The voluntary carbon market has been the breeding ground for offset project types welcomed into California’s regulated carbon market, which many say will face a shortage of offsets in its second phase. Market participants, including an official at one of the largest publicly-owned utilities in the United States, say it is critical for California regulators to quickly welcome even more voluntary project types. | Originally published on Ecosystem Marketplace
14 April 2014 | Offering its residential customers a chance to minimize the impact of their lifestyles and electricity usage on the environment has been the focus of the Sacramento Municipal Utility District’s (SMUD) Carbon Offset Program since it launched in 2007. Now SMUD, the public utility for Sacramento County and parts of nearby Placer County in California, is diving deeper into the carbon markets by helping to pay for the development of a new carbon offset project type that focuses on the restoration of wetlands in the state. SMUD is taking this step because the cap-and-trade program that it is regulated by enters its second phase in 2015, and many experts say its narrow palette of recognized offsets won’t meet projected demand starting in 2015 through the life of the program.
SMUD – one of the 10 largest publicly-owned utilities in the United States – allows its customers to lower their contributions to climate change with a $10 per month added charge on their bills. The charge has financed the purchase of carbon offsets from projects registered under the Climate Action Reserve (CAR), – an offset registry that supports projects to reduce greenhouse gas (GHG) emissions – including offsets generated by a dairy digester.
The utility joined forces last year with the American Carbon Registry (ACR), a different offset registry organization, and other partners on the development of a new method (or protocol) that would count the GHG emissions reductions created from projects that restore California deltaic and coastal wetlands and turn those into offsets for both the voluntary and eventually, they hope, for California’s regulated carbon market.
SMUD set out to identify voluntary offset protocols that are good candidates for acceptance by the California Air Resources Board (ARB), – the regulatory agency overseeing the state’s carbon market – that have potential to deliver GHG emissions reductions within California and that also deliver co-benefits – social, economic and environmental benefits beyond carbon reductions. The utility started out with a list of 12 project types and narrowed the list down to six after research and discussions with stakeholders, Obadiah Bartholomy, SMUD’s Senior Project Manager, told attendees at the Navigating the American Carbon World conference in San Francisco last month.
The list of offset project types that could be added to the state’s roster – which currently includes forestry, urban forestry, livestock and ozone-depleting substances protocols originally developed in the voluntary market – and would benefit from a demonstration project or further development includes avoided conversion of grasslands, nutrient management, rangelands soil carbon sequestration and enteric fermentation, he said. Rice cultivation, which the ARB could approve in September, was also on the list.
However, the protocol that caught SMUD’s attention was wetlands restoration, with the partners tailoring an ACR protocol already developed for the Mississippi Delta to suit California. The California version is still under development and has a long ways to go before producing offsets for the state’s regulated market, likely not until 2018, assuming California regulators adopt the protocol, he said. But the protocol has the potential to produce a significant amount of offsets – anywhere from seven to 26 million tonnes of avoided carbon emissions, according to ACR estimates – and has the attractive co-benefits that SMUD is actively looking to support.
“The others, other than rice, seemed a little farther out with even more barriers to expanding supply, not to say that we shouldn’t pursue them,” Bartholomy said. “We have to keep in mind that this is a very long-term endeavor that we’re embarking on.”
To date, the ARB has issued more than 7.5 million offsets, which should be plenty for the first phase of the program given that some organizations, particularly smaller entities, regulated by the cap-and-trade program have been slow to embrace offsets, market experts said.
SMUD, which is regulated by the cap-and-trade program because of its natural gas facilities and power imports, is one of the entities that have so far hesitated to make use of offsets to fulfill its compliance obligations, Bartholomy admitted.
“SMUD is one of those that’s kind of on the bubble,” he said. “I think we are going to make use of our 8%, but it takes some internal education and discussion and some willingness for us to bite the bullet.”
What the experts are concerned about is what they say is the likelihood that there will be a shortage of offsets in the middle and latter years of the program. California entities are allowed to meet up to 8% of their compliance obligations using offsets, meaning that the maximum demand during the second phase of the program in 2015-2017 is 91.8 million offsets. While many experts say the 8% maximum will never be exhausted, they are concerned that there will simply not be enough offsets generated under the four project types currently allowed in the program.
“My view is that the offset supply will be extremely short,” said Derek Six, CEO/CFO of offset project developer Environmental Credit Corp. “I think we’ll be short for a very long time.”
Consultancy Alpha Inception projects that total demand for offsets will only be about 50% of the possible maximum demand, meaning that the market should come out of the first compliance period with a pretty big surplus, but could be short in the second and third phases depending on what else happens in the market, said Founder and Manager Director Andre Templeman.
Another concern is that it takes time – usually several years – to get through the ARB’s rigorous evaluation process, the experts noted. In fact, the rice cultivation protocol, as well as one for coal mine methane projects, have been delayed several times as top regulators have sent their staff back to the drawing board for further examination and development.
“They are being extremely conservative and with good reason,” Templeman said. “They don’t want any holes to be opened up, especially in these early years of the program.”
California’s cap-and-trade program is currently scheduled to end in 2020, but there are discussions about how to meet the state’s 2030 target for reducing GHG emissions, with continuing the program –including the offsets component — being an option on the table.
“In those types of timeframes, expansion of supply through additional protocols is quite viable,” Bartholomy said.
California’s offset market has been plagued by a host of regulatory and legislative disruptions that have had the effect of restraining the development of offset projects, Templeman said. For example, a bill introduced into the California legislature last year by Senator Ricardo Lara sought to exclude all offsets outside of the state. The bill, which is likely to resurface this year, eventually was amended to focus its restrictions on international offsets because of arguments that California’s stringent environmental regulations would severely limit in-state offset development, he said.
“That’s the reality,” Templeman said. “If you took all of the out-of-state offsets out, you wouldn’t leave very many behind. That would be an interesting bill were it to pass because I think that would affect supply quite dramatically and in essence create a massive shortage.”
“That pressure is not going to go away,” he added. “There will be a bill at some point that will basically seek to say ‘we’re paying for it, we want some of the benefits to be local’.”
Another proposal not specific to the offset program would exempt the transportation sector that is scheduled to be phased into the cap-and-trade program in 2015 from its grasp by instead implementing a carbon tax on fuels. While the odds of the proposal making it into law are not strong, that bill if adopted would have a dramatic impact on the offset market because removing the transportation sector would have the effect of turning a market that is projected to be short into one that could be oversupplied by a factor of two, Templeman said. The mere proposal is problematic because “even if the bills themselves die, there are reasons these bills come up,” he said.
And then, of course, there are the so-called buyers’ liability provisions of California’s cap-and-trade program, which allows the ARB to invalidate offsets that the agency deems problematic and forces the buyers of these offsets to take responsibility for replacing them. The risk adds to the cost of buying offsets and makes them a less attractive option for smaller entities, Templeman said.
“You really have to be over a certain size before it really makes a lot of sense in today’s current market design,” he said, adding that he expects products to emerge during the second and third compliance periods that will address the invalidation risk for a cost.
Other concerns that have kept smaller entities out of the market, including the potential of getting stuck with offsets they did not need to purchase, should subside after the first few years of the program, Bartholomy said.
“I think that fear will recede as the market continues to demonstrate success,” he said.
Aside from adopting protocols from SMUD’s list of potential candidates, the ARB could also amend their rules to maximize the supply generated from the protocols already eligible. The costs of verifying the emissions reductions generated by livestock projects, for example, under current ARB rules are so high that they essentially exclude more than 95% of the dairies in the United States from participating in the program, Six said.
And the ARB could revisit voluntary offset protocols that it has previously rejected, such as pneumatic valves in the oil and gas sector, nitric acid production and organic waste digestion, in part because of the view that some of these activities are already regulated even if the specific emissions reductions associated with them do not fall under the carbon cap, Bartholomy said.
“Unfortunately, the logic behind that is still kind of murky,” he said. “I think we can hold out some hope that maybe if there is a shortage they may be willing to expand the offset supply.”
The Yurok Indian tribe became the first organization to cross the finish line in getting forestry compliance offsets approved by California’s cap-and-trade program. And the first issuance was a big one, with the tribe receiving 836,619 offset credits for an improved forest management project on tribal lands.
April 9, 2014 – The Yurok tribe has seen first-hand the devastation that deforestation wreaks on trees and plant and animal species living on its tribal lands. Now, with a big stamp of approval from California regulators, the tribe is hoping to tap into the carbon markets to help reverse these devastating trends.
The California Air Resources Board (ARB) on Wednesday announced that the Yurok Tribe/Forest Carbon Partners CKGG Improved Forest Management Project was the first to be issued offsets under its compliance forestry protocol. The improved forest management (IFM) project will guarantee long-term forest protection, improve forest habitat diversity, provide benefits to salmon and steelhead populations, and generate revenues for the Yurok Tribe. IFM projects are those in which existing forest areas are managed to increase carbon storage and/or to reduce carbon losses from harvesting or other silvicultural treatments.
“We have lost many of our old trees to deforestation, and numerous native plant and animal species, especially deer and elk, are struggling because of it,” said Thomas P. O’Rourke Sr., Chairman of the Yurok Tribe. “This forest carbon project enables the Tribe to help transition these acres back into a tribally managed natural forest system where wildlife and cultural resources like tanoak acorns, huckleberry, and hundreds of medicinal plants will thrive.”
The ARB’s compliance protocol was developed based on a version originally created by the Climate Action Reserve (CAR), which acted as the Offset Project Registry for the Yurok project, meaning the CAR pre-screened the project on behalf of the ARB. Forest projects that qualify under the cap-and-trade program must maintain or increase carbon in live trees for more than 100 years, a requirement that was originally established in CAR’s forestry protocol.
The Yurok project, which covers 8,000 acres of tribal land in Humboldt County, California, was issued 836,619 offsets by the ARB. By comparison, about 2.2 million forestry offsets have been issued by the ARB under the early action protocol – referring to offset projects initially developed under approved voluntary protocols that are transitioned to ARB offsets for use in the cap-and-trade program – since the first early action forestry offsets were issued in November 2013.
“The acceptance of this project into California’s carbon market will encourage other public and private owners of forest lands to develop offset projects,” said Linda Adams, former Secretary of the California Environmental Protection Agency and Chair of CAR’s Board of Directors
Regulated entities are limited to purchasing offsets for up to 8% of their compliance obligations under California’s cap-and-trade program.
“This project will offer California companies additional opportunities to find cost-effective ways of complying with the cap-and-trade program,” said ARB Chairman Mary Nichols. “It offers additional carbon reductions from a sector not covered by the cap-and-trade regulation, while providing financial resources to help the Yurok tribe restore its native lands and protect its watershed and habitat.”
Cosmetics giant Natura and a few other forward-thinking companies in Brazil have taken the leap into the voluntary carbon market to offset their greenhouse gas emissions, but the number and size of transactions is still small compared to the overall emissions reported by the country’s top companies. There is plenty of room for more voluntary transactions in Brazil, experts say, particularly if a finance mechanism currently being developed can sustain REDD initiatives until a new international climate agreement takes hold in 2020.
Brazilian company Natura caused quite a stir in the global carbon markets in 2013 when it engaged in a first-of-its-kind deal to purchase 120,000 tons of carbon offsets from a project developed by the Paiter-Suruí indigenous community in the Amazon under the Verified Carbon Standard’s Reduced Emissions from Deforestation and forest Degradation (REDD) methodology.
In 2007, the cosmetics giant launched its corporate carbon neutral program, which now supports 15 carbon offset projects in Brazil and one in Colombia, Mariama Vendramini told attendees of the Navigating the American Carbon World conference in San Francisco. Vendramini is the commercial and financial director for Biofilica, which provides environmental services and develops REDD offsets for Brazilian companies. She estimated the total number of offsets voluntarily purchased by the company at 1.5 million tonnes of carbon dioxide equivalent (MtCO2e).
It turns out that Natura is not alone in terms of Brazilian companies looking to voluntarily offset their greenhouse gas (GHG) emissions. In October 2013, Ticket Car launched a pilot program to allow its clients to manage and offset their vehicle emissions at about 1,500 tonnes of carbon dioxide equivalent (tCO2e) per year. Brazilian banking giant Santander also launched a pilot project to allow its clients who purchased cars to offset their emissions, with the pilot project leading to demand of about 70, 000 tCO2e in six months.
“We have those initiatives, we have a market, but we don’t have enough demand to meet the supply that we’re generating with REDD,” she said. “How do we scale it up? I think the solution is a compliance market or a compliance mechanism.”
In 2012, 130 companies in Brazil reported 360 MtCO2e in GHG emissions, according to the Brazilian Public Register. But only about 200,000 tonnes of offsets were voluntarily transacted in 2012, according to Forest Trends’ Ecosystem Marketplace’s State of the Voluntary Carbon Markets 2013 report.
“If you think of the inventories as the first step toward carbon management, we see there’s a lot of room for improvement,” Vendramini said. “All these companies that are reporting can take a step forward and go towards offsetting.”
Acre the Pioneer
The state of Acre, Brazil has earned plenty of attention and admiration for its work on environmental protection and sustainable development, efforts that have driven its monitoring and measuring work for REDD projects as well as its partnership with the US state of California, which could become the first compliance market to welcome REDD offsets.
In October 2010, Acre’s state legislature passed the System of Incentives for Environmental Services (SISA), which establishes incentives for a range of environmental services, including forest carbon, water resources, climate regulation, among others, according to an Environmental Defense Fund paper. The SISA explicitly created flexibility for harmonization and linkages with other systems of incentives for environmental services on a national, subnational or international level.
“Acre is one of the pioneers in South America and I think in the world to start an environmental services incentives policy,” said Alberto Tavares, Director and President of CDSA.
That same year, Acre signed a memorandum of understanding with the states of California and Chiapas, Mexico to work toward together to support forest conservation efforts, with an eye toward building a sector-based program that would allow REDD offsets to flow between the jurisdictions.
Acre will generate an estimated supply of about 118 MtCO2e emissions reductions between 2012 and 2020, assuming a linear reduction and that all emissions reductions are compensated for, according to an unpublished report produced by the International Institute for Sustainability, Brazil on behalf of the World Wildlife Fund and the Global Canopy Programme (GCP).
But here lies the challenge, according to a report called Stimulating Interim Demand for REDD+ Emissions Reductions: the Need for Strategic Intervention from 2015 to 2020 by the GCP, the Amazon Environmental Research Institute, Fauna & Flora International, and UNEP Finance Initiative. Even if California eventually gets to the point of accepting REDD offsets into its system, the entire potential demand for international REDD+ offsets from the US state program would only pay for about 68% of these emissions reductions, according to the report. If the Forest Carbon Partnership Facility Carbon Fund bought the rest of the offsets, it would also exhaust its entire funding just on purchasing emissions reductions from Acre, the report found.
A New Way to Pay
Brazil has a target of reducing its deforestation rate 80% below its average rate from 1996- 2005 through the end of the decade and had succeeded in slashing deforestation rates six years in a row before relapsing in 2013. But much of this work has been funded out-of-pocket, with the exception of some emission reductions funded by agreements with entities such as the government of Norway and German development bank KfW.
REDD proponents hope that mandatory emission reduction pledges will be implemented in 2020 under the United Nations Framework Convention on Climate Change, assuming international climate negotiators reach a deal in Paris next year, and that the agreement will include financial support for these projects. But such a mechanism does not currently exist, placing current REDD+ activities at risk if not properly financed, Vendramini said.
A proposed solution revolves around the use of public sector capital to increase demand for REDD+ emissions reductions by creating a facility – the Interim Forest Finance project – that can manage and deploy public sector capital for activities in countries such as Brazil, providing billions of US dollars for these projects.
Biofilica has been consulting on the Brazilian version of the facility, which would be capitalized by the Brazilian government and the funds redirected to finance REDD+ initiatives. Covered entities under compliance requirements would pay for emissions reductions at a fixed price indexed by inflation from 2020 on. As these corporations purchase the offsets, the government recovers its initial investment.
“By doing this, the government gets its return on investment, companies can get emissions reductions at a very competitive price from 2020 on and the REDD initiatives can continue existing,” Vendramini said. “We think this is a win-win-win situation where companies will win, government will win and the REDD initiatives also win.”