs are recovered, then the parties would share in the net profi ts from the project.

14

Carbon Finance

A. Financing Carbon Projects Cap and trade provides a macro economic system to address air pollution issues, whether sulfur dioxide from coal-fi red power plants, nitrogen oxides from various sources, particulate emissions, or greenhouse gas emissions. Many of these systems have been alive and well, but most people in the public are unaware of them. While market-based systems for addressing environmental concerns have continued to rise and have become a permanent part of regulatory systems in the United States and now in other countries, one aspect determines the success or failure of such systems. Because these systems are market based, they depend on largely private capital to fi nance their development and to sustain them. Th us, the fi nancing mechanisms are of critical importance and the availability of both debt and equity fi nancing serves as the driver for emission reductions.

B. Project Finance Because much of the driver for carbon credits in the form of off sets depends on individual projects to reduce greenhouse gas emissions, project fi nance is one of the key fi nancing mechanisms to drive the creation of carbon credits and to maintain the carbon credit supply and market. Th is has certainly been the case for the Clean Development Mechanism (CDM) and for the Certifi ed Emission Reduction (CER) market.

Project fi nance, as the name implies, typically involves borrowing that provides the assets of the project as collateral rather than having a sponsoring company pledge its assets. Th us, the project, and perhaps the single asset entity that owns and operates it, would be the source of a lender’s repayment of


principal and interest, and its assets would secure the note provided to fi nance the project. Project fi nance is a complex area of business and law, and this book does not intend to provide a complete explanation of project fi nance, but rather to provide a summary of the concepts and how they apply to carbon off set projects. 1

Project fi nance may have many defi nitions. One defi nition for project fi nance is:

[A] nonrecourse or limited recourse fi nancing structure in which debt, equity, and credit enhancement are combined for the construction and operation, or the refi nancing, of a particular facility in a capital-intensive industry, in which lenders base credit appraisals on the projected revenues from the operation for the facility, rather than the general assets or the credit of the sponsor of the facility, and rely on the assets of the facility, including any revenue-producing contracts and other cash fl ow generated by the facility, as collateral for the debt. 2

Typically such fi nancing structures are nonrecourse or limited recourse, meaning the lender does not rely on the creditworthiness of the entity alone that owns the project and its assets. In addition, the lender relies not necessarily on the value of the assets alone, but the fi nancial performance of the project to ensure repayment of the debt. 3

Since the performance of the project provides the basis for repayment of the loan, long-term off -take agreements must be obtained by the borrower-project developer to prove the economic sustainability of the project. Th ese agreement may be power purchase agreements (PPAs) or contracts to supply some other product, such as fertilizer or fuel, to provide the means of operation of the project and to repay the loan.

Various business structures may be used for projects that are seeking project fi nance. Th e structure of the ownership may be a single asset entity and a holding company that holds the stock of the entity that owns the project. A sponsor entity would then hold the stock of the holding company. Entities may be partnerships or limited liability companies, depending on the jurisdiction and other concerns such as reducing taxation on the project and the revenue it creates

1. For a more complete and detailed discussion of project fi nance in the international context, see Scott. L. Hoffman, The Law and Business of International Project Finance (Cambridge University Press 2008).

2. Id. at 4, citing Scott L. Hoff man , A Practical Guide to Transactional Project Finance: Risk Concepts and Contractual Considerations , 45 Bus. Law. 181 n.1 (1989).

3. Id. at 4.

CARBON FINANCE | 209

for various entities. For projects in the United States, tax fi nance structures may be established so that entities seeking to purchase the investment or produc-tion tax credits, as discussed in Chapter 18.

1. Equity Projects typically have two elements of fi nancing to construct and operate the project. Th e fi rst portion is an equity investment in which an investor places funds with the project entity for a partial ownership interest in the entity. Equity investment is oft en raised from venture capital fi rms or private equity fi rms that are in the business of identifying such projects and sponsor companies and conducting the necessary due diligence on the project and those that will be managing the project in order to determine if they will invest in the projects. Initial funding for pure “start up” companies may be the most diffi cult to obtain, and may come from fi rms or individuals that are oft en referred to as “angel” investors.

Investment may be based on the project meeting certain milestones, rather than payment in a lump sum. Th is protects the investor so that the money is used for specifi c purposes and so that steps along the way reduce the risk of total loss if the project fails at some point.

Th e type of stock granted to the investor may vary. Common stock may be granted to founders and angel investors, for example, but preferred stock to later investors who will seek to have powers of appointing directors. Some inves-tors may require antidilution rights so that later investment does not reduce their percentage ownership, as well as various other potential preferred rights. Th e timing of the investors’ return of capital will be a critical aspect of negotia-tions and development of the agreement with the investor.

2. Debt Th e second element of fi nancing the project typically involves securing a loan from a lender that allows the remainder of the funds to be obtained to construct and operate the project. As mentioned above, the project and perhaps a single asset entity that owns it will typically serve as the source of repayment of the interest and principal and serve as collateral for the note. In addition, as stated above, the note is typically nonrecourse or limited recourse to the sponsoring entity that would own the project or hold the shares in the entity that owns the project. In most projects, there must be a long-term contract with a credit-worthy entity that generates revenue for the project.

In renewable energy projects, that would be a power purchase agreement, and in other projects an agreement to purchase fuel such as biofuels or methane generated by the project. Th ese long-term off -take agreements provide the


comfort the lender needs that there will be suffi cient revenue to repay the loan. Th e due diligence by the lender necessarily will require review of the credit worthiness of the purchaser of the power or other output of the project.

Securing the interests in the off -take of the project will be necessary to ensure the lender may be able to obtain that revenue in the event of default by the project or project entity. Th e lender may require pledging of the stock of the project entity to obtain a security interest in the project. Th is structure ensures the sponsor entity is remote from the liabilities and debts of the project company.

3. Types of Agreements Typically Involved in Project Finance In order to set up the project and project company and then to develop the agreements to obtain debt fi nancing, many diff erent contracts are necessary. Some of those contracts are as follows:

Agreements Establishing Project and Project Entity: Th ese agreements allow •the setting up of the project and project entity, usually with the sponsor company. Th ese may be limited partnership agreements or limited liability company agreements. Intercompany Agreements: Th ese agreements provide for operation and •maintenance and advice and expertise oft en from the sponsoring company to the project entity. Technology Licensing Agreements: Th ese agreements provide licensing to •use technology developed by a third party or the sponsoring entity. Th ey allow the project entity and, at times, the sponsoring entity from having to develop specifi c technology for the project. Engineering, Procurement, and Construction Agreements (EPC •Agreements): Th ese agreements allow the construction of the project, typically with an engineering company and construction company that will design and build the project. Off -take Agreements: As discussed above, these agreements allow the sale of •the output of the project. PPAs are frequently the off -take agreement involved in renewable energy projects, which in turn generate carbon credits. An Emissions Reduction Purchase Agreement (ERPA) may be the off -take agreement where a project generates only carbon credits product and the sale as its only revenue stream. Th ese should be “take or pay agreements,” where the off -taker pays the project company even if it does not take the electricity or other output in order to ensure cash fl ow to the project and to satisfy lenders and investors.


Agreements with Investors: Th ese may be limited partnership or limited •liability company agreements that establish the rights and obligations between the project company and the investors, and the shares of the project company the investors will own, purchase price, and other key terms. REC Sale Agreements: Where renewable energy credits (RECs) will be •generated, depending on the country or state, the sale of the RECs must be established through a sales agreement. More discussion of REC issues is provided in Chapter 15. ERPAs: Th ese are agreements by which carbon credits are sold to third •parties. Th ese contracts are discussed in Chapter 20. Loan Agreements: Various loan agreements must be entered into with the •lender to create the loan and obtain security in various aspects of the project. Various consents from the sponsor and investing companies will be required. Operation and Maintenance Agreements: Th ese may involve the agreements •with the sponsoring company if that entity is to manage the project. Other agreements may be entered with third parties to provide maintenance of the equipment and machinery involve. Agreements with Equipment and Manufacturers: Th e equipment provided •such as wind turbines or solar panels will involve pricing, delivery, warranties, and other terms and conditions.

4. Managing Political Risk with International Projects A variety of risks face project developers, investors, and lenders in project devel-opment, as discussed in Chapter 13. For international projects, political risk is one of the most signifi cant risks. Political risk insurance may be obtained under certain circumstances from government lenders, such as the U.S. Oversees Private Investment Corporation or other governmental or multilateral banks, or private insurance companies.

C. Carbon Finance 1. Basic Elements of Carbon Finance Carbon credit projects require fi nancing like any other project being developed for any purpose. Th e fundamentals of carbon project fi nance are similar to other projects, but have specifi c challenges unique to projects that are designed to reduce greenhouse gas emissions, capture those emissions in the form of carbon credits, and monetize those credits. Carbon credit projects are unique in that the output of carbon credits is a new and completely diff erent legal, business, and technical area. Th us, there are inherently a diff erent set of issues


and risks that are presented by carbon credit projects and the fi nancing of those projects.

Two diff erent types of projects may be identifi ed that make a signifi cant diff erence in terms of their ability to obtain fi nancing, particularly now when the future of the Kyoto Protocol or a subsequent climate change treaty and U.S. legislation among other national legislative schemes that involve carbon markets are as yet unclear. Th e fi rst type is a project that relies purely on carbon credits to generate revenue that will be used to repay debt and equity investment, and to generate profi t for the developer. An example would be a compact fl uores-cent light project in which the project developer receives no portion of the energy savings of the party replacing the lights. Th e second type relies on other forms of revenue generation to address debt and equity repayment and project profi t. An example of this type of project would be a solar plant that would generate revenue from selling electricity and would also generate revenue from carbon credit sales.

Th e diff erence is important. Th e fi rst type of project would likely be perceived as having more risk than a project that has other sources of revenue. If the credits are not issued, the project may not be able to repay debt or equity. Th us, the risk of the project will be entirely tied up in the issuance of credits and the amount of credits issued.

For the second type of project, carbon credits may serve to increase the rate of return on investment and the internal rate of return, but that would not mean the project could not pay back its debt or equity. Th us, this type of project would generally be seen as presenting less risk to the lender evaluating a loan for the project and any equity investor considering investing in the project.

International development banks that are guided by policies set by their government or governments oft en have strong policies for investing in environ-mental, sustainable, and greenhouse-gas-reducing projects. However, as one banker told a client, “We are still a bank.” Th e bank must still ensure it has a clear way to recover principle and interest on the loan and that some collateral is avail-able if the loan is not repaid. If the revenue stream is only carbon credits, interna-tional development banks and other banks may fi nd it hard to agree to make a loan on the basis of carbon credits, for two reasons. First, as discussed above, the revenue stream may be perceived as too risky. Second, the ability to obtain a security interest in a hard asset is not present, if the debt is not repaid.

One argument is that if a credit-worthy off -taker, such as a large European utility were to enter into an Emissions Reduction Purchase Agreement (ERPA) (discussed in Chapter 20), then the fi nancial risk is less problematic. We have made this argument in attempting to secure loans for client carbon credit project developers. We have argued that the ERPA is much like the PPA that lenders


rely upon in power plant project development. Th e lenders are willing in some cases to consider that argument, if the ERPA is long term and if there is a “take or pay” requirement, such that the purchaser must buy the credits when presented to it. An agreement to purchase specifi ed numbers of credits over a period of years may be hard to obtain in the current legislative and international uncertainty of future carbon markets.

Turning to the project with revenue streams beyond carbon credit sales, the lender may consider the other products generated and to be sold by the project. Such off -take contracts provide a more certain income stream for projects than carbon credits alone. However, the trade-off may be demonstrating addi-tionality as a project developer may have to show the carbon credits are necessary to make the project work from an economic perspective. With a renewable energy project, for example, the sale of electricity with a long-term PPA with a party with good credit and reputation for repayment, and hard assets that may be used as collateral, may be able to obtain debt and equity that would be elusive for a pure carbon credit project. Th ese projects will likely be perceived to present less risk to the lender or investor.

Th e goal of raising money for a project is to fi nance the project so it can be built or implemented, and to then pay back the fi nancing and in doing so to generate cash fl ow to the project and developer and to generate as high a return to the developer as possible. In seeking this solution, the project developer must understand the costs and revenue streams of the project and the timing of them over a substantial period of time. Spreadsheets are used to develop pro forma fi nancial models in order that the developer can demonstrate understanding of the business and business planning, and to be able to show lenders and inves-tors that the project can pay them back, plus interest for the lender, and a profi t for the investor, at as high an internal rate of return (IRR) as possible.

To go over the concept of internal rate of return from a project (or any investment) we have to consider the concept as the annualized return rate or discount rate that would cause the net present value of all cash fl ows, whether income or costs or losses, equal to zero. So positive cash fl ows and negative cash fl ows would be brought to their current net present values and compared until the number reaches zero. Th e calculation is used to evaluate the investment return on a single project, and to compare multiple projects, so that an investor can use it as one of the most signifi cant factors to determine if the investor will invest in the project. In the context of evaluating an investment in a carbon credit project in this case, the investor would consider other investments, particularly those with less risk.

Depending on the analysis, the investor may decide to invest in the stock market, bonds, or other more traditional investments, or, alternatively, in the


carbon credit project. Because of this comparison of return and risk, carbon credit project tend to require signifi cantly higher IRRs than many other more traditional investments based on perceived if not actual higher risk with a carbon credit project. One might also assume that a pure carbon credit project may require a higher IRR than a project that has other revenue streams. Lenders may also consider the IRR as one element of evaluating the fi nancial risk in lending on the project, and in calculating the interest rate that it would charge on the loan, if it decides to go forward with fi nancing the project.

D. Carbon Credit Project Lenders and Investors 1. Multilateral Banks and Associated Carbon Funds A variety of multilateral banks and carbon funds provide fi nancing for carbon credit projects. Th e World Bank and its private lender, the International Finance Corporation (IFC), have been the main lender and served in some ways to start the international CER market under the CDM. Th e World Bank has estab-lished the Carbon Finance Unit. Within this unit the World Bank operates several carbon funds that are fi nanced with sovereign funds and private funds, depending on the project. Th e following funds are managed by the World Bank:

Prototype Carbon Fund; • Th e Netherlands CDM Facility; • Community Development Carbon Fund; • BioCarbon Fund; • Italian Carbon Fund; • Th e Netherlands European Carbon Facility; • Danish Carbon Fund; • Spanish Carbon Fund; • Umbrella Carbon Facility T1; • Umbrella Carbon Facility T2; • Forest Carbon Partnership Facility; • Carbon Partnership Facility; and • Carbon Fund for Europe. • 4

4. Th e World Bank, Carbon Finance Unit, available at http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/ENVIRONMENT/EXTCARBONFINANCE/0 ,,contentMDK:21842339∼menuPK:5213558∼pagePK:64168445∼piPK:64168309∼theSitePK:4125853,00.html

http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/ENVIRONMENT/EXTCARBONFINANCE/0,,contentMDK:21842339~menuPK:5213558~pagePK:64168445~piPK:64168309~theSitePK:4125853,00.html




Th ese funds have served to help create and sustain the international carbon market. Some of these funds were designed to support the development of carbon markets generally, but others were designed to support the develop-ment of certain types of projects. Examples are the Forest Carbon Partnership, designed to support Reduced Emissions from Deforestation and Forest Degradation (REDD) projects, 5 and the BioCarbon Fund, designed to demon-strate projects that sequester or conserve carbon in forest and agro-ecosystems. Th e BioCarbon Fund is a public/private initiative that “aims to deliver cost-eff ec-tive emission reductions, while promoting biodiversity conservation and poverty alleviation.” 6

Th e IFC has established its Carbon Finance Unit (CFU) to provide ser-vices to both buyers and seller of carbon credits. Th e CFU develops new products for the carbon markets and provides services to parties involved in the carbon markets. Th e CFU provides experience in project fi nance to manage credit risks in emerging markets where the CDM market has been the source of much of the international off set market. Th e products and services provided by the CFU include:

Carbon Delivery Guarantee; • Monetization of future cash fl ows from sales of carbon credits; • Debt and equity for carbon rich products and businesses; and • Assistance with fi nancial intermediaries and municipalities to help aggregate •carbon credits from their various investment operations. 7

IFC products and services may be critical to some projects in terms of arranging necessary fi nancing to enable project development. Th e IFC may take the risk with new products and services that may lead to private banks, funds, or insur-ance companies taking on that risk once the IFC proves the success of those products or services and their profi tability. An example would be carbon credit guaranties that may enable projects to obtain fi nancing where the output is carbon credits alone, giving the buyer and fi nancing entities comfort that the risk of project failure is addressed.

Th e IFC may be a buyer of credits from project developers, thus serving as the credit-worthy off -taker for some or all of the credits, allowing fi nancing or

5. Th e World Bank, Forest Carbon Partnership, available at http://www.forestcarbonpartnership.org/fcp/ (last visited Sept. 19, 2010).

6. Th e World Bank, BioCarbon Fund, available at http://wbcarbonfi nance.org/Router.cfm?Page=BioCF&ItemID= 9708&FID=9708 (last visited Sept. 19, 2010).

7. International Finance Corporation, Carbon Finance, available at http://www.ifc.org/carbonfi -nance (last visited Sept. 19, 2010).

http://www.forestcarbonpartnership.org/fcp/

http://www.forestcarbonpartnership.org/fcp/

http://wbcarbonfinance.org/Router.cfm?Page=BioCF&ItemID=9708&FID=9708

http://wbcarbonfinance.org/Router.cfm?Page=BioCF&ItemID=9708&FID=9708

http://www.ifc.org/carbonfinance

http://www.ifc.org/carbonfinance


investment in the project from other sources. Th e IFC is developing a post-2012 purchasing capability with the intent of maintaining the market and pricing for credits that would be produced and sold aft er the Kyoto Protocol expires. Th e proposed fund would attempt to raise 150 million euros for forward pur-chasing of CERs by projects for the period from 2013 to 2020. Th e CERs would be required to be generated primarily by projects fi nanced by the IFC or by local banks and fi nancial institutions that have been fi nanced by the IFC. 8

Signifi cant uncertainty exists as to the international off set market as a result of the inability of the countries of the United Nations to negotiate a post-Kyoto agreement. Th is is another example of how the IFC has served to assist in the development and promotion of the international carbon markets.

Financing for carbon credit projects may be available in some form and for certain projects from other bilateral or multilateral development banks. Some of them have been issued directives from their managing boards to promote fi nancing that reduces greenhouse gas emissions. Government-backed U.S. banks would include the Overseas Private Investment Corporation (OPIC) and the U.S. Export-Import Bank. Other development banks include the Inter-American Development Bank (IDB), the North American Development Bank, the African Development Bank, the Asian Development Bank, the Multilateral Carbon Credit Fund established by the European Bank for Reconstruction and Development and the European Investment Bank, and the Nordic Development Fund and the Nordic Investment Bank.

An example is the activity of the IDB. Th e IDB has established the Sustainable Energy and Climate Change Initiative (SECCI) and the Sustainable Energy and Climate Change IDB Special Program (SECCI IDB Fund). Th e SECCI IDB Fund was established to fi nance the main goals of SECCI:

Renewable Energy and Energy Effi ciency; • Biofuel Development; • Carbon Finance; and • Adaptation to Climate Change. • 9

Th e purpose of the Fund was stated as being for “mainstream” renewable energy, energy effi ciency, biofuels, carbon fi nancing, and the climate change adaptation

8. Th e International Finance Corporation, IFC Post 2012 Carbon Facility, available at http://www.ifc.org/ifcext/spiwebsite1.nsf/f451ebbe34a9a8ca85256a550073ff 10/0e078ea6f6b3d71485257719007ae862?OpenDocument (last visited Sept. 19, 2010).

9. Board of Directors, Inter-American Development Bank, Sustainable Energy and Climate Change IDB Special Program (SECCI IDB Fund) and Sustainable Energy and Climate Change Multidonor Fund, revised version 1–2 (Aug. 3, 2007).

http://www.ifc.org/ifcext/spiwebsite1.nsf/f451ebbe34a9a8ca85256a550073ff10/0e078ea6f6b3d71485257719007ae862?OpenDocument




in policies and programs in Latin America and the Caribbean. Th e conclusion was that the investment in these activities would lead to greater clean energy investments and reduced vulnerability to climate change in the region. 10

2. Private Banks Private banks have also served as investors and lenders in the carbon market. Some of the private banks that have fi nanced carbon credit–related transactions and projects include Deutsche Bank, BNP Paribas, Credit Suisse, JP Morgan, CitiBank, Mitsui, Barclays, Bank of America, Sumitomo, Morgan Stanley, and Goldman Sachs.

3. Private Carbon Funds, Private Equity Firms, and Hedge Funds In addition to private banks, investment fi rms have invested in carbon credit projects. Th ese funds include the investment arms of large international banks including Goldman Sachs, Merrill Lynch (now part of Bank of America), Mitsui, Barclays, BNP Paribas, Fortis (now part of BNP Paribas), and others. Funds associated with large insurance companies such as Conning, a subsidiary of Swiss Re, have established carbon funds. Specialized carbon funds have evolved as well, such as Climate Change Capital, RNK Capital, Greenhouse Gas-Credit Aggregation Pool, European Carbon Fund, Trading Emissions PLC, Merzbach Mezzanine Carbon Fund, ICECAP, Grey K Environmental Fund.

4. Utilities and Other Compliance Investors Utilities, oil companies, and other compliance investors may act directly to invest in carbon credit projects in order to secure a stream of carbon credits and to reduce the price for such credits. Th ese investments are oft en made to meet cur-rent or potential future compliance obligations. Th e investment may extend beyond entering ERPAs to purchase credits to providing funding for equity in projects. Some of the fi rms have established their own carbon funds to manage these investments.

10. Id . at 1.


P A R T F O U R

Other Credits That May Be Generated

from Carbon Credit Projects


15

Other Environmental Attributes, Including Renewable Energy Credits and Energy Effi ciency Credits

A. Environmental Attributes and Other Credits That May Enhance Carbon Credit Projects Th e reduction in electricity produced by fossil fuels, whether by substituting renewable energy for fossil-fuel-produced electricity or by reducing the use of electricity produced from fossil fuels, may produce a variety of government or voluntary credits, in addition to carbon credits. As a group, these are known as “environmental attributes.” Several types of environmental attributes can be generated.

As discussed in prior chapters, the reduction in electricity use also reduced the greenhouse gases generated by fossil-fuel-burning power plants. Th e green-house gas primarily avoided is carbon dioxide. Th e reduction in greenhouse gases, whether carbon dioxide, methane, or other types, we know is measured in CO 2 e. However, there are a variety of other environmental attributes in the form of other credits that may be registered and obtained that can be monetized.

Carbon credits are the main “commodity” that project developers are focused on internationally because they are in many countries the only means of monetizing the reduction in greenhouse gas emissions from various types

222 | OTHER CREDITS THAT MAY BE GENERATED

of projects. With respect to projects based on renewable energy or, in some juris-dictions, energy effi ciency, there are other types of credits that may be generated. Th ese credits are generally known as renewable energy credits or RECs. Many states in the United States by statute encourage or require electric utilities with power plants within their borders or that sell electricity within their borders to provide a percentage of that power from renewable energy sources. Th ese sources would include wind, solar, and various other forms of electricity produc-tion that meet that state’s defi nition of “renewable.”

In some states, credits may be issued for energy effi ciency projects that meet requisite standards. Th e energy effi ciency credits can be generated from projects such as the replacement of lighting, heating and air conditioning units, appli-ances, or other actions that reduce the amount of electricity used in a building or other physical operation, such as an industrial plant.

B. Renewable Portfolio Standards A Renewable Portfolio Standard (RPS) is the term used for statutes enacted by state legislatures to require that electricity suppliers that sell electricity include a minimum percentage of electricity produced by renewable sources by a date certain. Th e RPS, or minimum renewable portion, ranges from 12.5 percent in North Carolina by 2021 to 40 percent in Hawaii by 2030. Th e states also diff er on the types of electric utilities that are subject to the standards. Th e credit-trading markets described below allow the establishment of a market such that parties selling electricity may purchase those credits and use them to meet their compliance obligations.

As such, RPSs are another form of environmental market. As of December 2009, twenty-nine states and the District of Columbia have established a form of RPS. 1 Th ese states produce more than one-half of the electricity sales in the United States.

RECs can play a signifi cant economic role in encouraging the development of renewable energy. Th e typical state RPS requires that a certain amount of the electricity sold in that state be derived from renewable energy sources. Th e percentage can vary from a few percent to 20 percent under California’s legislation. 2 Th e defi nition of renewable energy source may vary from state

1. Th e Pew Center on Global Climate Change maintains a website that tracks states that have established an RPS or a form of similar program for requiring renewable or alternative energy, available at http://www.pewclimate.org/what_s_being_done/in_the_states/rps.cfm/ .

2. Senate Bill 1078 passed in 2002 imposed a renewable energy requirement of 20 percent of elec-tricity sold in California by 2017. Senate Bill 107 passed in 2006 accelerated that deadline to 2010.

http://www.pewclimate.org/what_s_being_done/in_the_states/rps.cfm/

OTHER ENVIRONMENTAL ATTR IBUTES | 223

to state. Th e types of facilities that may qualify as renewable energy sources include wind, solar, biomass, geothermal, wave, tidal, hydropower, and landfi ll gas.

One of the main policy goals of a state adopting an RPS is to encourage the development of renewable energy sources that may not otherwise arise in a typical market for electricity. Th e price of renewable energy may refl ect the cost of new technology or a new industry and the fact that fossil fuels are not required to internalize their other costs such as the pollutants they emit or the fact that they are not renewable, but at some point will be played out. Th us, state governments have determined to enact an RPS to attempt to allow the new form of energy production to develop over time by requiring a percentage of change by the local utilities.

An RPS is typically a market-based system by which the producer of electricity from a renewable source, say a wind turbine, obtains RECs. A REC is typically measured in megawatt-hours (MWh). RECs are awarded to sources of electricity that are generated by a renewable source. For private project developers of renewable energy, the project developer may give RECs generated by a project to utilities that must present them to a public utility commission to show that a certain percentage of the electricity sold in the state is from a renew-able source. Alternatively, a utility may construct its own renewable energy facility and use the RECs that may be issued for their own account. Th us, the util-ity may construct and operate its own renewable energy sources and generate its own RECS or purchase RECs from other renewable electricity producers. RECs can be purchased directly from a renewable energy project or on a secondary market where RECs are purchased and sold. Th e independent system operators that manage the electricity grids in various states typically manage this system. Th ose utilities that fail to obtain and submit RECS at requisite times face potential penalties.

Some states require that a certain percentage of power be produced from certain types of renewable sources. For example, wind may be a productive area in a state, but solar has not emerged to any signifi cant amount. A state may require that a certain percentage of the renewable energy requirement be derived, for example, from solar sources. Th e same number of credits can be awarded to this type of electricity or a multiplier may apply. For example, two times the amount of RECs may be generated from one megawatt hour (MWh) for solar as opposed to wind energy produced.

Th e timeframe by which a certain percentage of renewable power must be generated in a state is critical as well. Th ese levels typically increase over time.

In Texas, for example, the fi rst renewable energy standard was met several years before the deadline. Texas has the advantage of large areas of land where


the wind blows hard most times of the year. Texas quickly became the largest producer of wind energy of any state in the United States. Th e Texas Legislature established an initial goal in 1999 of 2000 new megawatts (MW) of renewable electricity by 2009. In 2005, it raised the level to 5,880 MW by 2015 and 10,000 MW by 2025. Th e 2015 goal must include 500 MW that originate from sources other than wind projects. Th e sources that qualify for the RPS in Texas are solar, wind, geothermal, hydroelectric, tidal energy, and biomass, which includes landfi ll gas production. Because the most benefi cial areas to construct renewable energy sources are oft en remote, where electricity transmission is not located, the Texas Legislature required a transmission plan to be created and executed by the Texas Public Utility Commission to allow wind energy genera-tion in West Texas to have the means to transmit the electricity to urban areas, where the demand for the electricity is found. If a retail electricity provider fails to submit suffi cient RECs for retirement, then that provider may be subject to a fi ne of $50 for each MWh of defi ciency. Th e rules provide for REC aggrega-tors that aggregate RECs from “micorgenerators” who generate a small amount of renewable electricity.

C. Renewable Energy Credits RECs were created to allow generators of electricity from renewable sources such as wind, solar, geothermal, biomass, etc., to sell the environmental attributes of the renewable power. RECs are created by states — since the United States has not adopted a federal program for renewable energy — through a national RPS that requires a certain portion of the electricity produced by utilities to be generated from renewable sources. Th e RECs in some states allow the renewable aspect to be separated from the physical electricity and sold separately, while in others they are bundled with the electricity. RECs are purchased by utilities and power marketers to achieve compliance with RPS requirements.

Th e underlying policy goals of these programs include reducing price risk from dependence on one or a few types of generating sources, which have largely been coal or natural gas, economic stimulation through construction of renewable energy projects, and the reduction in pollutants, including sulfur dioxide, nitrous oxide, and greenhouse gases. 3

3. Capturing the Power of Electric Restructuring 176 (2009).


A REC is generally defi ned as a tradable certifi cate representing one megawatt hour (MWh) of renewable energy that is physically metered and veri-fi ed from the generator or the renewable energy project.

As stated above, sales of RECs are either bundled, that is, sold, with the electricity produced by the renewable energy project, as is presently the case for California, or unbundled, that is, sold separately from the electricity, as is the case for the majority of states that have established an RPS.

Th e ability to buy and sell the RECs results in a REC market. Th e prices vary widely. In Texas for example, the RECs may sell for $1 to $2. In other states that price may be higher. Some RECS are source dependent, such as solar RECs. In New Jersey, the solar RECs (sRECs) sell for as much as $600 or more.

D. Energy Effi ciency Credits Some states, such as Connecticut, Pennsylvania, and Nevada, have extended the concept of RECs for renewable energy to energy effi ciency. Energy effi ciency credits are generated based on a verifi ed amount of electricity use that is reduced.

Under an RPS that includes an energy effi ciency requirement that utilities must meet, the utilities must demonstrate that they have achieved a certain amount of reduction in electricity use through energy effi ciency. Th e utilities then would become purchasers of the energy effi ciency credits to achieve this compliance obligation.

E. Credits for Traditional Pollutants Some of the traditional pollutants that are reduced are sulfur dioxide, nitrogen oxides, particulates, and mercury, some of which may be limited to coal-burning power plants as opposed to natural-gas-burning power plants.

F. Forward Capacity Markets Electricity production faces special challenges during periods of peak demand. Th ese periods typically occur during summer months when air conditioning places a greater demand on the electricity grid. At these peak periods, the utilities have what are known as “peaker plants” that produce the power needed to meet electricity demand that the power plants that are generally operating cannot meet.


In order to address this peak demand period, the independent system operators (ISOs) in some states project out the electricity needs for the next three years and then conduct auctions to purchase the power to obtain the needed sources of electricity to meet those demands during peak loads. In some of these states, the ISO allows energy effi ciency and other demand response sources to participate in these auctions with power producers. Th e types of providers that may participate in these forward capacity options include tradi-tional power generation, intermittent resources such as wind, solar, and hydro, imports of capacity from outside of the ISO, and demand resources, including real-time demand response, load management, distributed generation, and energy effi ciency.

Parties that can achieve a suffi cient level of power reduction or demand response reductions at peak demand periods may be able to participate in these forward capacity markets.

G. Contractual Issues in Selling RECs Outside California Although attempts have been made at developing a standard contract for selling RECS, 4 buyers and sellers tend to off er their own versions of contracts for selling them. Generally there are two types of contracts, those not involving RECs in California and those involving RECs in California.

For those contracts not involving RECs from California, the contract terms may or may not be directed by the public utility commissions. In each state, research into the requirements or forms required for buying and selling RECs should be conducted.

Some of the issues of importance include those below.

1. Type of Credit Th e contract must set out the type of RECs and address the unique nature of the state in which the RECs are being generated and sold. Unless and until a federal RPS is adopted, the contracts will vary by state. If other attributes such as energy effi ciency credits are to be sold, then the contract must identify those and address the specifi c issues related to those types of credits. In some states, such as

4. For example, a group of attorneys through the American Bar Association attempted to develop a model agreement, but it has not been used to any great extent. Th e ABA Master Renewable Energy Certifi cate Purchase and Sale Agreement, available at http://www.abanet.org/environ/commit-tees/renewableenergy/RECMasterContract.pdf .

http://www.abanet.org/environ/committees/renewableenergy/RECMasterContract.pdf

http://www.abanet.org/environ/committees/renewableenergy/RECMasterContract.pdf


New York, the contract must include all environmental attributes, and require form contracts are required. 5

2. Vintage of Credit Th e year or years of issue of the REC must be set out in the contract. Th is is important to be clear what is actually being sold. In some states, the REC from one year, say 2009, must be turned in by June 2010. Th us, stating the appropriate vintage is important so one is not purchasing RECS that have expired.

3. Quantity Being Sold Along with price, the quantity being sold determines the purchase price. For the compliance buyer, it is critical that it may rely on a minimum amount so that it may meet its compliance requirements.

4. Pricing Th e price of the REC is obviously a critical part of the contract and will be central to negotiating the business terms of the deal. In some states, the price may refl ect the penalty for failure to obtain suffi cient RECs to meet the compli-ance obligation of the electricity supplier.

5. Transfer Mechanism In most states, RECs can only be traded if they are registered through the state under the RPS. Most states maintain a REC registry that tracks the owner-ship of the RECs. As for prices and contracts, some states do not address these issues as the registry is not designed to serve as a trading exchange, but only to track ownership. Under most state laws, the regulating entity must be notifi ed when a REC has changed ownership or been traded.

Th e contract should address the mechanism of transferring the RECs as state regulations regarding registries and the means by which the REC may be traded may vary. Th e issue of whether the RECs are transferred before or aft er payment must be addressed as well. Upon transfer, the seller relinquished all rights to the RECs and the buyer obtains any and all rights to the RECs for its sole use. Normally, payment is made upon delivery, as discussed more below.

6. Payment Payment timing may depend on the credit worthiness of the buyer. If the buyer is an investment-grade company, then payment may be, for example, aft er ten days

5. New York State Energy Research and Development Authority RPS Standard Form Contract, available at http://www.nyserda.org/wms/docs_funding/916rfp.pdf .

http://www.nyserda.org/wms/docs_funding/916rfp.pdf


of delivery of the RECs. If not, then payment may be due three days before the delivery date.

7. Delivery Delivery is then an issue that depends upon payment. Delivery may be before or aft er payment, depending on the credit worthiness of the buyer, or its guaran-tor, if any. Delivery would be aff ected through the relevant state’s registry.

8. Representations and Warranties A variety of representations and warranties may be appropriate. Some of the more important are to state that the RECs meet the applicable state’s RPS standards. Another is that the RECs have not been previously sold nor are there any other claims in terms of a lender or other third-party rights to the RECs. An important issue is that the RECs have not been previously used to meet the state’s RPS requirements, and, therefore, would not be of any value to the buyer.

9. Eff ective Date and Termination Th e eff ective date will be set forth in the contract. If the contract serves as a master service agreement, then the eff ective date of subsequent trades will be governed by a confi rmation letter that will set forth other details.

Termination may arise in several ways. One would be expiration of the contract. Another would be if the state changes its laws such that the transaction is no longer of any use to the buyer, as described below. Insolvency of one or more parties may lead to termination as well. Termination may also arise if either party defaults and fails to perform its obligation under the contract.

10. Remedies and Damages Th e remedies and the means of calculating damages under the contract should be set forth in the agreement. For example, if the buyer fails to make payment or becomes insolvent or is a party to a bankruptcy proceeding, then the contracts typically provide relief to the other party to the agreement. Failure by the seller to deliver RECs would be another example of default.

11. Change in Law RECs like other many other environmental attributes are creations of state governments, and potentially in the future, national governments. Th us, legal changes can eliminate an RPS or change the rules in such a way as to make the transaction substantially diff erent or of less or no value to one or both of the par-ties. Th us, how changes in law may aff ect the transaction may be an important provision in a REC purchase and sale agreement.


H. Contractual Issues in Selling RECs Inside California In California, the situation is much diff erent than in most states. Initially, RECs in California were required to be bundled with the electricity sold, and could not be sold separately.

In March 2010, the California Public Utilities Commission (CPUC), issued a rule that changed these limitations. 6 Th ese RECs are referred to as tradable RECs, or TRECs. As a result, up to 25 percent of RECs may be pur-chased by utilities that are unbundled. For retail electricity providers, there is no limit on the amount of TRECs that can be used to meet their compliance obligations.

Many of the contract terms are set by the CPUC. Changes to those terms must be approved by the CPUC. Doing REC business in California is more complicated, and requires knowledge of the current standard terms and how the CPUC is currently administering those standard terms. Review of any new or developing CPUC regulations prior to negotiating a California REC agreement would be prudent.

6. See Cal. Pub. Util. Comm’n, Decision Authorizing Use of Renewable Energy Credits for Compliance with the California Renewables Portfolio Standard, Rulemaking 06–02–012 (Mar. 11, 2010).

16

Ecosystem Services: Wetlands and Biodiversity Credits

The nation behaves well if it treats the natural resources as assets

which it must turn over to the next generation increased and not

impaired in value. 1

Beyond carbon credits that may be generated from ecosystems such as forests, as discussed in Chapter 12, ecosystems may also generate other forms of credits for the “ecosystem services” that they represent. Ecosystem Services is a rather new concept. It has evolved over the last decade or so. Th e concepts of economics and ecology have begun to hybridize in this new area, and the devel-opment of the concepts of ecosystem services is the outgrowth of this cross-breeding of what has long been seen as incompatible ways of thinking and intellectual disciplines.

In a book published by the National Academies of Science in 2005, the authors concluded that:

In fact, the committee [which developed the study and book] quickly discovered that this is not an established fi eld — ecologists have only recently begun to think in terms of ecosystem services and their determinants, while economists have likewise only very recently begun to incorporate the factors aff ecting ecosystems services into their valuations

1. Attributed to President Th eodore Roosevelt, inscribed on the entrance of the American Museum of Natural History, Washington, D.C., quoted by National Academy of Sciences, in Valuing Ecosystem Services: Toward Better Environmental Decision-Making (2005).

ECOSYSTEM SERV ICES | 231

of these services. If we as a society are to understand properly the value of our natural capital, which is a prerequisite for sensible conservation decisions, then this growing fi eld must be developed further . . .” 2

As local, national, and global environmental, ecosystem, and climate impacts from human populations and activities have become an increasing concern not only to those who wish to conserve ecosystems and species, but also to those responsible for setting public policy and programs that aff ect signifi cant economic impacts of climate change or degradation of fi shing stocks, among many other examples, the understanding of the real value of ecosystems becomes of increasing importance. 3

Th e challenge has been that when ecosystems were facing destruction for purposes of land development, farming, cattle-raising, or other purposes, the economic value of the activity that would destroy or degrade the ecosystem was estimated, but there was no countervailing economic value stated for the eco-system or the “services” that it provides. Th us, a rather one-sided measure was taken, and in the balance, the development would largely win out. 4

Th e attempt to value the ecosystem services also arose in the context of measuring the “natural resource damages” under U.S. laws that required parties liable for damages to streams, lakes, or other ecosystems to pay damages to certain state or federal natural resource trustees. When these laws were passed, a means of calculating the natural resource damages in terms of economic damages, that is, a dollar fi gure for the damages, became a critical issue. Th e laws that created a claim for natural resource damages include the Comprehensive Environmental Response, Compensation, and Liability Act, the Clean Water Act, and the Oil Pollution Act. Various states have enacted laws that also require the payment of natural resource damages.

A. Wetlands Credits and Banking Th e fi rst area in which it became part of a regulatory system in the United States was in the context of the federal Clean Water Act. Under Section 404 of the Clean Water Act, parties required to obtain a permit to fi ll wetlands must mitigate the removal of the wetlands within the same watershed. 5 Section 404 established a program to permit the discharge of dredged or fi ll material into

2. Valuing Ecosystem Services , at vii.

3. See id. at 2.

4. See id.

5. 40 C.F.R. Part 230, Subpart J.


waters of the United States and prohibits any such discharge that will adversely aff ect municipal water supplies, shellfi sh and fi shery areas, or wildlife or recre-ational areas. Section 404 permits are issued by the U.S. Army Corp of Engineers.

Earthmoving activities and the discharge or placing of any amount of soil, concrete, rocks, or other fi ll materials onto wetlands, stream beds, or other waters of the United States without a permit constitutes a violation of Section 404 of the CWA. Wetlands are broadly defi ned and may include such unlikely or unexpected areas as certain forests, agricultural land, rangeland, and uplands. For example, shaping and creating a dry creek bed to handle storm water runoff from a development would most likely require a Section 404 permit from the Corps of Engineers. Dredging alone would not likely require a permit.

In order to permit development, the Corp of Engineers has created a system whereby entities may apply to establish wetlands mitigation banks. Th e banks consist of land that is typically already in part wetlands or wet areas that are enhanced to high-quality wetlands. A conservation easement is fi led in the deed records for the property so that the property will continue to be a wetland. Th e developer of the bank must provide for the continued monitoring and maintenance of the wetlands.

Th ird parties who seek to develop wetlands may purchase credits from the wetlands bank as part of mitigation required by the Corp of Engineers rules. Th e wetlands mitigation bank must be found in the same watershed as the development project. Th rough this system, a market for wetlands credits has been established.

Developers of greenhouse gas (GHG) reduction projects may turn to wetlands as a means of absorbing greenhouse gases, primarily CO 2 . Th e use of wetlands as a GHG reduction project to produce carbon credits may also pro-duce wetlands mitigation credits. Th e ability to generate both credit types would increase the revenue from the project.

B. Biodiversity Credits A new form of environmental credit or attribute that is starting to come into being is a biodiversity credit. Parties are seeking to develop these credits as a means of contribution to saving ecosystems and biodiversity. A book has recently been published to advise parties on setting up a biodiversity credit program. 6 Th e biodiversity credit is designed to allow parties who are developing property

6. Conservation and Biodiversity Banking: A Guide to Setting up and Running Biodiversity Credit Trading Systems (Nathaniel Carroll, Jessica Fox, & Ricardo Bayon eds., 2009).


to mitigate ecological impacts by purchasing credits from a bank in the same way as parties would do if they are impacting wetlands. Th e ability to address these issues through a biodiversity credit bank makes the process more effi cient for the developer and allows a larger, more concentrated area of an ecosystem to be preserved and enhanced.

As an example, the State of California has established a policy regarding what are known as conservation banks to protect species and their habitats. Th e explanation of the purpose of conservation banks was stated in that policy as follows:

A conservation bank is a single parcel, or a series of contiguous or non-contiguous parcels, of habitat which is managed for its natural resource values. Th e resource benefi ts derived from this management regime are sold as “credits” to project proponents who seek mitigation opportunities to compensate for resource impacts elsewhere. Credits may be generated to meet any number of resource conservation needs, including compensation for impacts to wetlands, threatened or endangered species, Environmentally Sensitive Habitat Areas, mudfl ats, sub-tidal areas, and less sensitive resources.

Conservation banks, if properly established and managed, serve several useful functions. First and foremost, banks provide for the conservation of important habitats and/or habitat linkages.

Second, they provide a viable alternative to the current practice of requiring piecemeal mitigation for individual project impacts. Individualized mitigation projects which have little connection with their surrounding ecosystem are oft en much more prone to failure than a mitigation project which is incorporated into a larger, ecosystem-based conservation bank or regional conservation plan.

Th ird, conservation banks can take advantage of economies of scale that are oft en not available to individualized mitigation projects.

Fourth, conservation banks provide signifi cant incentives for private landowner participation and represent one of the best examples of private/public partnerships in an era of shrinking budget resources.

Fift h, conservation banks can be a major funding component for the creation of an ecosystem preserve under a regional conservation plan.

Sixth, and fi nally, conservation banks simplify the regulatory compliance process while achieving greater conservation goals. 7

7. California Environmental Protection Agency, Offi cial Policy on Conservation Banks (Apr. 7, 1995).


In Florida, the U.S. Fish and Wildlife Service and the Florida Fish and Wildlife Conservation Commission have worked together to establish conservation banks to protect the Florida panther and its habitat. In doing so, the explanation of conservation banks was off ered:

Conservation banks for endangered species have been successful in other places across the country. Banks set up a system where the private sector provides funds to preserve and manage important habitat . . . forever. Landowners can sell credits to developers planning to impact what are usually marginal habitats elsewhere, ensuring the most valuable habitats continue to fl ourish.

Th is system off ers landowners an economic incentive to maintain and use the land in ways compatible with conservation. Fittingly, ranchers, who have been stewards of Florida’s landscape for generations, can pass that legacy to their children and grandchildren. 8

Th e state and federal wildlife agencies worked with private parties to develop conservation banks between protected habitat in order to ensure a passageway between the two habitat regions and, therefore, protect the endangered species.

Th e biodiversity and species credits are still in a development stage. International credits are being studied and developed, particularly with respect to forest preservation and protection of ecosystems, habitat, and the species that inhabit and depend on those systems. In the forest carbon arena, biodiversity credits allow another form of income to fi nance forest preservation, as will be discussed below.

C. Credit Stacking With the development of distinct environmental markets and credits, the devel-oper of projects will seek to obtain as many credits as possible to maximize the return on investment.

With wetland banking, conservation banking, water quality trading, and now carbon markets, opportunities to engage in natural resource markets continue to grow. Investors are attracted by the multiple markets and associated revenue streams, and developers are looking for increasingly

8. U.S. Fish and Wildlife Service and the Florida Fish and Wildlife Conservation Commission, Conservation Banking Can Help Save Panthers, available at http://myfwc.com/Newsroom/10/statewide/News_10_X_ConservationBankingOpEd.htm (last viewed Sept. 12, 2010).

http://myfwc.com/Newsroom/10/statewide/News_10_X_ConservationBankingOpEd.htm

http://myfwc.com/Newsroom/10/statewide/News_10_X_ConservationBankingOpEd.htm


comprehensive mitigation. Th e possibility of credit stacking, selling more than one natural resource credit type on a single acre of land, has emerged with particular interest.

Th e drive to maximize land management investments will push towards getting credit for all the attributes on a parcel of property. Understandably, landowners will argue that they deserve credit for every ecological benefi t they commit to protecting, including the species habitat, sequestered carbon, and downstream water quality improvements. On the fl ip side, if stacking is appropriately regulated, it may create demand for more specifi c credit types and result in more complete mitigation. With the logistics of markets for ecosystem services still being solidifi ed, the debate about credit stacking is active. 9

Th e process of credit stacking may make it easer to fi nd investment capital or debt to assist project developers in raising the funds necessary to preserve or restore ecosystems. As avoided deforestation known as Reducing Emissions from Deforestation and Forest Degradation (REDD) projects as well as refores-tation projects have the potential to take on a growing role in cap and trade programs, the ability to not only capture carbon credits but also other related types of credits such as biodiversity, wetlands, and water quality credits, enhances the ability to fund saving and regrowing forests, particularly rainforests in the Amazon and other parts of the world where deforestation is a signifi cant threat not only to these important ecosystems, but also a source of carbon sequestration.

9. Id. Chapter 11.

17

Water Credits

A. Increasing Water Demand and Decreasing Water Supply Water has been a scarce resource in many parts of the United States and through-out the world. One of the predicted outcomes of climate change is the reduction of the availability of fresh drinking water. In some places, water availability and supply is predicted to decrease signifi cantly. 1

Energy production, such as by means of coal-fi red power plants, uses sig-nifi cant amounts of water. As energy demand increases, so too will the demands for water. General demand for water will increase for not only energy production, but also agriculture, industrial use, and drinking. Populations in many areas are growing. Climate change will likely reduce water supply in many areas. As a result, the strains on societies and economies are predicted to increase dramati-cally as demand for water increases and supply of water decreases in many locations.

Certain carbon credit projects, as discussed below, may also be able to gen-erate water quantity or quality credits.

B. Why Water Is Becoming a Potential Tradable Commodity Water rights have been an important aspect of many national and state or provin-cial legal systems. How water rights are allocated and retained, and in some cases transferred, is critical to economic and social systems.

1. In South Australia, overall decline in rainfall has been predicted to be between 15 to 30 percent. Government of South Australia, Water for Good: A Plan to Ensure Our Water Future to 2050 16 ( June 2009).

WATER CREDITS | 237

Commentators have suggested establishing water as a tradable commodity, arguing a scarce resource like water may be best managed as a commodity that may be bought and sold, so that the price refl ects its economic, industrial, and social value.

C. Water Credits and Markets as a Means of Conserving a Scarce Resource 1. Water Quantity Trading Water rights or credit trading has evolved primarily in areas where water is a scarce resource. Australia is one of these areas. Water trading began in South Australia in 1988, in Victoria in 1989, and in New South Wales in 1990. 2 In Australia, the water trading market for groundwater is separate from the market for surface water. 3

Th e Water Exchange in Australia was founded in 1997, and purchased for $10.75 million by the National Stock Exchange of Australia Limited in 2007. Th is exchange had 20,000 customers, which consisted mostly of farmers trading water rights among each other.

2. Water Quality Trading As water must not only be in good supply, but must be of suffi cient quality, either fresh water or fresh water free from chemical or biological contaminants or disease vectors. Water quality trading is also becoming an area where many loca-tions are trying to use environmental markets, such as air pollutant emissions markets, to fi nd a more effi cient and fl exible program for regulating water pollu-tion discharges and the ultimate water quality of water bodies.

A World Resources Institute report published in March 2009 identifi ed fi ft y-seven water quality trading programs worldwide, where twenty-six are active, twenty-one are under consideration or development, and ten are inactive. 4 Th e majority of programs were in the United States, four in Australia, one in New Zealand, and one in Canada.

In the United States, the Environmental Protection Agency (EPA) has promoted water quality trading programs for over ten years “as an inno-vative approach for achieving water quality standards with fl exibility and

2. Sarah Bushey, Australian Water Markets Are Growing Up, Ecosystem Marketplace, available at http://www.ecosystemmarketplace.com/pages/dynamic/article.page.php?page_id=5219&section=home&eod=1 .

3. Id.

4. Mindy Selman, Suzie Greenhalgh, Evan Branosky, Cy Jones, & Jenny Guiling, World Resources Institute, Water Quality Trading Programs: An International Overview (March 2009).

http://www.ecosystemmarketplace.com/pages/dynamic/article.page.php?page_id=5219&section=home&eod=1

http://www.ecosystemmarketplace.com/pages/dynamic/article.page.php?page_id=5219&section=home&eod=1


economic effi ciency.” 5 Th e EPA’s water trading policy was based on the assump-tion that in watersheds in which a total maximum daily load limiting pollutants entering the watershed is in place and enforced, then a basis for trading exists as the Total Maximum Daily Loads (TMDL) remains the same. Th e TMDL is much like the cap in a cap and trade system for air emissions. Each permit must be designed to meet water quality standards. Th e EPA believes that the inclusion of trading provisions in National Pollution Discharge Elimination System permits issued under the Clean Water Act should serve to facilitate meet-ing the requirements of the Clean Water Act. 6

However, there are some complications under the federal Clean Water Act (CWA). Under Section 301(b), discharge permits are required to contain tech-nology-based effl uent limitations and, where necessary to meet water quality standards, strict effl uent discharge limitations. Th ese standards must be included, and trading does not eliminate them, except where specifi cally provided in effl u-ent guidelines. Care must be taken so that localized impacts are not caused by trading such that high concentrations of pollutants exist in smaller areas, even thought the larger watershed meets water quality standards.

Th us, there are clearly challenges to implementing a water quality trading system. Th ese challenges can be overcome with careful planning and analysis to develop a watershed-wide trading system. An example of such a system is the Long Island Sound Nitrogen Credit Exchange Program established by the State of Connecticut, and directed by a Nitrogen Credit Advisory Board appointed by the General Assembly and the governor. Th e Virginia General Assembly passed legislation allowing the formation of the Chesapeake Bay Nutrient Credit Exchange Program, including the creation of a watershed-based nutrient general permit incorporating trading and the formation of the Virginia Nutrient Credit Exchange Association.

D. Carbon Credit Projects and Water Credits As discussed in Chapter 16, credit stacking is a potential revenue enhancement for carbon credit projects involving forestry and wetlands. Carbon credit projects may be able to take advantage of these water credits in certain instances. An example might be where a forest project or wetlands project that is used to

5. Offi ce of Wastewater Management, Water Permits Division, U.S. Environmental Protection Agency, Water Quality Trading Toolkit for Permit Writers 1 (August 2007, updated June 2009, EPA 833-R-07–004).

6. Id .

WATER CREDITS | 239

create carbon credits and perhaps biodiversity credits also retains water and, therefore, creates water quantity or water quality credits. Another example might be an anaerobic biodigester that takes waste from concentrated animal feeding lots, farm waste, or other agricultural animal or plant waste and converts the waste into methane, electricity, or fertilizer. Th ese projects oft en signifi cantly reduce pollution of surface, and at times, groundwater. As a result, water quality credits may be possible to generate from these projects, depending on the loca-tion and regulatory system that may be in place.


P A R T F I V E

Government Incentives — Stimulating

Carbon Projects


18

Government Incentives for Renewable Energy and Other Types of Projects That Generate Carbon Credits

A. The Use of Government Incentives to Enhance Carbon Credit Projects Energy effi ciency and renewable energy are becoming increasingly attractive to manufacturers as they contribute to reduced costs and the ability to reduce the level of dependence on third-party energy providers. Th ese activities can produce positive corporate reputation, shareholder endorsement (particularly from institutional or “socially responsible investors,” such as state pension funds), and public perception. As climate change laws and controls on greenhouse gas emissions grow, the need to plan and develop strategy for the costs and opportunities that may apply to these developments becomes increasingly impor-tant. Companies are developing corporate strategies to address energy, climate change, greenhouse gas emissions, and related issues as part of their business strategies and as part of their sustainability and corporate social responsibility programs.

Many companies are considering how they will address energy use and the role that government incentives and environmental attributes will play in their strategy.

244 | GOVERNMENT INCENT IVES — STIMULAT ING CARBON PROJECTS

At the project level, estimating the cost of the project and then evaluating the funds that may be generated to off set some of those costs is a prudent step in overall cost reduction and estimating the rate of return on the projects being evaluated. Government incentives in various forms and the sale of environmental attributes serve to increase the rate of return on the investment in renewable or energy effi ciency projects.

Here we will review what government incentives may assist companies in developing energy effi ciency and renewable energy projects and other projects that may result in reductions in greenhouse gas emissions.

A variety of government incentives may apply to renewable energy or energy effi ciency projects. Incentives for manufacturing certain energy effi cient or renewable energy related technologies or equipment may apply as well.

Th e American Recovery and Reinvestment Act of 2009 (ARRA), which President Barack Obama signed into law on February 17, 2009, made signifi cant changes in prior tax and other incentives for renewable energy, energy effi ciency, carbon capture and storage, and alternative transportation fuels. Understanding the new or amended incentives may provide opportunities for companies engaged in these business areas and provide signifi cant assistance to municipali-ties that are looking for opportunities to address these issues. Th e ARRA should not be discussed alone, but in the context of the Emergency Economic Stabilization Act of 2008 (the EESA), which served as the vehicle for the eco-nomic rescue legislation signed into law on October 3, 2008, by President George W. Bush. Th e EESA is organized into three separate divisions, but the one that we will explore in this chapter, along with the ARRA, is Division B, entitled the Energy Improvement and Extension Act of 2008. Th e ARRA and the EESA together created signifi cant incentives for renewable energy, energy effi ciency, carbon capture and storage, and alternative transportation fuels.

Many of these projects will reduce greenhouse gas emissions and may qualify for carbon credits, renewable energy credits, energy effi ciency credits, or other environmental attributes, through voluntary carbon credit programs or current or future state and federal climate change legislation or Renewable Portfolio Standards. Combining both the incentives and carbon credit revenue may allow projects that would not otherwise be fi nancially feasible to become economically sound or signifi cantly improve the economics of otherwise profi table projects.

Th e EESA and ARRA provide signifi cant opportunities for parties engaged in projects in renewable energy, energy effi ciency, carbon capture and storage, and alternative transportation fuels. Coupled with the potential for carbon credit and other environmental attribute revenue, the new or enhanced incen-tives may signifi cantly improve the economics of these projects.

GOVERNMENT INCENT IVES FOR RENEWABLE ENERGY | 245

Not all of these grant programs or those that may be created in the future will provide incentives that can be used for carbon credit project developers or those whose products or businesses lead to greenhouse gas reductions to help reduce the costs of greenhouse gas emission reductions. However, these parties should keep in mind the various government grant programs as they evolve over time to determine if they may qualify for such grants.

B. Government Incentives 1. Government Grants Government grants apply to a variety of projects. Th e U.S. Department of Energy (DOE) has received billions of dollars through bills passed by Congress for a variety of activities. State and local governments may have access to the state or federal money for providing grants to companies that install energy-effi cient equipment or lighting, or distributed renewable energy projects.

At the federal level, Congress, in passing the EESA and the ARRA, provided billions of dollars in grant opportunities for companies engaged in renewable energy and energy effi ciency projects, both in terms of project devel-opers and manufacturers.

Th e ARRA provided funds for grants in the following areas:

$3.1 billion for states to promote energy conservation and to reduce the rate •of energy demand. $2 billion for manufacturers of advanced vehicle batteries and components. • $5 billion for installation of energy effi ciency improvements in the homes of •low-income families in order to reduce the energy bills of these families. $2.5 billion for applied research, development, demonstration, and •deployment activities, such as $800 million for biomass projects, $400 million for geothermal projects, and $50 million for research to increase the energy effi ciency of information and communications technology. $400 million for electrifi cation of transportation. • $300 million to create an alternative fuel vehicle pilot grant program. • $300 million for the energy effi cient appliance rebate program and the •Energy Star Program.

2. Government Tax Incentives A variety of tax incentives in the form of production tax credits and investment tax credits have been provided through federal statutes. State and local govern-ments may provide tax incentives in the form of property tax, franchise tax, or sales tax reductions to encourage this activity.


a. The EESA Th e EESA provided signifi cant tax incentives and extensions for tax credits for the following projects: (1) renewable energy, (2) energy effi ciency and conservation, (3) carbon capture and storage, and (4) transportation fuel. Below are examples of tax incentives and credits related to the foregoing projects.

i. Renewable Energy

Extended through 2009 (placed in service before January 1, 2010) the tax •credit for producing electricity from wind. Extended through 2010 (placed in service before January 1, 2011) such tax •credit for other facilities, including closed and open-loop biomass, solar energy, small irrigation power, landfi ll gas, trash combustion, and hydropower. Modifi es rules for and defi nitions of refi ned coal, trash and biomass facilities, and hydropower production. Included marine and hydrokinetic renewable energy as a renewable resource •for purposes of the tax credit for producing electricity from renewable resources.

ii. Energy Effi ciency and Conservation

Allows a new tax credit for investment in qualifi ed energy conservation •bonds for capital expenditures to reduce energy consumption in public buildings, implement green community programs, develop alternative and renewable energy sources, and promote mass commuting facilities. Extends through 2009 the tax credit for nonbusiness energy property •expenditures. Includes energy-effi cient biomass fuel stoves as property eligible for such tax credit. Modifi es tax credit standards for water heaters, geothermal heat pumps, and energy effi ciency improvements. Extends through 2013 the tax deduction for energy effi cient commercial •buildings. Extends through 2009 the tax credit for residential energy effi ciency •improvements.

iii. Carbon Capture and Storage

Allows a 30 percent investment tax credit for advanced coal-based generation •technology projects and increases the maximum credit amounts allocable for such projects to $2.55 billion.


Increases to 30 percent the investment tax credit rate for coal gasifi cation •projects and the aggregate credit amount for such projects.

iv. Transportation and Domestic Fuel

Increases and extends through 2009 income and excise tax credits for •biodiesel and renewable diesel used as fuel. Extends through 2009 the excise tax credit for alternative fuel and fuel •mixtures. Requires such fuels to include compressed or liquefi ed biomass gas and to meet certain carbon capture requirements. Allows a new tax credit for qualifi ed plug-in electric drive motor vehicles. •Limits the amount of such credit based upon the gross vehicle weight rating of such vehicles. Terminates such credit aft er 2014. Extends through 2010 the tax credit for alternative fuel vehicle refueling •property expenditures. Includes electricity as a clean-burning fuel for purposes of such credit. Provides for the treatment of certain income and gains from alcohol, •biodiesel, and alternative fuels and mixtures as qualifying income for publicly traded partnerships. Extends through 2013 the taxpayer election to expense costs of certain •refi nery property.

b. The ARRA Th e ARRA provided for numerous tax credits for renewable energy, energy effi -ciency, carbon capture and storage, and alternative transportation fuels. Some of the relevant tax incentives extended or established were as follows:

Extended renewable production tax credits for wind projects through •December 31, 2012, and closed-loop biomass, open-loop biomass, geothermal, small irrigation, hydropower, landfi ll gas, waste-to-energy, and marine renewable facilities through December 31, 2013. Provided for a new 30 percent investment tax credit for qualifi ed investments •in “qualifying advanced energy projects,” which are projects that reequip, expand, or establish a manufacturing facility for the production of one of the following:

Property designed to be used to produce energy from renewable resources; • Fuel cells, micro-turbines, or energy storage systems for use with electric or •hybrid electric motor vehicles; Electric grids to support the transmission of intermittent sources of •renewable energy;


Property designed to capture and sequester carbon dioxide emissions; • Property designed to refi ne or blend renewable fuels or to produce energy •conservation technologies; New qualifi ed plug-in electric drive motor vehicles, qualifi ed plug-in •electric vehicles or components designed for use with such vehicles; or Other advanced energy property destined to reduce greenhouse gas •emissions.

Amended Section 45Q of the Internal Revenue Code to provide that credits •for carbon capture and storage are limited to projects that permanently store carbon dioxide in a geologic formation. Removed limitation on investment tax credits if the project is or was •fi nanced with tax-exempt industrial development bonds or through other federal, state, or local government fi nancing.

Th e ARRA also authorized various grants and other incentives related to renew-able energy, energy conservation, carbon capture and storage, and energy effi -ciency projects. Below are examples of the grants and other incentives authorized by the ARRA:

$2.4 billion in qualifi ed energy conservation bonds to fi nance state, local, and •tribal government programs designed to reduce greenhouse gas emission and other qualifi ed conservation activities. Increased alternative refueling property credit for businesses to a 50 percent •credit and increases the cap for these credits to $50,000 — for hydrogen, to $200,000 — for 2009 and 2010. Increases the credit for individuals to 50 percent and the cap to $2,000 for 2009 and 2010.

3. Grants in Lieu of Tax Incentives Th e ARRA allowed owners of these facilities to opt for a 30 percent investment tax credit in lieu of a production tax credit when the property is placed in service. Th e time deadlines applicable to this Section 1603 (of the Tax Code) grant were set as December 31, 2010 to start construction or take steps to commit to a suffi cient contractual level for construction that the contract would qualify the project for the grant.

Under federal law, for a short period of time, tax incentives may be trans-formed into actual grants of up to 30 percent of the capital expenditures for a particular project. Th e ability to obtain these grants in lieu of tax credits requires certain actions to take place before the end of 2010. Qualifi ed property must be originally placed in service between January 1, 2009, and December 31, 2010 (regardless of when construction begins), or placed in service aft er 2010 and


before the credit termination date, which varies, depending upon the type of project, from January 1, 2013, to January 1, 2017, if construction of the property begins between January 1, 2009, and December 31, 2010. 1 Th e defi nition of construction includes entering an irrevocable contract with a contractual provi-sion that limits damages to an amount equal to at least 5 percent of the total contract price. Alternatively, if 5 percent of the physical work has begun or 5 percent of the cost had been paid or incurred by December 31, 2010, then this will be deemed by the Internal Revenue service (IRS) to meet the beginning of construction requirement. 2

Section 1603 of the ARRA provided that the following types of projects may be eligible:

property designed to be used to produce energy from the sun, wind, •geothermal deposits, or other renewable resources; fuel cells, microturbines, or an energy storage system for use with electric or •hybrid motor vehicles; electric grids to support the transmission of intermittent sources of •renewable energy, including storage of that energy; property designed to capture and sequester carbon dioxide emissions; • property designed to refi ne or blend renewable fuels, other than fossil fuels, •to produce energy conservation technologies (including energy-conserving lighting technologies and smart grid technologies); new qualifi ed plug-in electric drive motor, qualifi ed plug-in electric vehicles •or components, which are designed specifi cally for use with those vehicles, including electric motors, generators, and power control units; or other advanced energy property designed to reduce greenhouse gas emissions •as may be determined by the IRS.

Th e projects must be placed in service in 2009 or 2010, unless 5 percent of the project is under construction in 2010, and applications submitted by October 1, 2011. 3 Th e total amount of funds available for these grants may not exceed $2.3 billion.

As of May 23, 2010, the IRS had provided these grants to about 639 applicants. Th e majority of the grants were provided to solar electricity projects.

1. 1603 Guidance, at 5.

2. Id . at 5–6.

3. Th e IRS had developed a guidance document to provide information on the requirements of the program, eligible projects, and how to apply for the program. Payments for Specifi ed Energy Property in Lieu of Tax Credits under the American Recovery and Reinvestment Act of 2009 (March 2010), available at http://www.ustreas.gov/recovery/docs/guidance.pdf .

http://www.ustreas.gov/recovery/docs/guidance.pdf


Other projects that received grants included wind, geothermal, landfi ll gas, and biomass projects. 4

4. Government Loan Guarantees Th e DOE and certain other federal government agencies may provide federal loan guaranties for certain types of projects. Th e loan guaranty program began with the passage of the Energy Policy Act of 2005 (EPAct 2005) that authorized the DOE to issue loan guarantees to eligible projects that “avoid, reduce, or sequester air pollutants or anthropogenic emissions of greenhouse gases” and “employ new or signifi cantly improved technologies as compared to technologies in service in the United States at the time the guarantee is issued.” 5

Th e ARRA extended the authority of the DOE to issue loan guarantees and appropriated $6 billion for this program. Under this act, the DOE may enter into guarantees until September 30, 2011. Th e act amended EPAct 2005 by adding a new section defi ning eligible technologies for new loan guarantees. Eligible projects include renewable energy projects that generate electricity or thermal energy and facilities that manufacture related components, electric power transmission systems, and innovative biofuels projects. A specifi c limit for funding of biofuels projects was set at $500 million.

Th e act provides DOE the ability to guarantee loans that support early commercial use of advanced technologies, not energy research, development, and demonstration programs. Th e DOE has published Guidelines for the Loan Guarantee Program. Th e means by which the DOE obtains applications for loan guarantees under this program is to issue what is known as a “Solicitation Announcement” that provides the necessary information and invitation to have parties that may qualify to submit applications for those loan guarantees.

5. Property-Assessed Clean Energy Programs Th e Property Assessed Clean Energy (PACE) Program, by which property owners may fi nance eligible renewable energy systems and energy-effi cient technologies installed at their properties through an additional annual tax assess-ment that serves to pay for the loan from the municipality. Eligible properties include residential, commercial, and industrial. Th ese programs are generally funded through local government fund raising programs such as municipal bonds or local taxes. California, New Mexico, New York, Louisiana, and many other states have established PACE programs. Texas recently adopted a PACE program allowing municipalities to raise funds to loan to eligible parties.

4. Th e list is available on the IRS website. See http://www.ustreas.gov/recovery/1603.shtml .

5. 42 U.S.C. 16513(a)(1)-(2).

http://www.ustreas.gov/recovery/1603.shtml


Participation in the program by property owners is purely voluntary. Th e programs typically allow the renewable energy or energy effi ciency project to be fi nanced through low interest loans with as much as twenty-year payoff periods. Th is greatly enhances the ability to fi nance these projects.

6. Development Bonds Beyond federal incentives, many local municipalities may provide under their respective state laws may sell industrial development bonds and other bonds to use to fi nance local businesses to promote local economic development and job creation. Such bond programs may provide tens of millions or over a hundred million dollars for renewable energy electricity projects, and provide lower cost debt fi nancing for these projects. If a federal loan guarantee can be obtained under the programs discussed above, the bonds may be rated very high and the interest rates may be reduced, further reducing the fi nancing costs for projects.

C. Utility Incentives Local utilities in many instances will provide incentives for energy effi ciency, distributed renewable energy, and demand response. Th ese incentives may be funds created through additional charges nd passed to electricity ratepayers under state legislation and public utility commission regulations. Th ese funds pay to installers of new equipment or to electricity customers for the installation of renewable energy or energy effi ciency technology. Examples would include solar photovoltaic panels, solar water heaters, small-scale wind, geothermal heating or cooling, effi cient lighting, effi cient heating or air conditioning, effi cient electric motors, and other equipment or steps that reduce the use of energy drawn from the electrical grid. Th ese programs can provide substantial funds for these renewable energy or energy effi ciency projects, and should not be overlooked by project developers or companies considering installing energy effi ciency or renewable energy at their facilities.


P A R T S I X

Carbon Trading — Selling Credits and

the Carbon Markets


19

Fundamentals of Carbon Trading

A. A Regulatory “Commodity” Carbon trading has becomes a multibillion dollar business that appears to be on a future growth trend despite the uncertainties in the United States at the national level and about the international treaty under the aegis of the United Nations. Th e commodity largely exists because of greenhouse regulation. Th e EU coun-tries largely drive the trading for off sets for the European Union Emissions Trading Scheme (EU ETS).

Th e voluntary market exists and provides a pre-compliance market and a true voluntary market. Th e true voluntary market appears to be growing as well.

B. The Various Types of Carbon Credits Th e types of carbon credits are many. Kyoto credits include Certifi ed Emis-sion Reductions (CERs) under the Clean Development Mechanism of the Kyoto Protocol and Emission Reduction Units (ERUs) under the Joint Implementation program. Th e EU ETS trades European Union Allowances (EUAs). Th e Voluntary Carbon Standard issues Voluntary Carbon Units (VCUs). Th ese are the main carbon credits issued and traded, but this is not an exclusive list.

256 | CARBON TRADING — SELL ING CREDITS AND THE CARBON MARKETS

C. Primary or “Over-the-Counter” Markets and Bilateral Agreements Most carbon credits are traded on what is known as a primary market. Th e primary market consists of mainly project developers selling credits to either compliance buyers who need credits for meeting statutory obligations, or inves-tors buying the credits for sale to other parties.

Th e primary carbon trades are made through Emissions Reduction Purchase Agreements (ERPAs), which will be discussed in more detail in Chapter 20. Th e ERPAs vary from transaction to transaction, and no completely standard agreement exists, although various parties have attempted to develop standard agreements. Th ese are usually bilateral agreements between one buyer and one seller.

D. Secondary Markets and Exchanges Once the initial sale has occurred, later sales may be made in a second sale to a third party. Th is market is known as the secondary market. Th ese sales may be bilateral over-the-counter sales.

Exchanges have been created for carbon credit transactions. Th e Chicago Climate Exchange (CCX) trades voluntary credits in the United States. A related exchange, the European Climate Exchange (ECX), was launched by CCX in 2005, and is an exchange for allowances trade under the EU ETS. Futures and options contracts are traded on the EXC and CCX; ECX emissions futures contracts are standardized and all trades are cleared by ICE Clear Europe. Intercontinental Exchange Inc. (ICE) bought the ECX and CCX for $606 million in July 2010.

NYSE Euronext formed a joint venture with APX Inc. to expand its trading volume in electricity, renewable energy, and carbon dioxide allowances. Th e new exchange will be known as NYSE Blue aft er contributing its 60 percent stake in Paris-based BlueNext, the largest exchange for spot trading of carbon dioxide allowances.

NYMEX Holdings, Inc., the parent company of the New York Mercantile Exchange, Inc. formed Th e Green Exchange with Evolution Markets Inc., Morgan Stanley Capital Group Inc., Credit Suisse, JPMorgan, Merrill Lynch, Tudor Investment Corp., ICAP, and Constellation Energy. Th e companies forming the exchange state the goal is to reduce the cost of their customers’ management of their “carbon footprint,” and to build liquidity and demand for carbon credits and to allow risk management relating to these credits through derivatives markets. Th e exchange allows trading in European Union

FUNDAMENTALS OF CARBON TRADING | 257

Allowances under the European Union Emissions Trading Scheme, CERs under the UN Clean Development Mechanism, and verifi ed emission reductions issued through voluntary carbon standards. Trading in U.S. SO2 and NOx emissions allowances and certifi ed voluntary renewable energy certifi cates.

Other exchanges that provide trading in (EUAs) include Bluenext, Nord Pool, and Climex.

E. Future vs. Spot Markets As mentioned above, the exchanges and bilateral over-the-counter trades involve spot markets, but may also involve future sales. Spot markets are where a party buys credits at a current price for delivery immediately. Option agreements can be entered by two parties whereby one party may exercise the option to buy a certain amount of carbon credits from the other party at some date, and expiring at some later date. Futures contracts can be bought and sold on exchanges, which are like option agreements for the right to buy a certain amount of credits at some set or indexed price.

F. Off -Take Agreements For project developers, the forward sale of carbon credits can provide fi nancing for carbon credit projects, if some or all of the payment is received early before delivery of credits, or a known future revenue stream, if the buyer is a creditwor-thy entity. Th e ERPA then becomes an off -take agreement, much like a power purchase agreement for an electricity-generating project, such as a wind or solar project. Having a “take or pay” agreement can assist the project developer in obtaining equity investment and perhaps some degree of debt fi nancing of the project.

G. Carbon Indexes Several indexes have been created in order to track the prices of certain types of carbon credits. For example, the European Climate Exchange has maintained an index for EUAs and CERs. As mentioned above, the ECX has been acquired by ICE. Another example is Société Générale, which began trading CO 2 in early 2005, and which maintains the SGI-Orbeo Carbon Credit Index. Th is index tracks EUAs and CERs. Th e index for EUAs is based on the daily settlement price of the ECX1 CFI Futures. Th e index for CERs is based on the daily settlement price of the ICE ECX1 CER Futures. Th e settlement price for each


index is calculated as a volume-weighted average of trades during the daily settlement period.

H. Fungible Commodity vs. Diff erentiation One of the goals of some market proponents is to develop a fungible carbon credit that trades freely on an exchange. Th ere are certainly desirable benefi ts for such fungible credits. Fungibility makes for a more liquid market.

On the other hand, there may be value in diff erentiation of carbon credits in the sense of higher value for certain types of credits. One of the best examples is carbon credits from avoided deforestation or reforestation. Th ese credits tend to have a higher value in the voluntary markets. For public relations, advertising, and branding reasons, companies that off set their emissions with forest carbon credits may receive a greater benefi t than from, say, landfi ll gas projects. Some types of carbon credits have a more “charismatic” nature, which may bring higher prices. How this may play in a compliance market, where any credit turned into the government covers the legal obligation, remains to be seen.

I. Voluntary and Compliance Buyers Voluntary buyers tend to have diff erent reasons for purchasing carbon credits than compliance buyers. As stated above, for compliance buyers, any type of credit may do so long as they are admissible to the regulatory program and will be accepted by the governing agency.

On the other hand, voluntary buyers are typically trying to meet customer expectations or to appeal to customers and draw business away from competitors. Th us, the company’s or its products’ image and brand may require buying “charismatic” credits that can only be derived from certain types of projects. Th e fungible nature of credits may be missing in this circumstance. Th e type and location of the project may be critical for the success of the program for off setting an entity’s greenhouse gas emissions.

J. Investors and Speculators Investors and speculators in carbon credits will vary depending on the perceived growth of the market and the direction of movement of future market prices. Investors are necessary to provide the capital to project developers to allow the projects to go forward. Speculators act to merely buy and sell credits.

FUNDAMENTALS OF CARBON TRADING | 259

Some investors or speculators may buy credits to hedge some of their other investments. Carbon credits are seen an “non-correlated investments,” meaning that carbon credit prices may not change in response to interest rates or infl ation as other investments tend to do.

K. Carbon Credit Risk and Price In the ERPAs entered into by bilateral parties, the question arises as to who bears the risks described in prior chapters. To the extent the buyer bears these risks, the prices may rise. To the extent the seller bears these risks, the lower price the seller is likely to be willing to pay for the credits.

L. Other Price Drivers Th e extent to which the government in charge of a particular cap and trade regime decides to reduce the cap on greenhouse gas (GHG) emissions for the relevant jurisdiction, then the prices would likely increase. In addition, the prices for credits may move in response to coal and natural gas prices, as the lower the coal price, the more coal may be burned and, thus, the demand for carbon credits may increase, and thereby the price.

M. State of the Global Carbon Markets Th e state of the carbon market has evolved over the years since 2004 when much of the carbon credit trading really began. Regulatory and economic factors among other infl uences have aff ected carbon prices and the size of the carbon market. One of the yardsticks for the carbon market is published by the World Bank every year. Th e latest report is titled, “State and Trends of the Carbon Market 2010.” Th is report provides the data for the prior year and compares it to the year before that.

Th e 2009 numbers refl ected a signifi cant increase in volume of carbon trading, the sheer size of the market grew substantially. However, the value of the market did not increase that much, and certainly not in proportion to the growth in the market size. In 2008, the volume of allowances and off sets traded was reported to be 4.836 billion metric tons of CO 2 e and 8.700 billion in 2009 — almost doubling in one year. Th e value of the market was $135.066 billion in 2008, and only grew to $143.735 billion in 2009. Th e value increased by less than 10 percent. 1

1. See World Bank, State and Trends of the Carbon Market 2010 1 (May 2010).


Th e explanation may have more to do with the economic recession that began in 2007 and continued through 2009 into 2010.

Th e economic downturn caused industrial output and emissions to fall in 2009, considerably easing the compliance needs of regulated entities. In fact, emissions fell 11.2 % among the ETS installations that reported their data prior to the publication of this report.

In industries that suff ered most during the recession, such as steel and cement, companies took advantage of the one to two month overlap between the issuance of 2009 allowances (February 2009) and the 2008 deadline for compliance (April 2009) and quickly sold their 2008 EUA allocations to raise cash (while relying on their 2009 allocations to cover their 2008 emissions). Th e most desperate industrials, in a move to roll over current liabilities and regain liquidity, borrowed against their 2010–12 allowances. As a result EUA spot and front contract prices fell further and faster than the prices of other commodities, breaking the strong price correlation between carbon and crude oil. 2

Th e CER market actually declined in size and value. Th e World Bank identifi ed specifi c problems with the CDM process.

Structural issues hobbled the CDM market as well. Th e complexity and changing nature of regulations, ineffi ciencies in the regulatory chain and capacity bottlenecks caused delays and negatively impacted project fi nance. As a result, it now takes over three years for the average CDM project to make its way through the regulatory process and issue its fi rst [CERs]. 3

Th e market may continue to grow as the EU ETS dominates the global carbon market and the European Union appears to be prepared to continue its cap and trade program even if the United States does not engage in climate change legislation at the national level. If states and multi-state programs beyond the Regional Greenhouse Gas Initiative (RGGI) actually come into existence, this would add to the global carbon market.

2. Id. at 10.

3. Id. at 2.

20

Contractual Issues in Carbon Trading in the Primary Market

Carbon credits are typically sold through bilateral contracts known as Emissions Reduction Purchase Agreements, or ERPAs. Th ese contracts are over the counter, not typically traded on exchanges. Th e developer sells its credits to a third party, which may be a compliance buyer or investor. A variety of provisions appear in these contracts. Th e discussion below describes the most signifi cant of these provisions.

A. Defi nitions Each ERPA must contain a set of defi nitions that allow the specialized terms used in the contract to be defi ned for purposes of making the contract more clear and to reduce the risk of ambiguity in using key terms.

B. Conditions Precedent Conditions precedent provide the events that must occur before the agreement comes into eff ect and becomes binding. Th e events can be events neither party has control over or that one party must perform. For example, in order for the contract to come into eff ect, one might require that the project is approved by the host county by the Designated National Authority (DNA). Another exam-ple would be that the buyer would have to obtain a letter of credit to ensure payment when credits are issued and delivered to the buyer. Alternatively, if the


buyer is advancing funds before the project is completed and long before credit delivery, the buyer may require a letter of credit be provided by the seller so that the funds could be paid back if the project does not receive approval and is not implemented.

C. Price Th e price for carbon credits must be set in the ERPA. Th e price may be a set price, or based on an index, such as those discussed in Chapter 19. Some parties enter into contracts with a fl oor price below which the price cannot fall using the index, and others may have a ceiling above which the price may not rise. Still other agreements may have a “collar” with both a fl oor and a ceiling for prices that fl oat with an index.

D. Quantity and Delivery Th e amount of carbon credits to be delivered must be set forth in the contract. One approach is for the seller to agree to deliver a certain quantity of carbon credits every year for the term of the crediting period or some other term. Th is places the risk on the seller that the number of anticipated greenhouse gas (GHG) reductions will occur and that the estimated number of carbon credits will be issued by the relevant standards entity.

Another approach is to require the buyer to purchase up to a certain amount of credits or all of the credits actually issued and no obligation of the seller to deliver a specifi ed number of credits. Th is arrangement would put the risk of the underdelivery of credits on the buyer, if the buyer needs a certain number of credits for compliance purposes, for example.

ERPAs are generally forward contracts, meaning they provide for the delivery of carbon credits in the future. Contracts are oft en entered into before the project has been implemented, so they typically are for future delivery. Credits are issued on a periodic basis as the GHG reductions are verifi ed and the standards board issues credits. Th ese agreements may also be draft ed as options, where a potential buyer has the right to buy a certain amount of credits on a one-time or annual basis.

E. Payment Th e method and timing of payment may be prior to or upon delivery of the cred-its. If a project developer is able to convince a party to make an advance payment on a forward contract, this may serve to assist in the fi nancing of the project

CONTRACTUAL ISSUES IN CARBON TRADING IN THE PR IMARY MARKET | 263

construction and implementation. Typically, the forward contracts require payment at delivery.

Payment may be made with only the right to seek redress if the buyer fails to pay, or the contract may utilize an escrow arrangement to have a party release the credits upon payment being made into the escrow, or, the reverse, where the payment is held until the credits are delivered. Alternatively, a letter of credit could be used to secure payment by the buyer.

F. Obligations of Seller Th e obligations of the seller may include proceeding to complete the implemen-tation of the project, obtaining validation and verifi cation, and ultimately issuance of the carbon credits. Th e risk of failure to obtain the credits may fall on the seller, and the obligations to pursue the issuance of the credits gener-ally falls on the seller. Some of the obligations of the seller may include the following:

provide an initial verifi cation report to the buyer; • complete validation and obtain registration for the project; • develop and implement a monitoring plan; • carry out verifi cation and certifi cation, to ensure issuance of the Certifi ed •Emission Reductions (CERs) under the Clean Development Mechanism (CDM) of the Kyoto Protocol; operate the project in a competent and prudent manner as a reasonable and •prudent operator; deliver the CERs to the buyer; or • arrange for additional buyers to be added as project participants, if the buyer •resells the CERs to a third party before delivery.

G. Obligations of Buyer Th e obligations of the buyer typically involve acceptance of and payment for credits delivered by the seller. Some of the obligations of the buyer may include:

establish an account to receive delivery of the credits; • pay for the credits; and • communicate with the CDM Executive Board (EB), in a CER transaction, •as what is known as the Focal Point, the party in charge of directing the transfer of the CERs upon issuance and otherwise managing the relationship with the EB.


Th e buyer obligations are limited unless they serve as the party directing communications with the EB to attempt to complete the process of obtaining approval and issuance of the relevant carbon credits.

H. Representations and Warranties Representations by the buyer and the seller are included in ERPAs. Th ese would include representations regarding the ownership of the credits and that they have not been transferred to another party. Th e representations would gen-erally include one that states that no liens have been placed on the credits to be sold.

Other representations and warranties required of a seller may include the following:

the agreement is duly organized and validly existing under the laws of the •seller’s country and that the seller is qualifi ed to conduct its business in the relevant jurisdiction; the execution and performance of the agreement are within the seller’s •powers, have been duly authorized and do not violate or confl ict with or require any consent or waiver under any of the terms or conditions in the seller’s governing documents or any material contract, or any law, regulation, order, judgment, or other legal or regulatory determination; the agreement constitutes the legal, valid, and binding obligations of the •buyer and is enforceable in accordance with its terms; there are no bankruptcy proceedings pending or being contemplated, or to •its knowledge threatened against the buyer; there are no claims, actions, proceedings, or investigations pending to the •buyer’s knowledge threatened against or relating to the buyer before any competent authority that may materially adversely aff ect its ability to perform this agreement; the buyer is not subject to any outstanding judgment, rule, order, statement •of claim, injunction, or decree of competent authority that materially adversely aff ects its ability to perform the agreement; the agreement, the execution, and delivery of the agreement and the •fulfi llment and compliance with the terms of the agreement by the buyer will not materially confl ict with any of, or require the consent of any person under, any loan or security agreement, or other material agreement, to which the buyer is a party.


Other representations or warranties of a buyer or seller may be included in ERPAs negotiated by the parties involved in the transaction.

I. Share of Proceeds and Taxes Providing for which party will pay taxes should be addressed in the ERPA. Value added taxes, for example, may be charged by the jurisdiction where the credits are formed or where they are delivered. Domestic CER taxes may be charged. China imposes a CER tax, which the Chinese government refers to their share of CER revenue. Th ese taxes are as follows:

65 percent for hydrofl uorocarbon and perfl uorocarbon projects; • 30 percent for nitrous oxide projects; and • 2 percent for priority CDM projects in China, i.e., energy-effi cient •improvement, development, and utilization of new and renewable energy, recovery, and utilization of coal bed methane, and reforestation projects.

In other countries the question of whether taxes are imposed on the sale of carbon credits may have to be answered before negotiating a fi nal contract, or one party may agree to cover the taxes, regardless of which party they are imposed upon by the relevant taxing jurisdiction.

J. Default Th e ERPA should detail the acts, omissions, events, or circumstances that would place the seller or the buyer in default of the terms and conditions of the contract. Th ese could be the failure to deliver by the buyer the specifi c number of credits by a particular date or the failure of the buyer to make payment aft er timely delivery of the requisite number of credits. Other circumstances may result in default by either party. Th e remedies for default could be termination or other remedies, as discussed below.

Examples of default by either party that may be set out in the ERPA include the following:

failure to pay as required under the agreement; • failure to deliver credit pursuant to the relevant clauses of the agreement; • failure of a party to perform a material obligation under or commission of a •material breach of the agreement; or breach of a representation or warranty. •


Th e remedies are described below.

K. Termination Th e contracts should provide for the timing and circumstances under which the buyer or the seller respectively may terminate the agreement. A default under the contract may allow termination, depending on the type of default.

L. Remedies Th e remedies that the buyer or seller or both may pursue in the event of a default should be specifi ed. For a seller default, the remedies for the buyer may include:

Failure to complete the project or obtain verifi cation: termination and/or •seller obtaining credit for the buyer or paying the costs the buyer incurs to obtain the credits not delivered. Failure to deliver any credits: termination and/or seller obtaining credits for •buyer from other sources; payment to the buyer for the cost to purchase credits from another source. Failure to deliver a portion of the credits required under the contract: •termination or seller making up the shortfall by purchasing credits from other sources and delivering to the buyer; payment for the cost of credits paid by buyer to obtain the number of credits that were not delivered.

For a buyer default, the remedies may include:

Failure to pay: cancellation of contract, seeking lost profi ts for the lost sale. •

Where the seller does not guaranty any volume of credits, the issue of a shortfall does not arise and no remedies arise for the buyer. Th e buyer would be purchasing the number of credits delivered by the seller, regardless of the amount.

M. Choice of Law and Venue Th e contracts should state the law that applies to the contract. Th e contracts typically apply the laws of England or New York. Venue can vary signifi cantly, but is oft en New York or London. Cost of the dispute resolution process should be considered in setting the applicable law and venue. Legal costs in London are signifi cantly higher than in the United States.


N. Dispute Resolution Dispute resolution is very important for projects in developing countries. Most parties, project developers, and buyers do not want to be subject to the courts of a developing country. Typically, the international ERPAs involving CDM projects provide for international arbitration. Th ere are several diff erent arbitration groups and procedures that can be used. Venue for the arbitration is generally set as discussed above.

Projects in the United States or the European Union may allow the courts of those jurisdictions to try any dispute that might arise, or they may opt for an arbitration provision. Th e costs of courts versus arbitration in the United States may not be that diff erent. At one time, it was perceived that arbitration was generally less expensive to address contractual disputes than the courts. Th at perception is changing.

O. Force Majeure A force majeure event typically means the occurrence of any event or circum-stance, beyond the control of the relevant party to the agreement that causes that party aft er using all reasonable eff orts to be unable to comply with one or more of their obligations under the agreement. Delivery or acceptance obliga-tions may be excluded from the force majeure defi nition. A list of events that will not constitute force majeure may be included in the agreement.

P. Limitation of Liability Th e ERPA may contain a limitation of liability. An example of a limitation that may be found in an ERPA would be a limitation on the liability for loss of income, loss of profi ts or loss of contracts, or for any indirect or consequential loss or damage. Th e liability of the parties and limitations on such liabilities may be further defi ned in the agreement.

Q. Miscellaneous Issues A variety of other legal issues will be addressed in the agreement. Many of these issues are fairly standard issues included in miscellaneous provisions of many diff erent types of contracts. Examples may include the manner in which notice between the parties shall be accomplished, confi dentiality protections, and the extent to which and the manner of transfer and assignment of the agreement, among other provisions.


P A R T S E V E N

Carbon Accounting — Carbon Assets and Liabilities


21

The “Carbon Ledger” and Carbon Credit Accounting

A. Carbon Accounting Th e term “carbon accounting” has not been used to refer to the issues about which the accounting standards boards have been debating for six or more years. Rather, the term has been used to describe the process of measuring the green-house gas (GHG) emissions of companies and facilities. Many voluntary standards like the Carbon Disclosure Project and others have been developed. Th e European Union Emissions Trading Scheme (EU ETS), the Environmental Protection Agency (EPA) GHG reporting rules, and several U.S. states have provided regulations governing the monitoring and reporting of GHG emis-sions. One or more of these standards have been used to measure and/or report GHG emissions. In this context, “accounting” means the measurement of and reporting of GHG emissions or the accounting of emissions, not fi nancial accounting. Th e technical steps for measuring certain chemical emissions should not be confused with the accounting related to carbon credits or climate change or greenhouse-gas-related liabilities.

Th is chapter will explore the assessment of a company’s potential assets and liabilities as they relate to greenhouse gas emissions, emission allowances and off sets, and similar matters. Th us, the accounting will refl ect a strategic con-sideration for business entities and then the actual fi nancial accounting for those matters.

272 | CARBON ACCOUNTING — CARBON ASSETS AND L IAB IL IT I ES

B. Defi ning Carbon Assets and Liabilities As discussed in more detail in Chapter 22, for many companies, obligations or pressure to measure, monitor, and manage their greenhouse gas emissions has arisen from many sources. Government legislation and regulation is the fi rst source, but not the only one. Other entities pressure companies to monitor and reduce their GHG emissions, including socially conscious investors, lenders, employees, and customers. Th ese groups or entities may pressure companies to participate in voluntary programs such as the Carbon Disclosure Project, which was developed to set up a program for companies to disclose their GHG emis-sions and to state what steps they are taking to reduce those emissions. Th us, the lia-bility side of GHG emissions includes the costs of measurement and monitoring as well as managing emissions. On the other hand, some companies have assets that relate to GHG emissions as well. In this chapter we will explore both assets and lia-bilities and how they can be identifi ed, accounted for, and managed by companies.

Th e potential costs under regulatory systems or pressures by shareholder or customers to monitor or manage GHG emissions may be considered liabilities. We will call these “Carbon Liabilities.” However, there are assets that companies have that relate to GHG emissions. Examples would be GHG allowances or off set credits. Other assets may be undeveloped, such as unregulated greenhouse gas emissions of a company that could be induced to generate GHG off sets and produce profi ts in their sale or in reducing costs under a current or future regulatory scheme. We will call these “Carbon Assets.” Th ese are more practical defi nitions than accounting or legal defi nitions. We will discuss the accounting standards board approach to these issues in a more specifi c manner below. Th is discussion is directed at more generally understanding from a strategic perspec-tive the terms Carbon Assets and Carbon Liabilities.

Companies will fi nd now and in the future that accounting for these Carbon Liabilities and Carbon Assets will be necessary. Under regulations and guidance issued by the U.S. Securities and Exchange Commission, as discussed in Chapter 22, liabilities for complying with GHG emissions regulations and other liabilities that may arise from climate regulation or climate change itself may require disclosure by public companies. Accounting for Carbon Liabilities and Carbon Off sets may be governed by applicable accounting standards as well. Depending on where the company is domiciled, Generally Accepted Accounting Principles (GAAP) issued by the Financial Accounting Standards Board (FASB) or standards issued by the International Accounting Standards Board (IASB) will apply to determine the accounting practices to address Carbon Liabilities and Carbon Assets.

THE “CARBON LEDGER” AND CARBON CREDIT ACCOUNTING | 273

C. Forming a Carbon Ledger as Part of a Carbon Strategy Many companies in the European Union have already been practicing carbon accounting as the laws of the European Union, as explained in Chapter 5, require monitoring and reporting of GHG emissions. In addition, because the EU ETS has imposed obligations for meeting emission limits through the use of allow-ances and off sets, the companies are required to account for these assets. In the United States, companies are now required to monitor and report their GHG emissions under the EPA GHG reporting rules. Many companies have partici-pated in voluntary GHG reporting programs like the Carbon Disclosure Project in which they have also pledged to reduce their emissions, and to incur the costs for these emission management activities.

Companies have typically conducted steps to identify, account for, and track Carbon Liabilities, and, where allowances and off sets are required to meet compliance obligations, they have accounted for Carbon Assets. However, the accounting for all Carbon Liabilities and Assets may require actions beyond the mandatory or typical voluntary reporting standards. A more complete analysis of the extent of liabilities and assets may be appropriate. To accomplish this, companies can establish a “Carbon Ledger” that identifi es and measures Carbon Liabilities and Carbon Assets.

To prepare a Carbon Ledger, it is fi rst necessary to identify Carbon Liabilities. Examples may include the following:

Capital costs — required for reductions in greenhouse gas emissions; • Carbon allowances obligations — the cost of allowances and off sets that must •be purchased and submitted to state or federal government each year to achieve compliance, or to achieve a commitment in a voluntary program such as the Chicago Climate Exchange or the Carbon Disclosure Project, or other voluntary pledge to reduce GHG emissions; Climate litigation for alleged damages to the environment, property, or •economic in nature; Expenses for monitoring and reporting to voluntary GHG reporting •programs; Expenses for complying with customer or market demands to address GHG •emissions; Physical eff ect on or damage to markets, supply chains, or property; and • Brand or corporate reputation detriment resulting from failure to manage •GHG emissions.


Other costs and expenses may be faced by companies with signifi cant GHG emissions or that face other risks or liabilities as a result of market forces or legal requirements or claims.

Carbon Assets are perhaps less understood. Carbon credits held in the form of allowances or off sets may be considered assets. Other Carbon Assets may be less well known and less developed. Some of the Carbon Assets companies may hold include the following:

Carbon allowances awarded by a government without charge; • Contracts to purchase off sets at or below current market prices; • Carbon futures and derivative positions; • Carbon guaranties to provide credits if a carbon project developer or other •party fails to deliver carbon credits that have been contracted; Ability to reduce GHG emissions and sell excess carbon allowances; • Ability to reduce GHG emissions and register them to ensure they are •available for early action credits discussed in chapters 8 and 10; Ability to reduce GHG emissions of unregulated sources or facilities and sell •carbon off sets; Ability to utilize carbon credits or biodiversity to reduce objections to •mining, drilling for oil and gas, pipeline development, real estate development, or other activities for which governments or nongovernmental authorities object for environmental, climate change, ecological or species impact, or other related reasons; and Brand and corporate reputation enhancement and potentially market share •improvement from managing GHG emissions.

Some of these potential Carbon Assets may be less understood or known by companies that have the potential to capture and monetize or otherwise use these assets for their benefi t. Th e last potential asset may be the hardest to quan-tify, but may be of substantial value, depending on the industry or business.

Many companies have GHG emissions that are not currently regulated or that are not likely to be regulated. Other companies have the ability to reduce emissions today to address public pressure from shareholders, customers, or other constituencies. In reviewing the ability and alternatives available to reduce GHG emissions, consideration should be given by companies to how these reduc-tions may be registered and potentially transformed into carbon credits.

Where economically the costs for validation and verifi cation justify the attempt to obtain generation of carbon credits, either under a voluntary standard or in countries or states or provinces at the subnational level, generation of credits creates a new asset. Th e value of the credit would depend on the type of credits and the current market price. Th e value may be determined by future GHG


regulation and whether the credits may be used in future compliance systems as off sets or whether the credits would qualify for early action allowances.

As companies consider corporate strategies with respect to GHG emis-sions, the evaluation of Carbon Assets and Carbon Liabilities in the form of a Carbon Ledger would allow the company to better understand its current risks and opportunities with respect to climate change and greenhouse gas regulation and pressure from third parties. Th us, the Carbon Ledger provides a tool for management to evaluate the corporate strategy with respect to climate change and GHG issues.

D. Financial Accounting Treatment of Carbon Assets and Liabilities When developing the strategic Carbon Ledger, fi nancial accounting standards developed by the FASB and the IASB are important to consider, but they are central to actually preparing fi nancial statements that contain accounting for assets and liabilities related to carbon credits and GHG regulation. Unfortunately, the accounting boards have not fully addressed these issues. A certain amount of uncertainty exists as to how the accounting standards boards will address carbon issues.

In particular, standards for accounting for carbon allowances or off sets are not well defi ned. Carbon credits have similarities to intangible assets and inven-tory, but have diff erences from both. Th e question of how carbon credits should be valued is another question. Th ey could be valued based on their cost basis or based on fair value derived from carbon markets.

Accounting for the liability related to the obligation to obtain allowances to meet the statutory requirement for emissions of greenhouse gases remains an open question. As emissions occur, the regulated entity must obtain suffi cient allowances or off sets for each ton of emissions. Th e question is if the liability should be measured by the market value of the allowances that must be obtained to meet the compliance obligation. If the fair market value is to be determined, when should that occur?

How carbon credits will be accounted for under relevant standards is yet to be determined. A defi nitive decision regarding appropriate accounting is not expected until perhaps 2011.

Th e accounting standards boards must address several issues in developing the accosting for carbon credits. Th e main issues that must be addressed include:

Initial recognition of allowances allocated without charge — at cost or fair •value (market value); Initial recognition of allowances purchased — at cost or fair value; •


Subsequent treatment of allowances aft er initial receipt — at cost or fair value; • Recognition of liability to submit allowances — when emissions occur or •when allowances received; and Measurement of liability — at cost or fair value. •

Th ese issues have been a matter of discussion and development among the accounting boards for over six years. In 2004, it appeared that the IASB had settled on an approach for accounting for emissions rights, including carbon credits. Th e IASB issued an interpretation for emissions rights as follows:

Emission rights (allowances) are intangible assets that should be recognized •in the fi nancial statements in accordance with standards for accounting for Intangible Assets. When allowances are issued to a participant by government (or government •agency) for less than their fair value, the diff erence between the amount paid (if any) and their fair value is a government grant that is accounted for in accordance standards for Accounting for Government Grants and Disclosure of Government Assistance. As a participant produces emissions, it recognizes a provision for its •obligation to deliver allowances in accordance with standards for Contingent Liabilities and Contingent Assets. Th ese liabilities are normally measured at the market value of the allowances needed to settle them. 1

In 2005, the IASB voted to withdraw this interpretation. One reason for the withdrawal was that the European Financial Accounting Advisory Group decided that the interpretation would not be endorsed for use in the European Union. 2

In order to attempt to develop consistency internationally on these issues, the IASB began working with the FASB in the United States to develop account-ing standards for cap and trade programs for air emissions, including accounting for allowances and off sets.

In 2007, the IASB agreed to address the following key issues as part of its future work agenda:

Are the tradable permits in emission trading schemes (allowances and •credits) assets? If so:

How should an entity account for any allowances that it receives from •government for less than fair value?

1. International Accounting Standards Board, Emissions Trading Schemes, available at http://www.iasplus.com/agenda/emissiontrading.htm (last visited Sept. 19, 2010).

2. Id.

http://www.iasplus.com/agenda/emissiontrading.htm

http://www.iasplus.com/agenda/emissiontrading.htm


How should allowances and credits be accounted for? • How should changes in assets and liabilities (arising from emission trading •schemes) be reported in profi t or loss? 3

‘In 2007, the IASB announced that it does not plan to issue a new interpretation but to draft a revision of either IAS 38 on Intangible Assets or IAS 39 on Financial Instruments: Recognition and Measurement to accommodate the accounting for tradable permits, and to draft a revision of IAS 20 on Accounting for Government Grants and Disclosure of Government Assistance so that the accounting for allowances (and similar assets) issued by governments free of charge is addressed. 4

From 2008 to 2009, the staff s of the two boards made several presentations and developed papers on various issues related to accounting for emissions rights or credits. In February 2010, the IASB decided tentatively that an entity that receives emission allowances without charge from a governmental agency should recognize the allowances as assets and measure them at fair value. Under a cap and trade program, the same entity incurs an obligation under the relevant statute or regulations to reduce its emissions at a certain level, and the entity should recognize a liability for the obligation to pay for allowances throughout the commitment period. Th e IASB concluded that this liability exists irrespective of whether the entity has begun to emit GHGs for which it will be liable to submit allowances during the commitment period. 5

Later in a meeting in September 2010, the IASB staff discussed the ques-tion of whether a corresponding liability exists and is recognized when an entity receives an allocation of allowances from the government under a cap and trade program. Th e staff presented the boards with two views:

View 1–Th e allocation creates a present obligation and there is a liability for the allocation.

View 2–Th e allocation is not a present obligation and thus no liability exists until the entity emits. 6

Th e staff s further disaggregated View 1 into three alternative views on what the present obligation should be:

View 1(a)–an obligation to refrain from emitting to keep the allowances; View 1(b)–an obligation to return the allowances (if the entity emits); or

3. Id.

4. Id.

5. Id.

6. Id.


View 1(c)–an obligation to comply with the scheme requirements, to refrain from emitting to keep the allowances or to return the allowances. 7

It is not entirely clear when the IASB or the FASB will develop and issue more fi nal conclusions on how carbon credits must be accounted for or how the related liability to submit allowances will be addressed. A decision on some issues has been proposed for 2011. Until these issues are resolved, there will remain a certain degree of uncertainty as to how to account for these assets and liabilities. Entities must use judgment in accounting for assets and liabilities defi ned by the accounting boards’ standards.

7. Id.

22

Climate Risk Disclosure

A. Corporate Climate Change Liabilities 1 Climate change disclosure, or climate risk disclosure, has increasingly become an important issue for publicly traded companies when preparing fi nancial disclo-sures for public stock or public debt off erings or periodic reports submitted to the Securities and Exchange Commission (SEC). Aft er the U.S. Supreme Court decision in Massachusetts v. EPA , 2 declaring greenhouse gases (GHGs) are air pollutants under the Clean Air Act, the regulation of GHGs at the federal level appeared probable, at least through the Environmental Protection Agency (EPA). As discussed in Chapter 10, the EPA has moved forward with promulgating greenhouse gas regulation. Even if the Supreme Court had not ruled as it did, numerous bills have been fi led in Congress to regulate GHG emissions. Passage of climate change legislation at the federal level seems unlikely at this time, but EPA has moved forward with GHG emissions regulation under the existing federal Clean Air Act.

Some of the states are adopting GHG restrictions on their own, making GHG regulation a reality in certain regions of the United States. As a result, the challenge for publicly traded companies to determine what climate change disclosure may be appropriate has increased signifi cantly. Th e New York attorney general has conducted an investigation of fi ve utilities for alleged failure to adequately disclose climate risk under state securities laws. Th at same year, a group of institutional investors petitioned the SEC to issue an interpretive release

1. Portions of this chapter fi rst appeared in the Newsletter of the American Bar Association Environmental Disclosure Committee.

2. 549 U.S. 1438 (2007).


clarifying that material climate-related information must be included in corpo-rate disclosures under existing law.

As a result of this uncertainty and in response to the rulemaking petition, the SEC issued guidance for public companies in disclosing climate change mat-ters in their fi lings with the agency. On the mandatory side of disclosure, it is important to understand how fi nancial disclosure obligations may involve cli-mate change risk based on the mandatory disclosure requirements promulgated by the SEC under the traditional securities laws and the requirements of the Sarbanes-Oxley Act (Sarbanes-Oxley), and particularly the SEC guidance regard-ing climate change disclosure.

In addition, it is critical to appreciate disclosure pressures that extend beyond the mandated requirements of the SEC and Sarbanes-Oxley. Th e pres-sure for “voluntary” disclosure arises from initiatives and protocols developed by nongovernmental organizations (NGOs) that seek to create enough awareness among the public and institutional investors to compel companies to disclose environmental risk and impacts, and as a result to change their behavior to avoid future negative disclosure. NGO pressure on public companies and their investors and lenders has grown over the last decade.

Because climate change disclosure involves issues of strategic importance to the company, the management and board of directors of public companies should be involved in the setting of policies and procedures for determining what will be disclosed. In doing so, it is key for management and directors to evaluate the many interconnected and interrelated entities and interest groups that may aff ect their economic success. As these entities and interest groups demand ever more information on environmental and corporate social responsibility, how companies manage climate change disclosure demands is becoming increasingly important in managing shareholder and public stakeholder expectations.

For some companies with operations in states or countries where climate change regulation is already in eff ect or is in the process of being implemented, climate risk may present material fi nancial eff ects on the company that may require discussion in their public disclosures. For other companies, any disclosure at this stage will be forward-looking, focusing on potential future risks. Even for these companies, the stage is rapidly changing, as U.S. states have or are preparing to impose restrictions on GHG emissions. Care must be taken in deciding what to disclose — too little disclosure may not provide a full picture to investors; too much disclosure, particularly of inchoate or never realized fi nancial eff ects, may not provide realistic information to investors. Another challenge is the degree to which companies can accurately predict impacts from potential regula-tion or how climate change may physically impact their operations or how

CLIMATE RISK DISCLOSURE | 281

climate issues may aff ect their corporate reputation as called for in the SEC guidance. Disclosure in these areas may present companies with the risk of speculation on how such impacts may evolve or occur at all.

Signifi cant developments in climate change regulation have occurred in the United States as discussed in chapters 8 to 11. U.S. legislation has been off ered, but has only passed one house of Congress. Th e EPA has promulgated green-house gas reporting regulations and created a GHG registry. Th e EPA has also issued an Endangerment Finding and mandatory greenhouse gas regulations for mobile sources in terms of light-duty vehicles. Th e EPA has promulgated the Tailoring Rule to regulate greenhouse gases for certain stationary sources. Greenhouse gas monitoring and reporting rules have been adopted and issued by the EPA.

As discussed in Chapter 8, ten northeastern states — through the Regional Greenhouse Gas Initiative (RGGI) — California, western states — in the form of the Western Climate Initiative (WCI) — and midwestern states — through the Midwestern Greenhouse Gas Reduction Accord — are developing state-based programs to regulate greenhouse gas emissions, and to institute cap and trade programs.

As these U.S. programs and other international programs and national pro-grams, like the EU Emissions Trading Scheme, impose requirements on publicly traded corporations, the potential liabilities for these corporations continue to evolve. Th e question of the extent to which disclosure must be made under mandatory programs becomes a critical issue. Many public companies have chosen or have felt pressure to also participate in voluntary greenhouse gas, cli-mate change, or sustainability programs that include greenhouse gas and climate disclosure. Climate change disclosure has become a permanent fi xture of public company disclosure to the public and to inform investors.

Th is chapter will provide a discussion of these disclosure issues and how companies can respond to the challenges presented by them.

B. Securities and Exchange Commission Regulations Governing Environmental Financial Disclosure Based on the potential material eff ect that existing and developing regulatory programs may have, publicly traded companies should develop an appropriate strategy for climate risk disclosure. In doing so, public companies may have to manage disclosure in more than one form — ranging from SEC regulation to broader protocols for voluntary disclosure. Many larger companies have chosen


to participate in these voluntary environmental, sustainability, or climate change disclosure programs. For these companies, disclosure takes on a broader process than simply attempting to comply with SEC regulations alone.

SEC regulations involve several provisions that mandate disclosure sur-rounding environmental issues that implicate climate change issues, from new regulations imposing reductions in GHG emissions to litigation fi led by plain-tiff s seeking damages allegedly caused by a company’s GHG emissions. For some companies, these regulations or litigation could have a potential material eff ect on fi nancial costs, profi ts, and liabilities. In deciding what to disclose under any of the SEC’s rules, a public company must decide what information is material to investors and shareholders. Th e U.S. Supreme Court has concluded that infor-mation is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment deci-sion, or if the information would alter the total mix of available information.

A brief review of the specifi c SEC regulations is helpful in understanding the potential impact climate change disclosure issues may have on the content of a company’s disclosure statements.

1. Item 101 Item 101 is an SEC regulation that requires companies to disclose material eff ects that compliance with environmental laws will have on earnings, competitive position, and capital expenditures. 3 Specifi cally, the rule requires disclosure of estimated material capital expenditures for environmental control facilities for the current fi scal year, the next fi scal year, and further periods, if material. 4 Climate change issues are implicated as those doing business in the European Union, for example, may be required to expend additional capital to reduce GHG emissions from their facilities in EU countries. As states impose restrictions — such as California and states participating in the WCI, the RGGI, and the new Midwestern Greenhouse Gas Reduction Accord (MGGRA) — companies with operations in those states must evaluate the extent to which disclosure is neces-sary of the costs to meet the greenhouse gas regulations of these jurisdictions.

2. Item 103 Item 103 requires that companies disclose legal proceedings, including those related to environmental and health issues. 5 Environmentally-related pro-ceedings include pending or known to be contemplated claims, including

3. 17 C.F.R. § 229.101.

4. Id. § 229.101(c)(1)(xii).

5. Id. § 229.103.


administrative or judicial proceedings, even if initiated by the company itself. Th ese proceedings must be material before they must be disclosed. Th e material-ity issue has been specifi cally addressed for governmental proceedings. If a gov-ernment agency is a party to the proceeding and monetary sanctions could reach $100,000 or more, whether or not otherwise material to the company, the company must disclose this proceeding. 6

Climate change litigation against individual companies may be limited in the United States currently, but such litigation has been fi led. Some plaintiff s’ attorneys have pledged to obtain civil damage awards for climate change litiga-tion that exceeds what was obtained in the tobacco litigation. 7 Any material climate change cases fi led against publicly traded companies would have to be disclosed under Item 103. To the extent the New York attorney general proceeds with litigation against electric utility companies, claiming that these companies failed to disclose climate risk, these cases would likely have to be disclosed under this rule. It is necessary to keep in mind the low threshold for cases brought by government agencies.

3. Item 303 Item 303 requires that companies disclose, in the Management Discussion and Analysis (MD&A) section, “known trends, events or uncertainties” that may have a material eff ect on the company’s fi nancial condition. 8 A 1989 SEC Interpretive Release emphasized that S-K 303 applies to environmental trends and uncertainties, such as anticipated new regulations and Superfund liabilities. 9 Th is is the SEC regulation that may present the most immediate concern for publicly traded entities.

4. Item 503(c) Item 503(c) requires disclosure about the most signifi cant risks facing a publicly traded company.

C. Accounting Rules Th e next level of concern for public (as well as privately held companies) involves disclosure required by the Generally Accepted Accounting Principles (GAAP).

6. Id. § 229.103, Instructions, Item 5.

7. Lawyers Preparing for Explosion of Climate-related Work , The Dallas Morning News , June 25, 2007.

8. 17 C.F.R. § 229.303.

9. Securities Act Release No. 33-6835 (May 18, 1989).


In the environmental and safety context, the most important of these histor-ically has been Financial Accounting Standard No. 5, Accounting for Loss Contingencies (FAS 5). FAS 5 would typically cover lawsuits and other claims for damages, such as Superfund liabilities. A more recent accounting standard, Financial Accounting Standard No. 143, Accounting for Asset Retirement Obligations (FAS 143), and the follow-on interpretation, Financial Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (FIN 47), apply to legal obligations that arise at the time of retirement of an asset. Since most climate change legislation includes a cap and trade program, GHG emission allowances or credits will need to be accounted for in the coming years.

Th e Financial Accounting Standards Board (FASB) is currently engaged in a project to provide comprehensive accounting guidance for participants in emission allowance programs. Th e project will provide guidance on accounting for emission allowances and related liabilities. 10 Th e development of this guidance is discussed in Chapter 21.

D. The Sarbanes-Oxley Act Finally, Sarbanes-Oxley raises issues for public companies in the environmental disclosure context. Most prominent of these are Sections 302 and 906 that require CEOs and CFOs to certify that the fi nancial statements fairly present the fi nan-cial status of the company, and Sections 302 and 404 that require certain certifi -cations that the internal controls established by the company are adequate to ensure the accuracy of fi nancial statements. In addition, Section 404 requires that the independent fi nancial auditor review and attest to the adequacy of the com-pany’s internal controls. Consideration should be given as to disclosures being made by companies to meet these requirements. Are climate risks being consid-ered by CEOs and CFOs when they make certifi cations? Do the internal fi nan-cial controls address climate risk issues? At what point would it be appropriate to include climate risks, such as new capital costs or liability risks, in Sarbanes-Oxley compliance programs?

E. SEC Enforcement Th e importance of these internal controls as they relate to environmental reserves and disclosure was demonstrated in a recent SEC enforcement case against

10. Available at http://www.fasb.org/cs/ContentServer?c=FASBContent_C&pagename=FASB % 2FFASBContent_C % 2FProjectUpdatePage&cid=900000011097

http://www.fasb.org/cs/ContentServer?c=FASBContent_C&pagename=FASB%2FFASBContent_C%2FProjectUpdatePage&cid=900000011097

http://www.fasb.org/cs/ContentServer?c=FASBContent_C&pagename=FASB%2FFASBContent_C%2FProjectUpdatePage&cid=900000011097


Ashland Inc. (Ashland) and an environmental manager for alleged failure to properly record and report environmental fi nancial liabilities. 11 Th is case indi-cates the expectations of the SEC for corporate environmental disclosure and the necessary internal controls required for accurate disclosure. As a result of its factual and legal fi ndings, the SEC ordered Ashland to take several steps, includ-ing to better document all adjustments to its environmental remediation estimates and to form a complete audit trail for environmental estimates with reasons for each adjustment. Th e SEC also required that Ashland retain PricewaterhouseCoopers (PWC) to review its policies, procedures, and internal controls relating to environment reserves, review its procedures to address inter-nal complaints, and to submit the reports to Ashland’s audit committee and the SEC. Finally, the SEC required that Ashland’s audit committee or full board of directors review and adopt PWC recommendations, or develop and adopt alternative policies or procedures that are reviewed and approved by PWC.

Th e SEC required participation in this process by the audit committee or the full board of directors, apparently placing the expectation of ultimate authority and responsibility for implementing adequate fi nancial internal con-trols to monitor and report environmental disclosure on the board of directors. It is important to note that this case was decided on the law as it existed before the passage of Sarbanes-Oxley. Th e SEC expectations may be higher under Sarbanes-Oxley.

Th e importance of climate change disclosure should not be overlooked. Consideration should be given by the audit committee and, if it exists, the environmental committee of public companies to disclosure requirements as they apply to climate change and GHG emission regulations, and the impact these issues may have on a company and its current and future fi nancial conditions.

F. SEC Guidance Regarding Disclosure Related to Climate Change Th e environmental disclosure regulations, accounting rules, and SEC enforce-ment cases provided general guidance regarding environmental disclosure, but some level of clarity was missing in the context of climate change disclosure. As a result, on February 2, 2010, the SEC issued an interpretive release entitled, “Commission Guidance Regarding Disclosure Related to Climate Change.” Th e release states that it does not create any new rules or change any of the SEC’s disclosure requirements, but is designed to provide guidance to public companies

11. In re Ashland Inc. and William C. Olasin, SEC File No. 3-12487 (Nov. 29, 2006).


regarding the SEC’s existing disclosure requirements as they apply to climate change matters. 12

Th e SEC states that the four principal areas, which are discussed in more detail below, in which its rules may require disclosure relating to climate change are:

Th e impact of existing or pending legislation or regulations that relate to •climate change; Th e eff ect of treaties or other international accords; • Th e consequences, both positive and negative, including reputational harm, •of regulations or business trends; and Th e physical impacts of climate change. •

1. Overview of Existing Disclosure Requirements Th e rules that the SEC believes will be most likely to require disclosures in companies’ SEC fi lings are those discussed above. In deciding what to disclose under any of the SEC’s rules, a public company must decide what information is material to investors and shareholders. Th e U.S. Supreme Court has said that information is considered material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment decision, or if the information would alter the total mix of avail-able information. In the release, the SEC points out that, under the relevant Supreme Court cases, a public company should resolve any doubts about materi-ality in favor of disclosure.

In the release, the SEC also reviewed the requirements, initiatives, and other sources of information available regarding climate change and greenhouse gas emissions, in which many public companies have participated over the last several years, and listed the following disclosure programs:

Th e New York attorney general’s recent settlement agreements with three •energy companies regarding their disclosures about their greenhouse gas emissions and potential liabilities resulting from climate change and related regulation; Greenhouse gas monitoring and reporting regulations issued by some states •and now the U.S. Environmental Protection Agency (the EPA);

12. Commission Guidance Regarding Disclosure Related to Climate Change, Securities Act Release No. 33-9106, Exchange Act Release No. 34-61469, 75 Fed. Reg. 6290 (Feb. 8, 2010).


Th e Climate Registry, a nonprofi t collaboration among North American •states and provinces to calculate, verify, and publicly report greenhouse gas emissions for voluntary and state-mandated greenhouse gas emissions reporting; Th e Carbon Disclosure Project, which collects and distributes climate change •information relating to emissions, risks, and opportunities faced by participating companies; and Th e Global Reporting Initiative, a sustainability reporting framework for •companies regarding reporting of economic, environmental, and social performance, including issues involving climate change and greenhouse gases.

Th e SEC points out that, while disclosures or reporting under many of these existing programs is voluntary and may include information that is not relevant to reporting under SEC regulations, registrants should be aware that some of the information that may be reported through these voluntary mechanisms also may be required to be disclosed in fi lings made to the SEC.

2. Climate Change-related Topics That May Require Disclosure a. Impact of Legislation and Regulation Th e release analyzes how the SEC’s existing rules may require disclosure related to the impact of existing or pending legislation or regulatory initiatives, as follows:

Item 101 may require disclosure of capital costs incurred and to be incurred •relating to any regulation or legislation governing climate change or greenhouse gas emissions. Item 503(c) may require risk factor disclosure of existing or pending •legislation or regulation. Th e guidance states that registrants should consider “specifi c risks” and avoid “generic risk factor disclosure that could apply to any company.” Th e SEC notes, for example, that an energy company that may be particularly sensitive to climate change regulation may be subject to signifi cantly diff erent risks compared to companies that are reliant on products that may emit greenhouse gases, such as those in the transportation sector. Item 303 requires analysis of whether climate legislation is reasonably likely •to have a material eff ect on the registrant’s fi nancial condition or results of operations. For pending legislation, which is a known uncertainty, a two-step analysis applies:

First, management must evaluate whether the pending legislation or •regulation is reasonably likely to be enacted. Unless management


determines that it is not reasonably likely to be enacted, it must proceed on the assumption that it will be enacted. Second, management must determine whether, if enacted, the legislation •or regulation is reasonably likely to have a material eff ect on the registrant, its fi nancial condition, or results of operation. Unless management can determine that such a material eff ect is not reasonably likely, disclosure is required. If material, management must also disclose the diffi culties involved in assessing the timing and eff ect of the pending legislation or regulation.

One of the key issues raised in the interpretive release is found in the footnotes. In note 71, the guidance states that “Management should ensure that it has suffi cient information regarding the registrant’s greenhouse gas emissions and other operational matters to evaluate the likelihood of a material eff ect arising from the subject legislation or regulation.” Th is note refers back to footnote 62, which discusses Exchange Act Rules 13a-15 and 15d-15, which require that the principal executive and fi nancial offi cers must make certifi cations regarding the maintenance and eff ectiveness of a public company’s disclosure controls and procedures. Th us, it appears that the gathering of greenhouse gas emissions data falls within the scope of these rules for purposes of evaluating the need to make disclosures relating to climate change and the eff ectiveness of disclosure controls and procedures to ensure that the information is collected, evaluated, and dis-closed on a timely basis.

Another signifi cant point made by the guidance is that a registrant should not limit its disclosure to negative consequences, but must make disclosures about material new opportunities as well. For example, the guidance states that if a cap-and-trade-type system is put in place, a registrant may be able to profi t from the sale of allowances if its emissions levels are below its emissions allotment. Th ose that are not covered by statutory emissions caps may be able to profi t by selling off set credits for which they may qualify under climate change legislation or regulation.

In order to illustrate these issues, the guidance lists examples of possible consequences of pending legislation and regulation related to climate change:

Costs to purchase, or profi ts from sales of, allowances or credits under a •cap-and-trade system; Costs required to improve facilities and equipment to reduce emissions in •order to comply with regulatory limits or to mitigate the fi nancial consequences of a cap-and-trade regime; and Changes to profi t or loss arising from increased or decreased demand •for goods and services produced by the registrant arising directly


from legislation or regulation, and indirectly from changes in costs of goods sold.

b. International Accords Th e guidance also directs registrants to consider and disclose, if material, the impact on their businesses of international accords on climate change or green-house gas regulation, such as the Kyoto Protocol.

c. Indirect Consequences of Regulation or Business Trends Th e guidance states that indirect consequences, such as new opportunities or risks, may result from legal, technological, and scientifi c developments regarding climate change. Such developments may result in increased or decreased demand for products or services of particular companies. Examples provided are as follows:

Decreased demand for goods that produce signifi cant greenhouse gas •emissions; Increased demand for goods that result in lower emissions than competing •products; Increased competition to develop innovative new products; • Increased demand for generation and transmission of energy from alternative •energy sources; and Decreased demand for services related to carbon-based energy sources, such •as drilling services or equipment maintenance services.

Th e release states that disclosure about these business trends or risks may be required in the MD&A under Item 303, or in the business description under Item 101 of Regulation S-K. As an example, a company that plans to make changes in its product line or to take advantage of opportunities through material acquisitions of plants or equipment may be required to disclose these changes in its plan of operation under Item 101(a)(1).

Another example off ered is the potential impact of reputational damage where, because of a registrant’s sensitivity to public opinion, the public’s percep-tion of any available data relating to its greenhouse gas emissions could adversely aff ect its business operations or fi nancial condition.

d. Physical Impacts of Climate Change Th e release states that any physical impacts of climate change must be reported, if material to the registrant. Climate change may have an eff ect on a registrant’s business, facilities, and operations through severe weather, sea-level rises, melting


of permafrost, and temperature extremes. Examples of potential physical impacts to companies were identifi ed as follows:

For registrants with operations concentrated on coastlines, property damage •and disruptions to operations, including manufacturing operations or the transport of manufactured products; Indirect fi nancial and operational impacts from disruptions to the operations •of major customers or suppliers from severe weather, such as hurricanes or fl oods; Increased insurance claims and liabilities for insurance and reinsurance •companies; Decreased agricultural production capacity in areas aff ected by drought •or other weather-related changes, which would aff ect agricultural companies directly, and other companies that rely on them as suppliers, indirectly; Increased insurance premiums and deductibles, or a decrease in the •availability of coverage, for registrants with plants or operations in areas subject to severe weather; Changes in the availability or quality of water or other natural resources, •damages to facilities or decreased effi ciency of equipment, or decreases in consumer demand for products or services, such as heating fuels if temperatures increase; and Financial risks for some registrants, such as for banks whose borrowers’ assets •are in at-risk areas.

Although the interpretive release does not purport to establish any new disclo-sure requirements, public companies should evaluate whether they have suffi ciently detailed knowledge about their operations, including the level of greenhouse gas emissions, to satisfy existing disclosure requirements as inter-preted by the SEC.

One of the challenges for registered companies that are now subject to the SEC’s Guidance on climate risk is that the ability to predict an actual physical eff ect, and then to quantify the direct and indirect fi nancial and market risks. Numeric calculations would in most cases be inherently speculative. Companies may fi nd it diffi cult to state with any certainty whether these events will occur, and if they do, what the impact to the registrant might be. To overstate or speculate may have an adverse eff ect on prices for company stock, which in turn could adversely aff ect shareholders. A description of the diffi culty or uncertainly in predicting these eff ects may be appropriate in any disclosure statements on climate risk.


Public companies should evaluate their current disclosure practices, includ-ing their disclosure controls and procedures, to ensure that information about environmental compliance and risks, the impact of new and proposed cli-mate change laws and regulations and similar matters is collected and brought to the attention of the appropriate personnel in a timely manner, and that such information results in accurate, company-specifi c disclosure of all material infor-mation. Public companies should also monitor the disclosures they make about climate risk matters through other means to ensure consistency with their SEC fi lings.

G. Voluntary Climate Change Disclosure Protocols Beyond SEC regulations, accounting standards, and Sarbanes-Oxley, a plethora of protocols have emerged for “voluntary reporting” of environmental matters. Th ese voluntary disclosure protocols include disclosure of information regarding environmental, sustainability, corporate social responsibility, and, more recently, climate change and GHG emissions.

Th ese voluntary standards have evolved as a result of growing concern about corporate impacts on the environment and public health, but also at least in part as a result of the diffi culty in achieving results through the more traditional regulatory system. Th e key to this approach has been in the area of institutional investing, particularly state pension funds. Finding like-minded people in deci-sion-making roles in public pension funds, the NGOs have developed socially responsible investing groups and protocols, and utilized the power of the media and the Internet to launch public campaigns to convince companies to disclose their activities that aff ect the environment.

In addition, sustainability and corporate social responsibility have been the watchwords for several years. Many public corporations began issuing sustain-ability reports. Shareholder initiatives that involve environmental matters began to be proposed at a greater frequency. Most recently, climate change has become the focus of socially responsible investors. Protocols for disclosing a company’s “carbon footprint” and what they are doing about their GHG emissions have emerged.

Th e NGO pressure has similarly reached the fi nancial sector. Publicly funded and private banks have adopted lending principles such as the “Equator Principles” to provide environmental criteria to be used when making loans. 13

13. Http:// www.equator-principles.com/ .

Http://www.equator-principles.com/


Pressure has also been placed on investment fi rms, some of whom have retreated from investing in certain industries.

More recently, chemical manufacturers and oil companies have been facing numerous shareholder initiatives fi led by socially responsible investors to protest products or practices they consider to be public health or environmental threats. Th ese resolutions urge management to change corporate policies to reduce practices that the socially conscious investors believe are adversely impact-ing the environment. One of the most frequent demands in these shareholder initiatives in the last fi ve years has been that public companies disclose the eff ect climate change and GHG regulation will have on their companies’ fi nancial condition.

For example, the Global Reporting Initiative, the Carbon Disclosure Project, and Global Framework for Climate Risk Disclosure focus on climate change reporting. Care must be taken in considering whether to engag in any of these programs, as the motivations and goals of the disclosure requirements or protocol may go well beyond true “fi nancial” disclosure and instead address more “regulatory” disclosure. For example, one would not expect to disclose a company’s GHG emission levels company-wide or by facilities in a fi nancial report, but may do so in the context of a climate change regulatory program. In fact, measuring and reporting one’s GHG emissions would be a funda-mental aspect of such a regulatory system. Th e U.S. Environmental Protection Agency and several states have issued regulations requiring monitoring and reporting of GHG emissions from numerous industrial sources. Companies may report under state and federal GHG reporting rules as well as voluntary standards.

H. Voluntary Standards Evolving into Legal Requirements Th e demand for voluntary disclosure sprung from NGOs, and in recent years, has extended to state pension funds, where state offi cials in charge of these funds with substantial investments in publicly traded companies have joined the call for vol-untary disclosure. Recently, this voluntary call has evolved into a more pressing legal or mandatory demand.

With respect to reporting actual emissions, Congress has passed a law whereby the EPA has promulgated regulations to require companies to report their environmental regulations and several states have passed similar legislation. Th us, voluntary reporting of greenhouse gas emissions has become mandatory.


I. Offi cer and Director Liability Environmental and Climate Risk Management One of the growing concerns about the evolving mandatory fi nancial disclosure obligations and voluntary disclosure demands are the roles and responsibilities, and thereby potential personally liability, of offi cers and directors for overseeing these issues. Clearly, the individual responsibilities and liabilities of the CEO and the CFO have been increased by Sarbanes-Oxley. Other developments over the last couple of years have contributed further to the potentially greater responsibility for offi cers and directors to manage the risks encountered and to ensure adequate disclosure is made regarding such risks.

Th e case law regarding director liability and responsibility has been hinting at greater responsibility in the Delaware courts, long a reliable protector of directors. For example in the Caremark case, 14 the Delaware court held that direc-tors owe a fi duciary duty of care to the company they serve. To fulfi ll his or her duty of care, a director must make a good faith eff ort to be informed and to exercise appropriate judgment.

Th e duty of care includes a duty to supervise the company, including main-taining procedures to monitor compliance with law. Directors do not have a duty to “ferret out” wrongdoing in the absence of a red fl ag; however, where there are facts or circumstances that would create suspicions in the mind of an “ordinarily prudent director,” directors have an affi rmative duty to make reason-able inquiries and, if appropriate, to take action.

To ensure that they are receiving adequate information upon which to base their judgment, directors must be satisfi ed that adequate reporting proce-dures are in place and being followed. As the Caremark court noted, “relevant and timely information is an essential predicate for satisfaction of the board’s supervisory and monitoring role.” Furthermore, though directors are generally entitled to rely on reports of management, directors should critically review those reports (not just accept them blindly) and ask questions as necessary to become fully informed and to satisfy their concerns.

Th e Caremark decision has taken on particular importance in light of the report issued by the expert panel that investigated the explosion at the BP Texas City refi nery in March 2005. Th e expert panel led by Howard Baker issued the report (the Baker Report), which concluded that the company had not properly maintained safety policies and procedures, resulting in the explosion.

14. In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996).


Th e Baker Report called on directors to participate in overseeing the company’s safety planning and practices.

Th e Baker Report and the Caremark case together suggest that a corporate director should exercise enough due diligence to understand health and safety issues relating to the operations of the company and to ensure that adequate information is being supplied to him or her to carry out the director’s duty of care. In other words, there must be suffi cient gathering and boiling down of information and presentation of that information so it is readily understandable by the director. Th e key to such a process is appropriate information fl ow and adequate metrics being provided to the directors.

Th ese developments may be raising the bar for directors as expectations for overseeing environmental and safety practices of their company are converging with growing expectations aft er the passage of Sarbanes-Oxley that directors increase their oversight of fi nancial disclosure and internal controls to ensure fraud and inaccuracies are avoided in gathering, processing, and reporting corporate fi nancial information.

Th is convergence may be seen in the recent SEC order issued against Ashland, as discussed above, involving corporate environmental fi nancial disclo-sure and internal controls. Th e decision by the SEC indicates the agency expects the audit committee, if not the full board, to exercise oversight of the internal controls used to gather and report environmental costs and liabilities and to properly report them to the public through securities fi lings.

In light of such responsibilities, personal liability may arise for directors. A signifi cant slide in the stock price of a company aft er an environmental liability becomes public knowledge could result in a shareholder suit against directors. When this occurs, a question exists as to whether offi cers and directors are cov-ered by director and offi cer (D&O) insurance. A troubling appellate court deci-sion has been issued on this topic. Th e U.S. Court of Appeals for the Fift h Circuit, in National Union Fire Insurance Co. Pittsburgh, P.A. v. U.S. Liquids, Inc. , 15 ruled that the pollution exclusion in a D&O insurance policy eff ectively excluded claims fi led by shareholders against directors and offi cers alleging they failed to disclose environmental liabilities in fi lings with the SEC and in press releases. As a result of this case, directors and offi cers need to not only evaluate their potential risk of being sued, but also whether they would be covered by corporate D&O insurance policies. If environmental exclusions apply to shareholder suits, the company may be able to purchase additional coverage so that directors are not left without recourse for defense costs and protection against an adverse judgment.

15. 2004 U.S. App. LEXIS 2694 (5th Cir. Feb. 17, 2004).


J. Conclusion Environmental disclosure and risk management are inextricably intertwined, and no more relevant instance may exist over the coming years than in disclosure of climate risk. One particular challenge discussed above with respect to EPA’s Guidance is the ability of companies to estimate some of the potential impacts that the SEC states should be considered for disclosure. Determining the poten-tial for such impacts to occur, such as damage or disruption from extreme weather or sea level increases, or damage to reputation, may prove diffi cult, if not speculative. How these disclosures are evaluated and the language selected for particular disclosure statements may require a signifi cant degree of care.

Voluntary disclosure should be carefully considered in light of the informa-tion generated by the environmental management and environmental disclosure systems to ensure the accuracy of statements made to the public in any environ-mental or corporate social responsibility report. As a result, public companies should develop a practical approach to evaluate climate-related issues and formu-late strategies for responding to the myriad regulatory requirements and other stakeholder pressures relating to climate risk disclosure.


Acronyms and Abbreviations

AAU – Assigned Amount Unit ACR – American Carbon Registry CCS – Carbon Capture and Storage CCX – Chicago Climate Exchange CDM – Clean Development Mechanism CER – Certifi ed Emission Reduction

(= 1 metric ton of CO 2 e) CO 2 – Carbon dioxide CO 2 e – Carbon dioxide equivalent DOE – Designated Operational Entity EB – Executive Board (of the CDM) EC – European Commission EIA – Energy Information Administration EPA – U.S. Environmental Protection Agency ERPA – Emissions Reduction Purchase Agreement ERU – Emission Reduction Units ETS – Emission Trading Scheme EU – European Union EU ETS – European Union Emissions Trading Scheme EUA – European Union Allowance (= 1 metric ton CO 2 e) FERC – Federal Energy Regulatory Commission GHG – Greenhouse gas IETA – International Emissions Trading Association IFC – International Finance Corporation

298 | ACRONYMS AND ABBREV IAT IONS

IPCC – International Panel on Climate Change JI – Joint Implementation NAAQS – National Ambient Air Quality Standards NAMA – Nationally Appropriate Mitigation Action NEPA – National Environmental Policy Act PDD – Project Design Document PoA – Programme of Activities PPA – power purchase agreement PSD – Prevention of Signifi cant Deterioration Program REC – renewable energy credit REDD – Reducing Emissions from Deforestation and

Forest Degradation RGGI – Regional Greenhouse Gas Initiative RPS – Renewable Portfolio Standard UN – United Nations UNFCCC – United Nations Framework Convention on

Climate Change U.S. – United States VCS – Voluntary Carbon Standard VCSA – Voluntary Carbon Standard Association VCU – Voluntary Carbon Unit VER – Voluntary Emission Reduction WCI – Western Climate Initiative

Index

AB 32. See California Global Warming Solutions Act

Additionality, 23, 35, 43–44, 57, 67, 80, 151–52

Agriculture, Forestry, and Other Land Use, 185

benchmarks, use of, 97 carbon credit project risks, 199 CAR Forest Protocol, 188–89 Clean Development Mechanism, 43–44 Cooperation by Multi-State Programs,

97–98 defi ned, 23, 35, 43–44 performance standards, use of, 93–94,

97–98 Proposed Regulation for a California

Cap-and-Trade Program, 82 Regional Greenhouse Gas Initiative, 87 renewable energy projects, 178 Tool for the Demonstration and Assessment

of Additionality, 43–44 Western Climate Initiative, 93–94

Aff orestation, Reforestation, and Revegetation (ARR), 184

Africa impact of climate change on, 7

African Development Bank, 216 Agreements Establishing Project and Project

Entity, 210 Agreements with Equipment and

Manufacturers, 211 Agreements with Investors, 211 Agriculture, Forestry, and Other Land Use

(AFOLU), 183–87

additionality, 185 baseline, 185 leakage, 186 Methodology and Guidance, 184 monitoring, 186–87 permanence and related carbon buff er, 186

Air pollutant, defi ned, 102 Alito, Samuel, 109 Allowances

banking, 33, 56, 79, 166–67 borrowing, 33, 56, 79, 167 defi ned, 31 emission, 19–20, 31–33, 55, 77–79,

139–41 regulation of, 37 trading, 33, 56, 79, 166

American Association for the Advancement of Science, 14

American Carbon Registry (ACR), 68, 81, 177, 190, 204

American Meteorological Society, 14 American National Standards Institute, 154 American Recovery and Reinvestment Act of

2009 (ARRA), 244, 245 funds for grants, 245, 248–50 tax incentives to carbon credit projects,

247–48 Anthropogenic warming, 6 APX Inc., 68, 256 Arbitrary and capricious standard, 104 Asia

impact of climate change on, 7 Asian Development Bank, 216 Assigned Amount Units (AAUs), 45

300 | INDEX

Auctions, 141–44 main allowance auction, 141–42 Market Stability Reserve auction, 142–43 small business refi ner reserve, 143–44

Australia Carbon Pollution Reduction

Scheme, 61 controversy over climate change, 12 forest carbon projects, 203 Kyoto Protocol’s restriction on GHG

emissions, 22 National Stock Exchange of Australia

Limited, 237 Water Exchange, 237 water quality trading, 237 water quantity trading, 237

Avoiding planned deforestation (APD), 183 Avoiding unplanned frontier deforestation and

degradation (AUFDD), 184 Avoiding unplanned mosaic deforestation and

degradation (AUMDD), 184

Bali Action Plan, 47 Bali Road Map, 47 Bank of America, 217 Banking allowances, 33, 56, 166–67. See also

Allowances defi ned, 33 European Union Emissions Trading Scheme,

53, 56 Proposed Regulation for a California

Cap-and-Trade Program, 79 Proposed Legislation for a Federal

Cap-and-Trade Program, 139 Regional Greenhouse Gas Initiative, 86 Western Climate Initiative, 92

Barclays, 217 Benchmark, 97 Berlin Mandate, 42 Best Available Control Technology (BACT),

126, 128, 129, 131–32 Beyond Business as Usual (BBU), 23, 35, 188 BioCarbon Fund, 214, 215 Biodiversity credits, 232–34 Black carbon, 27 Bloomberg New Energy Finance, 70 Bluenext, 257 BNP Paribas, 217 BOOM projects, 193 Borrowing allowances, 33, 56, 167. See also

Allowances defi ned, 33 European Union Emissions Trading

Scheme, 56 Proposed Regulation for a California

Cap-and-Trade Program, 79

Proposed Legislation for a Federal Cap-and-Trade Program, 167

Regional Greenhouse Gas Initiative, 86 Western Climate Initiative, 92

BOT projects, 193 Boxer, Barbara, 33, 101 n 8 Brazil, 10, 47, 159, 169, 182

bilateral approach to GHG off sets, 50 National Academy of Sciences, 9

Breyer, Stephen, 103 “Building Bridges: State of the Voluntary

Carbon Markets 2010”, 70 Bush, George W., 107, 244 Buyers

compliance, 258 obligations of, 263–64 voluntary, 258

Caisse des Dépôts, 68 California, 74–84. See also United States

biodiversity credit program, 233 Climate Action Reserve, 80 Contractual issues in selling RECs, 229 Property Assessed Clean Energy

Program, 250 Proposed Regulation for a California

Cap-and-Trade Program, 74–84 Renewable Portfolio Standard in, 222 Western Climate Initiative and, 88

California Air Resources Board (CARB), 75. See also Proposed Regulation for a California Cap-and-Trade Program

California Climate Action Registry (CCAR), 187

California Environmental Quality Act, 108 n 35

California Global Warming Solutions Act, 27, 74–75

California Health and Safety Code, 83 California Public Utilities

Commission, 229 Canada

carbon trading programs in, 60–61 Environment Canada, 60 National Academy of Sciences, 8 water quality trading, 237

Cap, the defi ned, 30 European Union Emissions Trading



Cap-and-Trade Program, 138 Regional Greenhouse Gas Initiative, 85 setting, 138–39 Western Climate Initiative, 90–91

INDEX | 301

Cap and trade systems, 18–21, 25–38 additionality, 35, 57 banking allowances, 33, 56 borrowing allowances, 33, 56 defi ned, 54–55 early action, 36, 57 emission allowances, 31, 55 emission allowances, allocation of,

31–33, 55 emissions threshold, determining, 28 enforcement of, 38, 58 new or expanded facilities, 36–37, 57 off sets, 31, 34, 35, 37, 56 permitting, 30–31 regulated gases, defi ning, 25–28 regulated sources, determining, 28–30, 55 regulatory agencies, 37 safety valve and international

competitiveness, 34 setting, 30 supplementarity and linkage to, 35–36, 56 trading allowances, 33, 56 in United States, 20–21

Carbon accounting, 271 for reversals, 153

Carbon Assets, 272–78 fi nancial accounting treatment of, 275–78

Carbon capture & sequestration (CCS), 91 Carbon capture and storage (CCS), 190–92

government tax incentives for, 246–47 Carbon credit, 31, 41, 42, 275

fungible commodity vs. diff erentiation of, 258

risk and price, 259 types of, 255 voluntary, source of demand for, 65

Carbon credit project avoided deforestation and reforestation,

180–90 carbon capture and storage, 190–92 energy effi ciency, 178 fuel switching, 180 government incentives for, 243–45 landfi ll methane gas recovery projects,

178–79 lenders and investors, 214–17 natural gas production and distribution

projects, 179–80 renewable energy, 177–78 types and methodologies, 175–92 and water credits, 238–39

Carbon credit project development, 193–206 approval process, 196–99 basics of, 194 examples of, 200–206 feasibility study for, 194–95, 196

host country approval, 197 idea note, 196 implementation and monitoring, 198 issuance of credits, 198 Project Design Document, 196–97 registration, 197–98 risks of, 199–200 stakeholder participation requirement, 197 validation by designated operational

entity, 197 verifi cation and certifi cation, 198 Voluntary Carbon Standard process, 198–99

Carbon Disclosure Project, 271–73, 287, 292 Carbon Fed, 34 Carbon fi nance, 207–17. See also Financing

carbon projects; Project fi nance basic elements of, 211–14

Carbon Finance Unit (CFU), 214, 215 Carbon Fund for Europe, 214 Carbon funds, 18 Carbon indexes, 257–58 Carbon Ledger, forming, 273–75 Carbon Liabilities, 272–78

fi nancial accounting treatment of, 275–78 Carbon off set creation, 147–48. See also

Off sets Carbon Partnership Facility, 214 Carbon Pollution Reduction Scheme (CPRS)

(Australia), 61 Carbon registry, 144–45 Carbon trading

carbon credit risk and price, 259 carbon credits, types of, 255 carbon indexes, 257–58 contractual issues in. See Contractual issues

in carbon trading fungible commodity vs. diff erentiation, 258 future vs. spot markets, 257 global carbon markets, state of, 259–60 investors and speculators, 258–59 off -take agreements, 257 primary markets and bilateral

agreements, 256 regulatory “commodity”, 255 secondary markets and exchanges,

256–57 voluntary and compliance buyers, 258

Caremark case, 293–94 Cause or Contribute Finding, Environmental

Protection Agency, 125 CDM Executive Board, 23 Center for Biological Diversity v. NHTA ,

108 n 35 Certifi ed Emission Reduction (CER), 23, 44,

56, 62, 63, 72–73, 180, 196, 207, 216, 255, 263

302 | INDEX

Chamber of Commerce, U.S., 13 Charismatic credits, 37 Chesapeake Bay Nutrient Credit Exchange

Program, 238 Chicago Climate Exchange (CCX), 63, 66, 71,

204, 256, 273 China, 10, 159, 169

bilateral approach to GHG off sets, 50 carbon trading programs in, 63 Kyoto Protocol’s restriction on GHG

emissions, 22 National Academy of Sciences, 9

China National Petroleum Corp., 63 Chu, Steven, 10 CitiBank, 217 Clean Air Act of 1990 (CAA), 18, 20, 99–16,

122, 123, 126, 132, 133, 139, 172, 279 Clean Development Mechanism Market,

72–73. See also Markets Clean Development Mechanism (CDM), 18,

22–23, 53–54, 57, 62, 63, 93–94, 146, 154, 175–76, 179, 180, 192, 195, 204, 207, 215, 267. See also Kyoto Protocol

carbon credit approval process under, 196–99

Certifi ed Emission Reductions, 255, 263 Executive Board, 43–44, 46, 49, 50, 67 Project of Activities, 68 reforestation/aff orestation

methodology, 190 Clean Water Act (CWA), 231–32, 238 Climate Action Reserve (CAR),

181, 182, 190 additionality, 188–89 baseline, 188 Forest Project Protocol (FPP), 187–90 Forest Verifi cation Protocol (FVP), 187 leakage, 189 monitoring, 190 permanence and related carbon buff er,

189–90 Climate Change Capital, 217 Climate change disclosure. See Climate risk

disclosure Climate change science

controversy over, 12–15 development of, 3–15 environmental regulation and, 4 future policy development, 15 scientifi c institutions,

conclusions of, 5–11 scientifi c institutions, policy impact of

conclusions of, 12 “Climate Change Science: An Analysis of

Some Key Questions”, 11

Climate Gate, 13 Climate Group, 66 Climate Registry, Th e, 287 Climate Reserve Tons (CRTs), 190 Climate risk disclosure, 279–95

liabilities, 279–81 offi cer and director liability environmental

and, 293–94 Sarbanes-Oxley Act, 280, 284,

285, 291, 293 Securities and Exchange Commission

regulations governing. See Securities and Exchange Commission

voluntary climate change disclosure protocols, 291–92

voluntary standards, legal requirements for, 292

Climate, Community, and Biodiversity Alliance (CCBA), 69, 205

Climex, 257 CO 2 Allowance Trading Accounts

(COATs), 86 Cohens v. Virginia , 112 n 52 Coke Oven Environmental Task Force v. EPA ,

107 n 34 Columbia

Renewable Portfolio Standard in, 222 Comer v. Murphy Oil , 108, 111, 112, 112 n 51 “Command and control” model, 16–17, 127 Commodities Futures Exchange

Commission, 171 Commodity, 221

fungible commodity vs. diff erentiation, 258

regulatory, 255 Community Development Carbon

Fund, 214 Compliance with greenhouse gas emission

requirements, 163–66 Compliance or mandatory markets, 64. See also

Markets Comprehensive Environmental Response,

Compensation, and Liability Act, 231 Conditions precedent, 261–62 Conference of the Parties (COP), 42, 45, 46 Congress, U.S., 12, 16, 27, 28, 30, 32, 34, 35,

49, 61, 74, 100, 101, 103, 106, 107, 112, 114, 116, 117, 125, 133, 146, 155, 181, 182, 203, 245, 279, 281, 292

Connecticut Energy effi ciency credits in, 225

Connecticut v. American Electric Power , 108 n 37, 109–10, 110 n 39, 110 n 44

Conning, 217 Constellation Energy, 256

INDEX | 303

Contractual issues in carbon trading. See also Carbon trading

conditions precedent, 261–62 default, 265–66 defi ned, 261 delivery, 262 dispute resolution, 267 force majeure, 267 law and venue, choice of, 266 liability, limitation of, 267 obligations of buyer, 263–64 obligations of seller, 263 payment, 262–63 price, 262 quantity, 262 remedies, 266 representations, 264–65 share of proceeds and taxes, 265 termination, 266 warranties, 264–65

Contractual issues in selling RECs inside California, 229. See also California

Contractual issues in selling RECs change in law, 228 credit, vintage of, 227 credits, types of, 226–27 delivery, 228 eff ective date and termination, 228 payment, 227–28 pricing, 227 quantity being sold, 227 remedies and damages, 228 representations and warranties, 228 transfer mechanism, 227

Copenhagen Accord, 48 Corporate climate change liabilities, 279–81.

See also Liability(ies) Covered entities, 75–76, 79, 136–38, 164–65 Covered gases

Prevention of Signifi cant Deterioration Program, 129

Credit stacking, 234–35 Credit Suisse, 217, 256 Crediting periods, 153

Danish Carbon Fund, 214 Debt, 209–10 Default, 265–66 Delivery of carbon credits, 262 Department of Energy, U.S. (DOE), 245

Guidelines for the Loan Guarantee Program, 250

Designated National Authority (DNA), 197 Designated Operational Entity (DOE),

23, 43, 197

Deutsche Bank, 217 Developed countries

national academies of sciences, 8–11 Developing countries

national academies of sciences, 8–11 Development bonds, 251 Diff erentiation of carbon credits. See also

carbon credits fungible commodity vs., 258

Dispute resolution, 267 Double Approval Process, 67

Early action, 170–71 defi ning, 36 European Union Emissions Trading



Cap-and-Trade Program, 155, 170 Regional Greenhouse Gas Initiative, 87 Western Climate Initiative, 94

Economics vs. the environment, 16–17 emissions trading, bridging, 17–18

Ecosystem Marketplace, 70 Ecosystem services, 230–35 Emergency Economic Stabilization Act of

2008 (EESA), 244 tax incentives to carbon credit projects,

246–47 Emergency Planning and Community

Right-to-Know Act, 116, 116 n 7 Emission allowances, 19–20, 31, 55, 139–40.

See also Allowances allocation of, 31–33, 55, 77–79, 91–92,

140–41 Proposed Regulation for a California


Emission Reduction Tons (ERTs), 68 Emission Reduction Units (ERUs),

22, 44, 255 Emissions Reduction Purchase Agreement

(ERPA), 210–13, 256, 257, 259, 261, 262, 264

Emissions threshold, 135–36 determining, 28

Emitters of greenhouse gases, 136–37 Endangerment Finding, Environmental

Protection Agency, 13, 107, 124–25 Energy effi ciency, 178

conservation, government tax incentives for, 246

credits, 225

304 | INDEX

Energy Policy Act of 2005, 250 Enforcement

defi ned, 38 European Union Emissions Trading


Cap-and-Trade Program, 83–84 Proposed Legislation for a Federal


Engineering, Procurement, and Construction Agreements (EPC Agreements), 210

“Ensuring Real Reductions in Industrial Emissions”, 168

Environment vs. economics, 16–17 Environment Canada, 60. See also Canada Environmental attributes, 221–22 Environmental Defense Fund (EDF), 20–21 Environmental markets. See also Markets

emergence of, 17 working, 24

Environmental Protection Agency, U.S. (EPA), 16, 27, 114–32, 139–42, 144–48, 158, 203, 237–38, 271, 279, 281, 286, 292). See also Massachusetts v. EPA , U.S. Supreme Court opinion in

Cause or Contribute Finding, 125 “Endangerment Finding”, 13, 107, 124–25 Greenhouse Gas Reporting Rule. See

Greenhouse Gas Reporting Rule “Johnson Memo”, 125–26 Mobile Source Rule, 126 Tailoring Rule, 126–32

Environmental regulation, evolution of, 17 Environmental Resources Trust (ERT), 68 Equator Principles, 292 Equity, 209 Europe

impact of climate change on, 8 European Bank for Reconstruction and

Development, 216 European Carbon Fund, 217 European Climate Exchange (ECX), 256, 257 European Commission (EC), 32, 55 European Investment Bank, 216 European Market, 71–72. See also Markets European Union (EU), 22, 24, 50, 169, 203,

204, 273 Emissions Trading Scheme, 44 Policy on Climate Change, 52

European Union Allowances (EUAs), 53, 54, 71, 255, 256–57

European Union Emissions Trading Scheme (EU ETS), 26, 18–19, 22, 24, 52–58, 71–72, 175, 203, 204, 271, 273, 281

additionality, 57 banking allowances, 33, 56 borrowing allowances, 56 cap, defi ning, 54–55 carbon allowance requirement

under, 35–36 early action, 57 emission allowances, 55 emission allowances, allocation of, 32, 55 enforcement, 58 European Union Allowances, 255, 256–57 greenhouse gases, permitting

emissions of, 55 new or expanded facilities, 57 off sets, 56 Phase I (2005–2007), 53 Phase II (2008–2012), 53–54 Phase III (2013–2020), 54 regulated sources, defi ning, 55 regulated sources, determining, 28–29 safety valve and international

competitiveness, 56 supplementarity, 57 trading allowances, 56

Export-Import Bank, U.S., 216

Feasibility study, for carbon credit project development, 194–95

Federal Energy Regulatory Commission (FERC), 203

Federal legislation on climate change, development of, 133–72

auctions, 141–44 banking allowances, 166–67 borrowing allowances, 167 cap, setting, 138–39 carbon registry, 144–45 compliance with greenhouse gas emission

requirements, 163–66 Covered Entities, 136–38 early action, 170–71 emission allowances, 139–40 emission thresholds, 135–36 enforcement, 172 greenhouse gases, permitting emissions

of, 139 off sets, 145–63 regulated gases, defi ning, 133–35 regulatory agency or agencies, 171 safety valve international competitiveness,

167–69 supplementarity, 169–70 trading allowances and off sets, 166

Financial accounting treatment of carbon assets and liabilities,

275–78

INDEX | 305

Financial Accounting Standards Board (FASB), 272, 275, 276, 284

Financing carbon projects, 207. See also Carbon fi nance; Project fi nance

Florida. See also United States biodiversity credit program, 234 cap-and-trade programs in, 84 Department of Environmental

Protection, 84 Fish and Wildlife Service, U.S., 234 Florida Climate Protection Act, 84 Florida Fish and Wildlife Conservation

Commission, 234 Force majeure, 267 Forest Carbon Partnership, 215 Forest Carbon Partnership Facility, 214 Forest carbon projects, 203–6

risks of, 205–6 role in compliance systems, 204

Forest Project Protocol (FPP), Climate Action Reserve, 187–90

additionality, 188–89 baseline, 188 leakage, 189 monitoring, 190 permanence and related carbon buff er,

189–90 Forest Verifi cation Protocol (FVP), Climate

Action Reserve, 187 Forestry or land-management projects,

environmental considerations for, 156–57 Fortis, 217 Forward capacity markets, 225–26. See also

Markets France

National Academy of Sciences, 8 Friends of the Earth v. Mosbacher , 108 n 35 Fuel switching, 180 Fugitive emissions, 165–66 Future vs. spot markets, 257. See also Markets

Gazprom Marketing & Trading Ltd., 50 Generally Accepted Accounting Principles

(GAAP), 272, 283 Georgia v. Tennessee Copper Co. , 102–3,

102 n 14, 103 n 15 Germany

National Academy of Sciences, 8 Gillard, Julia, 61 Global Framework for Climate Risk

Disclosure, 292 Global Reporting Initiative, 287, 292 Goldenberg, José, 10 Goldman Sachs, 217 Government grants, 245, 248–50 Government incentives

to enhance carbon credit projects, use of, 243–45

Government loan guarantees, 250 Government tax incentives, 245–48

for carbon capture and storage, 246–47 for energy effi ciency and conservation, 246 for renewable energy, 246 for transportation and domestic fuel, 247

Green Exchange with Evolution Markets Inc., Th e, 256

Greenhouse eff ect, 5 Greenhouse gas emissions

cap and trade systems for, 25–38 regulation of, 37, 171

Greenhouse Gas Reporting Rule, 115–23 certifi cation and verifi cation, 121 covered facilities, 117–20 covered gases, 117 enforcement actions against facilities, 123 information, reporting, 121–22 monitoring and measurement, 121 penalties for failure to comply, 123 public availability of information, 122 reporting regulation requirements,

exiting, 123 Greenhouse Gas-Credit Aggregation Pool, 217 Greenhouse gases (GHGs)

emitters of, 136–37 permitting emissions of, 55 producers or importers of, 138

Greenhouse gases, permitting emissions of, 139

Proposed Regulation for a California Cap-and-Trade Program, 77

Regional Greenhouse Gas Initiative, 86 Western Climate Initiative, 91

Grey K Environmental Fund, 217 Grouped Projects, 68

Hawaii Renewable Portfolio Standard in, 222

Henninger, Daniel, 13–14

ICAP, 256 ICECAP, 217 Iceland

Kyoto Protocol’s restriction on GHG emissions, 22

Improved Forest Management (IFM), 184 Increasing water demand and decreasing water

supply, 237 India, 159, 169

bilateral approach to GHG off sets, 50 Kyoto Protocol’s restriction on GHG

emissions, 22 National Academy of Sciences, 9

306 | INDEX

Indonesia Bali Action Plan, 47

Industrial Sector, 168 Industrial Stationary Sources, 164 Inhofe, James, 101 n 8 InterAcademy Council

“Lighting the Way: Toward a Sustainable Energy Future”, 10

Inter-American Development Bank (IDB), 216

Intercompany Agreements, 210 Intercontinental Exchange Inc. (ICE), 256, 257 Intergovernmental Panel on Climate Change

(IPCC), 41 Internal forest off sets, 160–63

forested wetlands and peatlands, 163 national programs, 160–62 program for low-emitting

countries, 162–63 project-based deforestation reduction

credits, 163 state- or province-level programs, 162

Internal rate of return (IRR), 213, 214 International Accounting Standards Board

(IASB), 272, 275–78 emissions rights, interpretation for, 276 future work agenda, 276–77

International Clean Energy Deployment Program, 152

International Emissions Trading Association (IETA), 49, 66, 191–92

International Finance Corporation (IFC), 214–16

International off sets. See also Off sets credits importation, sectoral approach for,

168–69 forest off sets, 160–63 general issues, 157–58 issuance of credits, 159 sectoral credits, 158–59

International Panel on Climate Change (IPCC), 5–8, 12, 14, 184

Investors, 258–59 Issuance of credits, 155, 159, 198 Italian Carbon Fund, 214 Italy

National Academy of Sciences, 8

Japan bilateral approach to GHG

off sets, 49–50 carbon trading programs in, 61–63 forest carbon projects, 203, 204 Kyoto Protocol. See Kyoto Protocol National Academy of Sciences, 8

Japan Bank for International Cooperation ( JBIC), 50

“Johnson Memo”, 125–26 Joint Implementation ( JI), 44–45, 46, 53, 57

Emission Reduction Units, 255 JPMorgan, 217, 256

Kerry, John, 133 Kovacs, William, 13 Kyoto credits, 255 Kyoto Protocol, 12, 22–23, 26, 30, 36, 52,

61–62, 67, 138–39, 181, 182, 212, 216, 289

Assigned Amount Units, 45 Clean Development Mechanism, 18, 22–23,

43–44, 53–54, 57, 62, 63, 67, 68, 72–73, 93–94, 146, 154, 175–76, 179, 180, 190, 195–99, 204, 207, 215, 255, 263, 267

emissions trading, 45–46 general; principles of, 42–43 Joint Implementation ( JI), 44–45, 53, 57 Kyoto Units, 46 Marrakesh Accords, 42, 46–47 Meeting of the Parties, 46 Removal Unit, 45 restrictions on developing and developed

countries, 22 Kyoto Units, 46

Land use, land-use change, and forestry (LULUCF), 45

Landfi ll methane, 201 Landfi ll methane gas recovery projects, 178–79 Latin America

impact of climate change on, 7–8 Law and venue, choice of, 266 Leakage, 78, 150, 152–53, 182, 198

Agriculture, Forestry, and Other Land Use, 186

CAR Forest Protocol, 189 Carbon Capture and Storage, 191 Carbon Credit Project Types and

Methodologies, 177 Carbon credit project risks, 205 defi ned, 78, 153 forest projects, 182 Proposed Legislation for a Federal

Cap-and-Trade Program, 168 Tool to Calculate Baseline, Project, and/or

Leakage Emissions from Electricity Consumption, 176

Tool to Calculate Project or Leakage CO 2 Emissions from Fossil Fuel Combustion, 176

INDEX | 307

Liability(ies) corporate climate change, 279–81 limitation of, 267

“Lighting the Way: Toward a Sustainable Energy Future”, 10

Lindzen, Richard S., 12 Linkage, 35–36, 169 Loan Agreements, 211 Long Island Sound Nitrogen Credit Exchange

Program, 238 Louisiana. See also United States

Property Assessed Clean Energy Program, 250

Main allowance auction, 141–42. See also Auctions

Market Reserve, 167 Market Stability Reserve auction, 142–43.

See also Auctions Markets

Clean Development Market, 72–73 compliance or mandatory, 64 emergence of environmental, 17 environmental, 64 European Market, 71–72 forward capacity, 225–26 future vs. spot, 257 global carbon markets, state of, 259–60 pre-compliance, 65, 69–70 primary, 256 secondary, 256–57 voluntary, 64–70 working carbon, 21–24

Marrakesh Accords, 42, 46–47 Massachusetts v. EPA , U.S. Supreme

Court opinion in, 99–113, 114, 116, 124–26, 279

eff ect on cases fi led under NEPA, 107–8 eff ect on challenges to, 107 eff ect on tort suits, 108–9 eff ect on vehicle-related greenhouse gas

lawsuits, 107 federal common law litigation to impose

emission reductions, 109–11 federal statutory litigation, 100–109 implications of, 106–9 merits of, 104–6 origins of, 101–2 standing, issue of, 102–3 standing for states to challenge federal

administrative agency action, 109 state and federal common law litigation to

obtain damages, 111–13 state statutory litigation, 109 symbolic or political signifi cance of, 106

Mayo Foundation v. Surface Transportation Board , 108 n 35

Merrill Lynch, 217, 256 Merzbach Mezzanine Carbon Fund, 217 Mexico, 48, 159, 169

bilateral approach to GHG off sets, 50 National Academy of Sciences, 9

Midwestern Greenhouse Gas Reduction Accord (MGGRA), 27, 81, 95–96, 281

Mitsui, 217 Mobile Source Rule, Environmental Protection

Agency, 126 Monitoring, reporting, and verifi cation (MRV)

requirements, 154–55 Morgan Stanley Capital Group Inc.,

217, 256 Multilateral Carbon Credit Fund, 216

National Academies of Science, 8–12, 230–31

policy impact of conclusions of, 12 National Ambient Air Quality Standards

(NAAQS), 127, 128 National Environmental Policy

Act (NEPA), 107–8 National Pollution Discharge Elimination

System, 238 National Research Council, U.S., 11, 15 National Union Fire Insurance Co.

Pittsburgh, P.A. v. U.S. Liquids, Inc. , 294

Nationally Appropriate Mitigation Actions (NAMAs), 48

Native Village of Kivalina v. ExxonMobil Corporation , 112 n 53

Natural gas production and distribution projects, 179–80

Natural Resources Defense Council v. Reclamation Board , 108 n 35

Netherlands CDM Facility, Th e, 214 Netherlands European Carbon Facility,

Th e, 214 Nevada

Energy effi ciency credits in, 225 New Jersey

Renewable Energy Credits in, 225 New Mexico. See also United States

cap-and-trade programs in, 84 New Mexico Environment

Department, 84 New Mexico Environmental Improvement

Board, 84 Property Assessed Clean Energy

Program, 250

308 | INDEX

New or expanded facilities, 36–37, 171 European Union Emissions Trading



Cap-and-Trade Program, 171 Regional Greenhouse Gas

Initiative, 88 Western Climate Initiative, 95

New Orleans Pub. Serv., Inc. v. Council of the City of New Orleans , 112 n 52

New York. See also United States Property Assessed Clean Energy

Program, 250 New York Mercantile Exchange, Inc., 256 New Zealand

carbon trading programs in, 59–60 water quality trading, 237

New Zealand Emissions Trading Scheme (NZ ETS), 59–60

New Zealand Units (NZUs), 59–60 Nitrogen Credit Advisory Board, 238 Nongovernmental organizations

(NGOs), 31, 280 Nord Pool, 257 Nordic Development Fund, 216 Nordic Investment Bank, 216 North America

impact of climate change on, 8 North American Development Bank, 216 North Carolina

Renewable Portfolio Standard in, 222 North Carolina v. EPA , 127 n 27 NRDC v. EPA , 127 n 27 NYMEX Holdings, Inc., 256 NYSE Blue, 256 NYSE Euronext, 256

Obama, Barack, 107, 114, 115, 125, 244 Greenhouse Gas Reporting Rule and,

115–23 Offi ce of Management and Budget, 21 Offi cer and director liability environmental

and climate risk management, 293–94 Off sets, 19, 31, 34, 35, 56, 66, 145–63

accounting for reversals, 153 approval of projects, 153–54 carbon off set creation, 147–48 covered entity, 146 crediting periods, 153 defi ned, 34, 145 early, 155–56 European Union Emissions Trading

Scheme, 56

forestry or land-management projects, environmental considerations for, 156–57

international. See International off sets issuance of credits, 155 methodologies, 150–53 monitoring, reporting, and verifi cation

requirements, 154–55 project types, 148–50 Proposed Regulation for a California


Cap-and-Trade Program, 147–63 recordkeeping, 157 Regional Greenhouse Gas Initiative, 87 regulation of, 37, 171 retiring an, 146–47 term, 146 trading allowances and, 166 Western Climate Initiative, 93

Off sets Integrity Advisory Board, 147, 148, 150

Off -take Agreements, 210, 257 Oil Pollution Act, 231 Operation and Maintenance Agreements, 211 “Over the counter” transaction, 37, 68 Overseas Private Investment Corporation

(OPIC), 216, 211

Payment and carbon credits, 262–63 Peaker plants, 225–26 Pennsylvania

Energy effi ciency credits in, 225 Performance standard, 97 Pew Center on Global Climate

Change, 222 n 1 Pollution rights, 19 Power purchase agreements (PPAs),

194, 208, 212 Pre-compliance markets, 65, 69–70. See also

Compliance or mandatory markets; Markets

Prevention of Signifi cant Deterioration (PSD) Program, 126, 127–29

Price carbon credit risk and, 259 for carbon credits, 262

Primary forest, 181 Primary markets. See also Markets

and bilateral agreements, 256 “Project of Activities”, 68 Project Design Document (PDD),

154, 177, 182 Project fi nance, 207–11. See also Carbon

fi nance; Financing carbon projects

INDEX | 309

agreements, types of, 210–11 debt, 209–10 defi ned, 208 equity, 209 political risk with international projects,

managing, 211 Property Assessed Clean Energy (PACE)

Program, 250–51 Proposed Regulation for a California

Cap-and-Trade Program (California Air Resources Board), 74–84

additionality, 82 banking allowances, 79 borrowing allowances, 79 cap, the, 77 early action, 83 emission allowances, 77 emission allowances, allocation of, 77–79 enforcement, 83–84 greenhouse gases, permitting

emissions of, 77 new or expanded facilities, 83 off sets, 80–82 regulated gases, 75 regulated sources, 75–77 regulatory agency or agencies, 83 safety valve and competitiveness, 80 supplementarity, 82–83 trading allowances, 79

Prototype Carbon Fund, 214

Quantifi ed Emission Reductions and Limitation Commitment, 45

Quantity of carbon credits, 262

REC Sale Agreements, 211 Reducing Emissions from Deforestation and

Forest Degradation (REDD), 27–28, 47, 48, 81, 82, 181–86, 190, 215, 235

Regional Greenhouse Gas Initiative (RGGI), 26, 32, 85–88, 141, 260, 281

additionality, 87 banking allowances, 86 borrowing allowances, 86 cap, the, 85 early action, 87 emission allowances, 86 emission allowances, allocation of, 86 enforcement, 88 greenhouse gases, permitting

emissions of, 86 new or expanded facilities, 88 off sets, 87 regulated gases, 85 regulated sources, 85

regulatory agency or agencies, 88 safety valve and international

competitiveness, 87 supplementarity, 87 trading allowances, 86

Regulated gases defi ned, 25–28, 133–35 European Union Emissions Trading




Regulated sources determining, 55 European Union Emissions Trading



Cap-and-Trade Program, 136–38 Regional Greenhouse Gas Initiative, 85 Western Climate Initiative, 90

Regulatory agency or agencies, 171 greenhouse gas emissions, regulation of, 37 Proposed Regulation for a California


Cap-and-Trade Program, 171 Regional Greenhouse Gas Initiative, 88 trading of allowances and off sets,

regulation of, 37 Western Climate Initiative, 95

Regulatory commodity, 255. See also Commodity

Remedies, 266 Removal Unit (RMU), 45 Renewable energy, 177–78

credits (ERCs), 211, 222, 224–25 government tax incentives for, 246

Renewable Energy Certifi cates, 224 Renewable Portfolio Standard

(RPS), 222–24 Representations and carbon credits

ownership, 264–65 Reversals, accounting for, 153 RNK Capital, 217 Roberts, John, 103, 109 Rudd, Kevin, 61 Russia

bilateral approach to GHG off sets, 50 Kyoto Protocol’s restriction on GHG

emissions, 22

310 | INDEX

National Academy of Sciences, 8 Safety valve and international competitiveness,

34, 56, 167–69 European Union Emissions Trading

Scheme, 56 defi ned, 34 Proposed Regulation for a California


Cap-and-Trade Program, 167–69 Regional Greenhouse Gas Initiative, 87 Western Climate Initiative, 92–93

Sandor, Richard, 66 Sarbanes-Oxley Act, 280, 284, 285, 291, 293 Scalia, Antonin, 103, 109 Secondary markets and exchanges, 256–57.

See also Markets Sectoral approach for the importation of

international off set credits, 168–69 Sectoral credits, 158–59 Securities and Exchange Commission (SEC),

279–91 climate change, physical impacts of, 289–91 “Commission Guidance Regarding

Disclosure Related to Climate Change”, 285–91

enforcement case against Ashland Inc., 284–85

environmental fi nancial disclosure, regulations for, 281–83

existing disclosure requirements, overview of, 286–87

Financial Accounting Standards, 283–84 Generally Accepted Accounting Principles,

272, 283 impact of legislation or regulatory initiatives

on disclosures, 287–89 indirect consequences of regulation or

business trends, 289 international accords on climate change or

greenhouse gas regulation, 289 Item 101, 282, 287 Item 101(a)(1), 289 Item 303, 282–83, 287–88 Item 503(c), 283, 287

Seller, obligations of, 263 Share of proceeds and taxes, 265 Small Business Refi ners Reserve, 143–44, 167 Social Carbon Standard, 204, 205 Société Générale, 257 Solar projects, 201–3

free-standing or utility-scale, 201 non-utility-scale, 202–3

South Africa, 159, 169 bilateral approach to GHG off sets, 50

National Academy of Sciences, 9 Spanish Carbon Fund, 214 Speculators, 258–59 Spot vs. future markets, 257. See also Markets “State of the Voluntary Carbon Markets

Report, Th e”, 70 Sulfur dioxide emissions, 20–21 Sumitomo, 217 Supplementarity, 35–36, 57, 169–70

defi ned, 35–36 European Union Emissions Trading



Cap-and-Trade Program, 169–70 Regional Greenhouse Gas Initiative, 87 Western Climate Initiative, 94

Sustainable Energy and Climate Change IDB Special Program (SECCI IDB Fund), 216

Sustainable Energy and Climate Change Initiative (SECCI), 216

Tailoring Rule, Environmental Protection Agency, 126–32

Best Available Control Technology, 126, 128, 129, 131–32

covered gases, 129 Prevention of Signifi cant Deterioration

Program, application of, 127–30 State Implementation Plans (SIPs), 132 Title V permitting applicability, 130–31

Technology Licensing Agreements, 210 Termination, 266 Texas. See also United States

Renewable Portfolio Standard in, 222–24 Texas Public Utility Commission, 224 Property Assessed Clean Energy

Program, 250 Th omas, Clarence, 109 Tianjin Property Rights Exchange, 63 Total Maximum Daily Loads (TMDL), 238 Trading allowances, 33, 56. See also

Allowances and off sets, 166 European Union Emissions Trading



Cap-and-Trade Program, 166 Regional Greenhouse Gas Initiative, 86 regulation of, 171 Western Climate Initiative, 92

INDEX | 311

Trading Emissions PLC, 217 Traditional pollutants, credits for, 225 Transportation and domestic fuel

government tax incentives for, 247 Tudor Investment Corp., 256

Umbrella Carbon Facility T1, 214 Umbrella Carbon Facility T2, 214 UN Clean Development Mechanism

Certifi ed Emissions Reductions, 257 UN Framework Convention on Climate

Change (UNFCCC), 21, 41–42, 50, 190 Conference of the Parties, 42 Cooperative Mechanisms Programme, 191

United Kingdom National Academy of Sciences, 8

United Nations (UN), 18, 21, 23, 216, 255 Conference on Environment and

Development, 41 Environment Program, 41 General Assembly of, 41 International Panel on Climate Change,

5–8, 12, 14, 184 United States, 69, 169. See also individual states

Agency for International Development, 157, 159, 160

American Association for the Advancement of Science, 14

American Meteorological Society, 14 cap and trade system in, 20–21 Chamber of Commerce, 13 Chesapeake Bay Nutrient Credit Exchange

Program, 238 Chicago Climate Exchange, 66, 71 Clean Water Act, 238 controversy over climate change, 12 cooperation and potential linkage among

multi-state programs, 96–98 Department of Agriculture, 145, 148, 150, 155 Department of State, 157, 159, 160 Environmental Protection Agency. See

Environmental Protection Agency, U.S. forest carbon projects, 203 Kyoto Protocol’s restriction on GHG

emissions, 22 Long Island Sound Nitrogen Credit

Exchange Program, 238 multi-state programs, 85–95 National Academy of

Sciences, 9, 11, 12, 15 National Research Council, 11, 15 Nitrogen Credit Advisory Board, 238 Proposed Regulation for a California

Cap-and-Trade Program, 74–84 Regional Greenhouse Gas Initiative, 85–88

Renewable Energy Credits in, 225 Renewable Portfolio Standard in, 222–24 state climate change programs, 74 Virginia Nutrient Credit Exchange

Association, 238 water quality trading, 237

Utility incentives, 251

Virginia Nutrient Credit Exchange Association, 238

Voluntary carbon credits, 182 Voluntary Carbon Standard (VCS), 66–68, 81,

190, 198–99, 204, 255 Agriculture, Forestry, and Other Land Use,

183–87 Double Approval Process, 67 Registry System, 68

Voluntary Carbon Standard Association (VCSA), 66, 67, 175, 177, 181, 182, 198

Voluntary Carbon Units (VCUs), 67, 68, 198, 255

Voluntary carbon markets, 64–70. See also Markets

carbon credits, source of demand for, 65 aft er compliance systems establishment,

survival of, 70 current state of, 70 exchanges, 66 registries, 68 standards, 64–65, 66–68

Voluntary standards, legal requirements for, 292

Warranties and carbon credits ownership, 264–65

Water credits carbon credit projects and, 238–39 increasing water demand and decreasing

water supply, 236 as tradable commodity, 236–37 water quality trading, 237–38 water quantity trading, 237

Waxman-Markey Bill, 27, 32 Welfare, defi ned, 102 Western Climate Initiative (WCI), 27, 75, 81,

88–95, 141, 281 additionality, 93–94 banking allowances, 92 borrowing allowances, 92 cap, the, 90–91 early action, 94 emission allowances, 91 emission allowances, allocation of, 91–92 enforcement, 95 goals of, 89

312 | INDEX

Western Climate Initiative (WCI) (Cont’d) greenhouse gases, permitting

emissions of, 91 new or expanded facilities, 95 off sets, 93 regulated gases, 90 regulated sources, 90 regulatory agency or agencies, 95 safety valve and international

competitiveness, 92–93 supplementarity, 94 trading allowances, 92

Wetlands credits and banking, 231–32 Will, United States v. , 112 n 52 Winrock International, 68 World Bank, 18, 72, 214

“State and Trends of the Carbon Market 2010”, 259–60

World Economic Forum, 66 World Meteorological Organization, 41 World Resources Institute, 237

Documents

Carbon Trading Law