Carbon Credits and the State of Play of North American Carbon

Introduction

Global trade in carbon is a growing business. According to the World Bank, international carbon sales quadrupled in 2006 to over $25B USD¹. In North America, a patchwork quilt of voluntary and regulated carbon markets is emerging, causing a lot of confusion for buyers and sellers as to ‘what counts’ in these developing markets. Several companies in Alberta, called aggregators, are aggressively pursuing contracts with farmers and ranchers to secure carbon credits for sale into these markets. This Primer is designed to clarify the state of markets in Alberta, Canada and abroad.

The National Scene

In Canada, there’s been a lot of signalling but limited concrete action towards establishing a country-wide compliance-based carbon market (also known as Carbon Offset market). Without clearly established rules that (a) set targets for companies to reduce their GHG emissions – establishing a demand for carbon; and (b) set standards for the supply side (i.e. what counts and how many tonnes of carbon can be reduced from an activity), most sales tend to be speculative and occur at the margins. With federal politics being what they are, we can’t be sure when a national Offset System will be in place.

Carbon Offset	A reduction in GHG emissions from a PROJECT that features a new management practice, technology and/or control system, often referred to as "carbon credits"
Offset System	Provides a framework to allow a market for the supply and demand of project-based carbon offsets to be created, bought and sold

The Provincial Scene

At the Provincial level – at least 5 provinces have signalled their intentions to move forward with regulatory frameworks for Greenhouse Gases. In the lead is the province of Alberta, with Greenhouse Gas regulations set to be in place by July 1, 2007. Alberta rules will allow regulated companies to purchase offsets created only in Alberta to meet their targets, enabling a compliance-based carbon offset market in this province. The intent is to keep investment in Carbon Offset projects within the province, creating more benefits for Albertans from improved stewardship of our resources. More on the Alberta Carbon market later.

The North American Situation

In the US, a similar situation is arising. There are a number of smaller, regional markets developing, without any clear national system to knit them together. One of these markets is a voluntary-based market (Chicago Climate Exchange or CCX) which has a set of rules that are flexible to encourage participation by a wide variety of projects. Aggregators for the CCX are active in the prairie provinces and given the different set of rules required by this voluntary market – confusion reigns. Figure 1 shows the state of Carbon markets in North America and the world.

Figure 1. Status of the Global Carbon Market ²


A ‘Head’s Up for Buyers and Sellers in Alberta

Just like in any other market, buyers and sellers need to have a bit of ‘market intelligence’ to understand what the market will support, and whether it’s worthwhile to engage in market activity at this time. And, since these markets tend to be created and defined around an intangible environmental commodity – something relatively recent in North America – confidence in the ‘currency or commodity’ along with transparency and price discovery are underdeveloped. Making business decisions as to which market, when and the extent of engagement can be exceedingly difficult. Producers must weigh the risk of participating in these initiatives now, where opportunities exist, versus waiting to see how opportunities unfold in the very near future.

Compliance vs. Voluntary-Based Markets

Rules and requirements differ depending on whether a market is compliance-based (GHG regulated) or voluntary, (usually involving a group of firms who take on voluntary commitments to reduce GHGs). In a regulatory context, the government typically provides some structure to the market – setting the targets (demand) and providing standards to ensure offset credits meet compliance quality (they’re real, measurable and quantifiable and incremental(supply)). In this context, the regulated companies want to be sure what they are buying will meet their compliance obligations set out by governments. And, if a country has signed on to Kyoto, governments need to consider how these domestic compliance credits will mesh with our international obligations for Greenhouse Gas reduction³ .

Table 1. Common Characteristics of Voluntary and Compliance-Based Markets

Characteristics	Voluntary-Based	Compliance-Based
Demand	Set by interested trading firms for a variety of reasons: - Corporate social responsibility - Public relations - Learning about markets - Carbon Neutral Objectives	Set by Government regulations through compliance targets
Price	Relatively lower due to voluntary demand, thin markets and confidence of the market	Relatively higher; demand is mandatory; high standards/confidence in credits
Rules for Credit Supply	Decided by trading firms; science review/scrutiny may be limited	Overseen by Government to fit compliance criteria for regulations; strong, consensus science base to ensure integrity of the system.
Transaction Costs	Tend to be lower; emphasis on learning.	Higher; can be minimized by supply standards and government policy
Aggregation	Still needed to minimize risk and reduce transaction costs	Still needed to minimize risk and reduce transaction costs
Verification	May be 3rd party	Essential to have 3rd party audits
Practice Change	May or may not be required	Essential to have baseline and practice change to satisfy additionality criteria
System Integrity	Emphasis on learning; getting started; more flexible in rules	Emphasis on compliance; considers international rules/targets
Liability	Addressed through bilateral contracts	Rules in place; government policies will dictate how reversible carbon (soil and forestry sinks) need to be managed

At least 5 markets currently exist or are under development in North America, and the Chicago Climate Exchange is the only market at this stage that will accept outside credits:

California Climate Change Action Registry - has very recently signed legislation that requires the reduction of GHG emissions by law; Offset market being formed – supply standards being developed. Now includes over 10 Western and Mid Western States.

Performance-Based Electricity Standards - Seattle (voluntary) and Oregon (compliance-based).

Regional Greenhouse Gas Initiative (RGGI) – a compliance-based market involving a coalition of 10-US Northeast and mid-Atlantic states to tackle and reduce CO2-emissions created in the region. Still under development.

Chicago Climate Exchange - a voluntary emissions trading floor where companies who are seeking to learn about the market and/or reduce their long-term risk in a carbon constrained future, can get a head start on emissions reductions.

Alberta Carbon Offset Market – the first province to bring in Regulations in Canada; the rules for the market are:

• Projects must start after January 1, 2002 (credits can be claimed back to 2002 onwards);
• Reductions must be real, demonstrable, quantifiable (using accepted science), and verified by a qualified third party;
• Reductions must have clearly established ownership (e.g. do they belong to the seller or the firm that provided the new technology?);
• From an action not otherwise required by law
• From an action undertaken in Alberta
• Reductions can only be counted once for compliance purposes;

1. Demonstrate best available science has been used to quantify the tonnes of GHGs reduced by a practice change or new technology (fits the ‘real’ and quantifiable rules for the market);
2. Ensure the project is eligible under the particular market - guidance or market standards are typically issued by the government or program administrator;
3. Implement the project by changing practices or installing the technology; data and information management are key for reporting activity and enabling verification;
4. Verify GHG reductions achieved by the project – usually requires hiring third party auditors to give buyers confidence in the stated reductions;
5. Certify amount of carbon offsets in the form of a credit (or compliance unit) - in a compliance-based market the government typically needs to be involved to provide assurance to the buyers;
6. Deliver GHG offset credits for sale on the carbon market.

• How will I know what activities or technologies count when thinking about a contract for carbon credits?
• How do I know how many tonnes of emission reductions (or in the case of soil sinks – removals) can be created these changes in practice or technology?
• Where do I find the ‘best available science’ for quantifying these offsets?
• If I was reduced tilling before 2002, or have trees on my farm already, will I have anything to sell?
• How long do I have to maintain the practice or technology in order to gain credit?
• Where do I find these qualified third party auditors and how much do they cost? How often will they come to my farm to check out what I’m doing?
• What kinds of records and data do I have to keep and in what format?
• What happens if I have to till to control weeds, or what happens if my woodlot burns down, and I’m under contract?
• Will I require a legal easement on my property if I enter into contract?
• What’s the current price for a tonne of carbon?
• Where do I go to find out more information?

• Pork operations
• Beef operations
• Composting
• Soil Management
• Biofuels
• Biogas (anaerobic digestion)
• Biomass combustion
• Energy efficiency
• Waste heat recovery
• As well as others for other sector’s activities as well

• CCX Forest Carbon Emissions Offsets
• CCX Agricultural Soil Carbon Offsets
• CCX Agricultural Methane Emissions Offsets
• CCX Landfill Methane Emission Offsets
• CCX Renewable Energy Emission Offsets

• Past Crediting Period – for the 2003-2006 time period, the tonnes were retroactively based, required no practice change and the years involved were definitely ‘out of play’ for any system in Canada. Virtually no risk was involved for contracting. This period is now closed to new contracts.
• Current Crediting Period – for 2006-2010, this involves future actions and carries more risk. Penalties for breaking the contract will need to be assessed against potential value received.. Producers who sign up will be excluded from selling credits for the same activities into the Alberta market (contract stipulates a producer can’t enter into any other agreements once CCX signs the deal).
• Farm gate value of CCX deals – current trading price of offsets on the CCX is low (approximately $3 to 4 US per tonne), due to the voluntary nature of the market. By all reports, given the coefficients being used in the CCX projects, and accounting for secondary marketers involved in the deal, producers are reportedly expected to receive between $0.50 to $1.00 per acre/year or $3/tonne of CO2e over the contracting period (for soil sink projects). These estimates are dependent on the selling price of Carbon in the CCX market.
• Canadian Buyers are sceptical – companies who expect to be regulated in Canada, and understand the policy around project-based offsets are wary of CCX credits because of the more lenient requirements.
• Lack of Transparency – on several occasions, Canadian policy-makers have requested to see the standardized guidelines for project-based credit generation used by the CCX. The CCX administration has not provided these materials to date. This lack of transparency has given rise to scepticism by other developing compliance-based markets and acceptance of CCX credits in their systems.

1. With the kinds of carbon markets Canada/Alberta is considering, the value of the offsets will likely be higher; Alberta rules will allow regulated companies to pay $15/tonne of carbon into a Fund and receive regulatory relief. This effectively becomes the ceiling price in the Alberta market.
2. Producers who sign on for the second crediting period (2006-2010) may be forfeiting the opportunity for a higher rate of return here in Alberta.
3. In addition, the federal government has stated in its Notice of Intent to Regulate, that credit for early action may be considered - this opens up more opportunity for producers in Canada.