Tag Archives: cap and trade

EHS Journal Article on Sustainability, Financial Valuation

Recently, Elm posted a piece discussing comments from Kevin Parker, the CEO of Deutsche Asset Management, an investment firm with three-fourths of US$1 trillion under management.

We expanded that original post for EHS Journal, who just published it.  The expanded version dives deeper into trends in the past decade supporting Parker’s assessment of why capital markets are bullish on carbon-intensive investment opportunities even in light of this era of sustainability.

View the article in its entirety here.

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Well, There You Have It…

NYT reports that Washington has abandoned hope of issuing carbon legislation this year, including cap-and-trade.   The inaction is also dragging down regional/state programs as well, including the well-hyped RGGI trading program.  This shouldn’t come as a real surprise to anyone.

But it does continue to increase the business uncertainty surrounding emissions in the US.  Tune in again next year.  Or the year after….

Incubating Environmental “Black Swans” In the Nest

Our last entry discussed the concept of “Black Swan” events, a term created by noted author Nassim Nicholas Taleb to describe an event that is (a) so low in probablility that it is unforeseeable and (b) so catastrophic in impact that it changes history.

Certainly, risk assessments are predictive in nature and no one can predict the future with complete certainty.  But in our view, one of the best tools available for risk assessments is an open mind.    This can be a challenge in the EHSS world as we generally have engineering and other technical backgrounds.  We have been trained to seek absolutes and eliminate uncertainties.  At Elm, we believe that involving external support helps to identify and explore events (and their related exposures) that are relevant but get “technically rationalized” by internal staff.

With the BP oil spill and the December 2008 Kingston, Tennessee coal ash pond failure, we began thinking about some of the Black Swan events discussed with clients in the past.  Below are a handful of EHSS Black Swan risk events that we have discussed with clients over the past years – and some that are currently on our mind.

  • Radical change in EPA’s regulation of coal ash management (discussed several years before the Kingston event, and vehemently opposed by the client)
  • Catastrophic failure of GHG emissions trading market
  • Dramatic failures/errors in GHG footprint calculation methodology
  • Nationalization of privately-owned CO2 emissions assets
  • Regulation and class-action level public concerns over chemical content of consumer goods
  • Waste disposal liability for and public pressures about exporting electronic wastes
  • Dramatic increase in OSHA/EPA enforcement – frequency, severity and targeted industries/sites
  • Major expansion of pollution exclusions/limitations in insurance policies
  • Increased success of US-based NGOs in successfully obtaining US venue for lawsuits concerning EHSS allegations for non-US sites/projects/activities
  • Unprecedented shareholder and SEC pressure on public companies related to EHSS matters
  • Increased importance of EHSS in supply chains and procurement decisions

Perhaps these seem far-fetched to you or your company.  But if that is the case, the egg of that – or another – Black Swan is quietly incubating somewhere in your organization.

Another Major EU Carbon Trading Fraud Under Investigation

Bloomberg.com reported that earlier this week, European authorities launched a major investigation of several large companies that are thought to have played a role in a system of fraud and tax evasion that may have impacted 7% of the total CO2 emissions trading market for 2009 in the EU.

Prosecutors and tax investigators yesterday searched Deutsche Bank, HVB Group and RWE AG in a raid on 230 offices and homes to investigate 180 million euros ($238 million) of tax evasion. The probe targeted 150 suspects at 50 companies…

Yesterday’s raids were the biggest related to a fraud that may have tainted an estimated 7 percent of European Union carbon trades in 2009…

About 400 million metric tons of emission trades may have been fraudulent last year, or about 7 percent of the total market, including futures transactions, according to estimates from Bloomberg New Energy Finance.

Europe lost about 5 billion euros in revenue for the 18 months ending in 2009 because of value-added tax fraud in the CO2 market, according to Europol, a European law-enforcement agency.

CNBC Airs Feature on “Carbon Hunters”

Last night (April 20, 2010), CNBC aired an hour-long TV segment on the burgeoning industry labeled “carbon hunting”, the practice of finding, aggregating, marketing and selling carbon credits.

While the story illustrated successful projects, it also highlighted a myriad of risks in the carbon trading industry.

Check your local TV listings for the next airing.

This Week’s Zigzag in the US Climate Regulation Journey

Reuters has reported that the US Senate anticipates bringing the latest carbon emission bill to the floor next week.  Although details are currently sketchy, there are some interesting facets revealed in that article:

–       The bill’s greenhouse gas (GHG) reduction target is 17% by the year 2020;

–       The baseline year for this reduction is 2005;

–       Regional and state-specific GHG cap-and-trade programs would be eliminated and replaced by a federal program.

–       Cap-and-trade for electric power generators would begin in 2012; for manufacturing, the program would begin in 2016;

–       Domestic and international off-sets would be allowable

–       Transportation emissions reductions would be achieved through a motor fuel fee that would hopefully spur various forms of innovation, efficiency and reductions

One glaring aspect of these few details is whether/how companies will get “early action credit” for their GHG reduction efforts achieved prior to this bill’s 2005 baseline year.  Corporations that made major strides in GHG reductions between 2000 and 2005 may find themselves on the wrong end of the “80/20 rule”.  Those who chose to wait for more certainty could be in an improved competitive situation by spending less money to harvest the “low hanging fruit” to hit the 17% target.

“Surprised and Concerned” About Illegitimate Government-Sponsored CER Trading?

Environmental Leader has reported

that the Hungarian government sold 2 million previously used CERs, the market became tepid. Then when prices fell from more than 12 euro per credit to less than one euro, trading was suspended on two exchanges, Bluenext and Nord Pool.

The NYT provided more details of the transaction, stating

The credits appear to be part of massive blocks of CERs awarded to Eastern European states and Russia after the collapse of Soviet-era industry.  This created a loophole used by Hungary to reintroduce used CERs back into the market…

Carbon traders said countries like Hungary were exploiting the loophole to earn more money from the carbon trading system than they could by selling the credits that they had previously earned under the Kyoto system…

The traders said at least one other E.U. member state had acted similarly earlier this year.

The EU said they were “surprised and concerned” about the situation.  BusinessWeek quoted others who expressed more urgency about the matter:

“The supply and demand dynamics have been changed,” said Paul Kelly, chief executive officer of JPMorgan’s EcoSecurities unit. While the scope of the problem has yet to be determined, buyers are “questioning the authenticity” of what they are buying.

Unfortunately, this isn’t the only recent development that may cause market participants concern.  This is just the latest in a barrage of credibility and financial damage for GHG emissions trading, including:

  • Last year swindlers robbed governments of about 5 billion euros in revenues — about $6.8 billion — by selling carbon credits and disappearing before paying the required Value Added Tax on the transactions.
  • In January, swindlers used faked e-mail messages to obtain access codes for individual accounts on national registries that make up the bloc’s Emission Trading System, and then used the stolen codes to gain access to electronic certificates that represent quantities of greenhouse gases.
  • In Australia, recent fraud enforcement involved forcing a green power company, Global Green Plan, to purchase carbon credits it had promised to buy on behalf of customers, but never did.  The government is currently pursuing action against carbon capture company Prime Carbon over allegedly misleading claims made by the firm.
  • In Belgium, authorities have charged three Britons suspected of value added taxes (VAT) fraud on CO2 emissions permits.

In the U.S.,  the Regional Greenhouse Gas Initiative (RGGI), a group of Northeastern U.S. states that have a cap-and-trade program for utilities, faced its own demons.

  • The New Jersey government reallocated about $65 million in funds raised in the RGGI auction. The funds were intended for use in developing renewable energy projects, but instead are going to the state’s general fund, Reuters reports.
  • Last year, New York similarly took $90 million from its carbon fund.

So Now What?

Companies with a major stake in the GHG emissions game must conduct a detailed risk assessment of their GHG programs, solutions and exposures.  Given what has developed in the trading market in the past six months, it would be wide to carry out exposure identification, failure analyses, contingency planning and desktop exercises.

Such analyses and assessments may be critical for publicly traded companies in the United States due to SEC’s recent announcement and the newly effective EPA rule requiring reporting of greenhouse gas emissions from fossil fuel suppliers and industrial gas suppliers, direct greenhouse gas emitters and manufacturers of heavy-duty and off-road vehicles and engines.

Lawrence Heim, Director of The Elm Consulting Group International’s Atlanta office, said

Close to 10 years ago, I began posing the question ‘what if the GHG emissions trading market collapses?’  Assuming cohesive legally-enforceable emissions standards existed, the cost proposition presented by emissions trading in comparison to capital expenditures for pollution control equipment was quite attractive.  The impact of a material failure of the trading framework was significant.  This line of thought became incorporated into client risk assessments even back then.

In the US, we can look at the pollution control expenditures related to EPA’s New Source Review (NSR) enforcement initiative to provide insight into GHG control equipment costs.  Of course, NSR enforcement involves pollutants for which there are well-established and commercially-viable emissions control technologies.  We don’t have that luxury with carbon dioxide, which will likely translate into dramatically higher costs.

Further erosion of the viability of GHG emissions trading could have a significant impact on your company.  Please contact us if you would like to understand more about climate business risk assessments and potential risk mitigation options.

Details and Excerpts from the SEC’s Climate Risk Disclosure Interpretive Guidance

As we previously reported, the SEC issued their interpretive guidance concerning the need for publicly-traded companies to identify, assess and (if necessary) report climate-related business risks within existing SEC reports.  This interpretive guidance document was published in the Federal Register of February 8, 2010.

Elm has reviewed this publication and provides the following excerpts that we feel may be most critical to companies who are looking to address the requirements of the new Interpretive Guidance.    These excerpts may be slightly edited for length and clarity, but we have attempted to ensure that substantive information remains as in the publication.

The Commission has not quantified … a specific future time period that must be considered in assessing the impact of a known trend, event or uncertainty that is reasonably likely to occur. As with any other judgment required by Item 303, the necessary time period will depend on a registrant’s particular circumstances and the particular trend, event or uncertainty under consideration.

[Management] should not limit the information that management considers in making its determinations. Improvements in technology and communications in the last two decades have significantly increased the amount of financial and non-financial information that management has and should evaluate, as well as the speed with which management receives and is able to use information. While this should not necessarily result in increased MD&A disclosure, it does provide more information that may need to be considered in drafting MD&A disclosure. In identifying, discussing and analyzing known material trends and uncertainties, registrants are expected to consider all relevant information even if that information is not required to be disclosed, and, as with any other disclosure judgments, they should consider whether they have sufficient disclosure controls and procedures to process this information.

If management cannot make a determination concerning the known trend, demand, commitment, event or uncertainty likely to come to fruition, it must evaluate objectively the consequences of the known trend, demand, commitment, event or uncertainty, on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant’s financial condition or results of operations is not reasonably likely to occur.’’  Identifying and assessing known material trends and uncertainties generally will require registrants to consider a substantial amount of financial and non-financial information available to them, including information that itself may not be required to be disclosed.

Registrants should consider specific risks they face as a result of climate change legislation or regulation and avoid generic risk factor disclosure that could apply to any company.

Management must determine whether legislation or regulation, if enacted, is reasonably likely to have a material effect on the registrant, its financial condition or results of operations.

Examples of possible consequences of pending legislation and regulation related to climate change include:

  • 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.

We reiterate that climate change regulation is a rapidly developing area.  Registrants need to regularly assess their potential disclosure obligations given new developments.

Registrants also should consider, and disclose when material, the impact on their business of treaties or international accords relating to climate change.

Depending on the nature of a registrant’s business and its sensitivity to public opinion, a registrant may have to consider whether the public’s perception of any publicly available data relating to its greenhouse gas emissions could expose it to potential adverse consequences to its business operations or financial condition resulting from reputational damage.

Significant physical effects of climate change, such as effects on the severity of weather (for example, floods or hurricanes), sea levels, the arability of farmland, and water availability and quality.

Possible consequences of severe weather could include:

  • 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;

Clearly, SEC’s position is that such a risk identification and assessment framework be robust and extend far beyond a technical environmental scope.

These excerpts are presented for convenience and informational purposes only and should not be solely relied on in developing appropriate information/response to the SEC requirements.  Qualified expertise should be engaged to properly meet these requirements.

Dark Clouds on the Climate Horizon

In 2009, there was a general sense in the US that some regulatory and economic certainty would finally be established relative to greenhouse gases, and CO2 in particular.  The current administration made highly public moves and statements to that effect, which were mirrored by action in Congress and the Senate.  EPA issued its finding of endangerment.  And there was significant optimism that the COP15 Copenhagen meeting would bear fruit.

Fast forward to February 2010.  There has been quite a shift in direction and now there is arguably more business risk related to CO2/GHG than there was going into 2009.  Among recent highlights:

  • Nike formally announced that they are abandoning the use of carbon offsets and Renewable Energy Certificates (RECs), citing, among other concerns:

there is substantial scrutiny of the use of RECs, in particular related to whether they in fact help create new renewable power, or whether they are simply payment to a project that would have existed anyway. … Moving forward, however, our preference is to achieve climate neutrality through a combination of energy efficiency and the purchase of more direct forms of renewable energy, through on-site applications and other means.

  • The German Emissions Trading Authority (DEHSt) computer system was hacked and fraudulent European Union carbon allowance transactions were completed.  Read a report here.
  • Europol, the European law enforcement agency, reported on December 9, 2009 that

the European Union (EU) Emission Trading System (ETS) has been the victim of fraudulent traders in the past 18 months. This resulted in losses of approximately 5 billion euros for several national tax revenues.

As an immediate measure to prevent further losses France, the Netherlands, the UK and most recently Spain, have all changed their taxation rules on these transactions. After these measures were taken, the market volume in the aforementioned countries dropped by up to 90 percent.

  • The Copenhagen meeting failed to achieve the concrete results that had been expected.
  • The accuracy and veracity of data published by key climate scientists was called into question, creating the “Climategate” scandal.
  • The UK government published a report supporting a fixed price or auction reserve on carbon emissions over the current market-driven cap and trade.
  • National-level climate bills in the US are no longer getting the support they enjoyed in 2009.  Read more.
  • Arizona declined to participate in a regional GHG trading program, citing the difficult economy.

However, in contrast to the overarching trend, the US did see two important developments.  First, EPA promulgated its CO2 emissions reporting regulation in October 2009, which is effective calendar year 2010.  Second, SEC issued Interpretive Guidance on the inclusion of climate risks in financial disclosures.

There continues to be significant  uncertainty related to the financial value/risk of climate-related activities.  And that is not likely to change in the near future.

Debate Over Bolivia Carbon Project Spotlights Risks

The New York Times published an article highlighting questions surrounding a major forest preservation project in Bolivia sponsored by American Electric Power, BP and PacifiCorp, known the Noel Kempff Climate Action Project.

Greenpeace claims it found that from 1997 to 2009, the estimated reductions from the program had plummeted by 90 percent, to 5.8 million metric tons of carbon dioxide, down from 55 million tons. It also questioned the “additionality” of the program, which says that a specific forest area would not have been preserved without the program.

What is striking about this matter is not the debate of the project’s effectiveness (given the on-going controversy surrounding the use of forestry in climate risk management).  The surprise was a comment made by Glenn Hurowitz, a director of Avoided Deforestation Partners, a small nonprofit organization that claims to “advance the adoption of U.S. and international climate policies that include effective, transparent, and equitable market and non-market incentives to reduce tropical deforestation”:

In the proposed climate legislation, you can’t get credit for conservation or any other type of offsets until you’ve delivered the offsets. So inaccurate projections would not affect the issuance of credits.

This statement clearly demonstrates a critical business risk in using forestry for carbon management.

While “inaccurate projections” may not impact the issuance of credits, the sequestration calculations/projects have a significant impact on the upfront project support and financing.

It is reasonable to foresee that a failure of forestry to deliver on its projections will have a severely negative impact on the perception of forestry projects as a financially successful and viable carbon risk management tool.

As with any business investment, financial analyses are based on projections about what an investment will deliver in terms relevant to the investment.  In the case of forestry projects, calculations are completed to determine the amount of carbon that is projected to be absorbed and therefore generate the amount of credits/offsets.  These offsets create a financial return in terms of both cost avoidance and potentially revenue.  Financial analyses may be completed for different carbon management options and an investment is made in accordance with the option judged to be the “best” as defined by the criteria applied by the investor.

So what happens if the projections are inaccurate?  Sure, some offsets will likely be delivered by the project.  But will the investment deliver the anticipated return?  Will a shortfall trigger the need for pollution control investments and/or non-compliance penalties?

There continues to be a critical need to reduce risk in forestry-based carbon management investment.  As we have discussed before, it is advisable to take a deep dive into to uptake calculation methodologies, delivery milestones and scenario planning in advance of such investments.