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California Compliance Offset Program: 2013 A Year in Review
Under California’s Cap-and-Trade Program, covered entities may use offset credits for up to 8 percent of their total compliance obligation for each compliance period. Offsets are tradable credits that represent verified GHG emission reductions in sectors and sources not covered under the cap. The inclusion of offsets in the program support the development of innovative projects and technologies from sources not subject to a compliance obligation. Below is a quick recap of the first year of California’s compliance offset program.
Public comment period open for the Nitrogen Management Minimum Data Standard – comments due January 24
New policy concerning manufacturer recommendations for meter maintenance
Golden CCOs and Risk
Guest blog by Julian Richardson, CEO of Parhelion Underwriting Ltd.
All that glitters is not gold!
The train has left the station and the California carbon market is now well on its way to its first birthday, and that in itself is worth celebrating for a program whose arrival was something of a challenging pregnancy and difficult birth. Nonetheless, this delay has given the ARB and other stakeholders the opportunity to benefit from the experiences and learn from the mistakes of other programs that started earlier – in particular the Clean Development Mechanism (CDM) and the European Emissions Trading Scheme (EU ETS).
One important lesson learned from those programs was the importance of being able to challenge and, indeed, revoke any offsets that were not of sufficient environmental robustness and integrity. This integrity is crucial for any trading mechanism allowing offsets for compliance use. Without it, public and commercial trust is lost and the program will fail.
To achieve this integrity, the ARB has included within its regulations the opportunity to ‘invalidate’ offset credits that should not have been issued – also known as ‘buyer liability.’ Whilst ensuring the integrity of the program must be paramount, it does come at a cost to program participants. In this instance, the cost of including ‘invalidation’ provisions is that on one hand stakeholders are being encouraged to create and invest in an asset (offset credits), but on the other hand that asset is un-certain.
In the market, this has led to the development of a range of different grades of offset assets that can be bought and sold. The market has adopted the term ‘CCO’ to refer to California Carbon Offset. More specifically we hear about ‘CCO8s’ and ‘CCO3s’ and ‘Golden CCOs.’ But what exactly are these different grades and what does the price difference reflect?
Well, as is normal in any commodity market, the price difference reflects different risk profiles. The ‘3’ and ‘8’ refers to the length of ‘invalidation’ risk associated with a particular offset. Offsets that have been verified once have a liability tail of 8 years during which they may be invalidated by the ARB. This tail may be reduced to 3 years by having a second verification done by a different approved verifier. Simple!
What is less clear, however, is what is meant by a ‘Golden CCO.’ If you ask 5 people what they understand the term to mean you get 7 different answers. Equally the term ‘CCO’ itself is only a market expression and not defined anywhere in the regulations – but we’ll ignore that for the moment. Critically the issue seems to be whether ‘Delivery Risk’ is part of making CCOs Golden.
Like the ARB, Parhelion has had the benefit of learning from other carbon markets. The first product Parhelion developed was indeed a ‘Delivery Wrap’ for CDM credits. Strictly speaking ‘delivery’ is not actually a risk; it is a consequence. It is important to focus on actual real risks that lead to non-delivery which are many and varied. They include but are not limited to:
- Regulatory risk
- Credit risk
- Physical risk
- Operational risk
- Technology risk
Each of the above risks can themselves be disaggregated. Parhelion identified over 70 individual risks that could lead to non-delivery of CERs. A similar set of risks will apply to the generation of offsets for the California market.
How ‘Delivery Risk’ applies to California offsets will depend on what is actually being sold. If a project developer is seeking to forward sell a future stream of offsets in order to raise finance for the project costs then Delivery Risk will constitute a significant proportion of any risk discount applied. The size of this delivery risk will also vary significantly from project to project and counter party to counter party.
If, however, the project developer has sufficient resources to develop the project to completion before selling any offsets, then they can sell physical offsets, be they ROCs / CRTs or ARBOCs. At this point Delivery Risk has been removed.
The only remaining risks are ‘Conversion Risk’ and ‘Invalidation Risk.’ Conversion Risk relates to whether a Registry Offset Credit (ROC) will be converted into an ARBOC. In view of the important QA/QC role played by the registries, such as the Climate Action Reserve, this risk is perceived as small, and as more ROCs are converted, I believe this risk will become insignificant.
This leaves ‘Invalidation Risk.’ Whilst Invalidation Risk is not in my view a large risk, it is a very real risk. The ARB has effectively dealt itself a ‘get out of jail free’ card should there be any questions over the robustness and integrity of the offset program. Therefore irrespective of the excellent work being done by project developers to implement good quality projects; and by verifiers to ensure accurate verification of offsets; and by CAR to implement QA/QC controls to ensure only fully compliant offsets are generated and issued at the registry level – the risk remains. Mistakes do happen and there have already been instances where registry-issued offsets have effectively been invalidated.
The figure below illustrates how offset price and risk change over project development time.
Since ‘Delivery Risk’ can be so different and only applies to forward contracts, it is not helpful to include it in the definition of ‘Golden CCOs.’ That’s not to say Delivery Risk is not relevant, it is. More importantly, however, Delivery Risk is extremely hard to define and extremely diverse. Therefore it is appropriate to define ‘Golden CCOs’ as issued offsets with no invalidation risk.
The question then remains: how do you deal with ‘invalidation risk’? There are three options for this. The first option is for the risk to remain with the seller. In this case, the seller will agree to indemnify the offset owner in the event of any invalidation. The problem here is that many offset project developers are not credit worthy counter parties and these promises are only as good as the credit rating behind them. Buyers seeking to impose this liability on sellers may consider requiring the seller to hold insurance or demonstrate satisfactory creditworthiness.
The second option is then for the buyer of the offset to retain the risk. This decision will be down to the risk appetite of the buyer. However, if the buyer is willing to take this risk they will pay a lower price to the offset project developer – not an attractive option for the developer who should be keen to maximise the price they can achieve for their assets.
The third option is, therefore, to transfer the risk to a third party with a demonstrable ability to pay and an established reputation for a willingness to pay in the event of a loss. With the support of CAR, Parhelion has developed such a solution. There is, of course, a price associated with this but that price is well within the market spread between CCO3s and Golden CCOs.
To conclude, I think that trying to include ‘Delivery Risk’ within a broad generic definition such as a Golden CCO is a distraction. As Aristotle said “It is the mark of an educated mind to rest satisfied with the degree of precision which the nature of the subject admits and not to seek exactness where only an approximation is possible.”
© Parhelion Underwriting Ltd. 2013
About Parhelion
Parhelion has been the pioneer and recognized leader in the field of non-traditional insurance and risk finance solutions for the clean energy and climate finance sectors. This has included the successful development of innovative insurance products for the carbon trading, renewable energy and clean energy markets. Parhelion’s products are supported by leading Lloyd’s of London, International and Bermudan re/insurers. Parhelion provides advisory services to policy makers, multi-lateral and international financial institutions; investors; trader and project developers.
New approach to international forestry offset projects is introduced to the global market with adoption of Climate Action Reserve protocol
(Spanish version posted on the Carbon Finance Platform (“Plataforma Finanzas Carbono”) website)
On October 23, 2013 the Climate Action Reserve, North America’s most trusted, experienced and knowledgeable carbon offset registry, approved a new methodology for quantifying international forestry offset projects. The Mexico Forest Protocol provides a standardized approach for quantifying, monitoring and verifying greenhouse gas (GHG) benefits of forest carbon enhancement activities in Mexico. It was specifically developed to allow integration into larger initiatives to address forestry and climate change under evolving Mexico REDD+ policies.
The product of several years of collaboration among a diverse and dedicated group of stakeholders, the Mexico Forest Protocol provides standardized guidance for carbon enhancement projects that addresses eligibility, baseline, inventory, permanence, social and environmental safeguards, and measurement, reporting and verification (MRV) requirements. The protocol provides accounting tools that enable multiple carbon enhancement activities to occur under one project implemented by individual landowners and/or local communities. The protocol design provides for efficient reconciliation of this project accounting framework with jurisdictional accounting, by creating a clear delineation between avoided deforestation, which will be credited under jurisdictional accounting rules, and enhanced carbon sequestration, which may be credited at the project level.
The protocol was developed with an unprecedented level of involvement from ejidos (local communities), and as a result, reflects a high level of social and environmental safeguards. Environmental and local community benefits from forest offset projects implemented under the Reserve’s Mexico Forest Protocol will include:
- Improved forest health and resiliency to climate change.
- Capacity building in communities and ejidos.
- Increased employment opportunities in forest communities.
- Significant improvements to biodiversity, water quality, and soil conservation.
Pilot Phase
The Mexico Forest Protocol is not currently open for project submissions from the general public. Instead, the Reserve is actively engaged in the development of a select number of pilot projects, which will allow the organization to learn from hands-on application of the protocol so that it may be improved and refined before being opened to the public more broadly.
The Reserve is working closely with several landowners and communities to ‘road test’ the protocol and develop software and other accounting tools to standardize monitoring and reporting activities. This deliberate process is intended to ensure the protocol is as clear and accurate as possible before being released for general use. Additionally, the Reserve will be working to facilitate investment by private entities, particularly entities operating in both Mexico and the United States, in the project credits generated under the protocol.
Currently, the Reserve’s efforts are focused on launching two to three initial pilot projects. Pilot projects are being developed with national and local non-governmental organizations (NGOs) in Mexico and are following the advice and guidance of CONAFOR (the Mexican National Forestry Commission) and CONABIO (the Mexican National Commission for Knowledge and Use of Biodiversity). One pilot project will be located in the state of Mexico and at least one pilot project will be located in the state of Oaxaca.
Seeking Partnerships
The Reserve has developed important partnerships throughout the process of developing the Mexico Forest Protocol. Current relationships with Mexican governmental agencies, NGOs, and communities in Mexico have been invaluable to creating a favorable environment for progress. The Reserve continues to seek a variety of additional partnerships that will improve the efficiencies and effectiveness of its work.
The Reserve is seeking corporate investors, private foundations, NGOs, and other potential partners interested in providing financial support and/or in-kind assistance to support the pilot forestry projects in Mexico. During this pilot phase, funding and in-kind assistance will enable the development of the data management systems and educational tools that the protocol will rely on for standardizing analysis and reporting. This pilot phase will also allow the Reserve to further refine protocol guidance, while creating real voluntary market offset credits that can be retired by pilot phase partners to demonstrate corporate and social responsibility.
For more information or to discuss potential partnerships, please contact the Climate Action Reserve at policy@climateactionreserve.org.
Mexico Forest Protocol Version 1.0 was adopted by the Reserve Board on October 23, 2013
Errata and Clarifications released for the U.S. Livestock Project Protocol Versions 4.0, 3.0, 2.2, 2.1, and 2.0
New approach to international forestry offset projects is introduced to the global market with adoption of Climate Action Reserve protocol
Board of Directors adopts Mexico Forest Protocol
SACRAMENTO, CA – Marking a milestone for the Climate Action Reserve – North America’s most trusted, experienced and knowledgeable carbon offset registry – and REDD+ initiatives, the Reserve Board of Directors today adopted the organization’s Mexico Forest Protocol. The protocol, which is the product of several years of collaboration, represents a new approach to international forestry offset projects. It was developed with an unprecedented level of involvement from ejidos (local communities), and as a result, reflects a high level of social and environmental safeguards. Another differentiating characteristic of the protocol is that it was developed with an emphasis on how it would be implemented in practice and how it would be viewed by policymakers in Mexico and California.
“The work of the Climate Action Reserve to support clean technologies and better forest management is precisely what we need to spur innovation in Mexico. This protocol will not only be of benefit there, but will support California’s ongoing efforts to reduce greenhouse gas emissions, while expanding business opportunities and job creation” said Senator Lou Correa (D-Santa Ana), who also chairs the Select Committee on California-Mexico Cooperation.
“The Climate Action Reserve’s work in developing rigorous forestry standards has garnered attention beyond U.S. borders, and the Mexico Forest Protocol is an excellent way to introduce this type of performance standard to international forests. It’s very characteristic of the Reserve’s work – collaborating closely with government agencies, environmental groups and the business community to develop a standard that protects forests and can be put to use in real world situations,” said Stephan Schwartzman, Director of Tropical Forest Policy at the Environmental Defense Fund.
The Mexico Forest Protocol provides a standardized approach for quantifying, monitoring and verifying greenhouse gas (GHG) benefits of forest carbon enhancement activities in Mexico. It can be integrated into larger initiatives to address forestry and climate change under evolving Mexico REDD+ policies, such as jurisdictional REDD+ programs. The protocol also creates a clear delineation between avoided deforestation, which will be credited under jurisdictional accounting rules, and enhanced carbon sequestration, which may be credited at the project level.
Like all other Reserve protocols, the Mexico Forest Protocol was developed through collaboration among a dedicated group of diverse stakeholders. Unlike all other Reserve protocols, the Mexico Forest Protocol will not be open for project submissions immediately after its adoption. Instead, the Reserve is actively engaged in the development of three pilot projects, which will allow the organization to learn from hands-on application of the protocol so that it may be improved and refined before being opened to the public more broadly. The pilot projects are being developed with national and local NGOs in Mexico and are following the advice and guidance of CONAFOR (the Mexican National Forestry Commission) and CONABIO (the Mexican National Commission for Knowledge and Use of Biodiversity). One pilot project is located in the state of Mexico and two pilot projects are located in the state of Oaxaca.
“We are proud that our protocol for forestry projects in Mexico is the result of dedicated collaboration by a group of truly engaged stakeholders from forest communities, nonprofits, and state and federal government agencies. This protocol is unique in that it reflects the opinions and values from these diverse stakeholders and that it takes special care to address issues specific to Mexico forests. We strongly believe that this will establish a strong foundation for creating forest offset credits with true environmental integrity that can be used in a multitude of markets,” said Linda Adams, Chair of the Climate Action Reserve Board of Directors and Founding Partner of Clean Tech Advocates.