The United States’ resistance to ratify the Kyoto Protocol and the introduction of state and regional regulations rather than national carbon market have limited US activity in the global carbon market. However, the development of a voluntary carbon market in the US has occurred to compensate for the lack of a national, regulated carbon market. The US has been driving the global voluntary carbon market supplying the majority of voluntary carbon credits and providing the largest source of demand (Ecosystem market place, May 2009). Though the US voluntary carbon market has grown substantially to reach a transaction level of nearly 84 million tons in 2008, it accounted for only 3% of the transaction volume of EU Emissions Trading Scheme (EU ETS). In addition to the voluntary carbon market, a development of voluntary market for renewable energy as well as energy saving projects, indirectly supporting carbon emissions reduction, has taken place in the United States. While small on a global scale, these voluntary efforts have had a positive effect on carbon reduction and policy change in the United States.

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California’s Green Building Regulations, take effect on  July 1, 2009. The Green Building Regulations require a 15% reduction in overall energy use, which is equivalent to achieving the LEED® silver rating for new construction, below gold and platinum standards. The Green Building Regulations only set a floor, not a ceiling, and do not prevent municipalities, such as cities and counties, from enacting more stringent standards than the state or in my opinion would not prevent allowing more aggressive offsets to be undertaken within a U.S. Cap and Trade system. This would give financial incentives in the form of carbon credits for larger reductions than the baseline Green Building Regulations as the cost increases with greater reductions, the first reductions are often the easy things to do like changing light bulbs.

Aris Evia, LEED® AP and David Heckadon, LEED® AP of Gordon and Rees based in San Francisco are very active in the Advocacy for Green Buildings

The State of California Building Standards Commission (”Commission”) adopted the California Green Building Standards Code (”Green Building Regulations“) to apply to all new construction statewide. Prior to California’s adoption of its Green Building Regulations, the standard for green and sustainable buildings in California and across the nation was and is still set by the U.S. Green Building Council (”USGBC”) through its Leadership in Energy & Environmental Design (”LEED®”) levels of building certification. According to the USGBC, buildings nationwide account for 70% of electricity consumption, 39% of energy usage, 12% of potable water consumption, 40% of raw materials usage, 30% of waste output and produce 39% of associated greenhouse gases (”GHGs”) like chlorofluorocarbons (”CFCs”), hydrochlorofluorocarbons (”HCFCs”), and carbon dioxide (”CO2″).

The LEED® standards for rating new construction, existing buildings and commercial interiors are, from highest to lowest: platinum, gold, silver and certified. The LEED® rating system is based on the achievement of a certain number of credits, or points, towards LEED® certification: the higher the points, the more prestigious the rating. California’s Green Building Regulations are the approximate equivalent of achieving LEED® silver rating for new construction. The LEED® ratings will still remain the most applicable standard for nationwide market transformation in construction of both office buildings and homes, because they encourage and accelerate global adoption of sustainable green building and development practices through the creation and implementation of universally understood and accepted tools and performance criteria. However, California’s Green Building Regulations are just another example of California leading the charge on green and sustainable construction.

California’s Green Building Regulations are an important piece of the state’s ambitious goal to reduce the state’s CFCs, HCFCs, CO2 and other GHG emissions by 30% by 2020 as required by Assembly Bill (”AB”) 32, Chapter 488, Statutes of 2006, authored by then Assembly Speaker Fabian Nuñez (D - Los Angeles). Last October 2007, Governor Arnold Schwarzenegger vetoed AB 1058, authored by Assembly Members John Laird (D - Santa Cruz / Monterey) and Ted Lieu (D - El Segundo), which would have established green building construction best practices and made them an official statutory part of the California Public Resources Code.

The Governor’s veto message to the Legislature stated that he supports green construction standards and shares the goals of AB 1058, but believes that building standards should not be in the state’s statutes, but instead set by the Commission, presumably because the Governor desires a more phased approach to green building regulation and to inject more public participation into the lawmaking process.

California’s Green Building Regulations, which are 60 pages long, do not take effect until July 1, 2009. These standards will remain voluntary until the Commission completes its work on mandatory regulations which it hopes to have in place by late 2010 and early 2011. The highlights of the Green Building Regulations are set forth in the following goals:

• 15% reduction in overall energy use for all new construction by employing such strategies as solar energy, Energy Star-certified appliances, highly-reflective roofs, and elevators and escalators that move only when passengers are present;
• 20% reduction in water use for all new construction through low-flow toilets, waterless urinals and dual plumbing for potable and graywater;
• 50% reduction in water use for landscaping by utilizing such approaches as native plants, drip irrigation systems, and bioswales; and
• Use of environmentally sensitive materials like eco-friendly flooring, carpeting, paint, coatings, thermal insulation, acoustical wall and ceiling panels, and other recycled building materials.

The Green Building Regulations also identify various site improvements, i.e., parking for hybrid vehicles and improved and comprehensive storm water plans. Importantly, the Green Building Regulations do not specify how to make the reductions, but instead, suggest a variety of green and sustainable construction practices. In practice, a LEED® Accredited Professional (”AP”) may be in the best position to advise construction companies as to green and sustainable construction practices, because a LEED® AP has demonstrated a thorough understanding of green building practices and principles and is a building professional with the knowledge and skills to successfully steward the LEED® certification process.

The Green Building Regulations only set a floor, not a ceiling, and do not prevent municipalities, such as cities and counties, from enacting more stringent standards than the state. For example, San Francisco’s recent Green Building Ordinance is the approximate equivalent of achieving LEED® gold certification. Also, in April 2008, the City of Los Angeles became the largest U.S. city to enact mandatory green building standards for private development. The City of Los Angeles’ mandatory green building standards program applies generally to new development and remodels of non-residential development over 50,000 square feet, or 50 residential units, and requires compliance with the criteria for a LEED® Certified rating.

The most common argument against green and sustainable building practices are the upfront costs of implementing such measures and using such materials. However, supporters of green building respond that although a building may cost more to build on the front end, the sustainable building will perform better, i.e., consume less energy, be more water-use efficient, etc., thus leading to a greater return on investment (”ROI”) and a higher net operating income (”NOI”) associated with the building.

Another major issue with green building initiatives is that they inject yet another layer of risk into construction projects, and raise new issues for developers, builders, and design professionals. Perhaps the most obvious and immediate issue is whether California’s Green Building Regulations will elevate the standard of care for an architect or an engineer. A corollary of this issue is whether developers, builders and design professionals will expose themselves to more risk when they promise to deliver high-performance green buildings. From a contractual point of view, developers, builders and design professionals are now faced with the issue of whether to include and incorporate language into their contracts to require them to design and construct a sustainable building. Indeed, although green and sustainable building practices are an easy rallying point and have made important strides in recent times, the green building movement has raised the stakes and created new and still developing issues that the construction and real estate industries must now face.

The Carbon markets are continuing their rapid rise in the face of the economic meltdown. Initiatives are taking place throughout the US that will have far-reaching and beneficial effects on arresting the development of human induced Climate Change.from regional initiatives to voluntary standards.

However, does it matter that these standards vary, baselines differ and the sectors that are covered vary also. Or is it, just the way market formation occurs in the US, starting with different state-based activities, which over time will merge into a US-wide compliance market. Additionally, how will these US regional carbon schemes link into the global Accord the Kyoto Protocol? Or Won’t they?

Where do voluntary schemes fit in? Do they fall by the way-side, No, not if an 800 strong on-line webinar hosted by APX, Carbon Finance and Eco-System Marketplace that took place this morning is anything to go by.  This webinar was absolutely fascinating describing the various Voluntary markets. Go to APX site for download.

Voluntary markets are driven by the demand by large Corporations going ‘carbon neutral’. Corporations unable to reduce emissions sufficiently internally but nonetheless want to be good corporate citizens buy offsets of C02e emissions to balance their emission books from all kinds of projects, the most popular being energy efficiency and methane projects.

Examples of voluntray standards include the Gold Standard, Voluntary Carbon Standard, CCB Standard , a forestry standard and other standards under development include urban forestry and agriculture. Voluntray standards have in common some kind of broader benefits beyond reducing carbon that makes them appealing.

However, let’s return to the recently passed bill, the Western Climate Initiative 23^rd September 2008 in Sacramento, California, where, “Seven Western states and four Canadian provinces proposed a comprehensive program to cut greenhouse gas emissions from power plants, manufacturers and vehicles. The plan is aimed at cutting the region’s carbon emissions below 2005 levels by 2020″.

The Western Climate Initiative has a base year of 2005 below, which emissions have to be reduced. This is a different base year to the Kyoto Protocol countries, which have a base year of 1990. Under the Kyoto Protocol developed nations except the USA have to reduce emissions on average by 5% on 1990 levels. Does it matter that the base year is different in the Western Climate Initiative?

After the US elections in November the relationship between state-based US Climate Bills and the Kyoto Protocol, the global accord will be looked at, whether it is John McCain or Barack Obama, as both are committed to Climate Change legislative Initiatives. No doubt, seeing this the Europeans will want to talk to the US about harmony - harmonisation on many things will be on the agenda I suspect. How will the US link into the global accord?

Do baselines matter? May be or maybe not. Or is this just a negotiating point.

The Western Climate Initiative is hailed by Arnold Schwarzenegger as much broader than the Regional Gas Initiative (RGGI) discussed on this blog by David Poloncartz, launched recently by 10 Northeast states of the US. RGGI has a narrow focus of sectors capping emissions from power plants mostly. (rggi.com). The Western Climate Initiative according to Mr Schwarzenegger has boldly stated we are much broader in the number of sectors we cover.

Is it about politics, Gov. Arnold Schwarzenegger said in a statement,. “We’re sending a strong message to our federal governments that states and provinces are moving forward in the absence of federal action, and we’re setting the stage for national programs that are just as aggressive.”

Does the Western Climate Initiative headed by California believe that it’s program for action, will become the blueprint for the rest of the USA. To be fair the initiative is similar to other global initiatives in so far as the basic idea, “is to allow industries that emit greenhouse gases to buy and sell credits for their emissions. Businesses that cannot cut their emissions enough can buy the right to pollute from cleaner companies”.

Supporters say the program will combat global warming, spur green technologies, clean up the region’s energy supplies and reduce dependence on foreign oil.

The start date for the Western Climate Initiative is also interesting - Jan 1^st 2012, far enough out to for the detail and changes to be made post the U.S. election. Interestingly, the start date for the Australian Emissions Trading Scheme was initially set for 2010 but 2012 is looking more likely. This happens to be the same year as the end of the 1^st commitment period of the Kyoto Protocol.

Next year in Copenhagen the Conference of the Parties of the Kyoto Protocol will meet and hopefully the US will attend formally, to decide the program for the next commitment period for the targets for the Kyoto Protocol from 2012-2017.

So maybe different kinds of Climate plans are enacted but sit on the shelf waiting to be implemented until after we see what happens globally at the end of  2009 in Copenhagen for the next period.

Interestingly, in the wake of the financial melt-down, the US will probably have to be in many ways more cooperative than unilateral as all these issues dovetail into each other at the global level, climate change, energy independence, and terrorism. One tends to have to be more cooperative when financially strapped. Unilateralism only works when you are flush with cash - cooperation works when times are tough.

My next blog concerns the fascinating potential for the about face on CDM, the US could make in its own best interest.

EcoSecurities Report on Carbon Offsetting Trends Survey 2008

EcoSecurities and Climatebiz released a  report titled: Carbon Offsetting Trends Survey 2008. The report concerns the trends in the Voluntary Carbon Market. The data was collected from 65 large and multinational organizations. The responses were collected via an online questionnaire posted on www.greenbiz.com, www.climatebiz.com, www.cleantech.org, www.ecosecurities.com, www.2degreesnetwork.com between the 23rd July 2008 and 22nd August 2008. In addition, EcoSecurities also directly emailed more than 300 contacts from their own in house database in order to ensure the response sample was geographically and sectorially diverse.

The report paints a bright future for the Voluntary market in the US and North America particularly, which is growing and developing in response to companies indicating they will become carbon neutral. EcoSecurities is one of the largest and leading organizations in the business of sourcing, developing and trading emissions reductions or carbon credits. Their portfolio covers Voluntary markets such as the Gold Standard and Voluntary Carbon Standard (VCS) and in the Kyoto compliance markets the Clean Development Mechanism or (CDM) credits.

According to the report, “88% of responding companies are either offsetting/looking to offset or would consider offsetting in the future. In contrast, only 4% of the sample surveyed would never offset. If 74% have already implemented internal emission reduction activities, the fact that 56% of companies already offset or will consider offsetting in the next 1-2 years suggests that offsetting is valued as a complementary part of an organization’s overall carbon management strategy…Companies are planning ahead with regards to their offsetting, which is a good  thing. 25% of companies are planning to offset in the next 1-2 years“.

The Survey’s respondents showed that, “the most important and effective emissions reduction activity was energy efficiency at 33.9% compared to only 8.7 % of respondents indicating interest in renewable energy. Another interesting finding is that, “the most desirable location for emission reduction projects is in North America. It seems that US buyers desire most to purchase offsets from domestic projects. The least preferable ‘not preferable’ ratings were Australasia, the Middle East and Western Europe”.

Dr Jan Hamrin, from the Environmental Tracking Network of North America commented at a private luncheon hosted by Neal Dikeman, CEO of Carbonflow in San Francisco in September 08, “that adding renewable energy to the utility grid still faced decade old challenges with the lack of investment in infrastructure for transmission lines out to renewable power suppliers“. This remark seems to be in common with the Ecosecurities report findings that perhaps, utilities did not provide or were slow to respond in a number of ways including:  ”the lack of choice of competitive renewable tariffs from electricity suppliers”, which would encourage renewable energy uptake.

The report emphasized the importance of energy efficiency and the use of offsetting under the Voluntary Carbon market as a very powerful tool for companies to use in addition to work on absolute internal emission reductions and carbon footprint analysis.

However, there are issues with the on-going use of energy efficiency in the future in California, which concern how these Voluntary Energy Efficiency Credits would work with the new CA Cap and Trade system.

The future use of energy efficiency credits in the Voluntary market under a proposed California, Cap and Trade system requires that regulators understand the issue of how to deal with ‘double counting’ on the one hand and how to manage the issue of ‘verification’ on the other.

The issue of “double counting” has been best addressed in a Linked-In discussion by Cleantech.org called, “Discussion on energy efficiency carbon credits in the California Cap and Trade”, Simon Dawes of Carbonflow has commented that concerns about double counting on energy efficiency credits under a Cap and Trade system in CA can be worked through.

He states that, “Double counting is clearly the issue that drives concern over this process. In essence, if an energy efficiency program receives credits under a cap and trade system (when it is within the cap) and no other action is taken then double counting can happen. The energy provider sees a reduction in attributable emissions and the end user gets a credit to sell to someone else.

However, depending on the design of the system this effect can be readily prevented. Essentially, if the issue of an energy efficiency credit is matched by the cancellation of an emission permit or a reduction in the cap then double counting will not occur.

An alternate process could include the requirement that all energy efficiency credits are acquired and retired within the sector where they are created. The cancellation process is adopted for international trade in JI credits (one sending country reduces its cap and the receiving country increases its cap) and with the Voluntary Carbon Standard where a Volintary Emission Reduction originating from within a capped sector of an economy has to be matched with the cancellation of a regulated compliance instrument. Exactly how energy efficiency projects can be included depends on the design of the cap and trade scheme. Critical issues are banking and borrowing of permits, the balance of free allocation and auction of permits, and how the cap is managed over time. In any case, there are measures whcih can be taken to allow energy efficiency proejcts to operate within a capped sector without double counting”.

Simon Dawes, was an auditor with DNV for over 12 years, specializing in auditing of the emerging carbon markets before joining Carbonflow.

Dr Hamrin, in May 24^th 2007, in a report, “The Potential for Energy Savings Certificates (ESC) as a Major Tool in Greenhouse Gas Reduction Programs”, indicates support for this view where she says that, “Energy efficiency savings that meet additionality standards and have not been claimed elsewhere could be sold/traded in the voluntary GHG emissions market”.

The second issue is a practical one concerning verification. Both the EcoSecurities and the Hamrin report commented on the time and cost of the verification of micro-generation of energy efficiency credits from project activities for the VCS market.

Dr Hamrin’s, report elaborated this issue as follows, “Some of the major barriers to utilizing energy savings was the instituting of a rigorous system of energy savings evaluation, measurement and verification (EM&V) as it introduces additional costs, while at the same time, there are also benefits associated with greater certainty of the energy savings results that give these programs greater credibility”.

Neal Dikeman CEO, of Carbonflow has been aware of this problem for some time and has successfully set up a company, which in part will address the issue of verification of micro-credits. He has said that the ‘Carbonstep’ software is designed to automate and reduce the transaction of collecting energy efficiency micro-credits at the utility level”.

My conclusion, from this report is that there needs to be great attention to making sure that when mandatory systems are put in place some of the good initiatives that have thus far occurred in the voluntary market are not lost.

Since my interview with Julia Wilhelm of Studley the market leader on Green Buildings in San Francisco, a dialogue has developed amongst Green Building advocates.

Julia did an interview on me recently on her blog greensuite on my work on Green Buildings and the Greening of the Olympics, the first green building program globally.

Following on from this work, what is emerging is an interest by some Green Building advocates to develop the link between Green Buildings / energy efficiency and Carbon Trading. We would welcome any building owners, utilities to approach us concerning this topic.

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Ecosecurities, the leading project developer of CDM projects globally has kindly given GHGblog.com access to three of their top CDM projects in Asia and Brazil.

The Clean Development Mechanism (CDM) is a regulated market under the Kyoto Protocol whereby, countries and companies in the developed world can meet their emissions reduction targets by buying carbon credits that have been generated through projects that bring about reduced or avoided emissions in developing countries. This emissions trading mechanism was the brainchild of Brazil and Emissions Trading as a concept was based on the successful U.S. Sox and Nox environmental markets to reduce air pollution in California put forward by Bill Clinton, when the Kyoto Protocol was signed in 1997. So Emissions Trading was a democrat initiative.

However, the critics are lining up using the rhetoric of some kind of out-dated belief that market mechanisms are a problem not a solution. Clearly, developing countries are responding to the incentive approach with their feet. No-one is making them do it. The Asian CDM market in 2007 was worth US$17.5 billion, an enormous 200 per cent increase in market value since 2006. Asia has so far been the global leader in generating CDM credits. In 2007, China alone provided an enormous 62 per cent of the credits on the market, while Indonesia was responsible for 10 per cent and India 5 per cent.

Now to some great CDM projects.

Bondoc is a methane recovery, swine wastewater treatment and electricity generation project located on a large pig farm in the Candelaria, Philippines. The project uses anaerobic digestion technology to use organic waste material currently treated in the wastewater ponds to produce biogas.  The biogas produced in the project’s anaerobic digester is then used to generate electricity for use on-site.

Bondoc wastewater ponds from pig farm

Bondoc is a methane recovery, swine wastewater treatment and electricity generation project located on a large pig farm in the Candelaria, Philippines. The project uses anaerobic digestion technology to use organic waste material currently treated in the wastewater ponds to produce biogas.  The biogas produced in the project’s anaerobic digester is then used to generate electricity for use on-site.

Before the anaerobic digesters were installed, the farm deposited its waste in a series of open, concrete lagoons, which then degraded anaerobically releasing large amounts of methane, a potent GHG gas, into the atmosphere.

The farm also relied on electricity supply from the local fossil-fuelled grid, but now the farm can produce renewable electricity from biogas on-site, which reduces both their emissions and costs. As the methane emissions are now trapped and processed, the project has improved the local air quality by significantly reduced bad odours, which has improved quality of life for the adjoining community. The project has also facilitated the transfer of new, clean technology, to a developing country, and will act as a demonstration project in the area to encourage the development of renewable energy solutions with the aid of carbon finance

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I am speaking with Julia Wilhelm of Studley, the market leader in Green Buildings. She is a Leed Accredited Professional working for Studley, Inc., commercial tenant adviser. Julia is one of the new generation of professionals working with tenants and building owners to create Green Buildings in San Francisco. Leed is a Green Building accreditation under the auspice of the U.S. Green Building Council.

Studley is totally unique in its focus.  Most real estate companies derive a vast majority of their income representing and servicing landlords, not Studley-tenants are our focus. Our mission is to represent our clients zealously, without fear or favor, and through that commitment, to achieve superior results.  With respect to sustainability this means that we are able to advocate some “out of the box” type of green structures and concessions and it is starting to have a remarkable impact.   In an industry that is highly impactful-one of the largest consumers of natural resources, energy, and that converts natural land to the built environment, I feel personally and professionally gratified to be part of the solution.

FOR ME THIS IS FANTASTIC TO SEE THE NEW WAVE OF GREEN BUILDINGS PROFESSIONALS.

1. Could you explain how the market for Green Buildings is developing in San Francisco?

As few as two to three years ago, when I worked on one of the first LEED Certified office projects in San Francisco, the concept of green building was totally foreign to the landlord and ownership community here.  Likewise, tenants and occupants of space, other than the companies and organizations whose basic mission was focused on conservation or environmental issues, for the most part didn’t think about the environmental footprint of their operations or office space or were not aware of the means to improving it.  So, in helping the first company I worked with that truly cared about creating a model green office space just three years ago, it seemed that no one in the San Francisco real estate community had heard of LEED-the most widely adopted standard for green building in the US-or knew the energy performance of their buildings, water efficiency, or any other “green” characteristics.  So it was quite difficult to actually implement their green objectives in selecting and negotiating on the best office space for them.  Likewise the cost of materials that came from renewable resources, were locally sourced and were free of toxic properties were more expensive and the construction and design experts were not widely educated in how to utilize them.

Within the past 12 months alone, the awareness on the part of landlord and tenant communities on what green building means and how they can improve their own foot print has accelerated at an unbelievable pace.

Now all types of companies not just the environmental groups, most notably mature technology companies, financial services companies and law firms are rapidly adopting/demanding green building practices.  I believe this is being driven by a number of factors: at a grass roots level by their employees, because their investors or customers are now asking them what their sustainability statement is and facilities are a measurable and relatively easy means of demonstrating an environmental commitment, and because there is finally some real evidence of cost and long term economic benefits associated with green building.

These tenants are pushing the Landlord community to make changes.  My opinion is that most building owners have severely lagged behind demand in making investments in green retrofits or equitably sharing in the costs of their tenant’s efforts.  For example, if you are a company that is located in San Francisco and want to relocate your office to a LEED Certified building, you literally have one option that is currently on the market and one more that is being constructed-out of an 80M square foot market.  The few buildings that have undergone green retrofits are 100% leased.  I think this lagging supply is primarily the result of condensed investment horizons on the part of building owners over the past several years.  Historic +/-10 year holding periods for office building asset had become few years or even just months, as close to 80% of the class A buildings in San Francisco sold at record prices in 2006 and 2007, and many of them multiple times.  Without leasing space or creating additional demand, owners of major buildings were able to “flip” their assets for higher prices.  This too has changed and I am very hopeful that instead of the dramatic rental rate increases Landlords had thought would create value in their properties that they will go back to fundamentals and look towards reducing operations and maintenance costs through green retrofits and boost demand for their space by making concessions to attract tenants that care about the environmental foot print of their space.

I believe we are on the verge of this shift, and it will be accelerated by new legislation.  San Francisco is the first city in the US to pass a “Green Building Ordinance” which amended the Building Code to impose green building requirements for new structures that are 5,000 square feet or larger and renovations to existing buildings that are 25,000 square feet or larger.

2. Is it increasing and what initiatives are helping the expansion of the green building market.

Yes, it is rapidly increasing.    Unfortunately there are not many incentives available to groups that are employing green building strategies or undertaking green initiatives.  Most incentives are coming from local energy providers for improvements to efficiency.  But the pay-back for a change in light bulbs for example pays for itself in a matter of months anyhow so these incentives aren’t hugely significant.  There is one federal tax incentive I am aware of that was borne out of the Federal Energy Policy Act of 2005, also aimed at energy efficiency improvements.  The San Francisco Department of the Environment also provides companies with free technical assistance.

The bottom line is that there are very few incentives available.

3. Who is promoting the Green Building market? Is it tenants, building owners or developers?

I believe tenants are the primary drive behind promoting green building.  They represent the demand base to Landlords and the rental stream from their lease commitments is what a building’s value is fundamentally tied to (as well as a Landlord’s ability to secure financing).  So, if a company is challenging a landlord to make building or space related investments as a requirement in attracting or retaining them, in a competitive market with greater than 10% vacancy, which we are in now in San Francisco, there will be Landlords that will “go green” for a particular tenant or tenants.  Without this type of push, I have seen little proactive effort on the part of Landlords to make green related investment (more…)

I had a lively discussion with Susan Wood, the CEO of SCC Americas, at the Carbon Finance North America Conference last week. SCC Americas is the US arm of Syndicatum Carbon Capital, one of the largest developers of Kyoto based CDM carbon credit projects in the world, and Susan herself has been doing emissions trading for over a decade, after starting out as an environmental engineer.

The punchline in our chat was quite fascinating - the US voluntary carbon market does not reward complexity in projects, Susan says. Basically, US carbon credit developers are only doing a few limited types of projects, like methane destruction. Why? Because the buyers, who dictate the voluntary markets, tend to be scared off by anything complex that they do not understand, or anything that does not appear to be future proofed against coming US regulations. This stands in stark contrast to the CDM market, where complexity is often the hallmark of the major developers since the methodology and standards process is trusted to a much greater degree by compliance buyers than the voluntary standards are.

One other way to look at this issue is that much of the innovation in new ways to abate carbon is coming from CDM under Kyoto, not the voluntary markets. A bit sad, and a challenge to the voluntary standards community to get its act in order. Possibly the rise of new standards like Voluntary Carbon Standard and Green-e Climate will help fix the crisis in complexity, but we have been saying that for a while. As Susan puts it, we need it to happen yesterday.

Neal Dikeman is a founding partner at Jane Capital Partners LLC, a boutique merchant bank advising strategic investors and startups in cleantech. He is founding contributor of Cleantech Blog, a Contributing Editor to Alt Energy Stocks, Chairman of Cleantech.org, and a blogger for CNET’s Greentech blog. He is also the founder of Carbonflow, a provider of software solutions for the carbon markets.

The carbon markets are an area of keen interest for me personally and professionally, so it is always frustrating that the mainstream media largely refuses to learn the details.

In general, layman and media 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 (in carbon 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.

I caught up with a friend of mine, Marc Stuart, to give us a little teach in about the real story in carbon offsets, what matters, what does not, what works, and what still needs to be tweaked. Marc should know, he’s one of the founders of EcoSecurities plc (AIM:ECO.L), one of the first, and still the leader in generating and monetizing carbon credits. Marc, thanks for joining us, we appreciate the time and the teach in.

1. 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. I’ve always described it to people as “beyond business as usual”. 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” (BAU) 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 BAU 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 UN 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 UN’s Clean Development Mechanism (The CDM is the international system for creating carbon offsets called CERs) ultimately makes a binary decision about whether a project is eligible to participate or not. 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 (DNV). However, many projects don’t even make it to that decision point before they are dropped in the process.

2. 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 a 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.

3. 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 qualified Operational Entity, the Executive Board Registration and Issuance Team, the UNFCCC 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.

4. What about the voluntary carbon market in the US, 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 (Editors note: Marc 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. [Editors note: Other voluntary carbon standards we watch closely include Green-e Climate, put out by the people who certify most of the renewable energy credits (RECs) in the US]

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.

5. 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.

5. Given that the majority of CDM projects currently under development are located in China and India, how can we ensure that these countries eventually take on the binding targets we will need to reach the scientifically determined reductions in GHGs? Doesn’t the CDM simple create an incentive for these countries to avoid binding targets as long as possible?

It is clearly in the world’s interest to get as much of the global economy into a low carbon trajectory as quickly as possible. However, it is politically unrealistic to expect these countries—whose emissions per capita are between one fifth and one tenth the per capita of the United States—to make an equivalent commitment at this juncture, particularly considering that they are in the midst of an aggressive development trajectory. The CDM provides a way for ongoing engagement with these countries, developing the basic architecture of a lower carbon economy. And there is no doubt that China’s emissions in 2012, 2015 or 2020 will be measurably lower than they otherwise would have been, simply because of the current accomplishments of the CDM. Over time, the use of project based mechanisms will contribute to accelerating the development and dissemination of low carbon technologies, which will make those negotiations for binding caps from all major economies far more tenable.

6. It is widely believed that to address the climate crisis on the scale necessary to avert dangerous global warming, significant infrastructural and paradigm shifts must occur at an unprecedented scale. Some people are concerned that offsets provide a disincentive for making these shifts, since companies can just offset their emissions instead of making the changes themselves. Is this something you saw under the EU ETS at all, and if so, how can it be addressed in a US system?

Virtually all of the macroeconomic analysis that has been done of Phase I of the ETS shows that there were real emission reductions undertaken within the system, despite the fact that many companies were also actively seeking CDM CERs. Clearly the fact that both Kyoto and the EU ETS system place quantifiable limits on the use of CDM and Joint Implementation (JI) credits guarantees that emission reductions will also be made in-country as well, so pure “outsourcing” of emissions compliance is not possible. This also appears to be the model being pursued in most US legislation.

7. Many have complained that the CDM system is too administratively complex, unpredictable, and that the transaction costs of the system are so significant that they could almost negate any possible benefits. What lessons can be learned about structuring an offset system in a simpler, but still environmentally rigorous way? What steps is the CDM EB taking to address these issues?

The CDM treads a very fine line between ensuring environmental integrity of the offsets that it certifies and the need to have some kind of efficient process within an enormous global regulatory enterprise. To date, one has to think that they have gotten it about right, as business has complained about inefficiency and environmentalists have complained about environmental integrity. However, it is becoming increasingly clear that the project by project approval approach is creating logistical challenges as the system graduates from managing dozens, to hundreds, to now, quite literally, thousands of projects in all corners of the world. Ironically, it is the success of the CDM in terms of its very broad uptake by carbon entrepreneurs that is causing problems for the current model.

We believe the benefits of the CDM can be maintained by moving many project types into a more standardized approach, whereby emission reduction coefficients are determined “top-down” by a regulatory body, as opposed to being undertaken individually for every project by project proponents. For example, there are dozens of highly similar wind energy projects in China that all have microscopically different emission baselines. A conservative top down baseline set by the regulator (in this case, the CDM Executive Board) would enable projects to get qualified by the system in an efficient manner with far less bureaucratic overhang. This is how California’s Climate Action Reserve deals with project based reductions and we think that it could work well for many sectors.

8. Is there any difference between a renewable energy certificate (REC) and a carbon offset? Does EcoSecurities support the concept of selling RECs to offset carbon emissions?

While renewable energy clearly helps lower the carbon intensity of the electrical grid, there are a great number of other incentives for development of renewables in the US, including significant Production Tax Credits, and in most states, RECs or Green Tags. For EcoSecurities, this makes it extremely problematic to claim that these assets are additional, despite their obvious benefits to the global environment and decarbonization of the economy. Acknowledging this, EcoSecurities—along with many other companies—has steered clear of developing REC projects for VERs in the voluntary market. There are other firms that have chosen other approaches, which again highlights the need for standardized approaches like the VCS. That said, we are very active in helping create carbon value for RE projects throughout the developing world via the CDM, where incentives such as RECs are almost universally non-existent.

9. There has been a lot of concern about “carbon market millionaires” profiting from selling offsets, and that the only “greening” going on is in the lining of peoples’ pockets. As a carbon market millionaire yourself, what do you think about this concern?

Capital markets exist to reward innovation and punish underperformance. EcoSecurities has existed for more than 11 years and the founders – of which I am one – have devoted more than 15 years to building up various aspects of the carbon market. For many of those years, as we watched friends and colleagues flourish in other markets like internet and biotech, our decision to stay in this seemed fairly quixotic. But we understood enough of the science of climate change to recognize that a fundamental policy response had to be forthcoming, or we would be heading to a global catastrophe. Now those policies have come into focus and the overriding recognition is that society will need to mobilize trillions of dollars of capital to decarbonize the global economy. As part of the proverbial “bleeding edge” for many years, we were ironically well positioned to take advantage when early movers in the capital markets recognized the capabilities and brand that we had built up over a decade. As for whether that is the only greening – well, I can tell you that given the very conservative and difficult aspects of qualifying projects for the CDM, I am 100% certain that our activities contribute solidly to that decarbonization trajectory and that real emission reductions have occurred all over the world because of our efforts.

10) What lessons have you learned personally about the market as a cofounder of the leading CDM project developer in the world? You must have some interesting lessons learned for the US as you are probably unique amongst your competitors in having been based here in the US for over 10 years.

Thanks for the compliment but actually, I’m not that unique. I started in the market in the early 1990’s when the US was the epicenter of a future carbon trading regime, and Europe and Japan looked at it with suspicion and distaste. Quite a number of us from that era did not give up, but instead spent a fair bit of time since then getting our US passports stamped regularly to search the world for projects. It’s nice to see that we may finally be getting back to where we thought we would be a decade ago—with the US as a driving force for innovation in decarbonizing the world’s economy (coincidentally in a recent report produced by the UNFCCC, the US along with Germany, the UK and France provided over 70% of the clean technology currently being utilized in CDM projects). The US is in a perfect position to learn from the both the successes and mistakes within the first Kyoto iteration and I am looking forward to being part of that next stage as well.

11) What do you say to popular press who don’t seem to believe that Kyoto works?

Honestly, you haven’t seen what I have seen. I’ve traveled all over the world and seen the results of Kyoto, where “carbon entrepreneurs” – ranging from divisions within multinationals to garage inventors on their own—are seeking ways to cost effectively reduce GHG emissions. That simply would not have happened without the market signal that Kyoto created. The fact that the CDM has registered more than 1000 projects and has a backlog of several times that – despite the incredible bureaucratic requirements – shows an uptake several magnitudes beyond what anybody predicted when Kyoto was negotiated. When the managing director of a West African oil refinery is proudly detailing to you the steps he’ll be ordering his engineers to take to help save some 250,000 tonnes of CO2 emissions to the atmosphere, that’s when you realize that you’ve tapped into something significant. And having had the same basic conversation in Mumbai, Jakarta, Sao Paulo and Beijing, you realize that people really want to do something, but that you need a little push from a market. That said, we are still in the first tentative moments of what is probably a century long issue and there are doubtless many improvements that can and will be made. But we have undoubtedly proven that the basic premise works.

Thanks Marc. A pleasure to chat as always. Keep up the good fight.

Neal Dikeman is a founding partner at Jane Capital Partners LLC, a boutique merchant bank advising strategic investors and startups in cleantech. He is founding contributor of Cleantech Blog, a Contributing Editor to Alt Energy Stocks, Chairman of Cleantech.org, and a blogger for CNET’s Greentech blog. He is also the founder of Carbonflow, a provider of software solutions for the carbon markets.