In general, people who don't understand the details of the carbon markets attack carbon offsets in two areas.
First, questioning whether the credits are for a project that would have occurred anyway — a concept known in carbon as "additionality" — and second, questioning whether there are checks and balances to ensure the environmental standards are adhered to and the abatement actually happens — known as the validation and verification processes.
The frustrating part for anyone in the industry is that the entire of the carbon credit process set up under Kyoto is all about ensuring the answers to those two questions. Leading certification firms and carbon project developers have been dealing with the details behind those questions for years.
The biggest weakness of the carbon offset process to date has been that the high level of oversight and protection, while working, has led to higher costs and fewer projects getting done, rather than too many.
Bottom line, the carbon markets are working, and are pouring billions of dollars into fighting global warming, just like the NOx and SOx trading markets helped reduce air pollution faster and cheaper than anyone expected. Now it's time to figure out how to make them really scale.
In an interview, Marc Stuart tells us about the real story in carbon offsets. What matters, what doesn't, what works, and what still needs to be tweaked.
Marc Stuart - not Murray, mgr. of Flight Of The Conchords
Stuart should know, he's one of the founders of Dublin-based EcoSecurities (AIM: ECO), one of the first, and still the leader, in generating and monetizing carbon credits.
Even for those who don't know much about carbon offsets, many people have heard about the concept of additionality, and almost everyone intuitively understands it at some level. But it is devilishly complicated in practice. Can you explain additionality and give us some insight into the details?
Additionality is the core concept of the project-based emissions market. In a nutshell, it means that a developer cannot receive credits for a project that represents "business as usual" practices.
A classic and often cited example is that industrial forest companies should not be able to get credits simply for replanting the trees that they harvest from their plantations each year, since that is already part of their business model.
A utility changing out a 30 year old, fully depreciated turbine would not be able to claim the efficiency benefits, though a utility that swapped out something only five years old might be able to under certain circumstances.
Additionality is easy to definitively prove in cases where there is zero normal economic reason to make an investment, such as reducing HFC-23 from the refrigeration plants or N2O from fertilizer plants.
Such projects easily pass a "financial additionality" test, since it's clear that as a cost without a benefit, they wouldn’t have been economically feasible under a business as usual scenario.
It gets far more complex though with assets that contribute to both normal economic outputs and the development of carbon credits, in particular in renewables and energy efficiency. Sometimes these projects are profitable without carbon finance, but there may be other barriers preventing their execution that make them additional.
The U.N. has developed a very structured and rigorous process that projects must undergo to prove additionality. It is essentially a regulatory process with multiple levels of oversight, in which a body called the Executive Board to the U.N.'s Clean Development Mechanism ultimately makes a binary decision about whether a project is eligible to participate or not.
(The Clean Development Mechanism, or CDM, is the international system for creating carbon offsets called Certified Emission Reduction credits, or CERs.)
Anchored in the middle of that oversight is an audit process run by independent, licensed auditors, the largest of which is actually a multi-national nonprofit called Det Norske Veritas. However, many projects don’t even make it to that decision point before they are dropped in the process.
One of the benefits of carbon offsets often touted by those who support them is the idea that they provide compliance flexibility and liquidity in the early years of a compliance cap and trade system. What are your thoughts on how that works?
The simple reality is that many assets that emit carbon have long lifetimes and that legitimate investment decisions have been taken in the past that rightfully did not take into account the negative impact of carbon emissions.
For an easy example, think about somebody who is a couple of years into a six-year auto loan on a gas guzzler — can policy just force that person to immediately switch to a hybrid, especially since the used car market for his guzzler has now completely disappeared?
Even if society says yes, how long would it take for the auto industry to ramp up its production of hybrids? Now look at infrastructure — for example, most power plants and heavy industry facilities have lifetimes of thirty years plus.
Even if we were economically and politically able to affect a radical changeover, simply put, the physical capacity for building out new technology is limited, even in a highly accelerated scenario. So, like it or not, GHG emissions from the industrial world are going to take quite a while to stabilize and reduce.
The point of offsets is that, in fairly carbon efficient places like California or Japan, availability of low cost reductions within a cap and trade system is quite limited, meaning there is an incentive to look beyond the cap for other, credible, quantifiable, emissions reductions.
Reductions in GHGs that are uncapped, either by sector, activity, or geography, such as are found in the CDM, are thus a logical way to achieve real GHG reductions and accelerate dissemination of low carbon technologies.
In effect, the past helps subsidize changeover to the future as buyers of emission rights subsidize other, cheaper, GHG mitigation activities. As caps get more restrictive over time, capital changeover occurs. Offsets allow this to occur in an orderly and cost-effective manner.
There have been a number of studies questioning whether offsets are just "hot air" and whether carbon offset projects actually achieve real emission reductions. What is your response to these accusations?
As noted in the first question, the CDM in particular is a market that is completely regulated by an international body of experts supported by extensive bureaucracy to ensure that real emission reductions and sustainable development are occurring.
The first and foremost requirement of that body is to rule on whether each individual project is additional. Each project is reviewed by a qualified Operational Entity, the Executive Board Registration and Issuance Team, the United Nations Framework Convention on Climate Change CDM Secretariat and the CDM Executive Board itself.
Plus, there are multiple occasions for external observers to make specific comments, which are given significant weight. So, while there is always the chance something could get through, there are a lot of checks and balances in the system to prevent that.
That said, determining an individual emission baseline for a project — the metric against which emission reductions are measured — is a challenging process. The system adjusts to those challenges by trying to be as conservative as possible.
In other words, I would argue that in most CDM projects, there are fewer emission reductions being credited than are actually occurring. It is impossible for a hypothetical baseline to be absolutely exact, but it is eminently possible to be conservative.
Is it inconceivable that the opposite occasionally occurs and that more emission reductions are credited to a project than are real? We've never seen it in the more than 117 projects we've registered with the CDM, but I suppose it's possible.
What about the voluntary carbon market in the U.S., where there have been accusations that many projects would have happened anyway? How is this voluntary market different from what EcoSecurities does under the Clean Development Mechanism?
The voluntary market has had more of a "wild west" reputation compared to the compliance market. In some ways, that is deserved, but in some ways it is unfair.
For a number of years, the voluntary market was the only outlet for project developers in places like the United States and in sectors like avoided deforestation that were not recognized by the CDM. However, because there were virtually no barriers to entry and no functional regulation other than what providers would voluntarily undertake, it was difficult for consumers and companies to differentiate between legitimate providers and charlatans.
For EcoSecurities, while the voluntary market has been a very small part of our overall efforts, we always qualified projects according to vetted additionality standards such as the CDM and the California Climate Action Registry, and always used independent accredited auditors.
With the emergence of stand-alone systems like the Voluntary Carbon Standard (Stuart sits on the board of the VCS), and the growing demand for offsets from the corporate sector, I believe the "wild west" frontier is drawing to a close.
It is also important to note that while the voluntary market has recorded very explosive growth, it is still a very small fraction of the regulatory market, comprising a few tens of millions of dollars of transactions, versus the potential tens of billions of dollars of value embedded in the highly regulated and supervised CDM.
The fact that many observers still equate the occasional problems in the fringes of the voluntary market, which are increasingly history, with the real benefits being created in the Kyoto compliance market is a misperception we'd like to correct.
What about these projects we've heard about in China, where the sale of carbon credits generated from HFC-23 capture is far more valuable than production of the refrigerant gas that leads to its creation in the first place? How is this being addressed in the CDM and how can future systems ensure that there are not perverse incentives created like this?
HFC-23 projects are the epitome of what is often referred to as "low hanging fruit." In this case, most of the fruit might have actually been sitting on the ground.
While there is no doubt in anybody's mind that the market drove the mitigation of HFC-23 globally, the extreme disparity between the costs of reducing those gases and the market value those reductions commanded invariably led to questions whether there were more socially efficient ways to have reduced those emissions. In all likelihood, there were.
But to catalyze an overall market like this, it is probably important to get some easy wins at the outset to create broader investment interest and this certainly accomplished that. Moreover, Kyoto created a mechanism for engaging these kinds of activities.
It would have sent a much worse signal to the market to have changed the rules in the middle of the game. The CDM has subsequently adjusted the rules to make sure that no one can put new factories in place simply for the purposes of mitigating their emissions.
I don't see too many other situations like HFCs in the future, simply because there are no other gases where the disparity of mitigation costs and market value is so severe.