The first follow-up to my recent post on carbon policy details.
First, a note to non-carbon-wonks: "Additionality" is a term of art in the world of carbon policy. It describes the degree to which a given activity causes additional carbon reductions -- the idea being that we shouldn't pay for carbon reductions that were going to occur anyway. As a fantastic oversimplification, suppose your car broke down and you had to ride your bike to work. The principle of additionality says you shouldn't be paid for the carbon you didn't emit. (You would have ridden anyway -- what choice did you have?) But if there's an increment of money that would tip you over into getting rid of your car and always riding your bike, that's additional.
Theoretically, great idea. Practically? Stupid.
To understand why, go back to the test I posited in my earlier post: Does the metric increase or decrease the rate at which we invest capital to lower GHG emissions?
The answer for additionality is not what you'd expect, for rather subtle reasons.
First off, let's note a couple truths:
- No one's wallet is infinite.
- Any reduction in GHG emissions is going to require a change to the status quo and, therefore, some capital investment.
Note that the capital investment may be small (in the case of a CFL) or large (in the case of CCS). It may represent a really good, no-brainer investment (CFLs, energy efficiency, etc.) or a really bad investment (again, see CCS). But someone's got to make a decision to spend that money. And since all wallets are finite, any policy that preferentially directs resources towards lower-return investments is a policy that fails to maximize GHG reduction.
Let's make it concrete. Suppose I have a million bucks. Should I invest that million bucks in something that saves 1,000 tons of GHG emissions per year and saves me $500,000/year in energy costs, or should I invest it in something that saves 100 tons of GHG emissions per year and costs me $500,000/year in operating costs with no associated savings? That should not be a hard question ... yet additionality tests make it so.
Why? Because additionality is a qualitative test. Too often it ends up being boiled down to financial metrics. Good investments, by virtue of being good, are judged to fall into the "you would have done that anyway" box, while bad investments, by virtue of being unable to attract sufficient capital, are deemed worthy of public incentive. Implicit is that public funds should only be put toward shoddy investments!
Worse, these tests are inadvertently hostile toward energy efficiency, which is the low-hanging fruit in the GHG-reduction orchard. If I can build a power plant that is 10 percent more efficient than the grid, it will generate a little bit of profit, but probably not enough to justify the capital investment. That means the resulting CO2 reductions could almost certainly be justified as "additional," since I can't make the investment without getting a public incentive to do so.
Now suppose instead I want to build a power plant that is 50 percent more efficient than the grid. That one has much lower operating costs and is much more profitable ... which makes it more likely to fail additionality tests.
And so the additionality test will drive capital toward suboptimal investments and slow the rate at which we lower atmospheric GHG concentrations.
In practice, this makes carbon markets that rely on additionality tests extremely transaction-cost intensive. Potential project investors are at pains to explain and document why they're not going to do this project without public support. Some of those explanations are true, some are bogus. But in all cases, it's a pain in the butt to do all that justification (read: lots of time and money spent to get paid for carbon reductions). That means fewer carbon reductions are going to made. Investors just don't want to go through the hassle of all that explainin'.
The irony is that we have good examples of carbon reduction markets that don't work this way. Renewable energy credits are assigned as an attribute of the power, on a $/MWh basis. Make more renewable MWh and you get more $, rather than having to spend more time explaining why you deserve payment despite the fact that you're making money.
We need to do the same with carbon emissions. Let's stop worrying so much about whether or not investors are making too much money lowering carbon. Far more important is that we start lowering carbon.
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Comments
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ngoddard Posted 11:03 pm
26 Mar 2008
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Sean Casten Posted 11:43 pm
26 Mar 2008
In theory, it would seem appropriate to me that if person X takes an action that lowers GHG emissions, they ought to get paid an amount of money based on the $/ton of GHG price x the number of GHGs they reduce.
In practice, let's look at what I have to do if I am going to sell emissions credits today (say, for this project, which will produce 40+ MW of fuel-free power in West Virginia - a state who's power supply is 95% coal. Since our customer will now buy 40 MW less power from the grid, that means 40 MW of coal-fired power that won't have to run, eliminating something on the order of 290,000 tons of CO2 per year).
First, I have to hire someone to provide the papertrail to demonstrate that we wouldn't do the project but for the carbon payment (per the additionality test). Then, I have to hire another independent person to provide an unbiased opinion as to how much CO2 is reduced for every MWh you don't buy in West Virginia. (This is a huge issue, and one that continually perplexes environmental regulators, because it requires an assumption about what happens beyond your battery limits.) Once that's done, I have an audited paper trail for some number of tons that can be presumed to be going away by virtue of the project. But I still don't have a buyer. So now (in our present, all voluntary market), I have to go out and try to find someone who will buy those tons from me. And this is where the issue of "charismatic carbon" comes in, because in voluntary markets, a ton of GHG reduction from a windmill is worth more than a ton of GHG reduction from a heat recovery project at a silicon factory. (Think: which one looks sexier in a picture when you walk into Whole Foods?)
This whole process is both a pain in the a*&, and also prone to being absurdly conservative. (We actually went through the process of getting this approved for sale on the Chicago Climate Exchange, and the combination of the deep understatement of the total tons - they assumed that any power we reduced would displace a combined cycle gas turbine, as opposed to the WV coal fleet - and the low cost per ton basically made it not worth the time to pursue.
Which is sad. Because if there's a place where you really need big incentives to reduce carbon, it's in a place like West Virginia, where the power is cheap and carbon-intensive. And the reasons why the process is goofy are not innate to CCX - they are found in virtually all of the structures folks contemplate for regulated markets as well. My whole point of this series of posts is to try and get folks to understand where those pitfalls are - stay tuned.
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John Dewey Posted 12:04 am
27 Mar 2008
Forgive me for being uninformed, but why put a tax on fossil fuels? If the objective is to reduce CO2 emissions (not my objective, by the way), why not tax CO2 emissions? If a fossil fuel user can figure out how to elimimate or reduce his CO2 emissions, why should he be taxed the same as one who cannot?
If a tax is ever going to be accepted, it must be revenue neutral. And it can't include a huge redistribution of wealth.
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Capster Posted 12:31 am
27 Mar 2008
I think you are approaching this from one viewpoint, which is OK, but there are a number of ways to look at additionality. Let's start with one of your assumptions, first. You say that "any reduction in GHG is going to require some capital investment". This is not correct. A change in status quo, perhaps. Using your car bike analogy - you made no capital investment, you just rode your bike (or mass transit) to work. You actually reduced your cost and the impact on GHG. I think there are other, more realtime and large scale examples in business.
Second, let's appproach additionality from another viewpoint. What if there is a project which could reduce GHG by 1000 tons, but is not economic for a company (investment does not meet ROI hurdle, for example). But if they value the GHG reductions, which is not a "public incentive" as you call it but a real cost of business, then the project becomes economic. And perhaps very economic, if the credits are worth enough. Then that project, which would not have otherwise been built, would be built.
Using your final question, if you want to build a plant that is 50% more efficient, has lower operating costs and is efficient - dude, why wouldn't you build that, additional or not?!? Additionality is a tool to get GHG reduction projects built, NOT to stop otherwise profitable projects from going forward. Additionality simply values carbon - that's it - and says that if a project would be done on its economic merits, then it gets no value for the carbon. But for projects on the margin, this gives them a boost. It actually should increase the number of GHG reducing projects.
My company (large multi-national energy) has had plenty of internal discussions on this. We think that without additionality, carbon offsets are, to be blunt, complete crap. To be honest, and you can tell me if I'm wrong, you are looking at this as a project developer, with a perhaps too narrow view of this issue. We see this as a necessary issue for credibility in the offset market. CCX, quite frankly, in our eyes is not credible, because their "tests" are so limited. Center for Resource Solutions (the Green-e people, for those who don't know) has proposed much more stringent rules around offsets, and we agree with them. In the end, credibility will be critical in these markets.
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amazingdrx Posted 1:02 am
27 Mar 2008
Too many theory laden terms, too much economics that I suspect no one really understands. I realize it is hard to explain. But if you can't explain it to the average voter, do you really in fact understand it yourself?
Or is it self delusion, industry self delusion.
Cap and trade? A great bumpersticker. But too complex to understand in operation.
Direct subsidy? A great bumpersticker. Easy to understand. Take tax breaks away from the exxonmob, give them to a farmer down the road to produce biogas electricity or wind power. or give them to homeowners with solar panels.
No new taxes. No trading scamming. No complex economic theory. No increae in debt or deficit.
GHG and energy cost reduction.
http://amazngdrx.blogharbor.com/blog
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Russell Simon Posted 1:10 am
27 Mar 2008
- Russell
Carbonfund.org
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Sean Casten Posted 1:55 am
27 Mar 2008
This is why I cited the RECs example. Renewability is also an attribute of power, but it operates within an economic model that does not require one to first demonstrate whether or not that renewable metric was sufficiently economic on it's own merits to justify further investment. For that matter, virtually everything else that has value has a price independent of what one can afford to pay - you don't, after all, get very far talking to your landlord about whether their charge per square foot in your lease is appropriate given yours, or their personal economic considerations.
For carbon markets to really work, we need to put a price on a marginal unit of carbon emissions, and then price all tons equally, such that someone who emits one additional ton pays $A for doing so and someone who removes one marginal ton gets the same incentive. Any other model distorts capital allocation and will have the effect of slowing the rate at which the private sector deploys capital to reduce carbon emissions. And any system that includes additionality fails this test, for the simple reason that it places a differential value on tons that are reduced through different approaches.
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TerraPassTom Posted 2:34 am
27 Mar 2008
Sean: if you work within a capped sector, you will monetize the carbon reductions in the forms of allowances (the ability to sell yours, or hopefully, the need to buy less) and no-one will care about how you did it. Additionality doesn't apply in the allowance market. For your work, the price signal enforced by a carbon market should be a huge motivator for emitting entities. I agree its a shame its not up and running yet.
But in the offset market, we're always dealing with uncapped sectors, and there must be high credibility for the reductions, otherwise emissions just continue to expand. As a carbon offset buyer I want to know that I, collectively with other market participants did something to reduce emissions. If you find a gold mine CHP project, more power to you, but you don't need TerraPass funds to make it pencil out.
Tom Arnold
Chief Environmental Officer
TerraPass
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Pangolin Posted 5:12 am
27 Mar 2008
"We get to burn coal for cheap and you have to pay us to stop."
If that coal was expensive enough through the application of taxes your project would be profitable on the face of it simply as a cost savings.
Where: (cost coal) > (solar, wind or conservation), you will get solar wind or conservation as preferable sources of power supply. Particularly if where, taxes (T=a known and increasing slope) are applied so that.....
cost{coal+T}>{solar-T}, today but, cost{coal+(T+x)} > {Solar-(T+x)} next month.
There would be an incentive to make a strong early transition to non-coal power. Strangely, this solution seems to be off the table. As for the tax money return it to the owners of the atmosphere, the citizens on a per-capita basis. They could burn it and the overall benefit to the economy would still be there.
Instead we keep talking about vaugue "markets" where "emissions credits" would be traded among everybody but the poor guy who has to buy his power from the utility.
We played the "market regulated power" game in California and learned too late that insiders had bribed influenced the legislature to let them write the rules. It was a disaster. We got looted.
Sean, your argument is as clear as mud.
Put the Carbon Back
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Capster Posted 5:16 am
27 Mar 2008
However, "offsets" without additionality could be broadly defined in a million impossible to verify ways. Let's take your bike example - if my car broke down and I needed to ride my bike to get to work I would do it. Without additionality, I could then claim an "offset" was generated, and sell that to someone.
But the credibility would be lacking. What people want to know is that, when they spend dollars for offsets, there is an actual reduction that would not have otherwise happened without that spend. If I'm going to take a flight and generate a ton of carbon, I want to know that when I spend $20 on an offset, a ton is removed that wouldn't have otherwise been removed.
Without additionality, people won't necessarily do more projects - they'll just make more claims on ordinary things. Hey, our company changed replaced their chiller units with high efficiency units - nevermind that they would have done it anyway, because the payback is a no-brainer. But now we'll claim some offset that we'll try to sell. Is that credible? Is that what you want to buy? You'd spend $20 for a ton of carbon offset - that would have happened anyway? You think that makes sense? I don't. People want to know that the money they spend makes a real difference.
Additionality rules are admittedly cumbersome, but with experience we are finding they can be manageable. Per the CDM, whole types of projects can prima facia be accepted as additional, so you need not do one-off calculation on them. And CRS has a proposal out for GHG offsets which I think makes sense as well. It's not an easy hurdle, but it's a legitimate one.
I'm not interested in a market flooded with noncredible offsets - that will kill the whole thing. We need to instead go the other way - make sure that the offsets are very credible, so that they have true value.
In fact, if we ever want to have a unified market for offsets (EU, US, etc.) we in the US will have to agree to additionality - it's a basic tenet of the EU ETS.
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TerraPassTom Posted 5:32 am
27 Mar 2008
Allowances provide a hard limit on carbon emissions, and coal producers bear the cost of that limit, no matter how much the carbon prices goes up. That's not accomplished with a tax, where you just have to pray that the tax is set at a rate that hopefully curtails consumption. As an example, the rough doubling of gas prices from $2 to $4 is a carbon price of $200 per metric ton -- yet it hasn't really decreased consumption that much.
Do we want a world where emitters know that they have to pay a known fine to keep polluting, or one where they are freaking out about a carbon price that could be very high and are mustering all their efforts to keep there emissions going down?
A Cap links with Sean's world quite nicely -- with a price of carbon, anything that increases efficiency (such as great CHP projects) will suddenly look economic, as well as wind and renewable projects as you point out.
I agree that attention has to be paid to the details, and that the system is gameable. But with folks like you paying attention, I'm optimistic that an effective cap can be put in place.
Tom Arnold
Chief Environmental Officer
TerraPass
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Pangolin Posted 8:03 am
27 Mar 2008
It's true, actual use of gasoline hasn't dropped much at all. On the other hand the big three US auto makers are facing bankruptcy. Let me repeat that. The three remaining large automobile manufacturing concerns in the US, all three, are facing bankruptcy if their sales do not improve.
Why? They have too great a proportion of large trucks and SUV's in their inventories and very little to offer a quality or mileage conscious buyer. Meanwhile Prii are occupying US asphalt like an invading army of giant Legos. I myself walked past whole lots full of new and used US made automobiles to buy a slightly-used Toyota Matrix last June. The Chevy S-10 has been parked since then.
For most of us quitting our jobs is not a viable option. Biking to work requires a serious belief in your invulnerability or a really good afterlife and public transit is thin to nonexistent. Plus we may already have a large vehicle that has a significant sunk cost that we cannot simply defray by selling it. Our gasoline consumption cannot just be easily eliminated. What I think has happened is that it has been supported by two things; easily accessed credit and the promise of future discounts. Let's just leave the credit issue for another day.
Promised discounts? Who's promising future discounts on gas? Nobody less than the president (POTUS), the republican party, every happy-go-lucky exxon ad, and the implication of every auto ad seen on TV, newspapers or magazines. Not even Toyota can manage to make mileage savings the central feature of it's Prius ads even though it's a proven feature. They just wave "YES" signs.
Face it, the Iraq war is about stealing cheap oil from the Arabs. Everybody, everybody knows it and anybody who claims otherwise is a liar. We don't give a crap about arab democracy in Iraq, Iran, Syria, or Yemen and we don't have a shortage of sand. We're fighting for control of the last big reserves of oil. Every time that pResident Bush gets on TV and assures us that things are going well in Iraq what he really means is "that cheap gas that I've been promising you is coming soon, real soon."
Well, it's been five years now and most of us have the sense to know better but we still want to believe that we're getting all that free sex gas real soon. I mean, nobody is voting for John McCain on the hopes of a ripping economy or further tax cuts; they want the cheap gas they were promised.
What does that have to do with the price of coal? Has anybody looked at their television lately? The word "coal" is never, ever, every said alone. It's always referred to as "clean coal" especially on news programs where presumably they should know better. We've all had it drilled into us that coal is cheap and now advertising executives are trying to convince people that the biggest source of pollution on the planet is somehow "clean." "We're going to have "clean coal," even Barack Obama is saying it.
It's a lie. The big, cheap, source of anything is NOT going to be a fossil fuel. There will be NO discounts, it's all got to cost a whole lot more. When that happens people are going to find ways to conserve power.
Put the Carbon Back
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katakanadian Posted 4:30 pm
27 Mar 2008
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John Dewey Posted 12:28 am
28 Mar 2008
There's no question that the rise in gasoline prices caught Chevy and Ford with a glut of SUV's. But that's not why the firms are facing bankruptcy. Both Ford and GM have production labor costs that far exceed those of Japanese automakers. Those costs prevent the domestic automakers from investing anywhere close to as much for new product development as do Honda and Toyota.
Prius sales have benn increasing. But what vehicle models were the top sellers in the U.S. in 2007 - by a wide margin? Ford's F150 pickup and Chevrolet's Silverado pickup.
Chevy's Cobalt and Impala each outsold the Prius in 2007, and Ford's Focus was just about tied.
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amazingdrx Posted 3:01 am
28 Mar 2008
Air resistance for these big boxes is not much of a mileage spoiler at traffic jam speeds. They mainly sit in traffic spewing GHG. So plugin hybridize them.
Carbon fiber saves most of the SUV driver's favorite NASCAR racers from 200 mph concrete wall doom. It's tough, they like tough.
An 80 hp plugin electric drivetrain with 60 miles worth of batteries and a 20 kw backup diesel generator could power a giant monster the size of a humvee, if the vehicle only weighed around 1 ton.
Hypercar technology would work on gas guzzler designs just fine, thank you.
http://amazngdrx.blogharbor.com/blog
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Pangolin Posted 6:55 am
28 Mar 2008
60 percent increase in production in 2009
Toyota will increase production of the Toyota Prius in 2009 by 60 percent according to reports coming out of Japan. In 2007, Toyota produced some 280,000 Prius hybrid cars, and next year the automaker plans to produce 450,000 of the hybrids per year.
Yeah, those Prius sure suck. That's why my sister sold her Porshe Boxster and purchased a Toyota Camry hybrid and bumped her high-mileage Prius down to her daughter. I mean, who would trade a noisy, gas-guzzling, two-seat, ride like a bag of rocks, sports car for a five passenger, dead-quiet luxury car? (true story)
It's a good thing too that having the Prius on their lots doesn't get customers feet on the ground in Toyota dealerships either so that they can look over all the other Toyota vehicles. That never happens. Didn't have squat to do with my brother purchasing a Tacoma truck when a US make would have been cheaper.
Lets just blame the demise of the US automakers on health care costs and union wages. Everybody knows that automakers don't have any clout with congress to help push through a sane health care system that would cost US employers as much per capita as Japanese employers pay. No clout a'toll which is why the recent boost in CAFE requirements is going to hammer them so hard. No little loopholes in that law that they got past congress did they?
It must be nice to live in a fictional reality.
Put the Carbon Back
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EcoRobO Posted 11:25 pm
29 Mar 2008
The choices you have laid out for how to spend your million bucks don't serve as much of a demonstration. Of course you should make the first investment and choose to save $500k per year. The question is...should you be able to sell 1,000t of offsets? If you've made that first investment, you don't need the offset sales revenue.
Assume that there is a financial additionality test that means this first investment is not eligible for offsets. The second choice is something that would be financially additional, and you should generally expect that it will allow you to sell offsets. If the price of carbon rises over $10,000/ton and you are able to sell offsets from the second investment and not the first, you should begin to consider the second investment (actually, you should make your first investment, then consider borrowing another $1 million and make the second, too, but you have said you are capital constrained, so I guess making both investments is out of the question).
The point is, financial additionality won't drive you away from the first investment. You have all the incentive you need for it with the fat cash return it promises. The point is that a financial additionality test will lead you to consider the second investment when the price of carbon gets high enough. And that's just as it should be - with financial additionality in place, rising carbon prices mean more investments make sense when carbon is factored in.
The $10,000 price of carbon in this example is ridiculously high, of course, but that's just because you have given yourself such ridiculously different choices. A better question would be: what should you choose between a project that gives you $500k and 1,000 tons or $400k and 10,000 tons. Well, if you favor the second over the first, you're clearly relying on some value for the emission reductions, so you have selected a financially additional investment that could in theory allow you to sell offsets. If you can sell offsets at e.g. $15/ton, the second choice shoots up to $550k per year and is better than the first. At $25/ton, the second is at $650k per year and starts to look much better. And that's as it should be - the second investment reduces significantly more emissions. This example also proves that you don't have to lose money for an investment to be deemed additional.
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John Dewey Posted 5:41 am
30 Mar 2008
Sorry, pangolin, but the high labor costs are exactly the cause of domestic automakers problems. Don't misunderstand what I write, though. The leadership of GM and Ford are the ones who granted those concessions to the unions, and the leaders should rightfully be blamed. Of course, many of those shortsighted leaders have since departed.
The level of health care costs in the U.S. has nothing to do with the labor cost differential. Japanese automobiles sold in the U.S. are assembled in the U.S. Japanese automakers are moving subassembly manufacturing to the U.S. as well. Toyota and Honda pay the same U.S. health costs per auto worker as do Ford and GM. The big differences in labor costs are due to higher wage rates, underutilized workers, and retiree benefits, especially health insurance benefits.
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Sean Casten Posted 11:25 am
30 Mar 2008
So let's assume that we really do force shareholders to pay. Presumably, that makes coal-fired assets less economically attractive. How long until that starts to change the mix on the grid? 10 years? 20 years? The Clean Air Act is only just now starting to change the cost of coal-fired electricity, and that took 30 years.
Meanwhile, Hansen's saying we've got no more than 10 to substantively turn this boat around. We have to have carrots in place tomorrow to get investors to start putting projects in the ground - sticks alone are insufficient. And a tax is only a stick.
One final point: the additionality test is not innate to carbon policy, but is a function of the other rules within our existing cap & trade methodology. We can contemplate other rules, that are much simpler. More on that later...
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rcire Posted 12:40 am
31 Mar 2008
I am also curious about your general rationale. If investors are willing to invest in a project such as the WV project that you cite, I assume they are willing to do so based on the potential returns of the project itself. Why should those investors be granted access to the voluntary carbon market when their project (and subsequent carbon reductions) will be achieved regardless? I don't think that people are worrying about whether investors are making too much money as you suggest, but rather that capital is being allocated to the projects that need it the most. Projects such as your WV example clearly do not fit that mold and I as a potential credit buyer should move on to projects where my enabling capital will find its highest use.
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Backcut Posted 12:49 am
31 Mar 2008
"Natural" forests were carbon neutral but today's forests are FAR from being "natural".
Will we top 10 million more burned acres this summer??!? Some people really ARE hoping for that!
Scenic pics at http://Lhfotoware.blogspot.com
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Sean Casten Posted 1:49 am
31 Mar 2008
From a theoretical perspective, you may be right, in the sense that if we truly knew which projects would be built but for the monetization of carbon offsets, we could work an additionality provision. The problem is that no one ever truly knows what additionality means. Different businesses have different thresholds for capital allocation. Some businesses might really want the carbon sale regardless of financial return for the green "seal of approval" it would give them. And since there's no way to really know whether or not a given project is "additional", the entire process becomes analytically masturbatory - creating no value other than the pleasure it provides the analyzer.
From an investment allocation perspective, on the other hand, one simply needs to ensure consistent pricing - which additionality, by design, fails to do.
Here's an off-topic example: I met a guy a while back who had access to an aquifer in Texas who was planning on mining it to make bottled water to ship to Singapore. Really bad environmental idea, right? His reason for doing so was that the local municipalities all paid a rate for water that was set based on no differentiation between water for drinking and water for toilets. People won't pay $5/gallon for toilet water, but the municipalities didn't run two sets of pipes. And so he found himself in a situation where he could not economically tap the aquifer and deliver the water based on toilet-water pricing, but could for bottled water pricing. Ergo, really suboptimal investment allocation based on the fact that drinking water sent to Singapore is much more valuable per gallon (even after accounting for shipping fees) than drinking water sent to Houston.
Bringing this back to additionality, the problem with it is that it sets GHG prices at zero for some projects and >0 for other projects - which, like the Texas water developer is necessarily going to skew investment dollars towards suboptimal projects.
There is a larger issue at play which I wrote about last year. Namely, given the choice between policies that lower carbon and grow the economy and those which lower carbon and hurt the economy, we ought to pick the former every time. Moreover, we ought to preferentially deploy our limited resources towards those projects that deliver the maximum benefit on both axes, maximizing total carbon reduction per dollar. The additionality framework, at it's core goes in exactly the wrong directly by making low-return GHG reductions proportionally more attractive. This means that finite resources get exhausted quicker, which implicitly means less GHG reduction.
As to specific examples, this happens all the time in our existing environmental rules, which mandate capital dollars towards end-of-pipe, expense-inducing controls. This creates a hierarchy in every industrial purchasing department I've ever been in front of, whereby capital budgets are allocated first to the stuff you are mandated to do, then to core (e.g., non-energy, non-pollution control investments), and then to non-core activities. More often then not, there's no money left when you get to the end of the list, which is why the typical industrial won't put any money in projects that lower pollution and save them money unless they have extremely rapid paybacks. A more rational process wouldn't pursue the env't good/$ bad projects until we had first exhausted all the good/good options - which would have an ancillary benefit of creating more cash for those businesses, and therefore increasing the total emissions reduction.
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rcire Posted 2:44 am
31 Mar 2008
Do you also believe that those projects mandated by regulation should have access to carbon markets or is your criticism of additionality based solely on "financial additionality"?
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Sean Casten Posted 2:55 am
31 Mar 2008
I either misunderstand the question, or else we have a different conception of carbon futures. As a practical matter, it doesn't make any sense to me to have mandates and markets, for precisely the reason that (I think) you suggest. You can't force someone to do something and then pay them for doing what you forced them to do.
But the idea of a cap & trade is that you replace mandates with pricing. If you are an emitter, you will pay a financial price for your actions. And if you are an emissions-reducer, you'll get paid for your greatness. In this context, it's not a mandate, but an economic incentive to reduce emissions. Additionality takes that away by replacing the payment for greatness with a value judgment about who is great enough to be paid.
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rcire Posted 3:16 am
31 Mar 2008
Obviously, regulated projects would have occurred anyway so what is the difference between your argument (carbon credits resulting from projects occurring anyway for the purpose of maximizing investment return) and allowing mandated projects access to the carbon markets?
If there are no controls that lead to and protect the credibility of the voluntary carbon market, we have come full circle to the point made by ngoddard...essentially any carbon reducing activity would be eligible.
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juliev Posted 3:29 am
31 Mar 2008
Assume a business seeks to be as carbon-conscious as possible. it first invests in efficiency, then it seeks to use renewable energy, then it plans to purchase carbon offsets for whatever GHG emissions remain. also assume the business does not have the option to purchase green power from its utility and so seeks to generate its own renewable energy.
the question is this: can that business develop a renewable energy project (let's say solar), use the renewable energy in its operations, and then sell the offsets? so in other words, it's getting the benefit of both the power and the revenue from the offsets. does the answer change if the renewable energy project would not be financially feasible without the revenue from selling the offsets?
and are the answers any different for certain energy efficiency projects? let's say this business buys an old, multi-story office building that would be very expensive to overhaul for efficiency and it makes the business decision not to invest that money. could another company looking for carbon offsets comes to the business and offer to pay for the efficiency upgrades as a way to generate offsets? So, like the renewable situation, the business is essentially the project developer and gets the benefit of the project while also generating offsets. or is efficiency essentially never a candidate for carbon offsets since it generally has such a high rate of return?
to restate yet another way, can the developer of a carbon offset project also receive the direct energy benefits of that project (be it green energy or efficiency) or do the actors - the project developer, the recipient of the energy benefits, and the purchaser of the carbon offsets - have to be different entities? does the answer change if there is a credible offset market where additionality and other criteria exist?
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Sean Casten Posted 3:51 am
31 Mar 2008
If I'm understanding you correctly, your concern is that if we want to ensure that social good X occurs, we have to make sure that we only pay people who wouldn't do X independent of payment. And in the voluntary market, where the price of carbon (on the buy-side) is so strongly correlated by the trustworthiness of the audit, that's a fair question - but in many ways, this only points out the limitations of voluntary markets. (Which also price "charismatic carbon" more highly per ton, creating other distortions of economics.)
But once we get a regulated market (soon, I hope), that argument ought to be fully eliminated. After all, governments pay for X all the time without worrying about whether X is really necessary. Mortgage interest deductions stimulate home ownership, but we don't specify that you have to first demonstrate that you aren't wealthy enough to buy the home with cash. 401k plans allow you to tax defer income, but we don't limit those benefits only to the poor. Indeed, outside of carbon policy, I'm not aware of any place where we get worried about additionality.
Moreover, I'd argue that the reason we worry about it with carbon is not because of anything unique to GHG emissions, but only because we have framed the universe of GHG policy options in ways that raise the additionality question. (And many others, of course. Leakage, for example is only a concern if you have less than economy wide compliance.) But with less than full-participation, and a general failure to account for beyond-battery limits reductions, additionality is hard to avoid. (The latter issue is critical, but gets overlooked a lot. If I'm operating under a hard cap and I put a cogen plant on site, I'm increasing by local emissions but decreasing global emissions. Virtually every cap & trade system I'm aware of struggles mightily with quantifying that net impact, and almost always errs on the conservative side - again, placing a differentially higher value on local reductions.)
But all those are details for part V of this series, which I'm still working on...
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Sean Casten Posted 3:59 am
31 Mar 2008
Here's my answers - others feel free to chime in.
Generally speaking, the regulations have sought to force you to pick between RECs and carbon offsets, but not both. RECs are not technically carbon offsets, but their carbon offset-ish, and out of a concern for double-counting, you are not able to do as I think you suggest, generating renewable credits and selling carbon offsets. (In today's market, and in part because of the additionality issue, the REC is far more valuable, even at equivalent pricing.)
However, both RECs and carbon credits are assignable. There is a financial community that will buy your RECs/CCs from you in exchange for a lump sum cash payment, and these financial vehicles are used to finance a lot of renewable projects. The most common structure is one where you figure out how much of the total project capital you need (e.g., beyond your own ability to finance), and then you sell off enough of your projected future RECs/CCs to provide that money. This way, you get a cheaper project and you still (potentially) get the REC/CC revenue down the road if the project keeps running as advertised.
Yes, you can do third party ownership. In your building example, someone else could come in and do the upgrade and then secure the offsets. (We've done projects like this.) There are some legal niceties required to make sure all those rights and obligations are properly assigned, but this is very do-able. Whether that third party then keeps some of the proceeds of your energy savings or not is really a function of deal structure and overall economics rather than any regulatory stipulation.
Hope that helps.
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RealCarbon Posted 2:13 pm
01 Apr 2008
The first thing to recognize is that not all "carbon credits" are necessarily "carbon offsets."
A traditional cap and trade structure will allocate allowances to companies through some sort of distribution strategy. This could be auctions or freely based on historic emissions at a particular baseline. If you want a 5% reduction in emissions from a 1990 baseline, you would determine 1990 emissions levels and then allocate 95% of emissions in the form of allowances. For example, if 1990 emissions were 100 million tons of CO2, you would allocate 95 million tons among participating companies. At the end of the commitment period (say 5 years) companies whose emissions are less than their allowances are safe and those with more emissions than allowances will face huge penalties.
The trading system works great here because if you can reduce CO2 for less than the market price of an allowance, you can sell your allowance and make money. If you can't reduce cost effectively, then you have to sell.
For this system, additionality is not a factor. It simply doesn't exist. This is because the emissions are contained within a regulated system. The whole point is to make money on emissions reductions! It means the cap and trade market is working. You reduce co2 and save energy costs but can also sell your allowances to someone who can't reduce their CO2.
A carbon offset is a project that reduces CO2 OUTSIDE OF REGULATION. The reason additionality even exists is because Kyoto basically has a safety valve. It's cheaper to reduce CO2 in developing countries, but those developing countries ARE NOT CAPPED. If a country isn't capped, then it can keep increasing emissions. Therefore, you have to demonstrate that if you're going outside of a regulated country to get cheaper credits that they damn well wouldn't have happened without you. If you go to a developing country and look at money-making projects, they are far more likely to happen on their own as a nation develops than project that require carbon to be profitable. The strongest offsets are ones that could not have happened with your intervention, and that is key to allow a business to leave the cap and trade system to invest in reductions elsewhere and ensure the quality of those reductions.
Also, note that financial additionality isn't the only type of additionality (and financial additionality in its purest form no longer exists...things have loosened up considerably). You can also establish additionality by proving the ROI would not have been attractive otherwise (perhaps 5% without carbon financing vs. 15% with) or you can show that the project owners just don't have the technological capacity or skill to pull off the project without you (this has a great side benefit of causing technology transfer). Carbon offsets from these projects (Certified Emissions Reuctions) can be traded on the EU ETS at a 1:1 ratio with EU Allowances.
SO. Don't worry. There will be regulation soon and emissions allowances that follow. You'll be able to reduce a whole bunch of CO2 and sell your allowances to AEP for a small fortune. Additionality won't apply to you.
Most likely you'll complain about unregulated dairies that are able to sell offsets cheaper than you can make onsite reductions and bring down the market. If regulated, a dairy might be required to reduce emissions by 10% which would mean a dairy emitting 20,000 tons from waste lagoons would have to reduce by 2,000 tons. If it installs a digester that reduces 100% of its emissions (not possible, but work with me here), then it would only be able to sell 18k tons. If it isn't regulated, it can sell all 20,000. Selling more tons means more supply and lower prices.
An alternative would be command and control that would require all dairies to install biodigesters. It's a simple way to cut out a whole lot of CO2e. It would reduce the supply of cheap offsets and create a higher market price for allowances, which would cause more companies to reduce rather than buy since it would be cheaper.
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