Carbon Trading Law

Carbon Trading Law and Practice
This page intentionally left blank
Carbon Trading Law and Practice
Scott D. Deatherage
1
Oxford University Press, Inc., publishes works that further Oxford Universitys objective of excellence in research, scholarship, and education. Oxford New York Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Mexico City Nairobi New Delhi Shanghai Taipei Toronto Madrid Melbourne
With offices in Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore South Korea Switzerland Thailand Turkey Ukraine Vietnam
Copyright 2011 by Scott D. Deatherage

Published by Oxford University Press, Inc. 198 Madison Avenue, New York, New York 10016 Oxford is a registered trademark of Oxford University Press Oxford University Press is a registered trademark of Oxford University Press, Inc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of Oxford University Press, Inc. _____________________________________________________________________________
Library of Congress Cataloging-in-Publication Data
Deatherage, Scott. Carbon trading law and practice / Scott D. Deatherage. p. cm. Includes bibliographical references and index. ISBN 978-0-19-973221-0 (pbk. : alk. paper) 1. Emissions tradingLaw and legislation. 2. Emissions tradingLaw and legislationUnited States. 3. Carbon offsettingLaw and legislation. 4. Carbon offsettingLaw and legislationUnited States. I. Title. K3593.5.C37D43 2011 344.04634dc22 2010045984
___________________________________________________________________________________ 1 2 3 4 5 6 7 8 9 Printed in the United States of America on acid-free paper Note to Readers This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is based upon sources believed to be accurate and reliable and is intended to be current as of the time it was written. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Also, to confirm that the information has not been affected or changed by recent developments, traditional legal research techniques should be used, including checking primary sources where appropriate. (Based on the Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.)
You may order this or any other Oxford University Press publication by visiting the Oxford University Press website at www.oup.com
To Violet, my wife, and my two children, Brett and Ashley
Contents
Acknowledgments Preface Introduction

PART ONE
xxiii xxv xxix
The Emergence of Carbon Markets
Prelude to RegulationThe Development of Climate Change Science A. Typical Process of Regulation Following Science B. The Greenhouse Effect C. The Science of Climate Change 1. Conclusions of Scientific Institutions a. The International Panel on Climate Change i. Africa ii. Asia iii. Latin America iv. North America v. Europe b. National Academies of Science of the Major Emitting Developed and Developing Countries c. In the United States: the National Research Council and the National Academy of Sciences D. The Policy Impact of the Conclusions of the National Academies of Science E. Controversy over Climate Science F. Future Policy Development Based on Climate Science
3 4 5 5 5 5 7 7 7 8 8 8 11 12 12 15
viii | C O N T E N T S
The Emergence of Emissions Trading Concepts A. Economics vs. the Environment B. Evolution of Environmental Regulation and Emergence of Environmental Markets C. Emissions Trading as a Means of Bridging the Divide between the Economy and Environment D. Basic Concepts of Emissions Trading E. Cap and Trade Made in AmericaThe Advent of U.S. Emissions Markets with Sulfur Dioxide and Other Emissions F. Examples of Working Carbon Markets 1. The Kyoto Protocol 2. The European Union Emissions Trading Scheme G. Environmental Markets Are Alive and Well Fundamentals of Cap and Trade A. Defining the Regulated Gases B. Determining the Threshold Amount of Emissions to Be Regulated C. Determining the Regulated Sources D. Setting the Cap E. Permitting Emissions of Greenhouse Gases F. Emission Allowances G. Allocation of Emission Allowances H. Trading Allowances I. Banking Allowances J. Borrowing Allowances K. Safety Valve and International Competitiveness L. Offsets M. Additionality N. Supplementarity and Linkage to Other National and International Trading Systems O. Early Action P. New or Expanded Facilities Q. Regulatory Agency or Agencies 1. Regulation of Greenhouse Gas Emissions 2. Regulation of Trading of Allowances and Offsets R. Enforcement
16 16 17 17 18
20 21 22 24 24 25 25 28 28 30 30 31 31 33 33 33 34 34 35 35 36 36 37 37 37 38
C O N T E N T S | ix
PART TWO
Regulatory Structures
International Law A. The UN Framework Convention on Climate Change 1. Conference of the Parties B. The Kyoto Protocol 1. General Principles 2. The Clean Development Mechanism 3. Joint Implementation 4. Emissions Trading and Trading in Assigned Amount Units and Removal Units 5. Kyoto Units C. The Marrakesh Accords D. Bali, Copenhagen, and Cancun: Negotiations for a Post-Kyoto Treaty 1. The Bali Action Plan 2. The Copenhagen Accord 3. Cancun E. Alternatives to the UNFCCC The European Union Emissions Trading Scheme A. The EU Policy on Climate Change B. Phase I2005 to 2007 C. Phase II2008 to 2012 D. Phase III2013 to 2020 E. Fundamentals of the EU ETS 1. Defining the Cap 2. Defining the Regulated Sources 3. Permitting Emissions of Greenhouse Gases 4. Emission Allowances 5. Allocation of Emission Allowances 6. Trading Allowances 7. Banking Allowances 8. Borrowing Allowances 9. Safety Valve and International Competiveness 10. Offsets 11. Additionality 12. Supplementarity and Linkage to Other National and International Trading Systems 13. Early Action 14. New or Expanded Facilities 15. Enforcement
41 41 42 42 42 43 44 45 46 46 47 47 48 48 49 52 52 53 53 54 54 54 55 55 55 55 56 56 56 56 56 57 57 57 57 58
x | CONTENTS
Emissions Programs among Other Kyoto Countries A. New Zealand B. Canada C. Australia D. Japan E. China The Emergence of National and International Carbon Markets A. Compliance or Mandatory Markets B. Voluntary Markets 1. Voluntary Carbon Standards and Markets 2. Source of Demand for Voluntary Carbon Credits 3. Development of Voluntary Standards, Registries, and Exchanges a. Chicago Climate Exchange b. Voluntary Carbon Standard c. American Carbon Registry d. Climate, Community, and Biodiversity Alliance C. Pre-Compliance Markets and the Transition from Voluntary to Compliance Markets D. Survival of Voluntary Markets after Establishment of Compliance Systems E. The Current State of the Voluntary Market F. The European Market G. The Kyoto Protocol and the Clean Development Mechanism Market Developing Laws in the United StatesState Laws A. State Climate Change Programs B. Individual State Programs 1. California a. Regulated Gases b. Regulated Sources c. The Cap d. Permitting Emissions of Greenhouse Gases e. Emission Allowances f. Allocation of Emission Allowances g. Trading Allowances h. Banking Allowances i. Borrowing Allowances j. Safety Valve and Competitiveness k. Offsets
59 59 60 61 61 63 64 64 64 64 65 65 66 66 68 69 69 70 70 71 72 74 74 74 74 75 75 77 77 77 77 79 79 79 80 80
C O N T E N T S | xi
l. Additionality m. Supplementarity and Linkage to Other Trading Systems n. Early Action o. New or Expanded Facilities p. Regulatory Agency or Agencies q. Enforcement 2. Florida 3. New Mexico C. Multi-State Programs 1. Regional Greenhouse Gas Initiative a. Regulated Gases b. Regulated Sources c. The Cap d. Permitting Emissions of Greenhouse Gases e. Emission Allowances f. Allocation of Emission Allowances g. Trading Allowances h. Banking Allowances i. Borrowing Allowances j. Safety Valve and Competiveness k. Offsets l. Additionality m. Supplementarity and Linkage to Other Trading Systems n. Early Action o. New or Expanded Facilities p. Regulatory Agency or Agencies q. Enforcement 2. Western Climate Initiative a. Regulated Gases b. Regulated Sources c. The Cap d. Permitting Emissions of Greenhouse Gases e. Emission Allowances f. Allocation of Emission Allowances g. Trading Allowances h. Banking Allowances i. Borrowing Allowances j. Safety Valve and Competitiveness
82 82 83 83 83 83 84 84 85 85 85 85 85 86 86 86 86 86 86 87 87 87 87 87 88 88 88 88 90 90 90 91 91 91 92 92 92 92
xii | C O N T E N T S
k. Offsets l. Additionality m. Supplementarity and Linkage to Other Trading Systems n. Early Action o. New or Expanded Facilities p. Regulatory Agency or Agencies q. Enforcement D. Midwestern Greenhouse Gas Reduction Accord E. Cooperation and Potential Linkage among the Multi-State Programs Developing United States LawThe Courts A. Federal Statutory Litigation 1. The U.S. Supreme Court Landmark Decision in Massachusetts v. EPA 2. BackgroundHow Did the Matter Reach the U.S. Supreme Court? 3. StandingCould the Court Hear the Matter When the Emissions and Effects of Climate Change Are Global and Influenced by Emissions from Other Countries? 4. The Merits of the CaseDoes the EPA Have the Authority to Regulate, and, if so, the Ability to Defer Regulation of Greenhouse Gases under the Clean Air Act? 5. Implications of the Courts DecisionRegulation under the Clean Air Act and Other Federal Statutes, Corporate Environmental Disclosure, and Litigation Alleging Climate-Related Damages a. Symbolic or Political Significance b. Greenhouse Gases Are Air Pollutants and the EPA Has the Authority to Regulate Them c. Effect on Other Vehicle-Related Greenhouse Gas Lawsuits d. Effect on Challenges to the EPAs Decision Not to Regulate Greenhouse Gases from Power Plants e. Effect on Cases Filed under the National Environmental Policy Act, Challenging Governmental Action That Causes or Leads to Greenhouse Gas Emissions f. Effect on Tort Suits Filed by Individuals Claiming Damages from Greenhouse Gas Emissions
93 93 94 94 95 95 95 95 96 99 100 100 101
102
104
106 106 106 107
107
107 108
C O N T E N T S | xiii
10
g. Broadening Standing for States to Challenge Federal Administrative Agency Action B. State Statutory Litigation C. Federal Common Law Litigation to Impose Emission Reductions on Greenhouse Gas Emitters D. State and Federal Common Law Litigation to Obtain Damages from Greenhouse Gas Emitters Developing United States LawThe Environmental Protection Agency A. Federal Greenhouse Gas Reporting Program 1. What Gases Are Covered? 2. What Facilities Are Covered? a. Specific Source Categories b. Other Facilities That Emit 25,000 Tons per Year or More of CO2e of Combined Emissions from Listed Source Categories c. Facilities That Do Not Meet the First Two Source Categories, But That Emit 25,000 Tons of CO2e per Year from Stationary Fuel Combustion Sources d. Entities That Sell, Import, or Export Fossil Fuels, Industrial Greenhouse Gases, and CO2 e. Entities That Manufacture or Sell Vehicles or Engines in the United States 3. Monitoring and Measurement 4. Certification and Verification 5. Information That Must Be Reported a. Facilities That Emit Greenhouse Gases b. Suppliers of Greenhouse Gases or Materials That Produce Greenhouse Gases When Used 6. Public Availability of Information Submitted to the EPA 7. Exiting the Reporting Regulation Requirements 8. Enforcement Actions and Penalties for Failure to Comply with the Greenhouse Gas Reporting Rule B. EPA Regulation of Greenhouse Gas Emissions under the Clean Air Act 1. The EPAs Endangerment Finding 2. The EPAs Johnson Memo 3. The EPAs Mobile Source Rule
109 109 109 111 114 115 117 117 118
118
119 119 120 121 121 121 121 122 122 123 123 124 124 125 126
xiv | C O N T E N T S
11
4. The EPA Tailoring Rule a. Application of the Prevention of Significant Deterioration to Regulation of Greenhouse Gas Emissions b. Covered Gases c. Phases of Coverage, Beginning with Larger Sources i. Step 1: January 2, 2011 to June 30, 2011 (a) PSD applicability (b) Title V permitting applicability ii. Step 2: July 1, 2011 to June 30, 2013 (a) PSD applicability (b) Title V permitting applicability iii. Step 3: July 1, 2013 to April 29, 2016 d. Best Available Control Technology e. State Implementation Plans Developing United States LawCongress and Proposed Federal Climate Change Legislation A. Defining the Regulated Gases B. Emission Thresholds for Facilities That Emit Greenhouse Gases C. Covered Facilities: Determining What Emission Sources Would Be Regulated 1. Emitters of Greenhouse Gases 2. Producers or Importers of Greenhouse Gases or Materials That Emit Greenhouse Gases When Used or Burned D. Setting the Cap E. Permitting Emissions of Greenhouse Gases F. Emission Allowances G. Allocation of Emission Allowances H. Auctions 1. Main Allowance Auction 2. Market Stability Reserve 3. Small Business Refiner Reserve I. Auctioning Allowances for Other Entities J. Carbon Registry K. Offsets 1. General Issues Relating to Offsets 2. Carbon Offset CreationRules Relating to Offset Methodologies and Projects a. Basics of Offset Creation
126
127 129 129 129 129 130 130 130 130 131 131 132 133 133 135 136 136
138 138 139 139 140 141 141 142 143 144 144 145 145 147 147
C O N T E N T S | xv
3. Eligible Offset Project Types 4. Methodologies a. Additionality b. Activity Baseline c. Quantification Methods d. Leakage 5. Accounting for Reversals 6. Crediting Periods 7. Approval of Projects 8. Monitoring, Reporting, and Verification 9. Issuance of Credits 10. Early Offsets 11. Environmental Considerations for Forestry or Land-Management Projects 12. Recordkeeping 13. International Offsets a. General Issues b. Sectoral Credits c. Credits Issued by an International Body d. International Forest Offsets i. National Programs ii. State- or Province-Level Programs iii. Program for Low-Emitting Countries iv. Project-based Deforestation Reduction Credits v. Forested Wetlands and Peatlands L. Compliance with Greenhouse Gas Emission Requirements 1. Compliance Obligations 2. Phase in of Compliance Obligations for Certain Covered Entities M. Trading Allowances and Offsets N. Banking Allowances O. Borrowing Allowances P. Safety Valve International Competitiveness 1. Program to Provide Additional Allowances for Industrial Sources Facing International Competition 2. Use of Sectoral Approach for the Importation of International Offset Credits Q. Supplementarity and Linkage to Other National and International Trading Systems
148 150 151 152 152 152 153 153 153 154 155 155 156 157 157 157 158 159 160 160 162 162 163 163 163 163 164 166 166 167 167
168 168 169
xvi | C O N T E N T S
R. Early Action S. New or Expanded Facilities T. Regulatory Agency or Agencies 1. Regulation of Greenhouse Gas Emissions 2. Regulation of Trading of Allowances and Offsets U. Enforcement
PART THREE
170 171 171 171 171 172
Carbon Project Development and Carbon Finance
12
13
Carbon Credit Project Types and Methodologies A. Introduction to Carbon Credit Project Types and Methodologies B. Methodologies for Developing Carbon Credit Project Types C. Carbon Credit Project Types 1. Renewable Energy 2. Energy Efficiency 3. Landfill, Oil and Gas, and Other Methane Projects 4. Natural Gas Production and Distribution Projects 5. Fuel Switching 6. Agriculture, Forestry, and Land Use a. Avoided Deforestation and Reforestation i. The Voluntary Carbon Standard Agriculture, Forestry, and Other Land Use Guidance (a) The baseline (b) Additionality (c) Leakage (d) Permanence and Related Carbon Buffer (e) Monitoring ii. Climate Action Reserve Forestry Methodology (a) The baseline (b) Additionality (c) Leakage (d) Permanence and Related Carbon Buffer (e) Monitoring iii. CDM Reforestation/Afforestation Methodology 7. Carbon Capture and Storage Carbon Credit Project Development A. Project Development Generally
175 175 176 177 177 178 178 179 180 180 180 183 185 185 186 186 186 187 188 188 189 189 190 190 190 193 193
C O N T E N T S | xvii
14
B. Basics of Carbon Credit Project Development C. Feasibility Study D. The Carbon Credit Approval Process 1. The Process under the Clean Development Mechanism a. Project Feasibility Study b. Project Idea Note c. Project Design Document d. Stakeholder Participation e. Host Country Approval f. Validation by a Designated Operational Entity g. Registration h. Implementation and Monitoring i. Verification and Certification j. Issuance of Credits 2. The Voluntary Carbon Standard Process E. Carbon Credit Project Risks F. Examples of Projects 1. Landfill Methane 2. Solar Projects a. Solar Projects Generally b. Free-Standing or Utility-Scale Solar Projects c. Non-Utility-Scale Solar Projects 3. Forest Carbon Projects Carbon Finance A. Financing Carbon Projects B. Project Finance 1. Equity 2. Debt 3. Types of Agreements Typically Involved in Project Finance 4. Managing Political Risk with International Projects C. Carbon Finance 1. Basic Elements of Carbon Finance D. Carbon Credit Project Lenders and Investors 1. Multilateral Banks and Associated Carbon Funds 2. Private Banks 3. Private Carbon Funds, Private Equity Firms, and Hedge Funds 4. Utilities and Other Compliance Investors
194 194 196 196 196 196 196 197 197 197 197 198 198 198 198 199 200 201 201 201 201 202 203 207 207 207 209 209 210 211 211 211 214 214 217 217 217
xviii | C O N T E N T S
PART FOUR
Other Credits That May be Generated From Carbon Credit Projects
15
16
17
Other Environmental Attributes, Including Renewable Energy Credits and Energy Efficiency Credits A. Environmental Attributes and Other Credits That May Enhance Carbon Credit Projects B. Renewable Portfolio Standards C. Renewable Energy Credits D. Energy Efficiency Credits E. Credits for Traditional Pollutants F. Forward Capacity Markets G. Contractual Issues in Selling RECs Outside California 1. Type of Credit 2. Vintage of Credit 3. Quantity Being Sold 4. Pricing 5. Transfer Mechanism 6. Payment 7. Delivery 8. Representations and Warranties 9. Effective Date and Termination 10. Remedies and Damages 11. Change in Law H. Contractual Issues in Selling RECs Inside California Ecosystem Services: Wetlands and Biodiversity Credits A. Wetlands Credits and Banking B. Biodiversity Credits C. Credit Stacking Water Credits A. Increasing Water Demand and Decreasing Water Supply B. Why Water Is Becoming a Potential Tradable Commodity C. Water Credits and Markets as a Means of Conserving a Scarce Resource 1. Water Quantity Trading 2. Water Quality Trading D. Carbon Credit Projects and Water Credits
Government IncentivesStimulating Carbon Projects
221 221 222 224 225 225 225 226 226 227 227 227 227 227 228 228 228 228 228 229 230 231 232 234 236 236 236 237 237 237 238
PART FIVE
18
Government Incentives for Renewable Energy and Other Types of Projects That Generate Carbon Credits
243
C O N T E N T S | xix
A. The Use of Government Incentives to Enhance Carbon Credit Projects B. Government Incentives 1. Government Grants 2. Government Tax Incentives a. The EESA i. Renewable Energy ii. Energy Efficiency and Conservation iii. Carbon Capture and Storage iv. Transportation and Domestic Fuel b. The ARRA 3. Grants in Lieu of Tax Incentives 4. Government Loan Guarantees 5. Property-Assessed Clean Energy Programs 6. Development Bonds C. Utility Incentives
PART SIX
243 245 245 245 246 246 246 246 247 247 248 250 250 251 251
Carbon TradingSelling Credits and the Carbon Markets
19
20
Fundamentals of Carbon Trading A. A Regulatory Commodity B. The Various Types of Carbon Credits C. Primary or Over-the-Counter Markets and Bilateral Agreements D. Secondary Markets and Exchanges E. Future vs. Spot Markets F. Off-Take Agreements G. Carbon Indexes H. Fungible Commodity vs. Differentiation I. Voluntary and Compliance Buyers J. Investors and Speculators K. Carbon Credit Risk and Price L. Other Price Drivers M. State of the Global Carbon Markets Contractual Issues in Carbon Trading in the Primary Market A. Definitions B. Conditions Precedent C. Price D. Quantity and Delivery E. Payment F. Obligations of Seller
255 255 255 256 256 257 257 257 258 258 258 259 259 259 261 261 261 262 262 262 263
xx | C O N T E N T S
G. H. I. J. K. L. M. N. O. P. Q.
Obligations of Buyer Representations and Warranties Share of Proceeds and Taxes Default Termination Remedies Choice of Law and Venue Dispute Resolution Force Majeure Limitation of Liability Miscellaneous Issues
Carbon AccountingCarbon Assets and Liabilities
263 264 265 265 266 266 266 267 267 267 267
PART SEVEN
21
22
The Carbon Ledger and Carbon Credit Accounting A. Carbon Accounting B. Defining Carbon Assets and Liabilities C. Forming a Carbon Ledger as Part of a Carbon Strategy D. Financial Accounting Treatment of Carbon Assets and Liabilities Climate Risk Disclosure A. Corporate Climate Change Liabilities B. Securities and Exchange Commission Regulations Governing Environmental Financial Disclosure 1. Item 101 2. Item 103 3. Item 303 4. Item 503(c) C. Accounting Rules D. The Sarbanes-Oxley Act E. SEC Enforcement F. SEC Guidance Regarding Disclosure Related to Climate Change 1. Overview of Existing Disclosure Requirements 2. Climate Change-related Topics That May Require Disclosure a. Impact of Legislation and Regulation b. International Accords
271 271 272 273 275 279 279 281 282 282 283 283 283 284 284 285 286 287 287 289
C O N T E N T S | xxi
G. H. I. J.
c. Indirect Consequences of Regulation or Business Trends d. Physical Impacts of Climate Change Voluntary Climate Change Disclosure Protocols Voluntary Standards Evolving into Legal Requirements Officer and Director Liability Environmental and Climate Risk Management Conclusion
289 289 291 292 293 295 297 299
Acronyms and Abbreviations Index
Acknowledgments
This book could not have been written without the support of certain people. My wife Violet Deatherage has supported me in my career and business endeavors for these last 25 years, and supported me throughout the long process of conceiving and writing this book. My children Brett and Ashley have supported me in the excitement of their father writing his first book. Without my familys encouragement, this book would not have been possible. I would also like to acknowledge the support of friends such as Greg Rogers and Ted Benn who have supported me in my endeavor to develop a practice in the areas of climate change, greenhouse gas regulation, renewable energy, and energy efficiency. Others I would like to thank are my friends and clients at Incenergy, primarily Barry McConachie, Jeff Smith, and Liz Cunningham, who have also supported me and encouraged me in this endeavor and inspired me with their development of a demand response company that will become a significant player in this space. I would like to acknowledge the assistance of Jane Peck Hay, Head of the Commodities Legal Team for Direct Energy, who provided guidance and review of the chapter on renewable energy certificates, which was very helpful to me in preparing the important discussion of such an important element of renewable energy projects.
Preface
The origins of this book date back to my attendance of Carbon Expo, a carbon credit conference in Cologne, Germany in 2006. My goal was to learn about the the European Unions Emissions Trading Scheme and the activities surrounding the Kyoto Protocol. I wanted to understand the development of emissions markets for greenhouse gases. I was expecting a conference of a few hundred, but to my surprise found a large conference of several thousand people in attendance. In attendance were regulated industries, banks, investment houses, and entrepreneurs as well as government agencies and ministers focused on the European and international carbon markets and a for-profit mechanism for reducing greenhouse gas emissions. It appeared at that time, that international developments and the scienceas stated by the national academies of science of the major were leading developed and developing nations supported the view that anthropogenic greenhouse gas emissions were leading to climate change and potentially devastating results. It appeared that in time some form of greenhouse gas regulation would evolve in the United States, and the international trading of carbon credits would continue. My conclusion was that opportunity existed to those who understood carbon markets because states in the United States had or were developing greenhouse gas regulatory systems based on an emissions trading scheme, or what we refer to as cap and trade. During the writing of this book, the U.S. Congress first moved toward adopting climate change legislation, and then the legislation stalled in the Senate and appeared to have little chance of passage in the short term. The course of the political debate took several strange turns. As a group of politicians developed their attacks on regulation of greenhouse gases, an unfortunate
xxvi | P R E F A C E
strategy evolved. They began to attack the concept of emissions markets, that is, the concept of cap and trade. The issues of whether or not to regulate greenhouse gases, and what method would be best to carry out such regulation once the decision to regulate was made, were not separated. It does not appear that a national emissions trading market for greenhouse gases will be instituted in the United States, but the concept of emissions markets has and continues to invade various aspects of environmental regulation, and has spread around the world to both developed and developing countries. It has become a part of ongoing economic evolution. Markets that have grown in so many areas, from commodities to finance, and have reached global proportions, have now become part of regulatory programs. What I have discovered is that market-based programs are in fact for the most part considered beneficial and preferable to regulated industries once the decision is reached by governments to regulate a particular environmental issue. While industry likely will try to avoid regulation in the first instance, once the regulatory decision is made to regulate greenhouse gases, industry will likely favor using market-based systems in jurisdictions around the world, rather than a command and control style system where little flexibility exists among industry and third party carbon credit project developers through emissions markets. Even where mandatory regulation does not apply, the development of voluntary systems for trading voluntary reductions has already spread globally, with development of international voluntary standards for carbon credits and carbon credit exchanges in China and Brazil among other countries around the world. Thus, this book is focused on the foundation of greenhouse gas emissions markets and what has occurred at the federal and state level in the United States and internationally. The decision of whether to regulate in a sense precedes the discussion in this book. My interest is focused, once the regulatory decision is made by governments in a particular jurisdiction, in the fundamental structural aspects of greenhouse gas emissions markets and how different jurisdictions have addressed these fundamental aspects, and how the markets have functioned. Since the markets are products of the evolution that occurs once the legal or regulatory structure is established, the legal aspects are of critical importance in terms of the statute and regulations that are issued by regulatory agencies once the general law is established. What I have discovered in researching and writing this book is that the use of market-based systems as a means of regulating emissions and other environmental pollution or degradation is a growing phenomenon. As nations and states appear to be responding to scientific pronouncements regarding the existence and causes of climate change, environmental markets appear to be one of the main tools that will be used to address greenhouse gas emissions. I have been
P R E F A C E | xxvii
amazed as to the power of environmental markets to lead to the emergence of private entrepreneurs who create new technologies, new business plans and companies, and develop new projects to reduce greenhouse gases all with a for-profit motivea sort of greenhouse gas and energy entrepreneurialism. I have discovered that if these systems are created with enough profit potential, private capital in terms of angel investors, venture capitalists, private equity, and banks and other lenders will finance these new entrepreneurs. The incredible self-organizing power of the marketplace can make great strides in energy efficiency, renewable energy, and other means of reducing greenhouse gas emissionsall without government planning or control, but merely the establishment of general rules that then result in the emergence of a private system of greenhouse gas reductions. Adam Smith would be proud of such a system. As a result of the power of environmental markets in lieu of the traditional command and control regulatory systems, carbon trading will continue in some form at the state level in the United States and at an even larger scale in the European Union, Japan, New Zealand, and perhaps China, which will drive an international carbon market for offsets. It appears that both a voluntary carbon market and a carbon market based upon regulatory obligations will continue in the coming decade. Whether the international system will be focused on a United Nations program or bilateral arrangements, or perhaps the G20 and plus five, meaning China, Brazil, India, Mexico, and South Africa, will form their own trading program remains to be seen. The UN negotiations for a successor to the Kyoto Protocol continue, but an agreement seems unlikely in the short term. However the international, national, and subnational developments play out in terms of the reach of carbon markets, it is intended that this book will provide a fundamental explanation of the underlying legal systems that serve to create and sustain carbon credit creation and the trading of these credits, as well as a discussion of a series of related practical and business issues.
Introduction
Carbon trading is a term that has come to be used to refer to trading of greenhouse gas emission allowances needed in jurisdictions that require they be submitted by regulated entities for each ton of greenhouse gases emitted under a regulatory program, or, alternatively offsets from reducing greenhouse gas emissions, whether under a mandatory regulatory system or a voluntary program. This book is designed to provide a discussion of the fundamental legal and business issues that relate to the regulatory and voluntary programs driving greenhouse gas reductions and the trading of allowances and offsets under both regulatory systems and voluntary programs. It is hoped that it will provide the reader a basic understanding of the climate science that is driving emissions reductions, whatever controversy exists, the basic elements of emission markets and cap and trade programs, and the concepts underlying carbon credits and carbon trading. This book is not intended as a science book, but it is important to lay out the science that is driving the regulations that have been evolving over the last twenty years or more regarding international treaties, national regulatory programs in most of the industrialized countries, and evolving programs at the state or provincial level. The chapter on climate science attempts to lay out the conclusions of the national academies of science, including the U.S. academy, and the International Panel on Climate Change, the United Nations group of scientists enlisted to provide reports regarding climate change and its potential impacts. Not surprisingly, all scientists do not necessarily agree with all of these conclusions or studies. Controversy has erupted at the political and business association level as to the potential economic impacts.
xxx | I N T R O D U C T I O N
The reality is that science issues are addressed by the national academies, and their conclusions tend to drive public policy. As many in various industries have concluded, it is probable that in time all developed countries will have some form of national regulation of greenhouse gases. Even though no legislation has been passed at the national level in countries such as the United States or Australia, programs have been established at the state or subnational level. Thus, regulation exists or is developing in both countries. In the United States, the U.S. Environmental Protection Agency has issued regulations governing greenhouse gas emissions following a Supreme Court decision interpreting the current federal Clean Air Act. Historically, when the scientific academies reach conclusions regarding environmental matters, then in time, regulation to address those conclusions tends to follow. Whatever the ultimate decisions by local, state, national, and international entities may make regarding climate change and greenhouse regulation, this book is intended to provide an explanation of how environmental markets can be used to reduce the costs of greenhouse gas regulation if in fact regulations are established in any particular jurisdiction to regulate these emissions. This book is dedicated to reviewing the regulatory systems that have emerged and continue to emerge to address climate change and greenhouse gas emissions. Emission markets, and how they evolved and then were applied to greenhouse gas emissions, is a fundamental background that needs to be explored. Initially, environmental regulation focused on setting reductions in emissions or environmental degradation. In the United States, this led to thousands of pages of state and federal regulations across all fifty states that proscribed actions and prohibited other actions mostly of business and industry to reduce environmental impact. This approach has come to be known as command and control. Over time, economists and lawyers began formulating concepts that applied market principles to environmental regulation. One of the most famous of which is the emission market for sulfur dioxide emissions from coal-fired power plants established in the United States under the Clean Air Act. This program has largely been seen as a success in achieving the emission-reduction goals at lower cost than either industry or the government predicted. Emission markets have been applied to air pollutants of other types such as volatile organic compounds and nitrogen oxides that are the precursors to ground-level ozone that creates smog and particulates that can cause health problems and that are usually problematic in urban environments. Environmental markets have been established for other environmental concerns as well. Wetlands, water quality and quantity, species, habitat, and biodiversity are some of the markets that have emerged or that are beginning to emerge
I N T R O D U C T I O N | xxxi
and evolve. Markets for renewable energy and energy efficiency credits have emerged to increase the percentage of electricity produced from renewable energy sources. Thus, in addition to carbon credits, a variety of other environmental credits known as environmental attributes can be produced and sold and, thus, through a market system, drive the increased environmental performance and achieve the goals of environmental regulation with more flexibility than the traditional command and control approach. When the international community began developing an international treaty to address greenhouse gas emissions, it is not surprising that the United States that had pioneered the use of emission markets to address sulfur dioxide emissions in the 1990 Clean Air Act Amendments would argue for a cap and trade system and emission markets as a critical part of addressing climate change and reducing greenhouse gases on a global basis. The Kyoto Protocol was drafted to meet these goals, and emissions trading was a central part of the treaty. Since its beginning, billions of dollars in trading has occurred. The European Union established the European Trading Scheme that was designed to implement the Kyoto Protocol in Europe. This program has resulted in hundreds of billions of dollars in carbon trading. Other nations are considering emissions trading programs and exchanges, including Australia, Japan, China, Brazil, and South Korea. Thus, the concepts of emissions trading have spread throughout the global economy. The adoption of these programs still face opposition as a concern about costs and global competitiveness have led to many companies and industry associations opposing their adoption. On the other hand, many groups that would manufacture energy equipment that drives a low carbon energy source, such as solar photovoltaic panels, wind turbines, LED lights, and other renewable and energy-efficient projects, are advocating for legislation to drive a low carbon economy. In any event, the current legal systems that impose a cap and trade program are explained in the book. The elements of a cap and trade program are explained generally and then specific adopted or proposed systems internationally and in the United States. These chapters will orient the reader to the fundamentals of the legal requirements applying to regulated entities and the establishment of the parameters of an allowance and offset market. For greenhouse gas emission offsets, the necessities of established offset methodologies governing the ability to obtain offsets for particular types of projects are explained. Forest projects are explained in particular detail as they provide the largest potential source of carbon offsets and provide a means of reducing the deforestation and degradation of the worlds forests, particularly the remaining rainforests of the Amazon, Asia, and Africa. The financing of these
xxxii | I N T R O D U C T I O N
projects is outlined with discussion of the particular challenges in attracting both debt and equity financing for carbon credit projects. Once projects are financed, they must go through a rigorous process from governmental or nonprofit standards boards in order to obtain approval of the project as meeting a particular established methodology and then obtaining approval of the amount of greenhouse gases reduced and then the number of carbon credits issued. The challenges of the existing programs of the Kyoto Protocol and the United Nations implementation of the offset programs are discussed. The purchase and sale of carbon credits is explained. In particular, the contracts and the provisions typically included in those contracts are detailed. The bilateral nature of initial sales of credits along with the secondary market for trading carbon credits on a spot basis and in terms of futures contracts are presented. Both before and after the recent economic recession, government incentives have been provided for projects that reduce greenhouse gas emissions. Renewable energy and energy efficiency receive much of these incentives, but other activities such as carbon capture and storage below ground are discussed as well. Many of these projects may qualify for governmental or utility incentives in the United States and potentially other countries. Accounting for greenhouse gas emissions and carbon credits has become a significant issue for companies with operations in jurisdictions with greenhouse gas regulatory systems. The state of the still evolving accounting standards of U.S. and international accounting boards is discussed. A strategic approach of preparing a carbon ledger is proposed for consideration by affected companies. Financial disclosure related to climate change and greenhouse gas regulation has become a critical issue to companies as well. The U.S. Securities and Exchange Commission has recently issued guidance for companies in applying the agencys rules to climate change and greenhouse gas issues in terms of how legislation impacts the physical and financial operations of the company, to corporate reputation. In the European Union and the United States, mandatory greenhouse gas monitoring and reporting programs have been instituted. Many companies participate in voluntary disclosure in environmental, sustainability, or greenhouse gas programs. Climate change disclosure has likely become a permanent fixture in corporate disclosure, both in terms of mandatory financial disclosure and voluntary disclosure protocols. The development of a cap and trade program in the United States presents uncertainty for U.S. and global carbon markets, and the availability of debt and equity investment as a result of this uncertainty and the general state of domestic
I N T R O D U C T I O N | xxxiii
and international economies presents challenges to carbon credit project developers and the market for credits they produce. Prices have fallen significantly for carbon credits in the European market, the largest market for carbon credits. These prices reflect uncertainties to some extent in future regulatory programs but also the general economic, business, and financial uncertainty facing national and global economies and markets. One of the remarkable developments in the context of economies and markets related to greenhouse gas emissions and carbon credits is that industries and businesses in the United States, where a national carbon credit program has not yet emerged, are still looking for a means of monetizing reductions in greenhouse gas emissions that they are asked to implement by customers, shareholders, or corporate reputation, and as entrepreneurs they are accomplishing this through renewable energy, energy efficiency, and other products or services that reduce greenhouse gas emissions. This is one of many indications that carbon trading has spread into the economy, and businesses are looking for opportunities to obtain financial reward for their emission reductions. The concept of environmental markets and of carbon credits specifically has in a sense entered the marketplace. It is difficult to remove these concepts from the market once they have been introduced. In the future, whether emissions of greenhouse gases, sulfur dioxide, mercury, or nitrogen oxides, environmental markets provide a means of achieving the regulatory goal of reducing emissions at the lowest cost and giving industry the greatest flexibility. Carbon credits and emission markets as a means of addressing climate change and greenhouse gas emissions appear to be a fixture in current and future economies. The extent of the application of cap and trade programs and emission markets to greenhouse gas emissions appears to be growing, but elections and votes in state and national legislatures will determine to what extent these programs expand around the globe. It appears clear that Europeans will continue their Emissions Trading Scheme, and a $100 billion market or more will continue to grow and evolve over the next five to ten years. At least some state carbon market programs in the United States appear to be set to begin in 2012. Thus, this book will hopefully serve to educate those who are looking for a fundamental understanding of carbon trading law and business.
PART
ONE
The Emergence of Carbon Markets
Prelude to RegulationThe Development of Climate Change Science
To understand the purpose of carbon trading, one first has to understand the basic science underlying the concern with climate change. Carbon markets evolved as a response to a policy decision to reduce the impact of climate change. It is important to keep in mind the effort to engage governmental organizations, whether at the international, national, or subnational level, to develop a regulatory system, to reduce GHG emissions, and to find alternative means of producing energy, fueling vehicles, and increasing energy efficiency, derives from scientific institutions that caution these governments that action is necessary to reduce the risk of potentially significant damage to people, economies, and societies. While there is much controversy over climate science, as will be discussed below, the scientific academies of the major developed and developing nations are largely in agreement on climate change and its causes. The actual climate trends over the coming decades and further scientific research of what it causing these trends will eventually show whether current views of scientific academies are correct. In the near term, the question is to what extent the conclusions of the national academies and other scientific institutions will impact policy such that the United States at the national or state level will enact climate change statutes and GHG regulations, and the countries of the United Nations will adopt an international treaty to follow on or as an extension of the Kyoto Protocol, and what actions other major emitters in the developed and developing world will take as a result of the conclusions of the major scientific institutions.
4 | THE EMERGENCE
OF
CARBON MARKETS
If a decision is made to regulate and reduce GHG emissions, then the best means of reducing the impact on industry, the economy, and consumers is a critical issue. Much of the controvery over GHG regulation centers on the economic impact of climate change and GHG legislation. Thus, the use of emissions markets can provide a major contribution to reducing these impacts. This chapter will address the scientific issues and controversies as an introduction, but in the remaining chapters will mainly focus on carbon trading law and trading systems, and their use to reduce economic impacts of GHG regulation.
A. Typical Process of Regulation Following Science

In human systems, whether political, social, or economic, change through adaptation and innovation occurs as a result of a change in the surrounding circumstances. Here, substantial change has occurred as a result of the conclusions of the scientific institutions that the emission of GHGs is causing significant changes to the climate. The process has followed the evolution of other areas of environmental regulation over the last forty or fifty years. Historically, in the United States, evolution of a new environmental law typically occurs as follows:
A scientific discovery leads to a specific environmental concern; The scientific discovery is reviewed by multiple scientists and peer-reviewed
by scientific journals and state and national scientific academies;

A social or political movement regarding the issue emerges and lobbies
for state and federal action;

Legislative activity at the state level leads to state laws governing the issue; and After some period of time, congressional action in the form of an
environmental bill leads to a new federal statute or significant amendment to an existing statute. The concern over climate change and the impact to people, ecosystems, agriculture, society, and the economy have generated the same general pattern. To understand how this has come about, it is important to understand the science that underlies the movement for new GHG legislation at the US and international level. This chapter will review the science that has served as the starting point for the emergence of regulatory programs to reduce GHGs, and ultimately the topic of this book will be the use of a cap and trade system and carbon credits to attempt to harness the power of the marketplace to reduce the GHG emissions, which the scientific academies, as explained below, have concluded are causing climate change.
P R E L U D E T O R E G U L A T I O N T H E D E V E L O P M E N T O F C L I M A T E C H A N G E S C I E N C E | 5
B. The Greenhouse Effect

The first step to understanding climate science is to understand the greenhouse effect. The greenhouse effect is the basis for identifying and reducing emissions of gases that contribute to an increased greenhouse effect. To understand the greenhouse effect, it is first necessary to comprehend that the Earths surface would be expected to be about 19C on average. Actually the Earths surface (the global mean surface temperature) is about +14C. The reason the Earths surface is this warm is the presence of GHGs, which act as a partial blanket for the long wave radiation coming from the surface. This blanketing is known as the natural greenhouse effect.1 The greenhouse effect allows life as we know it to exist on Earth; without it, the surface would be too cold for current life to have evolved and survived. The two most important natural GHGs are water vapor and carbon dioxide. Carbon dioxide is the most significant GHG emitted from human activity. Methane and nitrous oxide are GHGs that are both emitted by human activity and occur in nature, while other GHGs such as perfluorocarbons and sulfur trifluoride are now being emitted by human activity that may not occur in nature or are uncommon in nature.
C. The Science of Climate Change

Scientists have been measuring temperature in the atmosphere for many decades. According to the national academies of science and other scientific institutions, observations and measurements show that the climate is in fact changing, from melting glaciers, to other effects that could have significant impacts on cities, states and provinces, and national governments, as well as the people who inhabit these areas.
1. Conclusions of Scientific Institutions

a. The International Panel on Climate Change The International Panel on Climate Change (IPCC) is the international institution created by the United Nations to study climate change and its causes. It has concluded that climate change is in large part being caused by human emissions of GHGs. Over the last hundred years the concentration of carbon dioxide in the environment has steadily risen. The IPCC in its 2007 report stated, Human activities intensify the blanketing effect through the release of GHGs.
1. Intergovernmental Panel on Climate Change, Fourth Assessment Report, Chapter 1: Historical Overview of Climate Change Science, at 97 (2007) (hereinafter Climate Change Science).
6 | THE EMERGENCE
OF
CARBON MARKETS
For instance, the amount of carbon dioxide in the atmosphere has increased by about 35% in the industrial era, and this increase is known to be due to human activities, primarily the combustion of fossil fuels and removal of forests. Thus, humankind has dramatically altered the chemical composition of the global atmosphere with substantial implications for climate.2 The IPCC concluded that most of the observed increase in global average temperatures since the mid-twentieth century very likely is caused by the observed increase in GHG concentrations resulting from human emissions. The IPPC further concluded that it is likely that significant warming in global average temperatures over the past fifty years averaged over each continent (except Antarctica) is caused by human GHG emissions.3 The IPPC evaluated other potential causes for global warming and areas of uncertainty. With respect to the impact of solar and volcanic activity over the last fifty years, which has been one of the potential causes of global warming asserted by parties who do not accept the conclusions of the IPCC and other scientific institutions, the IPCC determined that these phenomena would likely have produced cooling, rather than warming. Issues still remain in terms of the ability of climate scientists to evaluate all aspects of climate change and its causes. For example, the IPPC stated that difficulties remain in simulating and attributing observed temperature changes at smaller than continental scales.4 The IPPC has concluded that discernible human influences extend beyond average temperature to other aspects of climate. The scientists of the panel stated that human influences have very likely contributed to sea-level rise during the latter half of the twentieth century, likely contributed to changes in wind patterns, affecting extratropical storm tracks and temperature patterns; likely increased temperatures of extreme hot nights, cold nights, and cold days; and more likely than not increased risk of heat waves, areas affected by drought since the 1970s, and frequency of heavy precipitation events. Anthropogenic warming over the last three decades has likely had a discernible influence at the global scale on observed changes in many physical and biological systems.5 Spatial agreement between regions of significant warming across the globe and locations of
2. Climate Change Science, at 97. 3. Intergovernmental Panel on Climate Change, Fourth Assessment Report, Chapter 9: Understanding and Attributing Climate Change at 665 (2007) (hereinafter Attributing Climate Change). 4. Id. 5. IPCC 2007: Climate Change 2007: Synthesis Report, Contribution of Working Groups I, II, and III to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change [Core writing team, R. K. Pachauri and A. Reisinger (eds.)]. IPCC, Geneva, Switzerland, at 3033, available at http://www.ipcc.ch/publications_and_data/ar4/syr/en/contents.html.
significant observed changes in many systems consistent with warming is very unlikely to be due solely to natural variability.6 The IPCC has predicted future likely impacts due to climate change on the various continents.7 These impacts are stated below.
i. Africa
By 2020, between 75 and 250 million people are projected to be exposed to increased water stress due to climate change. By 2020, in some countries, yields from rain-fed agriculture could be reduced by up to 50 percent. Agricultural production, including access to food, in many African countries is projected to be severely compromised. This would further adversely affect food security and exacerbate malnutrition. Towards the end of the twenty-first century, projected sea-level rise will affect low-lying coastal areas with large populations. The cost of adaptation could amount to at least 5 to 10 percent of gross domestic product (GDP). By 2080, an increase of 5 to 8 percent of arid and semi-arid land in Africa is projected under a range of climate scenarios.
ii. Asia
By the 2050s, freshwater availability in Central, South, East, and South-East Asia, particularly in large river basins, is projected to decrease. Coastal areas, especially heavily populated mega delta regions in South, East, and South-East Asia, will be at greatest risk due to increased flooding from the sea and, in some mega deltas, flooding from the rivers. Climate change is projected to compound the pressures on natural resources and the environment associated with rapid urbanization, industrialization, and economic development. Endemic morbidity and mortality due to diarrhea disease primarily associated with floods and droughts are expected to rise in East, South, and South-East Asia due to projected changes in the hydrological cycle.
iii. Latin America

By mid-century, increases in temperature and associated decreases in soil water are projected to lead to gradual replacement of tropical forest by savanna in eastern Amazonia. Semi-arid vegetation will tend to be replaced by arid-land vegetation. There is a risk of significant biodiversity loss through species extinction in many areas of tropical Latin America. Productivity of some important crops is projected to decrease and livestock productivity to decline, with adverse
6. Id. at 39. 7. Id. at 5052.
8 | THE EMERGENCE
OF
CARBON MARKETS
consequences for food security. In temperate zones, soybean yields are projected to increase. Overall, the number of people at risk of hunger is projected to increase. Changes in precipitation patterns and the disappearance of glaciers are projected to significantly affect water availability for human consumption, agriculture, and energy generation.
iv. North America

Warming in western mountains is projected to cause decreased snowpack, more winter flooding, and reduced summer flows, exacerbating competition for overallocated water resources. In the early decades of the century, moderate climate change is projected to increase aggregate yields of rain-fed agriculture by 5 to 20 percent, but with important variability among regions. Major challenges are projected for crops that are near the warm end of their suitable range or which depend on highly utilized water resources. Cities that currently experience heat waves are expected to be further challenged by an increased number, intensity, and duration during the course of the century, with potential for adverse health impacts. Coastal communities and habitats will be increasingly stressed by climate change impacts interacting with development and pollution.
v. Europe
Climate change is expected to magnify regional differences in Europes natural resources and assets. Negative impacts will include increased risk of inland flash floods and more frequent coastal flooding and increased erosion (due to storminess and sea-level rise). Mountainous areas will face glacier retreat, reduced snow cover, and winter tourism, and extensive species losses (in some areas up to 60 percent, under high emissions scenarios, by 2080). In southern Europe, climate change is projected to worsen conditions (high temperatures and drought) in a region already vulnerable to climate variability, and to reduce water availability, hydropower potential, summer tourism, and, in general, crop productivity. Climate change is also projected to increase the health risks due to heat waves and the frequency of wildfires.8
b. National Academies of Science of the Major Emitting Developed and Developing Countries In addition to the IPCC, the national academies of sciences of the G8 nations, which consist of Canada, France, Germany, Italy, Japan, Russia, the United Kingdom,
8. Id. at 50.
and the United States,9 and the national academies of science of the +5Brazil, China, Mexico, South Africa, and India, five of the largest developing nations and economieshave considered the climate change and causation evidence and issued joint statements on these issues. The national academies of science from these countries have issued statements calling on national governments to take action to reduce GHGs and to develop means of adapting to climate change. In 2005, the national academies from the G8+5 signed a document declaring that there is strong evidence that climate change is occurring and that human activity is likely the cause of that change. There will always be uncertainty in understanding a system as complex as the worlds climate. However there is now strong evidence that significant global warming is occurring. The evidence comes from direct measurements of rising surface air temperatures and subsurface ocean temperatures and from phenomena such as increases in average global sea levels, retreating glaciers, and changes to many physical and biological systems. It is likely that most of the warming in recent decades can be attributed to human activities (IPCC 2001). This warming has already led to changes in the Earths climate.10 The 2005 statement called on the nations of the world to take action to reduce GHG emissions, to prepare for the adverse consequences of climate change that cannot now be avoided and to mitigate and adapt to such changes, and to develop and deploy clean energy technologies and approaches to energy efficiency, and to share this knowledge of technologies and approaches with other nations. These national academies issued two more statements in 2007 and 2008 regarding climate change. In 2007, the national academies concluded in a joint statement that the countries of the world should take the following actions:
Set standards and promote economic instruments for efficiency, and commit
to promoting energy efficiency for buildings, devices, motors, transportation systems, and in the energy sector itself; Promote understanding of climate and energy issues and encourage necessary behavioral changes within our societies; Define and implement measures to reduce global deforestation;
9. The European Union is part of the G8, but cannot host or chair the G8 meetings. 10. Joint Science Academies Statement: Global Response to Climate Change (2005).
10 | T H E E M E R G E N C E
OF
CARBON MARKETS
Strengthen economic and technological exchange with developing countries,
in order to leapfrog to cleaner and more efficient modern technologies; and

Invest strongly in science and technology related to energy efficiency,
zero-carbon energy resources, and carbon-removing technologies.11 In addition, these scientific academies advocated that national governments develop new sources for energy supply, including clean use of coal, carbon capture and storage, unconventional fossil fuel resources, advanced nuclear systems, advanced renewable energy systems (including solar, wind, biomass, and geothermal energy), smart grids, and energy storage technologies. In 2007, the InterAcademy Council, which consists of numerous national academies, issued a report entitled, Lighting the Way: Toward a Sustainable Energy Future.12 This report was commissioned by the governments of Brazil and China. The report provided what it considered a scientific consensus framework for directing global energy development, in terms of a science, technology, and policy road map for developing energy resources to drive economic growth in both industrialized and developing countries while also securing climate protection and global development goals. The report was prepared by a study panel of fifteen world-renowned energy experts, and co-chaired by Nobel Laureate Steven Chu, formerly the Director of the Lawrence Berkeley National Lab in the United States, who later became the U.S. Secretary of Energy, and Jos Goldenberg, former Secretary of State for the Environment for the State of So Paulo, Brazil. In 2008, the G8+5 academies issued another statement. In this statement, the academies called for mitigation to reduce further change in the climate and adaptation to address climate change that is already set to occur. Responding to climate change requires both mitigation and adaptation to achieve a transition to a low carbon society and our global sustainability objectives. We urge all nations, but particularly those participating in the 2008 G8 Summit in Hokkaido, Japan, to take the following actions: Call on G8+5 governments to agree, by 2009, a timetable, funding, and a coordinated plan for the construction of a significant number of CCS demonstration plants.
11. Joint Science Academies Statement on Growth and Responsibility: Sustainability, Energy Efficiency and Climate Protection (2007). 12. InterAcademy Council, Lighting the Way: Toward a Sustainable Energy Future (October 2007).
P RE L U D E T O R E G U L A T I O N T H E D E V E L O P M E N T O F C L I M A T E C H A N G E S C I E N C E | 11 Prepare for the challenges and risks posed by climate change by
improving predictive and adaptive capacities at global, national and local level and supporting the developing world in carrying out vulnerability analyses and addressing their findings. Take appropriate economic and policy measures to accelerate transition to a low carbon society and to encourage and effect changes in individual and national behavior. Promote science and technology co-operation, innovation and leapfrogging, e.g., by transfer of some basic critical low-carbon and adaptation technologies. Urge governments to support research on greenhouse gas reduction technologies and climate change impacts. As national science academies, we commit to working with our governments to help implement these actions.13 In reviewing the statements of these national academies of science from the most significant nations in terms of GHG emissions, it is clear that a consensus exists among these academies in terms of climate change science and the actions they believe their respective governments should take in terms of climate mitigation and adaptation.
c. In the United States: the National Research Council and the National Academy of Sciences In May 2001, the White House asked the National Research Council, which is a part of the National Academy of Sciences, to assess our current understanding of climate change by answering some key questions related to the causes of climate change, projections of future change, and critical research directions to improve understanding of climate change. In a report entitled Climate Change Science: An Analysis of Some Key Questions, the Academy concluded that changes observed over the last several decades are likely mostly due to human activities.14 The National Research Council and the National Academy of Sciences have not varied from the conclusion over the last nine years that the climate is changing and that the cause is largely human GHG emissions.
13. Joint Science Academies Statement: Climate Change Adaptation and the Transition to a Low Carbon Society (2008). 14. Climate Change Science: An Analysis of Some Key Questions (2001).
OF
CARBON MARKETS
D. The Policy Impact of the Conclusions of the National Academies of Science

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

The conclusions in the reports and statements by the IPCC, the national academies of science of the G8+5, and the U.S. National Academy of Sciences and various other U.S. science entities, are not without controversy among the public and certain scientists, whose opporsition is vociferous to say the least. Beyond scientists, representatives of industry and business groups, politicians, and certain media have attacked not only the conclusions of those who have published scientific papers and participated in the academies, universities, and the IPCC, but their character as well, asserting that the conclusions were based on fraud, not legitimate science. Thus, the debate among the public and policymakers has been extreme in certain countries, particularly Australia and the United States, the only industrialized country not to ratify the international climate agreement known as the Kyoto Protocol. An example of a strong advocate against climate science is Richard S. Lindzen, a professor of meteorology at the Massachusetts Institute of Technology. He has argued that in fact the climate is not changing in any way that reflects a warming trend.15 Other scientists have reached similar conclusions, or that if climate change is occurring that the cause is not in fact GHG emissions from human activities.
15. Richard S. Lindzen, The Climate Science Isnt Settled: Confident Predictions of Catastrophe Are Unwarranted, The Wall Street Journal, Nov. 30, 2009.
P RE L U D E T O R E G U L A T I O N T H E D E V E L O P M E N T O F C L I M A T E C H A N G E S C I E N C E | 13
The U.S. Chamber of Commerce has issued somewhat inconsistent statements about climate science and GHG regulation. After the U.S. Environmental Protection Agency (EPA) issued what is known as an Endangerment Finding (which will be discussed in a later chapter) saying that GHGs are endangering human health and welfare, William Kovacs, the Vice President for Environment, Technology, and Regulatory Affairs of the U.S. Chamber called for the Scopes monkey trial of the 21st century that would include witnesses, cross-examinations, and a judge who would determine if anthropogenic GHG emissions were causing climate change. Mr. Kovacs stated, It would be evolution versus creationism. It would be the science of climate change on trial.16 Later, Mr. Kovacs revised his response to a question posed on the National Journal Energy and Environment blog. He said, My Scopes monkey analogy was inappropriate and detracted from my ability to effectively convey the Chambers position on this important issue.17 Mr. Kovacs reiterated his call for a trial of the EPAs Endangerment Finding and the science underling the conclusions in the finding. One of the most significant controversies over climate science arose over what some have called Climate Gate. In November of 2009, computer hackers of unknown origin hacked into computers of climate scientists at the Climate Research Unit at the University of East Anglia in Great Britain. Subsequently, e-mails and documents obtained illegally from these computers were posted on the Internet. Some reviewers considered statements in these documents and e-mails to reveal scientific misbehavior, and that these climate scientists had conspired to overstate the science on climate change.18 The head of the program actually resigned pending investigations of the allegations. The criticism of East Anglia scientists and those who worked with them was blistering. The criticism grew to even challenging the credibility of science itself. Daniel Henninger, an editorial writer for The Wall Street Journal wrote an editorial that stated the following: What is happening at East Anglia is an epochal event. As the hard sciencesphysics, biology, chemistry, electrical engineeringcame to dominate intellectual life in the last century, some academics in the
16. Jim Tankersley, U.S. Chamber of Commerce Seeks Trial on Global Warming, L.A. Times, Aug. 25, 2009. 17. National Journal Experts Blog: Energy & Environment (Aug. 31, 2009), available at http:// energy.nationaljournal.com/2009/08/should-epa-bow-to-chambers-dem.php#1349896 (last visited Sept. 3, 2010). 18. Andrew C. Revkin, Hacked E-Mail Is New Fodder for Climate Dispute, N.Y. Times, Nov. 20, 2009.
OF
CARBON MARKETS
humanities devised the theory of postmodernism, which liberated them from their colleagues in the sciences. Postmodernism, a self-consciously unprovable theory, replaced formal structures with subjectivity. With the revelations of East Anglia, this slippery and variable intellectual world has crossed into the hard sciences. *** If the new ethos is that close-enough science is now sufficient to achieve political goals, serious scientists should be under no illusion that politicians will press-gang them into service for future agendas. Everyone working in science, no matter their politics, has an [sic] stake in cleaning up the mess revealed by the East Anglia emails. Science is on the credibility bubble. If it pops, centuries of what we understand to be the role of science go with it.19 Several investigations were conducted regarding these scientists activities. The conclusions were that the science was not in question, but criticisms were lodged against some of the scientists that were involved in terms of openness and transparency and certain other behaviors.20 The IPCC issued statements that hundreds of scientists across the world work on the scientific issues and that the lines of multiple lines of evidence support the work of the scientific community on climate change.21 The American Association for the Advancement of Science and the American Meteorological Society issued similar statements.22 As a result the political controversy over climate science and its conclusions remain at high levels. These are only some of the controversies and criticisms of climate science, and there are scientists who question whether climate change is occurring, or if it is occurring, whether human activity is a cause of that change.
19. Daniel Henninger, Climategate: Science Is Dying, The Wall Street Journal, Dec. 3, 2009, available at http://online.wsj.com/article/SB10001424052748704107104574572091993737848.html. 20. Ron Oxburgh, Huw Davies, Kerry Emanuel, Lisa Graumlich, David Hand, Herbert Huppert, & Michael Kelly, Report of the International Panel Set Up by the University of East Anglia to Examine the Research of the Climatic Research Unit, University of East Anglia (April 14, 2010); The Pennsylvania State University, Final Investigation Report Involving Dr. Michael E. Mann ( June 4, 2010). 21. International Panel on Climate Change, IPCC Chairman Statement on News Reports Regarding Hacking of the East Anglia University Email Communications (Dec. 4, 2009), available at http://www.ipcc.ch/pdf/presentations/rkp-statement-4dec09.pdf. 22. American Association for the Advancement of Science, AAAS Reaffirms Statements on Climate Change and Integrity (Dec. 12, 2009), available at http://www.aaas.org/news/ releases/2009/1204climate_statement.shtml; American Meteorological Society, Impact of CRU Hacking on the AMS Statement on Climate Change (Nov. 25, 2009), available at http://www. webcitation.org/5lnFDGhdZ.
P RE L U D E T O R E G U L A T I O N T H E D E V E L O P M E N T O F C L I M A T E C H A N G E S C I E N C E | 15
The public debate on climate science is likely to continue, which will likely effect in some states and at the national level any attempt to impose GHG regulations.
F. Future Policy Development Based on Climate Science

While the controversy may not end any time soon, climate science will continue to serve as the foundation of evolving climate change regulation. That the U.S. National Academy of Science and the National Research Council have provided conclusions on the issues will likely serve as the basis for future climate change and GHG regulation at the state and federal level in the United States. Elected officials will determine to what extent any legislation and regulations will be developed to regulate GHGs, or, once government agencies initiate regulatory programs, whether the legislators will act to block such programs. It is beyond the purview of this book to attempt to resolve any controversy or disagreement over the conclusions of the IPCC, scientific academies, or individual scientists. The point of this chapter is to note the scientific conclusions outlined above, and recognize the trends in environmental regulation over the last forty or fifty years. On this basis, climate science has led to GHG regulation in many countries at the national and international level, and at the state and provincial level, and even among local governments both in the United States and in other countries. Thus, climate science, like prior environmental science, has and likely will continue to drive GHG regulation. To what extent a particular jurisdiction will reject or adopt regulation remains to be seen.
The Emergence of Emissions Trading Concepts

A. Economics vs. the Environment
In the early 1970s, in the United States, Congress began adopting environmental statutes as it became clear that the economic development brought on by industrialization was creating very damaging environmental and public health issues, as well as significant degradation of our natural ecosystems. Statutes designed to reduce air pollution and water pollution were the first ones passed. In the following decades, statutes were passed to regulate solid and hazardous waste treatment storage and disposal and to cleanup abandoned hazardous waste disposal sites. Over the last fifty years, Congress has amended and strengthened these environmental statues. The initial approach to environmental protection was to set specific standards and procedures to govern air and wastewater emissions from specific sources of those pollutants. In other words, the regulated party has to comply with technology standards. Each facility also must obtain a permit that dictates specific limitations that apply to that facility, in addition to the more general requirements that the regulations impose on all facilities. This model resulted in hundreds of federal regulations being created by the U.S. Environmental Protection Agency (EPA). Failure to follow these regulations could result in civil and criminal sanctions. The model of the early environmental protection approach has been known as the command and control model. Under this model, the government sets out the specific standards in great detail that each regulated party must follow,
THE E MERGENCE
OF
E M I S S I O N S TR A D I N G C O N C E P T S | 17
and uses the threat of civil and criminal sanctions to motivate the industrial sources to comply. The model is based on a concept that, left to their own devices, companies will pollute without regard to the environmental impact, in order to avoid the costs of pollution that are externalized to society and the environment at large. Thus, government regulations are needed to force companies to internalize these costs and thereby reduce the level of pollutants released to the society and the environment. Inherent in this model is a fundamental view that the economy and economic development are damaging to the environment, and regulation is needed to force through government fiat economic actors to reduce this impact.
B. Evolution of Environmental Regulation and Emergence of Environmental Markets

The concept of markets as a form of government regulation is based initially on the basic principles of economic markets, as described above. The evolution is the combining of concepts of economics and environment, which have been and often are in conflict. On the one hand, economics and economists could not put a value on ecosystems or their component parts, such as habitat, species, water bodies, or the various living, physical, or chemical parameters, the change of which can have significant damaging effect on ecosystems and the flora and fauna that make up an ecosystem. On the other hand, ecologists could not comprehend economicsfinancial value and preservation of ecosystems were not consistent. No price could be put on the value of a habitat or a species. These two disciplines have been hybridizing at the margins in significant ways over the last few decades. In part, as the human agents making up human society and economies have begun to recognize the problems with having two systems that do not work in any harmonizing way, and that tend to work against the success of the other. Concepts of ecological or environmental value have evolved as governments attempt to impose the costs of damages to ecosystems on private parties or firms that have caused these damages.
C. Emissions Trading as a Means of Bridging the Divide between the Economy and Environment
The particular relevance for emissions trading is the need in the climate change context to make millions of decisions about taking actions in millions of places all over the world, or even at the state or national level. No governmental or centralized process can possibly manage such a system or even attempt to manage such a system in any efficient way, both in terms of cost or time. To think a
OF
CARBON MARKETS
United Nations program to identify and fund hundreds of thousands of projects around the world or to ask national governments to identify and fund thousands of projects in any one country, particularly the developed and larger developing countries, is simply not workable. Thus, a system that can allow individual agents acting on their own to search out the space of possibilities and find the most efficient and financially viable projects requires another approach. Emissions marketsor in the case of greenhouse gas emissions, carbon marketsserve to allow a complex system to allow adaptive agents, that is entrepreneurs and private capital, to search out projects first identified by the entrepreneurs or carbon credit project developers and then financed if the capital markets, international development bankslargely originally the World Bank and then private equity, private banks, new organisms called carbon funds, and other capital providers to decide the projects are viable and can return sufficient profits. Through setting up this private market via the Kyoto Protocol, that will be discussed in more detail in Chapter 4, and the European Union Emissions Trading Scheme, that will be discussed in more detail in Chapter 5, an international system of greenhouse gas emission reductions and a carbon market emerged from the primordial soup of entrepreneurs and capital providers based on the simple regulatory and market rules that were set up and the activities of thousands of adaptive agents. Theory and reality, thus, show that emissions markets and a cap and trade system actually work. Under the Kyoto Protocols Clean Development Mechanism alone, approximately 431,090,634 tons of greenhouse gas reductions have occurred largely through private project developers and private capital investment.1 No central governmental system was used to select the projects or to fund the projects, but the origin of the projects was largely through carbon credit project developers seeking out and finding funding for the projectsan environmental market in action.
D. Basic Concepts of Emissions Trading

To comprehend how this decentralized and self-organizing system or systems work, the first step is to understand cap and trade. This concept confuses many people who are not familiar with environmental regulation in general or the cap and trade programs developed under the U.S. Clean Air Act that were then incorporated in the Kyoto Protocol and the European Union Emissions Trading
1. United Nations Framework Convention on Climate Change, Clean Development Mechanism, available at http://cdm.unfccc.int/Statistics/Issuance/CERsRequestedIssuedBarChart.html (last visited Sept. 3, 2010).
THE E MERGENCE
OF
Scheme (EU ETS) specifically. The concept derives from a principle known as emissions trading, generally discussed above, through which pollution rights may be bought and sold between emitters of pollution. Under such a system, a company may reduce emissions at its facility or purchase emission rights from a party that has reduced its own emissions beyond those required by pollution regulations. This system of trading of allowances between polluting facilities permits less efficient pollution-reducing facilities to purchase allowances from more efficient pollution-reducing facilities. What emerges from this market system is a self-organizing system. The pollution rights are usually referred to as emission allowances and form what is often referred to as a cap and trade system. The cap is the limit placed on a state or country for a relevant type of emission of air pollution. The trade is the market for pollution allowances between regulated polluting facilities, in addition to purchases of another regulated facilitys allowances. The cap and trade systems typically also allow the use of what are known as pollution offsets. Offsets are generally reductions of emissions from activities that are not part of the regulated industry. The offsets can be used to meet the reductions required by a regulated polluting facility. In a cap and trade system where allowances are granted to a facility in a regulated industry, a particular facility may meet its reductions in emissions by reducing its emissions, buying another regulated facilitys allowances or buying offsets from a party in another industry or business. The system must also impose substantial fines for failing to meet the emission limits. The fines must be much higher than the cost of reducing its emissions and/or buying allowances or offsets to make the system work. Otherwise, the regulated facility would simply pay a fine rather than reducing its emissions or buying allowances or offsets. In other words, a cap and trade system is basically a market of emission allowances and offsets, where industry is forced to participate in the system by continually lowering allowed emissions generally and by each regulated facility. An example may provide the best way to understand the concept. Assume that two coal-fired power plants are required to reduce their emissions by 10,000 tons of carbon dioxide (CO2) each in order to meet a permitted limit on emissions. Lets say the first power plant, Plant A, can either install equipment to reduce the emissions or may buy allowances or offsets to meet that 10,000-ton limit. Plant B has the ability to reduce its emission by 15,000 tons for less than the market to sell its allowances for emitting CO2. Plant B offers to sell its excess allowances to Plant A. Plant A purchases these allowances, but must decide whether to reduce its emissions by 5,000 tons or purchase other allowances. Another party determines that it can reduce greenhouse gas emissions by
OF
CARBON MARKETS
installing a wind farm to offset electricity produced from a coal-fired power plant. The wind farm produces 5,000 offsets. Plant A negotiates with the wind farm owner to purchase the 5,000 offsets. In the above example, 20,000 tons of carbon dioxide emissions are eliminated. The cost to reduce the emissions are far less than if Plant A would have been required to reduce its emissions by 10,000 tons by installing expensive control systems. The outcome is a reduction of emissions at a far lower price. This is the basic concept behind cap and trade systemsa market-based system that allows the market to function and allows the parties in the emissions market to find the least-cost approach to reduce emissions. Such systems have to have several aspects to actually work. The aspects of systems that actually work include several necessary elements or traits. First, the reductions imposed on an industry or industries must be real, significant, and continue to decrease over time. Second, a substantial penalty must be imposed if a facility fails to meet its mandated emission reductions. Without real, mandated reductions, the reductions in pollution sought by the regulations do not occur, and the market for allowances and offsets is very low or zero. In such a situation, the environmental goals are not met and the market does not function. Where both are in place, the environment is enhanced and the economics emerge for a functioning emissions market.
E. Cap and Trade Made in AmericaThe Advent of U.S. Emissions Markets with Sulfur Dioxide and Other Emissions
Cap and trade concepts were invented in the United States. The most prominent of these systems is the sulfur dioxide emission markets that developed under Title IV of the 1990 Clean Air Act Amendments.2 Acid rain was a significant problem in the United States. Sulfur dioxide emissions from coal-fired power plants would transform in the atmosphere into sulfuric acid and fall in the rain, making it more acidic. The acidity caused damage to trees and other plants and rivers and streams. The implementation of the cap and trade system to address sulfur dioxide emissions from coal-fired power plants and the resulting damage from acid rain proved very successful both in terms of reducing acid rain and by reducing the costs of sulfur dioxide emission reductions. According to a report prepared by the Environmental Defense Fund (EDF), Cap and trade harnesses the forces of markets to achieve cost-effective environmental protection. Markets can achieve
2. 42 U.S.C. 76517651o.
THE E MERGENCE
OF
superior environmental protection by giving businesses both flexibility and a direct financial incentive to find faster, cheaper and more innovative ways to reduce pollution.3 The EDF website provides two figures that demonstrate how the emissions of sulfur dioxide were reduced, and compares the estimate costs and the actual coststhe actual costs were dramatically less than the estimated costs to achieve the emission reduction goals.4 On the eve of legislation, the EPA estimated that the program would cost $6 billion (in 2000 dollars) annually once it was fully implemented. The Office of Management and Budget has estimated actual costs to be $1.11.8 billionjust 20 to 30 percent of the forecast.5 The EDF offers two main reasons why cap and trade programs work: 1. Markets provide greater environmental effectiveness than command-andcontrol regulation because they turn pollution reductions into marketable assets. In doing so, this system creates tangible financial rewards for environmental performance. 2. Because cap-and-trade gives pollution reductions a value in the marketplace, the system prompts technological and process innovations that reduce pollution down to or beyond required levels. This point is not theoretical; experience has shown these results.6 The empirical results show that cap and trade can be used to direct resources more efficiently than a command and control system by marrying economics in the form of a market-based system for emission rights and an environmental regulatory system in the form of an emissions-reduction program.
F. Examples of Working Carbon Markets

These concepts led to the formation of an international carbon market that much of this book will discuss. Before moving into more detail, understanding the basic concepts will provide context for the chapters that follow. At the international level, the Kyoto Protocol along with the EU ETS serve as the carbon market that has grown to over $100 billion. The two systems create a set of
3. Environmental Defense Fund, The Cap and Trade Success Story, available at http://www.edf. org/page.cfm?tagID=1085. 4. Id. 5. Id. 6. Id.
OF
CARBON MARKETS
national markets involving numerous countries supplemented with carbon offsets largely derived from developing nations.
1. The Kyoto Protocol

International negotiations led to the first climate change treaty in Rio de Janeiro 1992. The countries of the United Nations entered into the UN Framework Convention on Climate Change (UNFCCC). This treaty stands as the basis for all other climate change negotiations since then. In 1997, the parties to the UNFCCC negotiated the Kyoto Protocol. The Kyoto Protocol stands as the basis for the current international climate change law and the bedrock of the international carbon credit trading system. Various other meetings of the parties have occurred over the last eleven years after the treaty was ratified by sufficient countries to allow it to go into effect. Various other related agreements through the Conference of the Parties are negotiated and issued several times a year. At present, the Kyoto Protocol imposes certain restrictions on developed countries. Developed countries are required to reduce their emissions to 1990 levels by establishing their own national greenhouse gas emissions reduction programs. Ranging from 8 percent reductions for the European Union to 7 percent for the United States (the United States did not submit to the agreement), 6 percent for Japan, 0 percent for Russia, and permitted increases of 8 percent for Australia and 10 percent for Iceland. Developing countries have no limits, including China and India. The Kyoto Protocol ironically included cap and trade conceptswhereby one party may purchase and use another partys emission reduction allowances or offset credits to meet their own compliance obligationsat the insistence of the U.S. delegation. The United States then did not ratify the agreement. The European Union took it into account by setting up the EU Emissions Trading Scheme, which will be discussed below. The first process by which countries may trade among themselves is outlined in Article 6 of the Kyoto Protocol, which is known as the Joint Implementation. This program involves trading between those countries on Annex I, or the developed countries that generally must reduce emissions under the agreement. Thus, European countries can develop projects, such as wind energy, fuel switching, or energy efficiency, and seek certification of those emissions. Once the reductions are verified, the credits known as Emission Reduction Units (ERUs) may be bought and sold among developed countries. The program that is best known for carbon trading is the Clean Development Mechanism (CDM) under Article 12 of the Kyoto Protocol. This program allows
THE E MERGENCE
OF
TABLE 2.1 Relative Greenhouse Gas Effect

Carbon dioxide, CO2 Methane, CH4 Nitrous oxide, N2O Hydrofluorocarbons, HFCs Perfluorocarbons, PFCs Sulphur hexafluoride, SF6 1 21 310 140 11,700 6,500 9,200 23,900
parties in developed countries with emission reduction commitments to invest in projects in developing countries that have no reduction commitments. The carbon credits produced through the CDM are known as Certified Emission Reductions (CERs). To administer this program and to review and approve projects and to issue credits, the United Nations formed the CDM Executive Board. A fairly rigorous process for establishing methodologies for measuring and verifying emissions reductions has been developed. The gases that may be reduced to generate CERs under the CDM are shown in Table 2.1, with the equivalent greenhouse gas affect of each ton in carbon dioxide equivalents. As you can see, a reduction in methane or other greenhouse gases other than CO2 produces a multiplier effect in terms of carbon credits, which are measured in carbon dioxide equivalents (CO2e). Each reduction in a ton of methane produces 21 tons of CO2e and 21 CERs.7 One of the qualifications that has caused many projects to be rejected by the Executive Board is the requirement that the project proves additionality. CDM projects must lead to additional emission reductions that are beyond business as usual. Additionality is a complex concept. Once the project meets the additionality requirement and is approved by the host country where the project is located and by the Executive Board, the project is then constructed or implemented. A third-party verifier, known as a Designated Operational Entity (DOE), must then verify completion of the project and the reductions in greenhouse gas emissions. Once the DOE report is submitted to the Executive Board, the Board reviews the submission and, if approved, the CERs are issued.
7. The use of the word ton throughout this book is to metric tons.
OF
CARBON MARKETS
2. The European Union Emissions Trading Scheme

The European Union established the EU ETS with a first phase in 2005 to 2007 and a second phase from 2008 to 2012 to coincide with the Kyoto Protocol period. The EU ETS is the largest emissions trading system in the world, covering over 10,000 installations. It includes combustion plants, oil refineries, coke ovens, iron and steel plants, and factories making cement, glass, lime, brick, ceramics, and pulp and paper. Other industries are to be added to the ETS, such as aviation, aluminum, and ammonia. The legislation covers CO2 initially, but other greenhouses gases (GHGs) may be added. At this time, the allowances are assigned without charge and not auctioned. In the future, the European Union will be auctioning some of the allowances. One of the criticisms lodged at the EU ETS is the problem with the First Phase, from 20052007, which was plagued with overallocation of allowances. The countries and companies applied for more allowances than there were emissionsdriving the price of allowances to near zero. Without scarcity, no market works. The European Union is working in the Second Phase to limit allowances, which has resulted in litigation by countries and companies against the European Union to try to increase the allotment of allowances. Nonetheless, the European Union has implemented a more robust emissions trading scheme to cap and begin reducing greenhouse gas emissions. The carbon market under this system is active and functioning well.
G. Environmental Markets Are Alive and Well

The emergence of such a large environmental market, by means of government setting up the process and letting entrepreneurs and capital providers figure out on their ownin a distributed and noncentralized processhow to solve environmental concerns, is a testament to self-organizing systems. Markets can serve to play a role in environmental regulation. The details of the system in terms of the laws, regulations, and guidance from legislatures and governing agencies must be developed and experimented with over time, but the ultimate goal can work. Cap and trade has received much scorn from some portions of the U.S. political and business circles. However, many in the potentially regulated industries, particularly utilities with coal-fired power plants, recognize that if there is to be greenhouse gas regulation, cap and trade is preferred to a command and control regulatory system or a pollution tax. For direct emitters of greenhouse gases, an environmental market system provides the flexibility and efficiencies that these industries require to reduce the cost of achieving the environmental regulatory goals.
Fundamentals of Cap and Trade
The emerging environmental emissions markets for greenhouse gases, as stated in the prior chapter, all arise primarily through government fiat. Voluntary systems arise as well, as certain business entities and even some local or state/provincial governmental entities have decided to offset their greenhouse gas emissions. In establishing both compliance systems and voluntary systems for emissions trading, a series of standards and regulations must be established. This chapter will focus on the compliance or mandatory cap and trade systems. All of the state or national governments establishing cap and trade programs face a complex set of issues and concerns. How these issues and concerns are addressed influence the effectiveness of the emissions trading markets and ultimately the goal of reducing emissions, as well as the economic impact on the regulated industry and the general consumer. In this chapter, the major issues that arise in the formation of legislation and regulations to establish a cap and trade system for greenhouse gas emissions will be discussed.
A. Defining the Regulated Gases

In order to establish an emissions market for air pollutants, the first step is to define the gases or materials that will be regulated. As discussed above, carbon dioxide constitutes the greatest mass of greenhouse gases emitted to the atmosphere, largely through the burning of fossil fuels. Studies indicate that
OF
CARBON MARKETS
carbon dioxide accounts for approximately 80 percent of the mass of greenhouse gases emitted by human activity in the United States each year.1 Carbon dioxide, however, is not the only greenhouse gas and does not cause the most significant amount of global warming of the greenhouse gases regulated at this time. There are five other greenhouse gases that are typically regulated:
methane, CH4 nitrous oxide, N2O hydrofluorocarbons, HFCs perfluorocarbons, PFCs sulphur hexafluoride, SF6
The relative greenhouse gas effect can be measured through comparing the impact of carbon dioxide to the other greenhouse gases. Figure 3.1provides a comparison of these gases. For example, under the Kyoto Protocol, methane is considered twenty-one times more potent as a greenhouse gas than CO2. Because of this disparity, regulators decided to convert greenhouse gases into a common unit. Not surprisingly, they selected CO2 as the common unit. The unit is expressed in CO2 equivalents and abbreviated as CO2e. If one is emitting one ton of methane, it would be expressed as 21 tons of CO2e. The European Union Emissions Trading Scheme (EU ETS), which will be discussed in more detail in a later chapter, initially regulated only carbon dioxide.2 Similarly, the Regional Greenhouse Gas Initiative (RGGI) involving ten of the northeastern states in the United States, which will be discussed in
TABLE 3.1 Relative Greenhouse Gas Effect
Carbon dioxide, CO2 Methane, CH4 Nitrous oxide, N2O Hydrofluorocarbons, HFCs Perfluorocarbons, PFCs Sulphur hexafluoride, SF6 1 21 310 140 11,700 6,500 9,200 23,900
1. U.S. EPA, 2007. Inventory of U.S. Greenhouse Gas Emissions and Sinks: 19902005, EPA 430-R-07002, EPA: Washington, DC, available at http://epa.gov/climatechange/emissions/usinventoryreport.html. 2. EU Emissions Trading Directive, Annex I.
FUNDAMENTALS
OF
CAP
AND
TR A D E
| 27
more detail in a later chapter as well, addressed only carbon dioxide.3 On the other hand, the California Global Warming Solutions Act (AB 32) addresses all six greenhouse gases,4 as does the developing program under the Western Climate Initiative and the Midwestern Greenhouse Gas Reduction Accord.5 The legislation that was voted out of the U.S. House of Representatives and was considered by the U.S. Senate would have regulated all six greenhouse gases. The European Union is considering regulating the other greenhouse gases as well. Thus, the developing trend is toward regulating all six greenhouse gases (GHGs). Other compounds and substances have been identified as being potentially regulated as GHGs. In the Waxman-Markey Bill passed by the House of Representatives, nitrogen trifluoride was included in the list of regulated greenhouse gases. Nitrogen trifluoride is used in the etching of silicon wafers, and for cleaning parts used in the manufacture of flat panel displays and thin film solar cells. This addition would make seven regulated greenhouse gases. Another compound being considered is actually not a gas, but a particulate. Black carbon is a material generated from burning wood and other materials. This material was included in some of the bills proposed in the U.S. Congress. The definition under this proposal was the light absorbing component of carbonaceous aerosols.6 Black carbon falls on snow and ice in the poles and absorbs sunlight, thereby heating the ice and contributing to the melting of the ice. The ice would otherwise reflect the sunlight and not be heated to the same extent. Some argue that reducing anthropogenic emissions of black carbon would be the most rapid way of reducing climate change.7 Some of the bills proposed in Congress called for the U.S. Environmental Protection Agency (EPA) to develop programs to mitigate black carbon emissions and to develop plans to mitigate international emissions of black carbon. One of the sources of black carbon is the millions of wood-burning stoves in the developing world. Cutting the use of such stoves would reduce black carbon emissions and reduce deforestation and degradation, and the associated ecological, biodiversity, and climate damages associated with Reducing Emissions from Deforestation and Forest
3. Regional Greenhouse Gas Initiative Memorandum of Understanding, at 2. 4. AB 32, 38550. 5. Midwestern Greenhouse Gas Reduction Accord (2007). 6. Waxman-Markey Discussion Draft, 333(a). 7. IPCC, Changes in Atmospheric Constituents and in Radiative Forcing, in Climate Change 2007: The Physical Science Basis. Contribution of Working Group I to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change 129, 136, 163 (2007), available at http://www.ipcc.ch/ipccreports/ar4-wg1.htm.
OF
CARBON MARKETS
Degradation (REDD). It would also reduce the work largely placed on the women of populations for gathering and hauling the wood to their homes.
B. Determining the Threshold Amount of Emissions to Be Regulated

After the specific gases are selected, the next step is to determine if there is a threshold amount of emissions of these gases a facility must emit before it will be regulated. In some cases, a threshold will not apply, as the governing body has determined that the facility emits sufficient greenhouse gases that no threshold is necessary. In other types of facilities, the governing body will establish a threshold in order to avoid regulating what may be considered too many facilities with small amounts of emissions to feasibly regulate. This level is usually referred to as the emissions threshold. In the United States, in bills passed or considered by Congress, 25,000 tons of CO2e per year was emerging as the emissions threshold under which a facility would not be required to monitor and report its emissions and would not generally be required to be regulated under a cap and trade system. The emissions threshold allows certain sources of emission to avoid regulation and any mandated reductions in their emissions. Small sources are typically too numerous to effectively regulate. Government environmental regulatory agencies would find themselves overwhelmed with permitting and otherwise regulating the sheer number of sources of emissions. In addition, certain small businesses and even household emissions could fall within the regulations and agencies typically avoid regulating small business and personal emissions directly.
C. Determining the Regulated Sources

The next step is the selection of those types of facilities that will be regulated. Tremendous political lobbying arises as the industries that would be regulated attempt to be excluded from any regulation or to reduce the impact of the regulations on their industry. The industry that is typically the main target of regulation involves electric utilities that operate coal-fired power plants. Coal-fired power plants are the largest single industrial source of greenhouse gas emissions, primarily in the form of CO2. The EU ETS initially regulated CO2 emissions from the following sources:
Combustion installations with rated thermal input exceeding 20 megawatts
(except hazardous or municipal waste installations); Mineral oil refineries;
FUNDAMENTALS Coke ovens;
OF
CAP
AND
TR A D E
| 29
Metal ore (including sulfide ore) roasting or sintering installations; Installations for the production of pig iron or steel (primary or secondary
fusion), including continuous casting, with capacity exceeding 2.5 tons per hour; Installations for the production of cement clinker in rotary kilns with a production capacity exceeding 500 tons per day or lime in rotary kilns with a production capacity exceeding 50 tons per day or in other furnaces with a production capacity exceeding 50 tons per day; Installations for the manufacture of glass including glass fibre with a melting capacity exceeding 20 tons per day; Installations for the manufacture of ceramic products by firing, in particular roofing tiles, bricks, refractory bricks, tiles, stoneware, or porcelain, with a production capacity exceeding 75 tons per day, and/or with a kiln capacity exceeding 4 m3 and with a setting density per kiln exceeding 300 kg/m3; and Industrial plants for the production of (a) pulp from timber or other fibrous materials, or (b) paper and board with a production capacity exceeding 20 tons per day.8
The European Union has begun to focus on other industries as well, such as aluminum, ammonia, and aviation. The types of facilities that could potentially be regulated include two types: those that emit greenhouse gases and those that produce or import gases or materials that when burned or used produce greenhouse gases. The first category would include the following types of source categories:
Electricity generation: fossil-fuel-fired power plants (coal, natural gas, etc.) Adipic acid production Primary aluminum production Ammonia manufacturing Cement production, excluding grinding-only operations Hydrochlorofluorocarbon production Lime manufacturing Petroleum refining Nitric acid production Phosphoric acid production Silicon carbide production Soda ash production
8. EU Emissions Trading Directive, Annex I.
OF
CARBON MARKETS
Titanium dioxide production Coal-based liquid or gaseous fuel production
A second group of emitters would include those that emit more than the emissions threshold of 25,000 tons of CO2e per year. These facilities would be a very long list of facilities. Other facilities that could be regulated are those that produce or import materials that when burned or used would release greenhouse gases. Included in this group would be fuel producers (e.g., petroleum refiners) and importers of petroleum-based or coal-based liquid fuel (e.g., gasoline, diesel, jet fuel, etc.), natural gas liquid, or petroleum coke the combustion of which would cause the emission of GHGs above a threshold in tons of CO2e per year or more. Natural gas distribution companies have been proposed to be regulated if they deliver above a threshold amount of cubic feet or more per year of natural gas to noncovered entities.
D. Setting the Cap

In order to effectively reduce greenhouse gas emissions, the cap must be set in the first year and then over time decreased to meet the intermediate and final greenhouse gas reduction goals. In addition, the baseline year is critical as well, as it becomes the year regions or countries and individual facilities must use to measure their progress and to determine the baseline for their individual permitted levels of emissions. An example can be found in one of the bills considered by Congress. The following goals were set based on a 2005 baseline year: 3 percent below 2005 levels by 2012; 17 percent below 2005 by 2020; 42 percent by 2030; and 83 percent below 2005 by 2050. Under the Kyoto Protocol, the baseline year was set as 1990. Developed nations were required under the treaty to reduce their emissions based on what they were in 1990. As U.S. emissions have risen significantly from 1990 to 2005, the U.S. goals in bills that were filed in Congress were adjusted to 2005 levels in order to attempt to make the reductions politically palatable.
E. Permitting Emissions of Greenhouse Gases

Emission limits for individual facilities are typically set in the form of a permit issued by the relevant governing agency. The permit serves to proscribe the various obligations of the regulated facility in terms of operations, monitoring,
FUNDAMENTALS
OF
CAP
AND
TR A D E
| 31
reporting, and the specific levels of greenhouse gases that may be emitted by the facility. This is the individual cap for a particular facility, such as a coal-fired power plant, oil refinery, or manufacturing plant.
F. Emission Allowances
In order for a cap and trade system to work, there must be a commodity to trade. In emissions markets, the tradable commodity is an emission allowance, sometimes referred to as an emission permit or credit. Emission allowances are the pollution rights that allow a source of air emissions to emit a unit of a pollutant into the air. In the context of a greenhouse gas cap and trade system these allowances are often referred to as a carbon credit. The term carbon credit often also refers to emission offsets that will be discussed later in this chapter. These offsets differ from allowances in that they are not the rights to pollute issued by a governmental agency to regulated facilities, but are the emission reductions from unregulated facilities that are not legally required to reduce their emissions as will be discussed later in this chapter. Emission allowances are distributed to individual facilities in terms of the amount of emissions that the particular facility may emit for a particular time period, which is typically an annual emissions rate in terms of tons per year. In order to achieve compliance with an air emissions statute that implements a cap and trade system, the facility must turn in the prescribed number of allowances alone or in combination with a permitted amount of offsets into the government at the end of the regulated period to cover each ton of emissions emitted by the facility during that period. If they fail to submit an adequate amount of allowances or offsets, then the government will charge a substantial penalty, as discussed later in this chapter.
G. Allocation of Emission Allowances

Allocation of the emission allowances can have a profound impact on the emissions trading system, the companies that own regulated facilities, and the market for allowances and offsets. The debate over allocation started as government and nongovernmental organizations (NGOs) began, because obviously the allowances have economic value. As explained in more detail in Chapter 21, companies are required to reflect a value for emission allowances on their balance sheet and financial statements. Governments and NGOs further saw the sale of the allowances as a way to raise funds for investment in renewable energy and other means of reducing greenhouse gas emissions, the impact of climate change, and the economic costs on citizens of higher electricity and other costs as
OF
CARBON MARKETS
a result of requiring the reductions in greenhouse gases from power plants and other industries. Industry opposes substantial auctions of allowances as they impose costs that, depending on the industry, they may not be possible to pass on to consumers. Governments also see emissions sales as a means of raising money for government projects unrelated to greenhouse gas emissions, climate change, and alternative energy sources that do not emit greenhouse gases. The allocation methods that have developed are basically threefold, although other methods are certainly possible and may evolve over time. First, governments, as the European Union did in its first two phases of its Emissions Trading Scheme, may issue the allowances without charge to the regulated facilities. Free allocation avoids costs incurred by regulated industries and indirectly by consumers. The problem is that some industries or facilities within industries may benefit by being less efficient as no cost is incurred initially to purchase the allowances necessary to operate. Moreover, the government loses an opportunity to raise funds to address greenhouse gas emissions, climate change, and the costs of a greenhouse gas reduction program on society and economies. These tradeoffs have been debated in the U.S. Congress and the European Commission. The second method of allocating emission allowances is to auction emission allowances to the highest bidder. The sale of the allowances by the government addresses the concerns over forcing an immediate internalization of pollution costs or at least some part of those costs by the regulated industries. On the other hand, it places an immediate cost on those industries during a transition to a lower greenhouse gas emitting economy. Depending on their financial state and place in international competition, the impact on domestic industry may be significant, and, therefore, on the country implementing greenhouse gas regulations. A third method is a hybrid of the first two approaches. It is a partial auction in which only a percentage of the allowances required by the regulated industries are auctioned. This approach reduces the cost of a complete auction on industries, while at the same time allows the government to raise new revenue to finance renewable energy and other means of reducing greenhouse gas emissions and reducing the impact of the emissions caps. Many northeastern states are auctioning 100 percent of allowances under the RGGI program. The EU Emissions Trading Scheme distributed allowances largely without cost to the regulated facilities, but the European Union is currently considering implementing an auction. The Waxman-Markey Bill passed by the House of Representatives produced a mixed approach, starting with a certain amount of allowances that would be auctioned, with the amount of allowances auctioned per industry varying to some extent. By doing so, the bill would
FUNDAMENTALS
OF
CAP
AND
TR A D E
| 33
favor certain entities, such as coal-fired power plants, over others, such as oil refineries that would receive fewer free allowances.
H. Trading Allowances
The other half of cap and tradetradeinvolves the ability to buy and sell allowances in order to set up a market that may set a price for carbon, or the cost of emissions of greenhouse gases. This is measured by the price for a ton of CO2e or carbon dioxide equivalent. GHG offsets may also be allowed to meet compliance obligations and be traded within the cap and trade system.
I. Banking Allowances
The concept of banking is an important concept for cap and trade systems. The term arises from the ability to use emission allowances or offsets in the year that they are issued or created, or to hold them, that is, bank them, for another future compliance year. In the initial EU ETS trial phase from 2005 to 2007, the emission allowances issued by the European Union had an expiration date at the end of 2007. Thus, once the expiration date passed, the allowances could not be used for the second phase of the ETS. Combined with what turned out to be an overallocation of allowances, the price for the 2007 allowances approached zero. Banking of emission allowances as well as offsets allows greater flexibility to facilities as to how they will make reductions in emissions, sell or purchase allowances, or hold allowances for a future compliance year. Banking also reduces the financial impact of emission-reduction regulations by allowing a party to hold allowances and use them in future years as opposed to potentially paying higher prices in future years. The ability to hold allowances generally increases the market value of the allowances, as they have value for more than one compliance year.
J. Borrowing Allowances
Another important concept that has arisen under proposed legislation in the United States is a concept known as borrowing. Borrowing is a concept whereby regulated firms may request from the regulating government agency additional allowances in a particular compliance year in order to provide the necessary allowances for retirement, and pay them back to the government in future years. The concept includes the payment of interest through turning in a certain percentage of higher allowances to the government than were borrowed.
OF
CARBON MARKETS
K. Safety Valve and International Competitiveness

The term safety valve refers to a price cap or other means of preventing the price of allowances from rising beyond a certain point. The process for reducing the economic impact of high carbon credit prices varies. Many industries support a safety valve in order to protect their firms from paying high prices for allowances and international competition. The financial community and offset developers oppose a safety valve and want to allow the market to determine the price for carbon. Some bills proposed in Congress did not have a specific safety valve, but would have created a sort of Carbon Fed that would have stepped in under certain circumstances to reduce a high price of carbon that may have emerged in a carbon market.
L. Offsets
A cap and trade system could exist with emission allowances alone. The firms would be given or purchasing these allowances in auctions or from the government at some fixed price. The emissions market would consist of parties who have more allowances than they need and those that need to purchase allowances as they are short on allowances, while the seller is long. Depending on the system, investors or speculators could buy and sell allowances as well. In order to drive the price of compliance down, and to create maximum flexibility, compliance firms may be allowed in the design of the specific cap and trade system to purchase the offsets produced by those who are not required to reduce their emissions, or perhaps go beyond what they would otherwise do. Offsets refer to the use of emission reductions from activities or facilities that are not required to reduce their emissions under a greenhouse gas regulatory regime. The offsets may arise from activities in the United States or in foreign countries. Studies, some of which are prospective models, demonstrate that offsets provide a means of lowering the cost of emission reductions. International offsets are generally the least expensive means of meeting compliance deadlines and obligations. One of the critical issues is the percentage of domestic and international offsets allowed under a particular emissions scheme. In one bill proposed in Congress, a 30 percent limit was placed on the use of offsets, and up to 15 percent of the total permitted emissions for a particular facility could have been met with international offsets.
FUNDAMENTALS
OF
CAP
AND
TR A D E
| 35
M. Additionality
Additionality may be one of if not the most challenging aspect of developing a carbon offset project. This concept was designed to ensure that a project that is being submitted for carbon creditsoffsetswould actually achieve a reduction in greenhouse gases that would have occurred without the carbon credits or the revenue that would be derived from the sale of carbon credits. The concept is expressed as Beyond Business as Usual or BBU. While simple in concept, in its application it can be quite complicated challenging lawyers, technical consultants, and financial experts.
N. Supplementarity and Linkage to Other National and International Trading Systems

Carbon offsets present many issues with respect to the import of those offsets into a developed country. One of those concerns is that if an unlimited amount of inexpensive offsets can be purchased by a regulated facility under a cap and trade regime, then the facility will simply buy sufficient offsets and avoid any pressure to reduce their own emissions. In the European Union, for instance, an import quota was imposed on the number of offsets that could be used to meet the carbon allowance requirement under the EU ETS. The concept of a limit on the amount of international carbon offsets that may be purchased and utilized by a domestic facility is known as supplementarity. The derivation of this term is that the use of international offsets will supplement domestic actions to reduce greenhouse gas emissions from a facility or faculties in the regulated country. Thus, it is intended that international offsets do not play a dominant role in the domestic reduction efforts. Supplementarity in theory will limit the amount of international offsets, probably cheap offsets, and thereby raise the price of offsets and allowances in a developed country. This increase in price, in theory, will encourage facilities to reduce their emissions. As stated above, one of the bills proposed in the U.S. Congress allowed up to 15 percent of the total permitted emissions for a particular facility to be met with international offsets. Linkage is a concept that relates to the ability of a governing body of one regulated jurisdiction to allow trading of allowances, offsets, or both produced within that jurisdiction with another jurisdiction. For example, assume that the United States establishes a cap and trade system, and the European Union continues its Emissions Trading Scheme. Both jurisdictions would be operating a
OF
CARBON MARKETS
cap and trade system, which could either permit allowances to be traded between an EU country and the United States, or they could keep their systems isolated and separate. The step of linking the two trading systems allows commerce in carbon credits between the countries. There are a variety of legal and economic complexities associated with this linkage. How these issues play out in international negotiations of a postKyoto Protocol treaty remain to be seen, as well as the bilateral negotiations between countries if a treaty to follow Kyoto is adopted.
O. Early Action
Early action consists of activities, retrofitting of equipment, boilers, etc., and other operational changes that reduce the emissions of greenhouse gases in advance of regulations that require GHG reductions. Companies have been encouraged to take early action before a regulatory program goes into effect. The difficulty with taking such action is that ones baseline may be reduced, and then the company would have to cut its emissions further when a cap and trade program requires reductions in GHGs. Such a circumstance may put that company at a competitive disadvantage to its domestic competitor that did not take early action and kept its baseline higher, and an even greater competitive disadvantage with an international competitor in a country that is not required to cut its emissions at all. The bills that have been offered in the House and Senate in the United States typically provide early action provisions that would eliminate or reduce the impact on companies that have taken early action. An example might be to provide additional allowances to companies that reduce their emissions before mandatory emissions are imposed.
P. New or Expanded Facilities

One of the great challenges, and one that raises opposition among industry and business groups, is the concern about the cap not on emissions, but on domestic economic growth. Consider a country and economy where greenhouse gases are capped. How does a new factory ever get built? Will not the cap prevent the new emissions from that plant? The way that these issues would have to be addressed would be to reserve carbon allowances for future growth, or to require that entity to purchase allowances and offsets to allow for the construction of the new facility that will be a new emissions source of greenhouse gases.
FUNDAMENTALS
OF
CAP
AND
TR A D E
| 37
The same issue arises for the expansion of a facility. The increased emissions must be addressed in the cap and trade regime.
Q. Regulatory Agency or Agencies

In establishing a cap and trade system, the jurisdiction for regulating various aspects of the system must fall on one or more governmental agencies or bodies. The regulatory responsibilities may be divided simply into two general roles: regulation of greenhouse gas emissions and regulation of the trading of allowances and offsets. It may be that these responsibilities are divided among two or more agencies and some overlap occurs.
1. Regulation of Greenhouse Gas Emissions

The first aspect of a cap and trade system requires the setting of emissions limits and addressing reporting of emissions and granting of permits to allow those emissions. The enforcement of these regulations would typically be managed by the agency setting up the regulations that must be promulgated under a statute and the various administrative responsibilities that derive from such a system. The agency would set up the reporting requirements, measurement methodologies, permit application, and operating requirements, review and issue permits, and address the issue of methodologies for offset projects, the extent to which international offsets are approved or allowed to be used. The type of regulatory knowledge and expertise for this type of regulation would typically be found in an environmental regulatory agency that regulates wastewater discharges, hazardous waste, and air pollutant emissions.
2. Regulation of Trading of Allowances and Offsets

One of the other major roles is to regulate the trading of allowances and offsets, in other words, the financial aspects of the transactions. Carbon credits become, to some degree, like a commodity that is traded, like a stock or agricultural or petroleum or oil commodity. To some extent the credits will be fungible and traded on an exchange. For other credits, the so-called charismatic credits, they may be traded between two parties in an over the counter transaction, not on an exchange. This type of regulation usually falls to a securities or commodity trading agency, not an environmental agency. Regulation of trading, trading markets, and financial instruments would not be an area of expertise of an environmental agency.
OF
CARBON MARKETS
R. Enforcement
The costs of purchasing any additional allowances or offsets required to meet a facilitys cap might be avoided if a penalty or other sanction did not accrue to the facilitys owner or operator. The country or state creating a cap and trade system generally enacts a civil enforcement process and establishes civil penalties to punish those parties that fail to submit sufficient allowances or offsets. In the European Union, the penalty per ton of CO2e was set at 200 euros so that companies would not be tempted to ignore the potential for reducing greenhouse gases, and, instead, to pay penalties rather than buying allowances or offsets.
PART
TWO
Regulatory Structures
International Law
A. The UN Framework Convention on Climate Change
The evolution of international climate change law in terms of the laws we work with today began in the 1980s with the adoption by the General Assembly of the United Nations (UN) of a resolution entitled, Protection of the Global Climate for Present and future Generations of Mankind.1 The Resolution called on countries of the UN to address climate change, and endorsed a prior decision by the UN Environment Program and the World Meteorological Organization to establish the Intergovernmental Panel on Climate Change (IPCC). The next step was the negotiation of the UN Framework Convention on Climate Change (UNFCCC). In June 1992 in Rio de Janeiro, Brazil, the UNFCCC was presented to the nations attending the UN Conference on Environment and Development for signature. Thus was born the convention that has served as the point of formation of UN treaties and polices on climate change issues ever since. The UNFCCC acknowledged that human activities are increasing the concentrations of greenhouse gases (GHGs) in the atmosphere and that this would lead to increasing warming of the Earth and to climate change.2 These changes would then lead to adverse effects on natural ecosystems and human beings. The objective of the UNFCCC was stated as follows:
to achieve, in accordance with the relevant provisions of the Convention, stabilization of greenhouse gas concentrations in the atmosphere at a level
1. UN General Assembly, Protection of Global Climate for Present and Future Generations of Mankind (New York: United Nations) (A/RES?43/53), 70th plenary meeting, Dec. 6, 1988. 2. UN Framework Conventions on Climate Change (adopted May 9, 1992, entered into force March 21, 1994) 1771 UNTS 107 (hereinafter UNFCCC).
42 | R E G U L A T O R Y S T R U C T U R E S
that would prevent dangerous anthropogenic interference with the climate system. Such a level should be achieved within a time frame sufficient to allow ecosystems to adapt naturally to climate change, to ensure that food production is not threatened and to enable economic development to proceed in a sustainable manner.3
In terms of actual commitments, Article 4 of the Convention discusses what the nations of the UN are supposed to accomplish. One of the most important is that developed countries are to adopt national polices and take measures to mitigate climate change through the limitations of GHG emissions and protecting GHG sinks and reservoirs.4 The UNFCCC established a Conference of the Parties to the Convention to carry out is work and to adopt and make the decisions necessary to promote the effective implementation of the Convention.5
1. Conference of the Parties

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

1. General Principles
The Kyoto Protocol was actually issued on December 11, 1997. The actual effectiveness of the Protocol did not occur until February 16, 2005, when a sufficient number of nations ratified the agreement. The rules for implementing the Protocol occurred in 2001 at the COP 7. These rules are known as the Marrakesh Accords. The general principles of the Kyoto Protocol address GHG reductions by developed countries and the ability to develop credits for emissions reductions and the trading of allowance and offsets internationally. These provisions led to the emergence of the international carbon market, named after the trading of credits that are measured in carbon dioxide equivalents, thus the term carbon credits.
3. UNFCCC, Art. 2. 4. Id. Art. 4(2)(a). 5. Id. Art. 7(2)(a).
I N T E R N A T I O N A L L A W | 43
In the document, goals were set for developed countries, listed in Annex I of the UNFCCC and Annex B of the Kyoto Protocol. These Annex I countries that ratified the treaty were supposed to meet specified targets for GHG emissions from a 1990 baseline of the estimate emissions for that country for that year. The goal was to reach these targets by 2012. Many of the nations will not reach these goals.
2. The Clean Development Mechanism

The mechanism of the Protocol that has resulted in the greatest growth in the international carbon market is the Clean Development Mechanism (CDM). This mechanism was established by Article 12 of the Protocol, and provides for a market mechanism to allow developed countries to obtain GHG offsets that help them meet their compliance obligations in their own country and the goals set out in the Protocol, and, at the same time, result in GHG reductions in developing countries and clean technology transfer to those countries from developing countries with developed country finance.6 The CDM is administered through an Executive Board established under the Protocol.7 The Protocol calls for third-party verifiers, known as Designated Operational Entities (DOEs), to validate the emissions reductions projects to be reviewed and approved by the Executive Board under the CDM.8 Subsequent to Executive Board approval of the project, DOEs also verify the actual GHG emission reductions from a project once it is installed or otherwise becomes operational. Two critical issues that evolved in more detail with the policies adopted by the Executive Board were set forth in Article 12: first, the reductions must provide real, measurable, and long-term benefits; and, second, that the reductions must be additional to any that would occur in the absence of the certified project activity.9 One of the critical issues, as discussed in a prior chapter, is proving additionality. The concept is fundamentally that the reduction is beyond business as usual. The reductions in GHG (GHG) emissions were not required by law and would not have occurred even without the issuance of carbon credits. The Executive Board has issued a document that provides a guide to how additionality may be proven, called Tool for the demonstration and assessment of additionality.
6. Kyoto Protocol, Art. 12(3). 7. Id. Art. 12(4). 8. Id. Art. 12(5). 9. Id. Art. 12(5)(b), (c).
The process provided in this Executive Board document to prove additionality involves the following steps:
Identification of alternatives to the project activityidentification of
alternatives to the project activity consistent with mandatory laws and regulations; Investment analysis to determine that the proposed project activity is not the most economically or financially attractivewhether sensitivity analysis concludes that the proposed CDM project activity is unlikely to be the most financially attractive or is unlikely to be financially attractive; or Barrier analysis to determine what barriers would prevent the implementation of the type of project activitywhether at least one alternative scenario, other than the proposed CDM project activity, is not prevented by any of the identified barriers; and Common practice analysisno similar activities can be observed, but essential distinctions between the proposed CDM project activity and similar activities can reasonably be explained. A developer must be able to demonstrate additionality to obtain the offset credits from the CDM. Parties to the Protocol may transfer carbon credits that are known as Certified Emission Reductions (CERs). With permission of the party countries, private entities may transfer CERs as well.10 The CDM provides a mechanism for projects to be implemented in developing countries and the reductions in GHG emissions to be incorporated into a kind of currency of carbon credits and CERs, and then monetized through the transfer process of the Kyoto Protocol from developing country to developed country, where they can be used as a percentage of the offsets needed to meet compliance obligations in that country. The CDM has thus become the international trading mechanism for carbon credits in the form of offsets. The EU Emissions Trading Scheme that will be discussed in Chapter 5 is a bigger market, but it is limited to the EU.
3. Joint Implementation
Article 6 of the Protocol allows trading of a certain type of carbon credit among the countries listed in Annex I of the Protocol. This program is referred to as Joint Implementation ( JI). Again, these credits, known as Emission Reduction Units (ERUs), may be traded among Annex I countries for projects that have
10. Id. Art. 12(9).
achieved GHG reductions.11 The countries involved in a transfer must be in compliance with their obligations under the Protocol, and must be implementing an active program to reduce their emissions to meet their Kyoto obligations to reduce GHG emissions.12 Private parties may engage in the trading of ERUs as well.13
4. Emissions Trading and Trading in Assigned Amount Units and Removal Units
The Protocol provides one other type of carbon credit and trading mechanism. The trading of credits is limited to Annex B countries, which are those that are part of the Annex I to the UNFCCC, and these credits are the Quantified Emission Reductions and Limitation Commitment which the countries in Annex B have committed to and are set out in Annex B. Article 17 of the Protocol provides for the Conference of the Parties to define the relevant principles, modalities, rules and guidelines, in particular for verification, reporting and accountability for emissions trading.14 The parties included in Annex B of the Protocol can then participate in the trading of emissions credits as one means of meeting their obligations under the Protocol.15 The trading of credits must be supplemental to the domestic programs in these countries to reduce their emissions, which must be the main process of reducing emissions.16 In addition to CERs and ERUs, countries that are parties to the Protocol and Annex B, may actually sell the assigned amount of GHGs to their country.17 These units are known as Assigned Amount Units (AAUs). Thus, one countrys GHG limits would decrease and one would increase. Generally, this has only been accomplished where the AAUs are greened by devoting the sales proceeds of the selling country to GHG reduction activities.18 Another little known unit is the Removal Unit (RMU) that on the basis of land use, land-use change, and forestry (LULUCF) activities such as removals by sink. These sinks
11. Id. Art. 6(1). 12. Id. Art. 5 and 7. 13. Id. Art. 6(4). 14. Id. Art. 17. 15. Id. 16. Id. 17. See id. Art. 3. 18. Sander Simonetti & Rutger de Witt Wijnen, International Emissions Trading and Green Investment Schemes, in Legal Aspects of Carbon Trading: Kyoto, Copenhagen, and Beyond 157175 (David Freestone & Charlotte Streck eds., 2009).
may be land-use change and forestry activities, limited to afforestation, reforestation, and deforestation.19 Because these are generally state-to-state transactions, they may have little direct relevance to private carbon trading, but may affect the market for private carbon credit transactions. If states buy credits for their domestic industries or other domestic purposes, the demand of industries in those countries may be reduced, and the credit price may fall.
5. Kyoto Units
Several types of carbon credits established under the Protocol have been introduced above, CERs, ERUs, and AAUs. In 2003, the Ninth COP created two additional types of units, Temporary CERs (tCERs) and Long-Term CERs (lCERs).20 Both of these units are associated with land use and forestry projects under the CDM.
C. The Marrakesh Accords

As stated above, the meeting of the parties to the UNFCCC is referred to as the COP. The meetings also include the Meeting of the Parties to the Kyoto Protocol (MOP). Thus, these meetings are known as the COP/MOP. The meeting at Marrakesh of the COP/MOP was particularly significant for the development of the Kyoto Protocol, which resulted in agreements, known as the Marrakesh Accords. The Marrakesh Accords was a lengthy document of more than two hundred pages, and included modalities and procedures for the CDM. One of the critical aspects of the CDM was the establishment of its governing body, known as the Executive Board. The members of this board are appointed through the COP/MOP. Since the formation of the Kyoto Protocol, various decisions have been made by the COP/MOP governing the CDM, JI, and emissions trading. These decisions established through the Marrakesh Accords and COP/MOP are too numerous to enumerate or discuss in this book. Some of the more important issues have been decided by the Executive Board of the CDM. These range from approval and disapproval of methodologies to be used to formulate design documents for GHG reduction projects and measuring their actual reductions, additionality guidance, and approval and suspension of DOEs that validate and verify projects and GHG emission reductions under the CDM.
19. See Kyoto Protocol, Art. 3(3)(4). 20. Decision 4/CMP.1.
Some of these issues will be discussed in later chapters in more detail. One of the decisions that is worth mentioning here is that the Marrakesh Accords provided that land use changes under the CDM would be limited to afforestation and reforestation, and that avoided deforestation would not be permitted to qualify as a CDM offset project.21 In later COP/MOP meetings, allowing Reducing Emissions from Deforestation and Forest Degradation (REDD) to produce carbon credits through offsets has become an important part of these discussions of a post-Kyoto treaty.
D. Bali, Copenhagen, and Cancun: Negotiations for a Post-Kyoto Treaty

1. The Bali Action Plan
The Kyoto period was set for 2008 to 2012, and at the end of this period the Protocol is set to expire. Two major meetings of the countries of the United Nations were set to attempt to negotiate a post-Kyoto treaty, or to extend the Kyoto Protocol. These meetings were held in Bali, Indonesia, in December 2007 and in Copenhagen, Denmark, in December 2009. Neither resulted in a treaty, but some progress was made in each toward what may follow Kyoto. The first meeting held in the Bali meeting resulted in what has come to be known as the Bali Action Plan. Under this Action Plan, the parties to the document agreed that developing nations for the first time would consider measuring, reporting, and verifying nationally appropriate mitigation actions, in other words a program to control their emissions in some manner. This is important as the GHGs emissions of several developing countries such as China and India have become significant, with China now being the largest global emitter. Countries such as Brazil and Indonesia are in the top group of emitters because of deforestation. What actual programs these countries may agree to continues as an ongoing debate, and will be discussed below. Funding for technology transfer, capacity building for mitigation activities, adaptation to climate change that occurs despite mitigation activities, and other activities in developing countries is a major area of negotiation and discussion. The Bali Action Plan, or what also has been called the Bali Road Map, was to lead to a final negotiation and agreement in Copenhagen in 2009.
21. Marrakesh Accord, 3. Modalities and procedures for a clean development mechanism as defined in Article 12 of the Kyoto Protocol, 7. Decision -/CP.7 (Article 12).
2. The Copenhagen Accord

In December 2009, the UN convened again to attempt to negotiate a new treaty to extend or to replace the Kyoto Protocol. The negotiations were difficult and controversial. The outcome was only an unenforceable agreement on several points. One of the major points was that developed countries commit to emissions targets for 2020 by January 31, 2010. The reductions once agreed to, were then subject to the issue of verification, which China opposed in its country. Some language was placed in the agreement that emissions reductions would meet standards for monitoring, reporting, and verification (MRV) under COP guidelines. One of the more difficult negotiating points was emissions in developing countries as China and India did not want to commit to caps on emissions. The agreement was that developing nations were to implement mitigation actions, known as Nationally Appropriate Mitigation Actions (NAMAs) to reduce growth in their carbon emissions. The NAMAs were to be submitted by January 31, 2010. China has committed to reducing its carbon intensity, that is the amount of emissions per unit of economic activity and slowing growth of emissions, but not caps. The least-developed and smaller nations were allowed to reduce emissions voluntarily and with international financial support. China did not want to be subject to mandatory reporting. The agreement reached was that developing countries would report their emissions and activities to meet the NAMAS every two years under their domestic MRV. The agreement also recognized the importance of reducing emissions from deforestation and forest degradation and the need to enhance removals of GHG emission by forests. The agreement also recognized that a program known as Reducing Emissions from Deforestation and Forest Degradation (REDD) should be established to enable the mobilization of financial resources from developed countries to help achieve this goal.
3. Cancun
UNFCCC meetings have continued over 2010 to attempt to work out agreement on further development of the Copenhagen Accord and the development of a post-Kyoto treaty. The next major meeting is scheduled in December 2010 in Cancun, Mexico. The potential for an international treaty seems low as of the writing of this book. What progress may be made toward agreement remains to be seen in Cancun. How countries such as the EU and Japan will address the issue in the absence of an international treaty after Kyoto remains a significant question. The ability of the United States to participate and ratify a treaty is in serious question.
E. Alternatives to the UNFCCC

As the negotiations for a treaty to replace or extend Kyoto appear to face a risk of failure, countries are beginning to consider alternatives. As will be discussed in Chapter 6, Japan is moving forward with a bilateral approach to GHG offsets. Bilateral carbon trading agreements outside of UN treaties may have been possible under bills proposed in Congress. It is possible that the Kyoto Protocol will not be extended through the UNFCCC process. This raises questions of future CDM viability. The CDM has been criticized by some NGOs for purportedly being too lax and letting projects slip through the review process without much oversight and that do not produce real GHG emission reductions. In reality, those involved in the process, including project developers, investors, and buyers of carbon credits seeking approval through the CDM, often see the process as being bureaucratic, slow, and overly concerned with matters that make little difference in the verification of real GHG reductions. Criticism of the CDM process has been growing as it has become increasingly inefficient and bureaucratic. The International Emissions Trading Association (IETA) has issued a report with fairly strong criticisms of the CDM process and how the Executive Board and its staff manage the process.22 IETA listed four structural inadequacies that prevent effective management: 1. 2. 3. 4. part-time governing bodies; inappropriate division of responsibilities; inadequate standardization; and neglect of due process.23
The report identified five enduring challenges that are nearly strangling the CDM today: 1. 2. 3. 4. 5. unrelenting time constraints; ineffective communication practices; lack of transparency; slow policy development and inadequate resolution of issues; and inadequate number and expertise of Secretariat staff.24
22. International Emissions Trading Association, State of the CDM 2009: Reforming for the Present and Preparing for the Future. 23. Id. 24. Id.
These issues may have played a role in Japans decision to initiate a bilateral approach that could serve as an alternative to the CDM process for reviewing, issuing, and trading carbon credits. Japan is moving forward with preparing for more bilateral agreements whereby Japan would work with developing countries directly and form its own monitoring, reporting, and verification (MRV) process and methodologies for different types of project activities in order to encourage GHG reduction projects in developing countries. The program would be supported by a 500 billion yen (US$5.6 billion) loan facility. Japan Bank for International Cooperation ( JBIC) is recruiting firms to study how to transfer Japans clean-energy technology to developing countries, how to measure the schemes effectiveness in cutting emissions, and how to finance the program. The Europe Union, which has pledged to continue its Emissions Trading Scheme with or without an extension of the Kyoto Protocol, is also reportedly considering a bilateral program for GHG offsets. The political wrangling and the requirement for a unanimous decision in the post-Kyoto negotiations may lead to the development of an alternative. It would seem that developed countries, project developers, investors, and corporate purchasers of carbon credits are looking for a more efficient system than the United Nations may be able to provide. For countries that are frustrated with the UN carbon credit system, the bilateral approach has considerable merit. Particularly where a group of developed countries formed an entity to take the place of the CDM and the CDM Executive Board, a greater efficiency in a GHG offset program could be established. The protocols of the CDM could be adopted. Many of the problems with the CDM could be more readily addressed without going through the Kyoto or UNFCCC process and votes by well over a hundred nations of the UNFCCC. Another country may be considering a CDM alternative. The Russian government could consider entering into bilateral agreements for purposes of selling carbon credits.25 A representative of Gazprom Marketing & Trading Ltd. advocated that Russia follow the developing policy of Japan in seeking bilateral agreements for carbon trading. Japan has taken steps toward a bilateral approach as a buyer of credits, while Russia could move in this direction as a seller of carbon credits. The problems of the UNs CDM process may not be curable. If not, then countries will continue to pursue alternatives. The G20 and the +5 countries China, Brazil, India, Mexico, and South Africacould form their own carbon
25. Bilateral Deals Could Be Solution for Russia: Investors, Point Carbon, Sept. 7, 2010, available at http://www.pointcarbon.com/news/1.1472590.
credit standards board and protocol, borrowing the protocols of the CDM, and creating their own. This would be an opportunity to make reforms, including those advocated by IETA. Promotion of programs of activities that aggregate lots of smaller projects so that it does not make economic sense to go through the validation and verification process, would greatly increase the efficiency of the system and reduce costs for smaller emissions reduction projects.
The European Union Emissions Trading Scheme

A. The EU Policy on Climate Change
The European Union established the EU Emissions Trading System (ETS) with a first phase from 2005 to 2007 and a second phase from 2008 to 2012 to coincide with the Kyoto Protocol period. The EU ETS is the largest emissions trading system in the world, covering over 10,000 installations. It includes combustion plants, oil refineries, coke ovens, iron and steel plants, and factories making cement, glass, lime, brick, ceramics, and pulp and paper. Other industries are to be added to the ETS, such as aviation, aluminum, and ammonia. The legislation covers CO2 initially, but other greenhouse gases (GHGs) may be added. At this time, the allowances are assigned without charge and are not auctioned. In the future, the European Union may be auctioning some of the allowances. One of the criticisms lodged at the EU ETS, is the problem with the First Phase, 20052007, which was plagued with overallocation of allowances. The countries and companies applied for more allowances than there were emissionsdriving the price of allowances to near zero. Without scarcity, no market works. The European Union is working in the Second Phase (20082012) to limit allowances, which has resulted in litigation by countries and companies against the European Union to try to increase the allotment of allowances. Nonetheless, the European Union has implemented a more robust emissions trading scheme to cap and begin reducing greenhouse gas emissions. The carbon market under this system is active and functioning well. This chapter will discuss the first three phases and basic elements of the EU ETS.
T H E E U R O P E A N U N I O N E M I S S I O N S TR A D I N G S C H E M E | 53
B. Phase I2005 to 2007

The implementation of the EU ETS in Phase I from 2005 to 2007 was in essence an experimental phase prior to the implementation of the Kyoto Protocol that began in 2008. In any ramp-up of such a large regulatory and environmental market, certain aspects of the trading system required significant improvement in Phase II. However, Phase I served the purpose of a transitional process into a more effective program for controlling greenhouse gas emissions and establishing a carbon trading program and an emissions trading market of unprecedented size and scope. One of the chief challenges in Phase I was the overallocation of allowances. Data on emissions from facilities in each member state was not complete. Thus, the allowances requested by the facilities and the members states turned out to be quite conservative in terms of protecting against underallocation. The result was allocation of more allowances than the total emissions of the regulated facilities under the scheme, and a drop in the price for European Union Allowances (EUAs) in the latter part of Phase I to almost zero. While some critiques of the EU ETS see this as a failure of cap and trade as a concept, one should consider that Phase I was an experimental stage designed to allow a start-up process and identification of issues and problems to be resolved in Phase II. The success of Phase I was the creation of the EU ETS, the worlds largest emissions trading market, and the development of a monitoring and reporting system and of a compliance process in terms of the European Union as a whole, the EU ETS members states, and the regulated industries within these countries.
C. Phase II2008 to 2012

Implementing Phase II of the EU ETS required a much stricter control of the allowances each country in the scheme was allocated. The allocation to each country became a central challenge for setting up Phase II. Unlike Phase I, in which banking of allowances was not allowed into Phase II, Phase II allowances may be banked and used in Phase III. The banking decision means that allowances will not go to zero value at the end of Phase II, and regulated entities and investors in EUAs will have more flexibility in terms of use or sales of these credits. Phase II covers CO2 and no other GHGs; however, individual countries may regulate other GHGs. In terms of allocation, 90 percent of the allowances are given freely to regulated entities, and 10 percent is auctioned. The Linking Directive permits entities to use Joint Implementation ( JI) and Clean Development Mechanism
(CDM) credits up to a maximum amount of 10 percent of a countrys total allocated number of allowances. Three non-EU countries joined the ETSIceland, Norway, and Liechtenstein. Currently, the economic recession has resulted in lower energy use and less demand for EUAs or offsets. As a result, EUAs have dropped in price.
D. Phase III2013 to 2020

Phase III will last from 2013 to 2020. The EU Council in March 2007 decided that it would pursue a 20 percent reduction in greenhouse gas emissions from 1990 levels by 2020 and by 30 percent if a sufficient number of other nations committed themselves to comparable reductions.1 On January 31, 2008, the EU parliament called for more stringent caps, if necessary to obtain agreement on an international climate change agreement.2 The actual emissions target will be a reduction in 2005 levels by 21 percent by 2020. From 2013 to 2020, during Phase III, the quantity of emission allowance issued each year will decline 1.74 percent compared to the average annual total issued by member states in accordance with the EU Commissions decision on their national allocation plans (NAPs) for Phase I.3 The allocation system will shift from NAPs to a more centralized EU allocation process. In addition, in Phase III all allowances not allocated for free must be auctioned. Full auctioning will occur by 2027, as discussed below. Monitoring and reporting rules have been amended and will be more stringent.
E. Fundamentals of the EU ETS

1. Defining the Cap
Since the EU system is a grouping of nations, each nation within the alliance must develop its own cap and allocation of EU allowances (EUAs) for the emission of greenhouse gases. The cap is essentially set by the allocation of EUAs, or what are referred to as the national allocation plan for each country (NAP). The NAP includes other aspects of the greenhouse gas regulatory system for the country, including, the allocation to each regulated operating facility, how
1. See Directive 2009/29/Ec of the European Parliament and of the Councilof April 23, 2009, amending Directive 2003/87/EC so as to improve and extend the greenhouse gas emission allowance trading scheme of the Community, Art. 1(1) (hereinafter EU ETS Amendment). 2. See id. 3. See id. Art. (9).
allocation will be managed for those facilities, and what amount will be reserved for new facilities.4
2. Defining the Regulated Sources

The EU ETS started with regulation of large greenhouse gas emitters, including electric power plants, oil refineries, coke ovens, glass manufacturers, iron and steel plants, cement plants, lime producers, ceramics plants, and pulp and paper facilities.5 The European Commission (EC) is adding other emitters, including the airline industrya decision that has been quite controversialand facilities producing aluminum, ammonia, chemicals, and petrochemicals.
3. Permitting Emissions of Greenhouse Gases

The EU ETS requires that regulated facilities obtain a greenhouse gas emissions permit.6 Such a permit is necessary to operate and to emit greenhouse gases. The EU member state issues the permit for the types of regulated facilities in that country.
4. Emission Allowances
As stated above, the emission allowances in the EU ETS are known as EU allowances, or EUAs. Every operating facility that has obtained a permit must have sufficient EUAs to meet the amount of greenhouse gases emitted in the previous year, and must submit those allowances to the EU member state in which the facility operates under the NAP for that country.
5. Allocation of Emission Allowances

As in every emissions market, emission allowances must be allocated to the regulated facilities. A variety of methods are available, from free allocation based on prior years emissions to auctioning allowances to a mix of the two systems. Under the EU ETS, member states could choose to allocate EUAs without charge to regulated facilities or to auction them. Initially, few nations auctioned the allowances, and those that did, auctioned a very small fraction. However, in Phase III of the EU ETS, starting in 2013, the allocation system will be moving toward auctioning of all allowances over the coming years. At that time, full auction will begin for electrical power producers, and other sectors will gradually increase from 20 percent auctioning to full auctioning by 2027. 7
4. EU ETS Directive, Art. 9. 5. Id. Annex I. 6. Id. Art. 6(1). 7. EU ETS Amendment, Arts. 10 and 10(a).
6. Trading Allowances
The EU ETS is founded upon the concept of an emissions market. The EUAs may be used for compliance purposes or sold by the facility that has received them to a third party. In other words, the EUAs are fully tradable. The EUAs are registered on an EU-wide registry. Trading must be accomplished through transfer through this registry to track title to the EUAs.
7. Banking Allowances
The ability to hold allowances issued in year one for future years, increases the liquidity of the market and balances out the emissions prices. The banking of allowances has been limited to each respective phase of the ETS initially. Starting in Phase II, EUAs may be banked for use in Phase III and any subsequent phases.
8. Borrowing Allowances
Borrowing is permitted. The ability to borrow against future issued EUAs is limited to the phase in which the facility it operating, and cannot be borrowed from future phases.
9. Safety Valve and International Competiveness

At this point, no safety valve is provided for controlling the prices of EUAs. The main mechanism for reducing the economic costs of the ETS is the use of offsets from the Kyoto Protocol, as described below.
10. Offsets
Offsets may be used for compliance purposes in the ETS. CDM credits or Certified Emission Reductions (CERS) may be purchased and Joint Implementation credits or ERUs may also be used to turn in for meeting the compliance obligations of a particular countrys NAP. In addition to the limit on the quantity of CERs or ERUs that may enter and be used by countries and facilities in the EU ETS, restrictions were imposed on the types of projects that generate credits. Forestry and land use credits are not permitted at this time to be used in the EU ETS.8 Certain limitations are also imposed on hydro projects with a capacity of over 20 megawatts9 and nuclear facilities.10
8. Directive 2004/101/EC of the European Parliament and of the Council of October 27, 2004 amending Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowance trading within the Community, in respect of the Kyoto Protocols project mechanisms, Art. 11a(3)(b). 9. Id. Art. 11b(6). 10. Id. Art. 11a(3)(a).
11. Additionality
Additionality is mainly a key criteria for obtaining approval of greenhouse gas offsets. The additionality requirements are met through the Kyoto Protocols CDM and JI programs as approved by the respective United Nations boards. As a result, there is no specific additionality requirement under the ETS.
12. Supplementarity and Linkage to Other National and International Trading Systems
On the other hand, supplementarity is a key aspect of the ETS. The use of offsets from the Kyoto programs must supplement the use of EUAs to meet a regulated facilitys compliance obligations and lead to the countrys compliance with its NAP approved under the EU ETS. The ETS requires that each country provide for a maximum level of offsets that may be used in any one year within the countrys NAP, and that specific facilities are only able to use a maximum amount for their compliance obligations. Generally, this amount is set at 10 percent for each facility.11 For Phase II of the EU ETS, the maximum is set at 11.4 percent or 1.4 billion tons CO2e. The EU ETS was formed with compliance with the Kyoto Protocol as a central aspect of the scheme. Thus, the relationships between the two programs are critical to understand in forming an idea of how the ETS works. In order for the EU ETS and the Kyoto Protocol to work together, and allow trading of CERs and ERUs, a linking directive was necessary. The linking directive limited the amount of offsets that could be used in the ETS and set limits on certain types of project activities, as discussed above.
13. Early Action

Credit for early action or the reductions of greenhouse gas emissions before the regulatory system goes into effect it less important now, as the program has been in effect for several years now.
14. New or Expanded Facilities

Of course each country would like to see expanding economies, which often leads to new sources of greenhouse gas emissions. In order to not prohibit the construction of such new sources, a reserve is created in each country for these new sources. In Phase III of the EU ETS, 5 percent of the EUAs for the ETS will be reserved for new facilities.
11. EU Emissions Trading Scheme Com (2006) 725 final, Nov. 29, 2006.
15. Enforcement
By April 30 of each year, each EU member state must ensure that the regulated greenhouse gas emitting facility turns in sufficient EUAs to cover its emissions for the prior year. In the event the facility fails to turn in sufficient EUAs, the member state must collect a fine for each metric ton of greenhouse gases emitted that is not covered by an allowance. The amount of the fine charged was set at 40 euros for Phase I and 100 euros for Phase II. The fine must be higher than the cost of purchasing an EUA in order to encourage compliance with the EU ETS and NAP.
Emissions Programs among Other Kyoto Countries
Other countries outside of the European Union have struggled with establishing a cap and trade system. Concerns over international competiveness of domestic industries have been a strong driver for hesitancy in adopting domestic cap and trade programs along the Kyoto Protocol and European Union Emissions Trading Scheme (EU ETS) models. This chapter will provide an overview of some of the developments in both developed and developing countries.
A. New Zealand
The New Zealand Emissions Trading Scheme (NZ ETS) started in January 1, 2008, initially only covered forestry. The NZ ETS was expanded in 2010 to include about one hundred emissions sources in the power generation, industrial, and liquid fuel sectors.1 No specific caps are imposed under the system. By May 31, 2011, regulated facilities must turn in New Zealand Units (NZUs) for the emissions for the second half of 2010.2 Electricity generators must submit allowances for their total emissions, and other industrial sectors that are regulated must submit 6090 percent of the NZUs that are provided from the government.
1. New Zealand Expands Carbon Scheme, Point Carbon News, Carbon Market AustraliaNew Zealand, 1 ( July 2, 2010), available at http://www.pointcarbon.com/news/1.1459607. 2. See id.
The bulk of NZUs are being supplied from forest carbon projects in New Zealand, whereby forests are protected and the carbon emissions avoided are producing carbon credits under the ETS.3 The carbon market in New Zealand is still small and not terribly liquid. Forest carbon developers were hanging onto their carbon credits in the hope of a rising price. In July 2010, the spot market for allowances was around NZ$18.0018.50, and some parties were predicting that regulated entities could purchase allowances for NZ$25, which at the time was the equivalent of about US$17.4 The New Zealand government is undergoing pressure to not implement a strict program until other countries, such as the United States, Japan, China, and Australia, adopt climate change legislation and greenhouse gas regulations and caps.
B. Canada
Canada is a signatory to the Kyoto Protocol, but has not established a greenhouse gas reduction plan that successfully reduced greenhouse gas emissions to meet its Kyoto commitment. Greenhouse gas emissions in Canada have risen over the relevant Kyoto period. According to Environment Canada, the national environmental agency, the current government has set a national target of 20 percent reduction in greenhouse gas emissions from 2006 levels by 2020, a reduction of approximately 610 megatons of greenhouse gas emissions.5 The stated federal program would focus on energy intensity rather than caps, and reduce energy intensity by 18 percent from 2006 to 2010, and 2 percent per year thereafter. Carbon capture and storage would be required of oil sands and coal-fired power plants by 2018. The program would also implement renewable and energy efficiency measures, such as transportation fuel efficiency, renewable fuels, and energy efficiency standards for appliances and equipment. The federal program would also rely on the greenhouse gas reduction programs being developed by various Canadian provinces, including, Alberta, British Columbia, Quebec, and Ontario. These goals range broadly from 50 percent reductions of business-as-usual reductions by 2050 in Alberta to 33 percent reductions of 2007 levels by 2020 in British Columbia.
3. See id. 4. See id. at 2. 5. Environment Canada, Turning the Corner: Detailed Emissions and Economic Modelling, available at http://www.ec.gc.ca/doc/virage-corner/2008-03/571/Annex1_eng.htm
EMISSIONS PROGRAMS
AMONG
O T H E R K Y O T O C O U N T R I E S | 61
In May 2010, the House of Commons passed a climate bill that would require a reduction of 25 percent below 1990 levels by 2020.6 The bill would require the Canadian government to establish an emissions trading program with allowances and offsets. The Canadian government had agreed to reduce its emissions by 17 percent based on 2005 levels by 2020. This is a very large disparity, and it would be very difficult for Canada to meet the greater reductions in the House of Commons bill. Canada has also been awaiting any action at the federal level in the United States, and would likely meet a national reductions imposed by Congress. Thus, the requirements of the United States and Canada would be generally harmonized if Congress takes action.
C. Australia
Australia has similarly struggled with enacting a climate bill. The Labor Party attempted to pass what is known as the Carbon Pollution Reduction Scheme (CPRS), but failed to garner the necessary votes to pass the bill. Kevin Rudd, who was the Labor Party leader and Prime Minister of Australia, lost his role as the Labor leader to Julia Gillard. Gillard made climate change a central plank in her election platform.7 The 2010 elections have been concluded and a clear majority did not occur; however, a coalition government has been formed with the Labor Party in control. The Green Party is part of the coalition and is supporting a carbon tax until the terms of a cap and trade system can be negotiated, with reports a statute can be passed in the coming years.8
D. Japan
Japan signed the Kyoto Protocol, but operated much in the vein of an industry voluntary greenhouse gas reduction programs for many years. Starting in 2008, a trial program was initiated whereby 528 firms participated in a voluntary program to test the effectiveness of a carbon trading program in Japan.9 Of these
6. Climate Bill Passes Canadas House, PointCarbon News, May 6, 2010, available at http://www. pointcarbon.com/news/1.1442718. 7. Gillard Mulls Climate, Tax Policies that Doomed Rudd, Business Week, June 24, 2010, available at http://www.businessweek.com/news/2010-06-24/gillard-mulls-climate-tax-policiesthat-doomed-rudd.html 8. Labor Holds on to Power in Australia, PointCarbon News, Sept. 7, 2010, available at http:// www.pointcarbon.com/ news/1.1472418. 9. Cap-and-Trade: Does It Fit Japan?, available at http://www.gov-online.go.jp/pdf/hlj_ar/ vol_0021e/16-17.pdf
firms, 455 set emission quota targets. Many companies have relied upon Certified Emission Reductions (CERs) generated through the Kyoto Protocol Clean Development Mechanism to meet their greenhouse gas reduction goals. On March 12, 2010, the Japanese cabinet endorsed a draft law that would create a cap on greenhouse gas emission in Japan and create a market for trading carbon credits.10 The goal of this law would be to cut greenhouse gas emissions by 25 percent by 2020. The covered entities would include electric-power generators, steel, and other industry groups. The goal would be to launch a carbon market by 2012 or 2013. In June 2010, the cabinet was proposing to try to move a climate bill through the upper house of the Japanese parliament by late 2010. The Japanese Environment Ministry proposed an emissions trading scheme in November of 2010 that would initially cover CO2, which would include 95 percent of GHGs emitted in Japan.11 On the other hand, the Japanese Ministry of Economy, Trade and Industry has proposed a voluntary program. One of the more significant aspects of the Japanese approach to carbon trading is how it is considering addressing international offsets. The Clean Development Mechanism has been criticized for its bureaucracy, slow processing of applications, changing rules, and methodologies, among other problems. Combined with the uncertainty of an international treaty after the Kyoto Protocol expires at the end of 2012, planning for countries such as Japan that are evaluating the formation of a cap and trade program for greenhouse gases raises concerns about the ability to obtain lower cost greenhouse gas offsets in developed countries to reduce the impact on domestic industries and the overall economy becomes difficult. With respect to international greenhouse gas offsets, particularly from developed countries, Japan has apparently decided to go it alone, in the sense that it is developing a program to enter into bilateral agreements with individual developing countries. The process would entail a treaty or agreement with a developing country, and the Japanese government would establish a program and protocols for evaluating and approving offset projects from that country and the issuance of carbon credits. Japan has reportedly already initiated a test program with certain countries and domestic corporations. According to one press
10. Japans Cabinet Endorses Cap-and-Trade Climate Bill, Bloomberg, Mar. 12, 2010, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=adciuCGMBEw8. 11. Japanese Ministry Unveils Final Draft of ETS, PointCarbon News, Nov. 16, 2010, available at http://www.pointcarbon.com/news/1.1486296.
EMISSIONS PROGRAMS
AMONG
O T H E R K Y O T O C O U N T R I E S | 63
article, Japan has entered into initial discussion with China to develop an offset program.12
E. China
China has not embraced a cap and trade system, and has negotiated against mandatory cuts in greenhouse gas emissions in developing countries. At the same time, voluntary carbon markets may be springing up in China. China has been the leader in generating offsets in the form of CERs under the Clean Development Mechanism. Thus, the concept of emissions trading, at least with respect to offsets, is well understood and encouraged in China. Another development is the formation of environmental trading exchanges in China. In 2002, China set up a sulfur dioxide trading program, and a water pollution trading program for Lake Tai. In the City of Tianjin, a carbon market is being developed. The exchange is a joint venture among the China National Petroleum Corp.the countrys largest oil and gas companythe Tianjin Property Rights Exchange, and the Chicago Climate Exchange.13 China is reportedly attempting to make fairly major strides through its developing five-year energy plan. China reportedly may take steps to generate 30 percent of its energy from noncarbon sources by 2015, cut energy use by 346 million tons of standard coal consumption per year, with the ultimate goal of reducing its carbon intensity by 4045 percent by 2020 based on 2005 levels, and may develop a pilot carbon trading scheme for the electricity generation, petroleum, and petrochemical industry sectors.14 While the development of carbon trading programs in these countries remains in the developmental stage, as it does in the United States, it appears that if these countries pursue greenhouse gas reductions, some level of carbon trading will play a role in all of these programs as they develop and are implemented. The use of market-based emissions control programs is definitely a concept that is spreading across the globe. It does seem apparent that a carbon market will endure in any event; the question is the structure and the size of the market.
12. Japans Big Business Pushes for Rival to CDM, PointCarbon News, Nov. 17, (2010), available at http://www.pointcarbon.com/news/1.1486550. 13. China May Start Its First City-Wide Carbon Market, Bloomberg, Mar. 5, 2010, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=arHr7BXpQIfQ. 14. China to Cut Coal Dependence, Point Carbon News ( June 20, 2010), available at http://www. pointcarbon.com/news/1.1459344.
The Emergence of National and International Carbon Markets

A. Compliance or Mandatory Markets
Environmental markets as mentioned in prior chapters in a sense appear to be an evolving aspect of modern economies. The use of emissions markets in particular to address air pollution issues is a preferred industry approach as it is more cost effective and allows more flexibility to industrial sources of air emissions, whether volatile organic compounds, sulfur dioxide, particulates, nitrous oxides, or greenhouse gases, it really does not matter. As the concept of environmental markets is permeating the globe where national and subnational governments are reviewing the mechanisms to control greenhouse gas emissions, we should expect that carbon trading will grow internationally.
B. Voluntary Markets
1. Voluntary Carbon Standards and Markets
One of the most interesting, if not surprising, markets for greenhouse gas offsets is the voluntary carbon market or markets. These markets exhibit an organic growth without any government mandate, thus the term voluntary markets. Various businesses and industries have sought to acquire carbon offsets generated from projects throughout the world in order to offset their greenhouse gas emissions and/or those of their customers in order to reduce their carbon footprint or those of their customers. In order to meet the demand for these voluntary carbon credits, standards boards and reviewers or validators/verifiers were required. One of the key
THE EMERGENCE
OF
NATIONAL
AND
I N T E R N A T I O N A L C A R B O N M A R K E T S | 65
problems with carbon credits is the concern or discovery that the credits do not reflect real, additional changes in behavior or changes in activities that lead to actual reductions in greenhouse gases. Stories have proliferated in the press regarding offsets that turned out not to reduce any greenhouse gas emissions at all. Thus, standards-setting boards were established to provide confidence that the carbon offsets are real and verifiable. These standards will be discussed below.
2. Source of Demand for Voluntary Carbon Credits

So why did these markets emerge? How is it possible that companies would actually spend hard-earned profits to reduce net emissions without any government mandate? It does not seem possible under a traditional view of economics or corporate behavior. The explanation may be best explained by the science of climate change and the causes of climate change discussed in Chapter 1. In order to expand on those concepts, as the public has become more aware of the current science on climate change and its causes, demand for action by consumer product and service companies to reduce greenhouse gas emissions or to offset them has grown dramatically. Hotel chains, airline companies, retail stores, and a variety of other consumer companies have been setting up programs to purchase carbon offsets and even selling them to their customers. These buyers are purchasing credits for green marketing programs or corporate policies. Other buyers are what are referred to as pre-compliance buyers. These buyers may be buying for marketing or public relations reasons but may also or solely be purchasing voluntary credits in order to amass a certain volume of credits before a mandatory program is instituted. The pre-compliance market will be discussed later in this chapter. Some buyers are purchasing options or forward sales or entering forward sale contracts with carbon credit project developers. Thus, these contracts look more like hedges on other commodities, and may be regulated as financial derivatives under any new climate legislation. We will discuss these issues in more detail in later chapters.
3. Development of Voluntary Standards, Registries, and Exchanges

As stated above, as the demand for voluntary carbon credits evolved, the emergence of standards boards, registries, and exchanges emerged to address the demands of the new market. New ones have emerged over the years and investors and entrepreneurs seized on the opportunities that emerging carbon markets created.
a. Chicago Climate Exchange While the name Chicago Climate Exchange (CCX) would at first blush imply an exchange alone, it really functions as a standards board and registry as well. The founder of the CCX is Dr. Richard Sandor, an economist who seized on the concepts of carbon trading in the very early days of the development of programs to address climate change. One of the main aspects of the CCX is that members of the exchange enter into legally binding agreements to meet certain greenhouse gas emissions from their operations. Those who exceed their voluntary goals, bank or sell the difference in terms of surplus allowances.1 With respect to offsets, the CCX establishes protocols for project activities. A program for parties who want to propose new offset protocols is available to allow new forms of greenhouse gas reductions. Guidance is provided for verification of the projects and offsets. Once projects and offsets are verified and allowances created, they are registered on the CCX carbon registry. The registry account holders use the registry to manage, register, and trade their allowances or offsets. For trading offsets, the CCX provides a trading platform as well. This is an electronic system for posting and accepting bids and offers much like any other commodity exchange used for buying and selling. The CCX provides a clearing and settlement program through the electronic trading platform. The movement of ownership occurs on the CCX carbon registry, which is linked to the exchange. b. Voluntary Carbon Standard While the CCX, and its sister companies in Europe, were part of the early movers in terms of initiating a voluntary carbon market, several other standards organizations for carbon credit review and issuance have emerged. We will focus on the more well-known standards boards for purposes of this chapter. One of the leading voluntary carbon standards organizations goes by a rather obvious name, the Voluntary Carbon Standard Association (VCSA) that administers the Voluntary Carbon Standard (VCS). The organization was formed by the Climate Group, the International Emissions Trading Association, and the World Economic Forum in late 2005. Version 1 of the VCS was released on March 28, 2006, as both a consultation document and a pilot standard for use
1. For more information regarding the CCX, see their website at http://www.chicagoclimatex. com/.
THE EMERGENCE
OF
NATIONAL
AND
in the market. The VCS is designed to serve as a global standard for issuing voluntary carbon credits. The self-stated objectives of the VCS are as follows:
Standardize and provide transparency and credibility to the voluntary offset
market; Enhance business, consumer, and government confidence in voluntary offsets; Create a trusted and tradable voluntary offset credit; the Voluntary Carbon Unit (VCU); Stimulate additional investments in emissions reductions and low carbon solutions; Experiment and stimulate innovation in emission reduction technologies and offer lessons that can be built into future regulation; and Provide a clear chain of ownership over voluntary offsets that prevent them being used twice. This is achieved through multiple VCS registries and a central project database that is open to the public.2
The VCS works by adopting methodologies that serve as the protocols for developing carbon credit projects. Some of these methodologies are created through the VCSA, and the VCSA also accepts methodologies adopted by the Executive Board of the Clean Development Mechanism (CDM) created under the Kyoto Protocol. In order to obtain approval of a carbon project and the issuance of VCUs, a third-party validator/verifier must validate the project design document submitted by the project developer, and verify the amount of greenhouse gas emissions actually reduced and, therefore, how many VCUs should be issued. The VCSA relies on third-party registries to actually issue the credits and maintain them on their registries. The VCSA does not take a direct role in the issuance of carbon credits for individual projects. Projects must be validated within two years of their start date. The VCSA believes this is necessary to ensure that the projects intend to pursue carbon finance from the outset and that the reductions meet the additionality tests. New methodologies are developed through the Double Approval Process. A project proposing a new or amended methodology must have two VCSapproved validators independently assess the methodology and provide a positive assessment of the methodology.
2. See the Voluntary Carbon Standard website at http://www.v-c-s.org/about.html. Various information, programs, methodologies, registry system, guidance documents, and other documents can be found on the website.
The VCSA allows for Grouped Projects, which is similar to the CDMs Project of Activities. A Grouped Project allows developers to bring a number of similar project activities into one Project Description, whereby these projects can be monitored under a centralized system. This allows the addition of new projects to the same program and the aggregation of smaller projects together for purposes of validation and verification. The VCS Registry System allows the tracking of all VCUs that are issued through the VCS-approved carbon registries. Currently the three approved carbon registries are APX Inc. (a leading environmental market infrastructure provider in North America), Caisse des Dpts (a leading French financial institution and developer of carbon registries in Europe), and Markit (a leading international financial markets meta-registry in the United States, United Kingdom, and Asia-Pacific). VCUs must be registered on one of these three registries, and all issuance, holding, transferring, and selling of VCUs will be managed through these registries. An exchange per se is not necessary to be utilized under the VCS. Typically, the trading of VCUs is managed through over-thecounter trades or bilateral agreements, rather than through clearing through an exchange.
c. American Carbon Registry Like the VCS, the American Carbon Registry (ACR) serves as a means of validating, verifying, and issuing carbon credits in the form of greenhouse gas offsets. The ACR was formed by Environmental Resources Trust (ERT), now a business unit of Winrock International (Winrock), in 1997. Winrock is a nonprofit organization whose stated mission is working with people in the United States and around the world to empower the disadvantaged, increase economic opportunity, and sustain natural resources.3 ERT is a leader in the field of environmental markets.4 The ACR was the first private voluntary greenhouse gas registry in the United States and offers the entire spectrum of carbon technical services for greenhouse gas accounting, verification, registration, over-the-counter (OTC) transactions and offset retirement.5 The unit established by the ACR for greenhouse gas offsets is the Emission Reduction Tons (ERTs). These carbon credits are registered, and the purchase, sale, and retirement is tracked on the ACRs registry.
3. See Winrock International website at http://www.winrock.org/about_us.asp. 4. See id., http://www.winrock.org/feature_ert_200802.asp. 5. See id.
THE EMERGENCE
OF
NATIONAL
AND
d. Climate, Community, and Biodiversity Alliance With the advent and growing demand for carbon credits from avoided deforestation and reforestation projects, standards for these types of projects and carbon credits evolved under the CCX, VCS, and ACR. One of the growing trends was the concern that the local communities and the biodiversity related to the preserved or regrown forests were addressed. The Climate, Community, and Biodiversity Alliance (CCBA) was born out of these concerns. The objectives of the CCBA are summarized as follows:
The Climate, Community and Biodiversity Alliance . . . is a partnership of international NGOs and research institutes seeking to promote integrated solutions to land management around the world. With this goal in mind, the CCBA has developed voluntary standards to help design and identify land management activities that simultaneously minimize climate change, support sustainable development and conserve biodiversity.6
The early drafts of the CCBAs standard (CCB Standard) were issued in 2004 and 2005, and the final standard was issued in May 2005. The standards were revised in 2008, and the second edition relaunched in December 2008. The CCBA issued new Rules for the use of the CCB Standard on June 21, 2010, which prescribe the requirements for the evaluation of projects against the CCB Standard and is intended to be used by project proponents and the independent auditors that evaluate the conformance of projects to the CCB Standard.7 This standard will be discussed in a later chapter addressing forest carbon projects.
C. Pre-Compliance Markets and the Transition from Voluntary to Compliance Markets

Some buyers of voluntary carbon credits are obtaining credits in order to amass a certain volume before a mandatory program is instituted. Thus, the term pre-compliance was coined. These purchases are made under the presumption that the cost of credits after a mandatory cap and trade program goes into effect
6. See CCBA website at http://www.climate-standards.org/. 7. Rules for the Use of the Climate, Community & Biodiversity Standards ( June 21, 2010), available at http://www.climate-standards.org/pdf/CCB_Standards_Rules_Version_June_21_2010. pdf.
will rise several fold. The pre-compliance buyers tend to be electricity generators, petroleum refining, steel, chemical, and other industries or businesses that anticipate potentially being required to reduce their emissions and that a cap and trade program will likely be the form of regulatory program that would be passed at some point in the future. These purchases are in effect a hedge against higher prices for credits in the future. The pre-compliance market demand increases as the potential for legislation is perceived to be likely and decreases as it as seen as less likely.
D. Survival of Voluntary Markets after Establishment of Compliance Systems

One of the current questions is the extent to which voluntary markets will continue in existence if mandatory systems are created in a particular countrythe primary country of interest being the United States. One thought is that once mandatory markets are created, the pre-compliance market would cease to exist as regulated entities would purchase offsets or allowances approved under the relevant governmental system. The other thought is that the mandatory market would serve to provide offsets or allowances for use by the volunteer, public relations market. What has been seen in Europe is that a voluntary market continues to survive. This may be that non-compliance purchasers find a more ready and less expensive source of offsets in the voluntary market, rather than purchasing in the mandatory market.
E. The Current State of the Voluntary Market

At least two reports are published annually that provide a study and analysis of the voluntary carbon markets. The first of these is entitled The State of the Voluntary Carbon Markets Report and was developed by Ecosystem Marketplace and Bloomberg New Energy Finance. In 2010, the report was issued and entitled Building Bridges: State of the Voluntary Carbon Markets 2010.8 The report reviews the prior market for the year prior to the year of issuance and compares it to the preceding years.
8. Katherine Hamilton, Milo Sjardin, Molly Peters-Stanley, & Thomas Marcello, Ecosystem Marketplace and Bloomberg New Energy Finance, Building Bridges: State of the Voluntary Carbon Markets 2010 ( June 14, 2010).
THE EMERGENCE
OF
NATIONAL
AND
In the 2010 Report, the authors report a tumultuous year for the voluntary carbon markets, as a result of the severe economic recession and the unpredictable nature of climate legislation in the United States.9 The report concludes that about one-half of the buyers were pure voluntary buyers, as opposed to pre-compliance buyers. The supply in 2009 was 93.7 million tons of CO2e, compared to 126.6 million tons in 2008a 26 percent decline, but still 39 percent above 2007 levels.10 Almost half the market was traded on the CCX in the form of Carbon Financial Instruments; however, exchange-traded deals dropped 40 percent in 2009. This indicates a shift to the over-the-counter market. Compared to the regulated markets, the voluntary markets were small, about 1 percent of the regulated markets.11 The total value of trades transacted were $387 million in 2009, as compared to $787.1 million in 2008.12 The OTC market constituted 84 percent of the market, and the CCX exchange market formed 14 percent of the market value. This may reflect lower prices for CCX credits. Average prices on the OTC market declined by 12 percent from $7.3/tCO2e to $6.5 per ton CO2e, while the CCX suffered a large price reduction of 73 percent from an average $4.4/tCO2e in 2008 to $1.2 per ton CO2e in 2009. These changes resulted in a market value decline in the CCX market of 84 percent. Voluntary credits sales price varied dramatically for as low as $0.3 per ton CO2e and as much as $111.0 per ton CO2e during 2009.
F. The European Market

The European Market is by far the largest carbon market. The EU Emissions Trading Scheme (ETS) has created a market that has grown to over $100 billion dollars per year in 2009. Total transactions in European Union Allowances (EUAs) have increased by about 18 percent to $118.5 billion.13 Trading volume increased by 105 percent. However, the average EUA prices fell 42 percent to $18.70 in 2009 compared to $32.50 in 2008.14 Futures trades constituted 73 percent of all transactions. Spot market trades grew in volume to 1.4 billion tons.
9. Id. at i. 10. Id. at ii. 11. Id. at iii. 12. Id. 13. World Bank, State and Trends of the Carbon Market 2010 5 (May 2010). 14. Id.
The World Bank report states that EU companies monetized their excess allowances to raise capital.15 In general, the economic recession and reduced demand for electricity and decreased greenhouse gas (GHG) emissions were significant factors affecting the EU carbon market. In considering the EU carbon market, the World Bank report concludes that the carbon market is actually functioning well:
As a market mechanism, the EU ETS should be evaluated according to how accurately it has reflected macro-economic trends. The fact that carbon prices fell along with the prices of mature energy commodities as the global economic crisis deepened, and rebounded amidst signs of recovery, suggests the market is both efficient and rational. The price of carbon reflected expectations for the amount of abatement required to limit emissions under a changed economic scenario.16
The evidence as reviewed by the World Bank analysts demonstrates that emissions markets and carbon markets in particular can work well to address reductions in emissions of air pollutants. Much like the SO2 market for coal-fired power plants in the United States, the GHG markets in the European Union have achieved reductions in emissions while allowing industry more flexibility in determining how to meet mandated reductions and in seeking the lowest cost reductions.
G. The Kyoto Protocol and the Clean Development Mechanis Market

Trading of Certified Emission Reductions (CERs) under the CDM of the Kyoto Protocol has grown dramatically since the inception of the CDM. The market value grew from nothing to $6.5 billion in 2008.17 CERs played a significant role in the EU ETS market as compliance buyers and investors and banks bought CERs. The financial crisis has a marked effect on the CER market. The volume and market value both declined significantly in 2009. Volume decreased from 401 to 211 million tons, and total value of the market trades dropped from $6.5 to
15. Id. at 2. 16. Id. at 6. 17. Id. at 37.
THE EMERGENCE
OF
NATIONAL
AND
$2.7 billion.18 Prices for CERs dropped as well from an average of $12.7 per ton from $16.1 in 2008.19 Compliance buyers did not purchase as many credits as demand for electricity and other economic activity decreased. Financial entities with their own financial challenges reduced their purchases of credits. Financial institutions reduced their lending and investment in project development as well, so fewer credits were being generated.20 As the economy recovers, these trends may reverse themselves, depending on how countries with a demand maintain their legislation on climate change and cap and trade as the regulatory system to use to address climate change concerns. The ability to obtain financing for carbon credit projects will be essential to the market.
18. Id. 19. Id. at 39. 20. Id. at 37.
Developing Laws in the United StatesState Laws
A. State Climate Change Programs

In the United States, the first regulation of greenhouse gases (GHGs) began in the states, and the developing laws at the state level was one of the significant factors in pushing Congress to act. While Congress has enacted only requirements and funding for the Environmental Protection Agency (EPA) to require GHG monitoring and reporting, and climate change legislation has been passed by the House of Representatives, but not the Senate, the states have moved forward with a significant degree of development of GHG regulatory systems. Cap and trade is a part of all of those enacted or developing systems, as will be described below. One of the interesting aspects of these multi-state programs is that Canadian provinces and Mexican states are also working with these programs and may participate in the regional GHG regulatory programs at some point in the future, making these programs cross-border, international programs.
B. Individual State Programs

1. California
California, a long-established leader in developing environmental initiatives that spread across the country at the state level and eventually become federal law, has enacted a climate change statute. The statute is known as the California Global Warming Solutions Act, also known as AB 32 from of its legislative number, Assembly Bill 32.
DEVELOPING LAWS
IN THE
U N I T E D S T A T E S S T A T E L A W S | 75
The California Air Resources Board (CARB) is the agency given the responsibility of developing the programs to implement AB 32. In developing a climate change and GHG regulatory program and cap and trade system, CARB is required to analyze many factors, including economic impacts, environmental impacts, public health impacts, equity between regulated entities, electricity reliability, conformance with other environmental laws, and potential disproportionate impacts on low-income communities. In November of 2010, CARB issued a proposed regulation to establish a cap and trade system (Proposed Rule). Under AB 32, the program must be adopted by January 1, 2011, and must go into effect by 2012. In developing this program, CARB is working with other states and developing the Western Climate Initiative, discussed below, and its cap and trade program for the participating states and provinces. Thus, CARB intends that the California program be part of a larger, regional cap and trade system. Since CARB is establing the cap and trade system through regulations as provided under AB 32, CARB is receiving public comments on the proposal.1 CARB set a hearing on the regulations on December 16, 2010.
a. Regulated Gases The gases listed in the Rule in the definition of greenhouse gases are as follows:
Carbon dioxide (CO2); Methane (CH4); Nitrous oxide (N2O); Hydrofluorocarbons (HFCs); Perfluorocarbons (PFCs); Nitrogen trifluoride (NF3); Sulfur hexafluoride (SF6); and Other fluorinated gases.2
b. Regulated Sources Covered Entities would include the following:

Cement production; Cogeneration; Glass production;
1. California Air Resources Board, Proposed Regulation for a California Cap-and-Trade Program (Oct. 19, 2010) (hereinafter Proposed Rule). 2. Id. 95810.
76 | R E G U L A T O R Y S T R U C T U R E S Hydrogen production; Iron and steel production; Lime manufacturing; Nitric acid production; Oil and natural gas systems; Petroleum refining; Pulp and paper manufacturing; Self-generation of electricity; and Stationary combustion.3
Covered entities would also include the following:

Electricity deliverers, meaning electricity generators located in California,
and parties importing electricity into California;4 Natural gas deliverers, meaning a public utility gas corporation operating in California; a publicly owned natural gas utility operating in California; or the operator of an intrastate pipeline not included in section 95811(c)(1) or section 95811(c)(2) that distributes natural gas directly to end users;5 Fuel deliverers, including California reformulated gasoline (RBOB), diesel fuel, distillate fuel oil, natural gas liquids, and biomass fuels; and Suppliers of CO2.6 The emissions threshold would generally be 25,000 tons per year.7 The cap and trade program would be developed in three compliance periods. The first compliance period would begin in 2012 and end in 2014, and apply to the list of covered entities, regulate electricity generating plants and importers of electricity generated in other states, and suppliers of CO2 that emit in excess of 25,000 tons CO2e.8 The second compliance period would begin in 2015 and end in 2017, and would expand the cap and trade program to suppliers of natural gas, suppliers of
3. Id. 95811(a). 4. Id. 95811(b). 5. Id. 95811(c). 6. Id. 95811(d)-f. 7. Id. 95812(b). 8. Id. 95840(a), 95851(a).
DEVELOPING LAWS
IN THE
RBOB and distillate fuel oils, and suppliers of liquefied petroleum gas generally above 25,000 tons.9 The Third Compliance Period would begin in 2018 and end in 2020. Any additional source types to be included in the regulatory system would have to be added by CARB through regulatory amendment.
c. The Cap The program would implement a cap on GHG emissions to reach 1990 levels by 2020. The program would allow a market-based system and other alternative compliance programs to achieve this reduction goal. The program to achieve the 2020 cap is required to be adopted by January 1, 2012. CARB would set what it calls an Allowances Base Budget for specific time periods in millions of allowances. The periods would correspond to three-year compliance periodsFirst Compliance Period 2012 to 2014, Second Compliance Period 2015 to 2017, and Third Compliance Period 2018 to 2020. The number of allowances would start in 2012 at 165.8 million allowances and decline to 159.7 million in 2014. With the increase in Covered Entities and the reach of the Second Compliance Period to other sectors of the economy, the allowances would be raised to 394.5 million allowances and decrease to 334.2 allowances in 2020.10 d. Permitting Emissions of Greenhouse Gases A permit would be required for each facility that governs the allowed GHG emissions and future reductions. The permitting program is outside of the cap and trade program and not addressed by the Proposed Rule. e. Emission Allowances Emission allowances would be created and used as the foundation of the cap and trade program. In order to enforce the cap, fewer total allowances would be issued each year. Allowances must be submitted and retired on an annual basis by each Covered Entity to meet their compliance obligations.11 Failure to do so would result in substantial penalties. f. Allocation of Emission Allowances The Proposed Rule provides for both free allocation and auctioning of allowances. The approach proposed is to have an initial percentage of the allowances being auctioned and then increasing to a higher percentage of auctioning
9. Id. 95840(b), 95851(b). 10. Id. 95841, Table 6-1. 11. Id. 95856.
of allowances in later years.12 In the Proposed Rule, CARB is allocating allowances in part based on the risk of the reductions in California resulting in increased emissions in other jurisdictions. The term used for this is leakage. For a group of entities, this means 100 percent of allowances would be directly allocated. A certain amount of allowances would be set aside to assist these industry types. The goal being to reduce the economic impact and reduce the competitive impact from international or domestic entities from jurisdictions that do not regulate GHGs. The allowances for certain entities would be allocated annually using a product output-based methodology and formula, while others would be based on a thermal energy methodology and formula.13 The regulation of the following types of sources are considered a high risk of leakage, and would get 100 percent of their industry assistance allowance:
Oil and gas extraction; Natural gas liquid extraction; Soda ash mining and manufacturing; Reconstituted wood product manufacturing; Paper manufacturing; Paperboard manufacturing; All other basic inorganic chemical manufacturing; Flat glass manufacturing; Glass container manufacturing; Cement manufacturing; Lime manufacturing; and Iron and steel mill.14
Other industries would be allocated 100 percent in the First Compliance Period, and decline to lower percentages in the Second and Third Compliance Periods.15 Certain industries would be allocated allowances based on a thermal efficiency formula. The leakage percent is plugged into the product or thermal efficiency formula depending on the industry type. The goal would be to use the allocation process to reduce economic impacts. If sufficient allowances are not directly allocated, then the covered entity would need to purchase additional allowances through the allowance auction. As discussed below, purchasing offsets may also serve to fill some portion of that need.
12. See id. 95870-95893. 13. Id. 95891. 14. Id. 95870, 95890-91. 15. Id.
DEVELOPING LAWS
IN THE
In the auction process, CARB is proposing to use soft collars, by which the CARB could adjust the supply of allowances or offsets in the emissions market once price triggers are reached through reserve allowance accounts. CARB is also proposing to use a reserve price below which no allowances would be sold to attempt to maintain a floor price for allowances, and by association, offsets. For calendar year 2012 the reserve price would be set at $10 per metric ton of CO2e for vintage 2012 allowances, and $11.58 per metric ton of CO2e for vintage 2015 allowances, and the reserve price would increase in auctions after 2012 by increased annually by 5 percent plus the rate of inflation.16 The Allowance Price Containment Reserve would be allocated one percent of the allowances from budget years 20122014, four percent of the allowances from budget years 20152017, and seven percent of the allowances from budget years 20182020.17
g. Trading Allowances Allowances may be sold freely to third parties. Covered Entities, entities voluntairloy submitting to regulation, and third party traders may register and seek approval to trade allowances under the program.18 The CARB is planning in the Proposed Rule to regulate trades and traders to ensure the integrity of the trading system and allowance and offset markets.19 h. Banking Allowances Allowances may be used to meet compliance obligations if the allowance has been issued for a current or previous compliance period.20 Offsets may be held or used for a compliance obligation.21 i. Borrowing Allowances Borrowing would not be allowed under the Proposed Rule.22
16. Id. 95111(b)(6). 17. Id. 95870(a). 18. Id. 95812-14, . 19. Id. 95831(b). 20. Id. 95922. 21. Id. 22. Id.
j. Safety Valve and Competitiveness CARB does not propose a price cap on allowances. To reduce costs of compliance with the program, CARB has proposed as discussed above to allocate a certain amount of free allowances and a reserve of allowances for sale to covered entities that would increase the supply of allowances and reduce allowance prices. Offsets are another mechanism to reduce compliance costs by providing a less expensive means of meeting compliance obligations by submitting offsets in lieu of allowances that tend to be more expensive than offsets. k. Offsets The offset program under development in California has faced challenges. A voluntary program was created by CARB in the California Climate Action Reserve (CAR). Voluntary GHG emissions reductions were intended to be registered with CAR, and it was intended that those offsets would be qualified for use in a future CARB cap and trade program. Unfortunately, after the methodologies were created, CARB determined that public notice and comment procedures had not been followed and the credits created under the CAR system could not be accepted in a future compliance system. CARB has identified certain CAR methodologies it will accept, as discussed below, but apparently may not necessarily adopt all of the CAR methodologies. CARB may adopt other project types and methodologies at later dates. In the Proposed Rule, a program for monitoring and issuing GHG offsets is proposed. The proposal contains a general set of requirements for offset credits, approval of offset methodologies, requirements for offset methodologies, additionality requirements, baseline emission calculations, requirements for operators of offset projects, verification, reporting, ownership and transferability, offsets issued by non-Carb programs, sector-based programs, and many other issues related to offsets.23 In addition to the Proposed Rule and the issues raised in the text of the Proposed Rule regarding offsets and the offset program, on July 29, 2010, CARB issued a letter after public workshops were conducted to gather public comment on the offset program.24 The workshops were held to development discussions on the role of offsets in the compliance program for addressing GHG emissions. Some of the conclusions of the letter were:
Offsets can serve to reduce the costs of compliance;
23. Id. 9594095997. 24. California Air Resources Board, Update Regarding the Proposed Offset Component of the California Cap-and-Trade Program ( July 29, 2010).
DEVELOPING LAWS
IN THE
Quality of the offsets is critical to maintaining the integrity of the cap and
trade program, and therefore, CARB plans to

Conduct analyses to ensure that compliance-eligible offset credits meet all
AB 32 requirements;
Ensure the cap-and-trade program meets all California Environmental
Quality Act requirements;

Take a conservative approach to ensure that all offsets used in the program
are real, additional, permanent, verifiable, and enforceable; and

Propose that all emission reductions from offset projects be verified by
third-party verifiers accredited by ARB. The offset program contained in the Proposed Rule would include verifier accreditation, requirements for verifier services, and conflict of interest provisions, among other provisions regulating the offset program. The Proposed Rule includes a process for allowing other qualified offset programs to be used in California.25 The offset types that CARB would include immediately are ozone depleting substances projects, livestock projects, urban forest projects, and U.S. forest projects.26 Other protocols may be approved in the future. In addition to CARB offsets, sector-based offsets may be allowed into the system from developing countries or from subnational jurisdictions within developing countries, the one provided for specifically in the proposed rule being from international reduced deforestation and degradation (REDD) projects.27 In what is known as a nested approach, project-based sector projects, currently only REDD projects, may be allowed within a jurisdiction and sector-based set of baseline emissions and reductions.28 Other sectors may be approved by CARB in the future. The Proposed Rule does provide for a limitation on the number of offset credits that can be used by a covered entity to meet its compliance obligations as will be discussed below under the section on supplementarity. CARB has made a a commitment to offsets. The rule, however, has limited the use of offset credits to four protocols. The rules allow the use of offset credits from other offset programs that may lead to acceptance of those offsets issued under the Voluntary Carbon Standard, the American Carbon Registry, and other voluntary standard programs, as well as other state programs from the Western Climate Initiative and potentially the Midwestern Greenhouse Gas
25. Proposed Rule 95941. 26. Id. 95973(a)(2)(C). 27. Id. 95991, 95993(a). 28. Id. 95994(a)(6).
Reduction Accord. The need for an increased supply from other offset programs to reduce the cost impact of the cap and trade program is recognized by CARB.
l. Additionality The definition and application of additionality requirements for offsets is still under development. The current proposed definition for the term additional is: greenhouse gas emission reductions or removals that exceed any greenhouse gas reduction or removals otherwise required by law, regulation or legally binding mandate, and that exceed any greenhouse gas reductions or removals that would otherwise occur in a conservative business-as-usual scenario.29 In the California program for offsets, there has been discussion about performance tests for additionality that would apply across the board to offset project types, and not require project by project analysis of additionality. Sectoral programs also have been discussed by which industries or businesses would have to show reductions in overall emissions before reductions in greenhouse gases at a specific facility could be credited. m. Supplementarity and Linkage to Other Trading Systems The Proposed Rule would address supplementarity by limiting the use of offsets for compliance obligations for covered entities to ensure reductions are made at emissions regulated facilities, rather than offsets alone being used to meet compliance obligations. The formula provided in the Proposed Rule is that O/S cannot be less than L. The term O refers to offset credits subject to the limitation, which are offset credits issued by CARB under its protocols, early action credits under programs existing before the beginning of the new program, and sectorbased offsets these sector-based credits being limited to REDD projects currently by the Proposed Rule. Only 25 percent of sector credits may be included in the calculation of O for this formula in the First and Second Compliance Periods, but up to 50 percent for subsequent compliance periods. S is the covered entities annual or triannual compliance obligation. L equals the quantitative offset credit usage limit of 0.08. Early action offset credits may arise from certain types of projects that are approved under third-party offset programs. The Early action projects GHG reductions must have occurred between January 1, 2005, and December 31, 2014, and the offset project must have commenced before January 1, 2012.30
29. Id. 95802(a)(3). 30. Id. 95991-95997.
DEVELOPING LAWS
IN THE
Linkage to other allowance and offset programs would be permitted under the Proposed Rule.31 A fairly detailed set of requirements have been proposed to ensure the integrity of the California program.
n. Early Action One of the requirements of AB 32 was to protect facilities that reduced their GHG emissions prior to a regulatory system going into effect. The Proposed Rule would allow third party offsets that were issued prior to the effective date of the final rule if the offsets were issused under the four offset protocols approved by CARB and discussed above or if an executive order is issued approving the program and offsets or if certain criteria listed in the rule are met.32 o. New or Expanded Facilities The Proposed Rule provides for facilities that are newly regulated by establishing a phase in of their compliance obligations.33 Newly constructed covered entities of facilities that were not in operation before 2011 may estimate emissions to obtain free allocation under the relevant provisions of the Proposed Rule.34 Under the thermal energy-based methodology, entities shall be assessed baseline annual steam and/or thermal energy use values based on expected activity levels. No specific provision is included for expanded facilities as to how these expansion activities will be allowed to go forward in the cap and trade system. These facilities would appear to be required to purchase additional allowances or offsets to meet their complianee obligations for any increased emissions. Increases in emissions would likely require approval from the permitting authority prior to the construction of the expansion. p. Regulatory Agency or Agencies CARB will be the main state agency regulating greenhouse gas emissions and the cap and trade program, as well as regulation of allowance and offset trading. q. Enforcement CARB has proposed enforcement provisions in the Proposed Rule. These provisions include the authority to suspend, revoke, or modify a Holding Account that contains allowances or offsets, to place restrictions on the account, to seek injunctions and penalties under the California Health and Safety Code, and
31. Id. 9594095943. 32. See id. 95990. 33. Id. 95853(e). 34. Id. 95891(c)(3).
other actions for failure to comply with the Proposed Rule or submit the necessary number of allowances or offsets for a compliance year.35
2. Florida
In June 2008, the current governor signed House Bill 7135 that provided for a comprehensive energy and climate change program.36 The Florida Climate Protection Act authorizes the Department of Environmental Protection to develop an electric-utility greenhouse gas cap and trade program. The agency is in the process of developing regulations to implement the cap and trade program. With a governors race in the fall of 2010, like many other state climate programs, the future of the program likely depends on the outcome of the election. Florida has considered joining one or more of the multi-state programs in more detail below.37 While Florida is not adjacent to any of the other states participating in a multi-state greenhouse gas program, participation is possible as it may gain the value of work of the analysis and program development completed by the other states. In addition, the consistency of a Florida program with one or more of the multi-state programs may allow the state to participate in offset trading with the other U.S. states and the potential for trading with participant provinces and states in Canada and Mexico.
3. New Mexico
The State of New Mexico has adopted through the New Mexico Environmental Improvement Board and the New Mexico Environment Department a capand-trade program.38 The rule was adopted on November 10, 2010. The rule may be challenged in court by opponents of a cap and trade program in the state. With the election of a new governor, the administrative agencies may alter their approach to greenhouse gas regulations. Thus, the longevity of this program is somewhat uncertain.
35. Id. 9601096013. 36. Florida Action Team on Energy and Climate Change, Floridas Energy and Climate Change Action Plan 42 (Oct. 15, 2008). 37. Florida Decision on Regional Greenhouse Gas Initiative Still Up in the Air, Environmental News Service (Sept. 7, 2009), available at http://www.ens-newswire.com/ens/sep2009/2009-0908-092.html 38. New Mexico Environmental Improvement Board, Order and Statement of Reasons for Adoption of New Regulations, In re. Proposed New Regulation: 20.2.350 NMACGreenhouse Gas Cap and Trade Provisons, EIB No. 10-4 (R) (Nov. 10, 2010), available at http://www.nmenv. state.nm.us/cc/documents/SOR_20_2_350_NMAC.pdf; New Mexico Environment Department, Greenhouse Gas Cap-and-Trade Provisions, to be codified at 20.2.350 NMAC, available at http:// www.nmenv.state.nm.us/cc/documents/20_2_350_NMAC_final.pdf.
DEVELOPING LAWS
IN THE
C. Multi-State Programs
1. Regional Greenhouse Gas Initiative
The first of the multi-state programs to develop a GHG regulatory system was the Regional Greenhouse Gas Initiative (RGGI), which was established in 2005 with seven northeastern and mid-Atlantic states, and has grown to ten states. The participating states are Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, and Vermont. This program involved five years of development and the adoption of a model rule to govern the participating states programs so that they would be compatible. Other states and Canadian provinces in the region are serving as observers in that they are working with the participating states, but have not yet joined RGGI or adopted the model program in their own state or province. The observer states and provinces are Pennsylvania, Qubec, New Brunswick, and Ontario. The participating states developed program that was modest and designed not to have a significant impact on electricity prices. The RGGI program includes a cap and trade system. The participating states developed a Model Rule, and each state adopts the Model Rule and implements and enforces the greenhouse gas regulatory program in their respective jurisdictions.39
a. Regulated Gases RGGI currently only regulates CO2, and not any of the other greenhouse gases. b. Regulated Sources The regulated entities are fossil-fuel power plants that generate 25 megawatts (MW) or more of electricity.40 Approximately 225 facilities in the region are regulated. c. The Cap A cap is set for the region and allotted for each state. The cap was set at 188 million tons of CO2 with the reduction of 10 percent of 1990 emissions levels by 2018. The reductions will be timed by a stabilization of emissions through 2014, and then a 2.5 percent reduction from 2015 to 2018. The first compliance period is 2009 to 2011.
39. Regional Greenhouse Gas Initiative Model Rule (Dec. 31, 2008) (hereinafter Model Rule). 40. Id. at XX-1.4.
d. Permitting Emissions of Greenhouse Gases A permit is required for each facility that governs the allowed GHG emissions and future reductions.41 The permitting program implements the cap and reductions at the facility level. e. Emission Allowances Allowances are required by each regulated facility. Each facility must submit a compliance certification report that states the emissions from the facility and the number of allowances required to cover the emissions for the prior year.42 f. Allocation of Emission Allowances Allowances for the regulated facilities are sold at quarterly auctions, with a very low reserve price of $1.86 initially, and then 80 percent of the most recent auction price. The program thereby is designed to keep carbon prices low. Allowances are allocated through auctions, with many states auctioning 100 percent of allowances. Prior to the beginning of the program in 2009, precompliance auctions were held in September and December 2008. The auctions are limited to compliance buyers and structured so that the prices are held to a low a price and to avoid speculation. The goal was to avoid significant increases in electricity prices. g. Trading Allowances Allowances may be sold freely traded to parties who have established CO2 Allowance Trading Accounts (COATs).43 An allowance registry or tracking system has been established in order to track purchases and trades of allowances.44 h. Banking Allowances Allowances may be held for future compliance years, and are not required to be used in the year they are purchased.45 i. Borrowing Allowances Borrowing is not currently permitted, but the prices have remained so law, that this is really not a necessary aspect of the trading program.
41. Id. at XX-3. 42. Id. at XX-4. 43. Id. at XX-1.5, XX-7. 44. Id. at XX-6. 45. Id. at XX-6.6.
DEVELOPING LAWS
IN THE
j. Safety Valve and Competiveness The low cap and auction system keep the prices of allowances low. As a result, no safety valve to control prices is necessary, and little concern exists regarding competiveness of the power plants, which are difficult to close and obtain power outside of the region. Since the regulatory program has not been applied to industry, there is little impact on the manufacturing sector, other than perhaps slightly higher electricity prices. k. Offsets Offsets are permitted,46 but with such low prices for allowances, there has not been and may not be a significant demand for offsets among power plants regulated under RGGI. l. Additionality Additionality as it applies to offsets has not been a critical issue, since, as stated above, offsets are not in demand at present. m. Supplementarity and Linkage to Other Trading Systems A limit on offsets has been established, but the use of offsets is not attractive under this system because the prices for allowances have been so low. As to linkage, the various interstate programs discussed below are evaluating trading between the three systems. A white paper on offset markets has been developed by the three regional programs. Potential problems with integrating the RGGI system with other state and regional systems is that the market prices for RGGI allowances are low and the system is limited to only CO2 and the electrical power industry. If the other systems are more economy-wide and cover all or most of the GHGs, then the programs may be difficult to integrate as prices for allowances will vary significantly, and other incompatibilities and negative effects may arise. n. Early Action Since the system is in effect, early action would be relevant only if RGGI were expanded beyond electricity production.47
46. Id. at XX-10. 47. Id. at XX-3.
o. New or Expanded Facilities The RGGI Model Rule provides for submission of permits and CO2 budgets for new sources.48 However, the process by which a new source obtains allowances or how this fits in the facility or state cap is not discussed. p. Regulatory Agency or Agencies Each of the participating states enforces the cap and trade and regulatory program through their environmental agencies. There is an RGGI entity that works with these agencies, but each state manages its own enforcement of the program. A GHG monitoring and reporting program has been established in each state. q. Enforcement As stated above, each state enforces the greenhouse gas regulatory program developed under the model rule. The environmental agency for each state is generally assigned by the state to implement and enforce the RGGI program in that jurisdiction.
2. Western Climate Initiative

The Western Climate Initiative (WCI) consists of western U.S. states and certain Canadian provinces and Mexican states developing a multi-state and potentially multi-national cap and trade program that would be economy wide and cover all of the greenhouse gases. The WCI is developing perhaps the leading program for a cap and trade program that would cover a significant part of the United States. The proposed start date of the WCI cap and trade program is January 2012. The membership of the WCI consists of partners who have pledged to participate in the program of greenhouse gas reductions, and observers who are have not yet committed to participation, but are involved in the meetings and following the developments of the WCI. California is a leading state in the WCI. The other states that are members are Arizona, Montana, New Mexico, Oregon, Utah, and Washington. Four Canadian provinces are also partners in the WCI: British Columbia, Manitoba, Ontario, and Quebec. The other U.S. states that are observers are Alaska, Colorado, Idaho, Kansas, Nevada, and Wyoming. Canadian provinces now acting as observers are Saskatchewan and the Yukon. The Mexican states that border the United States, Baja California, Chihuahua, Coahuila, Nuevo Leone, Sonora, and Tamaulipas, are observers.
48. Id. at XX-3.2.
DEVELOPING LAWS
IN THE
The WCI has progressed in the development of a greenhouse gas regulatory system. On July 27, 2010, the WCI issued a design document49 for this system. The design document resulted from two years of development by the seven U.S. states and four Canadian provinces that make up the WCI. The stated emissions goal of these states and provinces is to reduce regional GHG emissions to 15 percent below 2005 levels by 2020.50 The stated general goals of the WCI program are:
Creating a market-based system that caps GHG emissions and uses tradable
permits to incent development of renewable and lower-polluting energy sources; Encouraging GHG emissions reductions in industries not covered by the emissions cap, thus reducing energy costs regionwide; and Advancing policies that expand energy efficiency programs, reduce vehicle emissions, encourage energy innovation in high-emitting industries, and help individuals transition to new jobs in the clean-energy economy.51 The WCI cites an economic analysis performed by the Partner jurisdictions of the WCI that indicates the WCI Design can achieve the regional GHG emissions reduction goal and realize a cost savings of approximately US$100 billion by 2020 and underscores that mitigation of GHG emissions and the move to a clean energy economy is affordable, and can be achieved without negatively impacting the regional economy.52 The WCI concluded that its economic analysis underscores that mitigation of GHG emissions and the move to a clean-energy economy is affordable, and can be achieved without negatively impacting the regional economy. This result is consistent with other recent state and federal analysis of climate mitigation programs.53 Thus, these states believe that the program they have designed can accomplish the greenhouse gas reductions sought, avoid detrimental economic effects, and result in economic benefits.
49. Western Climate Initiative, The Design for the WCI Regional Program ( July 27, 2010), available at http://www.westernclimateinitiative.org/designing-the-program (hereinafter WCI Design). 50. Id. Design Summary, at 1. 51. Press Release, Western Climate Initiative, The WCI Partners Release Their Comprehensive Strategy to Address Climate Change and Spur a Clean-Energy Economy ( July 27, 2010) (hereinafter WCI Press Release). 52. Id. 53. Id.
a. Regulated Gases GHGs that will be regulated are carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride.54 b. Regulated Sources The regulated sources in general will include the following:
Electricity generation, including emissions from electricity generated outside
the WCI jurisdictions (or generated by a federal entity or on tribal lands) delivered into a WCI Partner jurisdiction; Combustion at industrial and commercial facilities; Industrial process emission sources, including oil and gas process emissions; Residential, commercial, and industrial fuel combustion at facilities with emissions below the WCI thresholds, which will be covered upstream of the emissions from use; and Transportation fuel combustion, which again will be covered upstream of the emissions form use. regulated through imposing the cap and trade program on the distributor of the fuels.55
The last two sets of emissions in the list will be covered upstream of the actual emissions from use. Coverage of these emissions will begin at the start of the second compliance period in 2015. The emissions threshold will be 25,000 tons CO2e per year.
c. The Cap Emission allowances may be traded within that jurisdiction and the jurisdictions of the other participating jurisdictionscreating a seven state and four province carbon market.56 The total allowances will be reduced over time to achieve the emissions reduction goal. The WCI is designed to work by each state or province adopting a cap and trade program through its own legislation or regulations. Each jurisdiction will issue its own allowances, forming the cap for that jurisdiction. The initial regional cap will be determined by calculating the best estimate of expected actual emissions for sources regulated during the first year of the program. 57
54. Western Climate Initiative, Design Recommendations for the WCI Regional Cap-and-Trade Program at 1 (2008) (hereinafter Design Recommendations). 55. Id. at 12-14. 56. WCI Design, Design Summary, at 6. 57. Id. at 4.
DEVELOPING LAWS
IN THE
For the second compliance period beginning in 2015, the best estimate of transportation fuels, residential, commercial, and industrial fuels, and any other sources included in the coverage of the program for the first time in 2015.58 For the cap in 2020, the regional cap will be set so that reductions achieved by the sources under the cap plus reductions from uncapped sources will meet the regional goal set for 2020. For the period after 2020, the participating jurisdictions will the regional cap at least three years before 2020.
d. Permitting Emissions of Greenhouse Gases As in other programs, a permit would be required for each facility for the GHG emissions allowed initially and then the reductions required over time. e. Emission Allowances Each jurisdiction will issue allowances under its GHG regulatory program. f. Allocation of Emission Allowances In order to allocate allowances to each jurisdiction, an annual allowance budget will be determined for each jurisdiction by the WCI that will fit within the regional cap that will decline from 2012 to 2020. Each allowance budget for each year from 2012 through 2020 will be set prior to the start of the program in 2012. Within each jurisdiction, the state or province will determine how the allocation of allowances will be made to regulated sources. The allocation for each year will be provided to the WCI. The WCI may determine that allocation to particular sectors of regulated sources should be made in a consistent manner. The WCI will particularly consider competitive issues among jurisdictions. Industries that will be considered specifically will include process (non-combustion) emissions where the greatest emission reduction potential is associated with large technology changes and high GHG emission intensity, such as aluminum, steel, cement, lime, pulp and paper, and oil refining.59 The WCI current plan is to have each jurisdiction allocate allowances for the following purposes:
Energy efficiency and renewable energy incentives and achievement; Research, development, demonstrations, and deployment (RDD&D) with
particular reference to carbon capture and sequestration (CCS); renewable energy generation, transmission and storage; and energy efficiency;
58. Id. at 5. 59. Id. at 8.
92 | R E G U L A T O R Y S T R U C T U R E S Promoting emission reductions and sequestration in agriculture, forestry, and
other uncapped sources; and

Human and natural community adaptation to climate change impacts.60
The participants may also consider allocating some of the allowances for these purposes:
Reducing consumer impacts, especially for low-income consumers; Providing for worker transition and green jobs; Achieving emission reductions in communities that experience
disproportionate environmental impacts; Supporting community-wide efforts funded by local governments to reduce GHG emissions; Providing transition assistance to industries; Recognizing early actions to reduce emissions; and/or Promoting economic efficiency.61
Auctions may be conducted by each jurisdiction of allowances. The extent of the use of auctions and the percent of allowances each regulated source must purchase to meet their compliance obligations will be determined by each jurisdiction.
g. Trading Allowances Allowances received in the allocation process may be sold freely to other covered facilities or third parties. h. Banking Allowances Banking will be permitted for allowances. i. Borrowing Allowances Borrowing of allowanced from future years will not allowed under the WCI. j. Safety Valve and Competitiveness No safety valve or price controls are currently planned, other than a minimum reserve price for auctions. The auction system proposed may reduce prices in quarterly auctions. Allowance reserves may be used to sell into the market at
60. Id. at 7. 61. Id.
DEVELOPING LAWS
IN THE
lower prices if market prices rise to high levels.62 Use of allowances from future periods may be sold early to assist in reducing costs regulated parties may have to pay.
k. Offsets The WCI will provide for an offset program. The use of offsets by regulated parties will be limited to no more than 49% of the total emission reductions from 20122020.63 Offset projects must have commenced after January 1, 2007, in order to be eligible for WCI credits.64 Offsets may be used by covered facilities up to a limit set by the WCI. The offsets may be generated through the WCI and other standards approved by the WCI. Certain types of offsets will be favored by the WCI. These project types are:
Agriculture (soil sequestration and manure management); Forestry (afforestation/reforestation, forest management, forest preservation/
conservation, forest products); and

Waste management (landfill gas and wastewater management).
The crediting period for nonsequestration WCI offset projects will be ten years. At the end of a crediting period a project proponent may renew a project subject to the current WCI offset protocol for that project type. Renewal of a project at the end of a crediting period will include a reevaluation of a projects additionality and a reevaluation of how the reductions are quantified and verified. Thus, the baseline scenario will be reevaluated at each renewal.
l. Additionality Additionality guidance will be developed by the WCI for the offset program. The WCI guidance recommends that a sector-specific or activity-specific performance standard be developed for WCI offset protocols based on a regional assessment of project performance or common practice.65 Performance standards provide a much more efficient and predictable means of determining additionality as opposed to the project specific analysis that makes it difficult for a project developer and its investors to predict if credits will be issued by a standards board. The Clean Development Mechanism (CDM) process has proven
62. Id. at 1112. 63. Design Recommendations at 1011. 64. Western Climate Initiative, Offset System Essential Elements Final Recommendations Paper 5 ( July 2010). 65. Id. at 10.
how this process may be somewhat unpredictable and changing over time even for project types and methodologies used many times.
m. Supplementarity and Linkage to Other Trading Systems The WCI will set a limit on the use of offsets by covered sources of emissions. The jurisdictions of the WCI will be linked and trading of allowances and offsets among the jurisdictions will be permitted. Linkage with other nonWCI compliance systems and offset programs will be pursued, but until an agreement is reached with those programs, allowances and offsets from those programs cannot be used to meet compliance obligations under the WCI or its participants.66 n. Early Action Early action is specifically addressed under the current plans for the WCI. The early reductions must occur after January 1, 2008, and before January 1, 2012.67 Early action allowances will be reserved for certain parties. In order to qualify for early action credits, the annual averages of absolute emissions and emission intensity must be below the annual averages of absolute emissions and emission intensity for 2005 to 2007.68 Part of the challenge may be the ability to demonstrate the baseline emissions from 2005 to 2007 and the actual emissions from 2008 to 2012. Some sources may not have measured their emissions in a way that the emissions can be documented. The WCI in June 2010 issued a guidance document on early action credits.69 The reductions must be voluntary, additional, real, verifiable, permanent, and enforceable. The early action allowances will be issued in each WCI Partner jurisdiction for reductions occurring prior to the regulatory system going into effect. These allowances will be in addition to the allowance budget for each jurisdiction. A jurisdiction issuing early action allowances to facilities may either identify those it believes have engaged in early reductions or ask them to submit an application, or establish an application program where sources chose to apply for early action allowances.70
66. Design Recommendations at 14. 67. WCI Design, Detailed Design, at DD-23. 68. Western Climate Initiative, Guidance to Partners for Distributing Early Reduction Allowances ( June 22, 2010). 69. Id. 70. Id. at 1.
DEVELOPING LAWS
IN THE
o. New or Expanded Facilities The allocation system for each jurisdiction must include provisions for allocating allowances for new entrants into the regulatory system, as well as the treatment of sources that shut down.71 p. Regulatory Agency or Agencies Each participating state or province will assign an agency to oversee the program. q. Enforcement The agencies assigned by each jurisdiction will enforce the program and address situations where covered sources fail to comply with applicable legislation and regulations. Specifically, the Detailed Design document provides that each jurisdiction establish in its program enforcement mechanisms that:
Provide general market surveillance, identify suspect transactions, and
provide for investigations and enforcement actions; Ensure consequences for noncompliance are comparable between the systems to be linked, and in particular that the consequences of failing to meet compliance unit surrender requirements are automatic; Respond in a timely manner to requests by enforcement agencies in the partner jurisdiction and all jurisdictions approved by the Partner jurisdiction for relevant and necessary information on market participants under investigation; and Transfer between systems in a timely manner relevant and necessary notice and information concerning all relevant enforcement actions undertaken by the systems jurisdictional enforcement authority. 72
D. Midwestern Greenhouse Gas Reduction Accord

The third multi-state program would be established in several midwestern states. The U.S. states and one Canadian province that are currently members of the Midwestern Greenhouse Gas Reduction Accord (MGGRA) are Iowa, Illinois, Kansas, Manitoba, Michigan, Minnesota, and Wisconsin. Observers are Indiana, Ohio, Ontario, and South Dakota. Again, gubernatorial elections in 2010 will determine how many states remain as participants in the program.
71. Detailed Design at 28. 72. Id. at DD-45.
The purpose of the MGGRA is to reduce GHG emissions in the participating states, and to jointly endeavor to: 1. establish GHG reduction targets and timeframes in the accord that are consistent with those established by the MGGRA member states and provinces; and 2. develop a market-based and multi-sector cap and trade mechanism to help achieve GHG reduction targets; and 3. join the Climate Registry to enable tracking, management, and crediting for entities that reduce GHG emissions; and 4. develop and implement other associated mechanisms and policies as needed to achieve the GHG reduction targets, such as a low-carbon fuel standard and regional incentives and funding mechanisms.73 The advisory group for the MGGRA has developed a model rule and a set of recommendations for the governors to consider. The model rule is very similar and follows almost the same format for the subcategories of the RGGI model rule. The coverage of the MGGRA as proposed by the advisory group would include the GHGs and sources of GHG emissions similar to the California and WCI programs with a threshold of 25,000 tons per year based on a threeyear rolling average.74 The similarities of the form of the MGGRA and RGGI model rule and the coverage of the MGGRA and the WCI being similar may allow the systems to engage in linkage and trading of allowances and offsets across the three multistate systems. The efforts of the three programs to cooperate and achieve similar goals are discussed below.
E. Cooperation and Potential Linkage among the Multi-State Programs

The three multi-state greenhouse gas regulatory programs have initiated cooperative activities to develop some degree of consistency across the programs. The outcome of the model rule of the MGGRA that follows the pattern of the RGGI model rule and the similarity of the coverage to the WCI program reveal growing cooperation among and an attempt to harmonize to a great extent the three programs.
73. Midwestern Greenhouse Gas Reduction Accord 3 (Nov. 15, 2007) (hereinafter Midwestern Accord). 74. Midwestern Greenhouse Gas Reduction Accord, Model Rule XX-1.4 (April 2010).
DEVELOPING LAWS
IN THE
Recently, the three groups issued a document on offset quality and the design and implementation of an offset program.75 The paper issued by the multistate programs contains fairly typical offset criteria. One of the significant aspects of the paper is the discussion of the alternative to project-level analysis of additionality and the use of a standard approach, discussed above under the WCI program, for project types. The paper identifies two types of standard approaches:
A benchmark is a qualitative eligibility criterion for a category of projects
that ensures that a project is unlikely to occur under standard market practice. A benchmark could include a technology or practice standard and could also be a qualitative market evaluation criterion; for example, a criterion that addresses the stacking of multiple project incentives based on typical project economics for a category of projects, considering other available noncarbon economic incentives. A performance standard is a quantitative eligibility criterion that establishes a metric for determining if categories of projects are unlikely to occur under standard market practice. The criterion is usually established in relation to the performance level achieved through standard market practice for the category of activities eligible under a certain offset category. Projects that meet or surpass the standard qualify as additional. Examples of performance standards include: Emission rate; Energy efficiency criteria; and Market penetration rate.76 The paper explains this standardized process as follows: It should be noted that this process is more straightforward than a project-by-project analysis of financial additionality, as it involves evaluating actual market practices and project economics in a defined market, based on projects that have already occurred and evidenced trends, rather than a counterfactual assessment of future alternative project-level investments. It also reduces transaction costs for project proponents, as
75. Regional Greenhouse Gas Initiative, Midwestern Greenhouse Gas Reduction Accord, and Western Climate Initiative, Ensuring Offset Quality: Design and Implementation Criteria for a High-Quality Offset Program (May 2010). 76. Id. at 1920.
they do not need to conduct such an analysis to support the development of project-specific evaluation assumptions.77 *** If a project exceeds standard market practice, it is assumed to be financially additional and is assumed to be implemented in response to the financial incentive provided through the receipt of offset compliance units that have a market value.78 The use of benchmarks and performance standards for additionality has the potential to greatly increase the efficiency of review and approval decisions of application for offset projects. These standards would create more certainty in the offset process and allow developers a better chance of obtaining investment or investment under better terms than using the project-by-project approach. The use of such standards may enhance the ability of project developers to use forward sales, discussed in a later chapter, to help finance greenhouse gas reduction projects designed to capture carbon credits and, thereby, to monetize the reductions. The cooperative effort of the three multi-state programs may lead to a linkage between the programs and trading of offsets between the programs and the respective participating states and provinces. Such a result would produce a significant North American carbon credit market. Elections in 2010 may result in some states pulling out of the programs. Thus, the future of these programs or at least participation by all of the states and thereby the size of the market is uncertain.
77. Id. at 19 n. 12. 78. Id. at 19 n. 13.
Developing United States LawThe Courts
From the U.S. Supreme Court opinion in Massachusetts v. EPA1: A well-documented rise in global temperatures has coincided with a significant increase in the concentration of carbon dioxide in the atmosphere. Respected scientists believe the two trends are related. For when carbon dioxide is released into the atmosphere, it acts like the ceiling of a greenhouse, trapping solar energy and retarding the escape of reflected heat. It is therefore a speciesthe most important speciesof a greenhouse gas.2 In sumat least according to petitioners uncontested affidavits the rise in sea levels associated with global warming has already harmed and will continue to harm Massachusetts. The risk of catastrophic harm, though remote, is nevertheless real. That risk would be reduced to some extent if petitioners received the relief they seek. We therefore hold that petitioners have standing to challenge the EPAs denial of their rulemaking petition.3 Because greenhouse gases fit well within the Clean Air Acts capacious definition of air pollutant, we hold that EPA has the statutory authority to regulate the emission of such gases from new motor vehicles.4
1. 549 U.S. 497 (2007). 2. Id. at 504. 3. Id. at 526. 4. Id. at 532.
Under the clear terms of the Clean Air Act, EPA can avoid taking further action only if it determines that greenhouse gases do not contribute to climate change or if it provides some reasonable explanation as to why it cannot or will not exercise its discretion to determine whether they do. To the extent that this constrains agency discretion to pursue other priorities of the Administrator or the President, this is the congressional design.5 U.S. laws relating to climate change and greenhouse gases have evolved dramatically from 2007 to the present. In this period, the courts have played a significant role in the evolution of climate change law. The courts have become a forum for states and environmental groups to attempt to impose restrictions through permits under state and federal statutes or to seek to have a court determine the level of reductions that significant emission sources must achieve under the public nuisance doctrine or other tort theories. In addition, plaintiffs have sued greenhouse gas emitters, asserting they are liable for damages allegedly caused by climate change.
A. Federal Statutory Litigation

1. The U.S. Supreme Court Landmark Decision in Massachusetts v. EPA
In a landmark case issued on April 2, 2007, from which the quotations above are taken, the U.S. Supreme Court ruled in Massachusetts v. EPA6 that the U.S. Environmental Protection Agency (EPA) acted in contravention of the federal Clean Air Act in deciding not to regulate greenhouse gas emissions from automobiles. In remanding the decision back to the EPA, the Court waded into a controversy that Congress and the Executive Branch were battling at the time, with numerous bills filed in Congress and the President expressing his opposition to mandatory limits on greenhouse gas emissions. In a sharply divided opinion, the majority voted 5 to 4 that Congress had provided the Court the power to review EPA decisions regarding greenhouse gas regulation of automobiles and that a causal link existed between the greenhouse gas emissions from new automobiles and the rise in sea levels that the Court concluded was harming and threatened to continue to harm the State of Massachusetts.7
5. Id. at 533. 6. 549 U.S. 497 (2007). 7. See supra notes 14.
D E V E L O P I N G U N I T E D S T A T E S L A W T H E C O U R T S | 101
The implications of this case were and continue to be significant, and allowed the EPA under the Obama administration to begin developing regulations under the Clean Air Act to regulate greenhouse gas emissions at the federal level, even if Congress did not pass climate change legislation. On the general policy front, the U.S. Supreme Court recognized not only that climate change was occurring, but that human emissions from greenhouse gases were a major cause of climate change. Moreover, it concluded that the EPA and the Bush administration in power at the time did not contest the impact of anthropogenic emissions greenhouse gases on the Earths climate. This decision gave substantial recognition at legal level from the highest court in the country to the conclusions discussed in Chapter 1 of the findings of the National Academies of Science and the American Association for the Advancement of Science, as well as other governmental entities, on of the most important being the National Oceanic and Atmospheric Administration. With respect to future legislation, the decision and the subsequent change in presidential administrations created the basis for the EPA to put pressure on Congress to pass a climate change bill, and affected industries to engage their lobbyists to address the issues and to seek a legislative alternative to the EPA rulemaking that industry general perceived would be much more strict than a statute that Congress may pass.8
2. BackgroundHow Did the Matter Reach the U.S. Supreme Court?

The origins of the decision by the EPA not to regulate greenhouse gas emissions provides an interesting review of a process largely ignored in rulemakingthe process of petitioning a government agency for the promulgation of new regulations. The controversy, or dispute in this case, began on October 20, 1999, when a group of nineteen private, nongovernmental organizations filed a petition with the EPA for a rule under the Clean Air Act to require automobile manufacturers to control the emissions of greenhouse gases from new automobiles. These organizations sought promulgation of a new rule under Section 202(a)(1) of the Clean Air Act that provides the EPA administrator shall regulate the emission of any air pollutant from any class or classes of new motor vehicles or new motor vehicle engines, which in his judgment cause, or contribute
8. Letter from the U.S. Chamber of Commerce to Senator Barbara Boxer, Chairman, and Senator James Inhofe, Ranking Member, Senator Committee on Environment and Public Works, dated November 3, 2009, advocating a climate bill be passed by Congress to avoid the EPA regulating greenhouse gas emissions.
to, air pollution which may reasonably be anticipated to endanger public health or welfare . . .9 The term air pollutant is defined under the Clean Air Act as any air pollutant agent or combination of such agents, including any physical, chemical, biological, radioactive . . . substances or matter which is emitted into or otherwise enters the ambient air.10 Welfare is defined as among other things . . . weather . . . and climate.11 The EPA requested public comment on the issue and received over 50,000 comments over a five-month period.12 After the comment period closed, the EPA decided not to regulate greenhouse gases emitted from automobiles under Section 202(a)(1).
3. StandingCould the Court Hear the Matter When the Emissions and Effects of Climate Change Are Global and Influenced by Emissions from Other Countries?
The global nature of the effect of greenhouse gas emissions on global warming and climate change placed the issue of standing directly before the Court, and presented a potential major legal obstacle for the State of Massachusetts and the other petitioners in the case to convince the Court that it should hear this issue at all. The question was whether the plaintiff could show that the harm it sought to remedy would be directly and causally related to the greenhouse gas emissions from vehicles that could be reduced if the EPA had acted to regulate them. In demonstrating one has standing to challenge an administrative agency decision, it is necessary to show an injury, causation, and redressabilitythe ability of the court to remedy the injury of the plaintiff. Otherwise, a court cannot effectively address the plaintiff s complaint or injury, and to hear the case would be of no avail and would waste scarce judicial time and resources.13 In considering the issue of standing, the Court concluded that states have special role and, therefore, face a reduced level of scrutiny in establishing standing in the federal courts. The Court, looking back to an opinion from 1907, Georgia v. Tennessee Copper Co.,14 concluded that states have a special interest in cases that
9. 42 U. S. C. 7521(a)(1). 10. Id. at 7602(g). 11. Id. at 7602(h). 12. Mass. v. EPA, 547 U.S. at 511(citing 68 Fed. Reg. 52,924 (2008)). 13. Id. at 51718. 14. 206 U.S. 230 (1907).
involve a quasi-sovereign power, [in] that capacity the State has an interest independent of and behind the titles of its citizens, in all the earth and air within its domain.15 In the 1907 case, Georgia sued Tennessee Copper Company for its emissions from its copper smelting operations that were having a devastating effect from sulfur dioxide air pollution on the surrounding land and forests. The Court in Massachusetts v. EPA concluded that Massachusetts, similar to Georgias right to protect its land and air, had special standing to protect the lands within its borders from rising sea levels that the Court concluded were occurring as a result of global warming.16 In addition, Justice Stephen Breyer, who wrote the opinion, pointed out that a party to whom Congress has provided a procedural right can assert that right without meeting all the normal standards for redressability and immediacy.17 In this instance, the Court ruled that Congress had afforded the right to challenge in court a decision by the EPA whether to regulate pollution from vehicles. In deciding that Massachusetts in fact had standing to challenge the EPAs decision on regulating greenhouse gas emissions, the Court relied upon the evidence it had been presented in terms of scientific reports and affidavits filed by the petitioners. The Court concluded that Massachusetts owns coastal lands that are currently being swallowedand are predicted to be more so in the futureby rising sea levels. One of the more fascinating debates between the majority and the dissenting Justices in an opinion authored by Chief Justice John Roberts and Justice Antonin Scalia was whether the reduction of greenhouse gases from U.S. vehicles would in fact reduce any flooding of coastal land owned by the State of Massachusetts, if China and India continued to increase their emissions. The majority concluded that, regardless of the emissions from China and India, any significant reduction in greenhouse gas emissions would reduce coastal floodingin essence identifying, apparently, an almost linear relationship between emissions and the harm caused.18 The majority opinion concluded that it was sufficient to establish a proportional reduction in greenhouse gas emissions and, therefore, a proportional reduction in climate change and its related harm on Massachusetts shoreline.19
15. Mass. v. EPA, 547 U.S at 537, quoting Georgia v. Tennessee Copper Co., 206 U.S. 230, 237 (1907). 16. Id. at 519. 17. Id. at 51721. 18. Id. at 52324, 54546. 19. Id. at 52427.
4. The Merits of the CaseDoes the EPA Have the Authority to Regulate, and, If So, the Ability to Defer Regulation of Greenhouse Gases under the Clean Air Act?
Having decided that Massachusetts has the right to challenge the EPAs decision to not regulate greenhouse gas emissions, the Court then turned to a review of the basis of the EPAs decision not to regulate greenhouse gas emissions. As stated above, the EPA had refused to promulgate limits on greenhouse gas emissions from vehicles after receiving a petition from private parties requesting that the EPA act to limit such emissions. In reviewing this decision, the Court applied the arbitrary and capricious standard. This standard of review under the Clean Air Act provides that the Court may reverse any such actions found to be . . . arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law.20 The provision at issue in this case involved the EPAs role in regulating pollution from vehicles. The Clean Air Act states in Section 202(a)(1) that the EPA shall by regulation prescribe . . . standards applicable to the emission of any air pollutant from any class or classes of new motor vehicles or new motor vehicle engines, which in the [Administrators] judgment cause, or contribute to, air pollution which may be reasonably anticipated to endanger pubic health or welfare.21 As stated above, the EPAs logic in its decision not to regulate greenhouse gases was first that greenhouse gases do not fit within the definition of an air pollutant under the Clean Air Act. To the contrary, the Court interpreted the definition of air pollutant to include any air pollution agent, and that any physical or chemical substance emitted into the ambient air could be considered an air pollutant.22 The definition was deemed broad enough to include carbon dioxide and other greenhouse gases that cause global warming.23 The EPA also stated in its explanation for its decision that even if it could regulate greenhouse gas emissions, it would not be appropriate to do so for two reasons. First, the President had decided to use voluntary standards to accomplish the reduction of
20. 42 U.S.C. 7607(d)(9)(A). 21. Id. 7521(a)(1). 22. Mass. v. EPA, 549 U.S. at 52829. 23. Id. at 529.
greenhouse gases.24 Second, the issuance of regulations by the EPA would detract from the Presidents negotiations with developing nations to reduce their greenhouse gas emissions.25 The Court ruled that the EPAs explanation did not constitute a reasoned basis for refusing to form a scientific judgment on the question of whether greenhouse gas emissions contribute to climate change. It further ruled that the EPA cannot avoid its statutory duty to reach a decision whether greenhouse gases cause global warming based on scientific uncertainties about certain aspects of climate change. If the scientific uncertainty is so profound that it precludes EPA from making a reasoned judgment, it must say so.26 The court ruled that the EPAs action was arbitrary, capricious, or otherwise not in accordance with law.27 In developing its opinion, the majority of the Court appeared to be influenced by certain EPA decisions. One of the primary issues affecting the decision was that historically the EPA, under a previous President, had concluded that it in fact did have the authority under the Clean Air Act to regulate greenhouse gases.28 The other issue was the fact that the EPA and the President have taken the position that greenhouse gases and climate change were serious issues, but voluntary measures should be taken to reduce these emissions.29 The fact that the EPA and the White House acknowledged the human contribution to global warming and the need to take action, albeit voluntary, appeared to inform the Courts decision that there was a sufficient causal link between greenhouse gas emissions and the harm currently being caused by global warming and future predicted harm. Ultimately, the Court reversed the court of appeals decision upholding the EPA decision not to regulate emissions from vehicles, and remanded the case to the lower court for further proceedings consistent with its decision regarding the EPAs power under the statute and the requirement that the EPA provide a reasoned explanation for its refusal to decide whether greenhouse gases cause or contribute to climate change.30 The result of the Courts decision was that the EPA did not necessarily have to decide to regulate greenhouse gas emissions
24. Id. at 533. 25. Id. at 53334. 26. Id. 549 U.S. at 536. 27. Id. 28. Id. at 521. 29. Id. at 526. 30. Id. at 535.
from vehicles, but it was required reconsider its decision and base it on the legislative requirements set forth in the Clean Air Act.
5. Implications of the Courts Decision Regulation under the Clean Air Act and Other Federal Statutes, Corporate Environmental Disclosure, and Litigation Alleging ClimateRelated Damages
Supreme Court decisions in landmark cases like Massachusetts v. EPA often have implications that range far beyond the specific issues decided by the Court. The potential implications of the case included the following.
a. Symbolic or Political Significance The symbolic or political significance of the case derives from the ruling of the highest court in the United States that the harms associated with climate change are serious and well recognized.31 The Court further agreed with Massachusetts that [a] reduction in domestic emissions would slow the pace of global emissions increases, no matter what else happens.32 Such a ruling of cause and effect by the U.S. Supreme Court may significantly increase public support for congressional action to regulate greenhouse gas emissions and embolden members of Congress to enact climate change legislation. Once a Democratic president was elected following this decision, it certainly emboldened the EPA to begin issuing green house gas regulations under the Clean Air Act with the full legal cover of the U.S. Supreme Court. Even the dissenting opinions gave cover to the EPA, as for example, the Chief Justice chided the majority for stepping into this area that he believed should have been left for the other political branches of government to resolve.33 That is in fact what the EPA has done under the Obama administration, reached decisions under the Act regarding the endangerment of human health and the environment and begun to develop regulations to address those stated harms by controlling greenhouse gas emissions in the U.S. economy. b. Greenhouse Gases Are Air Pollutants and the EPA Has the Authority to Regulate Them The Courts ruling that greenhouse gases are air pollutants under the Clean Air Act, and the narrow room left to the EPA not to regulate the emissions of these gases from automobiles, puts the matter squarely in the EPAs hands to decide how it will address greenhouse gases. With the historical objection of the
31. Id. at 521. 32. Id. at 526. 33. Id. at 535.
Bush administration to mandatory restrictions on greenhouse gases and the multitude of greenhouse gas bills reviewed by Congress, the Bush administration delayed addressing the issue of an endangerment finding before the George W. Bush presidential term was up leaving the issue to the next president. The Bush administration EPA did issue a Notice of Advance Rulemaking, as will be discussed below. Upon appointment of its new Administrator of the EPA by President Barack Obama, the EPA began pursuing an endangerment finding and taking other steps to regulate not only vehicles, but other sources of greenhouse gas emissions. These regulatory developments will be discussed in Chapter 10.
c. Effect on Other Vehicle-Related Greenhouse Gas Lawsuits California, Vermont, and Rhode Island enacted their own limitations on vehicle emissions and these regulations were challenged by automakers. The cases were stayed pending the decision in Massachusetts v. EPA. Based on the Courts ruling, the challenges to the states greenhouse gas limits on cars faces an uphill battle, and had little chance to succeed. d. Effect on Challenges to the EPAs Decision Not to Regulate Greenhouse Gases from Power Plants In addition to the challenge of the EPAs decision not to regulate greenhouse gas emissions, ten states, including Massachusetts, three environmental groups, and two cities, at the time of the issuance of the opinion in Massachusetts v. EPA, had sued the EPA for its refusal to regulate emissions from certain utility and industrial power plants in its promulgation of New Source Performance Standards under the Clean Air Act.34 In that case as well, the EPA determined it did not have the authority to regulate greenhouse gas emissions under the Clean Air Act. It would appear likely the Supreme Court would not agree with the EPA on that issue. Once the presidential election occurred, the EPA proceeded down the path of regulating these sources as well. e. Effect on Cases Filed under the National Environmental Policy Act, Challenging Governmental Action That Causes or Leads to Greenhouse Gas Emissions Several lawsuits had been filed under the National Environmental Policy Act (NEPA) against federal agencies for approving or funding projects in the United
34. Coke Oven Environmental Task Force v. EPA, No. 06-1131 (D.C. Cir. filed Apr. 7, 2006).
States and in foreign countries that emit greenhouse gases.35 These cases were affected by the Supreme Courts decision in Massachusetts v. EPA. The plaintiffs were able to argue that the causation issue has been resolved by the Supreme Court, and that regulation of greenhouse gases is required by federal statutes. Thus, the case certainly raised new opportunities for concerned citizens or neighbors to fight projects in their backyard or overseas, asserting that projects that release greenhouse gases must be reviewed under NEPA.
f. Effect on Tort Suits Filed by Individuals Claiming Damages from Greenhouse Gas Emissions A variety of tort suits have been filed claiming that the emissions of greenhouse gases have resulted in climate change that has damaged the plaintiffs in those cases. For example, in a case known as Comer v. Murphy Oil,36 filed in Mississippi by Hurricane Katrina victims against defendant classes of oil, coal, chemical, and insurance companies, the plaintiffs claim that the emissions contributed to the force of Hurricane Katrina. In another case, eight states, the City of New York, and three land trusts have sued the utilities that are the five largest carbon dioxide emitters in the United States.37 The plaintiffs assert that the emissions of greenhouse gases constitute a nuisance. The perceived challenge in these cases is one of causation, which was a central issue in the dissenting opinions of Massachusetts v. EPA. The question is: How do you connect emissions from specific sources into a global atmosphere to global warming, and then further establish that injuries alleged by specific plaintiffs are linked to the incremental global warming caused by those sources? Despite this proof problem, plaintiffs attorneys have apparently been considering the future opportunities in this area for some time. These attorneys may see the decision on standing in the Supreme Courts climate change opinion in Massachusetts v. EPA to open the door to arguing that parties emitting greenhouse gas emissions are causing global warming and thereby damaging their clients. As will be discussed later in this chapter, the case did lead to an opening for plaintiffs in climate change tort cases and federal common law
35. Center for Biological Diversity v. NHTA, No. 06-71891 (9th Cir. filed Apr. 12, 2006) (suit challenging failure to consider impacts of 2006 CAF standards on global warming under NEPA); Friends of the Earth v. Mosbacher, 2005 WL 2035596 (N.D. Cal. Aug. 23, 2005); Mayo Foundation v. Surface Transportation Board, No. 06-2031 (8th Cir. filed Apr. 14, 2006); Natural Resources Defense Council v. Reclamation Board, No. 06CS01228 (California Superior Court of Sacramento County, filed Aug. 18, 2006) (challenging California Reclamation Board for approval of a development project without considering the potential impacts of rising seal levels caused by global warming under the California Environmental Quality Act). 36. 2006 WL 1066645 (S.D. Miss. 2006). 37. Connecticut v. American Electric Power, 406 F.Supp.2d 265 (S.D.N.Y. 2005).
nuisance cases to overcome challenges of standing and political questions and the resulting dismissal of their claims.
g. Broadening Standing for States to Challenge Federal Administrative Agency Action The majority in Massachusetts v. EPA adopted a new view of standing for the ability of states to challenge federal administrative action. Responding to this standing analysis, Chief Justice Roberts scathingly criticized the majoritys view in his dissent, joined by Justices Scalia, Samuel Alito, and Clarence Thomas, as exceeding any previous Supreme Court opinions. The degree to which this reduced standard for state standing will thrive and prosper is unclear. To the extent the notion of a reduced standard for state standing develops in future Supreme Court cases, it could lead to a new level of state power in our federal system.
B. State Statutory Litigation

At the state level, cases have been filed to impose controls under state air pollution states. An example is a case filed in 2009 in Texas, which is the largest greenhouse gasemitting state in the United States and, if Texas were a country, would be the seventh largest greenhouse gas emitter in the world. In the Texas case, Public Citizen, Inc., a citizens group, or NGO, filed a lawsuit against the Texas Commission on Environmental Quality (TCEQ) alleging that the agency had violated the Texas Clean Air Act by not regulating CO2 from permitted sources.38 The suit seeks to require the TCEQ to impose CO2 emission limits on several proposed coal-fired power plants whose proponents were seeking permits to construct. The case is apparently modeled after the Massachusetts v. EPA case, but bases its claims on the Texas Clean Air Act rather than the federal Clean Air Act.
C. Federal Common Law Litigation to Impose Emission Reductions on Greenhouse Gas Emitters
In a case that opened the door for litigation to impose court-based emission reductions on industry, the U.S. Court of Appeals for the Second Circuit issued an opinion in State of Connecticut, et al. v. American Electric Power Company Inc.,
38. No. D-1-GN-09-003426 (Dist. Ct., Travis County, Tex. Filed Oct. 6, 2009).
et al. (Connecticut v. AEP)39 that allows eight states, New York City, and three land trusts to continue nuisance claims against five electrical power companies, including American Electric Power Company Inc. The district court had dismissed the case, concluding that setting emission caps was an undertaking for the political branches, which were charged with the identification and balancing of economic, environmental, foreign policy, and national security interests.40 The Second Circuit concluded that the plaintiffs did not bring a claim that constitutes a political question, but rather had simply presented a claim of common law nuisance that does not establish a national or international emissions policy.41 A substantial portion of the Second Circuits opinion was devoted to whether the plaintiffs had standing to bring their claims of nuisance. The court ultimately concluded that they had standing because they had alleged an injury in fact, presented a causal connection between the injury and the conduct complained of, and established that their injury will likely be redressed by a favorable decision.42 In terms of redressability, the Second Circuit compared the prospect of the plaintiff s request that the utilities reduce their carbon dioxide emissions to the prospect of reducing motor vehicle emissions (considered by the Supreme Court in Massachusetts v. EPA43) for support of its conclusion that the plaintiffs injury was redressable. In doing so, the Second Circuit cited the Supreme Courts reasoning in Massachusetts v. EPA that although regulation of motor vehicle emissions would not by itself reverse global warming, . . . it was sufficient for the redressability inquiry to show that the requested remedy would slow or reduce it.44 The utilities also argued that the plaintiffs claims were displaced by federal statutes. The court acknowledged that the EPA may have statutory authority under the Clean Air Act to regulate greenhouse gas emissions, but determined that the EPA had not yet done so at the time with respect to stationary sources (as opposed to mobile sources, for which the EPA has already proposed an
39. 582 F.3d 309 (2d Cir. 2009). 40. Id. at 320 (internal quotation marks omitted). 41. Id. at 325 (emphasis in original). 42. Id. at 34649. 43. 549 U.S. 497 (2007). 44. Conn. v. AEP, 582 F.3d at 348 (quoting Mass. v. EPA 549 U.S. at 525).
endangerment finding, a preliminary step to regulation of greenhouse gases from these sources).45 The case has been appealed to the U.S. Supreme Court. Interestingly, the Obama administration has filed a brief with the court arguing that the public nuisance action is prohibited because the EPA has now issued regulations governing greenhouse gas emissions from stationary sources.46 The federal defendant, the Tennessee Valley Authority, a federal entity that operates coal-fired power plants, is represented by the solicitor general that asked the Supreme Court to vacate the Second Circuits opinion and to remand it for consideration as to whether prudential standing considerations would argue for the court to withhold entering the issue, and whether the EPAs regulations would displace the courts power to consider addressing greenhouse gas emissions through a public nuisance claim.
D. State and Federal Common Law Litigation to Obtain Damages from Greenhouse Gas Emitters
In 2009, the U.S. Court of Appeals for the Fifth Circuit, Comer v. Murphy Oil, found that residents and owners of land and property along the Mississippi Gulf Coast have standing to pursue their public and private nuisance public and private nuisance, trespass, and negligence claims and that these claims do not present nonjusticiable political questions.47 The plaintiffs sought monetary damages for destruction of both private property and public property useful to them due to rising sea levels and to the increased ferocity of Hurricane Katrina, which they claimed defendants contributed to through their greenhouse gas emission. To arrive at its decision, the Fifth Circuit cited the Supreme Courts holding in Massachusetts v. EPA,48 which alluded to the existence both of a causal link between man-made greenhouse gas emissions and global warming, and between a warmer climate and rising ocean temperatures with the strength of hurricanes. Regarding the traceability test for purposes of standing, the court acknowledged that plaintiffs must show only that injuries may be fairly traceable to actions that
45. Id. at 379. 46. Gabriel Nelson, Obama Admin. Urges Supreme Court to Vacate Greenhouse Gas Nuisance Ruling, N.Y. Times, Aug. 25, 2010. 47. 585 F.3d 855 (5th Cir. 2009). 48. 549 U.S. 497 (2007).
contribute to, rather than solely or materially cause, greenhouse gas emissions and global warming.49 The Fifth Circuit also ruled that the claims do not present political questions. The common law tort claims of nuisance, trespass, and negligence were determined to be justiciable because they have plainly not been committed by the Constitution or federal laws or regulations to Congress or the President.50 This case took an interesting turn, when the matter was appealed to the full court of judges rather than the panel of three judges who issued the decision discussed above. Numerous judges recused themselves and a quorum of the full court was not available. The court decided the case could not be heard and denied the appeal and let the lower court ruling stand, effectively reversing the panel decision discussed above.51 A judge dissenting with the decision to take this approach wrote, [F]ederal courts lack the authority to abstain from the exercise of jurisdiction that has been conferred.52 The procedural twists this case went through create a result without an effective appeal. The appeal of the case to the Supreme Court may occur, and it may be years before the procedural and substantive issues are resolved. In another case, the Village of Kivilina, Alaska has sued eighteen energy companies, alleging that greenhouse gas emissions led to climate change that has melted ice around their village and causing the inhabitants of the village to have to move. The federal district court dismissed the cause of action, concluding that the plaintiffs claims presented nonjusticiable political questions and the plaintiffs did not have standing, because their harm was not fairly traceable to the defendants conduct.53 The case has been appealed to the Ninth Circuit Court of Appeals. Questions of causation still would appear to present significant barriers to recovery against individual defendants in cases like Comer v. Murphy Oil. The links between individual corporate emissions to climate change, that climate change to increased hurricanes, and those increased hurricane strength to particular damages would appear to be tremendous causal hurdles for plaintiffs
49. 585 F.3d at 866. 50. 585 F.3d at 870. 51. Comer v. Murphy Oil USA, 607 F.3d 1049 (5th Cir. 2010). 52. Id. at 872, quoting New Orleans Pub. Serv., Inc. v. Council of the City of New Orleans, 491 U.S. 350, 358, 109 S. Ct. 2506, 105 L. Ed. 2d 298 (1989) (quoting Cohens v. Virginia, 19 U.S. 264, 404, 5 L. Ed. 257 (1821)), and United States v. Will, 449 U.S. 200, 215, 101 S. Ct. 471, 66 L. Ed. 2d 392 (1980). 53. Native Village of Kivalina v. ExxonMobil Corporation, 663 F.Supp.2d 863 (2009).
attorneys and the experts they may hire to pursue these cases. It would also appear that in taking into account all of the other global emissions from industrial, deforestation, farming, electrical generation, transportation, and other sources would make the percentage each defendant would pay somewhat difficult to prove and, if proved, potentially very small.
10
Developing United States LawThe Environmental Protection Agency
As will be discussed in Chapter 11, the U.S. House of Representatives passed a climate bill, but no action was taken in the Senate. Even before it was clear Congress was not going to pass a climate bill in 2010, the EPA under the Obama administration took action to regulate greenhouse gas emissions. Thus, even without congressional action, a federal greenhouse gas (GHG) reduction program is being pursued by the EPA. The regulatory program can be divided into two parts. The first GHG program adopted consists of a monitoring and reporting regulatory system for GHG emissions. The second step taken was the issuance of decisions and regulations that form an actual federal regulatory system designed to require emission sources to reduce their GHG emissions. The EPA took this action under the Clean Air Act (CAA) following the decision to allow GHG regulation under the CAA by the Supreme Court in Massachusetts v. EPA in 2007, discussed in Chapter 9. The issuance of regulations to control GHG emissions was predicated on the election of a president in 2008 who would urge the EPA to move forward with issuance of GHG regulations. These two events have led to the promulgation of a climate change program in the United States. The system as adopted by the EPA, however, does not allow a market for trading emissions credits, but is a traditional command and control system that requires reductions through site-specific determinations of the best technology to control emissions at that source. It is not clear that if Congress does not take action during the
D EVELOPING U NITED S TATES L AW T HE E NVIRONMENTAL P ROTECTION A GENCY | 115
current presidential administration, whether the EPA will attempt to adopt a cap and trade program under the CAA for GHG emissions. The current system adopted by the EPA is of course not without controversy. Objections to the EPA action are numerous. Legal challenges to the EPAs decisions and regulations have been filed by industry groups, business associations, congressmen, states, and other plaintiffs. The lawsuits seek a stay of the regulations and ultimately a judicial decision striking down or ordering changes in the regulations adopted by the EPA. This chapter will provide a summary of the regulations adopted by the EPA and the lawsuits filed by various interest groups challenging their adoption.
A. Federal Greenhouse Gas Reporting Program

Under the Obama administration, the first step by the EPA in regulating GHGs was the development of the reporting rule. On September 22, 2009, the EPA issued its final greenhouse gas monitoring and reporting rule that requires approximately 10,000 facilities in the United States to measure their greenhouse gas emissions and start reporting them in early 2011 (Greenhouse Gas Reporting Rule).1 A congressional amendment to the Omnibus Spending Bill in December of 2007 appropriated funds and required the EPA to issue a proposed rule by September 2008, and a final rule by June 2009.2 While the EPA had authority under that appropriations bill to promulgate the Greenhouse Gas Reporting Rule, it took the position that it had the power to issue the regulations requiring the reporting of greenhouse gas emissions under the existing Clean Air Act. The EPA relied upon Sections 114 and 208 of the CAA on the basis that these provisions allow the EPA to require that the information be gathered and reported as the information is relevant to the EPAs regulatory activity under various provisions of the CAA.3 The EPA relied upon Section 114 for sources of emissions from stationary sources, and Section 208 for mobile sources such as vehicles, boats, and aircraft. Some industry groups asked the EPA for a delay until 2011 to start monitoring and until 2012 to start reporting their greenhouse gas emissions,
1. Mandatory Reporting of Greenhouse Gases; Final Rule, EPA, 74 Fed. Reg. 56,260 (Oct. 30, 2009) (hereinafter Greenhouse Gas Reporting Rule). 2. Consolidated Appropriations Act, 2008, R.R. 2764, Public Law 110161, 121-Stat. 2128 (Dec. 26, 2007). 3. Greenhouse Gas Reporting Rule, 74 Fed. Reg. at 56,26465.
but the EPA chose not to delay implementation of the rule.4 Regulated facilities had only two and one-half months to prepare for the monitoring that they were required to begin January 1, 2010. This imposed certain challenges for many companies that were required to install or modify continuous emission monitors or that have numerous facilities that are regulated. However, the EPA allowed regulated parties to use best available monitoring methods for parameters that cannot be reasonably measured under the relevant sections of the rule for the regulated source until March 31, 2010, and the ability to request an extension until December 31, 2010.5 Under the Greenhouse Gas Reporting Rule, the EPA has adopted a substantial program of greenhouse gas monitoring and reporting with a publicly available registry. The program is economy wide and covers 85 percent or more of greenhouse gas emissions in the United States.6 The EPA is in part implementing the Greenhouse Gas Reporting Rule to gather information for future regulatory and policy decisions. Thus, many of those sources that will be required to report under the Greenhouse Gas Reporting Rule may be regulated under a federal greenhouse gas system developed under the Clean Air Act following the Massachusetts v. EPA decision issued by the Supreme Court, or if Congress passes a climate bill at some point in the future. While the Greenhouse Gas Reporting Rule does not impose any reduction obligations, prior reporting only rules, such as the Toxic Release Reporting of SARA Title III,7 have shown that companies reporting emissions manage what they measure. In other words, once companies are required to publicly report their emissions, they generally begin to identify ways to reduce those emissions.8 As stated above, the monitoring of greenhouse gas monitoring began on January 1, 2010. The first reports are required to be submitted to the EPA by March 31, 2011, and annually thereafter. The EPA has issued subsequent changes to its rules and proposed adding GHG reporting requirements to other sources of emissions.
4. Id. at 56,27374. 5. Id. at 56,274. 6. Id. at 56,264. 7. 42 U.S.C. 1100150 (known as the Emergency Planning and Community Right-to-Know Act, or Title III of the Superfund Amendments and Reauthorization Act of 1986). 8. A survey of companies in certain regulated industries published in a 1994 report found that 94 percent of their facilities reduced or eliminated hazardous wastes, reportable releases to the environment, or stored chemicals. S. Santos, V. Covello, D. McCallum, & E. David, Industry Response to SARA Title III: Pollution Prevention, Risk Reduction and Risk Communication, at 3 (May 1994).
1. What Gases Are Covered?

The EPA has identified the traditional greenhouse gases for reporting: carbon dioxide (CO2), methane, nitrous oxide, sulfur hexafluoride, hydrofluorocarbons, chlorofluorocarbons, perfluorocarbons, and certain other fluorinated gases.9 For each emission source type, the regulations provide the types of greenhouse gases that must be reported.10 For purposes of comparing emissions of the various gases using a single unit, the gases are converted into the equivalent greenhouse gas impact of CO2.11 The conversion is based on the principle discussed elsewhere in this book that gases other than CO2 have a greater impact in terms of causing the greenhouse effect and thereby global warming. For example, one metric ton of methane emissions expressed in carbon dioxide equivalent (CO2e) units would be reported as 21 metric tons of CO2e. This is critical in understanding the threshold levels for application of the reporting requirements, as the non-CO2 greenhouse gas emissions must be converted to CO2e before determining whether the greenhouse gas reporting obligations apply to a particular facility. It is also important to keep in mind that reporting will be in metric tons.
2. What Facilities Are Covered?

Four categories of facilities are required to measure and report their greenhouse gas emissions. In addition, vehicle manufacturers would be required to report the greenhouse gas emissions of their vehicles. Research and development activities (as defined in 40 C.F.R. 98.6) are not considered to be part of any source category subject to the rule. The EPA deferred several source categories. These source categories are as follows: electronics manufacturing, ethanol production, underground coal mines, oil and natural gas systems, food processing, industrial landfills, and wastewater treatment facilities. Subsequently, the EPA has proposed rules covering some of these deferred sources. The source category for manure management was deferred as Congress had passed a bill preventing the EPA from expending funds to regulate this source.
9. Greenhouse Gas Reporting Rule, 74 Fed. Reg. at 56,388 (to be codified at 40 C.F.R. 98.6). 10. For example, the facilities that fall within the General Stationary Fuel Combustion Source Category, must only report CO2, CH4, and N2O emissions. Id. at 56,397 (to be codified at 40 C.F.R. 98.6) 11. Id. at 56,377 (to be codified at 40 C.F.R. 98.2(b)).
a. Specific Source Categories The first category of facilities required to report under the Greenhouse Gas Reporting Rule are facilities that fall under a list of source categories identified by the EPA.12 These sources include the following:
Electricity generating facilities that are subject to the Acid Rain Program
(ARP) or otherwise report CO2 mass emissions year-round through 40 C.F.R. part 75; Adipic acid production; Aluminum production; Ammonia manufacturing; Cement production; HCFC22 production; HFC23 destruction processes that are not co-located with a HCFC-22 production facility and that destroy more than 2.14 metric tons of HFC-23 per year; Lime manufacturing; Nitric acid production; Petrochemical production; Petroleum refineries; Phosphoric acid production; Silicon carbide production; Soda ash production; Titanium dioxide production; Municipal solid waste landfills that generate CH4 in amounts equivalent to 25,000 metric tons CO2e or more per year, as determined according to 40 C.F.R. part 98, subpart HH; and Manure management systems that emit CH4 andN2O (combined) in amounts equivalent to 5,000 metric tons CO2e or more per year, as determined according to 40 C.F.R. part 98, subpart JJ.
b. Other Facilities That Emit 25,000 Tons per Year or More of CO2e of Combined Emissions from Listed Source Categories The second category of sources required to report are facilities that emit 25,000 or more metric tons of CO2e per year of combined emissions from stationary fuel combustion units, miscellaneous uses of carbonate, and all source categories
12. Id. at 56,26667.
that are listed and located at the facility in any calendar year.13 These sources are as follows:
Ferroalloy Production. Glass Production. Hydrogen Production. Iron and Steel Production. Lead Production. Pulp and Paper Manufacturing. Zinc Production.
c. Facilities That Do Not Meet the First Two Source Categories, But That Emit 25,000 Tons of CO2e per Year from Stationary Fuel Combustion Sources The third source of facilities required to report are those that meet all of the following conditions:
(1) the facility does not contain any source category designated in the first two groups of categories; (2) the aggregate maximum rated heat input capacity of stationary fuel combustion units at the facility is 30 mmBtu/hr or greater; and (3) the facility emits 25,000 metric tons of CO2e per year or more from all stationary fuel combustion sources. For 2010 only, the facilities falling under this group were allowed to submit an abbreviated GHG report according to 40 C.F.R. 98.3(d).14
d. Entities That Sell, Import, or Export Fossil Fuels, Industrial Greenhouse Gases, and CO2 The final category of entities required to submit greenhouse gas emission reports under the Greenhouse Gas Reporting Rule are suppliers of coal, coal-based liquid fuels, petroleum products, natural gas and natural gas liquids, producers of industrial GHGs as listed in the Greenhouse Gas Reporting Rule, importers and exporters of industrial GHGs and CO2, and importers and exporters of industrial greenhouse gases and CO2 exceeding 25,000 metric tons of CO2e per year. The entities covered are any supplier (as defined in 40 C.F.R. Part 98,
13. Id. at 56,267. 14. Id.
subparts LL through PP) of any of the products as listed below in any calendar year starting in 2010:15
Coal-based liquid fuels: All producers of coal-to-liquid fuels; importers and
exporters of coal-to-liquid fuels with annual imports or annual exports that are equivalent to 25,000 metric tons CO2e or more per year; Petroleum products: All petroleum refiners that distill crude oil; importers and exporters of petroleum products with annual imports or annual exports that are equivalent to 25,000 metric tons CO2e or more per year; Natural gas and natural gas liquids: All natural gas fractionators and all local natural gas distribution companies; Industrial GHGs: All producers of industrial GHGs; importers and exporters of industrial GHGs with annual bulk imports or exports of N2O, fluorinated GHGs, and CO2 that in combination are equivalent to 25,000 metric tons CO2e or more per year; and CO2: All producers of CO2; importers and exporters of CO2 with annual bulk imports or exports of N2O, fluorinated GHGs, and CO2 that in combination are equivalent to 25,000 metric tons CO2e or more per year.
e. Entities That Manufacture or Sell Vehicles or Engines in the United States The types of engine manufacturers or importers that are required to report are as follows:
Highway heavy-duty (engine and vehicle); Nonroad diesel; Marine diesel (other than C3); C3 marine; Locomotives; Small spark-ignition; Large spark-ignition; Marine spark-ignition; Snowmobiles; Highway motorcycles; Off-highway motorcycles/ATVs; and Aircraft.
15. Id.
3. Monitoring and Measurement

The EPA reviewed several monitoring or measurement options in developing the Greenhouse Gas Reporting Rule. The EPA selected the option of combined direct emission measurement and facility-specific calculations. Facilities that already have installed continuous emission monitors (CEM) are generally required to add a greenhouse gas measurement capability to that CEM so that GHGs are measured on a continuous basis. Those that do not have CEM devices would have the choice to install them or to use facility specific calculation methods.
4. Certification and Verification

The EPA reviewed several options regarding certification and verification of the greenhouse gas emissions reported to the EPA. The agency decided to require certification by a designated representative of the facility submitting the report and to have the EPA verify the emissions report. No third-party verification is currently required.
5. Information That Must Be Reported

The critical question is what information must be submitted in the reports to the EPA for the prior reporting year. The information varies between the emitters of greenhouse gases and suppliers of greenhouse gases or materials when used emit greenhouse gases. In addition to the address of the facility and the year for which the report is submitted, the facility must provide the following:
a. Facilities That Emit Greenhouse Gases For facilities that are direct emitters of greenhouse gases, the following information must be provided to the EPA:
Annual facility emissions (excluding biogenic CO2), expressed in metric tons
of CO2e per year, aggregated for all GHG from all source categories in 40 CFR part 98, subparts C through JJ that are located at the facility; Annual emissions of biogenic CO2 (i.e., CO2 from combustion of biomass) aggregated for all applicable source categories in subparts C through JJ located at the facility; Annual GHG emissions for each of the source categories located at the facility, by gas. Gases are: CO2 (excluding biogenic CO2), biogenic CO2, CH4, N2O, and each fluorinated GHG; Within each source category, emissions broken out at the level specified in the respective subpart (e.g., some source categories require reporting for each individual unit or each process line);
122 | R E G U L A T O R Y S T R U C T U R E S Additional data specified in the applicable subparts for each source category.
This includes activity data (e.g., fuel use, feedstock inputs) that were used to generate the emissions data and additional data to support Quality Assurance/Quality Control (QA/QC) and emissions verification; and Total pounds of synthetic fertilizer produced through nitric acid or ammonia production and total nitrogen contained in that fertilizer. 16
b. Suppliers of Greenhouse Gases or Materials That Produce Greenhouse Gases When Used For suppliers of GHGs, the following information must be submitted to the EPA:17
Annual quantities of each GHG that would be emitted from combustion use
of the products supplied, imported, or exported during the year. Report this for each applicable supply category in 40 C.F.R. part 98 subparts KK through PP, by gas. Also report total quantity, expressed in metric tons of CO2e, aggregated for all GHGs from all applicable supply categories; and Additional data specified in the applicable subparts for each supply category. This includes data used to calculate GHG quantities or needed support QA/QC and verification.
6. Public Availability of Information Submitted to the EPA

The information provided by the regulated facilities will be made available to the general public by a website developed by the EPA. The EPA in the preamble to the rule stated that it would protect information claimed as confidential business information (CBI) in accordance with its rules relating to CBI in 40 C.F.R. part 2, subpart B.18 It did caution that it viewed general emission date submitted under Sections 114 and 202 of the Clean Air Act not to qualify as CBI. The EPA noted that it would promulgate another rule to address concerns of some of the regulated community regarding information reported under the rule and CBI protection determinations by the EPA with respect to that data.19
16. Id. at 56,268. 17. Id. 18. Id. 19. Id. and n. 10.
7. Exiting the Reporting Regulation Requirements

Once subject to this reporting rule, a regulated facility must continue to submit GHG reports annually unless the emissions fall below thresholds for a certain number of years.20 A reporter can cease reporting if the required annual GHG reports demonstrate that reported GHG emissions are either (1) less than 25,000 metric tons of CO2e per year for five consecutive years, or (2) less than 15,000 metric tons of CO2e per year for three consecutive years. The entity reporting for the facility must notify the EPA that the facility intends to stop reporting under the rule and explain the reasons for the reduction in emissions that result in the facility falling below the relevant threshold for the stated time frame. The EPA clarified that the opt-out provision applies to all facilities and suppliers subject to the rule, regardless of their applicability category (i.e., whether rule applicability was initially triggered by an all-in source category, those for which a threshold was not provided, or a source category with a 25,000 metric tons CO2e threshold). Records must be kept for the years that a party is claiming that it may opt out of the rule.
8. Enforcement Actions and Penalties for Failure to Comply with the Greenhouse Gas Reporting Rule
The EPA states in the preamble to the rule that it will take enforcement action against those facilities that fail to monitor or report greenhouse gas emissions or quantities supplied, to collect data as required by the rules, to maintain records, to calculate data as required by the provided methodologies, to continuously monitor emissions, and falsification of records. Such enforcement actions could be brought under Sections 113 or 203205 of the Clean Air Act, which provide for administrative, civil, or criminal sanctions. The relief could include injunction or civil penalties up to $37,500 per day of violation.21 Falsification of records or tampering with monitoring equipment or testing may lead to criminal prosecution.
20. Id. 21. Id. at 56,360 and n. 31.
B. EPA Regulation of Greenhouse Gas Emissions under the Clean Air Act
1. The EPAs Endangerment Finding
The Endangerment Finding, serves as the EPAs determination on the impact of greenhouse gas emissions on human health and environment has come to be known, arose out of the U.S. Supreme Court decision in Massachusetts v. EPA (discussed in Chapter 9), which required the EPA to make a decision on the health and environmental impact on GHG emissions based on legal challenges to its prior decision on whether to regulate emissions from light-duty vehicles (LDVs). In considering the level of emissions from LDVs, the EPA estimated that on-road vehicles, which LDVs are a subset, contribute more than 23 percent of GHG emissions in the United States. The EPA estimated that its LDV rule would reduce GHG emissions by approximately 950 million metric tons and conserve 1.8 billion barrels of oil over the lifetime of model year 2012 to 2016. The level of interest in this finding was enormous because of the extent of the regulation that would ultimately be imposed on GHG emissions sources. After the proposed endangerment finding was published, approximately 380,000 public comments were filed with the EPA. The endangerment finding covered six greenhouse gases: carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulfur hexafluoride. The EPA reviewed what it concluded were the relative scientific reports and concluded that a scientific consensus demonstrates that human activities are contributing GHG concentrations in the atmosphere at such a level that they have caused the Earth to warm over the last one hundred years. The agency concluded that the reports show the steepest increase in warming occurred in recent decades, and cited increases of
average surface temperatures; including melting ice in the Arctic, melting glaciers around the world, ocean temperatures, rising sea levels, acidification of the oceans due to excess carbon dioxide, changing precipitation patterns, and changing patterns of ecosystems and wildlife.22
22. On December 15, 2009, the final findings were published in the Federal Register. Cause or Contribute Findings for Greenhouse Gases under Section 202(a) of the Clean Air Act; Final Rule, 74 Fed. Reg. 66,495 (Dec. 15, 2009). The decision was effective January 14, 2010.
President Barack Obama and EPA Administrator Lisa Jackson stated that in proposing and adopting the endangerment finding and the LDV vehicle rule that they preferred a solution enacted by Congress in the form of a climate bill, particularly one that sets a price on carbon through a cap and trade program. However, the administration stated that in the absence of congressional action, the EPA would move forward with greenhouse gas regulation under the CAA pursuant to the Supreme Courts opinion in Massachusetts v. EPA. The EPA administrator actually signed two findings on December 7, 2009, under section 202(a) of the CAA:
Endangerment Finding: The Administrator finds that the current and
projected concentrations of the six key well-mixed greenhouse gasescarbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF6)in the atmosphere threaten the public health and welfare of current and future generations. Cause or Contribute Finding: The Administrator finds that the combined emissions of these well-mixed greenhouse gases from new motor vehicles and new motor vehicle engines contribute to the greenhouse gas pollution which threatens public health and welfare. While the findings alone do not impose any requirements on LDV vehicles, they form the basis for adopting the LDV rule. Ten petitions for reconsideration of the endangerment finding were filed with the EPA after it was issued. On July 29, 2010, the EPA denied all ten Petitions for Reconsideration of the Endangerment and Cause or Contribute Findings on July 29, 2010.23 Lawsuits by various industry and political groups have been filed challenging the endangerment finding.
2. The EPAs Johnson Memo

During the Bush administration, the EPA responded to the Supreme Courts Massachusetts v. EPA decision issued by then EPA Administrator Stephen Johnson, which has become known as the Johnson Memo. Under the Obama administration, the EPA has modified parts of the Johnson Memo, and has republished it in the Federal Register.24 The EPAs conclusions in that publication
23. EPAs Denial of the Petitions to Reconsider the Endangerment and Cause or Contribute Findings for Greenhouse Gases Under Section 202(a) of the Clean Air Act, available at http://epa. gov/climatechange/endangerment/petitions.html. 24. Reconsideration of Interpretation of Regulations that Determine Pollutants Covered by the Clean Air Act Permitting Programs; Final Rule, 75 Fed. Reg. 17,004 (Apr. 2, 2010).
address issues of when the LDV rules will go into effect, how this initial regulation of greenhouse gases will trigger other aspects of the CAA, such as the Prevention of Significant Deterioration (PSD) Program and Title V permitting, and a variety of other aspects of how the EPA will proceed with respect to regulating greenhouse gas emissions. The Johnson Memo was issued on December 18, 2008, and its main topic was the EPAs interpretation regarding which pollutants were subject to regulation for the purposes of the PSD permitting program. The EPA under both administrations concluded that is permissible to construe sections 165(a)(4) and 169(3) of the CAA to find that a pollutant, here greenhouse gases, becomes subject to regulation at the point that a regulatory restriction or control takes effect.25
3. The EPAs Mobile Source Rule

As stated above, the Mobile Source Rule or LDV Rule was proposed after the decision in Massachusetts v. EPA. The regulation of LDVs was designed to reduce emissions from these vehicles as a starting point to reduce greenhouse gas emissions within the U.S. economy. For stationary sources, the most important aspect of the rule is that it triggers regulation of stationary sources under Section 165(a)(4) and 169(3) of the CAA under the EPAs re-publication of the Johnson Memo, as amended.
4. The EPA Tailoring Rule

On May 10, 2010, the EPA announced its final Tailoring Rule.26 This rule was developed to address regulation of greenhouse gas emissions under the CAA through EPA or state programs (most states are delegated responsibility to implement the CAA). The EPAs concern was that using the general emission thresholds under the CAAfor example, 250 tons of emissions per year for certain pollutantswould apply permitting requirements to hundreds of thousands of facilities, which would be unmanageable for the EPA and costly to regulated parties. The import of this rule is that it imposes the CAAs Prevention of Significant Deterioration and Title V Operating Permit programs on sources that emit 75,000 tons or more of CO2e per year. Sources subject to the Tailoring Rule will be required to install Best Available Control Technology to reduce greenhouse gas emissions. The answer to the question of what technology to control
25. Id. at 17,017. 26. Prevention of Significant Deterioration and Title V Greenhouse Gas Tailoring Rule; Final Rule, 75 Fed. Reg. 31,513 ( June 3, 2010) (hereinafter Tailoring Rule).
greenhouse gas emissions would be available for particular types of industry sources remains unclear at this time. The EPA is holding meetings to consider this question. Thus, the rule as adopted would create a greenhouse gas regulatory system under the CAA. The approach being taken by the EPA is a command and control regulatory system, rather than the cap and trade system that provides a much more flexible approach and a market-based system for addressing greenhouse gas emissions. While the House of Representatives passed a bill in 2009, the Senate has yet to vote on a climate change bill with a cap and trade system as of the publication of this book. Without such a bill, under the Tailoring Rule, the EPA would regulate greenhouse gas emissions without any potential for trading emission rights between facilities and would reduce the potential for cost reductions and efficiency in a systemic reduction in greenhouse gas emissions. The EPA has discussed the potential for developing a cap and trade system for GHG emissions under the current provisions of the CAA, but has not taken steps as yet to implement a market-based system. At least two prior market-based programs adopted by the EPA for other pollutants have been remanded by the Circuit Court of Appeals for the District of Columbia.27 The current approach under the Tailoring Rule is a typical command and control system. The regulatory system under the Tailoring Rule would cover approximately 70 percent of the national GHG emissions from stationary sources and subject them to permitting requirements under the CAA. The facilities covered would include power plants, refineries, and cement plants, among others.
a. Application of the Prevention of Significant Deterioration to Regulation of Greenhouse Gas Emissions The Prevention of Significant Deterioration Program (PSD) discussed generally above was created under Sections 160 to 169B of the CAA. It is designed to prevent areas that have not fallen below the National Ambient Air Quality Standards (NAAQS) from approaching those concentrations.28 Permits are required if
27. See NRDC v. EPA, 489 F.3d 1364 (D.C. Cir. 2007) (vacating the Clean Air Mercury Rule); North Carolina v. EPA, 531 F.3d 896 D.C. Cir. 2008) (vacating the Clean Air Interstate Rule). The D.C. Circuit later reinstated the Clean Air Interstate Rule, including the cap and trade program, until the EPA issued a new rule in accordance with the courts opinion. North Carolina v. EPA, 531 F.3d 896, 901 (D.C. Cir. 2008). On July 6, 2010, the EPA reissued a new rule meant to replace the prior CAIR with a less ambitious emissions market program than the prior version of CAIR. The response of the court in any subsequent litigation will remain to be seen. 28. 42 U.S.C. 74707492.
certain thresholds of pollutants are exceeded, which are classified as a major source for a new source or a major modification for an existing source. First, to understand the PSD program it is important to identify those pollutants that are regulated. The regulated pollutants are those for which an NAAQS has been established by the EPA. These pollutants are as follows:
Nitrogen oxides; Volatile organic compounds;29 Sulfur dioxide; Fine particulate; Carbon monoxide; and Lead.
In general, the threshold amount of emissions of for these pollutants for a Major Source or Major Modification is 250 tons per year. This measurement is based on the potential to emit, not actual emissions. For 28 specified sources, the threshold is 100 tons per year. These sources of emissions include the following:
Power plants (fossil-fuel fired); Refineries; Cement plants; Lime plants; and Iron and steel plants.30
The process by which the PSD will be applied to major sources and major modifications in the context of GHG emissions will be discussed below. Under the PSD Program, regulated sources must adopt and install the Best Available Control Technology (BACT) to control air emissions. The analysis of what is BACT for a particular source is generally carried out on a facilityspecific basis. Environmental, economic, energy, and other impacts are evaluated in this process. The permitting authority, whether the EPA or the state, determines through this process what emission controls must be installed to reduce emissions of the relevant pollutants. The EPA will implement GHG emissions regulation and reductions through the PSD program. While the PSD program is more complicated and its application to GHG emissions is complex as well, this discussion is intended to provide a basic understanding of both the PSD
29. Nitrous oxides and volatile organic compounds are precursors for ozone and, thus, are the pollutants regulated as emissions from sources. 40 C.F.R. 52.21(b)(1)(ii). 30. The list of sources are found at id. 52.21(b)(1)(i)(a).
program and the application of the program to GHG emissions through the Tailoring Rule. In November 2010, the EPA issued guidance regarding BACT analysis for control technologies to guide permitting authorities, whether the EPA or states, in implementing the BACT requirements for GHGs under the PSD program.31
b. Covered Gases Under the Tailoring Rule, the GHGs that would be covered under the PSD program would be as follows:
Carbon dioxide (CO2); Methane (CH4); Nitrous oxide (N2O); Hydrofluorocarbons (HFCs); Perfluorocarbons (PFCs); and Sulfur hexafluoride (SF6).32
To determine the amount of emissions for regulatory purposes, the sum of the six gases are estimated and converted to CO2e, and then compared to the thresholds of emissions established in the rule.33 Thus, the EPA will use a common metric for GHGs of CO2e to measure and determine thresholds for GHG emissions.
c. Phases of Coverage, Beginning with Larger Sources
i. Step 1: January 2, 2011 to June 30, 2011

(A ) P S D A P P L I C A B I L I T Y
As discussed above, the regulation of stationary sources will begin with larger sources and the program will be phased in over time. From January 2, 2011 to June 30, 2011, GHG emissions alone will not trigger PSD requirements. The trigger will be two-part for GHG emissions. First, a major modification or major source must be part of the permit application. The GHG regulation will only be triggered if a source triggers PSD regulations
31. EPA, PSD and Title V Permitting Guidance For Greenhouse Gases (Nov. 2010), available at http://www.regulations.gov/search/Regs/home.html#docketDetail?R=EPA-HQ-OAR-20100841. 32. Tailoring Rule, 75 Fed. Reg. at 31,522. 33. Id.
and is required to address other air pollutants.34 Second, once other pollutants require PSD permitting, then GHG emissions will be regulated only if the new source or major modification increases GHG emissions by 75,000 tons of CO2e or more per year.35
(B ) T I T L E
V P E R M I T T I N G A P P L I C A B I L I T Y Title V permitting will apply only to those sources that already have been required to obtain Title V permits. The facility will only be required to address GHGs in the permit if the facility is applying for, renewing, or revising its Title V permit.36 The EPA estimates that this phase will cover sources accounting for approximately 65 percent of GHG emissions from stationary sources in the United States.
ii. Step 2: July 1, 2011 to June 30, 2013

(A )
In the second step or phase, the EPA will begin to regulate sources on the basis of GHG emissions. The prior sources in Step 1 will continue to be regulated. Sources that emit 100,000 metric tons or more of CO2e begin to be regulated. A major modification will be regulated if it results in a net emissions increase of 75,000 tons or more.
PSD APPLICABILITY
(B ) T I T L E V P E R M I T T I N G A P P L I C A B I L I T Y
A source that is not already subject to a Title V permit will not be subject to Title V unless its emissions are 100,000 tons of CO2e per year or more.37 For sources that must apply for a Title V permit once they meet or exceed the threshold, they will have one year after becoming subject to Title V to submit a permit application, absent a requirement by the permitting authority, such as a state, to apply within a shorter time period.38 For those sources that emit more than 100,000 tons per year as of July 1, 2011, a Title V permit application must be submitted by July 1, 2012.39 The EPA expects that this step will include the largest industrial sources from energy-intensive source categories, the largest landfills, the largest coal mines, and the largest oil and gas production operations.
34. Id. at 31,523. 35. Id. 36. Id. 37. Id. at 31,52324. 38. Id. 39. Id.
iii. Step 3: July 1, 2013 to April 29, 2016

During the implementation of Step 2, the EPA will evaluate the potential regulation of additional smaller sources, but the EPA does not intend to regulate sources that emit less than 50,000 tons per year during the six-year period leading up to 2016. A Step 3 regulation would become effective on July 1, 2013. The EPA committed to conduct a study as to how to address smaller sources and to complete that study within five years that it pledges to complete by April 2015. The EPA would then issue a rule on these smaller sources by April 2016.40 This action would be in addition to Step 3 in the EPAs rulemaking program for GHG emissions under the CAA.
d. Best Available Control Technology The applicability provisions lead to the most challenging aspect of the rule: What control technologies must be implemented to reduce greenhouse gas emissions? The EPA stated in the preamble to the Tailoring Rule that defining Best Available Control Technology for controlling greenhouse gas emissions would take time. The agency stated that it anticipated issuing guidance by June 2010, and policy guidance by the end of 2010 on BACT for GHG emissions.41 Some of the documents that the EPA plans to issue are:
Initial technical data and information concerning available and emerging
GHG control measures; GHG Mitigation Strategies Database; RACT/BACT/LAER Clearinghouse enhancements; GHG technical white papers on control techniques and measures for the largest GHG emitting industrial sectors (e.g., power plants, industrial boilers, cement plants, refineries, and iron and steel, pulp and paper, and nitric acid plants); General guidance for applying the PSD requirements, including BACT, for GHGs; and Training workshops with example BACT analyses for EPA regions and states.42
One of the more significant issues is what BACT would be for controlling GHG emissions from coal-fired power plants. One view is that it would be
40. Id. at 31,52425. 41. Id. at 31,526. 42. J. Mangino, EPA Office of Air Quality Planning and Standards, Prevention of Significant Deterioration and Title V Greenhouse Gas Tailoring Rule ( June 2010).
switching to natural gas. Another is that carbon capture and sequestration would be required. Other sources such as petroleum refineries, Portland cement plants, and lime plants, for example, will face similar critical questions as to what would be required to reduce GHG emissions and to what extent reductions would be required. Energy efficiency or fuel efficiency may be another approach the EPA may take in proscribing control technologies to GHG emission sources.
e. State Implementation Plans Current State Implementation Plans (SIPs) that are the roadmap by which the EPA approves delegation to the states the power to implement the CAA in that state, may not provide for GHG regulation. This raises questions as to how states will exercise jurisdiction over GHG emissions. The EPAs position is that to the extent state law has similar language regarding subject to regulation, states may adopt the EPAs approach by interpreting the phrase in the same way as the EPA in the amendments to the Johnson Memo and the Tailoring Rule. How states will address the issue of GHG emissions regulation will perhaps vary and depend on a variety of factors. Some have objected to any participation in greenhouse gas regulation and filed lawsuits challenging the Tailoring Rules.43 The EPA is preparing to take over state programs if they do not enforce the greenhouse gas regulations.44
43. The State of Texas has filed a lawsuit challenging the EPAs power to require the state to regulate greenhouse gases, joining seventeen other lawsuits filed against the EPA over the Tailoring Rule by other states, business groups, and advocacy groups. The EPA also sent a letter to EPA Regional Administrator Al Armendariz. Texas Joins Challengers to EPAs Greenhouse Gas Tailoring Rule, N.Y. Times, Aug. 5, 2010. 44. Id.
11
Developing United States LawCongress and Proposed Federal Climate Change Legislation
The development of federal legislation on climate change in the United States began in 2008 with proposed legislation and proposed bills in the Senate in 2010. The provisions of the legislation were to be codified in Title VII of the federal Clean Air Act, which, as discussed in previous chapters, is the U.S. statute governing air pollution regulation and permitting. While legislation was passed in the U.S. House of Representatives, no legislation had passed the Senate as of the writing of this book, and it did not appear that the legislation would pass the Senate in 2010. The nature of the proposed legislation is of interest in terms of structure and coverage. The discussion below follows the Senate bill offered by Senators John Kerry and Barbara Boxer.
A. Defining the Regulated Gases

Under the proposed bill, there would be seven types of greenhouse gases that would be regulated:
Carbon dioxide (CO2) Methane (CH4) Nitrous oxide (N2O)
134 | R E G U L A T O R Y S T R U C T U R E S Sulphur hexafluoride (SF6) Hydrofluorocarbons (HFCs) Perfluorocarbons (PFCs) Nitrogen trifluoride (NF3)1
In addition to these types of gases, the Environmental Protection Agency (EPA) would be able to designate other gases as greenhouse gases under the criteria provided under the statute.2 Once a gas has been determined to be a greenhouse gas, then the EPA would be required to determine whether the gas would be regulated under Section 619, which governs hydrofluorocarbons.3 Another compound being considered is actually not a gas, but a particulate. Black carbon is a material generated from burning wood and other materials. This material was included in the statute. The definition was the light absorbing component of carbonaceous aerosols.4 The EPA would be required to develop programs to mitigate black carbon emissions and to develop plans to mitigate international emissions of black carbon. The EPA would be required to make a determination as to the relative contribution to global warming over a one-hundred-year period and determine the CO2e value for each greenhouse gas.5 Because the gases have different relative contributions to global warming, a unified measure or unit is required in order to regulate the emissions and to have a common unit for emission allowances and offsets. Since CO2 is the main greenhouse gas emitted from human activities, and the least in terms of relative greenhouse gas effect, the other gases would be converted to a carbon dioxide equivalent, or CO2e. In order to convert the mass of emissions of the other greenhouse gases to CO2e, a multiplier is provided for each greenhouse gas. An example of a conversion that would be performed is the emissions of methane. If 1,000 tons of methane were emitted by a particular source for any given time period, the multiplier that would be used under the federal statute
1. Clean Energy Jobs and American Power Act, to have been codified at 42 U.S.C. 711(a) (hereinafter Proposed Legislation). 2. Id. 711(a)(8). 3. Id. 619. 4. Id. 333(a). 5. Id. 711(b)(1)(2).
D E V E L O P I N G U N I T E D S T A T E S L A W | 135
would be 25. The carbon dioxide equivalent, therefore, for the emissions of 1,000 tons of methane would equal 25,000 tons CO2e.
B. Emission Thresholds for Facilities That Emit Greenhouse Gases

For certain large sources of emissions there would not be an emissions threshold, based on the assumption that those types of sources will always exceed the minimum emissions to be regulated.6 The multiplier effect for greenhouse gases other than CO2, discussed above, is a dual-edged sword. For emission sources that would be regulated, the multiplier effect creates greater liability for that facility in terms of creating an obligation to obtain the necessary allowances and offsets to submit to the EPA for each year of operations. In other words, a facility that emits 1,000 tons of CO2 may not be regulated as it falls below a regulatory threshold of 25,000 ton per year of CO2e, as discussed below. A facility that emits 1,000 tons of methane on the other hand, as explained above, must convert the methane emissions into CO2e, which equals 25,000 tons CO2e per year. Depending on the source type, the emission of 25,000 tons per year of CO2e may cause the facility to be a Covered Facility, as discussed below, and, therefore, be subject to all of the regulations under Title VII of the proposed Act. Since some of the multipliers or conversion factors are even higherfor example, nitrous oxide is 298 and the highest one is HFC-23, which is 14,800a few tons or even less than two tons for HFC-23 could put a facility over the regulatory threshold. For those facilities that would not be regulated, the multiplier effect may create an opportunity. For example, an unregulated facility, such as a landfill, that emits 1,000 tons per year over ten years of methane could convert the methane emissions to CO2e by multiplying by 25, which would be 25,000 tons CO2e per year. If the methane were burned for electricity use, the emissions of the 25,000 tons CO2e of methane would largely be averted by using another conversion factor, because it would be converted for the most part to CO2 in the combustion process, although as combustion is not complete some would still be emitted as methane. The actual emissions after combustion would be CO2 and perhaps a few tons of methane that did not combust as the combustion is not likely 100 percent efficient. Thus, the CO2e equivalent after installing and
6. Id.
operating the project would be significantly fewer tons of CO2e with respect to the CO2 emitted (a 1-to1 measure) and a few tons of CO2e for the methane emitted (a 1-to-25 conversion). Thus, the difference for which carbon credits or offsets could be claimed would be somewhat under 25 times in terms of tons of CO2e. The conversion factor for other greenhouse gases is a curse for regulated emitters and a blessing for the carbon credit project developer. It is important to note, that the destruction of HFCs has become very controversial. The reason is that for a small investment in a destruction system for HFCs, millions of dollars in carbon credits may be generated. As a result of the controversy of this quick-wealth generation for what is perceived as doing not that much for reducing climate change, the ability to continue to utilize the reduction of HFCs for carbon credits may be in doubt over time.
C. Covered Facilities: Determining What Emission Sources Would Be Regulated

The types of facilities that would be regulated include two types of what are defined as Covered Entities:7 those that emit greenhouse gases and those that produce or import gases or materials that when burned or used produce or emit greenhouse gases or are greenhouse gases themselves and are released to the environment when used.
1. Emitters of Greenhouse Gases

The first category of emission sources involves source categories that emit greenhouse gases and to which a minimum threshold of greenhouse gas emissions does not apply. The list of these emission sources would be as follows:
Electricity Source: Fossil-fuel-fired power plants (coal, natural gas, etc.); Geologic Sequestration Sites: any site where CO2 is geologically sequestered
in subsurface formations for purposes of permanent storage; Adipic Acid Production; Primary Aluminum Production; Ammonia Manufacturing; Cement Production: excluding grinding-only operations; Hydrochlorofluorocarbon Production; Lime Manufacturing;
7. Id. 701(13).
D E V E L O P I N G U N I T E D S T A T E S L A W | 137 Petroleum Refining; Nitric Acid Production; Phosphoric Acid Production; Silicon Carbide Production; Soda Ash Production; Titanium Dioxide Production; and Coal-based Liquid or Gaseous Fuel Production;
The next group of emissions sources that is regulated includes those that emit 25,000 tons of CO2e per year and would be specifically identified in the definition of covered entity. This group of sources is identified as follows:
Ethanol production; Ferroalloy production; Fluorinated gas production; Food processing; Glass production; Hydrogen production; Iron and steel production; Lead production; Pulp and paper manufacturing; Zinc production; Any chemical or petrochemical source that produces acrylonitrile,
carbon black, ethylene, ethylene dichloride, ethylene oxide, or methanol; and Nitrogen trifluoride sources. In addition to the specifically identified sources, there is another source to which the emissions threshold applies. This group is made up of those sources that operate fossil-fuel-fired combustion devices that are not electricity sources but that individually or as a group emit 25,000 tons CO2e or more per year, and that fall within these categories:
Almost any type of manufacturing, food, textile, apparel, wood products,
pulp and paper, printing, pharmaceutical, concrete, metals production and forming, coating, engraving, furniture, semiconductors, electronics, vehicle and machine manufacturing, etc.; and Facilities that recover liquid hydrocarbons from oil and gas fields, natural gas processing plants, or natural gas pipelines.
2. Producers or Importers of Greenhouse Gases or Materials That Emit Greenhouse Gases When Used or Burned
In addition to those entities that emit greenhouse gas emissions, the statue regulates those entities that produce or import materials that when burned or used release greenhouse gases. Included in this group would be:
Fossil fuel producers (e.g., petroleum refiners) and importers of petroleum-
based or coal-based liquid fuel (e.g., gasoline, diesel, jet fuel, etc.), natural gas liquid, or petroleum coke the combustion of which would cause the emission of 25,000 tons of CO2e per year or more.8 Producers of petroleum-based, coal-based liquid fuels, petroleum coke, or natural gas liquid. This includes all facilities that produce these materials if the combustion of those materials would generate 25,000 tons or more per year of CO2e. Any stationary source that produces and any entity that imports for sale or distribution in bulk, or in products designated by the EPA, 25,000 or more tons of CO2e per year of: fossil-fuel-based carbon dioxide; nitrous oxide; perfluorocarbons; sulfur hexafluoride; any other fluorinated gas (except for nitrogen trifluoride) that is designated by the EPA as a greenhouse gas; or any combination of greenhouse gases described above. Natural gas distribution companies that deliver 460,000,000 cubic feet or more per year of natural gas to noncovered entities.
D. Setting the Cap

The following greenhouse gas emission reduction goals were set for regulated sources based on a 2005 baseline year: 3 percent by 2012; 20 percent by 2020; 42 percent by 2030; and 83 percent by 2050.9 These reductions would apply to Covered Entities described above. The legislation uses 2005 as the baseline year. As seen in the Chapter 4 discussing the Kyoto Protocol, the baseline year internationally has been 1990 for reductions in Annex I nations under the Kyoto
8. Id. 701(13)(B), (C), and ( J). 9. Id. 703.
Protocol, like Europe, Canada, and Japan. Using this baseline year, the reductions would be 7 percent by 2020.
E. Permitting Emissions of Greenhouse Gases

Under the Clean Air Act (CAA), emission limits for individual facilities would be typically set in the form of a permit issued by the EPA or a state environmental agency, where the program has been delegated by the EPA to the state.10 The permit serves to proscribe the various obligation of the regulated facility in terms of operations, monitoring, reporting, and the specific levels of pollutants that may be emitted by the facility. Under the new statute, Section 727 provides that a stationary source covered by Title V of the CAA, which governs sources of regulated air pollutants other than greenhouse gases, and that qualifies as a covered entity under the new Title VII of the CAA must obtain or amend its existing Title V permit to address greenhouse gas emissions.11 The permit would require that the owner or operator of such covered entity hold emissions allowance or offset credits at least equal to the total annual amount of CO2e for its combined emissions attributable greenhouse gas emissions to which Section 722 applies, and a representation to this effect be filed.12 Unless the designated representative of the owner or operator has filed such a representation, a permit cannot be issued and no emission allowances or offset may be issued to that covered entity.13
F. Emission Allowances
The EPA administrator establishes the quantity of emission allowances to be distributed each year, beginning in 2012.14 In order to track the allowances issued each year, each allowance would have its own unique number.15 The number of emission allowances in tons of CO2e is set in the statute, starting at 4.627 million tons of CO2e (MtCO2e), and increases until 2018 to 5.482 MtCO2e, and
10. Id. 76617661f. 11. Id. 727(a). 12. Id. 727(a). 13. Id. 727(b). 14. Id. 721(a)(b). 15. Id.
then declines to 4,873 in 2020, 3,533 MtCO2e in 2020, and 1,035 MtCO2e in 2050.16
G. Allocation of Emission Allowances

Emission allowances under the statute would be distributed in two ways: by free allocation and by auction. In addition to allocating allowances to specific industries, the EPA is required to allocate allowances to certain specific programs to achieve a reduction economic impact to certain segments of the economy or society. These allocations may change over time but now include the following:
Program for electricity consumers; Program for small local distribution companies (LDCs), which deliver in
any given year less than 4 million megawatt hours of electricity to electricity consumers; Program for natural gas consumers; Program for home heating oil consumers; Program for domestic fuel production, including petroleum refiners and small refiners; Program for commercial deployment of carbon capture and sequestration technologies; Program for early action; Program for Clean Vehicle Technology; Program for state and local investment in energy efficiency and renewable energy; Program for energy efficiency in building codes; Energy Innovation Hubs; ARPA-E research; International Clean Energy Research; Additional reserve for international climate change adaptation and security; and State greenhouse gas reduction and climate adaptation;
The EPA would be required to auction for each calendar year the allowances allocated to the respective programs outline above, as well as a variety of other programs to fund those programs. The states developed greenhouse gas programs in advance of a federal system. As a result some states have issued and continue to issue emission
16. Id. 721(e)(1).
allowances before the statute goes into effect. The EPA is required to issue regulations allowing the exchange of state greenhouse gas allowances issued before December 31, 2011, or the date that is nine months after the first auction of federal allowances.17 The states whose allowances may be exchanged include California and those that are members of the Regional Greenhouse Gas Initiative and the Western Climate Initiative.18 The exchange may not be a one-to-one exchange, but the amount of federal allowances provided would be in the amount to compensate for the cost of obtaining and holding the state allowances.19 Thus, proof of purchase price or value of the state allowances would need to be provided and proof of ownership or title to the allowances. The total amount of state allowances exchanged would be deducted from the federal allowances to be auctioned,20 thereby not adding to the size of the cap of greenhouse gas emissions allowed by the statute.
H. Auctions
1. Main Allowance Auction
The main allowance auction would be conducted in order to allow the sale of initial allowance to covered entities in order for them to obtain a portion of the allowances or offsets necessary to meet their compliance obligations. These auctions would be held quarterly starting on March 31, 2011, and would include allowances for vintage years of 2012 and later years in the 2011 auction, and staring tin 2012 would include vintages for the year in which the auction is being conducted and future years.21 The auction would be a sealed bid auction in a single round of bidding in a uniform price format.22 The bill does not explain in any detail what is meant by a uniform price format. In general, auctions would be conducted as multiple-price auctions and single-price auctions. Multiple price auctions would be generally where bidders submit competitive bids and specify the price they would be willing to pay. Successful competitive bidders pay the price equivalent to their bid. Single-price auctions similarly involve bidders submitting competitive bids specifying the price they would be willing to pay. Successful bidders pay the
17. Id. at 777(a). 18. Id. 19. Id. at 777(b)(1). 20. Id. at 777(b)(2). 21. Id. at 778(b)(1). 22. Id. at 778(b)(1).
price equivalent to the highest accepted price regardless of the price they bid. For example, all Treasury securities auctions are now single-price auctions.23 Thus, it would appear the auction sets the price for all bidders, and that the bidder receives allowances if it bids at the selected price or above. If a covered entity bid too low, below the selected allowance price through the auction, it is not clear whether they would receive any allowances at all. The actual approach to the auction would be developed and clarified by the EPA through promulgation of regulations. The minimum auction price was established as $10 (in constant 2005 dollars) for the 2012 auction, and for years after 2012, the auction price would increase 5 percent plus inflation.24 No restriction was placed on these allowances in terms of use for any compliance year or banking, trading, or borrowing. No person could purchase any more than 5 percent of the allowances offered for sale at any particular quarterly auction.25 Bidding is open to any person, but such bidders must disclose their representation and the party who would benefit from the winning bid, and must provide financial assurance to demonstrate the party can consummate the purchase of allowances from any winning bid.26
2. Market Stability Reserve

One of the price control mechanisms is the auction of allowances through the Market Stability Reserve auction. This auction is restricted to those covered entities that would be required to comply with the requirement of Section 722 the following year.27 The auction would be held quarterly and allowances that would be sold would be those that would be allocated to the various governmental or other entities under Section 771 of the statute as discussed above; those allowances, if any, previously offered for auction but not sold; and allowances created by using the auction proceeds to purchase domestic and international offsets and retiring them and creating new domestic allowances to replace them.28 In addition, parties holding offsets may request that the EPA sell their offsets in this auction and obtain the proceeds of the sale of those offsets, which would
23. Http://www.treasurydirect.gov/indiv/research/indepth/auctions/res_auctions_faq. htm#single. 24. Proposed Legislation, at 778(d). 25. Id. at 778(b)(6). 26. Id. at 778(b)(4), (5). 27. Id. at 726(a)(2). 28. Id. at 726(b)(1)(2).
be retired and allowances established in their place to provide to the winning covered entity bidder.29 The minimum reserve auction price was established as $28 (in constant 2005 dollars) for the 2012 auction. For years after 20132017, the reserve auction price shall increase 5 percent plus inflation, until 2028, when the price would increase 7 percent from the previous years price, plus inflation.30 These allowances must be used for the calendar year for the year purchased, and only for compliance purposes. These allowances cannot be banked, traded, or borrowed. Limits on purchases would be 20 percent of the covered entitys emissions allowance or offset credits retired in the most recent year, except for 2012, where the limit would be the amount of greenhouse gas emissions reported by that entity in 2011 and that would be subject to regulation under the greenhouse gas cap and trade system.31 No person may purchase any more than 20 percent of the allowances offered for sale.32 Bidders must disclose their representation and the party who would benefit from the winning bid, and must provide financial assurance to demonstrate the party can consummate the purchase of allowances from any winning bid.33
3. Small Business Refiner Reserve

In order to reduce the impact of the greenhouse gas emission restrictions on small petroleum refiners, the statute provides a program to sell a certain percentage of the allowances at a reduced price to small refiners. The EPA must set aside the amount of allowances to be sold to small petroleum refiners pursuant to Section 771 in an amount equal to: For each of the vintage years 2012 and 2013, 6.2 percent of the emission allowances established under section 721(a); For each of the vintage years 2014 and 2015, 5.4 percent of the emission allowances established under section 721(a); and
29. Id. at 726(h). 30. Id. at 726(c). 31. Id. at 726(e). 32. Id. at 726(i)(5). 33. Id. at 726(i)(3), (4).
For each of the vintage years 2016 through 2024, 4.9 percent of the emission allowances established under section 721(a).34 The allowances would be made available to the small refiners for purchase from January 1 of the vintage year of the allowance to January 14 of the following year.35 The price of each allowance is not determined by auction directly, but by the average price for allowances of the same vintage year for the auction conducting during the twelve months preceding the small refiners purchase of allowances from this program.36 These allowances must be used for the calendar year for the year purchased, and only for compliance purposes. These allowances cannot be banked, traded, or borrowed.37 The EPA would required to set by regulation the amount of allowances any one person may purchase in terms of percent of the allowances offered for sale, based on a fair allocation between all small refiners.38
I. Auctioning Allowances for Other Entities

In addition to auctioning allowances under its other programs, the statute provides that other parties may arrange to have their allowances auctioned off in the EPA auctions, and set a price they would accept in such auction.39 Thus entities could sell their allowances on consignment through the government auction. As there would be secondary exchanges and brokers that currently auction other carbon credits, parties holding allowances that they wish to sell should consider these other options and whether a better price would likely be obtained through these other sales options and mechanisms.
J. Carbon Registry
A carbon registry may have two meanings, and under the statute there would be two registries that the EPA would to set up. The first registry discussed under
34. Id. at 778(f )(1). 35. Id. at 778(f )(2). 36. Id. at 778(f )(3). 37. Id. at 778(f )(4). 38. Id. at 778(f )(5). 39. Id. at 779.
the Act serves to track the measured and reporting greenhouse gas emissions from those parties required to measure and report such emissions.40 These emissions become the basis for the regulation of the covered entities, whereby they must hold and retire an equivalent number of tons of CO2e in allowances or offset credits. The second registry relates to carbon credits, including both allowances and offset credits. In order to track allowances and offsets, the statute requires the EPA to develop a registry on which all allowances and offset credits would be registered. The EPA would to develop by regulation a system for issuing, system for issuing, recording, holding, and tracking allowances, offset credits, and term offset credits.41 The registry would set out the necessary procedures and requirements for an orderly and competitive functioning of the allowance and offset credit markets.42 The information in the registry must be published on the Internet. Each ton of CO2e of an allowance or carbon offset credit issued by the EPA or the Department of Agriculture, as the case may be for domestic land use or forestry, or exchanged for a state allowance or offset or international allowance or offset would be assigned a unique number. The registry would also serve as the database to determine which allowances or offset credits have been retired, cancelled, or transferred in order to achieve compliance by the covered entities whose emissions would be regulated under the Act. The two databases then would be a central part of the U.S. cap and trade program.
K. Offsets
1. General Issues Relating to Offsets
The first step to understanding the offset program under the statute is to review the definition of offset under the Act. The actual term is offset credit and is any such credit issued under part D, the offset section, of the Act.43 The term offset project means a project or activity that reduces or avoids greenhouse gas emissions, or sequesters greenhouse gases, and for which offset credits would be or may be issued under part D.44
40. Id. at 713. 41. Id. at 724(d). 42. Id. 43. Id. at 700(39). 44. Id. at 700(40).
The critical aspect of the offset credit is that the credit may be used in lieu of an allowance to comply with the cap and trade program.45 The statute established a program for using such offsets. The number of offsets that covered entities may use system side is capped at a maximum of two billion tons CO2e annually.46 A covered entity may use one ton of domestic offset credits or one ton of international offset credits, up to 2018, at which time 1.25 tons of international offsets may be used, to offset its emissions for the relevant compliance year.47 For any covered entity, the amount of offsets that it may use to meet its annual compliance obligations is determined by taking the amount of greenhouse gas emissions, unless excluded by the Act, from the year before the relevant compliance year and dividing that number by the total number of greenhouse gas emissions, unless excluded by the Act, by all covered entities in that time frame, and multiplying that quotient by two billion tons CO2e.48 The amount of offsets allowed per each covered entity may be three-fourths domestic offsets, and one-fourth international credits.49 The EPA, however, is required increase the percentage of international offsets that may be used if the amount of domestic offsets available for use for a particular compliance year is likely to offset less than 900,000 tons of CO2e; this increase may be up to 750 million tons per year of additional international offsets that may be used by covered entities to meet their compliance obligation in a particular year.50 The President would be allowed to recommend to Congress that the two billion tons of offsets be increased or decreased. Term offsets may be used as well. These offsets have an expiration date, at which time other offsets must be used to continue to meet the compliance obligation. Term offsets have not been favorably welcomed under the Clean Development Mechanism of the Kyoto Protocol. They would not be expected to be a significant part of a cap and trade program in the United States. Once turned into the EPA to meet compliance obligations, the allowances and offsets would be retired. Retire under the statute means
with respect to an allowance, offset credit, or term offset credit established or issued under this title, means to disqualify such allowance or offset
45. Id. at 722(d). 46. Id. at 722(d)(1)(A)(i). 47. Id. at 722(d)(1)(A)(ii), (D). 48. Id. at 722(d)(1)(B)(i). 49. Id. at 722(d)(1)(B)(iii). 50. Id. at 722(d)(1)(B)(iii).
credit for any subsequent use under this title, regardless of whether the use is a sale, exchange, or submission of the allowance, offset credit, or term offset credit to satisfy a compliance obligation.51
By retiring an allowance or offset, the EPA ensures the numbered ton of CO2e cannot be used again by any covered entity and cannot be bought or sold or otherwise traded or transferred. The retirement, thus, takes that permitted emission out of the system and serves to effectively cap the emissions of the emissions control regulatory system.
2. Carbon Offset CreationRules Relating to Offset Methodologies and Projects

The means to create carbon credits in the form of offsets will be discussed in more detail in Chapter 13. The basics of the offset program under the statute would be outline below.
a. Basics of Offset Creation The EPA is required to develop and issue regulations to develop a program for issuing offset credits under part D of the Act.52 An Offsets Integrity Board would be established within thirty days after passage of the Act.53 The EPA is required to consult with the Advisory Board and other federal agencies in formulating these regulations. These regulations would be required to accomplish the following:
authorize the issuance of offset credits with respect to qualifying offset
projects that result in reductions or avoidance of greenhouse gas emissions, or sequestration of greenhouse gases; ensure that such offset credits represent verifiable and additional greenhouse gas emission reductions or avoidance, or increases in sequestration; ensure that offset credits issued for sequestration offset projects would be only issued for greenhouse gas reductions that would be permanent; provide for the implementation of the requirements of this part; include as reductions in greenhouse gases reductions achieved through the destruction of methane and its conversion to carbon dioxide, and reductions achieved through destruction of chlorofluorocarbons or other ozone depleting substances, if permitted by the President under section 619(b)(9)
51. Id. at 700(47). 52. Id. at 732(a). 53. Id. at 731.
and subject to the conditions specified in Section 619(b)(9), based on the carbon dioxide equivalent value of the substance destroyed; and establish a process to accept and respond to comments from third parties regarding programs established under this part in a timely manner.54 The EPA must designate the Department of Agriculture to be the lead agency in terms of agriculture and forest projects. In order to function, the Act requires that the President establish within the registry established to track allowances an Offset Registry.
3. Eligible Offset Project Types

The EPA would develop and amend from time to time a list of eligible offset project types that may generate domestic and international offset credits, under the advisement of the Offsets Integrity Advisory Board.55 The Act established the following project types as the initial list that may qualify for offsets if all criteria would be met:
methane collection at mines, landfills, and natural gas systems; fugitive emissions from the oil and gas sector that reduce greenhouse gas
emissions that would otherwise have been flared or vented; nonlandfill projects that involve collection, combustion, or avoidance of emissions from organic waste streams that would have otherwise emitted methane into the atmosphere, including manure management, composting, or anaerobic digestion projects; projects involving afforestation or reforestation of acreage not forested as of January 1, 2009; forest management resulting in an increase in forest carbon stores, including harvested wood products; projects that capture and geologically sequester uncapped greenhouse gas emissions with or without enhanced oil or methane recovery in active or depleted oil, carbon dioxide, natural gas reservoirs or other geological formations; recycling and waste minimization projects; projects to abate the production of nitrous oxide at nitric acid production facilities and other stationary sources; projects for biochar production and use;
54. Id. at 732(b). 55. Id. at 733(a).
D E V E L O P I N G U N I T E D S T A T E S L A W | 149 projects that destroy ozone-depleting substances that have been phased out
of production;
projects in communities reliant on small, isolated electricity grids involving
conversion from diesel to renewable sources of energy, including electricity generation facilities with emissions below required levels for compliance with any limitation on district or home heating in those communities; projects relating to agricultural, grass land, and rangeland sequestration and management practices, including (a) altered tillage practices, including the avoided abandonment of conservation practices; (b) winter cover cropping, continuous cropping, and other means to increase biomass returned to soil in lieu of planting followed by fallowing; (c) the use of technology or practices to improve the management of nitrogen fertilizer use, including slow and controlled-release fertilizers (including absorbed, coated, occluded, or reacted fertilizers) and stabilized nitrogen fertilizers (including urease, nitrification inhibitors, and nitrogen stabilizers) that are recognized by State regulators of fertilizers; (d) reduction in methane emissions from rice cultivation; (e) reduction in carbon emissions from organically managed soils and farming practices used on certified organic farms; (f ) reduction in greenhouse gas emissions due to changes in animal management practices, including dietary modifications and pasture-based livestock systems; (g) resource-conserving crop rotations of at least 3 years; and (h) practices that will increase the sequestration of carbon in soils on crop land, hayfields, native and planted grazing land, grassland, or rangeland; projects for changes in carbon stocks attributed to land management change, including (a) improved management or restoration of cropland, grassland, rangeland (including grazing practices), and forest land; (b) avoided conversion that would otherwise release carbon stocks; (c) reduced deforestation; (d) management and restoration of peatland or wetland; (e) urban tree-planting, landscaping, greenway construction, and maintenance; (f ) sequestration of greenhouse gases through management of tree crops; (g) adaptation of plant traits or new 11 technologies that increase sequestration by forests; and (h) projects to restore or prevent the conversion, loss, or degradation of vegetated marine coastal habitats;
projects that reduce emission reductions from manure and effluent, including (a) waste aeration; (b) biogas capture and combustion; and (c) improved management or application to agricultural land; and projects that reduce the intensity of greenhouse gas per unit of agricultural production.56
Any person would petition the EPA to add project types to the list of acceptable projects, and the EPA would have twelve months to either grant or deny the petition.57
4. Methodologies
For each of the project types listed above and any others that the EPA, in consultation with the Department of Agriculture and the Offset Integrity Advisory Board, may permit to be used to produce offsets, the EPA would be required to develop what are known as methodologies to establish baselines if the project were not developed and then the tracking of greenhouse gas emission reductions after implementation of the project.58 The methodologies must provide for several aspects:
Additionality, to show real emissions reductions; Activity Baselines, to show the business as usual baseline if the project had
not been implemented;

Quantification Methods; Leakage, to address the emissions from other operations or locations if the
project is implemented.59 These methodologies and the calculations and documents generated by them that would be submitted to the EPA would form the foundation of ensuring the integrity of the offset project and the offsets generated by the project. Review and validation and verification by independent, third-party verifiers of these documents would provide another layer of assurance of the validity of the projects and the actual greenhouse gases offset, thereby, ensuring that the system is reducing emissions.
56. Id. at 733(a)(3). 57. Id. at 733(c). 58. Id. at 734. 59. Id. at 734(a).
The EPA is required by the statute to give due consideration to those methodologies that exist as of the time of enactment of the Act.60 For example, the Executive Board of the Clean Development Mechanism under the Kyoto Protocol has established numerous greenhouse gas project type methodologies. The Climate Action Reserve created under the California climate statute and the Voluntary Carbon Standard has developed methodologies as well. The use of these methodologies by the EPA allows the agency to avoid reinventing the methodologies and allows the carbon market more efficiency and continuity as once a methodology is developed and accepted, the market knows the issues and the requirements for developing a project and the rules for obtaining carbon credits in the form of offsets. The use of the preexisting methodologies would be a tremendous benefit to the offset industry and the covered entities.
a. Additionality Additionality may be one of if not the most challenging aspect of developing a carbon offset project. This concept was designed to ensure that a project that is being submitted for carbon credits, offsets, would actually achieve a reduction in greenhouse gases that would have occurred without the carbon credits or the revenue that would be derived from the sale of carbon credits. The business as usual approach would not qualify as additional, but the greenhouse gas reductions must be beyond business as usual. The statute defines additionality as follows: the extent to which reductions or avoidance of greenhouse gas emissions, or sequestration of greenhouse gases, would be additional. The term additional is defined as follows:
when used with respect to reductions or avoidance of greenhouse gas emissions, or to sequestration of greenhouse gases, means reductions, avoidance, or sequestration that result in a lower level of net greenhouse gas emissions or atmospheric concentrations than would occur in the absence of an offset credit.
This definition for purposes of establishing an offset project and the resulting offsets is actually a much longer test provided under the Act. Any greenhouse gas reduction, avoidance, or sequestration qualifies as being additional only to the extent it results from activities that
are not required by or undertaken to comply with any law, including any
regulation or consent order;

60. Id. at 734(e).
152 | R E G U L A T O R Y S T R U C T U R E S were not commenced prior to January 1, 2009, except in the case of offset project activities that commenced after January 1, 2001, and were
registered as of the date of enactment of this title under an offset program with respect to which the President has made an affirmative determination under section 740(a)(2); or activities that are readily reversible, with respect to which the President may set an alternative earlier date under this subparagraph that is not earlier than January 1, 2001, where the President determines that setting such an alternative date may produce an environmental benefit by removing an incentive to cease and then 5 reinitiate activities that began prior to 6 January 1, 2009; are not receiving support under section International Clean Energy Deployment Program of the statute, which provides funding for greenhouse gas reduction, avoidance, and sequestration projects in developing countries;61 and exceed the activity baseline established for the project type, as discussed below.62
b. Activity Baseline In developing a methodology for a particular offset type, the EPA would include a standard protocol to set a conservative estimate of the business as usual performance or practices for the relevant type of activity, with an adequate margin of safety to ensure that the greenhouse gas reductions are real and the offsets have environmental integrity.63 c. Quantification Methods Each methodology would provide that the quantification methods and equations for each project type exceed the activity baseline and provide the protocols for monitoring and verification, which includes accounting for uncertainty in these quantification methodologies.64 d. Leakage As discussed previously in Chapter 3 (Fundamentals of Cap and Trade), the issue of leakage is that the reductions in one project are moved to another place or activity, such that no real reductions actually occur. Leakage is defined in the
61. Section 323 of the Proposed Legislation. 62. Id. at 734(a)(1). 63. Id. at 734(a)(2). 64. Id. at 734(a)(3).
Act as a significant increase in greenhouse gas emissions, or significant decrease in sequestration, which is caused by an offset project and occurs outside the boundaries of the offset project.65 Each methodology must provide for a means of accounting for and mitigating against potential leakage from the specific project type and account for uncertainty in that process.66
5. Accounting for Reversals

Another potential concern with offset projects is the potential for the emissions to be reversed in terms of the emissions being emitted after all. Reversal is defined in the Act as an intentional or unintentional loss of sequestered greenhouse gases to the atmosphere.67 The statute requires that the EPA develop mechanisms to account for, discourage, and to provide a means of compensating for any reversal. The President may establish offset reserves, insurance, or other mechanisms to compensate for and protect against reversals from sequestration activities.68
6. Crediting Periods
A crediting period is defined as the period with respect to which an offset project is eligible to earn offset credits as under the Act.69 The number of years of a crediting period is set forth generally, but would be determined specifically by EPA regulation.70 For most project types, the crediting period may not be less than five years or more than ten. For forestry projects, the period shall not exceed twenty years. For term offsets, the crediting period may not exceed five years. These crediting periods would be of immense importance as the project developer earns income from the greenhouse gas project based on the amount of credits generated from the project on an annual basis times the years the project generates credits.
7. Approval of Projects
The EPA would issue regulations proscribing the requirements for submitting a petition for approval of an offset project. The statute provides little guidance
65. Id. at 700(34). 66. Id. at 734(a)(4). 67. Id. at 700(48). 68. Id. at 734(b). 69. Id. at 700(14). 70. Id. at 734(c).
as to what must be contained in a petition to approve an offset project, but requires the EPA to respond and either approve or reject the project within ninety days.71 The Act provides that the EPA may establish through issuance of regulation for a voluntary preapproval review that is nonbinding on the agency.72 As discussed in Chapter 13, under the Clean Development Mechanism (CDM) of the Kyoto Protocol, a party must submit a Project Design Document (PDD) and a third-party validation of the PDD to the Executive Board for a review and approval. A project developer would not initiate the project unless a project receives sufficient review and approval to give the project developer enough confidence that the carbon credits would be issued upon completion and submission of the verification of the greenhouse gas reductions achieved by the project. The preapproval process may be helpful, but it should be binding to be of more assistance to the project developer and to assist in obtaining financing for the project. The Act provides for an appeal of determinations made by the EPA regarding approval of the project.73 One of the problems under the CDM is that there initially was no appeal process, and once a project was denied approval by the Executive Board, no process was available to clarify or to attempt to change a potentially errant denial of a project.
8. Monitoring, Reporting, and Verification

The integrity of an emissions offset program depends in large part on the monitoring, reporting, and verification (MRV) requirements and their reliability. The first step is the development of adequate methodologies for each project type, and then the MRV program determines whether the project actually results in any additional greenhouse gas reductions over time. The statute requires that a project developer submit a report prepared by a third-party verifier accredited by the American National Standards Institute or the EPA to verify the amount of greenhouse gases reduced or avoided through carbon credit projects.74 Regulations would be required to be developed to provide the components of the report, which at a minimum shall include the designated representative of the project developer, the quantity of greenhouse gases reduced, avoided, or sequestered, the applicable methodologies, a certification
71. Id. at 735(c)(d). 72. Id. at 735(f ). 73. Id. at 735(e). 74. Id. at 736.
that the project meets applicable requirements, and a certification that the conflict of interest requirements of the verifier have been met.75
9. Issuance of Credits
Issuance of credits under the process requires the submission of the verification report as to greenhouse gas reductions, avoidance, or sequestration, and the President, probably through either the EPA for most project types or the Department of Agriculture for land use, agriculture, and forestry projects. The agency reviewing the verification report must make a decision as to the verification report within ninety days, which must
make the report publicly available, determine the quantity of emissions reduced, avoided, or sequestered by the
project,
notify the offset developer in writing of the decision and make such decision
publicly available.76 Once the agency approves the verification report, it must issue one offset credit for each ton of CO2e reduced, avoided, or sequestered,
which has already occurred, that is ex post, not ex ante, which has occurred after January 1, 2009, and issue such credits within two weeks after the determination has been
made as to the verification report.77 The agency may audit projects on an ongoing basis, offset credits, and of thirdparty verifiers.78
10. Early Offsets

Since the statute follows carbon trading programs established by the states and would effectively take over the role of those programs, it was necessary for Congress to address the offsets created pursuant to those programs. The Act provides that the President may through a public notice and comment process issue federal offset credits under the Act in the amount of one offset credit for
75. Id. at 736(c). 76. Id. at 737(a). 77. Id. at 737(b), (d). 78. Id. at 738.
each ton of CO2e reduced, avoided, or sequestered, that has not expired or been retired, and that meets the following requirements:
Derives from a project initiated after January 1, 2001, For greenhouse gas reductions or avoidance occurring after January 1, 2009,
up to three years after the date of enactment of the Act or the date regulations establishing an offset program would be issued, Was issued under a regulatory or voluntary program the President determines was established under a State or tribal program initiated before January 1, 2009, and that program is approved by the President, in which standards, methodologies, and protocols have been developed through public consultation or peer review process and made publicly available, established those standards, methodologies, and protocols requiring offsets to be permanent, additional, verifiable, and enforceable, that the offsets are verified by a state regulatory party or accredited third party, credits are registered in a publicly accessible registry., where the issuing entity, administrator, or representative was not involved in the funding of the project; The credit is transferred to the President in order to have a federal offset credit issued in its place (the President will attempt to have the original credit retired under the program under which it was issued).79 Other programs not established under a state or tribal program or not established prior to January 1, 2009, but that meet the requirements above may be approved as well. This provision would apparently apply to review of voluntary programs, such as the Voluntary Carbon Standard, the Chicago Climate Exchange, or the American Carbon Registry. Any petition to approve such a program must receive a decision within 180 days.80
11. Environmental Considerations for Forestry or Land-Management Projects

The Act provides specific environmental considerations that must be applied to domestic forestry or land-management projects through regulations that
Ensure native species are given primary consideration,
79. Id. at 740(a). 80. Id. at 740(e).
D E V E L O P I N G U N I T E D S T A T E S L A W | 157 Enhance biological diversity, Prohibit the use of federally or state-designated noxious weeds, With respect to forestry project, are conducted under widely accepted,
environmentally sustainable forestry practices,

Ensure that the project area was not converted from native ecosystems, such
as forests, grassland, scrubland, or wetland that took place at least ten year prior to the enactment of the Act or January 1, 2009, whichever is earlier, and To the maximum extent practicable, ensures that the use of offset credits would satisfy emission reduction commitments made by the United States under the United Nations Framework Convention on Climate Change.81 Land use and forestry projects would likely provide a substantial percentage of offsets for trading and for compliance by covered entities.
12. Recordkeeping
Records would be required to be kept by both project developers and third-party verifiers. The following records must be kept for not less than the crediting period for the project plus an additional five years:
any offset project approval petition submitted to the appropriate officials
under the offset approval process; any reversals which occur with respect to an offset project; any verification reports; and any other aspect of the offset project that the appropriate officials determine is appropriate.82
13. International Offsets

a. General Issues The EPA is required to issue regulations within two years of enactment of the statute governing the importation and use of international offsets for use in meeting compliance obligations under the Act, in consultation with the Department of State and the Agency for International Development (AID).83 As discussed above in this chapter, the amount of international credits that may be imported into the United States and the amount covered entities may use to meet compliance obligations is limited.
81. Id. at 741. 82. Id. at 744. 83. Id. at 744(a).
International offsets would be issued by the EPA. The regulations must proved that international offsets be issued by the EPA only if
the United States is a party to a bilateral or multilateral international
agreement or arrangement that includes the country of origin of the project that generated the emissions offset; the country of origin is a developing country; the international agreement or arrangement including that country ensures that the requirements for offsets under the statute apply to the issuance of international offsets; provides for the appropriate distribution of international offsets; provides that the offset project developer is eligible to receive service of process in the United States for all civil and criminal actions in Federal courts.84 The criteria for international credits would be strict and the ability to serve the project developer would require that a project developer that intends to sell credits into the U.S. carbon market plan ahead and submit to such jurisdiction or this may force many of the project developers to be either U.S. entities or U.S. subsidiaries of foreign entities. This requirement may drive a substantial portion of project development offices to the United States. As discussed above, the number of international offsets is limited in terms of the total amount per year that all covered entities may use and the amount any one covered entity may use. However, the EPA is permitted by the Act to allow more international offsets into the U.S. carbon market. The EPA may not include in any international offset program any credits issued for the destruction of hydrofluorocarbons.85
b. Sectoral Credits Three categories of international offset credits may be allowed into the U.S. carbon market, sector based credits, credits issued by an international body, and forest-relaated credits. The category to be discussed in this subsection is sector-based credits. Sectors are industries or businesses that generate greenhouse gases from which offsets are developed. The Act defines the term sectoral basis as follows:
The issuance of international offset credits only for the quantity of sector-wide reductions or avoidance of greenhouse gas emissions, or
84. Id. at 744(b). 85. Id. at 744(h).
sector-wide increases in sequestration of greenhouse gases, achieved across the relevant sector or sectors of the economy relative to a baseline level of emissions established in an agreement or arrangement [entered into with one or more countries] for the sector.86
The EPA shall identify sectors or combination of sectors within developing countries in which the issuance for the industrial or business sector is appropriate, and issue credits only on a sectoral basis for those activities.87 For those countries that have relatively high comparative emissions, such as China, India, Brazil, Mexico, and South Africa (although these countries are not identified in the Act), the sectors would be established if that industry or business sector if located in the United States generally would be subject to compliance obligations for greenhouse gas emissions.88 The Act sets forth the criteria on which the EPA would determine, in consultation with the Department of State and the AID, for which sectors in which countries only sectoral credits would be issued. These criteria include the gross domestic product, national greenhouse gas emissions, whether the sector would be regulated in United States, whether the sector sells products in the international markets, risk of leakage within the sector if offset credits were issued on project level versus a sectoral basis, capacity to monitor, measure, report, and verify emissions from the sector, ability to encourage countries to make national greenhouse gas reductions, among other factors that the EPA may find appropriate.89 Specific criteria would be used to determine the baseline emissions for a particular sector.90
c. Credits Issued by an International Body For international offset credits issued by an international body, the EPA again would exchange those credits for a U.S. credit, and seek to extinguish the international credit with the international body established under the UN Framework Convention on Climate Change (UNFCCC), if such program meets the requirements discussed above for international offset for imported into the U.S. carbon market and provides equal or greater integrity as the offset programs established under the Act.91
86. Id. at 744(c)(3)(A). 87. Id. at 744(c). 88. Id. at 744(c)(2)(A). 89. Id. at 744(c)(2). 90. Id. at 744(c)(3)(B). 91. Id. at 744(d).
d. International Forest Offsets The statute allows international offset credits to be imported into the United States if they meet the other requirements for international offset credits for activities to reduce deforestation only if the activity occurs in
a country listed by the EPA in consultation with the State Department and
AID and which has entered into an appropriate international agreement or arrangement, as discussed above, that have the capacity to affect deforestation reduction activities at a national level and is taking part in deforestation activities, a state or province (of a country) listed by the EPA in consultation with the State Department and AID and which has entered into an appropriate international agreement or arrangement, as discussed above, and is not part of the lower emitting countries listed by the EPA, that has the capacity to affect deforestation reduction activities at a national level and is taking part in deforestation activities; or a country listed by the EPA in consultation with the State Department and AID and which has entered into an appropriate international agreement or arrangement, as discussed above, and emits less than 1 percent of total anthropogenic global greenhouse gases, and less than 3 percent of global greenhouse gas emissions from deforestation.92
i. National Programs
The first category applies to most nations. Under this category, the quantity of international offset credits that may be issued by the EPA is based on the comparison of the national emissions from deforestation in that country to the national deforestation baseline that is established under an international agreement or arrangement, and that meets the baseline requirements of the Act. To be eligible and be placed on the list established by the EPA, the country must demonstrate capacity to participate in deforestation reduction activities at a national level based on the following criteria:
The capacity to monitor, measure, report, and verify forest carbon fluxes; The institutional capacity to reduce emissions from deforestations, including,
among other things, independent third-party verification and transparent and equitable distribution of offset revenues for local actions;
92. Id. at 744(e).
D E V E L O P I N G U N I T E D S T A T E S L A W | 161 Have a land use or forest sector strategic plan that assesses national and local drivers of deforestation and forest degradation
and identifies reforms to national policies needed to address them; estimates the countrys emissions from deforestation and forest degradation; identifies improvements in and a timeline for data collection, monitoring, and institutional capacity necessary to implement an effective national deforestation reduction program (including a national deforestation baseline); establishes a timeline for implementing the program and transitioning forest-based economies to low-emissions from forests and land use; institutes a program to provide for consultation and participation by indigenous and forest-dependent communities; distributes revenues from activities to reduce deforestation transparently, publicly, and overseen by independent third parties; includes a national registry for information relating to deforestation and degradation policy.93
In addition to meeting these national criteria, to be eligible for the deforestation credits, the countries must establish a national deforestation baseline that meets several criteria:
Is national in scope; Is consistent with nationally appropriate mitigation commitments or actions
with respect to deforestation, based on average annual historic deforestation rates for at least five years; Has a trajectory that would result in net zero deforestation in twenty years, with a land use plan that identifies intact and primary forests; Can be adjusted over time to reflect changing circumstances; Is designed to account for all significant sources of greenhouse gas emissions from deforestation; Is consistent with the national deforestation baseline, if any, under the Deforestation Assistance Program for developing countries established under the Act.94
93. Id. at 744(e)(4). 94. Id. at 744(e)(2).
ii. State- or Province-Level Programs

Offsets generated from state and province level programs may be exchanged for U.S. credits if the state or province is listed by the EPA. The criteria would be as follows:
The country is not one of the developing countries with low-level emissions
in total and from deforestation listed by the EPA;

The state or province is undertaking deforestation reduction activities; The state or province has the capacity to engage in deforestation reduction
activities; including The capacity to monitor, measure, report, and verify forest carbon fluxes; The institutional capacity to reduce emissions from deforestations, including, forest governance and mechanisms to deliver forest conservation resources for local actions; The country demonstrates efforts to transition to a national program within five year and is making a good faith effort to develop a land use or forest program that meets the requirements for a national program under the Act, discussed above. The issuance of credits would be based on the reductions compared to the state or provincial baseline established under the criteria for the national baseline discussed above. The program would phase out after five years from the first calendar year for which a covered entity must demonstrate compliance under the Act.95
iii. Program for Low-Emitting Countries

The program for low-emitting countries allows the EPA to list those countries eligible for the exchange of avoided deforestation credits if the country is making a good faith effort to develop a land use or forest sector strategic plan and a monitoring plan for major forest areas in the country.96 A project-level or program-level deforestation baseline may be used, and either project-level or program-level offset credits may be exchanged as U.S. offset credits.97 The lowemitting country deforestation program would phase out after eight years from the first calendar year for which a covered entity must demonstrate compliance
95. Id. at 744(e)(5)(D). 96. Id. at 744(e)(6). 97. Id. at 744(e)(6)(B)(C).
under the Act.98 The EPA may extend this program for up to five years for leastdeveloped countries where the country lacks capacity to develop a deforestation reduction program and the country is receiving assistance under the Act to develop such capacity.99
iv. Project-based Deforestation Reduction Credits

The statute primarily discusses national or state/province-level offset credits for deforestation reductions. The Act provides that the EPA may issue a portion of the total quantity of available credits under the national or state/provincial program directly to a project developer for activities that contributed to a reduction in emissions.100 The issuance must be authorized by the international deforestation program under the relevant international greenhouse gas reduction agreement or arrangement with the United States, and the credits must be issued under a state/provincial program by a state/provincial government.101 What is unclear is whether the project-level credit process would be phased out with the state/provincial program as provided under the Act, and discussed above.
v. Forested Wetlands and Peatlands

The EPA may be rule expand the scope of the deforestation programs to include forested wetlands and peatlands. Wetlands and peatlands may contain large amounts of sequestered greenhouse gases, and when disturbed or burned may release CO2 and methane in large quantities. Protection of these ecosystems, therefore, is critical to reducing greenhouse gas emissions in the same way as preserving forests.
L. Compliance with Greenhouse Gas Emission Requirements

1. Compliance Obligations
The compliance obligations in terms of the cap on the emissions and the requirement to hold emission allowances or offset credits that equal the annual emissions in a particular year would be phased in for various types of covered entities over time. The covered entity may not in combination emit greenhouse gases and have greenhouse gas emission attributable to it in excess of its allowable
98. Id. at 744(e)(6)(D)(i). 99. Id. at 744(e)(6)(D)(ii). 100. Id. at 744(e)(7). 101. Id. at 744(e)(7)(A)(B)
emissions level, which is the number of emissions allowances or offset credits it holds as of 12:01 a.m. on April 1 of a compliance year.102
2. Phase in of Compliance Obligations for Certain Covered Entities

Generally, all covered entities must be in compliance by 2013.103 Some categories of covered entities would not be required to be incompliance the first year, but would be phased into the program over time. One group of covered entities known as Industrial Stationary Sources must comply by 2014. This group encompasses the following categories of covered entities:
Any stationary source that has emitted 25,000 or more tons of carbon
dioxide equivalent of nitrogen trifluoride in 2008 or any subsequent year;

Adipic Acid Production; Primary Aluminum Production; Ammonia Manufacturing; Cement Production: excluding grinding-only operations; Hydrochlorofluorocarbon Production; Lime Manufacturing; Petroleum Refining; Nitric Acid Production; Phosphoric Acid Production; Silicon Carbide Production; Soda Ash Production; Titanium Dioxide Production; Coal-based Liquid or Gaseous Fuel Production; Any chemical or petrochemical source that produces acrylonitrile, carbon
black, ethylene, ethylene dichloride, ethylene oxide, or methanol; or emits 25,000 tons of CO2e or more per year. emissions sources that is regulated includes those that emit 25,000 tons of CO2e per year and would be specifically identified in the definition of Covered Entity. This group of sources is identified as follows: Ethanol production Ferroalloy production Fluorinated gas production Food processing
102. Id. at 722(a). 103. Id. at 722(b).
D E V E L O P I N G U N I T E D S T A T E S L A W | 165 Glass production Hydrogen production; Beneficiation or other processing (including agglomeration) of metal ores; Iron and steel production Lead production Pulp and paper manufacturing Zinc production Any fossil fuel-fired combustion device (such as a boiler) or grouping of such
devices that is all or part of an industrial source not specified in the categories of the covered entities above, and has emitted 25,000 or more tons of carbon dioxide equivalent in 2008 or any subsequent year. Certain other categories would be phased in over time as well. Small business refiners must comply by 2015. Natural gas local distribution companies must comply by 2016. For certain entities, the emissions or those attributable to them would be net of certain emissions from fuels for which allowances or offset credits have already been purchased, for example, if a supplier of petroleum-based or coal-based liquid fuel has already assigned allowances for the emissions from the future burning of the fuel, then the party burning it would not need to hold allowances for the emissions the actual burning of the fuel.104 The degree to which emissions would be regulated from biomass fuel derives from the source of the CO2 the plants convert through photosynthesis into biomass. Generally, allowances would not be required for the burning of biomass or gas derived from biomass, as the CO2 originates from the atmosphere and is then returned to the atmosphere so no net increase in greenhouse gas emissions in the atmosphere occurs. When the source of the CO2 uptake by plants is from a covered entity that would add net greenhouse gas emissions the outcome is different. Allowances must be obtained to address the emissions of CO2 from the burning of algae that is made into a fuel if the CO2 is derived from emissions from a covered entity. Those allowances must be obtained for the CO2 at the point emitted from the covered entities or at the CO2 is generated by burning the algal fuels.105 Fugitive emissions generally would be excluded from cap and trade programs. This term is defined under the Act as emissions from leaks, valves, joints,
104. See, e.g., id. at 722(b)(6). 105. Id. at 722(b)(10).
or other small openings in pipes, ducts, or other equipment, or from vents.106 These emissions initially would not be covered under the Act, although the EPA may enact regulations to cover them if the EPA determines the CO2e value of emissions can be adequately measured to ensure the integrity of emission allowances, the allowance tracking system, and the limits on emissions.107 No allowances or offset credits would be required if the fuels are exported for sale or use.108
M. Trading Allowances and Offsets

The statute provides that the holder of an allowance or offset may, without restriction, sell, exchange, transfer, hold for compliance . . . or retire such allowance or offset.109 Generally, such ability is not restricted under the Act, except in certain situations such as the Market Stability Reserve or the Small Business Refiners Reserve, so that any party may own and trade allowances and offsets.110 The actual legal transfer of an allowance or offset is not effective until the certification of the designated representative of the transferor is received and recorded by the EPA in accordance with the regulation promulgated by the EPA.111 This is a critical aspect of the trading system and title to such allowances and credits as would be discussed in more detail in Chapter 14 (Carbon Finance).
N. Banking Allowances
The concept of banking of emission allowances and offsets is that the emission credits do not expire in the year they would be issued, but may be used in future years. Banking may be for a few years or be unlimited. The allowances issued under the statute have unlimited banking potential, and may be used in any year after they would be issued.112 The EPA by regulation, however, may establish expiration dates if necessary to ensure the authenticity of allowances or credits
106. Id. at 700(25). 107. Id. at 722(b)(11). 108. Id. at 722(b)(12). 109. Id. at 724(a)(b). 110. Id. at 724(b). 111. Id. at 724(c). 112. Id. at 725(a).
or the allowance tracking system.113 It must be recalled that some allowances for example, those that would be purchased pursuant to the Market Reserve and the Small Business Refiners Reservemay not be banked, but must be turned into the EPA for retirement for compliance purposes in the year purchased.
O. Borrowing Allowances
Another important concept of the statute is borrowing. An allowance may be used in the calendar year preceding the vintage year without interest, and may be used for one to five years prior to the vintage year up to 15 percent of the allowances needed for compliance, but in such circumstances an 8 percent interest rate is charged in terms of additional allowances that must be paid for each year the allowance is borrowed.114 Three key issues must be kept in mind in borrowing. First, the allowances must be those issued by the EPAthey cannot be international allowances or offsets. Second, the allowances being borrowed from future years must be owned by the borrower, not a third party. Here the allowances could be transferred from say a related entity, a sort of inter-company transfer, or purchased from a third party, but the price might be too high for such a transaction to make sense, depending on the market price for allowances at the time. Third, as with banking, some allowances, as mentioned above, that would be purchased pursuant to the Market Reserve and the Small Business Refiners Reserve, may not be borrowed, but must be turned into the EPA for retirement for compliance purposes in the year purchased.
P. Safety Valve International Competitiveness

The term safety valve refers to a price cap or other means of preventing the price of allowances from rising beyond a certain point. While sought by covered entities, no safety valve was provided for under the Act. However, the Market Stability Reserve to allow additional credits to be bought provides for a sort of loose cap on prices as the minimum price is $28 per ton. As a result, it may be possible for covered entities to always purchase allowances at this price, thus creating a form of cap on prices. The Small Business Refiners Reserve provides another means for that group of entities to reduce their costs of compliance.
113. Id. at 725(b)(1). 114. Id. at 725(b)(2).
1. Program to Provide Additional Allowances for Industrial Sources Facing International Competition
Other programs under the Act would be designed to address the potential for leakage in the form of greenhouse gasemitting industries and activities of moving from the Untied States to China or other countries without greenhouse gas regulatory systems that cap facility emissions. One of these programs is entitled Ensuring Real Reductions in Industrial Emissions. This program allows the granting of additional allowances for industrial sources of greenhouse gas emissions where the energy or greenhouse gas intensity of the product would create an international competitive advantage to those manufacturers in countries that do not have similar greenhouse gas reduction requirements.115 Covered entities that may take advantage of this program would be those the EPA identifies out of a group referred to as the Industrial Sector. This group is the manufacturing sector as defined in the industrial codes NAICS 31, 32, and 33, or is part of, or an entire, sector that beneficiates or otherwise processes (including agglomeration) metal ores, including iron and copper ores, soda ash, or phosphate, but does not include any part of a sector that extracts metal ores, soda ash, or phosphate.116 Petroleum refining is excluded from this group. The EPA must identify an initial list of Eligible Industrial Sections by June 30, 2011.117 Covered entities that would be part of an Eligible Industrial Sector may receive additional allowances for each vintage year based on their direct and indirect (such as electricity consumption from fossil fuel electric power plants) carbon factors.118 The method for deriving the carbon factors and, thereby, the number of allowances a covered entity in an Eligible Industrial Sector may obtain for any particular vintage year is set forth in the Act.119
2. Use of Sectoral Approach for the Importation of International Offset Credits

The program to allow the importation of international offset credits into the United States on a sectoral basis, as discussed above in section K (Offsets), is another means of addressing the international competitiveness concern.
115. Id. at 761. 116. Id. at 762(3). 117. Id. at 763(a). 118. Id. at 764. 119. Id. at 763-64.
The sectoral approach only allows offsets of emissions from entities in a sector if the overall industrial sector is reducing its total emissions from a projected baseline. Thus, a developing country that has significant emissions, such as China, India, Brazil, Mexico, or South Africa, would only be able to take advantage of offset projects and offset credits for importation into the United States if the country implements a program to reduce greenhouse gas emissions from its industrial sectors.
Q. Supplementarity and Linkage to Other National and International Trading Systems

Carbon offsets present many issues with respect to the import of those offsets into a developed country. One of those concerns is that if an unlimited amount of inexpensive offsets can be purchased by a regulated facility under a cap and trade regime, then the facility would simply buy sufficient offsets and avoid any pressure to reduce their own emissions. The concept of a limit on the amount of international carbon offsets that may be purchased and utilized by a domestic facility is known as supplementarity. This issue is discussed above in this chapter. The amount of international offset credits that would be allowed into the United States is capped in total. In addition, the amount of international offset credits that may be used by any one entity is capped as well. Thus, the use of international offset credits is capped, and they serve only as a supplement to the cuts that would be supposed to be made by the covered entities. The ability to trade emission allowances between developed countries is another aspect of greenhouse gas cap and trade programs. This term, as discussed in Chapter 3, is called linkage. Linkage allows two trading systems to engage in international commerce in carbon credits between the countries. The term linkage relates in part to the linking of the two computer databases or registries of the two countries such that the trading can occur. The statute would allow the EPA to allow linkage with certain international climate change programs to reduce greenhouse gas emissions. In order to do so, the Act requires that the other program be operated by a national or supranational foreign government (meaning the European Union, as an example of multiple countries) that imposes a mandatory absolute tonnage limit on greenhouse gas emissions or one or more economic sectors and is at least as stringent as the U.S. program.120 To operate effectively, if an allowance is retired in the
120. Id. at 728(a)(1)(2).
United States, there must be a program to retire the allowance in the country of origin.121 The EPA may in the implementing regulations or subsequently issue modifying regulations that limit the percentage of international emission allowances that may be used.122
R. Early Action
Companies have been encouraged to take early action before a regulatory program goes into effect, and the concern is that these companies should not be punished, but rather rewarded for their action prior to the statute going into effect. The Act addresses this issue through provision of additional allowances to the companies that have engaged in early action. The program addresses early action in two ways. First, entities that have obtained state or voluntary allowances or offset credits may apply for allowances under the Act.123 Under the first scenario, the allowances granted would be for an amount reflecting the average monetary value of the credits between January 1, 2006, and January 1, 2009.124 Second, an entity that did not obtain allowances or offsets, may apply for allowance credits if:
the entity publicly stated its greenhouse gas reduction goals and publicly
reported actual emissions; the entity demonstrated entity-wide net greenhouse gas reductions; and the entity demonstrates the actual projects or process improvements resulting in reductions and provides documentation of those reductions.125 Emission allowances for early action demonstrations without state or voluntary carbon credits would be provided allowances equal to the approximate CO2e value received by entities that received credits in the first group that held state or voluntary credits.126 A few other provisions apply to this program.127 The exchange for allowances may only occur if the credits have not been retired, used to meet a voluntary
121. Id. at 728(c)(2). 122. Id. at 728(d). 123. Id. at 782(a)(1). 124. Id. at 782(b)(1). 125. Id. at 782(a)(2). 126. Id. at 782(b)(2). 127. Id. at 782(b)(3)(6), (c).
or mandatory commitment, or have expired. Once issued, the credit must be retired for purposes of use for which it was originally issued. The exchange must occur within a deadline set by the EPA. Participation in this early action program does not preclude an entity in participating in an offset program discussed above.
S. New or Expanded Facilities

One of the great challenges, and that raises opposition among industry and business groups, is the concern about the cap not on emissions, but on domestic economic growth. Under the program for industrial sectors that may be affected by international competition from countries that do not have a greenhouse gas regulatory system, the Act provides for the distribution of emission allowance rebates for the first and second years of operation of a new entity in an eligible industrial sector, and other distributions consistent with the program for existing entities.128
T. Regulatory Agency or Agencies

1. Regulation of Greenhouse Gas Emissions
Under the Act, the EPA is the main entity regulating greenhouse gas reporting, permitting, and issuance of allowances and offsets. The Department of Agriculture would serve to establish the program for offsets for land use, agriculture, and forestry.
2. Regulation of Trading of Allowances and Offsets

Regulation of trading of allowances and offsets, in other words, the financial aspects of the transactions, would be first managed by the EPA in terms of maintaining registries of the carbon allowances and offset credits, tracking ownership and title to credits, and retirement of credits, and international trading of credits into the United States. Regulation of trading in terms of fraud or misfeasance, trading markets, and financial instruments would not be an area of expertise of an environmental agency, would be managed by the Commodities Futures Exchange Commission.
128. Id. at 764(b)(1)(C).
U. Enforcement
Facilities that fail to submit adequate carbon allowances or offsets would face potential sanctions by the EPA. Under the statute, parties would face up to $25,500 per day per violation administrative proceedings, civil, and criminal sanctions, as Section 113 of the Clean Air Act that contains the enforcement sections have been amended to provide for enforcement under the new Title VII of the Act.129 Thus, facilities would have an incentive to turn in carbon allowances or offsets in order to avoid these penalties that would by design cost the facility more than the price of an allowance or offset. Specifically, the statute provides for a penalty for failure to hold sufficient allowances or offsets for a covered entities emissions for the prior year. Each ton of CO2e that the covered entity fails to hold would be a separate violation, and the amount paid shall be equal to the product of the tons of CO2e emitted or attributable to the covered entity that the owner or operator failed to hold on the relevant deadline and twice the fair market value of the emissions established for the emissions allowances for the calendar year for which the emissions allowances were due.130 In addition, the owner or operator of the covered facility would remain liable for any other fine, penalty, or assessment arising under the Act, and would be required to offset the emissions emitted by or attributable to the covered entitys excess emissions the following calendar year.131
129. 42 U.S.C. 7413. 130. Proposed Legislation, 723(a)(b). 131. Id. at 723(b)(c).
PART
THREE
Carbon Project Development and Carbon Finance
12
Carbon Credit Project Types and Methodologies

A. Introduction to Carbon Credit Project Types and Methodologies
The general description of carbon credit standards and issues is important, but the creation or generation of carbon credits arises from the type of project actually implemented. The application of the general standards, whether under the European Union Emissions Trading Scheme (EU ETS), the Clean Development Mechanism (CDM), or a voluntary standard to a specific project, is where the real challenge for the project developer arises. To the novice, the creation of carbon credits appears somewhat easy: reduce greenhouse gases and the credits are generated. This is simply not the case. The generation of carbon credits through developing a project and applying for validation by a third party and the carbon standards board or entity is by no means an easy, straightforward, or necessarily guaranteed process. The first challenge is that if there is no established methodology for a project, then no carbon credits can be generated. A methodology must first be developed and approved by the relevant carbon standard entity. Fortunately, the Voluntary Carbon Standard Association (VCSA), for example, accepts the methodologies of the CDM. One of the questions of the U.S. system is whether the CDM methodologies or state methodologies will be accepted by the U.S. agencies that will be approving and issuing U.S. carbon credits and offsets. The other problem is that generation and approval of methodologies, at least within the CDM, has been a very slow process, taking a year or more to be approved. The streamlining of this process would greatly enhance the development of projects that reduce greenhouse gas emissions at international and national levels.
176 | C A R B O N P R O J E C T D E V E L O P M E N T
AND
CARBON FINANCE
The second challenge is that even where a methodology exists, not all projects will be validated by a third-party verifier or approved by the CDM Executive Board or by other standards entities. Projects may be disapproved for a variety of reasons. One of the most common reasons is the failure to establish additionalitythat the carbon credit generation and revenue were necessary to enable the project to go forward. The failure to show the project was beyond business as usual can cause a project to fail to obtain approval. The development of the project design document is thus critical for each carbon credit project. Demonstrating the greenhouse gas (GHG) reductions is only one part of this process. A variety of other factors will play a role in obtaining the validators and verifiers approval and then the approval, in some cases, of the carbon credit standards crediting board.
B. Methodologies for Developing Carbon Credit Project Types

As explained above, a carbon credit project has no value in terms of generating carbon credits if there is no approved methodology for that specific type of project. For example, if one were to reduce greenhouse gases from a landfill, but there was no methodology by which a party could prove the baseline and demonstrate the reduction of greenhouse gases initially and over time through monitoring, then there would be no means to develop the project and have a standards board issue carbon credits. Methodologies are the protocols by which the project developer proves up his or her project. The CDM methodologies provide the currently most advanced system for demonstrating this process. Under the CDM, the Executive Board has first approved various tools to use in developing baselines and monitoring projects. The tools approved so far are as follows:
Tool for the demonstration and assessment of additionality; Combined tool to identify the baseline scenario and demonstrate
additionality;
Tool to calculate project or leakage CO2 emissions from fossil fuel
combustion;
Tool to determine methane emissions avoided from disposal of waste at a
solid waste disposal site;

Tool to calculate baseline, project, and/or leakage emissions from electricity
consumption;
Tool to determine project emissions from flaring gases containing
methane;
C A R B O N C R E D I T P R O J E C T TY P E S
AND
M E T H O D O L O G I E S | 177
Tool to calculate the emission factor for an electricity system; and Tool to determine the mass flow of a greenhouse gas in a gaseous stream.
One or more of these tools may be cited in the methodologies that have been developed and approved by the Executive Board. Each methodology generally addresses several issues. First, the specific definitions will be stated that may apply to the project types that the methodology will address. Second, the applicability of the standard to specific projects will be explained. Third, a baseline methodology procedure to determine the greenhouse gas emissions that would be emitted in the absence of the implementation of the project will be described. Fourth, the means by which additionality will be shown is provided. Fifth, equations to calculate the baseline and project reductions in greenhouse gases will be included. The potential for leakage, where emissions move from the project to some other location, may be discussed, and how it must be addressed in order to prove the existence and amount of reductions. A monitoring methodology will then be provided, and the data and parameters to be monitored will be described. Other standards boards, such as the Voluntary Carbon Standard Association (VCSA) and the American Carbon Registry will often accept the methodologies established under the CDM. The other standards boards will also allow for the creation of new methodologies or the modification of existing methodologies, such as CDM methodologies. The VCSA allows for a double-approval process whereby one validator reviews both the new or modified methodology and the Project Design Document (PDD), and a second validator also reviews and comments on the new or modified methodology. The two validators must both approve the new methodology.
C. Carbon Credit Project Types

There are numerous types of carbon credit project types. This chapter will discuss some of the more prominent or interesting of these project types.
1. Renewable Energy
Renewable energy may take several forms. Wind, solar, biomass, geothermal, wave and tidal, landfill gas, and hydro are some of the main types of renewable energy. Those for which a methodology has been approved under the CDM include the following;
biomass; landfill methane recovery;
178 | C A R B O N P R O J E C T D E V E L O P M E N T wind; solar; geothermal; and hydropower.
AND
CARBON FINANCE
With the growth of renewable energy, this project type has the potential for substantial expansion. One of the challenges with the sector growth is with additionality. Questions have arisen with the CDM Executive Board with wind energy projects in China and whether they are truly additional or the project would have been built without carbon credits, as there has been a significant expansion of wind energy in China. The additonality challenge to these projects raises questions to some with the concept of additionality or how it is applied. Clearly, wind energy that replaces coal reduces greenhouse gas emissions. To not grant carbon credits once the industry gets off the ground and starts to grow would suggest only the early-entry projects will get credits in a country, and the later entrants will be denied credits. This may to some seem counterintuitive and counter to the goal of reducing greenhouse gas emissions and switching a significant percentage of power production to renewable energy sources.
2. Energy Efficiency
Energy efficiency provides one of the more intriguing project types. Under the CDM, methodologies for energy efficiency projects have been established. These projects evaluate the reduction in electrical usage for a particular facility or groups of facilities. The greenhouse gas emission reductions are indirect in the sense that they account for the reductions not at the location where energy efficiency is increased, but through the reduction of the power produced from the electrical grid from which the facility obtains its electricity. The calculations involve both the reduction in power produced, and the loss of electricity along the transmission and distribution lines to the facility. This accounts for the total electricity that must be produced to provide the final received power at the particular location. In general, these calculations are made through factors for carbon or greenhouse gases produced by the grid in the respective state or country, and the line losses for that particular area. These are calculated by third-party entities or government agencies, such as the Energy Information Administration in the United States for U.S. states.
3. Landfill, Oil and Gas, and Other Methane Projects

Landfill methane gas recovery projects have been one of the most popular forms of carbon credit projects. Landfills that serve as the disposal point for municipal
AND
waste produce a significant amount of methane from the degradation of organic material, such as food waste, in the garbage received by the landfill and buried underground. The methane migrates up through the soil and is emitted into the atmosphere. As methane is a greenhouse gas, the reduction of its emissions serves as a potential carbon credit project. The projects are attractive, as has been discussed above, because methane is considered a much more potent greenhouse gas than CO2resulting in a 21 times multiplier for methane in terms of carbon credits that may be produced for each ton of methane reduced. The CDM developed methodologies for this type of project early on in the program. The projects may address methane reductions in several ways. First, the methane may be flared so that the methane is burned and converted into CO2. Second, the methane may be burned in turbines that in turn produce electricity. Third, in some cases, the methane may be processed so that contaminant gases are removed and the methane placed in a pipeline to a distribution system or directly to a point of use, such as a nearby factory, or, in some cases, some of the methane may be used as a transportation fuel where buses, trucks, or other vehicles are able to burn the gas in their engines. In terms of carbon credits, since CO2 is formed from burning the methane, a complete 21 times multiplier may not be available because the emissions of the CO2 must be deducted from the emissions of methane avoided. Despite this reduction, landfill gas projects and other methane reduction projects provide significant opportunities for higher profit carbon credit projects as a result of the multiplier effect.
4. Natural Gas Production and Distribution Projects

As pointed out, a landfill has a 21 times multiplier for carbon credits when the emissions are reduced. Methane reduction projects as a result are sought-after projects. The production and transportation and distribution of natural gas provide a significant opportunity for carbon credit project. The reason is that some degree of natural gas leaks out of the systems for producing and transporting natural gas to the ultimate end user. Steps to reduce these leaks result in less methane being emitted to the atmosphere and provide an opportunity to obtain carbon credits from those reductions. Another opportunity arises from flared or vented natural gas. An astounding amount of natural gas is either vented directly to the atmosphere or flared as there is no feasible market or transportation system available to transport the gas to a market. To the extent the gas can be captured and piped to a market for use, documentation of a reduction in greenhouse gas emissions may be possible.
AND
CARBON FINANCE
One of the largest amounts of carbon credits issued from a single project under the CDM resulted from the Rang Dong offshore oil field in the waters off of Vietnam. The project involved the capture of the methane that had been flared and then piping it into the shore for burning as a heating fuel. The project was submitted to the Executive Board for approval as a carbon credit project. The Executive Board granted 4.43 million Certified Emission Reductions (CERs). The value on at the time was approximately 15 euros per CER, which would have been 66 million euros or US$103 million. As is clearly evident, methane reductions in the oil and gas industry have a tremendous potential for producing carbon credits through established methodologies.
5. Fuel Switching
Methane plays a role in another carbon credit project type called fuel switching. This project type is fairly broad. The idea is that when a lower carbon fuel is substituted for a higher carbon fuel, the difference may be used to calculate the reduction in greenhouse gas emissions. Methodologies exist for these fuel switching projects. For methane, it can be used to substitute for coal or diesel in electricity production and reduce greenhouse gas emissions, or for gasoline or diesel in vehicles to again reduce greenhouse gas emissions. One of the other fuel switching opportunities is in the form of biomass use in place of fossil fuels. A specific example is the substitution of wood pellets produced from waste wood for coal in a coal-fired power plant. Since the carbon in the wood is pulled from the atmosphere by trees, the emission of carbon from the burning of the wood does not add to net atmospheric carbon. Of course, if you were to cut down the rainforests to produce the wood, this may not be a net reduction. The discussion below will describe avoided deforestation projects to produce carbon credits.
6. Agriculture, Forestry, and Land Use

a. Avoided Deforestation and Reforestation Forest projects are a much more complicated type of project for a number of reasons. The discussion of this area will be more detailed as the potential source of credits is so large. Forests are a significant storing house for carbon and when burned, release a large amount of carbon dioxide and other greenhouse gases into the atmosphere. As a result, forests provide the low-cost approach for the first tranche in anthropogenic greenhouse gas reductions as we seek the low hanging fruit in terms of low-cost, large-volume offsets. Forest preservation and regrowth provide the potential for the larger-volume and lower-cost source of greenhouse gas reductions and offsets for greenhouse gas emissions. As carbon
AND
capture and storage by which CO2 from coal-fired power plants and other sources is injected underground for long-term storage takes several years to bring on line, Reducing Emissions from Deforestation and Forest Degradation (REDD) can serve to make a significant step toward emissions reduction to be achieved by 2020 as is being discussed in Congress for a U.S. climate change and cap and trade program, and in terms of international negotiations for a treaty to follow the Kyoto Protocol. The size of the emissions from forest destruction is startling. In gross and relative terms, it is rather astounding. The destruction of forests actually accounts for somewhere between 17 and 22 percent of human greenhouse gas emissions. Thus, controlling the greenhouse gas emissions from deforestation is critical to any global plan to reduce climate change, particularly in the first few years as costlier reductions are developed, and perhaps ways to reduce those costs. The amount of greenhouse gas emissions from deforestation exceeds the amount of emissions from all transportation activities. A second aspect of deforestation relates to the areas that have already been lost or significantly degraded. For example, farmland that was previously what we call primary forestforest that existed in its natural state prior to being deforested or degraded. In these areas, opportunities exist for reforesting the land through tree planting. Two types of reforestation are possible. First, the forest can be replanted with native species that would have been present prior to the destruction of the forests. The second involves the planting of non-native species or otherwise planting for the purpose of harvesting some or all of the trees. The second approach has the goal of using trees to absorb or sequester CO2, and then using the harvested wood in ways that maintain the carbon in building or other products for a significant period of time. In understanding the challenges of private development of forest carbon projects, it is important to comprehend the issues of these projects. First, let us consider avoided deforestation projects. One of the first issues is simply measuring the amount of carbon in the forests that would be released if destroyed. There are certain protocols that can be used now developed by the Voluntary Carbon Standard Association (VCSA), which has become the main standards-setting organization for forest-related offset projects internationally, or the Climate Action Reserve (created by the State of California), which is the primary standard for domestic forest projects in the United States. Another issue is the question of permanence. For growing forests, a significant risk is permanence, that is, to what extent will the forest be preserved over a very long period, as opposed to short-term preservation with destruction to follow. If the forest is logged or it burns or dies from disease, then the carbon sequestered in the trees, plant life, and soil, largely will be emitted to the
AND
CARBON FINANCE
atmosphere and future sequestration of carbon dioxide will not occur. The carbon credits that are generated would be without substance if after five years the forest is destroyed. Forestry projects are largely long-term projects, lasting twenty to one hundred years in most cases. Parties must show the registration entity and the verifiers that review the Project Design Document that the forest will not be cut down, burned, or harvested within the relevant project period. One approach used by the VCSA to address permanence concerns is to hold back a percentage of the verified credits and to release them back over time, say the thirty-year life of the project, to the project developer. One of the other major concerns for forest projects is leakage. For forest projects, leakage involves the question of whether the reduction in deforestation or degradation in one area results in that activity moving to a nearby property or one a significant distance away. As an illustration, burning forests for soybean farming, which is such a significant problem in Brazil, moves from one part of a state in a country where actions have been taken to stop such burning to another area in that state or to another state. Measuring and addressing these issues is required by the VCSA. Though the real game right now for REDD and reforestation projects lies with the VCSA, Climate Action Reserve (CAR), and voluntary carbon credits, it appears fairly clear that forest carbon projects will play a role and be a large part of future compliance markets. Current U.S. federal legislation that has passed the House of Representatives, California legislation, and the three multi-state climate change regulatory programs that are evolving will include forest carbon as an offset type. Thus, even if Congress does not act to pass climate change legislation, a significant number of states will implement programs that include forest carbon offsets. The discussions at the international level appear to be moving toward accepting forest-based offset credits. The Kyoto Protocol as implemented by the United Nations allows a limited use of forest carbon from reforestation. Discussions are moving forward in terms of expanding the use of forest offsets from avoided deforestation through a REDD mechanism to be implemented under the Kyoto Protocol or its successor treaty. The greenhouse gas emissions from forest destruction are so massive, that we cannot avoid taking on the need to reduce this destruction dramatically. More and more major greenhouse gas emitters in the United States are beginning to review this opportunity and to look at investing in project-based REDD opportunities. The thinking is that investment in a project or entering into emission-reduction purchase agreements that allow a company to have a right to purchase REDD credits once approved and verified, provides a good hedging mechanism for future offset prices. More and more companies are looking at
AND
both domestic and international forest carbon projects either as project developers or as investors to ensure that they take advantage of the opportunities that forest carbon projects provide. For utilities and refining companies that face significant risk in a compliance system governing GHG emissions and need to purchase significant amounts of allowances or offsets, carbon credits generated from avoided deforestation have the potential to supply large amounts of credits at lower prices. As a result, many of these companies have been evaluating investment in forest carbon projects. This section of the book will explore in more detail the standards that have emerged for projects that are designed to allow the development of carbon credits from forest preservation and protection.
i. The Voluntary Carbon Standard Agriculture, Forestry, and Other Land Use Guidance
The Voluntary Carbon Standard (VCS) has emerged as the leading international standard on forest carbon credits. The VCS has invested significant amounts of time to develop the guidance for Agriculture, Forestry, and Other Land Use (AFOLU) projects. In this guidance, four types of activities are covered.
Afforestation, Reforestation, and Revegetation; Agricultural Land Management; Improved Forest Management; Reducing Emissions from Deforestation and Degradation.1
This subchapter will focus on the three forest-related projects. Other land use projects will be discussed in a separate subchapter. Reducing Emissions from Deforestation and Forest Degradation (REDD) can be broadly defined, as the name implies the destruction of natural forest or the degradation of those forests. For example, the burning of forests for crop land would be considered destruction and the logging of a significant number of the trees in a particular forest tract would be considered degradation. The VCS AFOLU standard further divides REDD into three subcategories: 1. Avoiding planned deforestation (APD), where the plans have been authorized by the relevant governmental body;
1. Voluntary Carbon Standard, Tool for AFOLU Methodological Issues, at 23, Nov. 2008 (hereinafter VCS AFOLU Tool).
AND
CARBON FINANCE
2. Avoiding unplanned frontier deforestation and degradation (AUFDD), where the deforestation or degradation is moving in the direction of that land and will likely occur in the future; 3. Avoiding unplanned mosaic deforestation and degradation (AUMDD), where the deforestation or degradation likely will occur under a mosaic configuration. The VCS AFOLU Guidance describes this as where human populations and associated agricultural activities and infrastructure (roads, towns, etc.) are spread out across the landscape and most areas of forest within such a configured region or country are accessible. Afforestation, Reforestation, and Revegetation (ARR) projects entail areas that have already been deforested or significantly degraded. Projects that may qualify for ARR are those that establish, increase, or restore a tree cover through the planting, sowing, or other human-assisted natural regeneration of woody vegetation to increase carbon stocks in woody biomass and, in certain cases, soils. Enrichment planting and thinning are considered Improved Forest Management (IFM) project activities, rather than ARR. Improved Forest Management (IFM) activities are those where parties change the forest management practices for forests that are used for cutting trees for wood products, such as saw timber, pulp wood, and fuel wood. The forest lands must meet the elements of the International Panel on Climate Change (IPCC) category forests remaining as forests.2 In addition, these lands must have received legal approval as required in a particular jurisdiction, such as areas that have been designated, sanctioned, or approved for the tree removal actions, such as logging concessions or plantations. Absent these legal authorizations or permits, the project is not eligible for crediting by the under the IFM category. Examples of projects types that may qualify for IFM are provided in the AFOLU Methodology and Guidance. Moving from conventional logging to reduced impact logging (RIL) resulted in fewer trees being harvested. Second, one may cease logging of logged forests or prevent logging of forests that would otherwise be logged, resulting in forest conservation, which is know as conversion of logged forests to protected forests (LtPF). Third, a change in logging practices by extending the cutting rotation in managed forest where different plots have the same-age trees planted at the same time. Fourth, a project could consist of increasing the productivity of forests (LtHP). The number of options to produce carbon credits from forests thus is quite wide ranging. For purposes of this discussion, we will focus on Reduced Emissions from Deforestation and Degreation (REDD) and Afforestation, Reforestation,
2. IPCC AFOLU 2006 Guidelines.
AND
and Revegetation (ARR) projects as they tend to be the most attractive projects because they reduce the destruction to forests or replace previously existing forest and REDD project may produce the largest number of carbon credits. The critical first step is establishing the baseline from which all future calculations of estimated and monitored reductions in GHG emissions will be compared. The VCS requires that the project baseline address the changes in the use of the land and the land cover and the resulting emissions of GHGs. The baseline must be calculated in different ways, depending on whether the project involves avoided planned deforestation, avoided unplanned frontier deforestation and degradation, or avoided unplanned mosaic deforestation and degradation. The baseline net GHG emissions and the reductions in emissions must be estimated every year during the crediting period. The baseline must be developed and approved by the VCS, and must be reassessed at least once every ten years. The VCS standard and Guidance require that the project proponent account for CO2, nitrous oxide, and methane. The carbon pools are those sources of GHG sequestration in the forest. The pools that the VCS suggests be estimated are above-ground biomass, belowground biomass, dead wood, litter, and soil carbon. Often, these calculations and analyses take much of the time in studying a particular forest tract. Long-lived wood products removed from the forest may act as another pool. Not all pools must be evaluated or included if the exclusion would make the calculation of carbon credits more conservative, meaning include less carbon sequestered. For REDD projects, all pools that would result in a five percent or more decrease in carbon stocks must be included. The crediting period, or that period of time over which the project would last, is set at a minimum of twenty years and a maximum of one hundred years. Periods of thirty years are common in projects submitted to the VCS for approval thus far.
(A ) T H E B A S E L I N E (B )
Additionality follows a similar approach to the process proscribed for CDM projects.3 For REDD projects, the project developer must demonstrate in the documents submitted to the VCS that the land would have been converted to a use other than forests if not for the REDD project.4 Thus, the risk to the forest must be demonstrated both in terms of a risk that actually exists and the extent of that risk.
ADDITIONALITY
3. UNFCCC/CCNUCC CMD Executive Board, Tool for the Demonstration and Assessment of Additionality. 4. VCS AFOLU Tool, at 67.
(C )
AND
CARBON FINANCE
L E A K A G E Under the AFOLU guidelines, leakage is defined as any increase in greenhouse gas emissions that occurs outside a projects boundary (but within the same country), but is measurable and attributable to the project activities.5 For small projects, leakage does not need to be assessed. Small projects are considered to be those that are less than 10,000 hectares in size.6 The approach to measuring leakage will vary, depending on the type of REDD project.
The VCS Guidance provides significant discussion regarding determining permanence and the risk of potential future losses of GHG emissions from REDD projects. A documented risk analysis must be prepared by the project proponent. The baseline calculation and risk analysis are reviewed by the third party VCS verifier at both validation and verification. Based on the risk analysis, a buffer must be set up by the project proponent to provide a means of addressing the risk. Thus, if the risk is considered to be 20 percent of the overall carbon credit potential that may be validated and verified, the project proponent would be required to set aside 20 percent of the overall carbon credits. To account for potential losses during the project period, the project manager must submit periodic reports, verified by a third party, to show that the forest has not been degraded or destroyed during that period. Fortunately, the project developer does not need to wait until the end of the crediting period to receive the carbon credits in the buffer. Over time, if the developer can demonstrate the project is maintaining its carbon offsets, a portion of the credits in the buffer can be released by the VCS.
(D ) P E R M A N E N C E A N D R E L A T E D C A R B O N B U FF E R (E ) M O N I T O R I N G
Monitoring is a major part of all carbon projects, but it is more complex under a forest carbon project. For VCS AFOLU projects, the monitoring must be conducted and a monitoring plan presented that includes both the baseline case and the result of the project on GHG emissions.7 Leakage must also be monitored.8 In order to conduct this monitoring, the VCS AFOLU Tool requires that the IPCC 2006 Guidelines serve as the basis for estimating CO2 and non-CO2 emissions; forest regrowth and the CO2 sequestered from the atmosphere from avoided forest degradation; and reductions in the carbon in the forest arising from removal of biomass that exceeds the regrowth of
5. Id. at 7. 6. Id. 7. VCS AFOLU Tool, at 4. 8. Id. at 7.
AND
the forests.9 Finally, the IPCC Guidelines must be used to provide evaluation of quality assurance and control and to analyze the degree of uncertainty in the estimating and monitoring process.
ii. Climate Action Reserve Forestry Methodology

The State of California, as discussed in this section, has established climate change and GHG regulations and is working with the Western Climate Initiative to develop a multi-state GHG regulatory program. As part of the California program, the state has developed the Climate Action Reserve (CAR, formerly the California Climate Action Registry or CCAR) that serves as a registry for carbon offset projects. As all such programs, much like the VCS and the CDM, methodologies are required to determine the GHG reductions and the number of credits in the form of tons of CO2e to be awarded to the project developer. In the forest area, CAR has developed a Forest Project Protocol (FPP). The FPP provides eligibility rules, methods to calculate reductions, procedures for assessing risks, and approaches for long term monitoring and reporting. The goal of this protocol is to facilitate the creation of GHG emission reductions and ensure that they are calculated in a complete, consistent, transparent, accurate, and conservative manner.10 For these projects, CAR establishes a process and documentation requirements for project developers that are applying for validation and verification of forest-based carbon offsets. Initially, the FPP covered only projects in California, but it has been expanded to cover forest projects anywhere in the United States. CAR has issued the Reserves Forest Verification Protocol (FVP), which provides guidance to carbon offset verifiers who verify the project has been initiated and the quantity of GHG emission reductions that have occurred. These verifiers provided the necessary transparency and validity of the GHG projects and the offsets and carbon credits that then are available for sale. As provided under the VCS AFOLU Guidance, the CAR Forest Protocol provides for three types of forest projects: (1) Reforestation, (2) Improved Forest Management, and (3) Avoided Conversion. The Avoided Conversion project type is similar to the REDD project type under the VCS. While these project types are similar in description, the standards for the types of projects and the qualifications for these projects to be accepted as valid projects vary quite a bit with respect to some of the project types.
9. Id. at 9. 10. Climate Action Reserve, Forest Project Protocol, Version 3.0 (hereinafter CAR Forest Protocol).
(A )
AND
CARBON FINANCE
T H E B A S E L I N E Under the CAR Forest Protocol, the baseline for Avoided Conversion is determined by calculating what would have happened in the absence of the project. The calculations involve estimating the carbon stock losses that would have occurred as a result of the conversion of the forest to a nonforest use. Two steps are involved:
1. characterizing and projecting the baseline; 2. discounting for the uncertainty of the probability of conversion.11 The baseline calculation is different from the VCS AFOLU process for REDD. 1. specifying the highest-value land use for the Project Area, using an appraisal; 2. estimating the rate of conversion and removal of forest carbon stocks; 3. using a compute simulation to project the changes in carbon stocks over the next one hundred years. The rate of conversion must be calculated using planning documentation for the Project Area or identifying a default annual conversion rate based on a table provided in the Forest Protocol.12 The next steps involved calculations for other aspects of the carbon as changes would occur over time. One step is estimating the carbon in harvested wood products. Thus, the carbon sequestered in wood products that would have been removed from the forest must be estimated.13 Actual carbon stocks must be estimated and updated on a regular basis. The actual carbon in harvested wood products for harvested wood must be calculated. Secondary Effects must also be estimated. Secondary Effects are those that may not be intended, and include for Avoided Conversion projects the shift of conversion to other areas.14 Additionality is a prerequisite for any CAR forest project. The business as usual test applies. The baseline, as discussed above, must be rigorously analyzed using quantitative analysis and that analysis must be reviewed and approved by CAR. The actual GHG reductions must be
(B ) A D D I T I O N A L I T Y
11. Id. at 31. 12. Id. at 3132. 13. Id. at 3233. 14. Id. at 34.
AND
demonstrated again using quantitative analysis and providing sufficient documentation. The actual definition provided in the CAR Forest Protocol states, Forest project practices that exceed the baseline characterization, including any applicable mandatory land use laws and regulations.15
(C )
L E A K A G E Under the CAR Forest Protocol, leakage is referred to as one part of the potential Secondary Effects of a forest project. As mentioned above in discussing the baseline and calculation of the results of the forest carbon project, Secondary Effects must be estimated. For Avoided Conversion projects, the shift of conversion activities or leakage to another area other than the project area must be calculated.16
(D ) P E R M A N E N C E A N D R E L A T E D C A R B O N B U FF E R
As with the VCS protocol, permanence is a key concern with respect to forest carbon projects. The means by which the CAR Forest Protocol addresses permanence issues differs from the VCS, where a buffer serves as the main mechanism to address permanence risk. The CAR Forest Protocol uses three mechanisms to address permanence.
1. The requirement for all Forest Owners to monitor on-site carbon stocks, submit annual monitoring reports, and submit to annual third-party verification of those reports along with periodic verifier site visits for the duration of the Project Life; 2. The requirement for all Forest Owners to sign a Project Implementation Agreement with the Reserve, which obligates Forest Owners to retire CRTs to compensate for reversals of GHG reductions and removals; and 3. The maintenance of a Buffer Pool to provide insurance against reversals of GHG reductions and removals due to unavoidable causes (including natural disturbances such a fires, pest infestations, or disease outbreaks).17 The Buffer Pool is one by which multiple projects contribute, not a buffer for a particular project as with the VCS AFOLU protocol. The contribution to the Buffer Pool will vary based on each projects reversal risk.18 As insurance products evolve to cover these risks through insurance carriers, they may be
15. Id. at 41. 16. Id. at 15. 17. Id. at 35. 18. Id. at 36.
AND
CARBON FINANCE
allowed to take the place of the Buffer Pool and other permanence risk management tools. The Buffer Pool only serves to address unavoidable reversals that are not planned, such as fire, insects, or disease. Logging would not be compensated from the Buffer Pool. Instead, the Forest Owner would be required to address these avoidable reversals by retiring Climate Reserve Tons (CRTs) to address the reversal.19 If the reversal causes the carbon stocks to fall below the baseline, then the project will be terminated.
(E )
M O N I T O R I N G Under the CAR Forest Protocol, monitoring must occur every year and the results must be report to CAR over the one-hundredyear life of the project. The Forest Owner must develop a monitoring plan in accordance with the CAR Forest Protocol, which must be submitted to and approved by CAR.20
iii. CDM Reforestation/Afforestation Methodology

The CDM based on decisions of the UN Framework Convention on Climate Change (UNFCCC) meetings originally limited forest projects to afforestation where trees are replanted. Avoided deforestation or REDD projects have not been permitted, but significant discussion has occurred about allowing REDD projects to obtain carbon credits under the Kyoto Protocol, or any treaty signed to follow the Kyoto Protocol. Only a few projects have been approved under the CDM. The main challenge for project developers is that the credits are temporary. They can be used for a period of a few years and then new credits have to be obtained to replace them. This makes their value and usefulness to compliance buyers limited. The price and desirability of the credits is lacking, and so these projects have not been pursued under the CDM, but rather the other voluntary standards, such as the VCS, American Carbon Registry (ACR), and the CAR have been used instead.
7. Carbon Capture and Storage

Carbon capture and storage (CCS) involves the injection of CO2 into the ground for long-term storage or sequestration. The main goal of CCS is to capture greenhouse gases from coal-fired utilities and inject it underground. However, other sources of CO2 can serve as the source for CCS. For example, natural gas
19. Id. at 3738. 20. Id. at 3839.
AND
processing plants must remove excess CO2 from natural gas to meet specifications for natural gas pipelines. This rather pure CO2 may serve as a good source for injection, particularly if located in areas where it may be used to enhance oil or natural gas recovery. Carbon credits can contribute to the ability to finance these projects; even carbon credit sales alone may not be sufficient at this time, based on the price of carbon currently to finance the costs of CCS. The International Emissions Trading Association (IETA) on May 31, 2007, sent a letter to the UNFCCC Cooperative Mechanisms Programme supporting the adoption by the UN body methodologies for approving CCS carbon credits generated under the CDM. The IETA noted several issues the UN body was concerned about in reviewing CCS as a carbon-credit-generating technology. The concerns were as follows:
Long-term physical leakage levels of risks and uncertainty; Project boundary issues and projects involving more than one country; Long-term responsibility for monitoring the reservoir and any remediation
measures after the crediting period; Long-term liability for storage sites; Accounting options for any long-term seepage from reservoirs; Criteria and steps for the selection of suitable storage sites; Potential leakage paths and site characteristics and monitoring methodologies for physical leakage from the storage site and related infrastructure, for example, transportation; Operation of reservoirs, dynamics of carbon dioxide distribution within the reservoir and remediation issues; and Any other relevant matters, including environmental impacts.
The IETA in its letter pointed out that significant advancement has been made in terms of developing CCS projects and addressing regulatory issues related to CCS from the date of the International Panel on Climate Change Report from 2006. The Sleipner field has operated in the North Sea continental shelf since 1996, where CO2 is separated from natural gas produced from the field, and then the CO2 is injected into a sandstone layer, a deep saline aquifer, about 800 meters below the North Sea. In Norway, a new CCS project was about to begin operation to inject CO2 stripped from the natural gas stream back for injection into a subsea geological formation. In 2006 production of liquid natural gas (LNG) from the Snhvit field will start. The CO2 produced with the gas on the Snhvit field is to be captured and stored 2,600 metres beneath the seabed at the edge of the reservoir. A total of 700,000 tons will be stored annually.
AND
CARBON FINANCE
The IETA letter notes that various European countries and the European Union are working to develop regulatory systems and modifying the EU Emissions Trading System to permit the use of CCS to produce carbon credits. In the United States, CCS has been promoted by various groups, including certain oil and gas interests that can use the CO2 for enhanced oil recovery (EOR). Natural sources of the gas have been used for EOR in Texas for several decades. The potential for the use of CCS to redice CO2 emissions may be a critical step in controlling GHG emissions. A report prepared by Alliance Bernstein,21 a Wall Street investment firm, concludes that one of the activities that will be required to meet global greenhouse reduction goals is CCS. The report estimates that CCS could be used to inject CO2 to produce an increased yield of natural gas of 7 billion cubic feet (bcf ) by 2015, 70 bcf by 2020, 500 bcf by 2030, and thereby sequester 60 gigatons of CO2 by 2030. The injection for enhanced oil and gas recovery could increase yield by 11 million barrels of oil per day. The injection for coal-bed methane recovery could increase the yield of natural gas by 3,000 trillion cubic feet. Enhanced oil and gas recovery would offset a significant portion of the cost for capturing and injecting the CO2. An enormous number of carbon credits could be generated for use or sale if the CDM and other boards approved methodologies for this project type. The American Carbon Registry is developing a methodology for this project type in addition to the consideration by the CDM. Under proposed U.S. legislation, emission allowances would be granted for these projects in addition to other government incentives that would be available, with certain total caps and other limitations, for CCS projects. The U.S, Department of Energy has already awarded grants to projects under the economic stimulus funding legislation. How the potential for CCS will evolve in the United States and internationally is still uncertain. If CCS becomes a more widely-used technology, the ability to capture carbon credits for GHGs sequestered may become an important aspect of CCS funding. This will depend on the development of methodologies for obtaining carbon credits for CCS.
21. Alliance Bernstein, Changing Climate, Changing Opportunities: Winners and Losers in the Global Effort to Control Carbon Emissions, available at http://www.google.com/search?q=alliance + bernstein + climate&rls=com.microsoft:en-us&ie=UTF-8&oe=UTF-8&startIndex= &startPage=1.
13
Carbon Credit Project Development

A. Project Development Generally
Carbon credit projects face many of the same issues and risks that other domestic and international projects face. Some of the same issues that arise in other areas of project development arise with respect to carbon credit projects. Many other issues are specific to carbon projects. Review of general project development is appropriate. We will generally discuss renewable energy projects as background as many carbon credit projects also involve renewable energy. Renewable projects fall mostly into two types. Most are built by developers and operated by the project developer. These types of projects are known as BOOM projectsbuild, own, operate, and maintain. However, there are BOT projects as wellbuild, operate, and transfer. The second type involves the project developer building and operating the project until a third party is prepared to purchase the project and then take over operations. We will discuss mainly the BOOM project types. These projects must demonstrate financial viability to lenders and equity investors as they typically need to show the ability to generate revenue, cover costs, finance debt, return equity, and generate a profit sufficient to attract lenders and equity investors to the project. The financial issues and challenges that these projects face are several fold. First, the project must obtain the funds for construction. This funding may be a short-term construction loan of, say, six to twelve months. Long-term financing must be available to pay the construction loan. Where grants are available, there may be an opportunity to finance the amount of the grant until it is paid by the government agency. In the United States for example, until the end of 2010,
AND
CARBON FINANCE
30 percent of the capital expenditures for certain renewable energy projects may be obtained in the form of a grant in lieu of production tax credits or investment tax credits. If a project developer can obtain a loan for this amount, it makes financing the project much easier. More discussion on carbon finance will be provided in Chapter 14. For projects that are renewable energy, the revenues from the project will mainly be the electricity purchased by a utility or other third party. These are generally long-term power purchase agreements (PPAs) of five to twenty years. The project developer and their lenders and investors prefer as long a term of PPA as possible to guaranty payment of debt and equity, interest, and return on investment. Other possible revenues include tax credits sold to third-party tax investors, local, state, and federal incentives, utility incentives, renewable energy credits (RECs), and, depending on the location of the project, carbon credits.
B. Basics of Carbon Credit Project Development

Chapter 12 describes various carbon credit project types and methodologies. The point to remember is that there must be an approved project methodology in order to obtain carbon credits from a type of project. If a methodology does not exist, then the developer who wants to pursue that project type would have to obtain approval of a new methodology. At times, one can use an existing methodology in a similar area and modify it for the new project type. Projects include renewable energy (wind, solar, hydropower, biomass, and geothermal), energy efficiency, methane capture (landfills, vented and flared natural gas from oil and gas production, and natural gas capture from pipelines), and a variety of other project types. Each of these project types presents unique challenges to project developers. Financing the project, discussed in Chapter 14, requires project developers to plan the project and develop feasibility studies to convince investors and lenders that the risks inherent in these projects can be managed.
C. Feasibility Study
Project developers developing greenhouse gas reduction projects or companies taking action within their facilities or selling products or installing them need to first ask the question: Are the steps taken to reduce greenhouse gases and to create carbon credits going to generate more revenue than the costs of generating the
C A R B O N C R E D I T P R O J E C T D E V E L O P M E N T | 195
carbon credits? We generally refer to this as a carbon credit feasibility study. It is wise to first conduct a feasibility study to determine if the approach to reducing greenhouse gas emissions will generate sufficient income or net profit to make the endeavor worthwhile from a business perspective, or to what extent the project will produce sufficient rate of return to garner investment from third parties. Examples of costs that the feasibility study should evaluate include the following:
equipment to reduce greenhouse gas emissions; installing or constructing the equipment or other aspects of the physical
project;
preparing a project design document (PDD) and other documents necessary
to obtain carbon credits through review by the validator and potentially the standards boards; third-party validator and verifier of the PDD and actual greenhouse gas reductions; taxes and Clean Development Mechanism (CDM) (or other standards board) charges; and legal fees in entering contracts to implement the project, sell the carbon credits, and other advices and counsel. The feasibility study should then utilize the tools and methodologies that apply to the project to estimate the annual carbon credits generated over the relevant crediting period. The current and future estimated carbon credit price should then be applied with an appropriate discount rate to produce the amount of money that may be generated by the sales of carbon credits over the crediting period. Applying the costs and revenue in the economic model developed will indicate the net revenue generated. From there the present value and the internal rate of return of the project may be generated for both the project developer and company and any relevant investor or lender that may be evaluating investment or lending to the project. These feasibility studies and economic models are developed using spreadsheets and equations from the relevant methodologies. Other steps in a feasibility study may include, and probably should include, an evaluation of additionality standards to attempt to determine whether the relevant standards body will likely consider the project and the greenhouse gas emission reductions to be additional.
AND
CARBON FINANCE
D. The Carbon Credit Approval Process

1. The Process under the Clean Development Mechanism
A project under the CDM must occur in a country that is a signatory to the Kyoto Protocol. Countries are participants in the program. As will be described below, the project must receive approval from the host country. The process for obtaining approval and issuance of Certified Emission Reductions (CERs) is described below.
a. Project Feasibility Study As discussed above in more detail, a project developer generally will evaluate a potential project to determine if it is economically feasible and if it is likely to qualify for CERs under the CDM. Once the project developer has made this determination, then the developer will follow the process for attempting to obtain carbon credits. b. Project Idea Note The project developer may then develop a project idea note (PIN) to gauge potential carbon credit buyer interest or investor interest in the project. The PIN will generally describe the project, the location of the project, the amount of carbon credits that are estimated to be generated, the financing structure, the proposed crediting period in terms of the years that credits would be generated, the cost of the project, and the estimated price for the credits. c. Project Design Document The Project Design Document (PDD) is required by the CDM in order to apply for carbon credits. The elements of a PDD are as follows:
general description of project activity; application of a baseline and monitoring methodology; duration of the project activity/crediting period; environmental impacts; and takeholders comments.1
The PDD is a critical document in terms of getting approval for carbon credits. It is reviewed by the third-party validator, as discussed below, and the CDM staff
1. Clean Development Mechanism Project Design Document Form (CDM-PDD) Version 03 ( July 28, 2006).
before approval is given to a project. It is also important for obtaining investment in a project by third-party investors, and, if a market exists, for sale of some or all of the credits on a forward basis, either as a financing mechanism by receipt of some payment in advance, or to be paid on delivery, which acts as an off-take agreement, and may assist the developer in obtaining equity investment or debt financing.
d. Stakeholder Participation Under the local stakeholder participation requirement, the project developer must seek comments on the project design document from local stakeholders, and provide a summary of the comments received and a report reviewing these comments to demonstrate how they were addressed. This report must be submitted for validation by an approved third-party validator, known as a Designated Operational Entity (DOE). DOEs are entities approved by the Executive Board of the CDM (EB) that review PDDs and validate them prior to submission to the EB. e. Host Country Approval The host country where the project is to be implemented must provide approval of the project. The agency that reviews these requests and determines if the project will be approved is known as the Designated National Authority (DNA). A letter of approval must be obtained from the DNA in order to proceed with the process to obtain approval for the project by the EB. f. Validation by a Designated Operational Entity An independent third party must review the PDD and other documents to be submitted to the CDM Executive Board before submission for approval. The DOE must review the PDD and local stakeholder report and determine if they meet CDM requirements. Without approval from the DOE, the project developer may not submit the PDD to the EB. The DOE makes the validation report available to the public and receive public comments for thirty days. The DOE must then submit the report to the EB. g. Registration The DOE then submits the project for registration to the EB. This body will make the validation report publicly available and receive comments for thirty days. The EB is supposed to register the project, unless review is requested by a member of the EB based on an issue related to registration requirements. This is where a project may receive comments and questions that can take some period
AND
CARBON FINANCE
of time to be reviewed. The project must meet the requirements of the methodologies for that project type. The additionality requirements must be met as well. This is another area where projects may face delay or denial of registration.
h. Implementation and Monitoring After the project is registered, then the project developer will implement the project. At this point, the project developer must begin monitoring the performance of the project and measure the reductions in greenhouse gases (GHGs). Other parameters such as leakage or environmental effects may have to be monitored as well. The monitoring must follow the monitoring plan submitted in the PDD. i. Verification and Certification The monitoring results will then be submitted to a different DOE than the one that performed the validation for verification and certification, which is required to request issuance of CERs. The DOE reviews the monitoring report and evaluates the reduction in greenhouse gases and issues a verification report and certifies the amount of GHG reductions. Once the DOE submits its verification and certification to the EB, the DOE becomes responsible for any underperformance in terms of GHG reductions. The DOE must carry adequate liability insurance to cover this risk. j. Issuance of Credits Once the verification is received, the EB will issue the amount of CERs set forth in the verification and certification into a designated account. A charge is deducted from the amount of CERs verified to pay for the operation of the CDM. This charge is known as the share of proceeds, and amounts to 2 percent of the CERs that were verified and certified. At this point, the credits become available to the project developer and may be sold and transferred to a third party.
2. The Voluntary Carbon Standard Process

Some of the steps for obtaining approval under the CDM are similar to those required under the Voluntary Carbon Standard (VCS). The Voluntary Carbon Standard Association (VCSA) relies more on the validator and verifier for approving certain aspects of projects. Projects seeking registration under the VCS Program must be validated and verified by a validator and verifier accredited under an approved carbon credit standards board or the International Standards
Organization under standard ISO 14065:2007.2 Validation and verification can be carried out by the same accredited entity. Validation must occur at the time of or before the first verification. The verification statement shall state the actual amount of Voluntary Carbon Units (VCUs) associated with the project specific monitoring report that has been verified. The validation or verification statement shall:
be addressed to the VCS Board; describe the level of assurance of the validation or verification statement; describe the objectives, scope, and criteria of the validation or verification; describe whether the data and information supporting the GHG assertion
were hypothetical, projected, and/or historical in nature;

be accompanied by the responsible partys GHG assertion; and include the validator or verifiers conclusion on the GHG assertion, including
any qualifications or limitations.3 To register credits, the developer must submit a request for issuance of credits to a VCS-approved registry.
E. Carbon Credit Project Risks

A variety of risks arise in attempting to develop carbon credit projects. A list of some of the more significant risks is as follows:
Project Risk: In essence there is the risk the project is never completed
because of a variety of factors, such as management failure.

Regulatory Risk: Regulatory risk involves the potential that a project is not
approved or some aspect regarding meeting a methodology in terms of baseline or actual GHG reductions is questioned or disapproved by the standards board. Additionality Risk: This is perhaps the most significant risk, and the basis for denial of most projects that fail to achieve regulatory approval. Validation/Verification Risk: One of the critical aspects of the project risk is the failure to meet the third-party verifiers expectations and review of the application of a particular methodology to a project.
2. Voluntary Carbon Standard Association, Voluntary Carbon Standard 2007.1 2122 (Nov. 18, 2008). 3. Id. at 23.
AND
CARBON FINANCE
Financial Risk: The ability to obtain funding to complete the project. Political Risk: Projects in other countries face the risk that the government in
that country may not approve a project, may confiscate or nationalize a project, may not make payments under a contract, such as a power purchase agreement with a national government, or may otherwise take action to stop a project, take title to or possession of a project, or make the project less or completely financially unviable. Purchase of political risk insurance may be appropriate, depending on the particular project and its location. Project Completion Risk: The ability to avoid a political decision or action that would impede the completion of the project, such as a takeover of the relevant property, denial of any approvals for the project, or the taking or taxing of the credits that may be produced. Land Title Risk: In implementing projects in developing countries, it is important to determine if the party with whom you are negotiating an agreement to develop a project has the rights to the land where the project will be implemented. Otherwise, one risks the potential for construction and ownership of the project to be placed in a party who has not been paid and with whom one had no binding or enforceable agreement. In some countries, title insurance can be purchased in addition to title review by local counsel to assist with addressing title risk. Carbon Credit Title Risk: Title to the carbon credits generated from a project in part flows from land title. In other cases, the title of carbon credits may flow from the issue of who is the owner of the project or of the reductions in greenhouse gases. In some instances, such as energy efficiency projects, it is important to obtain an assignment of the rights to carbon credits if the project developer is installing the energy efficiency project on another partys land, manufacturing plant, refinery, building, or other structure that the project developer does not own. Currency Fluctuation Risk: The risk of the fluctuation of currency can be a significant risk in terms of purchasing or buying land or operations, or engaging in future carbon credit or other revenue transactions, where currency from one country is to be expatriated to another country. How currency is set in transaction and purchasing currency hedges may be means of managing these risks.
These are some of the more significant risks carbon credit project developers face.
F. Examples of Projects
The discussion of project types in Chapter 12 revealed an array of potential projects. Each type of project raises unique challenges in terms of development
and proving additionalityas mentioned above, one of the more significant barriers in terms of obtaining approval of carbon credit projects from the CDM EB or other carbon standards organizations.
1. Landfill Methane
One of the most common types of carbon credit projects has been capturing methane produced by municipal waste landfills. This project type, as mentioned in Chapter 12, has been attractive because of the multiplying effect of capturing one ton of methane resulting in 21 tons of CO2e or 21 CERs. These projects are also common in developing countries and are not generally required to capture methane under any laws in the country, so additionality can be met for these projects. In the United States and some developed countries, air pollution laws may already require that the methane be captured to reduce air pollution, even if not for climate-related reasons. In the early days of the CDM, the amount of methane that could be generated was overestimated. Projects were capturing perhaps 30 percent of what was estimated. Thus, the projects were underperforming for the project developer, investors, and buyers of the CERs that were to be produced. The engineering estimation process was altered in order to attempt to better predict the amount of gasa gas curvethat would be produced from the landfills. This type of project remains of high interest to developers because the process to capture the gas is well known, the prediction of CERs that may be generated is better known, and the multiplier effect remains in effect, resulting in significant profits from these projects.
2. Solar Projects
a. Solar Projects Generally Solar involves two general types of technologies: solar thermal and solar photovoltaic (PV). Solar thermal is the use of mirrors or other means to heat water or other liquid that is then used to drive a turbine and produce electricity. Solar PV uses silicon or other material that is excited by photons and transfers that energy into electrons to produce electricity. We will focus on solar PV in this section. b. Free-Standing or Utility-Scale Solar Projects Utility-scale solar projects involve many of the issues that wind and even some fossil fuel electricity plants face. These projects involve constructing large solar PV installations generally of 10 megawatts (MW) or more. The project is designed to sell the electricity into an electrical grid, generally to an electric utility that in turn sells the electricity to its customers on a wholesale or retail level. At times, large consumers of electricity will purchase the electricity, but the power still enters the grid.
AND
CARBON FINANCE
c. Non-Utility-Scale Solar Projects Non-utility-scale solar projects are distinguished from a projectan example of which will be discussed belowwhere the power is sold in whole or substantial part to one entity or small group of entities, and the electricity is not transferred into the grid. In the case of a solar rooftop project, the electricity is sold to the tenant, or if the owner and party using the building are the same then the owner of the building. Thus, the off-taker is a smaller entity and the installation is much smaller than a utility-scale solar project. The size of the project would likely be less than 5 MW, some less than 1 MW. The discussion below regarding the legal issues associated with a solar rooftop project is based on U.S. laws. Similar concerns would apply to projects in other countries, but the potential solutions and laws that apply would vary. One of the key concerns is protecting the ownership of the solar equipment that is installed. A fixture filing may be necessary to record in county deed records to ensure that the solar installation is not considered part of the real property and subject to liens of lenders not actually providing funding for the solar PV, but for the building or other fixtures. A nondisturbance arrangement may be needed such that the senior interest permits the less senior interest to install the solar equipment and to retain ownership and again avoid it becoming collateral to the building owners or tenants financing. A lease or sublease may be the means of achieving these goals. The solar developer will be entering a PPA with the building owner or tenant, but a separate lease outside of the PPA should be entered into with the appropriate party. In order to ensure protection and notice to buyers and other lenders, it may be appropriate to file a memorandum of lease in the local deed records. In any transaction like this, a risk may arise to the project if the owner of the building or property is subject to a bankruptcy proceeding. Under the bankruptcy code, bankrupt entities may reject executory contracts, which a lease is typically considered. The value of the lease, however, is that while the bankrupt entity could reject the lease, it would still be required to pay damages and allow the tenant, here the solar project developer, to continue to maintain the solar PV installation on the property. If there is a utility interconnection to the grid, an agreement may be entered with a party or the utility to purchase the electricity generated from the solar PV. If connected to the grid, the solar project developer could continue to operate and sell its electricity to the grid. One of the key issues in this context is a net metering agreement with the utility. A net metering agreement is one in which the solar PV owner may sell excess electricity back into the grid. For example, if a party installs solar PV on its
roof and at certain times during the day is generating more electricity than it is using, then the meter actually turns backwards and the amount of the charges are netted from the electricity otherwise purchased by the owner. One challenge here is that the local public utility regulations may limit the size of a solar PV project that is able to have net metering rights. For example, in some states the size may not exceed 2 MW. The other challenge is that the credit is usually given to the electricity customer, which presents challenges when that party is in bankruptcy. A lien may be necessary, if it can be achieved, against those credits in the event the owner fails to pay. Other regulatory issues arise. One is the risk of being regulated by the Federal Energy Regulatory Commission (FERC). One exemption applied to a qualifying facility (QF), and facilities under 20 MW of solar PV allows selfcertification to the FERC. There may also be state public utility rules that apply, and those should be addressed as well before entering into an agreement with a landowner/customer. These projects may benefit from the forward capacity market that will be discussed in Chapter 15. This market involves the trading or sale of credits arising from reduction of peak electrical demand on the electrical grid. Certain FERC and state public utility commission regulations allow parties to take advantage of activities that reduce the demand at peak times, usually during the day in the summer months from, for example, May or June through September. Since solar power generation is highest in the summer months and during peak heat times, demand response provides a relief from the power that must be generated from fossil-fuel-burning and other plants during peak demand.
3. Forest Carbon Projects

As climate change laws have been adopted at the state level in the United States, and as Congress and the U.S. Environmental Protection Agency (EPA) have considering climate change legislation or regulations, the potential impact on industries, particularly coal-burning utilities and oil refineries, may be substantial. In the European Union, companies are already struggling with these issues. Forest carbon projects could provide the large number of offsets needed to reduce international competitiveness concerns of nations such as the members of the European Union, the United States, Australia, and Japan. Although forest carbon credits are not yet allowed as offsets in the European Union Emissions Trading Scheme (EU ETS), this may change in the coming years. Forest carbon projects are probably the most complicated and difficult to validate and verify. If climate change legislation is adopted in the future in the United States, or forest carbon credits are allowed in other countries to serve to meet mandatory
AND
CARBON FINANCE
compliance obligations, such as the European Union or Japan, some companies may consider acquiring large numbers of forest credits as offsets. If this were to occur, the demand could be as much as hundreds of millions of metric tons of forest credits. In considering the potential source of these carbon credits, many of these companies have concluded that the only source of a large volume of these credits arises from the preservation of the worlds forests. Avoided deforestation projects provide a critical pivot point for reducing global greenhouse gas emissions while reducing the economic impact of such reductions. If 17 to 20 percent of greenhouse gases can be reduced just by ending the logging and cutting and burning for subsistence agriculture, we will be that much further ahead with respect to addressing the greenhouse gases from fossil fuel use. The emissions from deforestation are larger than the emissions from the transportation sector. The goal of this section is to briefly discuss forest-derived carbon credits and the role they may play in climate change regulatory programs and how major GHG emitters may evaluate the opportunities and risks that may arise from investing in these projects. The role of forest carbon in compliance systems has been limited. As stated above, the EU ETS does not currently permit the use of forest carbon to offset greenhouse gas emissions in the European Union. The international program under the Kyoto Protocol referred to as the Clean Development Mechanism (CDM) did not originally allow forest carbon into the system, and then limited it to reforestation alone, not avoided deforestation. In addition, the credits were limited to temporary credits that only last for a short period and then have to be replaced by new carbon credits. Not surprisingly, the investment in these CDM forest credits has been very limited. Since the regulatory programs initially did not permit at all or only a very limited role for forest carbon, the development of forest carbon shifted to a voluntary program. The voluntary programs arose from the demand by those who were not required to invest in carbon credits but for their customers or public relations or corporate social responsibility or sustainability programs that decided to invest in these projects. Scientists, nongovernmental organizations, governmental entities, and others invested significant time developing methods to measure the carbon in existing forests and replanted forests. These led to nonprofits establishing standards for parties who engage in these projects to obtain verified and validated carbon credits. As discussed in Chapter 12, several programs for forest carbon credits exist today, such as the Chicago Climate Exchange (CCX), the American Carbon Registry, Social Carbon, and the VCS. Other benefits may arise from
preserving forests, if managed in a particular way that extends beyond greenhouse gas reductions. Biodiversity and species can be protected and preserved, and communities that live in and around the forests may have their economic condition improved through planning of the projects that takes these communities into account. The Climate, Community, and Biodiversity Alliance provides a standard for certifying that both community and biodiversity are taken into account in forest carbon projects. The Social Carbon standard addresses community issues as well. Forest carbon credit projects present some of the same risks faced by other carbon offset projects. Certain other risks may be of particular importance in forest carbon development or may be unique to forest carbon credit projects. Some of the risks are as follows:
Project Risk: In essence there is the risk the project never is completed
because of a variety of factors, such as management failure. This may include failure to obtain landowner purchase or lease, or failure to gain local government approval, as may be required. Validation/Verification Risk: One of the critical aspects of the project risk is the failure to meet the third-party verifiers expectations and review of the application of a particular methodology to a project. In the forest context, since methodologies are just now being developed, the project developer generally has to prepare and present a methodology for the particular project by which the baseline carbon emissions and monitoring of actual emissions would be completed under the project. Under the VCS Guidance, a dual approval is required of first the proposed methodology and then the project design document that applies that methodology to the project being developed. Financial Risk: The ability to obtain funding to complete the project. Political Risk: The ability to avoid a political decision or action that would impede the completion of the project, such as a takeover of the relevant property, denial of any approvals for the project, or the taking or taxing of the credits that may be produced. Land Title and Land Tenure Risk: Land title is a critical issue that must be addressed before moving forward with a particular forest tract. Title in developing countries can be difficult to prove. Squatters and other people claiming title to land creates another risk that must be resolved. Permanence Risk: Permanence concerns arise from the risk of fires, drought, or pests destroying or degrading the forests. Leakage Risk: Leakage results from parties moving to another nearby forest and harvesting trees or burning the forest for agricultural purposes so that the net reduction in forests is of concern.
AND
CARBON FINANCE
Currency Fluctuation Risk: Currency risk arises from fluctuations in
exchange rates, say from the U.S. dollar to the Brazilian Real. Purchase prices or lease prices quoted in one currency may change for the developer over time. Currency hedges, where available, may be a means of attempting to address this risk. All of these risks must be managed in order to obtain funding for a project, and some of them are necessary to discuss and address in order to obtain approval from third-party validators to have a project approved by a standards board and then verification in order to have credits actually issued. The challenge of obtaining funding for these projects is probably the most difficult of the various carbon credit project types. Managing the risks to make the project feasible is difficult. The ability to find a market for the credits is hampered by the regulatory uncertainty surrounding the EU ETS and the UN Framework Convention on Climate Change (UNFCCC) negotiations over Reducing Emissions from Deforestation and Forest Degradation (REDD) and reforestation. However, a group of developers are pursuing forest carbon projects. Most of these developers are seeking a lease or easement to enter into with forest landowners in developing countries that would require the landowners to preserve the forest in exchange for payments derived from forest carbon credit sales. The investment in the project is lessened and the risk is shared with the landowner to some extent. The developer typically pays the development costs for forest studies, preparation of project design documents, and third-party validators, as well as other costs. The developer may be allowed to recoup these costs before any payment is made to the landowner. After costs are recovered, then the parties would share in the net profits from the project.
14
Carbon Finance
A. Financing Carbon Projects
Cap and trade provides a macro economic system to address air pollution issues, whether sulfur dioxide from coal-fired power plants, nitrogen oxides from various sources, particulate emissions, or greenhouse gas emissions. Many of these systems have been alive and well, but most people in the public are unaware of them. While market-based systems for addressing environmental concerns have continued to rise and have become a permanent part of regulatory systems in the United States and now in other countries, one aspect determines the success or failure of such systems. Because these systems are market based, they depend on largely private capital to finance their development and to sustain them. Thus, the financing mechanisms are of critical importance and the availability of both debt and equity financing serves as the driver for emission reductions.
B. Project Finance
Because much of the driver for carbon credits in the form of offsets depends on individual projects to reduce greenhouse gas emissions, project finance is one of the key financing mechanisms to drive the creation of carbon credits and to maintain the carbon credit supply and market. This has certainly been the case for the Clean Development Mechanism (CDM) and for the Certified Emission Reduction (CER) market. Project finance, as the name implies, typically involves borrowing that provides the assets of the project as collateral rather than having a sponsoring company pledge its assets. Thus, the project, and perhaps the single asset entity that owns and operates it, would be the source of a lenders repayment of
AND
CARBON FINANCE
principal and interest, and its assets would secure the note provided to finance the project. Project finance is a complex area of business and law, and this book does not intend to provide a complete explanation of project finance, but rather to provide a summary of the concepts and how they apply to carbon offset projects.1 Project finance may have many definitions. One definition for project finance is: [A] nonrecourse or limited recourse financing structure in which debt, equity, and credit enhancement are combined for the construction and operation, or the refinancing, of a particular facility in a capitalintensive industry, in which lenders base credit appraisals on the projected revenues from the operation for the facility, rather than the general assets or the credit of the sponsor of the facility, and rely on the assets of the facility, including any revenue-producing contracts and other cash flow generated by the facility, as collateral for the debt.2 Typically such financing structures are nonrecourse or limited recourse, meaning the lender does not rely on the creditworthiness of the entity alone that owns the project and its assets. In addition, the lender relies not necessarily on the value of the assets alone, but the financial performance of the project to ensure repayment of the debt.3 Since the performance of the project provides the basis for repayment of the loan, long-term off-take agreements must be obtained by the borrowerproject developer to prove the economic sustainability of the project. These agreement may be power purchase agreements (PPAs) or contracts to supply some other product, such as fertilizer or fuel, to provide the means of operation of the project and to repay the loan. Various business structures may be used for projects that are seeking project finance. The structure of the ownership may be a single asset entity and a holding company that holds the stock of the entity that owns the project. A sponsor entity would then hold the stock of the holding company. Entities may be partnerships or limited liability companies, depending on the jurisdiction and other concerns such as reducing taxation on the project and the revenue it creates
1. For a more complete and detailed discussion of project finance in the international context, see Scott. L. Hoffman, The Law and Business of International Project Finance (Cambridge University Press 2008). 2. Id. at 4, citing Scott L. Hoffman, A Practical Guide to Transactional Project Finance: Risk Concepts and Contractual Considerations, 45 Bus. Law. 181 n.1 (1989). 3. Id. at 4.
C A R B O N F I N A N C E | 209
for various entities. For projects in the United States, tax finance structures may be established so that entities seeking to purchase the investment or production tax credits, as discussed in Chapter 18.
1. Equity
Projects typically have two elements of financing to construct and operate the project. The first portion is an equity investment in which an investor places funds with the project entity for a partial ownership interest in the entity. Equity investment is often raised from venture capital firms or private equity firms that are in the business of identifying such projects and sponsor companies and conducting the necessary due diligence on the project and those that will be managing the project in order to determine if they will invest in the projects. Initial funding for pure start up companies may be the most difficult to obtain, and may come from firms or individuals that are often referred to as angel investors. Investment may be based on the project meeting certain milestones, rather than payment in a lump sum. This protects the investor so that the money is used for specific purposes and so that steps along the way reduce the risk of total loss if the project fails at some point. The type of stock granted to the investor may vary. Common stock may be granted to founders and angel investors, for example, but preferred stock to later investors who will seek to have powers of appointing directors. Some investors may require antidilution rights so that later investment does not reduce their percentage ownership, as well as various other potential preferred rights. The timing of the investors return of capital will be a critical aspect of negotiations and development of the agreement with the investor.
2. Debt
The second element of financing the project typically involves securing a loan from a lender that allows the remainder of the funds to be obtained to construct and operate the project. As mentioned above, the project and perhaps a single asset entity that owns it will typically serve as the source of repayment of the interest and principal and serve as collateral for the note. In addition, as stated above, the note is typically nonrecourse or limited recourse to the sponsoring entity that would own the project or hold the shares in the entity that owns the project. In most projects, there must be a long-term contract with a credit-worthy entity that generates revenue for the project. In renewable energy projects, that would be a power purchase agreement, and in other projects an agreement to purchase fuel such as biofuels or methane generated by the project. These long-term off-take agreements provide the
AND
CARBON FINANCE
comfort the lender needs that there will be sufficient revenue to repay the loan. The due diligence by the lender necessarily will require review of the credit worthiness of the purchaser of the power or other output of the project. Securing the interests in the off-take of the project will be necessary to ensure the lender may be able to obtain that revenue in the event of default by the project or project entity. The lender may require pledging of the stock of the project entity to obtain a security interest in the project. This structure ensures the sponsor entity is remote from the liabilities and debts of the project company.
3. Types of Agreements Typically Involved in Project Finance

In order to set up the project and project company and then to develop the agreements to obtain debt financing, many different contracts are necessary. Some of those contracts are as follows:
Agreements Establishing Project and Project Entity: These agreements allow
the setting up of the project and project entity, usually with the sponsor company. These may be limited partnership agreements or limited liability company agreements. Intercompany Agreements: These agreements provide for operation and maintenance and advice and expertise often from the sponsoring company to the project entity. Technology Licensing Agreements: These agreements provide licensing to use technology developed by a third party or the sponsoring entity. They allow the project entity and, at times, the sponsoring entity from having to develop specific technology for the project. Engineering, Procurement, and Construction Agreements (EPC Agreements): These agreements allow the construction of the project, typically with an engineering company and construction company that will design and build the project. Off-take Agreements: As discussed above, these agreements allow the sale of the output of the project. PPAs are frequently the off-take agreement involved in renewable energy projects, which in turn generate carbon credits. An Emissions Reduction Purchase Agreement (ERPA) may be the off-take agreement where a project generates only carbon credits product and the sale as its only revenue stream. These should be take or pay agreements, where the off-taker pays the project company even if it does not take the electricity or other output in order to ensure cash flow to the project and to satisfy lenders and investors.
C A R B O N F I N A N C E | 211 Agreements with Investors: These may be limited partnership or limited
liability company agreements that establish the rights and obligations between the project company and the investors, and the shares of the project company the investors will own, purchase price, and other key terms. REC Sale Agreements: Where renewable energy credits (RECs) will be generated, depending on the country or state, the sale of the RECs must be established through a sales agreement. More discussion of REC issues is provided in Chapter 15. ERPAs: These are agreements by which carbon credits are sold to third parties. These contracts are discussed in Chapter 20. Loan Agreements: Various loan agreements must be entered into with the lender to create the loan and obtain security in various aspects of the project. Various consents from the sponsor and investing companies will be required. Operation and Maintenance Agreements: These may involve the agreements with the sponsoring company if that entity is to manage the project. Other agreements may be entered with third parties to provide maintenance of the equipment and machinery involve. Agreements with Equipment and Manufacturers: The equipment provided such as wind turbines or solar panels will involve pricing, delivery, warranties, and other terms and conditions.
4. Managing Political Risk with International Projects

A variety of risks face project developers, investors, and lenders in project development, as discussed in Chapter 13. For international projects, political risk is one of the most significant risks. Political risk insurance may be obtained under certain circumstances from government lenders, such as the U.S. Oversees Private Investment Corporation or other governmental or multilateral banks, or private insurance companies.
C. Carbon Finance
1. Basic Elements of Carbon Finance
Carbon credit projects require financing like any other project being developed for any purpose. The fundamentals of carbon project finance are similar to other projects, but have specific challenges unique to projects that are designed to reduce greenhouse gas emissions, capture those emissions in the form of carbon credits, and monetize those credits. Carbon credit projects are unique in that the output of carbon credits is a new and completely different legal, business, and technical area. Thus, there are inherently a different set of issues
AND
CARBON FINANCE
and risks that are presented by carbon credit projects and the financing of those projects. Two different types of projects may be identified that make a significant difference in terms of their ability to obtain financing, particularly now when the future of the Kyoto Protocol or a subsequent climate change treaty and U.S. legislation among other national legislative schemes that involve carbon markets are as yet unclear. The first type is a project that relies purely on carbon credits to generate revenue that will be used to repay debt and equity investment, and to generate profit for the developer. An example would be a compact fluorescent light project in which the project developer receives no portion of the energy savings of the party replacing the lights. The second type relies on other forms of revenue generation to address debt and equity repayment and project profit. An example of this type of project would be a solar plant that would generate revenue from selling electricity and would also generate revenue from carbon credit sales. The difference is important. The first type of project would likely be perceived as having more risk than a project that has other sources of revenue. If the credits are not issued, the project may not be able to repay debt or equity. Thus, the risk of the project will be entirely tied up in the issuance of credits and the amount of credits issued. For the second type of project, carbon credits may serve to increase the rate of return on investment and the internal rate of return, but that would not mean the project could not pay back its debt or equity. Thus, this type of project would generally be seen as presenting less risk to the lender evaluating a loan for the project and any equity investor considering investing in the project. International development banks that are guided by policies set by their government or governments often have strong policies for investing in environmental, sustainable, and greenhouse-gas-reducing projects. However, as one banker told a client, We are still a bank. The bank must still ensure it has a clear way to recover principle and interest on the loan and that some collateral is available if the loan is not repaid. If the revenue stream is only carbon credits, international development banks and other banks may find it hard to agree to make a loan on the basis of carbon credits, for two reasons. First, as discussed above, the revenue stream may be perceived as too risky. Second, the ability to obtain a security interest in a hard asset is not present, if the debt is not repaid. One argument is that if a credit-worthy off-taker, such as a large European utility were to enter into an Emissions Reduction Purchase Agreement (ERPA) (discussed in Chapter 20), then the financial risk is less problematic. We have made this argument in attempting to secure loans for client carbon credit project developers. We have argued that the ERPA is much like the PPA that lenders
rely upon in power plant project development. The lenders are willing in some cases to consider that argument, if the ERPA is long term and if there is a take or pay requirement, such that the purchaser must buy the credits when presented to it. An agreement to purchase specified numbers of credits over a period of years may be hard to obtain in the current legislative and international uncertainty of future carbon markets. Turning to the project with revenue streams beyond carbon credit sales, the lender may consider the other products generated and to be sold by the project. Such off-take contracts provide a more certain income stream for projects than carbon credits alone. However, the trade-off may be demonstrating additionality as a project developer may have to show the carbon credits are necessary to make the project work from an economic perspective. With a renewable energy project, for example, the sale of electricity with a long-term PPA with a party with good credit and reputation for repayment, and hard assets that may be used as collateral, may be able to obtain debt and equity that would be elusive for a pure carbon credit project. These projects will likely be perceived to present less risk to the lender or investor. The goal of raising money for a project is to finance the project so it can be built or implemented, and to then pay back the financing and in doing so to generate cash flow to the project and developer and to generate as high a return to the developer as possible. In seeking this solution, the project developer must understand the costs and revenue streams of the project and the timing of them over a substantial period of time. Spreadsheets are used to develop pro forma financial models in order that the developer can demonstrate understanding of the business and business planning, and to be able to show lenders and investors that the project can pay them back, plus interest for the lender, and a profit for the investor, at as high an internal rate of return (IRR) as possible. To go over the concept of internal rate of return from a project (or any investment) we have to consider the concept as the annualized return rate or discount rate that would cause the net present value of all cash flows, whether income or costs or losses, equal to zero. So positive cash flows and negative cash flows would be brought to their current net present values and compared until the number reaches zero. The calculation is used to evaluate the investment return on a single project, and to compare multiple projects, so that an investor can use it as one of the most significant factors to determine if the investor will invest in the project. In the context of evaluating an investment in a carbon credit project in this case, the investor would consider other investments, particularly those with less risk. Depending on the analysis, the investor may decide to invest in the stock market, bonds, or other more traditional investments, or, alternatively, in the
AND
CARBON FINANCE
carbon credit project. Because of this comparison of return and risk, carbon credit project tend to require significantly higher IRRs than many other more traditional investments based on perceived if not actual higher risk with a carbon credit project. One might also assume that a pure carbon credit project may require a higher IRR than a project that has other revenue streams. Lenders may also consider the IRR as one element of evaluating the financial risk in lending on the project, and in calculating the interest rate that it would charge on the loan, if it decides to go forward with financing the project.
D. Carbon Credit Project Lenders and Investors

1. Multilateral Banks and Associated Carbon Funds
A variety of multilateral banks and carbon funds provide financing for carbon credit projects. The World Bank and its private lender, the International Finance Corporation (IFC), have been the main lender and served in some ways to start the international CER market under the CDM. The World Bank has established the Carbon Finance Unit. Within this unit the World Bank operates several carbon funds that are financed with sovereign funds and private funds, depending on the project. The following funds are managed by the World Bank:
Prototype Carbon Fund; The Netherlands CDM Facility; Community Development Carbon Fund; BioCarbon Fund; Italian Carbon Fund; The Netherlands European Carbon Facility; Danish Carbon Fund; Spanish Carbon Fund; Umbrella Carbon Facility T1; Umbrella Carbon Facility T2; Forest Carbon Partnership Facility; Carbon Partnership Facility; and Carbon Fund for Europe.4
4. The World Bank, Carbon Finance Unit, available at http://web.worldbank.org/WBSITE/ EXTERNAL/TOPICS/ENVIRONMENT/EXTCARBONFINANCE/0,,contentMDK:2184 2339menuPK:5213558pagePK:64168445piPK:64168309theSitePK:4125853,00.html
These funds have served to help create and sustain the international carbon market. Some of these funds were designed to support the development of carbon markets generally, but others were designed to support the development of certain types of projects. Examples are the Forest Carbon Partnership, designed to support Reduced Emissions from Deforestation and Forest Degradation (REDD) projects,5 and the BioCarbon Fund, designed to demonstrate projects that sequester or conserve carbon in forest and agro-ecosystems. The BioCarbon Fund is a public/private initiative that aims to deliver cost-effective emission reductions, while promoting biodiversity conservation and poverty alleviation.6 The IFC has established its Carbon Finance Unit (CFU) to provide services to both buyers and seller of carbon credits. The CFU develops new products for the carbon markets and provides services to parties involved in the carbon markets. The CFU provides experience in project finance to manage credit risks in emerging markets where the CDM market has been the source of much of the international offset market. The products and services provided by the CFU include:
Carbon Delivery Guarantee; Monetization of future cash flows from sales of carbon credits; Debt and equity for carbon rich products and businesses; and Assistance with financial intermediaries and municipalities to help aggregate
carbon credits from their various investment operations.7 IFC products and services may be critical to some projects in terms of arranging necessary financing to enable project development. The IFC may take the risk with new products and services that may lead to private banks, funds, or insurance companies taking on that risk once the IFC proves the success of those products or services and their profitability. An example would be carbon credit guaranties that may enable projects to obtain financing where the output is carbon credits alone, giving the buyer and financing entities comfort that the risk of project failure is addressed. The IFC may be a buyer of credits from project developers, thus serving as the credit-worthy off-taker for some or all of the credits, allowing financing or
5. The World Bank, Forest Carbon Partnership, available at http://www.forestcarbonpartnership. org/fcp/ (last visited Sept. 19, 2010). 6. The World Bank, BioCarbon Fund, available at http://wbcarbonfinance.org/Router. cfm?Page=BioCF&ItemID= 9708&FID=9708 (last visited Sept. 19, 2010). 7. International Finance Corporation, Carbon Finance, available at http://www.ifc.org/carbonfinance (last visited Sept. 19, 2010).
AND
CARBON FINANCE
investment in the project from other sources. The IFC is developing a post-2012 purchasing capability with the intent of maintaining the market and pricing for credits that would be produced and sold after the Kyoto Protocol expires. The proposed fund would attempt to raise 150 million euros for forward purchasing of CERs by projects for the period from 2013 to 2020. The CERs would be required to be generated primarily by projects financed by the IFC or by local banks and financial institutions that have been financed by the IFC.8 Significant uncertainty exists as to the international offset market as a result of the inability of the countries of the United Nations to negotiate a postKyoto agreement. This is another example of how the IFC has served to assist in the development and promotion of the international carbon markets. Financing for carbon credit projects may be available in some form and for certain projects from other bilateral or multilateral development banks. Some of them have been issued directives from their managing boards to promote financing that reduces greenhouse gas emissions. Government-backed U.S. banks would include the Overseas Private Investment Corporation (OPIC) and the U.S. Export-Import Bank. Other development banks include the Inter-American Development Bank (IDB), the North American Development Bank, the African Development Bank, the Asian Development Bank, the Multilateral Carbon Credit Fund established by the European Bank for Reconstruction and Development and the European Investment Bank, and the Nordic Development Fund and the Nordic Investment Bank. An example is the activity of the IDB. The IDB has established the Sustainable Energy and Climate Change Initiative (SECCI) and the Sustainable Energy and Climate Change IDB Special Program (SECCI IDB Fund). The SECCI IDB Fund was established to finance the main goals of SECCI:
Renewable Energy and Energy Efficiency; Biofuel Development; Carbon Finance; and Adaptation to Climate Change.9
The purpose of the Fund was stated as being for mainstream renewable energy, energy efficiency, biofuels, carbon financing, and the climate change adaptation
8. The International Finance Corporation, IFC Post 2012 Carbon Facility, available at http:// www.ifc.org/ifcext/spiwebsite1.nsf/f451ebbe34a9a8ca85256a550073ff10/0e078ea6f6b3d714852 57719007ae862?OpenDocument (last visited Sept. 19, 2010). 9. Board of Directors, Inter-American Development Bank, Sustainable Energy and Climate Change IDB Special Program (SECCI IDB Fund) and Sustainable Energy and Climate Change Multidonor Fund, revised version 12 (Aug. 3, 2007).
in policies and programs in Latin America and the Caribbean. The conclusion was that the investment in these activities would lead to greater clean energy investments and reduced vulnerability to climate change in the region.10
2. Private Banks
Private banks have also served as investors and lenders in the carbon market. Some of the private banks that have financed carbon creditrelated transactions and projects include Deutsche Bank, BNP Paribas, Credit Suisse, JP Morgan, CitiBank, Mitsui, Barclays, Bank of America, Sumitomo, Morgan Stanley, and Goldman Sachs.
3. Private Carbon Funds, Private Equity Firms, and Hedge Funds

In addition to private banks, investment firms have invested in carbon credit projects. These funds include the investment arms of large international banks including Goldman Sachs, Merrill Lynch (now part of Bank of America), Mitsui, Barclays, BNP Paribas, Fortis (now part of BNP Paribas), and others. Funds associated with large insurance companies such as Conning, a subsidiary of Swiss Re, have established carbon funds. Specialized carbon funds have evolved as well, such as Climate Change Capital, RNK Capital, Greenhouse Gas-Credit Aggregation Pool, European Carbon Fund, Trading Emissions PLC, Merzbach Mezzanine Carbon Fund, ICECAP, Grey K Environmental Fund.
4. Utilities and Other Compliance Investors

Utilities, oil companies, and other compliance investors may act directly to invest in carbon credit projects in order to secure a stream of carbon credits and to reduce the price for such credits. These investments are often made to meet current or potential future compliance obligations. The investment may extend beyond entering ERPAs to purchase credits to providing funding for equity in projects. Some of the firms have established their own carbon funds to manage these investments.
10. Id. at 1.
PART
FOUR
Other Credits That May Be Generated from Carbon Credit Projects
15
Other Environmental Attributes, Including Renewable Energy Credits and Energy Efficiency Credits
A. Environmental Attributes and Other Credits That May Enhance Carbon Credit Projects
The reduction in electricity produced by fossil fuels, whether by substituting renewable energy for fossil-fuel-produced electricity or by reducing the use of electricity produced from fossil fuels, may produce a variety of government or voluntary credits, in addition to carbon credits. As a group, these are known as environmental attributes. Several types of environmental attributes can be generated. As discussed in prior chapters, the reduction in electricity use also reduced the greenhouse gases generated by fossil-fuel-burning power plants. The greenhouse gas primarily avoided is carbon dioxide. The reduction in greenhouse gases, whether carbon dioxide, methane, or other types, we know is measured in CO2e. However, there are a variety of other environmental attributes in the form of other credits that may be registered and obtained that can be monetized. Carbon credits are the main commodity that project developers are focused on internationally because they are in many countries the only means of monetizing the reduction in greenhouse gas emissions from various types
222 | O T H E R C R E D I T S T H A T M A Y B E G E N E R A T E D
of projects. With respect to projects based on renewable energy or, in some jurisdictions, energy efficiency, there are other types of credits that may be generated. These credits are generally known as renewable energy credits or RECs. Many states in the United States by statute encourage or require electric utilities with power plants within their borders or that sell electricity within their borders to provide a percentage of that power from renewable energy sources. These sources would include wind, solar, and various other forms of electricity production that meet that states definition of renewable. In some states, credits may be issued for energy efficiency projects that meet requisite standards. The energy efficiency credits can be generated from projects such as the replacement of lighting, heating and air conditioning units, appliances, or other actions that reduce the amount of electricity used in a building or other physical operation, such as an industrial plant.
B. Renewable Portfolio Standards

A Renewable Portfolio Standard (RPS) is the term used for statutes enacted by state legislatures to require that electricity suppliers that sell electricity include a minimum percentage of electricity produced by renewable sources by a date certain. The RPS, or minimum renewable portion, ranges from 12.5 percent in North Carolina by 2021 to 40 percent in Hawaii by 2030. The states also differ on the types of electric utilities that are subject to the standards. The credittrading markets described below allow the establishment of a market such that parties selling electricity may purchase those credits and use them to meet their compliance obligations. As such, RPSs are another form of environmental market. As of December 2009, twenty-nine states and the District of Columbia have established a form of RPS.1 These states produce more than one-half of the electricity sales in the United States. RECs can play a significant economic role in encouraging the development of renewable energy. The typical state RPS requires that a certain amount of the electricity sold in that state be derived from renewable energy sources. The percentage can vary from a few percent to 20 percent under Californias legislation.2 The definition of renewable energy source may vary from state
1. The Pew Center on Global Climate Change maintains a website that tracks states that have established an RPS or a form of similar program for requiring renewable or alternative energy, available at http://www.pewclimate.org/what_s_being_done/in_the_states/rps.cfm/. 2. Senate Bill 1078 passed in 2002 imposed a renewable energy requirement of 20 percent of electricity sold in California by 2017. Senate Bill 107 passed in 2006 accelerated that deadline to 2010.
O T H E R E N V I R O N M E N T A L A T T R I B U T E S | 223
to state. The types of facilities that may qualify as renewable energy sources include wind, solar, biomass, geothermal, wave, tidal, hydropower, and landfill gas. One of the main policy goals of a state adopting an RPS is to encourage the development of renewable energy sources that may not otherwise arise in a typical market for electricity. The price of renewable energy may reflect the cost of new technology or a new industry and the fact that fossil fuels are not required to internalize their other costs such as the pollutants they emit or the fact that they are not renewable, but at some point will be played out. Thus, state governments have determined to enact an RPS to attempt to allow the new form of energy production to develop over time by requiring a percentage of change by the local utilities. An RPS is typically a market-based system by which the producer of electricity from a renewable source, say a wind turbine, obtains RECs. A REC is typically measured in megawatt-hours (MWh). RECs are awarded to sources of electricity that are generated by a renewable source. For private project developers of renewable energy, the project developer may give RECs generated by a project to utilities that must present them to a public utility commission to show that a certain percentage of the electricity sold in the state is from a renewable source. Alternatively, a utility may construct its own renewable energy facility and use the RECs that may be issued for their own account. Thus, the utility may construct and operate its own renewable energy sources and generate its own RECS or purchase RECs from other renewable electricity producers. RECs can be purchased directly from a renewable energy project or on a secondary market where RECs are purchased and sold. The independent system operators that manage the electricity grids in various states typically manage this system. Those utilities that fail to obtain and submit RECS at requisite times face potential penalties. Some states require that a certain percentage of power be produced from certain types of renewable sources. For example, wind may be a productive area in a state, but solar has not emerged to any significant amount. A state may require that a certain percentage of the renewable energy requirement be derived, for example, from solar sources. The same number of credits can be awarded to this type of electricity or a multiplier may apply. For example, two times the amount of RECs may be generated from one megawatt hour (MWh) for solar as opposed to wind energy produced. The timeframe by which a certain percentage of renewable power must be generated in a state is critical as well. These levels typically increase over time. In Texas, for example, the first renewable energy standard was met several years before the deadline. Texas has the advantage of large areas of land where
the wind blows hard most times of the year. Texas quickly became the largest producer of wind energy of any state in the United States. The Texas Legislature established an initial goal in 1999 of 2000 new megawatts (MW) of renewable electricity by 2009. In 2005, it raised the level to 5,880 MW by 2015 and 10,000 MW by 2025. The 2015 goal must include 500 MW that originate from sources other than wind projects. The sources that qualify for the RPS in Texas are solar, wind, geothermal, hydroelectric, tidal energy, and biomass, which includes landfill gas production. Because the most beneficial areas to construct renewable energy sources are often remote, where electricity transmission is not located, the Texas Legislature required a transmission plan to be created and executed by the Texas Public Utility Commission to allow wind energy generation in West Texas to have the means to transmit the electricity to urban areas, where the demand for the electricity is found. If a retail electricity provider fails to submit sufficient RECs for retirement, then that provider may be subject to a fine of $50 for each MWh of deficiency. The rules provide for REC aggregators that aggregate RECs from micorgenerators who generate a small amount of renewable electricity.
C. Renewable Energy Credits

RECs were created to allow generators of electricity from renewable sources such as wind, solar, geothermal, biomass, etc., to sell the environmental attributes of the renewable power. RECs are created by statessince the United States has not adopted a federal program for renewable energythrough a national RPS that requires a certain portion of the electricity produced by utilities to be generated from renewable sources. The RECs in some states allow the renewable aspect to be separated from the physical electricity and sold separately, while in others they are bundled with the electricity. RECs are purchased by utilities and power marketers to achieve compliance with RPS requirements. The underlying policy goals of these programs include reducing price risk from dependence on one or a few types of generating sources, which have largely been coal or natural gas, economic stimulation through construction of renewable energy projects, and the reduction in pollutants, including sulfur dioxide, nitrous oxide, and greenhouse gases.3
3. Capturing the Power of Electric Restructuring 176 (2009).
A REC is generally defined as a tradable certificate representing one megawatt hour (MWh) of renewable energy that is physically metered and verified from the generator or the renewable energy project. As stated above, sales of RECs are either bundled, that is, sold, with the electricity produced by the renewable energy project, as is presently the case for California, or unbundled, that is, sold separately from the electricity, as is the case for the majority of states that have established an RPS. The ability to buy and sell the RECs results in a REC market. The prices vary widely. In Texas for example, the RECs may sell for $1 to $2. In other states that price may be higher. Some RECS are source dependent, such as solar RECs. In New Jersey, the solar RECs (sRECs) sell for as much as $600 or more.
D. Energy Efficiency Credits

Some states, such as Connecticut, Pennsylvania, and Nevada, have extended the concept of RECs for renewable energy to energy efficiency. Energy efficiency credits are generated based on a verified amount of electricity use that is reduced. Under an RPS that includes an energy efficiency requirement that utilities must meet, the utilities must demonstrate that they have achieved a certain amount of reduction in electricity use through energy efficiency. The utilities then would become purchasers of the energy efficiency credits to achieve this compliance obligation.
E. Credits for Traditional Pollutants

Some of the traditional pollutants that are reduced are sulfur dioxide, nitrogen oxides, particulates, and mercury, some of which may be limited to coal-burning power plants as opposed to natural-gas-burning power plants.
F. Forward Capacity Markets

Electricity production faces special challenges during periods of peak demand. These periods typically occur during summer months when air conditioning places a greater demand on the electricity grid. At these peak periods, the utilities have what are known as peaker plants that produce the power needed to meet electricity demand that the power plants that are generally operating cannot meet.
In order to address this peak demand period, the independent system operators (ISOs) in some states project out the electricity needs for the next three years and then conduct auctions to purchase the power to obtain the needed sources of electricity to meet those demands during peak loads. In some of these states, the ISO allows energy efficiency and other demand response sources to participate in these auctions with power producers. The types of providers that may participate in these forward capacity options include traditional power generation, intermittent resources such as wind, solar, and hydro, imports of capacity from outside of the ISO, and demand resources, including real-time demand response, load management, distributed generation, and energy efficiency. Parties that can achieve a sufficient level of power reduction or demand response reductions at peak demand periods may be able to participate in these forward capacity markets.
G. Contractual Issues in Selling RECs Outside California

Although attempts have been made at developing a standard contract for selling RECS,4 buyers and sellers tend to offer their own versions of contracts for selling them. Generally there are two types of contracts, those not involving RECs in California and those involving RECs in California. For those contracts not involving RECs from California, the contract terms may or may not be directed by the public utility commissions. In each state, research into the requirements or forms required for buying and selling RECs should be conducted. Some of the issues of importance include those below.
1. Type of Credit
The contract must set out the type of RECs and address the unique nature of the state in which the RECs are being generated and sold. Unless and until a federal RPS is adopted, the contracts will vary by state. If other attributes such as energy efficiency credits are to be sold, then the contract must identify those and address the specific issues related to those types of credits. In some states, such as
4. For example, a group of attorneys through the American Bar Association attempted to develop a model agreement, but it has not been used to any great extent. The ABA Master Renewable Energy Certificate Purchase and Sale Agreement, available at http://www.abanet.org/environ/committees/renewableenergy/RECMasterContract.pdf.
New York, the contract must include all environmental attributes, and require form contracts are required.5
2. Vintage of Credit
The year or years of issue of the REC must be set out in the contract. This is important to be clear what is actually being sold. In some states, the REC from one year, say 2009, must be turned in by June 2010. Thus, stating the appropriate vintage is important so one is not purchasing RECS that have expired.
3. Quantity Being Sold

Along with price, the quantity being sold determines the purchase price. For the compliance buyer, it is critical that it may rely on a minimum amount so that it may meet its compliance requirements.
4. Pricing
The price of the REC is obviously a critical part of the contract and will be central to negotiating the business terms of the deal. In some states, the price may reflect the penalty for failure to obtain sufficient RECs to meet the compliance obligation of the electricity supplier.
5. Transfer Mechanism
In most states, RECs can only be traded if they are registered through the state under the RPS. Most states maintain a REC registry that tracks the ownership of the RECs. As for prices and contracts, some states do not address these issues as the registry is not designed to serve as a trading exchange, but only to track ownership. Under most state laws, the regulating entity must be notified when a REC has changed ownership or been traded. The contract should address the mechanism of transferring the RECs as state regulations regarding registries and the means by which the REC may be traded may vary. The issue of whether the RECs are transferred before or after payment must be addressed as well. Upon transfer, the seller relinquished all rights to the RECs and the buyer obtains any and all rights to the RECs for its sole use. Normally, payment is made upon delivery, as discussed more below.
6. Payment
Payment timing may depend on the credit worthiness of the buyer. If the buyer is an investment-grade company, then payment may be, for example, after ten days
5. New York State Energy Research and Development Authority RPS Standard Form Contract, available at http://www.nyserda.org/wms/docs_funding/916rfp.pdf.
of delivery of the RECs. If not, then payment may be due three days before the delivery date.
7. Delivery
Delivery is then an issue that depends upon payment. Delivery may be before or after payment, depending on the credit worthiness of the buyer, or its guarantor, if any. Delivery would be affected through the relevant states registry.
8. Representations and Warranties

A variety of representations and warranties may be appropriate. Some of the more important are to state that the RECs meet the applicable states RPS standards. Another is that the RECs have not been previously sold nor are there any other claims in terms of a lender or other third-party rights to the RECs. An important issue is that the RECs have not been previously used to meet the states RPS requirements, and, therefore, would not be of any value to the buyer.
9. Effective Date and Termination

The effective date will be set forth in the contract. If the contract serves as a master service agreement, then the effective date of subsequent trades will be governed by a confirmation letter that will set forth other details. Termination may arise in several ways. One would be expiration of the contract. Another would be if the state changes its laws such that the transaction is no longer of any use to the buyer, as described below. Insolvency of one or more parties may lead to termination as well. Termination may also arise if either party defaults and fails to perform its obligation under the contract.
10. Remedies and Damages

The remedies and the means of calculating damages under the contract should be set forth in the agreement. For example, if the buyer fails to make payment or becomes insolvent or is a party to a bankruptcy proceeding, then the contracts typically provide relief to the other party to the agreement. Failure by the seller to deliver RECs would be another example of default.
11. Change in Law

RECs like other many other environmental attributes are creations of state governments, and potentially in the future, national governments. Thus, legal changes can eliminate an RPS or change the rules in such a way as to make the transaction substantially different or of less or no value to one or both of the parties. Thus, how changes in law may affect the transaction may be an important provision in a REC purchase and sale agreement.
H. Contractual Issues in Selling RECs Inside California

In California, the situation is much different than in most states. Initially, RECs in California were required to be bundled with the electricity sold, and could not be sold separately. In March 2010, the California Public Utilities Commission (CPUC), issued a rule that changed these limitations.6 These RECs are referred to as tradable RECs, or TRECs. As a result, up to 25 percent of RECs may be purchased by utilities that are unbundled. For retail electricity providers, there is no limit on the amount of TRECs that can be used to meet their compliance obligations. Many of the contract terms are set by the CPUC. Changes to those terms must be approved by the CPUC. Doing REC business in California is more complicated, and requires knowledge of the current standard terms and how the CPUC is currently administering those standard terms. Review of any new or developing CPUC regulations prior to negotiating a California REC agreement would be prudent.
6. See Cal. Pub. Util. Commn, Decision Authorizing Use of Renewable Energy Credits for Compliance with the California Renewables Portfolio Standard, Rulemaking 0602012 (Mar. 11, 2010).
16
Ecosystem Services: Wetlands and Biodiversity Credits

The nation behaves well if it treats the natural resources as assets which it must turn over to the next generation increased and not impaired in value.1
Beyond carbon credits that may be generated from ecosystems such as forests, as discussed in Chapter 12, ecosystems may also generate other forms of credits for the ecosystem services that they represent. Ecosystem Services is a rather new concept. It has evolved over the last decade or so. The concepts of economics and ecology have begun to hybridize in this new area, and the development of the concepts of ecosystem services is the outgrowth of this crossbreeding of what has long been seen as incompatible ways of thinking and intellectual disciplines. In a book published by the National Academies of Science in 2005, the authors concluded that:
In fact, the committee [which developed the study and book] quickly discovered that this is not an established fieldecologists have only recently begun to think in terms of ecosystem services and their determinants, while economists have likewise only very recently begun to incorporate the factors affecting ecosystems services into their valuations
1. Attributed to President Theodore Roosevelt, inscribed on the entrance of the American Museum of Natural History, Washington, D.C., quoted by National Academy of Sciences, in Valuing Ecosystem Services: Toward Better Environmental Decision-Making (2005).
E C O S Y S T E M S E R V I C E S | 231
of these services. If we as a society are to understand properly the value of our natural capital, which is a prerequisite for sensible conservation decisions, then this growing field must be developed further . . . 2
As local, national, and global environmental, ecosystem, and climate impacts from human populations and activities have become an increasing concern not only to those who wish to conserve ecosystems and species, but also to those responsible for setting public policy and programs that affect significant economic impacts of climate change or degradation of fishing stocks, among many other examples, the understanding of the real value of ecosystems becomes of increasing importance.3 The challenge has been that when ecosystems were facing destruction for purposes of land development, farming, cattle-raising, or other purposes, the economic value of the activity that would destroy or degrade the ecosystem was estimated, but there was no countervailing economic value stated for the ecosystem or the services that it provides. Thus, a rather one-sided measure was taken, and in the balance, the development would largely win out.4 The attempt to value the ecosystem services also arose in the context of measuring the natural resource damages under U.S. laws that required parties liable for damages to streams, lakes, or other ecosystems to pay damages to certain state or federal natural resource trustees. When these laws were passed, a means of calculating the natural resource damages in terms of economic damages, that is, a dollar figure for the damages, became a critical issue. The laws that created a claim for natural resource damages include the Comprehensive Environmental Response, Compensation, and Liability Act, the Clean Water Act, and the Oil Pollution Act. Various states have enacted laws that also require the payment of natural resource damages.
A. Wetlands Credits and Banking

The first area in which it became part of a regulatory system in the United States was in the context of the federal Clean Water Act. Under Section 404 of the Clean Water Act, parties required to obtain a permit to fill wetlands must mitigate the removal of the wetlands within the same watershed.5 Section 404 established a program to permit the discharge of dredged or fill material into
2. Valuing Ecosystem Services, at vii. 3. See id. at 2. 4. See id. 5. 40 C.F.R. Part 230, Subpart J.
waters of the United States and prohibits any such discharge that will adversely affect municipal water supplies, shellfish and fishery areas, or wildlife or recreational areas. Section 404 permits are issued by the U.S. Army Corp of Engineers. Earthmoving activities and the discharge or placing of any amount of soil, concrete, rocks, or other fill materials onto wetlands, stream beds, or other waters of the United States without a permit constitutes a violation of Section 404 of the CWA. Wetlands are broadly defined and may include such unlikely or unexpected areas as certain forests, agricultural land, rangeland, and uplands. For example, shaping and creating a dry creek bed to handle storm water runoff from a development would most likely require a Section 404 permit from the Corps of Engineers. Dredging alone would not likely require a permit. In order to permit development, the Corp of Engineers has created a system whereby entities may apply to establish wetlands mitigation banks. The banks consist of land that is typically already in part wetlands or wet areas that are enhanced to high-quality wetlands. A conservation easement is filed in the deed records for the property so that the property will continue to be a wetland. The developer of the bank must provide for the continued monitoring and maintenance of the wetlands. Third parties who seek to develop wetlands may purchase credits from the wetlands bank as part of mitigation required by the Corp of Engineers rules. The wetlands mitigation bank must be found in the same watershed as the development project. Through this system, a market for wetlands credits has been established. Developers of greenhouse gas (GHG) reduction projects may turn to wetlands as a means of absorbing greenhouse gases, primarily CO2. The use of wetlands as a GHG reduction project to produce carbon credits may also produce wetlands mitigation credits. The ability to generate both credit types would increase the revenue from the project.
B. Biodiversity Credits
A new form of environmental credit or attribute that is starting to come into being is a biodiversity credit. Parties are seeking to develop these credits as a means of contribution to saving ecosystems and biodiversity. A book has recently been published to advise parties on setting up a biodiversity credit program.6 The biodiversity credit is designed to allow parties who are developing property
6. Conservation and Biodiversity Banking: A Guide to Setting up and Running Biodiversity Credit Trading Systems (Nathaniel Carroll, Jessica Fox, & Ricardo Bayon eds., 2009).
to mitigate ecological impacts by purchasing credits from a bank in the same way as parties would do if they are impacting wetlands. The ability to address these issues through a biodiversity credit bank makes the process more efficient for the developer and allows a larger, more concentrated area of an ecosystem to be preserved and enhanced. As an example, the State of California has established a policy regarding what are known as conservation banks to protect species and their habitats. The explanation of the purpose of conservation banks was stated in that policy as follows: A conservation bank is a single parcel, or a series of contiguous or noncontiguous parcels, of habitat which is managed for its natural resource values. The resource benefits derived from this management regime are sold as credits to project proponents who seek mitigation opportunities to compensate for resource impacts elsewhere. Credits may be generated to meet any number of resource conservation needs, including compensation for impacts to wetlands, threatened or endangered species, Environmentally Sensitive Habitat Areas, mudflats, sub-tidal areas, and less sensitive resources. Conservation banks, if properly established and managed, serve several useful functions. First and foremost, banks provide for the conservation of important habitats and/or habitat linkages. Second, they provide a viable alternative to the current practice of requiring piecemeal mitigation for individual project impacts. Individualized mitigation projects which have little connection with their surrounding ecosystem are often much more prone to failure than a mitigation project which is incorporated into a larger, ecosystem-based conservation bank or regional conservation plan. Third, conservation banks can take advantage of economies of scale that are often not available to individualized mitigation projects. Fourth, conservation banks provide significant incentives for private landowner participation and represent one of the best examples of private/ public partnerships in an era of shrinking budget resources. Fifth, conservation banks can be a major funding component for the creation of an ecosystem preserve under a regional conservation plan. Sixth, and finally, conservation banks simplify the regulatory compliance process while achieving greater conservation goals.7
7. California Environmental Protection Agency, Official Policy on Conservation Banks (Apr. 7, 1995).
In Florida, the U.S. Fish and Wildlife Service and the Florida Fish and Wildlife Conservation Commission have worked together to establish conservation banks to protect the Florida panther and its habitat. In doing so, the explanation of conservation banks was offered: Conservation banks for endangered species have been successful in other places across the country. Banks set up a system where the private sector provides funds to preserve and manage important habitat . . . forever. Landowners can sell credits to developers planning to impact what are usually marginal habitats elsewhere, ensuring the most valuable habitats continue to flourish. This system offers landowners an economic incentive to maintain and use the land in ways compatible with conservation. Fittingly, ranchers, who have been stewards of Floridas landscape for generations, can pass that legacy to their children and grandchildren.8 The state and federal wildlife agencies worked with private parties to develop conservation banks between protected habitat in order to ensure a passageway between the two habitat regions and, therefore, protect the endangered species. The biodiversity and species credits are still in a development stage. International credits are being studied and developed, particularly with respect to forest preservation and protection of ecosystems, habitat, and the species that inhabit and depend on those systems. In the forest carbon arena, biodiversity credits allow another form of income to finance forest preservation, as will be discussed below.
C. Credit Stacking
With the development of distinct environmental markets and credits, the developer of projects will seek to obtain as many credits as possible to maximize the return on investment. With wetland banking, conservation banking, water quality trading, and now carbon markets, opportunities to engage in natural resource markets continue to grow. Investors are attracted by the multiple markets and associated revenue streams, and developers are looking for increasingly
8. U.S. Fish and Wildlife Service and the Florida Fish and Wildlife Conservation Commission, Conservation Banking Can Help Save Panthers, available at http://myfwc.com/Newsroom/10/ statewide/News_10_X_ConservationBankingOpEd.htm (last viewed Sept. 12, 2010).
comprehensive mitigation. The possibility of credit stacking, selling more than one natural resource credit type on a single acre of land, has emerged with particular interest. The drive to maximize land management investments will push towards getting credit for all the attributes on a parcel of property. Understandably, landowners will argue that they deserve credit for every ecological benefit they commit to protecting, including the species habitat, sequestered carbon, and downstream water quality improvements. On the flip side, if stacking is appropriately regulated, it may create demand for more specific credit types and result in more complete mitigation. With the logistics of markets for ecosystem services still being solidified, the debate about credit stacking is active.9 The process of credit stacking may make it easer to find investment capital or debt to assist project developers in raising the funds necessary to preserve or restore ecosystems. As avoided deforestation known as Reducing Emissions from Deforestation and Forest Degradation (REDD) projects as well as reforestation projects have the potential to take on a growing role in cap and trade programs, the ability to not only capture carbon credits but also other related types of credits such as biodiversity, wetlands, and water quality credits, enhances the ability to fund saving and regrowing forests, particularly rainforests in the Amazon and other parts of the world where deforestation is a significant threat not only to these important ecosystems, but also a source of carbon sequestration.
9. Id. Chapter 11.
17
Water Credits
A. Increasing Water Demand and Decreasing Water Supply
Water has been a scarce resource in many parts of the United States and throughout the world. One of the predicted outcomes of climate change is the reduction of the availability of fresh drinking water. In some places, water availability and supply is predicted to decrease significantly.1 Energy production, such as by means of coal-fired power plants, uses significant amounts of water. As energy demand increases, so too will the demands for water. General demand for water will increase for not only energy production, but also agriculture, industrial use, and drinking. Populations in many areas are growing. Climate change will likely reduce water supply in many areas. As a result, the strains on societies and economies are predicted to increase dramatically as demand for water increases and supply of water decreases in many locations. Certain carbon credit projects, as discussed below, may also be able to generate water quantity or quality credits.
B. Why Water Is Becoming a Potential Tradable Commodity

Water rights have been an important aspect of many national and state or provincial legal systems. How water rights are allocated and retained, and in some cases transferred, is critical to economic and social systems.
1. In South Australia, overall decline in rainfall has been predicted to be between 15 to 30 percent. Government of South Australia, Water for Good: A Plan to Ensure Our Water Future to 2050 16 ( June 2009).
W A T E R C R E D I T S | 237
Commentators have suggested establishing water as a tradable commodity, arguing a scarce resource like water may be best managed as a commodity that may be bought and sold, so that the price reflects its economic, industrial, and social value.
C. Water Credits and Markets as a Means of Conserving a Scarce Resource

1. Water Quantity Trading
Water rights or credit trading has evolved primarily in areas where water is a scarce resource. Australia is one of these areas. Water trading began in South Australia in 1988, in Victoria in 1989, and in New South Wales in 1990.2 In Australia, the water trading market for groundwater is separate from the market for surface water.3 The Water Exchange in Australia was founded in 1997, and purchased for $10.75 million by the National Stock Exchange of Australia Limited in 2007. This exchange had 20,000 customers, which consisted mostly of farmers trading water rights among each other.
2. Water Quality Trading

As water must not only be in good supply, but must be of sufficient quality, either fresh water or fresh water free from chemical or biological contaminants or disease vectors. Water quality trading is also becoming an area where many locations are trying to use environmental markets, such as air pollutant emissions markets, to find a more efficient and flexible program for regulating water pollution discharges and the ultimate water quality of water bodies. A World Resources Institute report published in March 2009 identified fifty-seven water quality trading programs worldwide, where twenty-six are active, twenty-one are under consideration or development, and ten are inactive.4 The majority of programs were in the United States, four in Australia, one in New Zealand, and one in Canada. In the United States, the Environmental Protection Agency (EPA) has promoted water quality trading programs for over ten years as an innovative approach for achieving water quality standards with flexibility and
2. Sarah Bushey, Australian Water Markets Are Growing Up, Ecosystem Marketplace, available at http://www.ecosystemmarketplace.com/pages/dynamic/article.page.php?page_id=5219 &section=home&eod=1. 3. Id. 4. Mindy Selman, Suzie Greenhalgh, Evan Branosky, Cy Jones, & Jenny Guiling, World Resources Institute, Water Quality Trading Programs: An International Overview (March 2009).
economic efficiency.5 The EPAs water trading policy was based on the assumption that in watersheds in which a total maximum daily load limiting pollutants entering the watershed is in place and enforced, then a basis for trading exists as the Total Maximum Daily Loads (TMDL) remains the same. The TMDL is much like the cap in a cap and trade system for air emissions. Each permit must be designed to meet water quality standards. The EPA believes that the inclusion of trading provisions in National Pollution Discharge Elimination System permits issued under the Clean Water Act should serve to facilitate meeting the requirements of the Clean Water Act.6 However, there are some complications under the federal Clean Water Act (CWA). Under Section 301(b), discharge permits are required to contain technology-based effluent limitations and, where necessary to meet water quality standards, strict effluent discharge limitations. These standards must be included, and trading does not eliminate them, except where specifically provided in effluent guidelines. Care must be taken so that localized impacts are not caused by trading such that high concentrations of pollutants exist in smaller areas, even thought the larger watershed meets water quality standards. Thus, there are clearly challenges to implementing a water quality trading system. These challenges can be overcome with careful planning and analysis to develop a watershed-wide trading system. An example of such a system is the Long Island Sound Nitrogen Credit Exchange Program established by the State of Connecticut, and directed by a Nitrogen Credit Advisory Board appointed by the General Assembly and the governor. The Virginia General Assembly passed legislation allowing the formation of the Chesapeake Bay Nutrient Credit Exchange Program, including the creation of a watershed-based nutrient general permit incorporating trading and the formation of the Virginia Nutrient Credit Exchange Association.
D. Carbon Credit Projects and Water Credits

As discussed in Chapter 16, credit stacking is a potential revenue enhancement for carbon credit projects involving forestry and wetlands. Carbon credit projects may be able to take advantage of these water credits in certain instances. An example might be where a forest project or wetlands project that is used to
5. Office of Wastewater Management, Water Permits Division, U.S. Environmental Protection Agency, Water Quality Trading Toolkit for Permit Writers 1 (August 2007, updated June 2009, EPA 833-R-07004). 6. Id.
W A T E R C R E D I T S | 239
create carbon credits and perhaps biodiversity credits also retains water and, therefore, creates water quantity or water quality credits. Another example might be an anaerobic biodigester that takes waste from concentrated animal feeding lots, farm waste, or other agricultural animal or plant waste and converts the waste into methane, electricity, or fertilizer. These projects often significantly reduce pollution of surface, and at times, groundwater. As a result, water quality credits may be possible to generate from these projects, depending on the location and regulatory system that may be in place.
PART
FIVE
Government Incentives Stimulating Carbon Projects
18
Government Incentives for Renewable Energy and Other Types of Projects That Generate Carbon Credits
A. The Use of Government Incentives to Enhance Carbon Credit Projects
Energy efficiency and renewable energy are becoming increasingly attractive to manufacturers as they contribute to reduced costs and the ability to reduce the level of dependence on third-party energy providers. These activities can produce positive corporate reputation, shareholder endorsement (particularly from institutional or socially responsible investors, such as state pension funds), and public perception. As climate change laws and controls on greenhouse gas emissions grow, the need to plan and develop strategy for the costs and opportunities that may apply to these developments becomes increasingly important. Companies are developing corporate strategies to address energy, climate change, greenhouse gas emissions, and related issues as part of their business strategies and as part of their sustainability and corporate social responsibility programs. Many companies are considering how they will address energy use and the role that government incentives and environmental attributes will play in their strategy.
244 | G O V E R N M E N T I N C E N T I V E S S T I M U L A T I N G C A R B O N P R O J E C T S
At the project level, estimating the cost of the project and then evaluating the funds that may be generated to offset some of those costs is a prudent step in overall cost reduction and estimating the rate of return on the projects being evaluated. Government incentives in various forms and the sale of environmental attributes serve to increase the rate of return on the investment in renewable or energy efficiency projects. Here we will review what government incentives may assist companies in developing energy efficiency and renewable energy projects and other projects that may result in reductions in greenhouse gas emissions. A variety of government incentives may apply to renewable energy or energy efficiency projects. Incentives for manufacturing certain energy efficient or renewable energy related technologies or equipment may apply as well. The American Recovery and Reinvestment Act of 2009 (ARRA), which President Barack Obama signed into law on February 17, 2009, made significant changes in prior tax and other incentives for renewable energy, energy efficiency, carbon capture and storage, and alternative transportation fuels. Understanding the new or amended incentives may provide opportunities for companies engaged in these business areas and provide significant assistance to municipalities that are looking for opportunities to address these issues. The ARRA should not be discussed alone, but in the context of the Emergency Economic Stabilization Act of 2008 (the EESA), which served as the vehicle for the economic rescue legislation signed into law on October 3, 2008, by President George W. Bush. The EESA is organized into three separate divisions, but the one that we will explore in this chapter, along with the ARRA, is Division B, entitled the Energy Improvement and Extension Act of 2008. The ARRA and the EESA together created significant incentives for renewable energy, energy efficiency, carbon capture and storage, and alternative transportation fuels. Many of these projects will reduce greenhouse gas emissions and may qualify for carbon credits, renewable energy credits, energy efficiency credits, or other environmental attributes, through voluntary carbon credit programs or current or future state and federal climate change legislation or Renewable Portfolio Standards. Combining both the incentives and carbon credit revenue may allow projects that would not otherwise be financially feasible to become economically sound or significantly improve the economics of otherwise profitable projects. The EESA and ARRA provide significant opportunities for parties engaged in projects in renewable energy, energy efficiency, carbon capture and storage, and alternative transportation fuels. Coupled with the potential for carbon credit and other environmental attribute revenue, the new or enhanced incentives may significantly improve the economics of these projects.
GOVERNMENT INCENTIVES
FOR
R E N E W A B L E E N E R G Y | 245
Not all of these grant programs or those that may be created in the future will provide incentives that can be used for carbon credit project developers or those whose products or businesses lead to greenhouse gas reductions to help reduce the costs of greenhouse gas emission reductions. However, these parties should keep in mind the various government grant programs as they evolve over time to determine if they may qualify for such grants.
B. Government Incentives
1. Government Grants
Government grants apply to a variety of projects. The U.S. Department of Energy (DOE) has received billions of dollars through bills passed by Congress for a variety of activities. State and local governments may have access to the state or federal money for providing grants to companies that install energy-efficient equipment or lighting, or distributed renewable energy projects. At the federal level, Congress, in passing the EESA and the ARRA, provided billions of dollars in grant opportunities for companies engaged in renewable energy and energy efficiency projects, both in terms of project developers and manufacturers. The ARRA provided funds for grants in the following areas:
$3.1 billion for states to promote energy conservation and to reduce the rate
of energy demand. $2 billion for manufacturers of advanced vehicle batteries and components. $5 billion for installation of energy efficiency improvements in the homes of low-income families in order to reduce the energy bills of these families. $2.5 billion for applied research, development, demonstration, and deployment activities, such as $800 million for biomass projects, $400 million for geothermal projects, and $50 million for research to increase the energy efficiency of information and communications technology. $400 million for electrification of transportation. $300 million to create an alternative fuel vehicle pilot grant program. $300 million for the energy efficient appliance rebate program and the Energy Star Program.
2. Government Tax Incentives

A variety of tax incentives in the form of production tax credits and investment tax credits have been provided through federal statutes. State and local governments may provide tax incentives in the form of property tax, franchise tax, or sales tax reductions to encourage this activity.
a. The EESA The EESA provided significant tax incentives and extensions for tax credits for the following projects: (1) renewable energy, (2) energy efficiency and conservation, (3) carbon capture and storage, and (4) transportation fuel. Below are examples of tax incentives and credits related to the foregoing projects.
i. Renewable Energy
Extended through 2009 (placed in service before January 1, 2010) the tax
credit for producing electricity from wind. Extended through 2010 (placed in service before January 1, 2011) such tax credit for other facilities, including closed and open-loop biomass, solar energy, small irrigation power, landfill gas, trash combustion, and hydropower. Modifies rules for and definitions of refined coal, trash and biomass facilities, and hydropower production. Included marine and hydrokinetic renewable energy as a renewable resource for purposes of the tax credit for producing electricity from renewable resources.
ii. Energy Efficiency and Conservation

Allows a new tax credit for investment in qualified energy conservation
bonds for capital expenditures to reduce energy consumption in public buildings, implement green community programs, develop alternative and renewable energy sources, and promote mass commuting facilities. Extends through 2009 the tax credit for nonbusiness energy property expenditures. Includes energy-efficient biomass fuel stoves as property eligible for such tax credit. Modifies tax credit standards for water heaters, geothermal heat pumps, and energy efficiency improvements. Extends through 2013 the tax deduction for energy efficient commercial buildings. Extends through 2009 the tax credit for residential energy efficiency improvements.
iii. Carbon Capture and Storage

Allows a 30 percent investment tax credit for advanced coal-based generation
technology projects and increases the maximum credit amounts allocable for such projects to $2.55 billion.
FOR
Increases to 30 percent the investment tax credit rate for coal gasification
projects and the aggregate credit amount for such projects.
iv. Transportation and Domestic Fuel

Increases and extends through 2009 income and excise tax credits for
biodiesel and renewable diesel used as fuel. Extends through 2009 the excise tax credit for alternative fuel and fuel mixtures. Requires such fuels to include compressed or liquefied biomass gas and to meet certain carbon capture requirements. Allows a new tax credit for qualified plug-in electric drive motor vehicles. Limits the amount of such credit based upon the gross vehicle weight rating of such vehicles. Terminates such credit after 2014. Extends through 2010 the tax credit for alternative fuel vehicle refueling property expenditures. Includes electricity as a clean-burning fuel for purposes of such credit. Provides for the treatment of certain income and gains from alcohol, biodiesel, and alternative fuels and mixtures as qualifying income for publicly traded partnerships. Extends through 2013 the taxpayer election to expense costs of certain refinery property.
b. The ARRA The ARRA provided for numerous tax credits for renewable energy, energy efficiency, carbon capture and storage, and alternative transportation fuels. Some of the relevant tax incentives extended or established were as follows:
Extended renewable production tax credits for wind projects through
December 31, 2012, and closed-loop biomass, open-loop biomass, geothermal, small irrigation, hydropower, landfill gas, waste-to-energy, and marine renewable facilities through December 31, 2013. Provided for a new 30 percent investment tax credit for qualified investments in qualifying advanced energy projects, which are projects that reequip, expand, or establish a manufacturing facility for the production of one of the following: Property designed to be used to produce energy from renewable resources; Fuel cells, micro-turbines, or energy storage systems for use with electric or hybrid electric motor vehicles; Electric grids to support the transmission of intermittent sources of renewable energy;
248 | G O V E R N M E N T I N C E N T I V E S S T I M U L A T I N G C A R B O N P R O J E C T S Property designed to capture and sequester carbon dioxide emissions; Property designed to refine or blend renewable fuels or to produce energy
conservation technologies; New qualified plug-in electric drive motor vehicles, qualified plug-in electric vehicles or components designed for use with such vehicles; or Other advanced energy property destined to reduce greenhouse gas emissions. Amended Section 45Q of the Internal Revenue Code to provide that credits for carbon capture and storage are limited to projects that permanently store carbon dioxide in a geologic formation. Removed limitation on investment tax credits if the project is or was financed with tax-exempt industrial development bonds or through other federal, state, or local government financing. The ARRA also authorized various grants and other incentives related to renewable energy, energy conservation, carbon capture and storage, and energy efficiency projects. Below are examples of the grants and other incentives authorized by the ARRA:
$2.4 billion in qualified energy conservation bonds to finance state, local, and
tribal government programs designed to reduce greenhouse gas emission and other qualified conservation activities. Increased alternative refueling property credit for businesses to a 50 percent credit and increases the cap for these credits to $50,000for hydrogen, to $200,000for 2009 and 2010. Increases the credit for individuals to 50 percent and the cap to $2,000 for 2009 and 2010.
3. Grants in Lieu of Tax Incentives

The ARRA allowed owners of these facilities to opt for a 30 percent investment tax credit in lieu of a production tax credit when the property is placed in service. The time deadlines applicable to this Section 1603 (of the Tax Code) grant were set as December 31, 2010 to start construction or take steps to commit to a sufficient contractual level for construction that the contract would qualify the project for the grant. Under federal law, for a short period of time, tax incentives may be transformed into actual grants of up to 30 percent of the capital expenditures for a particular project. The ability to obtain these grants in lieu of tax credits requires certain actions to take place before the end of 2010. Qualified property must be originally placed in service between January 1, 2009, and December 31, 2010 (regardless of when construction begins), or placed in service after 2010 and
FOR
before the credit termination date, which varies, depending upon the type of project, from January 1, 2013, to January 1, 2017, if construction of the property begins between January 1, 2009, and December 31, 2010.1 The definition of construction includes entering an irrevocable contract with a contractual provision that limits damages to an amount equal to at least 5 percent of the total contract price. Alternatively, if 5 percent of the physical work has begun or 5 percent of the cost had been paid or incurred by December 31, 2010, then this will be deemed by the Internal Revenue service (IRS) to meet the beginning of construction requirement.2 Section 1603 of the ARRA provided that the following types of projects may be eligible:
property designed to be used to produce energy from the sun, wind,
geothermal deposits, or other renewable resources;

fuel cells, microturbines, or an energy storage system for use with electric or
hybrid motor vehicles;

electric grids to support the transmission of intermittent sources of
renewable energy, including storage of that energy;

property designed to capture and sequester carbon dioxide emissions; property designed to refine or blend renewable fuels, other than fossil fuels,
to produce energy conservation technologies (including energy-conserving lighting technologies and smart grid technologies); new qualified plug-in electric drive motor, qualified plug-in electric vehicles or components, which are designed specifically for use with those vehicles, including electric motors, generators, and power control units; or other advanced energy property designed to reduce greenhouse gas emissions as may be determined by the IRS. The projects must be placed in service in 2009 or 2010, unless 5 percent of the project is under construction in 2010, and applications submitted by October 1, 2011.3 The total amount of funds available for these grants may not exceed $2.3 billion. As of May 23, 2010, the IRS had provided these grants to about 639 applicants. The majority of the grants were provided to solar electricity projects.
1. 1603 Guidance, at 5. 2. Id. at 56. 3. The IRS had developed a guidance document to provide information on the requirements of the program, eligible projects, and how to apply for the program. Payments for Specified Energy Property in Lieu of Tax Credits under the American Recovery and Reinvestment Act of 2009 (March 2010), available at http://www.ustreas.gov/recovery/docs/guidance.pdf.
Other projects that received grants included wind, geothermal, landfill gas, and biomass projects.4
4. Government Loan Guarantees

The DOE and certain other federal government agencies may provide federal loan guaranties for certain types of projects. The loan guaranty program began with the passage of the Energy Policy Act of 2005 (EPAct 2005) that authorized the DOE to issue loan guarantees to eligible projects that avoid, reduce, or sequester air pollutants or anthropogenic emissions of greenhouse gases and employ new or significantly improved technologies as compared to technologies in service in the United States at the time the guarantee is issued.5 The ARRA extended the authority of the DOE to issue loan guarantees and appropriated $6 billion for this program. Under this act, the DOE may enter into guarantees until September 30, 2011. The act amended EPAct 2005 by adding a new section defining eligible technologies for new loan guarantees. Eligible projects include renewable energy projects that generate electricity or thermal energy and facilities that manufacture related components, electric power transmission systems, and innovative biofuels projects. A specific limit for funding of biofuels projects was set at $500 million. The act provides DOE the ability to guarantee loans that support early commercial use of advanced technologies, not energy research, development, and demonstration programs. The DOE has published Guidelines for the Loan Guarantee Program. The means by which the DOE obtains applications for loan guarantees under this program is to issue what is known as a Solicitation Announcement that provides the necessary information and invitation to have parties that may qualify to submit applications for those loan guarantees.
5. Property-Assessed Clean Energy Programs

The Property Assessed Clean Energy (PACE) Program, by which property owners may finance eligible renewable energy systems and energy-efficient technologies installed at their properties through an additional annual tax assessment that serves to pay for the loan from the municipality. Eligible properties include residential, commercial, and industrial. These programs are generally funded through local government fund raising programs such as municipal bonds or local taxes. California, New Mexico, New York, Louisiana, and many other states have established PACE programs. Texas recently adopted a PACE program allowing municipalities to raise funds to loan to eligible parties.
4. The list is available on the IRS website. See http://www.ustreas.gov/recovery/1603.shtml. 5. 42 U.S.C. 16513(a)(1)-(2).
FOR
Participation in the program by property owners is purely voluntary. The programs typically allow the renewable energy or energy efficiency project to be financed through low interest loans with as much as twenty-year payoff periods. This greatly enhances the ability to finance these projects.
6. Development Bonds
Beyond federal incentives, many local municipalities may provide under their respective state laws may sell industrial development bonds and other bonds to use to finance local businesses to promote local economic development and job creation. Such bond programs may provide tens of millions or over a hundred million dollars for renewable energy electricity projects, and provide lower cost debt financing for these projects. If a federal loan guarantee can be obtained under the programs discussed above, the bonds may be rated very high and the interest rates may be reduced, further reducing the financing costs for projects.
C. Utility Incentives
Local utilities in many instances will provide incentives for energy efficiency, distributed renewable energy, and demand response. These incentives may be funds created through additional charges nd passed to electricity ratepayers under state legislation and public utility commission regulations. These funds pay to installers of new equipment or to electricity customers for the installation of renewable energy or energy efficiency technology. Examples would include solar photovoltaic panels, solar water heaters, small-scale wind, geothermal heating or cooling, efficient lighting, efficient heating or air conditioning, efficient electric motors, and other equipment or steps that reduce the use of energy drawn from the electrical grid. These programs can provide substantial funds for these renewable energy or energy efficiency projects, and should not be overlooked by project developers or companies considering installing energy efficiency or renewable energy at their facilities.
PART
SIX
Carbon Trading Selling Credits and the Carbon Markets
19
Fundamentals of Carbon Trading
A. A Regulatory Commodity
Carbon trading has becomes a multibillion dollar business that appears to be on a future growth trend despite the uncertainties in the United States at the national level and about the international treaty under the aegis of the United Nations. The commodity largely exists because of greenhouse regulation. The EU countries largely drive the trading for offsets for the European Union Emissions Trading Scheme (EU ETS). The voluntary market exists and provides a pre-compliance market and a true voluntary market. The true voluntary market appears to be growing as well.
B. The Various Types of Carbon Credits

The types of carbon credits are many. Kyoto credits include Certified Emission Reductions (CERs) under the Clean Development Mechanism of the Kyoto Protocol and Emission Reduction Units (ERUs) under the Joint Implementation program. The EU ETS trades European Union Allowances (EUAs). The Voluntary Carbon Standard issues Voluntary Carbon Units (VCUs). These are the main carbon credits issued and traded, but this is not an exclusive list.
256 | C A R B O N TR A D I N G S E L L I N G C R E D I T S
AND THE
CARBON MARKETS
C. Primary or Over-the-Counter Markets and Bilateral Agreements

Most carbon credits are traded on what is known as a primary market. The primary market consists of mainly project developers selling credits to either compliance buyers who need credits for meeting statutory obligations, or investors buying the credits for sale to other parties. The primary carbon trades are made through Emissions Reduction Purchase Agreements (ERPAs), which will be discussed in more detail in Chapter 20. The ERPAs vary from transaction to transaction, and no completely standard agreement exists, although various parties have attempted to develop standard agreements. These are usually bilateral agreements between one buyer and one seller.
D. Secondary Markets and Exchanges

Once the initial sale has occurred, later sales may be made in a second sale to a third party. This market is known as the secondary market. These sales may be bilateral over-the-counter sales. Exchanges have been created for carbon credit transactions. The Chicago Climate Exchange (CCX) trades voluntary credits in the United States. A related exchange, the European Climate Exchange (ECX), was launched by CCX in 2005, and is an exchange for allowances trade under the EU ETS. Futures and options contracts are traded on the EXC and CCX; ECX emissions futures contracts are standardized and all trades are cleared by ICE Clear Europe. Intercontinental Exchange Inc. (ICE) bought the ECX and CCX for $606 million in July 2010. NYSE Euronext formed a joint venture with APX Inc. to expand its trading volume in electricity, renewable energy, and carbon dioxide allowances. The new exchange will be known as NYSE Blue after contributing its 60 percent stake in Paris-based BlueNext, the largest exchange for spot trading of carbon dioxide allowances. NYMEX Holdings, Inc., the parent company of the New York Mercantile Exchange, Inc. formed The Green Exchange with Evolution Markets Inc., Morgan Stanley Capital Group Inc., Credit Suisse, JPMorgan, Merrill Lynch, Tudor Investment Corp., ICAP, and Constellation Energy. The companies forming the exchange state the goal is to reduce the cost of their customers management of their carbon footprint, and to build liquidity and demand for carbon credits and to allow risk management relating to these credits through derivatives markets. The exchange allows trading in European Union
FUNDAMENTALS
OF
C A R B O N TR A D I N G
| 257
Allowances under the European Union Emissions Trading Scheme, CERs under the UN Clean Development Mechanism, and verified emission reductions issued through voluntary carbon standards. Trading in U.S. SO2 and NOx emissions allowances and certified voluntary renewable energy certificates. Other exchanges that provide trading in (EUAs) include Bluenext, Nord Pool, and Climex.
E. Future vs. Spot Markets

As mentioned above, the exchanges and bilateral over-the-counter trades involve spot markets, but may also involve future sales. Spot markets are where a party buys credits at a current price for delivery immediately. Option agreements can be entered by two parties whereby one party may exercise the option to buy a certain amount of carbon credits from the other party at some date, and expiring at some later date. Futures contracts can be bought and sold on exchanges, which are like option agreements for the right to buy a certain amount of credits at some set or indexed price.
F. Off-Take Agreements
For project developers, the forward sale of carbon credits can provide financing for carbon credit projects, if some or all of the payment is received early before delivery of credits, or a known future revenue stream, if the buyer is a creditworthy entity. The ERPA then becomes an off-take agreement, much like a power purchase agreement for an electricity-generating project, such as a wind or solar project. Having a take or pay agreement can assist the project developer in obtaining equity investment and perhaps some degree of debt financing of the project.
G. Carbon Indexes
Several indexes have been created in order to track the prices of certain types of carbon credits. For example, the European Climate Exchange has maintained an index for EUAs and CERs. As mentioned above, the ECX has been acquired by ICE. Another example is Socit Gnrale, which began trading CO2 in early 2005, and which maintains the SGI-Orbeo Carbon Credit Index. This index tracks EUAs and CERs. The index for EUAs is based on the daily settlement price of the ECX1 CFI Futures. The index for CERs is based on the daily settlement price of the ICE ECX1 CER Futures. The settlement price for each
AND THE
CARBON MARKETS
index is calculated as a volume-weighted average of trades during the daily settlement period.
H. Fungible Commodity vs. Differentiation

One of the goals of some market proponents is to develop a fungible carbon credit that trades freely on an exchange. There are certainly desirable benefits for such fungible credits. Fungibility makes for a more liquid market. On the other hand, there may be value in differentiation of carbon credits in the sense of higher value for certain types of credits. One of the best examples is carbon credits from avoided deforestation or reforestation. These credits tend to have a higher value in the voluntary markets. For public relations, advertising, and branding reasons, companies that offset their emissions with forest carbon credits may receive a greater benefit than from, say, landfill gas projects. Some types of carbon credits have a more charismatic nature, which may bring higher prices. How this may play in a compliance market, where any credit turned into the government covers the legal obligation, remains to be seen.
I. Voluntary and Compliance Buyers

Voluntary buyers tend to have different reasons for purchasing carbon credits than compliance buyers. As stated above, for compliance buyers, any type of credit may do so long as they are admissible to the regulatory program and will be accepted by the governing agency. On the other hand, voluntary buyers are typically trying to meet customer expectations or to appeal to customers and draw business away from competitors. Thus, the companys or its products image and brand may require buying charismatic credits that can only be derived from certain types of projects. The fungible nature of credits may be missing in this circumstance. The type and location of the project may be critical for the success of the program for offsetting an entitys greenhouse gas emissions.
J. Investors and Speculators

Investors and speculators in carbon credits will vary depending on the perceived growth of the market and the direction of movement of future market prices. Investors are necessary to provide the capital to project developers to allow the projects to go forward. Speculators act to merely buy and sell credits.
FUNDAMENTALS
OF
| 259
Some investors or speculators may buy credits to hedge some of their other investments. Carbon credits are seen an non-correlated investments, meaning that carbon credit prices may not change in response to interest rates or inflation as other investments tend to do.
K. Carbon Credit Risk and Price

In the ERPAs entered into by bilateral parties, the question arises as to who bears the risks described in prior chapters. To the extent the buyer bears these risks, the prices may rise. To the extent the seller bears these risks, the lower price the seller is likely to be willing to pay for the credits.
L. Other Price Drivers

The extent to which the government in charge of a particular cap and trade regime decides to reduce the cap on greenhouse gas (GHG) emissions for the relevant jurisdiction, then the prices would likely increase. In addition, the prices for credits may move in response to coal and natural gas prices, as the lower the coal price, the more coal may be burned and, thus, the demand for carbon credits may increase, and thereby the price.
M. State of the Global Carbon Markets

The state of the carbon market has evolved over the years since 2004 when much of the carbon credit trading really began. Regulatory and economic factors among other influences have affected carbon prices and the size of the carbon market. One of the yardsticks for the carbon market is published by the World Bank every year. The latest report is titled, State and Trends of the Carbon Market 2010. This report provides the data for the prior year and compares it to the year before that. The 2009 numbers reflected a significant increase in volume of carbon trading, the sheer size of the market grew substantially. However, the value of the market did not increase that much, and certainly not in proportion to the growth in the market size. In 2008, the volume of allowances and offsets traded was reported to be 4.836 billion metric tons of CO2e and 8.700 billion in 2009 almost doubling in one year. The value of the market was $135.066 billion in 2008, and only grew to $143.735 billion in 2009. The value increased by less than 10 percent.1
1. See World Bank, State and Trends of the Carbon Market 2010 1 (May 2010).
AND THE
CARBON MARKETS
The explanation may have more to do with the economic recession that began in 2007 and continued through 2009 into 2010. The economic downturn caused industrial output and emissions to fall in 2009, considerably easing the compliance needs of regulated entities. In fact, emissions fell 11.2% among the ETS installations that reported their data prior to the publication of this report. In industries that suffered most during the recession, such as steel and cement, companies took advantage of the one to two month overlap between the issuance of 2009 allowances (February 2009) and the 2008 deadline for compliance (April 2009) and quickly sold their 2008 EUA allocations to raise cash (while relying on their 2009 allocations to cover their 2008 emissions). The most desperate industrials, in a move to roll over current liabilities and regain liquidity, borrowed against their 201012 allowances. As a result EUA spot and front contract prices fell further and faster than the prices of other commodities, breaking the strong price correlation between carbon and crude oil.2 The CER market actually declined in size and value. The World Bank identified specific problems with the CDM process.
Structural issues hobbled the CDM market as well. The complexity and changing nature of regulations, inefficiencies in the regulatory chain and capacity bottlenecks caused delays and negatively impacted project finance. As a result, it now takes over three years for the average CDM project to make its way through the regulatory process and issue its first [CERs].3
The market may continue to grow as the EU ETS dominates the global carbon market and the European Union appears to be prepared to continue its cap and trade program even if the United States does not engage in climate change legislation at the national level. If states and multi-state programs beyond the Regional Greenhouse Gas Initiative (RGGI) actually come into existence, this would add to the global carbon market.
2. Id. at 10. 3. Id. at 2.
20
Contractual Issues in Carbon Trading in the Primary Market
Carbon credits are typically sold through bilateral contracts known as Emissions Reduction Purchase Agreements, or ERPAs. These contracts are over the counter, not typically traded on exchanges. The developer sells its credits to a third party, which may be a compliance buyer or investor. A variety of provisions appear in these contracts. The discussion below describes the most significant of these provisions.
A. Definitions
Each ERPA must contain a set of definitions that allow the specialized terms used in the contract to be defined for purposes of making the contract more clear and to reduce the risk of ambiguity in using key terms.
B. Conditions Precedent
Conditions precedent provide the events that must occur before the agreement comes into effect and becomes binding. The events can be events neither party has control over or that one party must perform. For example, in order for the contract to come into effect, one might require that the project is approved by the host county by the Designated National Authority (DNA). Another example would be that the buyer would have to obtain a letter of credit to ensure payment when credits are issued and delivered to the buyer. Alternatively, if the
AND THE
CARBON MARKETS
buyer is advancing funds before the project is completed and long before credit delivery, the buyer may require a letter of credit be provided by the seller so that the funds could be paid back if the project does not receive approval and is not implemented.
C. Price
The price for carbon credits must be set in the ERPA. The price may be a set price, or based on an index, such as those discussed in Chapter 19. Some parties enter into contracts with a floor price below which the price cannot fall using the index, and others may have a ceiling above which the price may not rise. Still other agreements may have a collar with both a floor and a ceiling for prices that float with an index.
D. Quantity and Delivery

The amount of carbon credits to be delivered must be set forth in the contract. One approach is for the seller to agree to deliver a certain quantity of carbon credits every year for the term of the crediting period or some other term. This places the risk on the seller that the number of anticipated greenhouse gas (GHG) reductions will occur and that the estimated number of carbon credits will be issued by the relevant standards entity. Another approach is to require the buyer to purchase up to a certain amount of credits or all of the credits actually issued and no obligation of the seller to deliver a specified number of credits. This arrangement would put the risk of the underdelivery of credits on the buyer, if the buyer needs a certain number of credits for compliance purposes, for example. ERPAs are generally forward contracts, meaning they provide for the delivery of carbon credits in the future. Contracts are often entered into before the project has been implemented, so they typically are for future delivery. Credits are issued on a periodic basis as the GHG reductions are verified and the standards board issues credits. These agreements may also be drafted as options, where a potential buyer has the right to buy a certain amount of credits on a onetime or annual basis.
E. Payment
The method and timing of payment may be prior to or upon delivery of the credits. If a project developer is able to convince a party to make an advance payment on a forward contract, this may serve to assist in the financing of the project
CONTRACTUAL ISSUES
IN
IN THE
P R I M A R Y M A R K E T | 263
construction and implementation. Typically, the forward contracts require payment at delivery. Payment may be made with only the right to seek redress if the buyer fails to pay, or the contract may utilize an escrow arrangement to have a party release the credits upon payment being made into the escrow, or, the reverse, where the payment is held until the credits are delivered. Alternatively, a letter of credit could be used to secure payment by the buyer.
F. Obligations of Seller
The obligations of the seller may include proceeding to complete the implementation of the project, obtaining validation and verification, and ultimately issuance of the carbon credits. The risk of failure to obtain the credits may fall on the seller, and the obligations to pursue the issuance of the credits generally falls on the seller. Some of the obligations of the seller may include the following:
provide an initial verification report to the buyer; complete validation and obtain registration for the project; develop and implement a monitoring plan; carry out verification and certification, to ensure issuance of the Certified
Emission Reductions (CERs) under the Clean Development Mechanism (CDM) of the Kyoto Protocol; operate the project in a competent and prudent manner as a reasonable and prudent operator; deliver the CERs to the buyer; or arrange for additional buyers to be added as project participants, if the buyer resells the CERs to a third party before delivery.
G. Obligations of Buyer
The obligations of the buyer typically involve acceptance of and payment for credits delivered by the seller. Some of the obligations of the buyer may include:
establish an account to receive delivery of the credits; pay for the credits; and communicate with the CDM Executive Board (EB), in a CER transaction,
as what is known as the Focal Point, the party in charge of directing the transfer of the CERs upon issuance and otherwise managing the relationship with the EB.
AND THE
CARBON MARKETS
The buyer obligations are limited unless they serve as the party directing communications with the EB to attempt to complete the process of obtaining approval and issuance of the relevant carbon credits.
H. Representations and Warranties

Representations by the buyer and the seller are included in ERPAs. These would include representations regarding the ownership of the credits and that they have not been transferred to another party. The representations would generally include one that states that no liens have been placed on the credits to be sold. Other representations and warranties required of a seller may include the following:
the agreement is duly organized and validly existing under the laws of the
sellers country and that the seller is qualified to conduct its business in the relevant jurisdiction; the execution and performance of the agreement are within the sellers powers, have been duly authorized and do not violate or conflict with or require any consent or waiver under any of the terms or conditions in the sellers governing documents or any material contract, or any law, regulation, order, judgment, or other legal or regulatory determination; the agreement constitutes the legal, valid, and binding obligations of the buyer and is enforceable in accordance with its terms; there are no bankruptcy proceedings pending or being contemplated, or to its knowledge threatened against the buyer; there are no claims, actions, proceedings, or investigations pending to the buyers knowledge threatened against or relating to the buyer before any competent authority that may materially adversely affect its ability to perform this agreement; the buyer is not subject to any outstanding judgment, rule, order, statement of claim, injunction, or decree of competent authority that materially adversely affects its ability to perform the agreement; the agreement, the execution, and delivery of the agreement and the fulfillment and compliance with the terms of the agreement by the buyer will not materially conflict with any of, or require the consent of any person under, any loan or security agreement, or other material agreement, to which the buyer is a party.
CONTRACTUAL ISSUES
IN
IN THE
Other representations or warranties of a buyer or seller may be included in ERPAs negotiated by the parties involved in the transaction.
I. Share of Proceeds and Taxes

Providing for which party will pay taxes should be addressed in the ERPA. Value added taxes, for example, may be charged by the jurisdiction where the credits are formed or where they are delivered. Domestic CER taxes may be charged. China imposes a CER tax, which the Chinese government refers to their share of CER revenue. These taxes are as follows:
65 percent for hydrofluorocarbon and perfluorocarbon projects; 30 percent for nitrous oxide projects; and 2 percent for priority CDM projects in China, i.e., energy-efficient
improvement, development, and utilization of new and renewable energy, recovery, and utilization of coal bed methane, and reforestation projects. In other countries the question of whether taxes are imposed on the sale of carbon credits may have to be answered before negotiating a final contract, or one party may agree to cover the taxes, regardless of which party they are imposed upon by the relevant taxing jurisdiction.
J. Default
The ERPA should detail the acts, omissions, events, or circumstances that would place the seller or the buyer in default of the terms and conditions of the contract. These could be the failure to deliver by the buyer the specific number of credits by a particular date or the failure of the buyer to make payment after timely delivery of the requisite number of credits. Other circumstances may result in default by either party. The remedies for default could be termination or other remedies, as discussed below. Examples of default by either party that may be set out in the ERPA include the following:
failure to pay as required under the agreement; failure to deliver credit pursuant to the relevant clauses of the agreement; failure of a party to perform a material obligation under or commission of a
material breach of the agreement; or

breach of a representation or warranty.
AND THE
CARBON MARKETS
The remedies are described below.
K. Termination
The contracts should provide for the timing and circumstances under which the buyer or the seller respectively may terminate the agreement. A default under the contract may allow termination, depending on the type of default.
L. Remedies
The remedies that the buyer or seller or both may pursue in the event of a default should be specified. For a seller default, the remedies for the buyer may include:
Failure to complete the project or obtain verification: termination and/or
seller obtaining credit for the buyer or paying the costs the buyer incurs to obtain the credits not delivered. Failure to deliver any credits: termination and/or seller obtaining credits for buyer from other sources; payment to the buyer for the cost to purchase credits from another source. Failure to deliver a portion of the credits required under the contract: termination or seller making up the shortfall by purchasing credits from other sources and delivering to the buyer; payment for the cost of credits paid by buyer to obtain the number of credits that were not delivered. For a buyer default, the remedies may include:
Failure to pay: cancellation of contract, seeking lost profits for the lost sale.
Where the seller does not guaranty any volume of credits, the issue of a shortfall does not arise and no remedies arise for the buyer. The buyer would be purchasing the number of credits delivered by the seller, regardless of the amount.
M. Choice of Law and Venue

The contracts should state the law that applies to the contract. The contracts typically apply the laws of England or New York. Venue can vary significantly, but is often New York or London. Cost of the dispute resolution process should be considered in setting the applicable law and venue. Legal costs in London are significantly higher than in the United States.
CONTRACTUAL ISSUES
IN
IN THE
N. Dispute Resolution
Dispute resolution is very important for projects in developing countries. Most parties, project developers, and buyers do not want to be subject to the courts of a developing country. Typically, the international ERPAs involving CDM projects provide for international arbitration. There are several different arbitration groups and procedures that can be used. Venue for the arbitration is generally set as discussed above. Projects in the United States or the European Union may allow the courts of those jurisdictions to try any dispute that might arise, or they may opt for an arbitration provision. The costs of courts versus arbitration in the United States may not be that different. At one time, it was perceived that arbitration was generally less expensive to address contractual disputes than the courts. That perception is changing.
O. Force Majeure
A force majeure event typically means the occurrence of any event or circumstance, beyond the control of the relevant party to the agreement that causes that party after using all reasonable efforts to be unable to comply with one or more of their obligations under the agreement. Delivery or acceptance obligations may be excluded from the force majeure definition. A list of events that will not constitute force majeure may be included in the agreement.
P. Limitation of Liability
The ERPA may contain a limitation of liability. An example of a limitation that may be found in an ERPA would be a limitation on the liability for loss of income, loss of profits or loss of contracts, or for any indirect or consequential loss or damage. The liability of the parties and limitations on such liabilities may be further defined in the agreement.
Q. Miscellaneous Issues
A variety of other legal issues will be addressed in the agreement. Many of these issues are fairly standard issues included in miscellaneous provisions of many different types of contracts. Examples may include the manner in which notice between the parties shall be accomplished, confidentiality protections, and the extent to which and the manner of transfer and assignment of the agreement, among other provisions.
PART
SEVEN
Carbon Accounting Carbon Assets and Liabilities
21
The Carbon Ledger and Carbon Credit Accounting

A. Carbon Accounting
The term carbon accounting has not been used to refer to the issues about which the accounting standards boards have been debating for six or more years. Rather, the term has been used to describe the process of measuring the greenhouse gas (GHG) emissions of companies and facilities. Many voluntary standards like the Carbon Disclosure Project and others have been developed. The European Union Emissions Trading Scheme (EU ETS), the Environmental Protection Agency (EPA) GHG reporting rules, and several U.S. states have provided regulations governing the monitoring and reporting of GHG emissions. One or more of these standards have been used to measure and/or report GHG emissions. In this context, accounting means the measurement of and reporting of GHG emissions or the accounting of emissions, not financial accounting. The technical steps for measuring certain chemical emissions should not be confused with the accounting related to carbon credits or climate change or greenhouse-gas-related liabilities. This chapter will explore the assessment of a companys potential assets and liabilities as they relate to greenhouse gas emissions, emission allowances and offsets, and similar matters. Thus, the accounting will reflect a strategic consideration for business entities and then the actual financial accounting for those matters.
272 | C A R B O N A C C O U N T I N G C A R B O N A S S E T S
AND
LIABILITIES
B. Defining Carbon Assets and Liabilities

As discussed in more detail in Chapter 22, for many companies, obligations or pressure to measure, monitor, and manage their greenhouse gas emissions has arisen from many sources. Government legislation and regulation is the first source, but not the only one. Other entities pressure companies to monitor and reduce their GHG emissions, including socially conscious investors, lenders, employees, and customers. These groups or entities may pressure companies to participate in voluntary programs such as the Carbon Disclosure Project, which was developed to set up a program for companies to disclose their GHG emissions and to state what steps they are taking to reduce those emissions. Thus, the liability side of GHG emissions includes the costs of measurement and monitoring as well as managing emissions. On the other hand, some companies have assets that relate to GHG emissions as well. In this chapter we will explore both assets and liabilities and how they can be identified, accounted for, and managed by companies. The potential costs under regulatory systems or pressures by shareholder or customers to monitor or manage GHG emissions may be considered liabilities. We will call these Carbon Liabilities. However, there are assets that companies have that relate to GHG emissions. Examples would be GHG allowances or offset credits. Other assets may be undeveloped, such as unregulated greenhouse gas emissions of a company that could be induced to generate GHG offsets and produce profits in their sale or in reducing costs under a current or future regulatory scheme. We will call these Carbon Assets. These are more practical definitions than accounting or legal definitions. We will discuss the accounting standards board approach to these issues in a more specific manner below. This discussion is directed at more generally understanding from a strategic perspective the terms Carbon Assets and Carbon Liabilities. Companies will find now and in the future that accounting for these Carbon Liabilities and Carbon Assets will be necessary. Under regulations and guidance issued by the U.S. Securities and Exchange Commission, as discussed in Chapter 22, liabilities for complying with GHG emissions regulations and other liabilities that may arise from climate regulation or climate change itself may require disclosure by public companies. Accounting for Carbon Liabilities and Carbon Offsets may be governed by applicable accounting standards as well. Depending on where the company is domiciled, Generally Accepted Accounting Principles (GAAP) issued by the Financial Accounting Standards Board (FASB) or standards issued by the International Accounting Standards Board (IASB) will apply to determine the accounting practices to address Carbon Liabilities and Carbon Assets.
THE CARBON LEDGER
AND
CARBON C REDIT ACCOUNTING
| 273
C. Forming a Carbon Ledger as Part of a Carbon Strategy

Many companies in the European Union have already been practicing carbon accounting as the laws of the European Union, as explained in Chapter 5, require monitoring and reporting of GHG emissions. In addition, because the EU ETS has imposed obligations for meeting emission limits through the use of allowances and offsets, the companies are required to account for these assets. In the United States, companies are now required to monitor and report their GHG emissions under the EPA GHG reporting rules. Many companies have participated in voluntary GHG reporting programs like the Carbon Disclosure Project in which they have also pledged to reduce their emissions, and to incur the costs for these emission management activities. Companies have typically conducted steps to identify, account for, and track Carbon Liabilities, and, where allowances and offsets are required to meet compliance obligations, they have accounted for Carbon Assets. However, the accounting for all Carbon Liabilities and Assets may require actions beyond the mandatory or typical voluntary reporting standards. A more complete analysis of the extent of liabilities and assets may be appropriate. To accomplish this, companies can establish a Carbon Ledger that identifies and measures Carbon Liabilities and Carbon Assets. To prepare a Carbon Ledger, it is first necessary to identify Carbon Liabilities. Examples may include the following:
Capital costsrequired for reductions in greenhouse gas emissions; Carbon allowances obligationsthe cost of allowances and offsets that must
be purchased and submitted to state or federal government each year to achieve compliance, or to achieve a commitment in a voluntary program such as the Chicago Climate Exchange or the Carbon Disclosure Project, or other voluntary pledge to reduce GHG emissions; Climate litigation for alleged damages to the environment, property, or economic in nature; Expenses for monitoring and reporting to voluntary GHG reporting programs; Expenses for complying with customer or market demands to address GHG emissions; Physical effect on or damage to markets, supply chains, or property; and Brand or corporate reputation detriment resulting from failure to manage GHG emissions.
AND
LIABILITIES
Other costs and expenses may be faced by companies with significant GHG emissions or that face other risks or liabilities as a result of market forces or legal requirements or claims. Carbon Assets are perhaps less understood. Carbon credits held in the form of allowances or offsets may be considered assets. Other Carbon Assets may be less well known and less developed. Some of the Carbon Assets companies may hold include the following:
Carbon allowances awarded by a government without charge; Contracts to purchase offsets at or below current market prices; Carbon futures and derivative positions; Carbon guaranties to provide credits if a carbon project developer or other
party fails to deliver carbon credits that have been contracted; Ability to reduce GHG emissions and sell excess carbon allowances; Ability to reduce GHG emissions and register them to ensure they are available for early action credits discussed in chapters 8 and 10; Ability to reduce GHG emissions of unregulated sources or facilities and sell carbon offsets; Ability to utilize carbon credits or biodiversity to reduce objections to mining, drilling for oil and gas, pipeline development, real estate development, or other activities for which governments or nongovernmental authorities object for environmental, climate change, ecological or species impact, or other related reasons; and Brand and corporate reputation enhancement and potentially market share improvement from managing GHG emissions.
Some of these potential Carbon Assets may be less understood or known by companies that have the potential to capture and monetize or otherwise use these assets for their benefit. The last potential asset may be the hardest to quantify, but may be of substantial value, depending on the industry or business. Many companies have GHG emissions that are not currently regulated or that are not likely to be regulated. Other companies have the ability to reduce emissions today to address public pressure from shareholders, customers, or other constituencies. In reviewing the ability and alternatives available to reduce GHG emissions, consideration should be given by companies to how these reductions may be registered and potentially transformed into carbon credits. Where economically the costs for validation and verification justify the attempt to obtain generation of carbon credits, either under a voluntary standard or in countries or states or provinces at the subnational level, generation of credits creates a new asset. The value of the credit would depend on the type of credits and the current market price. The value may be determined by future GHG
THE CARBON LEDGER
AND
| 275
regulation and whether the credits may be used in future compliance systems as offsets or whether the credits would qualify for early action allowances. As companies consider corporate strategies with respect to GHG emissions, the evaluation of Carbon Assets and Carbon Liabilities in the form of a Carbon Ledger would allow the company to better understand its current risks and opportunities with respect to climate change and greenhouse gas regulation and pressure from third parties. Thus, the Carbon Ledger provides a tool for management to evaluate the corporate strategy with respect to climate change and GHG issues.
D. Financial Accounting Treatment of Carbon Assets and Liabilities

When developing the strategic Carbon Ledger, financial accounting standards developed by the FASB and the IASB are important to consider, but they are central to actually preparing financial statements that contain accounting for assets and liabilities related to carbon credits and GHG regulation. Unfortunately, the accounting boards have not fully addressed these issues. A certain amount of uncertainty exists as to how the accounting standards boards will address carbon issues. In particular, standards for accounting for carbon allowances or offsets are not well defined. Carbon credits have similarities to intangible assets and inventory, but have differences from both. The question of how carbon credits should be valued is another question. They could be valued based on their cost basis or based on fair value derived from carbon markets. Accounting for the liability related to the obligation to obtain allowances to meet the statutory requirement for emissions of greenhouse gases remains an open question. As emissions occur, the regulated entity must obtain sufficient allowances or offsets for each ton of emissions. The question is if the liability should be measured by the market value of the allowances that must be obtained to meet the compliance obligation. If the fair market value is to be determined, when should that occur? How carbon credits will be accounted for under relevant standards is yet to be determined. A definitive decision regarding appropriate accounting is not expected until perhaps 2011. The accounting standards boards must address several issues in developing the accosting for carbon credits. The main issues that must be addressed include:
Initial recognition of allowances allocated without chargeat cost or fair
value (market value);

Initial recognition of allowances purchasedat cost or fair value;
AND
LIABILITIES
Subsequent treatment of allowances after initial receiptat cost or fair value; Recognition of liability to submit allowanceswhen emissions occur or
when allowances received; and Measurement of liabilityat cost or fair value. These issues have been a matter of discussion and development among the accounting boards for over six years. In 2004, it appeared that the IASB had settled on an approach for accounting for emissions rights, including carbon credits. The IASB issued an interpretation for emissions rights as follows:
Emission rights (allowances) are intangible assets that should be recognized
in the financial statements in accordance with standards for accounting for Intangible Assets. When allowances are issued to a participant by government (or government agency) for less than their fair value, the difference between the amount paid (if any) and their fair value is a government grant that is accounted for in accordance standards for Accounting for Government Grants and Disclosure of Government Assistance. As a participant produces emissions, it recognizes a provision for its obligation to deliver allowances in accordance with standards for Contingent Liabilities and Contingent Assets. These liabilities are normally measured at the market value of the allowances needed to settle them.1 In 2005, the IASB voted to withdraw this interpretation. One reason for the withdrawal was that the European Financial Accounting Advisory Group decided that the interpretation would not be endorsed for use in the European Union.2 In order to attempt to develop consistency internationally on these issues, the IASB began working with the FASB in the United States to develop accounting standards for cap and trade programs for air emissions, including accounting for allowances and offsets. In 2007, the IASB agreed to address the following key issues as part of its future work agenda:
Are the tradable permits in emission trading schemes (allowances and
credits) assets? If so: How should an entity account for any allowances that it receives from government for less than fair value?
1. International Accounting Standards Board, Emissions Trading Schemes, available at http:// www.iasplus.com/agenda/emissiontrading.htm (last visited Sept. 19, 2010). 2. Id.
THE CARBON LEDGER
AND
| 277
How should allowances and credits be accounted for? How should changes in assets and liabilities (arising from emission trading
schemes) be reported in profit or loss?3 In 2007, the IASB announced that it does not plan to issue a new interpretation but to draft a revision of either IAS 38 on Intangible Assets or IAS 39 on Financial Instruments: Recognition and Measurement to accommodate the accounting for tradable permits, and to draft a revision of IAS 20 on Accounting for Government Grants and Disclosure of Government Assistance so that the accounting for allowances (and similar assets) issued by governments free of charge is addressed.4 From 2008 to 2009, the staffs of the two boards made several presentations and developed papers on various issues related to accounting for emissions rights or credits. In February 2010, the IASB decided tentatively that an entity that receives emission allowances without charge from a governmental agency should recognize the allowances as assets and measure them at fair value. Under a cap and trade program, the same entity incurs an obligation under the relevant statute or regulations to reduce its emissions at a certain level, and the entity should recognize a liability for the obligation to pay for allowances throughout the commitment period. The IASB concluded that this liability exists irrespective of whether the entity has begun to emit GHGs for which it will be liable to submit allowances during the commitment period.5 Later in a meeting in September 2010, the IASB staff discussed the question of whether a corresponding liability exists and is recognized when an entity receives an allocation of allowances from the government under a cap and trade program. The staff presented the boards with two views: View 1The allocation creates a present obligation and there is a liability for the allocation. View 2The allocation is not a present obligation and thus no liability exists until the entity emits.6 The staffs further disaggregated View 1 into three alternative views on what the present obligation should be: View 1(a)an obligation to refrain from emitting to keep the allowances; View 1(b)an obligation to return the allowances (if the entity emits); or
3. Id. 4. Id. 5. Id. 6. Id.
AND
LIABILITIES
View 1(c)an obligation to comply with the scheme requirements, to refrain from emitting to keep the allowances or to return the allowances.7 It is not entirely clear when the IASB or the FASB will develop and issue more final conclusions on how carbon credits must be accounted for or how the related liability to submit allowances will be addressed. A decision on some issues has been proposed for 2011. Until these issues are resolved, there will remain a certain degree of uncertainty as to how to account for these assets and liabilities. Entities must use judgment in accounting for assets and liabilities defined by the accounting boards standards.
7. Id.
22
Climate Risk Disclosure

A. Corporate Climate Change Liabilities1
Climate change disclosure, or climate risk disclosure, has increasingly become an important issue for publicly traded companies when preparing financial disclosures for public stock or public debt offerings or periodic reports submitted to the Securities and Exchange Commission (SEC). After the U.S. Supreme Court decision in Massachusetts v. EPA,2 declaring greenhouse gases (GHGs) are air pollutants under the Clean Air Act, the regulation of GHGs at the federal level appeared probable, at least through the Environmental Protection Agency (EPA). As discussed in Chapter 10, the EPA has moved forward with promulgating greenhouse gas regulation. Even if the Supreme Court had not ruled as it did, numerous bills have been filed in Congress to regulate GHG emissions. Passage of climate change legislation at the federal level seems unlikely at this time, but EPA has moved forward with GHG emissions regulation under the existing federal Clean Air Act. Some of the states are adopting GHG restrictions on their own, making GHG regulation a reality in certain regions of the United States. As a result, the challenge for publicly traded companies to determine what climate change disclosure may be appropriate has increased significantly. The New York attorney general has conducted an investigation of five utilities for alleged failure to adequately disclose climate risk under state securities laws. That same year, a group of institutional investors petitioned the SEC to issue an interpretive release
1. Portions of this chapter first appeared in the Newsletter of the American Bar Association Environmental Disclosure Committee. 2. 549 U.S. 1438 (2007).
AND
LIABILITIES
clarifying that material climate-related information must be included in corporate disclosures under existing law. As a result of this uncertainty and in response to the rulemaking petition, the SEC issued guidance for public companies in disclosing climate change matters in their filings with the agency. On the mandatory side of disclosure, it is important to understand how financial disclosure obligations may involve climate change risk based on the mandatory disclosure requirements promulgated by the SEC under the traditional securities laws and the requirements of the Sarbanes-Oxley Act (Sarbanes-Oxley), and particularly the SEC guidance regarding climate change disclosure. In addition, it is critical to appreciate disclosure pressures that extend beyond the mandated requirements of the SEC and Sarbanes-Oxley. The pressure for voluntary disclosure arises from initiatives and protocols developed by nongovernmental organizations (NGOs) that seek to create enough awareness among the public and institutional investors to compel companies to disclose environmental risk and impacts, and as a result to change their behavior to avoid future negative disclosure. NGO pressure on public companies and their investors and lenders has grown over the last decade. Because climate change disclosure involves issues of strategic importance to the company, the management and board of directors of public companies should be involved in the setting of policies and procedures for determining what will be disclosed. In doing so, it is key for management and directors to evaluate the many interconnected and interrelated entities and interest groups that may affect their economic success. As these entities and interest groups demand ever more information on environmental and corporate social responsibility, how companies manage climate change disclosure demands is becoming increasingly important in managing shareholder and public stakeholder expectations. For some companies with operations in states or countries where climate change regulation is already in effect or is in the process of being implemented, climate risk may present material financial effects on the company that may require discussion in their public disclosures. For other companies, any disclosure at this stage will be forward-looking, focusing on potential future risks. Even for these companies, the stage is rapidly changing, as U.S. states have or are preparing to impose restrictions on GHG emissions. Care must be taken in deciding what to disclosetoo little disclosure may not provide a full picture to investors; too much disclosure, particularly of inchoate or never realized financial effects, may not provide realistic information to investors. Another challenge is the degree to which companies can accurately predict impacts from potential regulation or how climate change may physically impact their operations or how
C L I M A T E R I S K D I S C L O S U R E | 281
climate issues may affect their corporate reputation as called for in the SEC guidance. Disclosure in these areas may present companies with the risk of speculation on how such impacts may evolve or occur at all. Significant developments in climate change regulation have occurred in the United States as discussed in chapters 8 to 11. U.S. legislation has been offered, but has only passed one house of Congress. The EPA has promulgated greenhouse gas reporting regulations and created a GHG registry. The EPA has also issued an Endangerment Finding and mandatory greenhouse gas regulations for mobile sources in terms of light-duty vehicles. The EPA has promulgated the Tailoring Rule to regulate greenhouse gases for certain stationary sources. Greenhouse gas monitoring and reporting rules have been adopted and issued by the EPA. As discussed in Chapter 8, ten northeastern statesthrough the Regional Greenhouse Gas Initiative (RGGI)California, western statesin the form of the Western Climate Initiative (WCI)and midwestern statesthrough the Midwestern Greenhouse Gas Reduction Accordare developing state-based programs to regulate greenhouse gas emissions, and to institute cap and trade programs. As these U.S. programs and other international programs and national programs, like the EU Emissions Trading Scheme, impose requirements on publicly traded corporations, the potential liabilities for these corporations continue to evolve. The question of the extent to which disclosure must be made under mandatory programs becomes a critical issue. Many public companies have chosen or have felt pressure to also participate in voluntary greenhouse gas, climate change, or sustainability programs that include greenhouse gas and climate disclosure. Climate change disclosure has become a permanent fixture of public company disclosure to the public and to inform investors. This chapter will provide a discussion of these disclosure issues and how companies can respond to the challenges presented by them.
B. Securities and Exchange Commission Regulations Governing Environmental Financial Disclosure

Based on the potential material effect that existing and developing regulatory programs may have, publicly traded companies should develop an appropriate strategy for climate risk disclosure. In doing so, public companies may have to manage disclosure in more than one formranging from SEC regulation to broader protocols for voluntary disclosure. Many larger companies have chosen
AND
LIABILITIES
to participate in these voluntary environmental, sustainability, or climate change disclosure programs. For these companies, disclosure takes on a broader process than simply attempting to comply with SEC regulations alone. SEC regulations involve several provisions that mandate disclosure surrounding environmental issues that implicate climate change issues, from new regulations imposing reductions in GHG emissions to litigation filed by plaintiffs seeking damages allegedly caused by a companys GHG emissions. For some companies, these regulations or litigation could have a potential material effect on financial costs, profits, and liabilities. In deciding what to disclose under any of the SECs rules, a public company must decide what information is material to investors and shareholders. The U.S. Supreme Court has concluded that information is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment decision, or if the information would alter the total mix of available information. A brief review of the specific SEC regulations is helpful in understanding the potential impact climate change disclosure issues may have on the content of a companys disclosure statements.
1. Item 101
Item 101 is an SEC regulation that requires companies to disclose material effects that compliance with environmental laws will have on earnings, competitive position, and capital expenditures.3 Specifically, the rule requires disclosure of estimated material capital expenditures for environmental control facilities for the current fiscal year, the next fiscal year, and further periods, if material.4 Climate change issues are implicated as those doing business in the European Union, for example, may be required to expend additional capital to reduce GHG emissions from their facilities in EU countries. As states impose restrictionssuch as California and states participating in the WCI, the RGGI, and the new Midwestern Greenhouse Gas Reduction Accord (MGGRA)companies with operations in those states must evaluate the extent to which disclosure is necessary of the costs to meet the greenhouse gas regulations of these jurisdictions.
2. Item 103
Item 103 requires that companies disclose legal proceedings, including those related to environmental and health issues.5 Environmentally-related proceedings include pending or known to be contemplated claims, including
3. 17 C.F.R. 229.101. 4. Id. 229.101(c)(1)(xii). 5. Id. 229.103.
administrative or judicial proceedings, even if initiated by the company itself. These proceedings must be material before they must be disclosed. The materiality issue has been specifically addressed for governmental proceedings. If a government agency is a party to the proceeding and monetary sanctions could reach $100,000 or more, whether or not otherwise material to the company, the company must disclose this proceeding.6 Climate change litigation against individual companies may be limited in the United States currently, but such litigation has been filed. Some plaintiffs attorneys have pledged to obtain civil damage awards for climate change litigation that exceeds what was obtained in the tobacco litigation.7 Any material climate change cases filed against publicly traded companies would have to be disclosed under Item 103. To the extent the New York attorney general proceeds with litigation against electric utility companies, claiming that these companies failed to disclose climate risk, these cases would likely have to be disclosed under this rule. It is necessary to keep in mind the low threshold for cases brought by government agencies.
3. Item 303
Item 303 requires that companies disclose, in the Management Discussion and Analysis (MD&A) section, known trends, events or uncertainties that may have a material effect on the companys financial condition.8 A 1989 SEC Interpretive Release emphasized that S-K 303 applies to environmental trends and uncertainties, such as anticipated new regulations and Superfund liabilities.9 This is the SEC regulation that may present the most immediate concern for publicly traded entities.
4. Item 503(c)
Item 503(c) requires disclosure about the most significant risks facing a publicly traded company.
C. Accounting Rules
The next level of concern for public (as well as privately held companies) involves disclosure required by the Generally Accepted Accounting Principles (GAAP).
6. Id. 229.103, Instructions, Item 5. 7. Lawyers Preparing for Explosion of Climate-related Work, The Dallas Morning News, June 25, 2007. 8. 17 C.F.R. 229.303. 9. Securities Act Release No. 33-6835 (May 18, 1989).
AND
LIABILITIES
In the environmental and safety context, the most important of these historically has been Financial Accounting Standard No. 5, Accounting for Loss Contingencies (FAS 5). FAS 5 would typically cover lawsuits and other claims for damages, such as Superfund liabilities. A more recent accounting standard, Financial Accounting Standard No. 143, Accounting for Asset Retirement Obligations (FAS 143), and the follow-on interpretation, Financial Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (FIN 47), apply to legal obligations that arise at the time of retirement of an asset. Since most climate change legislation includes a cap and trade program, GHG emission allowances or credits will need to be accounted for in the coming years. The Financial Accounting Standards Board (FASB) is currently engaged in a project to provide comprehensive accounting guidance for participants in emission allowance programs. The project will provide guidance on accounting for emission allowances and related liabilities.10 The development of this guidance is discussed in Chapter 21.
D. The Sarbanes-Oxley Act

Finally, Sarbanes-Oxley raises issues for public companies in the environmental disclosure context. Most prominent of these are Sections 302 and 906 that require CEOs and CFOs to certify that the financial statements fairly present the financial status of the company, and Sections 302 and 404 that require certain certifications that the internal controls established by the company are adequate to ensure the accuracy of financial statements. In addition, Section 404 requires that the independent financial auditor review and attest to the adequacy of the companys internal controls. Consideration should be given as to disclosures being made by companies to meet these requirements. Are climate risks being considered by CEOs and CFOs when they make certifications? Do the internal financial controls address climate risk issues? At what point would it be appropriate to include climate risks, such as new capital costs or liability risks, in Sarbanes-Oxley compliance programs?
E. SEC Enforcement
The importance of these internal controls as they relate to environmental reserves and disclosure was demonstrated in a recent SEC enforcement case against
10. Available at http://www.fasb.org/cs/ContentServer?c=FASBContent_C&pagename=FASB %2FFASBContent_C%2FProjectUpdatePage&cid=900000011097
Ashland Inc. (Ashland) and an environmental manager for alleged failure to properly record and report environmental financial liabilities.11 This case indicates the expectations of the SEC for corporate environmental disclosure and the necessary internal controls required for accurate disclosure. As a result of its factual and legal findings, the SEC ordered Ashland to take several steps, including to better document all adjustments to its environmental remediation estimates and to form a complete audit trail for environmental estimates with reasons for each adjustment. The SEC also required that Ashland retain PricewaterhouseCoopers (PWC) to review its policies, procedures, and internal controls relating to environment reserves, review its procedures to address internal complaints, and to submit the reports to Ashlands audit committee and the SEC. Finally, the SEC required that Ashlands audit committee or full board of directors review and adopt PWC recommendations, or develop and adopt alternative policies or procedures that are reviewed and approved by PWC. The SEC required participation in this process by the audit committee or the full board of directors, apparently placing the expectation of ultimate authority and responsibility for implementing adequate financial internal controls to monitor and report environmental disclosure on the board of directors. It is important to note that this case was decided on the law as it existed before the passage of Sarbanes-Oxley. The SEC expectations may be higher under SarbanesOxley. The importance of climate change disclosure should not be overlooked. Consideration should be given by the audit committee and, if it exists, the environmental committee of public companies to disclosure requirements as they apply to climate change and GHG emission regulations, and the impact these issues may have on a company and its current and future financial conditions.
F. SEC Guidance Regarding Disclosure Related to Climate Change

The environmental disclosure regulations, accounting rules, and SEC enforcement cases provided general guidance regarding environmental disclosure, but some level of clarity was missing in the context of climate change disclosure. As a result, on February 2, 2010, the SEC issued an interpretive release entitled, Commission Guidance Regarding Disclosure Related to Climate Change. The release states that it does not create any new rules or change any of the SECs disclosure requirements, but is designed to provide guidance to public companies
11. In re Ashland Inc. and William C. Olasin, SEC File No. 3-12487 (Nov. 29, 2006).
AND
LIABILITIES
regarding the SECs existing disclosure requirements as they apply to climate change matters.12 The SEC states that the four principal areas, which are discussed in more detail below, in which its rules may require disclosure relating to climate change are:
The impact of existing or pending legislation or regulations that relate to
climate change;
The effect of treaties or other international accords; The consequences, both positive and negative, including reputational harm,
of regulations or business trends; and The physical impacts of climate change.
1. Overview of Existing Disclosure Requirements

The rules that the SEC believes will be most likely to require disclosures in companies SEC filings are those discussed above. In deciding what to disclose under any of the SECs rules, a public company must decide what information is material to investors and shareholders. The U.S. Supreme Court has said that information is considered material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment decision, or if the information would alter the total mix of available information. In the release, the SEC points out that, under the relevant Supreme Court cases, a public company should resolve any doubts about materiality in favor of disclosure. In the release, the SEC also reviewed the requirements, initiatives, and other sources of information available regarding climate change and greenhouse gas emissions, in which many public companies have participated over the last several years, and listed the following disclosure programs:
The New York attorney generals recent settlement agreements with three
energy companies regarding their disclosures about their greenhouse gas emissions and potential liabilities resulting from climate change and related regulation; Greenhouse gas monitoring and reporting regulations issued by some states and now the U.S. Environmental Protection Agency (the EPA);
12. Commission Guidance Regarding Disclosure Related to Climate Change, Securities Act Release No. 33-9106, Exchange Act Release No. 34-61469, 75 Fed. Reg. 6290 (Feb. 8, 2010).
C L I M A T E R I S K D I S C L O S U R E | 287 The Climate Registry, a nonprofit collaboration among North American
states and provinces to calculate, verify, and publicly report greenhouse gas emissions for voluntary and state-mandated greenhouse gas emissions reporting; The Carbon Disclosure Project, which collects and distributes climate change information relating to emissions, risks, and opportunities faced by participating companies; and The Global Reporting Initiative, a sustainability reporting framework for companies regarding reporting of economic, environmental, and social performance, including issues involving climate change and greenhouse gases. The SEC points out that, while disclosures or reporting under many of these existing programs is voluntary and may include information that is not relevant to reporting under SEC regulations, registrants should be aware that some of the information that may be reported through these voluntary mechanisms also may be required to be disclosed in filings made to the SEC.
2. Climate Change-related Topics That May Require Disclosure

a. Impact of Legislation and Regulation The release analyzes how the SECs existing rules may require disclosure related to the impact of existing or pending legislation or regulatory initiatives, as follows:
Item 101 may require disclosure of capital costs incurred and to be incurred
relating to any regulation or legislation governing climate change or greenhouse gas emissions. Item 503(c) may require risk factor disclosure of existing or pending legislation or regulation. The guidance states that registrants should consider specific risks and avoid generic risk factor disclosure that could apply to any company. The SEC notes, for example, that an energy company that may be particularly sensitive to climate change regulation may be subject to significantly different risks compared to companies that are reliant on products that may emit greenhouse gases, such as those in the transportation sector. Item 303 requires analysis of whether climate legislation is reasonably likely to have a material effect on the registrants financial condition or results of operations. For pending legislation, which is a known uncertainty, a two-step analysis applies: First, management must evaluate whether the pending legislation or regulation is reasonably likely to be enacted. Unless management
AND
LIABILITIES
determines that it is not reasonably likely to be enacted, it must proceed on the assumption that it will be enacted. Second, management must determine whether, if enacted, the legislation or regulation is reasonably likely to have a material effect on the registrant, its financial condition, or results of operation. Unless management can determine that such a material effect is not reasonably likely, disclosure is required. If material, management must also disclose the difficulties involved in assessing the timing and effect of the pending legislation or regulation. One of the key issues raised in the interpretive release is found in the footnotes. In note 71, the guidance states that Management should ensure that it has sufficient information regarding the registrants greenhouse gas emissions and other operational matters to evaluate the likelihood of a material effect arising from the subject legislation or regulation. This note refers back to footnote 62, which discusses Exchange Act Rules 13a-15 and 15d-15, which require that the principal executive and financial officers must make certifications regarding the maintenance and effectiveness of a public companys disclosure controls and procedures. Thus, it appears that the gathering of greenhouse gas emissions data falls within the scope of these rules for purposes of evaluating the need to make disclosures relating to climate change and the effectiveness of disclosure controls and procedures to ensure that the information is collected, evaluated, and disclosed on a timely basis. Another significant point made by the guidance is that a registrant should not limit its disclosure to negative consequences, but must make disclosures about material new opportunities as well. For example, the guidance states that if a cap-and-trade-type system is put in place, a registrant may be able to profit from the sale of allowances if its emissions levels are below its emissions allotment. Those that are not covered by statutory emissions caps may be able to profit by selling offset credits for which they may qualify under climate change legislation or regulation. In order to illustrate these issues, the guidance lists examples of possible consequences of pending legislation and regulation related to climate change:
Costs to purchase, or profits from sales of, allowances or credits under a
cap-and-trade system;
Costs required to improve facilities and equipment to reduce emissions in
order to comply with regulatory limits or to mitigate the financial consequences of a cap-and-trade regime; and Changes to profit or loss arising from increased or decreased demand for goods and services produced by the registrant arising directly
from legislation or regulation, and indirectly from changes in costs of goods sold.
b. International Accords The guidance also directs registrants to consider and disclose, if material, the impact on their businesses of international accords on climate change or greenhouse gas regulation, such as the Kyoto Protocol. c. Indirect Consequences of Regulation or Business Trends The guidance states that indirect consequences, such as new opportunities or risks, may result from legal, technological, and scientific developments regarding climate change. Such developments may result in increased or decreased demand for products or services of particular companies. Examples provided are as follows:
Decreased demand for goods that produce significant greenhouse gas
emissions;
Increased demand for goods that result in lower emissions than competing
products;
Increased competition to develop innovative new products; Increased demand for generation and transmission of energy from alternative
energy sources; and Decreased demand for services related to carbon-based energy sources, such as drilling services or equipment maintenance services. The release states that disclosure about these business trends or risks may be required in the MD&A under Item 303, or in the business description under Item 101 of Regulation S-K. As an example, a company that plans to make changes in its product line or to take advantage of opportunities through material acquisitions of plants or equipment may be required to disclose these changes in its plan of operation under Item 101(a)(1). Another example offered is the potential impact of reputational damage where, because of a registrants sensitivity to public opinion, the publics perception of any available data relating to its greenhouse gas emissions could adversely affect its business operations or financial condition.
d. Physical Impacts of Climate Change The release states that any physical impacts of climate change must be reported, if material to the registrant. Climate change may have an effect on a registrants business, facilities, and operations through severe weather, sea-level rises, melting
AND
LIABILITIES
of permafrost, and temperature extremes. Examples of potential physical impacts to companies were identified as follows:
For registrants with operations concentrated on coastlines, property damage
and disruptions to operations, including manufacturing operations or the transport of manufactured products; Indirect financial and operational impacts from disruptions to the operations of major customers or suppliers from severe weather, such as hurricanes or floods; Increased insurance claims and liabilities for insurance and reinsurance companies; Decreased agricultural production capacity in areas affected by drought or other weather-related changes, which would affect agricultural companies directly, and other companies that rely on them as suppliers, indirectly; Increased insurance premiums and deductibles, or a decrease in the availability of coverage, for registrants with plants or operations in areas subject to severe weather; Changes in the availability or quality of water or other natural resources, damages to facilities or decreased efficiency of equipment, or decreases in consumer demand for products or services, such as heating fuels if temperatures increase; and Financial risks for some registrants, such as for banks whose borrowers assets are in at-risk areas.
Although the interpretive release does not purport to establish any new disclosure requirements, public companies should evaluate whether they have sufficiently detailed knowledge about their operations, including the level of greenhouse gas emissions, to satisfy existing disclosure requirements as interpreted by the SEC. One of the challenges for registered companies that are now subject to the SECs Guidance on climate risk is that the ability to predict an actual physical effect, and then to quantify the direct and indirect financial and market risks. Numeric calculations would in most cases be inherently speculative. Companies may find it difficult to state with any certainty whether these events will occur, and if they do, what the impact to the registrant might be. To overstate or speculate may have an adverse effect on prices for company stock, which in turn could adversely affect shareholders. A description of the difficulty or uncertainly in predicting these effects may be appropriate in any disclosure statements on climate risk.
Public companies should evaluate their current disclosure practices, including their disclosure controls and procedures, to ensure that information about environmental compliance and risks, the impact of new and proposed climate change laws and regulations and similar matters is collected and brought to the attention of the appropriate personnel in a timely manner, and that such information results in accurate, company-specific disclosure of all material information. Public companies should also monitor the disclosures they make about climate risk matters through other means to ensure consistency with their SEC filings.
G. Voluntary Climate Change Disclosure Protocols

Beyond SEC regulations, accounting standards, and Sarbanes-Oxley, a plethora of protocols have emerged for voluntary reporting of environmental matters. These voluntary disclosure protocols include disclosure of information regarding environmental, sustainability, corporate social responsibility, and, more recently, climate change and GHG emissions. These voluntary standards have evolved as a result of growing concern about corporate impacts on the environment and public health, but also at least in part as a result of the difficulty in achieving results through the more traditional regulatory system. The key to this approach has been in the area of institutional investing, particularly state pension funds. Finding like-minded people in decision-making roles in public pension funds, the NGOs have developed socially responsible investing groups and protocols, and utilized the power of the media and the Internet to launch public campaigns to convince companies to disclose their activities that affect the environment. In addition, sustainability and corporate social responsibility have been the watchwords for several years. Many public corporations began issuing sustainability reports. Shareholder initiatives that involve environmental matters began to be proposed at a greater frequency. Most recently, climate change has become the focus of socially responsible investors. Protocols for disclosing a companys carbon footprint and what they are doing about their GHG emissions have emerged. The NGO pressure has similarly reached the financial sector. Publicly funded and private banks have adopted lending principles such as the Equator Principles to provide environmental criteria to be used when making loans. 13
13. Http://www.equator-principles.com/.
AND
LIABILITIES
Pressure has also been placed on investment firms, some of whom have retreated from investing in certain industries. More recently, chemical manufacturers and oil companies have been facing numerous shareholder initiatives filed by socially responsible investors to protest products or practices they consider to be public health or environmental threats. These resolutions urge management to change corporate policies to reduce practices that the socially conscious investors believe are adversely impacting the environment. One of the most frequent demands in these shareholder initiatives in the last five years has been that public companies disclose the effect climate change and GHG regulation will have on their companies financial condition. For example, the Global Reporting Initiative, the Carbon Disclosure Project, and Global Framework for Climate Risk Disclosure focus on climate change reporting. Care must be taken in considering whether to engag in any of these programs, as the motivations and goals of the disclosure requirements or protocol may go well beyond true financial disclosure and instead address more regulatory disclosure. For example, one would not expect to disclose a companys GHG emission levels company-wide or by facilities in a financial report, but may do so in the context of a climate change regulatory program. In fact, measuring and reporting ones GHG emissions would be a fundamental aspect of such a regulatory system. The U.S. Environmental Protection Agency and several states have issued regulations requiring monitoring and reporting of GHG emissions from numerous industrial sources. Companies may report under state and federal GHG reporting rules as well as voluntary standards.
H. Voluntary Standards Evolving into Legal Requirements

The demand for voluntary disclosure sprung from NGOs, and in recent years, has extended to state pension funds, where state officials in charge of these funds with substantial investments in publicly traded companies have joined the call for voluntary disclosure. Recently, this voluntary call has evolved into a more pressing legal or mandatory demand. With respect to reporting actual emissions, Congress has passed a law whereby the EPA has promulgated regulations to require companies to report their environmental regulations and several states have passed similar legislation. Thus, voluntary reporting of greenhouse gas emissions has become mandatory.
I. Officer and Director Liability Environmental and Climate Risk Management

One of the growing concerns about the evolving mandatory financial disclosure obligations and voluntary disclosure demands are the roles and responsibilities, and thereby potential personally liability, of officers and directors for overseeing these issues. Clearly, the individual responsibilities and liabilities of the CEO and the CFO have been increased by Sarbanes-Oxley. Other developments over the last couple of years have contributed further to the potentially greater responsibility for officers and directors to manage the risks encountered and to ensure adequate disclosure is made regarding such risks. The case law regarding director liability and responsibility has been hinting at greater responsibility in the Delaware courts, long a reliable protector of directors. For example in the Caremark case,14 the Delaware court held that directors owe a fiduciary duty of care to the company they serve. To fulfill his or her duty of care, a director must make a good faith effort to be informed and to exercise appropriate judgment. The duty of care includes a duty to supervise the company, including maintaining procedures to monitor compliance with law. Directors do not have a duty to ferret out wrongdoing in the absence of a red flag; however, where there are facts or circumstances that would create suspicions in the mind of an ordinarily prudent director, directors have an affirmative duty to make reasonable inquiries and, if appropriate, to take action. To ensure that they are receiving adequate information upon which to base their judgment, directors must be satisfied that adequate reporting procedures are in place and being followed. As the Caremark court noted, relevant and timely information is an essential predicate for satisfaction of the boards supervisory and monitoring role. Furthermore, though directors are generally entitled to rely on reports of management, directors should critically review those reports (not just accept them blindly) and ask questions as necessary to become fully informed and to satisfy their concerns. The Caremark decision has taken on particular importance in light of the report issued by the expert panel that investigated the explosion at the BP Texas City refinery in March 2005. The expert panel led by Howard Baker issued the report (the Baker Report), which concluded that the company had not properly maintained safety policies and procedures, resulting in the explosion.
14. In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996).
AND
LIABILITIES
The Baker Report called on directors to participate in overseeing the companys safety planning and practices. The Baker Report and the Caremark case together suggest that a corporate director should exercise enough due diligence to understand health and safety issues relating to the operations of the company and to ensure that adequate information is being supplied to him or her to carry out the directors duty of care. In other words, there must be sufficient gathering and boiling down of information and presentation of that information so it is readily understandable by the director. The key to such a process is appropriate information flow and adequate metrics being provided to the directors. These developments may be raising the bar for directors as expectations for overseeing environmental and safety practices of their company are converging with growing expectations after the passage of Sarbanes-Oxley that directors increase their oversight of financial disclosure and internal controls to ensure fraud and inaccuracies are avoided in gathering, processing, and reporting corporate financial information. This convergence may be seen in the recent SEC order issued against Ashland, as discussed above, involving corporate environmental financial disclosure and internal controls. The decision by the SEC indicates the agency expects the audit committee, if not the full board, to exercise oversight of the internal controls used to gather and report environmental costs and liabilities and to properly report them to the public through securities filings. In light of such responsibilities, personal liability may arise for directors. A significant slide in the stock price of a company after an environmental liability becomes public knowledge could result in a shareholder suit against directors. When this occurs, a question exists as to whether officers and directors are covered by director and officer (D&O) insurance. A troubling appellate court decision has been issued on this topic. The U.S. Court of Appeals for the Fifth Circuit, in National Union Fire Insurance Co. Pittsburgh, P.A. v. U.S. Liquids, Inc.,15 ruled that the pollution exclusion in a D&O insurance policy effectively excluded claims filed by shareholders against directors and officers alleging they failed to disclose environmental liabilities in filings with the SEC and in press releases. As a result of this case, directors and officers need to not only evaluate their potential risk of being sued, but also whether they would be covered by corporate D&O insurance policies. If environmental exclusions apply to shareholder suits, the company may be able to purchase additional coverage so that directors are not left without recourse for defense costs and protection against an adverse judgment.
15. 2004 U.S. App. LEXIS 2694 (5th Cir. Feb. 17, 2004).
J. Conclusion
Environmental disclosure and risk management are inextricably intertwined, and no more relevant instance may exist over the coming years than in disclosure of climate risk. One particular challenge discussed above with respect to EPAs Guidance is the ability of companies to estimate some of the potential impacts that the SEC states should be considered for disclosure. Determining the potential for such impacts to occur, such as damage or disruption from extreme weather or sea level increases, or damage to reputation, may prove difficult, if not speculative. How these disclosures are evaluated and the language selected for particular disclosure statements may require a significant degree of care. Voluntary disclosure should be carefully considered in light of the information generated by the environmental management and environmental disclosure systems to ensure the accuracy of statements made to the public in any environmental or corporate social responsibility report. As a result, public companies should develop a practical approach to evaluate climate-related issues and formulate strategies for responding to the myriad regulatory requirements and other stakeholder pressures relating to climate risk disclosure.
Acronyms and Abbreviations
AAU ACR CCS CCX CDM CER CO2 CO2e DOE EB EC EIA EPA ERPA ERU ETS EU EU ETS EUA FERC GHG IETA IFC
Assigned Amount Unit American Carbon Registry Carbon Capture and Storage Chicago Climate Exchange Clean Development Mechanism Certified Emission Reduction (= 1 metric ton of CO2e) Carbon dioxide Carbon dioxide equivalent Designated Operational Entity Executive Board (of the CDM) European Commission Energy Information Administration U.S. Environmental Protection Agency Emissions Reduction Purchase Agreement Emission Reduction Units Emission Trading Scheme European Union European Union Emissions Trading Scheme European Union Allowance (= 1 metric ton CO2e) Federal Energy Regulatory Commission Greenhouse gas International Emissions Trading Association International Finance Corporation
298 | A C R O N Y M S
AND
A BBREVIATIONS
IPCC JI NAAQS NAMA NEPA PDD PoA PPA PSD REC REDD RGGI RPS UN UNFCCC U.S. VCS VCSA VCU VER WCI
International Panel on Climate Change Joint Implementation National Ambient Air Quality Standards Nationally Appropriate Mitigation Action National Environmental Policy Act Project Design Document Programme of Activities power purchase agreement Prevention of Significant Deterioration Program renewable energy credit Reducing Emissions from Deforestation and Forest Degradation Regional Greenhouse Gas Initiative Renewable Portfolio Standard United Nations United Nations Framework Convention on Climate Change United States Voluntary Carbon Standard Voluntary Carbon Standard Association Voluntary Carbon Unit Voluntary Emission Reduction Western Climate Initiative
Index
AB 32. See California Global Warming Solutions Act Additionality, 23, 35, 4344, 57, 67, 80, 15152 Agriculture, Forestry, and Other Land Use, 185 benchmarks, use of, 97 carbon credit project risks, 199 CAR Forest Protocol, 18889 Clean Development Mechanism, 4344 Cooperation by Multi-State Programs, 9798 defined, 23, 35, 4344 performance standards, use of, 9394, 9798 Proposed Regulation for a California Cap-and-Trade Program, 82 Regional Greenhouse Gas Initiative, 87 renewable energy projects, 178 Tool for the Demonstration and Assessment of Additionality, 4344 Western Climate Initiative, 9394 Afforestation, Reforestation, and Revegetation (ARR), 184 Africa impact of climate change on, 7 African Development Bank, 216 Agreements Establishing Project and Project Entity, 210 Agreements with Equipment and Manufacturers, 211 Agreements with Investors, 211 Agriculture, Forestry, and Other Land Use (AFOLU), 18387
additionality, 185 baseline, 185 leakage, 186 Methodology and Guidance, 184 monitoring, 18687 permanence and related carbon buffer, 186 Air pollutant, defined, 102 Alito, Samuel, 109 Allowances banking, 33, 56, 79, 16667 borrowing, 33, 56, 79, 167 defined, 31 emission, 1920, 3133, 55, 7779, 13941 regulation of, 37 trading, 33, 56, 79, 166 American Association for the Advancement of Science, 14 American Carbon Registry (ACR), 68, 81, 177, 190, 204 American Meteorological Society, 14 American National Standards Institute, 154 American Recovery and Reinvestment Act of 2009 (ARRA), 244, 245 funds for grants, 245, 24850 tax incentives to carbon credit projects, 24748 Anthropogenic warming, 6 APX Inc., 68, 256 Arbitrary and capricious standard, 104 Asia impact of climate change on, 7 Asian Development Bank, 216 Assigned Amount Units (AAUs), 45
300 | I N D E X
Auctions, 14144 main allowance auction, 14142 Market Stability Reserve auction, 14243 small business refiner reserve, 14344 Australia Carbon Pollution Reduction Scheme, 61 controversy over climate change, 12 forest carbon projects, 203 Kyoto Protocols restriction on GHG emissions, 22 National Stock Exchange of Australia Limited, 237 Water Exchange, 237 water quality trading, 237 water quantity trading, 237 Avoiding planned deforestation (APD), 183 Avoiding unplanned frontier deforestation and degradation (AUFDD), 184 Avoiding unplanned mosaic deforestation and degradation (AUMDD), 184 Bali Action Plan, 47 Bali Road Map, 47 Bank of America, 217 Banking allowances, 33, 56, 16667. See also Allowances defined, 33 European Union Emissions Trading Scheme, 53, 56 Proposed Regulation for a California Cap-and-Trade Program, 79 Proposed Legislation for a Federal Cap-and-Trade Program, 139 Regional Greenhouse Gas Initiative, 86 Western Climate Initiative, 92 Barclays, 217 Benchmark, 97 Berlin Mandate, 42 Best Available Control Technology (BACT), 126, 128, 129, 13132 Beyond Business as Usual (BBU), 23, 35, 188 BioCarbon Fund, 214, 215 Biodiversity credits, 23234 Black carbon, 27 Bloomberg New Energy Finance, 70 Bluenext, 257 BNP Paribas, 217 BOOM projects, 193 Borrowing allowances, 33, 56, 167. See also Allowances defined, 33 European Union Emissions Trading Scheme, 56 Proposed Regulation for a California Cap-and-Trade Program, 79 Proposed Legislation for a Federal Cap-and-Trade Program, 167 Regional Greenhouse Gas Initiative, 86 Western Climate Initiative, 92 BOT projects, 193 Boxer, Barbara, 33, 101n8 Brazil, 10, 47, 159, 169, 182 bilateral approach to GHG offsets, 50 National Academy of Sciences, 9 Breyer, Stephen, 103 Building Bridges: State of the Voluntary Carbon Markets 2010, 70 Bush, George W., 107, 244 Buyers compliance, 258 obligations of, 26364 voluntary, 258 Caisse des Dpts, 68 California, 7484. See also United States biodiversity credit program, 233 Climate Action Reserve, 80 Contractual issues in selling RECs, 229 Property Assessed Clean Energy Program, 250 Proposed Regulation for a California Cap-and-Trade Program, 7484 Renewable Portfolio Standard in, 222 Western Climate Initiative and, 88 California Air Resources Board (CARB), 75. See also Proposed Regulation for a California Cap-and-Trade Program California Climate Action Registry (CCAR), 187 California Environmental Quality Act, 108n35 California Global Warming Solutions Act, 27, 7475 California Health and Safety Code, 83 California Public Utilities Commission, 229 Canada carbon trading programs in, 6061 Environment Canada, 60 National Academy of Sciences, 8 water quality trading, 237 Cap, the defined, 30 European Union Emissions Trading Scheme, 54 Proposed Regulation for a California Cap-and-Trade Program, 77 Proposed Legislation for a Federal Cap-and-Trade Program, 138 Regional Greenhouse Gas Initiative, 85 setting, 13839 Western Climate Initiative, 9091
I N D E X | 301
Cap and trade systems, 1821, 2538 additionality, 35, 57 banking allowances, 33, 56 borrowing allowances, 33, 56 defined, 5455 early action, 36, 57 emission allowances, 31, 55 emission allowances, allocation of, 3133, 55 emissions threshold, determining, 28 enforcement of, 38, 58 new or expanded facilities, 3637, 57 offsets, 31, 34, 35, 37, 56 permitting, 3031 regulated gases, defining, 2528 regulated sources, determining, 2830, 55 regulatory agencies, 37 safety valve and international competitiveness, 34 setting, 30 supplementarity and linkage to, 3536, 56 trading allowances, 33, 56 in United States, 2021 Carbon accounting, 271 for reversals, 153 Carbon Assets, 27278 financial accounting treatment of, 27578 Carbon capture & sequestration (CCS), 91 Carbon capture and storage (CCS), 19092 government tax incentives for, 24647 Carbon credit, 31, 41, 42, 275 fungible commodity vs. differentiation of, 258 risk and price, 259 types of, 255 voluntary, source of demand for, 65 Carbon credit project avoided deforestation and reforestation, 18090 carbon capture and storage, 19092 energy efficiency, 178 fuel switching, 180 government incentives for, 24345 landfill methane gas recovery projects, 17879 lenders and investors, 21417 natural gas production and distribution projects, 17980 renewable energy, 17778 types and methodologies, 17592 and water credits, 23839 Carbon credit project development, 193206 approval process, 19699 basics of, 194 examples of, 200206 feasibility study for, 19495, 196 host country approval, 197 idea note, 196 implementation and monitoring, 198 issuance of credits, 198 Project Design Document, 19697 registration, 19798 risks of, 199200 stakeholder participation requirement, 197 validation by designated operational entity, 197 verification and certification, 198 Voluntary Carbon Standard process, 19899 Carbon Disclosure Project, 27173, 287, 292 Carbon Fed, 34 Carbon finance, 20717. See also Financing carbon projects; Project finance basic elements of, 21114 Carbon Finance Unit (CFU), 214, 215 Carbon Fund for Europe, 214 Carbon funds, 18 Carbon indexes, 25758 Carbon Ledger, forming, 27375 Carbon Liabilities, 27278 financial accounting treatment of, 27578 Carbon offset creation, 14748. See also Offsets Carbon Partnership Facility, 214 Carbon Pollution Reduction Scheme (CPRS) (Australia), 61 Carbon registry, 14445 Carbon trading carbon credit risk and price, 259 carbon credits, types of, 255 carbon indexes, 25758 contractual issues in. See Contractual issues in carbon trading fungible commodity vs. differentiation, 258 future vs. spot markets, 257 global carbon markets, state of, 25960 investors and speculators, 25859 off-take agreements, 257 primary markets and bilateral agreements, 256 regulatory commodity, 255 secondary markets and exchanges, 25657 voluntary and compliance buyers, 258 Caremark case, 29394 Cause or Contribute Finding, Environmental Protection Agency, 125 CDM Executive Board, 23 Center for Biological Diversity v. NHTA, 108n35 Certified Emission Reduction (CER), 23, 44, 56, 62, 63, 7273, 180, 196, 207, 216, 255, 263
302 | I N D E X
Chamber of Commerce, U.S., 13 Charismatic credits, 37 Chesapeake Bay Nutrient Credit Exchange Program, 238 Chicago Climate Exchange (CCX), 63, 66, 71, 204, 256, 273 China, 10, 159, 169 bilateral approach to GHG offsets, 50 carbon trading programs in, 63 Kyoto Protocols restriction on GHG emissions, 22 National Academy of Sciences, 9 China National Petroleum Corp., 63 Chu, Steven, 10 CitiBank, 217 Clean Air Act of 1990 (CAA), 18, 20, 9916, 122, 123, 126, 132, 133, 139, 172, 279 Clean Development Mechanism Market, 7273. See also Markets Clean Development Mechanism (CDM), 18, 2223, 5354, 57, 62, 63, 9394, 146, 154, 17576, 179, 180, 192, 195, 204, 207, 215, 267. See also Kyoto Protocol carbon credit approval process under, 19699 Certified Emission Reductions, 255, 263 Executive Board, 4344, 46, 49, 50, 67 Project of Activities, 68 reforestation/afforestation methodology, 190 Clean Water Act (CWA), 23132, 238 Climate Action Reserve (CAR), 181, 182, 190 additionality, 18889 baseline, 188 Forest Project Protocol (FPP), 18790 Forest Verification Protocol (FVP), 187 leakage, 189 monitoring, 190 permanence and related carbon buffer, 18990 Climate Change Capital, 217 Climate change disclosure. See Climate risk disclosure Climate change science controversy over, 1215 development of, 315 environmental regulation and, 4 future policy development, 15 scientific institutions, conclusions of, 511 scientific institutions, policy impact of conclusions of, 12 Climate Change Science: An Analysis of Some Key Questions, 11 Climate Gate, 13 Climate Group, 66 Climate Registry, The, 287 Climate Reserve Tons (CRTs), 190 Climate risk disclosure, 27995 liabilities, 27981 officer and director liability environmental and, 29394 Sarbanes-Oxley Act, 280, 284, 285, 291, 293 Securities and Exchange Commission regulations governing. See Securities and Exchange Commission voluntary climate change disclosure protocols, 29192 voluntary standards, legal requirements for, 292 Climate, Community, and Biodiversity Alliance (CCBA), 69, 205 Climex, 257 CO2 Allowance Trading Accounts (COATs), 86 Cohens v. Virginia, 112n52 Coke Oven Environmental Task Force v. EPA, 107n34 Columbia Renewable Portfolio Standard in, 222 Comer v. Murphy Oil, 108, 111, 112, 112n51 Command and control model, 1617, 127 Commodities Futures Exchange Commission, 171 Commodity, 221 fungible commodity vs. differentiation, 258 regulatory, 255 Community Development Carbon Fund, 214 Compliance with greenhouse gas emission requirements, 16366 Compliance or mandatory markets, 64. See also Markets Comprehensive Environmental Response, Compensation, and Liability Act, 231 Conditions precedent, 26162 Conference of the Parties (COP), 42, 45, 46 Congress, U.S., 12, 16, 27, 28, 30, 32, 34, 35, 49, 61, 74, 100, 101, 103, 106, 107, 112, 114, 116, 117, 125, 133, 146, 155, 181, 182, 203, 245, 279, 281, 292 Connecticut Energy efficiency credits in, 225 Connecticut v. American Electric Power, 108n37, 10910, 110n39, 110n44 Conning, 217 Constellation Energy, 256
I N D E X | 303
Contractual issues in carbon trading. See also Carbon trading conditions precedent, 26162 default, 26566 defined, 261 delivery, 262 dispute resolution, 267 force majeure, 267 law and venue, choice of, 266 liability, limitation of, 267 obligations of buyer, 26364 obligations of seller, 263 payment, 26263 price, 262 quantity, 262 remedies, 266 representations, 26465 share of proceeds and taxes, 265 termination, 266 warranties, 26465 Contractual issues in selling RECs inside California, 229. See also California Contractual issues in selling RECs change in law, 228 credit, vintage of, 227 credits, types of, 22627 delivery, 228 effective date and termination, 228 payment, 22728 pricing, 227 quantity being sold, 227 remedies and damages, 228 representations and warranties, 228 transfer mechanism, 227 Copenhagen Accord, 48 Corporate climate change liabilities, 27981. See also Liability(ies) Covered entities, 7576, 79, 13638, 16465 Covered gases Prevention of Significant Deterioration Program, 129 Credit stacking, 23435 Credit Suisse, 217, 256 Crediting periods, 153 Danish Carbon Fund, 214 Debt, 20910 Default, 26566 Delivery of carbon credits, 262 Department of Energy, U.S. (DOE), 245 Guidelines for the Loan Guarantee Program, 250 Designated National Authority (DNA), 197 Designated Operational Entity (DOE), 23, 43, 197 Deutsche Bank, 217 Developed countries national academies of sciences, 811 Developing countries national academies of sciences, 811 Development bonds, 251 Differentiation of carbon credits. See also carbon credits fungible commodity vs., 258 Dispute resolution, 267 Double Approval Process, 67 Early action, 17071 defining, 36 European Union Emissions Trading Scheme, 57 Proposed Regulation for a California Cap-and-Trade Program, 83 Proposed Legislation for a Federal Cap-and-Trade Program, 155, 170 Regional Greenhouse Gas Initiative, 87 Western Climate Initiative, 94 Economics vs. the environment, 1617 emissions trading, bridging, 1718 Ecosystem Marketplace, 70 Ecosystem services, 23035 Emergency Economic Stabilization Act of 2008 (EESA), 244 tax incentives to carbon credit projects, 24647 Emergency Planning and Community Right-to-Know Act, 116, 116n7 Emission allowances, 1920, 31, 55, 13940. See also Allowances allocation of, 3133, 55, 7779, 9192, 14041 Proposed Regulation for a California Cap-and-Trade Program, 77 Regional Greenhouse Gas Initiative, 86 Western Climate Initiative, 91 Emission Reduction Tons (ERTs), 68 Emission Reduction Units (ERUs), 22, 44, 255 Emissions Reduction Purchase Agreement (ERPA), 21013, 256, 257, 259, 261, 262, 264 Emissions threshold, 13536 determining, 28 Emitters of greenhouse gases, 13637 Endangerment Finding, Environmental Protection Agency, 13, 107, 12425 Energy efficiency, 178 conservation, government tax incentives for, 246 credits, 225
304 | I N D E X
Energy Policy Act of 2005, 250 Enforcement defined, 38 European Union Emissions Trading Scheme, 58 Proposed Regulation for a California Cap-and-Trade Program, 8384 Proposed Legislation for a Federal Cap-and-Trade Program, 172 Regional Greenhouse Gas Initiative, 88 Western Climate Initiative, 95 Engineering, Procurement, and Construction Agreements (EPC Agreements), 210 Ensuring Real Reductions in Industrial Emissions, 168 Environment vs. economics, 1617 Environment Canada, 60. See also Canada Environmental attributes, 22122 Environmental Defense Fund (EDF), 2021 Environmental markets. See also Markets emergence of, 17 working, 24 Environmental Protection Agency, U.S. (EPA), 16, 27, 11432, 13942, 14448, 158, 203, 23738, 271, 279, 281, 286, 292). See also Massachusetts v. EPA, U.S. Supreme Court opinion in Cause or Contribute Finding, 125 Endangerment Finding, 13, 107, 12425 Greenhouse Gas Reporting Rule. See Greenhouse Gas Reporting Rule Johnson Memo, 12526 Mobile Source Rule, 126 Tailoring Rule, 12632 Environmental regulation, evolution of, 17 Environmental Resources Trust (ERT), 68 Equator Principles, 292 Equity, 209 Europe impact of climate change on, 8 European Bank for Reconstruction and Development, 216 European Carbon Fund, 217 European Climate Exchange (ECX), 256, 257 European Commission (EC), 32, 55 European Investment Bank, 216 European Market, 7172. See also Markets European Union (EU), 22, 24, 50, 169, 203, 204, 273 Emissions Trading Scheme, 44 Policy on Climate Change, 52 European Union Allowances (EUAs), 53, 54, 71, 255, 25657 European Union Emissions Trading Scheme (EU ETS), 26, 1819, 22, 24, 5258, 7172, 175, 203, 204, 271, 273, 281 additionality, 57 banking allowances, 33, 56 borrowing allowances, 56 cap, defining, 5455 carbon allowance requirement under, 3536 early action, 57 emission allowances, 55 emission allowances, allocation of, 32, 55 enforcement, 58 European Union Allowances, 255, 25657 greenhouse gases, permitting emissions of, 55 new or expanded facilities, 57 offsets, 56 Phase I (20052007), 53 Phase II (20082012), 5354 Phase III (20132020), 54 regulated sources, defining, 55 regulated sources, determining, 2829 safety valve and international competitiveness, 56 supplementarity, 57 trading allowances, 56 Export-Import Bank, U.S., 216 Feasibility study, for carbon credit project development, 19495 Federal Energy Regulatory Commission (FERC), 203 Federal legislation on climate change, development of, 13372 auctions, 14144 banking allowances, 16667 borrowing allowances, 167 cap, setting, 13839 carbon registry, 14445 compliance with greenhouse gas emission requirements, 16366 Covered Entities, 13638 early action, 17071 emission allowances, 13940 emission thresholds, 13536 enforcement, 172 greenhouse gases, permitting emissions of, 139 offsets, 14563 regulated gases, defining, 13335 regulatory agency or agencies, 171 safety valve international competitiveness, 16769 supplementarity, 16970 trading allowances and offsets, 166 Financial accounting treatment of carbon assets and liabilities, 27578
I N D E X | 305
Financial Accounting Standards Board (FASB), 272, 275, 276, 284 Financing carbon projects, 207. See also Carbon finance; Project finance Florida. See also United States biodiversity credit program, 234 cap-and-trade programs in, 84 Department of Environmental Protection, 84 Fish and Wildlife Service, U.S., 234 Florida Climate Protection Act, 84 Florida Fish and Wildlife Conservation Commission, 234 Force majeure, 267 Forest Carbon Partnership, 215 Forest Carbon Partnership Facility, 214 Forest carbon projects, 2036 risks of, 2056 role in compliance systems, 204 Forest Project Protocol (FPP), Climate Action Reserve, 18790 additionality, 18889 baseline, 188 leakage, 189 monitoring, 190 permanence and related carbon buffer, 18990 Forest Verification Protocol (FVP), Climate Action Reserve, 187 Forestry or land-management projects, environmental considerations for, 15657 Fortis, 217 Forward capacity markets, 22526. See also Markets France National Academy of Sciences, 8 Friends of the Earth v. Mosbacher, 108n35 Fuel switching, 180 Fugitive emissions, 16566 Future vs. spot markets, 257. See also Markets Gazprom Marketing & Trading Ltd., 50 Generally Accepted Accounting Principles (GAAP), 272, 283 Georgia v. Tennessee Copper Co., 1023, 102n14, 103n15 Germany National Academy of Sciences, 8 Gillard, Julia, 61 Global Framework for Climate Risk Disclosure, 292 Global Reporting Initiative, 287, 292 Goldenberg, Jos, 10 Goldman Sachs, 217 Government grants, 245, 24850 Government incentives to enhance carbon credit projects, use of, 24345 Government loan guarantees, 250 Government tax incentives, 24548 for carbon capture and storage, 24647 for energy efficiency and conservation, 246 for renewable energy, 246 for transportation and domestic fuel, 247 Green Exchange with Evolution Markets Inc., The, 256 Greenhouse effect, 5 Greenhouse gas emissions cap and trade systems for, 2538 regulation of, 37, 171 Greenhouse Gas Reporting Rule, 11523 certification and verification, 121 covered facilities, 11720 covered gases, 117 enforcement actions against facilities, 123 information, reporting, 12122 monitoring and measurement, 121 penalties for failure to comply, 123 public availability of information, 122 reporting regulation requirements, exiting, 123 Greenhouse Gas-Credit Aggregation Pool, 217 Greenhouse gases (GHGs) emitters of, 13637 permitting emissions of, 55 producers or importers of, 138 Greenhouse gases, permitting emissions of, 139 Proposed Regulation for a California Cap-and-Trade Program, 77 Regional Greenhouse Gas Initiative, 86 Western Climate Initiative, 91 Grey K Environmental Fund, 217 Grouped Projects, 68 Hawaii Renewable Portfolio Standard in, 222 Henninger, Daniel, 1314 ICAP, 256 ICECAP, 217 Iceland Kyoto Protocols restriction on GHG emissions, 22 Improved Forest Management (IFM), 184 Increasing water demand and decreasing water supply, 237 India, 159, 169 bilateral approach to GHG offsets, 50 Kyoto Protocols restriction on GHG emissions, 22 National Academy of Sciences, 9
306 | I N D E X
Indonesia Bali Action Plan, 47 Industrial Sector, 168 Industrial Stationary Sources, 164 Inhofe, James, 101n8 InterAcademy Council Lighting the Way: Toward a Sustainable Energy Future, 10 Inter-American Development Bank (IDB), 216 Intercompany Agreements, 210 Intercontinental Exchange Inc. (ICE), 256, 257 Intergovernmental Panel on Climate Change (IPCC), 41 Internal forest offsets, 16063 forested wetlands and peatlands, 163 national programs, 16062 program for low-emitting countries, 16263 project-based deforestation reduction credits, 163 state- or province-level programs, 162 Internal rate of return (IRR), 213, 214 International Accounting Standards Board (IASB), 272, 27578 emissions rights, interpretation for, 276 future work agenda, 27677 International Clean Energy Deployment Program, 152 International Emissions Trading Association (IETA), 49, 66, 19192 International Finance Corporation (IFC), 21416 International offsets. See also Offsets credits importation, sectoral approach for, 16869 forest offsets, 16063 general issues, 15758 issuance of credits, 159 sectoral credits, 15859 International Panel on Climate Change (IPCC), 58, 12, 14, 184 Investors, 25859 Issuance of credits, 155, 159, 198 Italian Carbon Fund, 214 Italy National Academy of Sciences, 8 Japan bilateral approach to GHG offsets, 4950 carbon trading programs in, 6163 forest carbon projects, 203, 204 Kyoto Protocol. See Kyoto Protocol National Academy of Sciences, 8 Japan Bank for International Cooperation ( JBIC), 50 Johnson Memo, 12526 Joint Implementation ( JI), 4445, 46, 53, 57 Emission Reduction Units, 255 JPMorgan, 217, 256 Kerry, John, 133 Kovacs, William, 13 Kyoto credits, 255 Kyoto Protocol, 12, 2223, 26, 30, 36, 52, 6162, 67, 13839, 181, 182, 212, 216, 289 Assigned Amount Units, 45 Clean Development Mechanism, 18, 2223, 4344, 5354, 57, 62, 63, 67, 68, 7273, 9394, 146, 154, 17576, 179, 180, 190, 19599, 204, 207, 215, 255, 263, 267 emissions trading, 4546 general; principles of, 4243 Joint Implementation ( JI), 4445, 53, 57 Kyoto Units, 46 Marrakesh Accords, 42, 4647 Meeting of the Parties, 46 Removal Unit, 45 restrictions on developing and developed countries, 22 Kyoto Units, 46 Land use, land-use change, and forestry (LULUCF), 45 Landfill methane, 201 Landfill methane gas recovery projects, 17879 Latin America impact of climate change on, 78 Law and venue, choice of, 266 Leakage, 78, 150, 15253, 182, 198 Agriculture, Forestry, and Other Land Use, 186 CAR Forest Protocol, 189 Carbon Capture and Storage, 191 Carbon Credit Project Types and Methodologies, 177 Carbon credit project risks, 205 defined, 78, 153 forest projects, 182 Proposed Legislation for a Federal Cap-and-Trade Program, 168 Tool to Calculate Baseline, Project, and/or Leakage Emissions from Electricity Consumption, 176 Tool to Calculate Project or Leakage CO2 Emissions from Fossil Fuel Combustion, 176
I N D E X | 307
Liability(ies) corporate climate change, 27981 limitation of, 267 Lighting the Way: Toward a Sustainable Energy Future, 10 Lindzen, Richard S., 12 Linkage, 3536, 169 Loan Agreements, 211 Long Island Sound Nitrogen Credit Exchange Program, 238 Louisiana. See also United States Property Assessed Clean Energy Program, 250 Main allowance auction, 14142. See also Auctions Market Reserve, 167 Market Stability Reserve auction, 14243. See also Auctions Markets Clean Development Market, 7273 compliance or mandatory, 64 emergence of environmental, 17 environmental, 64 European Market, 7172 forward capacity, 22526 future vs. spot, 257 global carbon markets, state of, 25960 pre-compliance, 65, 6970 primary, 256 secondary, 25657 voluntary, 6470 working carbon, 2124 Marrakesh Accords, 42, 4647 Massachusetts v. EPA, U.S. Supreme Court opinion in, 99113, 114, 116, 12426, 279 effect on cases filed under NEPA, 1078 effect on challenges to, 107 effect on tort suits, 1089 effect on vehicle-related greenhouse gas lawsuits, 107 federal common law litigation to impose emission reductions, 10911 federal statutory litigation, 100109 implications of, 1069 merits of, 1046 origins of, 1012 standing, issue of, 1023 standing for states to challenge federal administrative agency action, 109 state and federal common law litigation to obtain damages, 11113 state statutory litigation, 109 symbolic or political significance of, 106 Mayo Foundation v. Surface Transportation Board, 108n35 Merrill Lynch, 217, 256 Merzbach Mezzanine Carbon Fund, 217 Mexico, 48, 159, 169 bilateral approach to GHG offsets, 50 National Academy of Sciences, 9 Midwestern Greenhouse Gas Reduction Accord (MGGRA), 27, 81, 9596, 281 Mitsui, 217 Mobile Source Rule, Environmental Protection Agency, 126 Monitoring, reporting, and verification (MRV) requirements, 15455 Morgan Stanley Capital Group Inc., 217, 256 Multilateral Carbon Credit Fund, 216 National Academies of Science, 812, 23031 policy impact of conclusions of, 12 National Ambient Air Quality Standards (NAAQS), 127, 128 National Environmental Policy Act (NEPA), 1078 National Pollution Discharge Elimination System, 238 National Research Council, U.S., 11, 15 National Union Fire Insurance Co. Pittsburgh, P.A. v. U.S. Liquids, Inc., 294 Nationally Appropriate Mitigation Actions (NAMAs), 48 Native Village of Kivalina v. ExxonMobil Corporation, 112n53 Natural gas production and distribution projects, 17980 Natural Resources Defense Council v. Reclamation Board, 108n35 Netherlands CDM Facility, The, 214 Netherlands European Carbon Facility, The, 214 Nevada Energy efficiency credits in, 225 New Jersey Renewable Energy Credits in, 225 New Mexico. See also United States cap-and-trade programs in, 84 New Mexico Environment Department, 84 New Mexico Environmental Improvement Board, 84 Property Assessed Clean Energy Program, 250
308 | I N D E X
New or expanded facilities, 3637, 171 European Union Emissions Trading Scheme, 57 Proposed Regulation for a California Cap-and-Trade Program, 83 Proposed Legislation for a Federal Cap-and-Trade Program, 171 Regional Greenhouse Gas Initiative, 88 Western Climate Initiative, 95 New Orleans Pub. Serv., Inc. v. Council of the City of New Orleans, 112n52 New York. See also United States Property Assessed Clean Energy Program, 250 New York Mercantile Exchange, Inc., 256 New Zealand carbon trading programs in, 5960 water quality trading, 237 New Zealand Emissions Trading Scheme (NZ ETS), 5960 New Zealand Units (NZUs), 5960 Nitrogen Credit Advisory Board, 238 Nongovernmental organizations (NGOs), 31, 280 Nord Pool, 257 Nordic Development Fund, 216 Nordic Investment Bank, 216 North America impact of climate change on, 8 North American Development Bank, 216 North Carolina Renewable Portfolio Standard in, 222 North Carolina v. EPA, 127n27 NRDC v. EPA, 127n27 NYMEX Holdings, Inc., 256 NYSE Blue, 256 NYSE Euronext, 256 Obama, Barack, 107, 114, 115, 125, 244 Greenhouse Gas Reporting Rule and, 11523 Office of Management and Budget, 21 Officer and director liability environmental and climate risk management, 29394 Offsets, 19, 31, 34, 35, 56, 66, 14563 accounting for reversals, 153 approval of projects, 15354 carbon offset creation, 14748 covered entity, 146 crediting periods, 153 defined, 34, 145 early, 15556 European Union Emissions Trading Scheme, 56 forestry or land-management projects, environmental considerations for, 15657 international. See International offsets issuance of credits, 155 methodologies, 15053 monitoring, reporting, and verification requirements, 15455 project types, 14850 Proposed Regulation for a California Cap-and-Trade Program, 8082 Proposed Legislation for a Federal Cap-and-Trade Program, 14763 recordkeeping, 157 Regional Greenhouse Gas Initiative, 87 regulation of, 37, 171 retiring an, 14647 term, 146 trading allowances and, 166 Western Climate Initiative, 93 Offsets Integrity Advisory Board, 147, 148, 150 Off-take Agreements, 210, 257 Oil Pollution Act, 231 Operation and Maintenance Agreements, 211 Over the counter transaction, 37, 68 Overseas Private Investment Corporation (OPIC), 216, 211 Payment and carbon credits, 26263 Peaker plants, 22526 Pennsylvania Energy efficiency credits in, 225 Performance standard, 97 Pew Center on Global Climate Change, 222n1 Pollution rights, 19 Power purchase agreements (PPAs), 194, 208, 212 Pre-compliance markets, 65, 6970. See also Compliance or mandatory markets; Markets Prevention of Significant Deterioration (PSD) Program, 126, 12729 Price carbon credit risk and, 259 for carbon credits, 262 Primary forest, 181 Primary markets. See also Markets and bilateral agreements, 256 Project of Activities, 68 Project Design Document (PDD), 154, 177, 182 Project finance, 20711. See also Carbon finance; Financing carbon projects
I N D E X | 309
agreements, types of, 21011 debt, 20910 defined, 208 equity, 209 political risk with international projects, managing, 211 Property Assessed Clean Energy (PACE) Program, 25051 Proposed Regulation for a California Cap-and-Trade Program (California Air Resources Board), 7484 additionality, 82 banking allowances, 79 borrowing allowances, 79 cap, the, 77 early action, 83 emission allowances, 77 emission allowances, allocation of, 7779 enforcement, 8384 greenhouse gases, permitting emissions of, 77 new or expanded facilities, 83 offsets, 8082 regulated gases, 75 regulated sources, 7577 regulatory agency or agencies, 83 safety valve and competitiveness, 80 supplementarity, 8283 trading allowances, 79 Prototype Carbon Fund, 214 Quantified Emission Reductions and Limitation Commitment, 45 Quantity of carbon credits, 262 REC Sale Agreements, 211 Reducing Emissions from Deforestation and Forest Degradation (REDD), 2728, 47, 48, 81, 82, 18186, 190, 215, 235 Regional Greenhouse Gas Initiative (RGGI), 26, 32, 8588, 141, 260, 281 additionality, 87 banking allowances, 86 borrowing allowances, 86 cap, the, 85 early action, 87 emission allowances, 86 emission allowances, allocation of, 86 enforcement, 88 greenhouse gases, permitting emissions of, 86 new or expanded facilities, 88 offsets, 87 regulated gases, 85 regulated sources, 85 regulatory agency or agencies, 88 safety valve and international competitiveness, 87 supplementarity, 87 trading allowances, 86 Regulated gases defined, 2528, 13335 European Union Emissions Trading Scheme, 55 Proposed Regulation for a California Cap-and-Trade Program, 75 Proposed Legislation for a Federal Cap-and-Trade Program, 133 Regional Greenhouse Gas Initiative, 85 Western Climate Initiative, 90 Regulated sources determining, 55 European Union Emissions Trading Scheme, 55 Proposed Regulation for a California Cap-and-Trade Program, 7577 Proposed Legislation for a Federal Cap-and-Trade Program, 13638 Regional Greenhouse Gas Initiative, 85 Western Climate Initiative, 90 Regulatory agency or agencies, 171 greenhouse gas emissions, regulation of, 37 Proposed Regulation for a California Cap-and-Trade Program, 83 Proposed Legislation for a Federal Cap-and-Trade Program, 171 Regional Greenhouse Gas Initiative, 88 trading of allowances and offsets, regulation of, 37 Western Climate Initiative, 95 Regulatory commodity, 255. See also Commodity Remedies, 266 Removal Unit (RMU), 45 Renewable energy, 17778 credits (ERCs), 211, 222, 22425 government tax incentives for, 246 Renewable Energy Certificates, 224 Renewable Portfolio Standard (RPS), 22224 Representations and carbon credits ownership, 26465 Reversals, accounting for, 153 RNK Capital, 217 Roberts, John, 103, 109 Rudd, Kevin, 61 Russia bilateral approach to GHG offsets, 50 Kyoto Protocols restriction on GHG emissions, 22
310 | I N D E X
National Academy of Sciences, 8 Safety valve and international competitiveness, 34, 56, 16769 European Union Emissions Trading Scheme, 56 defined, 34 Proposed Regulation for a California Cap-and-Trade Program, 80 Proposed Legislation for a Federal Cap-and-Trade Program, 16769 Regional Greenhouse Gas Initiative, 87 Western Climate Initiative, 9293 Sandor, Richard, 66 Sarbanes-Oxley Act, 280, 284, 285, 291, 293 Scalia, Antonin, 103, 109 Secondary markets and exchanges, 25657. See also Markets Sectoral approach for the importation of international offset credits, 16869 Sectoral credits, 15859 Securities and Exchange Commission (SEC), 27991 climate change, physical impacts of, 28991 Commission Guidance Regarding Disclosure Related to Climate Change, 28591 enforcement case against Ashland Inc., 28485 environmental financial disclosure, regulations for, 28183 existing disclosure requirements, overview of, 28687 Financial Accounting Standards, 28384 Generally Accepted Accounting Principles, 272, 283 impact of legislation or regulatory initiatives on disclosures, 28789 indirect consequences of regulation or business trends, 289 international accords on climate change or greenhouse gas regulation, 289 Item 101, 282, 287 Item 101(a)(1), 289 Item 303, 28283, 28788 Item 503(c), 283, 287 Seller, obligations of, 263 Share of proceeds and taxes, 265 Small Business Refiners Reserve, 14344, 167 Social Carbon Standard, 204, 205 Socit Gnrale, 257 Solar projects, 2013 free-standing or utility-scale, 201 non-utility-scale, 2023 South Africa, 159, 169 bilateral approach to GHG offsets, 50 National Academy of Sciences, 9 Spanish Carbon Fund, 214 Speculators, 25859 Spot vs. future markets, 257. See also Markets State of the Voluntary Carbon Markets Report, The, 70 Sulfur dioxide emissions, 2021 Sumitomo, 217 Supplementarity, 3536, 57, 16970 defined, 3536 European Union Emissions Trading Scheme, 57 Proposed Regulation for a California Cap-and-Trade Program, 8283 Proposed Legislation for a Federal Cap-and-Trade Program, 16970 Regional Greenhouse Gas Initiative, 87 Western Climate Initiative, 94 Sustainable Energy and Climate Change IDB Special Program (SECCI IDB Fund), 216 Sustainable Energy and Climate Change Initiative (SECCI), 216 Tailoring Rule, Environmental Protection Agency, 12632 Best Available Control Technology, 126, 128, 129, 13132 covered gases, 129 Prevention of Significant Deterioration Program, application of, 12730 State Implementation Plans (SIPs), 132 Title V permitting applicability, 13031 Technology Licensing Agreements, 210 Termination, 266 Texas. See also United States Renewable Portfolio Standard in, 22224 Texas Public Utility Commission, 224 Property Assessed Clean Energy Program, 250 Thomas, Clarence, 109 Tianjin Property Rights Exchange, 63 Total Maximum Daily Loads (TMDL), 238 Trading allowances, 33, 56. See also Allowances and offsets, 166 European Union Emissions Trading Scheme, 56 Proposed Regulation for a California Cap-and-Trade Program, 79 Proposed Legislation for a Federal Cap-and-Trade Program, 166 Regional Greenhouse Gas Initiative, 86 regulation of, 171 Western Climate Initiative, 92
I N D E X | 311
Trading Emissions PLC, 217 Traditional pollutants, credits for, 225 Transportation and domestic fuel government tax incentives for, 247 Tudor Investment Corp., 256 Umbrella Carbon Facility T1, 214 Umbrella Carbon Facility T2, 214 UN Clean Development Mechanism Certified Emissions Reductions, 257 UN Framework Convention on Climate Change (UNFCCC), 21, 4142, 50, 190 Conference of the Parties, 42 Cooperative Mechanisms Programme, 191 United Kingdom National Academy of Sciences, 8 United Nations (UN), 18, 21, 23, 216, 255 Conference on Environment and Development, 41 Environment Program, 41 General Assembly of, 41 International Panel on Climate Change, 58, 12, 14, 184 United States, 69, 169. See also individual states Agency for International Development, 157, 159, 160 American Association for the Advancement of Science, 14 American Meteorological Society, 14 cap and trade system in, 2021 Chamber of Commerce, 13 Chesapeake Bay Nutrient Credit Exchange Program, 238 Chicago Climate Exchange, 66, 71 Clean Water Act, 238 controversy over climate change, 12 cooperation and potential linkage among multi-state programs, 9698 Department of Agriculture, 145, 148, 150, 155 Department of State, 157, 159, 160 Environmental Protection Agency. See Environmental Protection Agency, U.S. forest carbon projects, 203 Kyoto Protocols restriction on GHG emissions, 22 Long Island Sound Nitrogen Credit Exchange Program, 238 multi-state programs, 8595 National Academy of Sciences, 9, 11, 12, 15 National Research Council, 11, 15 Nitrogen Credit Advisory Board, 238 Proposed Regulation for a California Cap-and-Trade Program, 7484 Regional Greenhouse Gas Initiative, 8588 Renewable Energy Credits in, 225 Renewable Portfolio Standard in, 22224 state climate change programs, 74 Virginia Nutrient Credit Exchange Association, 238 water quality trading, 237 Utility incentives, 251 Virginia Nutrient Credit Exchange Association, 238 Voluntary carbon credits, 182 Voluntary Carbon Standard (VCS), 6668, 81, 190, 19899, 204, 255 Agriculture, Forestry, and Other Land Use, 18387 Double Approval Process, 67 Registry System, 68 Voluntary Carbon Standard Association (VCSA), 66, 67, 175, 177, 181, 182, 198 Voluntary Carbon Units (VCUs), 67, 68, 198, 255 Voluntary carbon markets, 6470. See also Markets carbon credits, source of demand for, 65 after compliance systems establishment, survival of, 70 current state of, 70 exchanges, 66 registries, 68 standards, 6465, 6668 Voluntary standards, legal requirements for, 292 Warranties and carbon credits ownership, 26465 Water credits carbon credit projects and, 23839 increasing water demand and decreasing water supply, 236 as tradable commodity, 23637 water quality trading, 23738 water quantity trading, 237 Waxman-Markey Bill, 27, 32 Welfare, defined, 102 Western Climate Initiative (WCI), 27, 75, 81, 8895, 141, 281 additionality, 9394 banking allowances, 92 borrowing allowances, 92 cap, the, 9091 early action, 94 emission allowances, 91 emission allowances, allocation of, 9192 enforcement, 95 goals of, 89
312 | I N D E X
Western Climate Initiative (WCI) (Contd) greenhouse gases, permitting emissions of, 91 new or expanded facilities, 95 offsets, 93 regulated gases, 90 regulated sources, 90 regulatory agency or agencies, 95 safety valve and international competitiveness, 9293 supplementarity, 94 trading allowances, 92 Wetlands credits and banking, 23132 Will, United States v., 112n52 Winrock International, 68 World Bank, 18, 72, 214 State and Trends of the Carbon Market 2010, 25960 World Economic Forum, 66 World Meteorological Organization, 41 World Resources Institute, 237

Carbon Trading Law

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Carbon Trading Law

Uploaded by

Copyright:

Available Formats

Carbon Trading Law and Practice

This page intentionally left blank