Climate Change and Carbon Markets an International Framework

Climate Change and Carbon Markets An International Framework

July 2015

This document is written by Carbon Credit Capital®, LLC. (CCC) is a Voluntary Carbon Emission Reduction management company.

This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change.

CLIMATE CHANGE AND CARBON MARKETS An International Framework July / 2015

2015 version updates, editing and contributions by Aaron Kirshenberg 2014 version updates, editing and contributions by Annis Benn 2013 version updates, editing and contributions by Tricia Jamison, Dain Lee, and Yuliya Lisouskaya

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ABSTRACT

Climate change is one of the most challenging international policy problems the world has ever faced. This report examines a wide range of issues surrounding climate change, including various aspects of the developing international framework to address it, as well as the state of global carbon markets.

There is a broad consensus among climatologists that unabated anthropogenic greenhouse gas emissions are already leading to substantial changes in the Earth’s climate, and are threatening to push us across unknown tipping points. The environmental costs of exploiting the world’s natural resources and raw materials to meet the burgeoning demands of the 21st century are unsustainable. States must urgently take collective action to address this issue in order to preserve future human welfare.

This assessment analyzes the economic, environmental, and social costs of climate change, with a view to informing effective climate change policy. The complex and dynamic nature of this issue requires an understanding of the science, impacts, technology options, economics, and ethics of climate change policy.

Only an all-encompassing approach will allow us to define and direct our climate change goals accordingly. Above all, climate change is a global problem and thus it must ultimately be addressed on a global scale. Building upon this premise, this report surveys the political, legal, and international relations aspects of climate change policy, including various global and regional carbon market frameworks and mechanisms.

While the Kyoto Protocol acts as the platform for much of today’s carbon market activity, it has become evident that the current framework of international climate negotiations and treaties has not yielded expected results. There is much to learn from the Kyoto Protocol, which was unable to garner participation from several large industrial polluters including the United States. Some of the key issues that Kyoto and subsequent climate negotiations have been unable to reconcile include free-riding, leakage, adaptation, the enforcement of emissions targets and timetables, and how to account for fast-growing developing economies such as China, India and Brazil.

Despite these imperfections, the Kyoto Protocol established important flexible mechanisms that stimulated mitigation efforts to help countries reach their compliance targets. Additionally, outside of the purview of the Kyoto Protocol, several other regional trading mechanisms, carbon markets, and climate change initiatives have been adopted across the globe.

While climate policies have the potential to be effective on a domestic or even regional level, they face difficulties on a global scale, including the distribution of emissions reductions across countries and the need for methods to encourage developing countries to participate by eliminating incentives for free riding and identifying low-cost mitigation options.

TABLE OF CONTENTS

LIST OF TABLES ...... IV

ACRONYMS ...... V

CHAPTER 1: SCIENCE OF CLIMATE CHANGE ...... 1

1.1 GREENHOUSE GASES AND CLIMATE CHANGE ...... 1 1.2 EFFECTS OF GLOBAL CLIMATE CHANGE ...... 1 1.3 HUMAN ACTIVITY AND GLOBAL CLIMATE CHANGE ...... 3 1.3.1 ECONOMIC SECTORS PRIMARILY RESPONSIBLE FOR GHG EMISSIONS ...... 3 1.4 PROJECTED GHG EMISSIONS GROWTH: IEA SCENARIOS ...... 4

CHAPTER 2: ECONOMICS OF CLIMATE CHANGE ...... 6

2.1 CLIMATE CHANGE MITIGATION AS A PUBLIC GOOD ...... 6 2.2 COSTS OF CLIMATE CHANGE ...... 6 2.2.1 ESTIMATING COSTS ...... 6 2.2.2 DISCOUNT RATE ...... 8 2.3 ESTIMATED COSTS OF CLIMATE CHANGE REGULATION ...... 8 2.3.1 STERN REVIEW: PROJECTED MITIGATION AND ADAPTATION COSTS ...... 10

CHAPTER 3: TECHNOLOGY OPTIONS FOR EMISSIONS REDUCTION ...... 11

3.1 COMBINING TECHNOLOGY OPTIONS: THE “WEDGE” THEORY ...... 11 3.2 EXAMPLES OF ENERGY EFFICIENCY IMPROVEMENTS ...... 12 3.3 FUEL SWITCHING ...... 13 3.4 NUCLEAR ENERGY ...... 13 3.5 RENEWABLE ENERGY TECHNOLOGIES ...... 14 3.5.1 HYDROPOWER ...... 15 3.5.2 BIOMASS ...... 16 3.5.3 WIND POWER ...... 17 3.5.4 SOLAR ENERGY ...... 17 3.5.5 GEOTHERMAL ENERGY ...... 18 3.5.6 LANDFILL GAS ...... 18 3.6 FORMS OF CARBON SEQUESTRATION ...... 18 3.6.1 CARBON CAPTURE AND STORAGE (CCS) ...... 19 3.6.2 AIR CAPTURE ...... 19 3.6.3 BIO-SEQUESTRATION AND SOILS ...... 19

CHAPTER 4: POLICY AND REGULATORY OPTIONS FOR EMISSIONS REDUCTION ...... 21

4.1 CAP AND TRADE SYSTEMS ...... 21 4.2 CARBON TAX ...... 22 4.3 RENEWABLE PORTFOLIO STANDARDS (RPS) ...... 23 4.4 FEED-IN TARIFFS ...... 24 4.5 TAX CREDITS ...... 24 4.6 SUBSIDIES ...... 24

CHAPTER 5: UNFCCC AND THE KYOTO PROTOCOL ...... 26

5.1 KYOTO PROTOCOL ...... 26 5.1.1 KYOTO PARTICIPANTS ...... 26 5.1.2 KYOTO PROTOCOL MECHANISMS ...... 26 5.1.3 INSUFFICIENT PARTICIPATION IN KYOTO PROTOCOL ...... 27 5.2 MORE ON KYOTO’S FLEXIBLE MECHANISMS ...... 27 5.2.2 CDM PROJECTS AND “BUSINESS AS USUAL” ...... 28 This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. i

5.2.3 MEASURING CARBON EMISSIONS FROM DIFFERENT PROJECTS ...... 29 5.2.4 THE INTERNATIONAL TRANSACTION LOG (ITL) ...... 29 5.2.5 CDM-SPECIFIC RISKS AND FORMS OF MITIGATION ...... 30 5.3 CONTROVERSY SURROUNDING AGRICULTURE, FORESTRY AND OTHER LAND USE (AFOLU) PROJECTS ...... 31

CHAPTER 6: THE EU ETS ...... 32

6.1 THE EU ETS FRAMEWORK ...... 32 6.1.1 GREENHOUSE GASES AND SECTORS ...... 32 6.2. RESULTS: PHASES 1, 2, AND 3...... 32 6.3 STRUCTURAL REFORM ...... 33

CHAPTER 7: OTHER NATIONAL AND REGIONAL APPROACHES ...... 34

7.1 U.S. FEDERAL LEVEL REGULATIONS...... 34 7.1.1. CLIMATE ACTION PLAN ...... 34 7.1.2 CLEAN POWER PLAN ...... 34 7.1.3 PTC AND ITC ...... 34 7.1.4 DOE LOANS AND GRANTS ...... 35 7.2 U.S. STATE AND REGIONAL REGULATIONS ...... 36 7.2.1 CALIFORNIA AB 32 ...... 36 7.2.2 RGGI ...... 37 7.3 CANADA ...... 37 7.3.1 NATION-WIDE POLICIES ...... 37 7.3.2 ALBERTA ...... 38 7.3.3 WESTERN CLIMATE INITIATIVE ...... 38 7.4 GERMANY - ENERGIEWENDE ...... 38 7.5 CHINA ...... 39 7.6 INDIA ...... 40 7.7 JAPAN ...... 40

CHAPTER 8: THE CARBON MARKET ...... 42

8.1 BACKGROUND ...... 42 8.2 TRADABLE CARBON COMMODITIES ...... 42 8.2.1 THE KYOTO PROTOCOL ...... 42 8.2.2 EU ETS ...... 42 8.2.3 VOLUNTARY MARKET ...... 43 8.3 PRIMARY SOURCES OF CERS ...... 43 8.4 PRIMARY BUYERS OF CERS AND ERUS ...... 45 8.5 PRICING EUAS ...... 46 8.6 THE VOLUNTARY CARBON MARKET ...... 47 8.7 RETAIL (OTC) CARBON MARKETS ...... 47 8.8 PRICING OTHER TRADABLE CARBON UNITS ...... 49 8.9 LESSONS FROM THE EU ETS ...... 49

CHAPTER 9: CARBON FINANCE AND EMISSIONS REDUCTIONS PROJECTS ...... 51

9.1 CARBON FINANCE ...... 51 9.2 FORMAL EXCHANGES ...... 51 9.3 EMISSIONS REDUCTION PROJECT PARTICIPANTS ...... 51 9.4 PROJECT LIFE CYCLE ...... 52 9.4.1 CDM PROJECTS ...... 52 9.5 TYPICAL FINANCING STRUCTURES ...... 53 9.6 AVAILABLE SOURCES OF FINANCING ...... 54 9.6.1 GRANTS ...... 54 9.6.2 LOANS ...... 54 9.6.3 EQUITY ...... 55 This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. ii

9.7 PROJECT COSTS ...... 56 9.8 PROJECT REVENUES AND CASH FLOWS ...... 56 9.9 PROJECT RISKS ...... 57 9.10 RISK MITIGATION ...... 58 9.11 ECONOMIC FEASIBILITY AND CARBON FINANCE ...... 58 9.12 INNOVATIVE FINANCIAL PRODUCTS ...... 60

CHAPTER 10: THE CORPORATE RESPONSE ...... 61

10.1 IMPACTS OF CLIMATE CHANGE ON CORPORATIONS ...... 61 10.2 CORPORATE RESPONSE ...... 61 10.3 CLIMATE-RELATED RISK ...... 61 10.4 PRESENT IMPACTS ...... 62 10.5 SECTORS AT RISK ...... 63 10.5.1 THE INSURANCE INDUSTRY AND CLIMATE CHANGE ...... 66 10.6 THE BUSINESS CASE FOR ADDRESSING CLIMATE CHANGE ...... 68 10.7 CORPORATE ACTIONS ...... 68 10.7.1 GHG EMISSIONS MITIGATION ...... 69 10.7.2 ENHANCING CLIMATE RESILIENCE ...... 70 10.7.3 CAPITALIZING ON OPPORTUNITIES ...... 70

CHAPTER 11: THE INVESTOR RESPONSE ...... 71

11.1 IMPORTANCE OF CLIMATE CHANGE TO INVESTORS ...... 71 11.1.1 INVESTOR RESPONSE ...... 71 11.2 CLIMATE CHANGE-RELATED INVESTMENTS ...... 72 11.3 CURRENT INVESTMENTS ...... 72 11.4 INVESTOR TYPES ...... 73 11.5 BARRIERS AND RISKS TO CLIMATE CHANGE MITIGATION PROJECTS ...... 74

LIST OF FIGURES

Figure 1: The Greenhouse Effect ...... 1 Figure 2: Carbon Dioxide Concentration at Mauna Loa Observatory ...... 3 Figure 3: Greenhouse Gas Emissions By Source ...... 4 Figure 4: Global Carbon Dioxide Emissions By Region ...... 4 Figure 4: The Marginal Cost of Abatement ...... 9 Figure 5: Illustrative Emissions Paths to Stabilize at 550ppm CO2e ...... 10 Figure 6: Emissions stabilization wedge ...... 11 Figure 7: Illustrative marginal abatement option cost curve ...... 12 Figure 8: Variation in Levelized Costs of New Generation Resources, 2018 ...... 14 Figure 9: Electricity Generation from Renewables by Region in the New Policies Scenario (TWh) ...... 15 Figure 10: Biomass System Schematic ...... 16 Figure 11: Components of Carbon Capture and Storage ...... 19 Figure 12: Tax vs. Cap and trade ...... 22 Figure 13: The Marginal Cost of Abatement ...... 23 Figure 14: CDM Project Cycle ...... 28 Figure 15: Determining Additionality ...... 29 Figure 16: The Role of the International Transaction Log (ITL) in Verifying Transaction Validity ...... 30 Figure 17: CDM Projects by Category ...... 31 Figure 18: California's AB 32 ...... 36 Figure 20: Prices and Volumes for EUAs, CERs, ERUs in Secondary Market, 2008-2011 ...... 43 Figure 21: EUA Prices ...... 43 Figure 22: Registered Projects by Region ...... 44 Figure 23: Annual CERs by Host Country ...... 45 Figure 24: Total Expected CERs by 2012 ...... 46 Figure 25: Primary CDM Buyer Countries ...... 46 Figure 26: Price of EUAs from 2004-2009 ...... 47 Figure 27: Voluntary Carbon Supply Chain ...... 48 Figure 28: Historical Offset Demand by Transacted Volume, All Voluntary Carbon Markets ...... 48 Figure 29: Typical Parties in an Emissions Reduction Project ...... 52 Figure 30: Emissions Reduction Project Life Cycle ...... 53 Figure 31: Structure of Typical Project Cash Flows ...... 57 Figure 32: Project Finance with Carbon Revenue ...... 59 Figure 33: World Bank Emissions Reduction Project Validation and Verification Costs ...... 60 Figure 34: Ceres Physical Risks from Climate Change, by Sector ...... 64 Figure 35: KPMG Climate Change Risk Analysis by Sector ...... 66 Figure 36: Annual Global Economic and Insured Losses from Natural Disasters by Type of Peril ...... 67 Figure 37: Annual Global Economic and Insured Losses from Natural Disasters as a Percentage of Global GDP ...... 67 Figure 38: Global Total New Investment in Clean Energy, 2004-2012 ($BN) ...... 72 Figure 39: Barriers and Risks to Climate Change Mitigation Projects ...... 74

LIST OF TABLES

Table 1: Carbon Content of Different Fossil Fuels ...... 13 Table 2: Regional Distribution of CDM Projects ...... 44 Table 3: Typical Energy Generation Project Costs by Period ...... 56 Table 4: Typical CDM Cost Ranges ...... 59

ACRONYMS

AAU Assigned Amount Unit AD Avoided Deforestation AFOLU Agriculture Forestry and Land-use BAU Business As Usual CER Certified Emission Reduction CCAR California Climate Action Registry CCX Chicago Climate Exchange CDM Clean Development Mechanism (Kyoto Protocol) CH4 Methane CO2 Carbon Dioxide CO2e Carbon Dioxide Equivalent COP Conference of the Parties CSR Corporate Social Responsibility DAF Development Adjustment Factor EO Earth Observation ER Emission Reduction ERU Emission Reduction Unit ES Ecosystem Service EU ETS European Union Emissions Trading Scheme FAO Food and Agriculture Organization FCPF Forest Carbon Partnership Facility FLEGT Forest Law Enforcement Governance and Trade GHG Greenhouse Gas GIS Geographic Information System GOFC-GOLD Global Observation of Forest and Land Cover Dynamics GPS Global Positioning System GWP Global Warming Potential HFLD High Forest Low Deforestation IPCC Intergovernmental Panel on Climate Change LCER Long-term Certified Emission Reduction LULUCF Land Use, Land Use Change and Forestry MRV Measurable, Reportable, Verifiable NAP National Allocation Plan NOx Nitrogen Oxides (nitrous oxide + nitrogen dioxide) N2O Nitrous Oxide REC Renewable Energy Credit REDD Reducing Emissions from Deforestation and Degradation REDD+ Reducing Emissions from Deforestation and Degradation plus enhancement of carbon stocks RGGI Regional Greenhouse Gas Initiative SF6 Sulfuric Hexafluoride SFM Sustainable Forest Management SOx Sulfur Oxides (sulfur dioxide + sulfur trioxide) SRI Socially Responsible Investing TCER Temporary Certified Emission Reduction UNFCCC United Nations Framework on Climate Change VER Voluntary Emission Reduction

CHAPTER 1: SCIENCE OF CLIMATE CHANGE

1.1 Greenhouse gases and climate change

The stability of the Earth’s climate is reliant on a delicate balance of inputs and outputs. Although there are a number of factors that affect local temperatures, the predominant component controlling globally averaged temperatures is incoming and outgoing solar radiation. In a simplistic model of the Earth system, the atmosphere and cloud cover reflects some of the incoming solar energy, but the remainder reaches the earth in wavelengths from the ultraviolet (UV) to infrared (IR) parts of the spectrum. However, it reradiates that energy mostly in the form of IR radiation back into the atmosphere. Greenhouse gases (GHGs), such as water vapor, carbon dioxide (CO2) and methane (CH4), prevent much of that radiation from escaping the earth’s atmosphere and reaching outer space. Their molecular structure is such that it absorbs IR radiation and then emits some of it back towards the earth’s surface, effectively trapping heat and creating what is known as the “greenhouse effect” (Figure 1). Many greenhouse gases have existed throughout the history of the Earth in fluctuating concentrations and have contributed to the natural variability in average temperature over that time. They play an integral role in the climate system by helping to maintain the Earth’s surface temperature at a level suitable to sustain life. However, the dramatic increase in GHG emissions since the industrial revolution has led to the “enhanced greenhouse effect,” whereby the increasing concentrations of atmospheric GHGs are disrupting the climate system.

Figure 1: The Greenhouse Effect1

As GHG concentrations continue to rise, more IR radiation is trapped in the Earth’s atmosphere, decreasing the total amount of outgoing radiation and changing the Earth’s energy balance. While there are certainly other influences that affect temperatures at different times in different regions, the prevailing trend in average global temperatures has been one of warming. Although some regions may benefit from climate change, most must brace for severe consequences including irregular precipitation patterns, sea-level rise and increased frequency of extreme weather events.

1.2 Effects of global climate change

Climate change is a unique environmental problem due to the long-lived nature of greenhouse gases and the geographic diffusion of their effects. Unlike conventional air pollutants, whose effects are felt locally over relatively short timescales, GHGs are diffuse and have lifetimes in the atmosphere of hundreds of years. This means that the effects of emissions are felt globally and in the aggregate, leading to a disconnect between those who emit and those who bear the consequences of emissions. Since GHGs subtly alter the composition of the global climate system, local effects will depend on the factors that drive local weather patterns. This reality about the nature of GHGs makes climate change one of the most harrowing collective action problems in history, because the costs of regulation or decreased consumption are not directly linked to the benefits of climate change mitigation. In addition, those who have contributed

1 The Pew Center for Climate and Energy Solutions, Climate Change 101: Science and Impacts, http://www.c2es.org/docUploads/climate101-science.pdf, accessed July 2012. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 1

least to the problem—the developing world—will in general have the poorest ability to cope with the impacts of climate change.

Of the many effects of climate change, some of the most likely and most potentially harmful include:

Rising sea level: Global average sea level rose about seven inches (17 cm) over the 20th century. This increase is largely due to the warming of the oceans during this time, which causes thermal expansion. The rate of sea level rise is expected to increase in coming years due to melting of mountain glaciers and of the Greenland and Antarctic ice sheets. In 2014, researchers at NASA determined that the West Antarctic Ice Sheet appears to be melting irreversibly, which alone could contribute 4 feet of sea level rise.2 By the end of the 21st century, sea levels are estimated to rise another 8-24 inches (20-60 cm)3, displacing coastal populations, significantly accelerating shoreline erosion, causing greater amounts of flood damage, and increasing levels of fresh water contamination. Small island nations like the Maldives and the Marshall Islands are in danger of being completely submerged by the rising sea in the future.

Receding snow pack: Mountain glaciers and snow cover have been declining worldwide and are expected to continue to contract. Reduced snowfall will strongly affect freshwater availability for many who depend on river flow from the Himalayas, Andes, Rockies and other mountain ranges for fresh water for agricultural, industrial and domestic use.

Ocean warming and acidification: As atmospheric CO2 concentrations increase, the ocean absorbs CO2 from the air, which causes seawater to become increasingly acidic. Acidification, combined with warmer ocean temperatures, is likely to be dangerous for a wide range of ocean species that have evolved to live within narrow temperature and pH ranges. Coral reefs, which are home to a quarter of the biological species in the ocean,4 are especially at risk. Fisheries will likely be affected as well due to species migration. For the last 300 million years the oceans pH has been slightly basic at 8.2, however, in the last 200 years, the pH level has dropped to 8.1, a 25% increase in acidity.5

Disappearance of Arctic sea ice: GHG-related climate change causes temperatures to increase more at high northern latitudes than at other locations around the world. This high-latitude warming has resulted in reductions in Arctic sea ice, especially in the late summer/early fall when ice extent reaches its seasonal minimum.6 Several recent independent estimates of Arctic sea ice indicate that there has been 50% sea ice loss in just the last 40 years.7 Climate modeling studies indicate that this trend will continue; in some projections, late summer sea ice is expected to disappear entirely before the end of the 21st century. Both people and wildlife that depend on sea ice for hunting and fishing are threatened by this change. The loss of Arctic sea ice may become a source of political conflict as different countries vie for access to and ownership of these newly opened shipping lanes. Note that 2012 saw record loss in arctic sea ice extent.

Heavier storms and more intense droughts: Over the past several decades storms over land areas have become more intense and more frequent. At the same time, more intense droughts have been observed over wider areas since the 1970s. Increases in drought intensity and length have occurred mainly in the tropics and subtropics, and these trends are expected to continue, especially in Northern Africa, the Sahel, the Mediterranean, Central America, and as recently seen in Southern California.. Climate projections also

2 NASA Jet Propulsion Laboratory (2014). “West Antarctic Glacier Loss Appears Unstoppable.” http://www.jpl.nasa.gov/news/news.php?release=2014-148 3 Intergovernmental Panel on Climate Change, Working Group 1 (2007). Climate Change 2007: The Physical Science Basis. Cambridge: Cambridge University Press, p. 5-7; p. 13. 4 Jim Hansen, Tell Barack Obama the Truth – the Whole Truth, http://www.columbia.edu/~jeh1/mailings/2008/20081229_Obama_revised.pdf, accessed July 2013. 5 National Geographic, Ocean Acidification, http://ocean.nationalgeographic.com/ocean/critical-issues-ocean- acidification/, accessed May 2015 6 Richter-Menger, J., et al, Arctic Report Card 2008: Sea Ice Cover, http://www.arctic.noaa.gov/reportcard/, accessed July 2013. 7 National Oceanic and Atmospheric Administration, National Climatic Data Center, US Department of Commerce, Climate Indicators, http://www.ncdc.noaa.gov/bams-state-of-the-climate/2009-time-series/arctic_seaice, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 2

indicate that the upward trend in intense precipitation events is highly likely to continue, accompanied by the potential dangers of flooding and agricultural damage. A scientific rule of thumb relating crop ecology to climate change states that “every 1 degree Celsius increase in temperature above ideal levels, reduces grain yields by 10 percent.”8

1.3 Human activity and global climate change

There is very high confidence among climatologists that anthropogenic (human-induced) GHG emissions are the leading cause of global climate change. Greenhouse gas concentrations increase as a result of fossil fuel combustion, industrial manufacturing, agricultural practices and other human activities.

Since the beginning of the industrial revolution, atmospheric concentrations of CO2 have increased about 38%, methane concentrations have more than doubled, and NOx concentrations have risen by about 15%.9 In May of 2013, the concentration of carbon dioxide in the atmosphere reached 400 parts per million (ppm), the highest level in several hundred millennia.10 Reaching this threshold represents a powerful and concerning symbol of the growing human influence on the Earth’s climate.

Figure 2: Carbon Dioxide Concentration at Mauna Loa Observatory11

The increasingly severe impacts of rapidly rising emissions on climate underscore the need for reductions in anthropogenic GHGs.

1.3.1 Economic sectors primarily responsible for GHG emissions

Climate change results in large part from greenhouse gas emissions associated with power production, land use, agricultural practices, transportation, industrial manufacturing, buildings, other energy-related

8 Lester R. Brown, Rising Temperatures and Rising Seas: The Yield Effect, Plan B: Rescuing a Planet Under Stress and a Civilization in Trouble, The Earth Policy Institute, New York: W.W. Norton & Company, 2003: 64. 9 Intergovernmental Panel on Climate Change, Working Group 1 (2007). Climate Change 2007: The Physical Science Basis. Cambridge: Cambridge University Press, p. 3. 10 International Energy Agency, Redrawing of Energy-Climate Map, http://www.worldenergyoutlook.org/media/weowebsite/2013/energyclimatemap/RedrawingEnergyClimateMap.pdf, accessed July 2013. 11 Scripts Institution of Oceanography, The Keeling Curve, http://keelingcurve.ucsd.edu, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 3

categories, and waste management. Of these eight source categories, depicted in proportion to one another in Figure 3, power, industry and transport activities generate more than half of the 42 billion tons of carbon emissions recorded at the turn of the millennium.12 Figure 3: Greenhouse Gas Emissions By Source13

Global emissions trends over time, by emission type and region are presented in Figure 4.

Figure 4: Global Carbon Dioxide Emissions By Region14

1.4 Projected GHG emissions growth: IEA scenarios

Global GHG emissions are expected to grow in the future due to increases in population, energy use and economic development. Average global surface temperature increase of 2°C over the pre-industrial average is considered to be the limit to how much warming the earth can endure while avoiding the most dangerous effects of climate change. The International Energy Agency has described a number of scenarios that can play out under various policy interventions in an effort to illustrate what will be necessary to stay under the 2° limit.15

The 450 Scenario sets out an energy pathway consistent with the goal of limiting the global increase in temperature to 2°C by limiting concentration of greenhouse gases in the atmosphere to around 450 parts per million of CO2. To be consistent with the required trajectory in the 450 Scenario, energy-related CO2 emissions must begin to decline this decade, even though the level of energy demand is expected to

12 Stern, N. (2007), The economics of climate change: The Stern review. Cambridge: Cambridge University Press. 13 Adapted from Figure 1, p. iv of The Stern review. 14 Global Carbon Dioxide Emissions by Region, U.S. Energy Information Administration (EIA), http://rainforests.mongabay.com/09-carbon_emissions.htm, accessed July 2013. 15 International Energy Agency, Redrawing of Energy-Climate Map, http://www.worldenergyoutlook.org/media/weowebsite/2013/energyclimatemap/RedrawingEnergyClimateMap.pdf, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 4

increase by 0.5% per year, on average: CO2 emissions peak by 2020 and then decline by 2.4% per year on average until 2035.16

The Current Policies Scenario assumes no changes in policies from the mid-point of the year of publication (previously called the Reference Scenario).

The New Policies Scenario takes account of broad policy commitments and plans that have been announced by countries, including national pledges to reduce greenhouse-gas emissions and plans to phase out fossil-energy subsidies, even if the measures to implement these commitments have yet to be identified or announced.

The Deferred Investment Case analyses how global markets might evolve if investment in the upstream industry in Middle East and North Africa countries were to fall short of that required in the New Policies Scenario over the next few years.

The Low Nuclear Case examines the implications for global energy balances of a much smaller role of nuclear power than that projected in any of the three scenarios presented in the WEO-2011.17

Policies that have been implemented, or that are now being pursued, suggest that the long-term average temperature increase is more likely to be between 3.6 °C and 5.3 °C (compared with pre-industrial levels), with most of the increase occurring this century. While global action is not yet sufficient to limit the global temperature rise to 2 °C, this target still remains technically feasible, though extremely challenging. To keep open a realistic chance of meeting the 2 °C target, intensive action is required before 2020, the date by which a new international climate agreement is due to come into force.18

16 Ibid. 17 International Energy Agency, Publications: Scenarios and Projections, http://www.iea.org/publications/scenariosandprojections/, accessed July 2013. 18 International Energy Agency, Redrawing of Energy-Climate Map, http://www.worldenergyoutlook.org/media/weowebsite/2013/energyclimatemap/RedrawingEnergyClimateMap.pdf, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 5

CHAPTER 2: ECONOMICS OF CLIMATE CHANGE

2.1 Climate change mitigation as a public good

Public goods are defined as goods that are non-rival and non-excludable. A non-rival good is a good whose consumption by one individual does not prevent its consumption by other individuals. A non- excludable good is a good that cannot be stopped from being consumed by others. Some examples of public goods include moonlight and sunlight.

Climate change avoidance is also a public good, because the benefits of avoiding climate change are both non-rival (anyone can benefit regardless of who else benefits), and non-excludable (nobody can be prevented from enjoying the benefits of preventing climate change). Any policy measures implemented by a country to reduce carbon emissions inherently benefits everyone else as well, not just the country trying to lower their carbon emissions. As a result, solving the problem of climate change is hampered by the free rider problem, in which certain countries actively seek to receive the benefits of lowering emissions without paying for it.

2.2 Costs of climate change

The economic impacts of climate change are broad ranging.19 They include costs to government and society, as well as costs to businesses and the environment. A conservative estimate of the economic risks and costs from global warming is a 5% loss in global gross domestic product (GDP). Taking into account a wider range of impacts, that damage total rises to 20% and possibly greater.20

Some of the costs associated with climate change impacts derive from destruction and insurance premium increases that result from hurricane, tornado, flooding and storm surges. Costs can also be accrued from leakage and site contamination cleanup, property devaluations caused by both conventional fossil fuel and some renewable energy generation, and inhabitant and ecosystem displacement through hydroelectric dam flooding. Compliance with climate change regulation also places unique financial burdens, at least initially, at corporate, state and federal levels.

The model of calculating the true cost to an economy of natural disasters is continually developing, as extreme weather events become more frequent and more intense. The resulting loss to the chain of production, consumption and everything that goes into it happens over time. In addition to infrastructural damages, many growing economies are faced with massive disruptions in their development. Unlike their better-developed counterparts, the ripple effects of a disaster may extend and deepen over time.21

Without policy interventions, emitters of greenhouse gases have no incentive to reduce their emissions because there are no direct market consequences for emitting. In fact, maintaining the status quo of goods manufacturing and power production is of greater economic benefit to emitters than paying the costs associated with replacing or retrofitting carbon-intensive facilities, even after the benefits associated with corporate social responsibility and public image are taken into account. The introduction of fines for emitting greenhouse gases and financial gain through the trading of permits and environmental credit commodities provides a disincentive for companies to emit, because the true costs of pollution are reflected in the price of production.

2.2.1 Estimating costs

Due to the fact that there are so many underlying assumptions that need to be made when it comes to calculating the cost of climate change, figures vary significantly. According to the World Development

19 Nicholas Stern, Stern Review on the Economics of Climate Change, http://www.hmtreasury.gov.uk/stern_review_report.htm, accessed July 2013. 20 Ibid., iv. 21 Ann Goodman, The cost of disaster: putting a price tag on climate change, http://www.greenbiz.com/blog/2012/06/08/cost-disaster-calculating-price-tag-climate-change, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 6

Report, the cost of climate change from 2010 to 2050 is expected to be anywhere from 30 to 100 billion dollars a year. The World Bank estimates this number to be higher and places the range at 70 to 100 billion dollars a year. In 2012 alone, the U.S. Climate Disruption Budget totaled almost 100 billion dollars, exceeding taxpayer money that was spent on transportation or education. According to the insurance industry, “2012 was the second costliest year in U.S. history for climate-related disasters, with more than $139 billion in damages.” Private insurance companies covered only 25% of this cost, while taxpayer money and public insurance companies covered the remaining 75%.22

In order to come up with the most accurate cost model for climate change, it is imperative to look at real estate losses, hurricane damages, energy costs and water scarcity. While there are overlaps with each category, by procuring data from these four categories, we can get an estimation for the cost of climate change. However, the availability of technology will play a large role in the cost.

Hurricanes While one of the biggest debates amongst the scientific community is the effect of global warming on hurricanes, recent studies using computer models have shown that warmer waters mean that future hurricanes will be stronger, increasing flood damage and erosion in the Caribbean and along the Atlantic coast. Recent hurricanes like Katrina and Sandy have wrought extensive damage, costing billions of dollars in taxpayers’ money. Damages from hurricanes may reach an additional $43 billion by the year 2050, and $422 billion by the year 2100.23

Real Estate Losses Real estate losses will largely come from the inundation of low-lying properties near bodies of water. Even if the piece of real estate is above water, a hurricane or a rainstorm could cause damage by creating surges of floodwater. Additional costs will come from making real estate more resilient to the effects of climate change. Finally, property values may also decline in order to reflect the added risk of climate-related damage. If our current path continues, up to $100 billion of existing coastal property will be under water by the year 2050, and up to $500 billion by the year 2100. The risk of property loss due to climate change in the U.S. is highest in the southeast and Atlantic coast.24

Energy Costs The continuous rise in temperature will signify an increase in demand for energy for air-conditioning and refrigeration. By the year 2050, it is expected that the average American will experience 27-50 days over 95°F per year. This is three times greater than the average of the past 30 years. This increase in temperature will lead to higher demand for energy that could outstrip supply and lead to higher energy costs.25 In addition, economic development in developing nations such as China and India will contribute to the increase in demand for more energy.

Water and Agriculture In addition to causing massive hurricanes and melting glaciers, climate change also leads to droughts, which can have an enormous impact on agriculture and the global food supply. In the U.S. South and Southwest, states are already experiencing a reduction in precipitation, which has not only created a water scarcity problem, but also increased costs in cultivating crops and the price of food found in supermarkets.

Observing these four impacts of climate change as well as historical data gives a fairly accurate picture of the cost of climate change over the years. According to studies performed by the Natural Resources

22 Estimating the costs of climate change, Climate Funds Update, http://www.climatefundsupdate.org/resources/estimated-costs-climate-change, accessed July 2013. 23 Frank Ackerman and Elizabeth A. Stanton, The Cost of Climate Change: What We’ll Pay if Global Warming Continues Unchecked, National Resources Defense Council, http://www.nrdc.org/globalwarming/cost/contents.asp, accessed May 2015. 24 Risky Business, Executive Summary, Sept 3rd 2014, http://riskybusiness.org/reports/national-report/executive- summary, accessed May 2015 25 Ibid. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 7

Defense Council (NRDC), the “true cost of all aspects of global warming—including economic losses, non-economic damages, and increased risks of catastrophe—will reach 3.6 percent of U.S. GDP by 2100 if business-as-usual emissions are allowed to continue.”26

Additional temperature increases in the Midwest, Southeast, and lower Great Plains could cause up to a 70% loss in average annual crop yields of corn, soy, cotton, and wheat. However, at the same time, increased temperatures and carbon fertilization may lead to improvements in agricultural yields in other northern states and the upper Great Plains.27

2.2.2 Discount rate

The discount rate compares two different economic events that have occurred at different times. Thus, it allows for the conversion of future economic costs into today’s value. By using the discount rate to look at today’s value, preventing climate change can be seen as an investment.

Unfortunately, it is difficult to arrive at an accurate discount rate due to imperfect information and the fact that people value future consumption differently. It is important to note that a high discount rate will result in not enough investment while a low discount rate will result in too much investment towards climate change mitigation.

2.3 Estimated costs of climate change regulation

Climate change regulations generate two major types of costs: compliance costs for the regulated industries, and administrative costs for the government agencies charged with implementing regulations. Regulated industries may also face fines for non-compliance. For instance, the largest existing cap-and- trade market, the EU Emissions Trading Scheme (EU ETS), raised its penalty for non-compliance from €40 per ton in Phase 1 to €100 per ton in Phase 2.28 This is in addition to shouldering the cost of the purchase of more allowances. Companies must perform cost-benefit analyses to determine whether changes in emissions-generating practices are economically more attractive than the penalties levied for non-compliance. Even when compliance is the selected option, decisions must be made regarding whether it is more financially beneficial to act immediately to reduce emissions through retrofitting and purchase allowances to match the remainder of emissions, or pay penalties in the short term while accumulating the capital necessary to make major production changes or build entirely new facilities at a later date. This ties into what economists refer to as the marginal cost of abatement that a given entity faces (see Figure 5 below).

26 Frank Ackerman and Elizabeth A. Stanton, The Cost of Climate Change: What We’ll Pay if Global Warming Continues Unchecked, National Resources Defense Council, http://www.nrdc.org/globalwarming/cost/contents.asp, accessed May 2015. 27 Risky Business, Executive Summary, Sept 3rd 2014, http://riskybusiness.org/reports/national-report/executive- summary, accessed May 2015 28 European Commission, Climate Action, August 2014. Retrieved from http://ec.europa.eu/clima/policies/ets/pre2013/index_en.htm This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 8

Figure 5: The Marginal Cost of Abatement29

29 Scott Barrett, Economics of Reducing Greenhouse Gas Emissions, Columbia University, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 9

2.3.1 Stern Review: projected mitigation and adaptation costs

30 Figure 6: Illustrative Emissions Paths to Stabilize at 550ppm CO2e

Achieving these deep cuts in emissions will have a cost. The Stern Review estimates the annual costs of stabilization at 500-550ppm CO2e to be around 1% of GDP by 2050 – a level that is significant, but preferable to the economic costs of leaving climate change unaddressed.31

In order to combat climate change, greenhouse gases need to be mitigated and reduced from the current rate of emissions. Emissions can be reduced in the following four ways:

1. Increase energy efficiency, which cuts emissions and saves money. 2. Decrease demand for energy-intensive goods and services. 3. Switch consumption of energy to that produced from renewable sources. 4. Engage in carbon sequestration and preventing deforestation, removing GHGs from the atmosphere.

30 Malte Meinshausen. What does a 2oC target mean for greenhouse gas concentrations? A brief analysis based on multi-gas emission pathways and several climate sensitivity uncertainty estimates (Cambridge: Cambridge University Press, 2006), 265-280. 31 Nicholas Stern, Stern Review on the Economics of Climate Change, http://www.hmtreasury.gov.uk/stern_review_report.htm, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 10

CHAPTER 3: TECHNOLOGY OPTIONS FOR EMISSIONS REDUCTION

3.1 Combining technology options: the “wedge” theory

Effectively addressing climate change requires a combination of technological and behavioral changes. In 2004, Robert Socolow and Stephen Pacala of Princeton University first presented the “wedge” theory, made up of seven components of emission reduction technologies and practices. The number of wedges has since increased to eight. The wedge theory illustrates how employing a combination of different existing technologies can result in environmental and energy strategies that will reduce future greenhouse gas emissions to acceptable levels, and is portrayed visually in Figure 7. Each of the eight smaller wedges in this theory signifies a reduction of carbon from 0 to 1Gt of carbon per year within a 50-year period. Renewable electricity and fuels, energy efficiency and conservation, fuel switching, nuclear fission, forests and soils, and carbon capture and storage are theorized as being capable of reducing global emissions from a projected 14Gt of carbon per year (under the present emissions scenario) to 7Gt of carbon per year.

Figure 7: Emissions stabilization wedge32

The five most commonly used emissions mitigation strategies are (a) reductions in demand for emissions- intensive goods and services; (b) efficiency gains that result in money-saving opportunities and emissions reductions; (c) low-carbon technologies already available but presently more expensive than fossil-fuel equivalents; (d) non-fossil fuel emission reductions; and (e) carbon sequestration, or carbon capture and storage. Each strategy carries its own costs and benefits, which may or may not differ from its business- as-usual fossil fuel equivalents. The marginal cost of abating one ton of GHG using various technologies from present conditions onward is depicted in Figure 8.

32 Robert H. Socolow, Wedges PowerPoint Presentation, http://cmi.princeton.edu/wedges/slides.php, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 11

Figure 8: Illustrative marginal abatement option cost curve33

The emissions-mitigating capacity, or abatement potential of solar or wind farming may increase per unit as technology advances and these options are brought to scale.

3.2 Examples of energy efficiency improvements

Energy efficiency improvements allow for reducing the amount of energy used in a given process. Internal energy efficiency projects can be implemented in a power plant at the electricity generation level or at the consumer level. At the electricity generation level, energy efficiency means using less fuel to generate the same amount of electricity, reducing the GHG emissions for a given level of electricity production This can be accomplished by improving and maintaining existing equipment and by implementing best practices throughout the entire fuel cycle, including drilling, transport, processing, and combustion. For example, firing equipment is often given a low priority within maintenance procedures and thus contributes little to the overall efficiency of the power plant.34 However, ensuring that a plant’s firing equipment is reliable through regular maintenance, proper management and adjustments in fuel quality can reduce GHG emissions. Aging boiler equipment can also contribute to efficiency losses. Strategies to attain higher boiler efficiency include optimizing boiler design and benchmarking against other power plants. The potential benefit of these improvements is the decreased production of energy waste. Instrumentation and control systems of a power plant manage plant performance; moreover, using advances in digital monitoring technology, these control systems can be upgraded while proper management techniques can be internally promoted to guarantee the efficient operation of the plant. Finally, system upgrades can help control the maintenance of plant equipment, reducing costs and increasing overall efficiency.

At the end-user level, it is possible to reduce GHG emissions by reducing the amount of energy used by individuals in their homes. For example, in residential buildings, it is possible to reduce energy use by replacing incandescent bulbs with compact fluorescent lighting and upgrading appliances like refrigerators and washing machines with newer energy efficient models. Installing efficient heating ventilation and cooling (HVAC) systems in new buildings and retrofitting older buildings to optimize the energy used for heating and cooling can drastically reduce the need for electricity. The U.S. energy grid, which was built in the late 19th century, has been pushed to the brink due to rising energy demands. This has led to a shift towards smart grid technologies, which employ variable generation as well as computerized digital technology with demand response, to create a more efficient and low- emission energy system.35

33 Nicholas Stern, Stern Review on the Economics of Climate Change, http://www.hmtreasury.gov.uk/stern_review_report.htm, accessed July 2013. 34 United States Energy Association. Handbook of climate change mitigation options, http://pdf.usaid.gov/pdf_docs/pnacj647.pdf, accessed July 2013.

35 U.S. Department of Energy, Smartgrid.gov This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 12

Energy can also be conserved through behavioral changes. Simple measures such as turning up the thermostat in the summer and turning it down in the winter can make a meaningful impact on one’s own energy consumption. However, the amount of GHG emissions reduced from these strategies depends on the type of technology used to generate the electricity initially. A consumer whose energy is derived from fossil fuel sources can greatly decrease their own carbon footprint by decreasing energy use, whereas one who relies on renewable sources will not have the same effect.

3.3 Fuel switching

Fuel switching is the replacement of a carbon-heavy fuel with one that has lower carbon content. The carbon content of various fossil fuel types is shown in Table 1. For example, burning natural gas rather than coal produces fewer metric tons of carbon emissions for a given amount of energy production. Prospects for reducing GHG emissions through fuel switching are promising since coal-fired plants converted to burn natural gas to produce electricity can reduce emissions by 60% per kilowatt-hour of energy production.36 Drastic energy efficiencies and conservation can be attained by substituting natural gas for oil, and both of these fuels for coal. This dramatic cut in carbon emissions by burning natural gas creates a ‘bridge’ towards cleaner energy sources by buying more time to make such a switch to renewable, carbon-free sources.

The advent of hydraulic fracturing has drastically improved resource extraction capabilities, and has helped create a boom in shale gas in the US, which has temporarily alleviated fears of shortages in oil and natural gas. As future outlooks grow less worried with exhausting the planet’s stocks of fossil fuels, concern has shifted to the growing environmental costs of exploiting these natural resources.

Table 1: Carbon Content of Different Fossil Fuels37

Coal 25.4 metric tons carbon per terajoule (TJ) Oil 19.9 metric tons carbon/TJ Natural Gas 14.4 metric tons carbon/TJ

Fuel switching also includes switching from a carbon to a non-carbon based fuel type. Non-carbon based fuels include the use of biomass, waste materials and certain pretreated plastics. Although some of these fuels generate carbon emissions, if they are less carbon intensive than the alternative fossil fuel, then they still create a net GHG reduction.

3.4 Nuclear energy

Nuclear energy refers to the energy that is produced from fission, the act of splitting uranium atoms. The fission process produces heat, which is then used to boil water to create steam. The steam turns a turbine that is connected to a generator. Electricity is generated as the turbine turns. Although nuclear energy produces lower amounts of carbon than its fossil fuel counterparts, there are debates on whether or not it can be considered renewable energy. Unlike solar or wind, nuclear derives its energy from uranium, which is a finite resource. In addition, nuclear energy plants are known for producing radioactive pollutants, which diverges heavily from the notion of clean and renewable energy. While there have been nuclear accidents, for example in Fukushima in 2011 and Chernobyl in 1986, nuclear energy is actually relatively safe and accidents are rare. In terms of cost, nuclear energy production is relatively inexpensive, however, the cost of building a new plant can reach billions of dollars, depending on the scale and amount of energy produced. When accidents occur, the cost can be extremely high. The partial meltdown of the Fukushima plant that had zero casualties is estimated to cost 100 billion dollars. If such incidents are factored in, the cost of building and generating electricity from a nuclear power plant becomes very expensive. Ever since the Fukushima incident, there has been a backlash against nuclear energy in many parts of the world, including

36 Ibid. 37 Scott Barrett, Technology Options for reducing atmospheric concentrations, Columbia University (July 2012). This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 13

the United States. Japan has met their large energy demand by increasing their LNG imports and investing in ventures to build up their solar and wind infrastructure.

3.5 Renewable energy technologies

Renewable energy is broadly defined as energy produced from an inexhaustible source.38 Despite their importance, without revolutionary advances in technology, renewables will remain complimentary to fossil fuel technology. Factors preventing renewables’ becoming competitive with fossil fuels include cost, scale, lack of suitable infrastructure, transmission, intermittence, and storage. One of the biggest hurdles for both solar and wind technologies, for example, is the tradeoff between generation cost and location, given that the highest quality sources of solar and wind power tend to be far from load centers, increasing the costs of transmission. Figure 9 provides some sample-levelized costs of various energy sources. Levelized cost is the average cost of the energy produced by the plant, found by dividing the cost of plant installation by the total amount of energy it is expected to produce. Regarding scale, the largest solar generation facilities and wind farms don’t provide as much power as conventional industrial power plants do. This may change with more progress in research and development.39

Figure 9: Variation in Levelized Costs of New Generation Resources, 201840

Renewable energy sources can be classified as first, second or third generation based on the maturity level of the technology and its deployment potential. First generation technologies are considered mature and

38 United States Energy Association. Handbook of climate change mitigation options, http://pdf.usaid.gov/pdf_docs/pnacj647.pdf, accessed July 2013. 39 J.A. Edmonds et al., Global Energy Technology Strategy: Addressing Climate Change, PNNL, (May 2007): 90. 40 US Energy Information Administration, Annual Energy Outlook 2013, http://www.eia.gov/forecasts/aeo/, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 14

economically competitive, while second generation are considered market-ready and are being deployed. The third generation category includes alternatives requiring continued research and development to reach a stage where large-scale contributions to emissions reduction or climate change mitigation are possible. The first generation includes hydropower, biomass combustion, and geothermal power and heat. The second-generation includes wind energy, solar photovoltaics and modern forms of bioenergy. Finally, the third-generation technologies include a range of nascent technologies, including tidal energy and enhanced geothermal systems.41 Figure 10 illustrates the growth of renewable electricity generation over time, including predicted levels in future decades. Low carbon electricity supply must increase from 30% (current levels) to 80% by 2050 to meet most warming scenarios standards.

Figure 10: Electricity Generation from Renewables by Region in the New Policies Scenario (TWh) 42

3.5.1 Hydropower

Hydropower refers to the process of producing electricity by capturing the energy of moving water as it passes through a turbine. The flow of water forces the turbine, which is connected to a generator, to rotate, thus converting the motion of rotation into electrical energy. The amount of energy generated from these systems depends on the flow and energy of the water moving through the turbine unit. Hydropower has several benefits over other energy technologies. For example, these systems generally have long technical lifetime (more than 50 years) and reduced maintenance costs. Thus, electricity generated from large hydropower plants provides a lower-cost energy option. One downside of hydropower is site selection, as the plant must be located near an appropriate body of water. Additionally, hydropower plants can have

41 International Energy Agency, Renewables in Global Energy Supply, January 2007. Accessed July 2014 from https://www.iea.org/publications/freepublications/publication/renewable_factsheet.pdf 42 International Energy Agency, World Energy Outlook 2012, http://www.worldenergyoutlook.org/publications/weo- 2012/, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 15

deleterious impacts on the surrounding environment, as they flood surrounding land to create the reservoir and impede migration patterns for migratory fish. In certain instances hydropower systems can be located near the end-users, which reduce the cost of energy transmission infrastructure and associated energy losses. In addition, small-scale hydropower systems with reduced environmental impact, for example some run-of-the-river (ROR) plants, can provide effective, low-maintenance alternatives to supply energy in remote areas. In order to ensure that these systems do not have harmful effects on the surrounding environment and ecosystem, the proper due diligence including well-developed feasibility assessments must be performed. Ill-effects can include dry rivers and damage to fish, flora and fauna in the area.

3.5.2 Biomass

The term “biomass” can refer to numerous natural renewable resources, which store energy in a molecular form and can be converted to heat, electricity, other fuels or chemicals. Sources of biomass include forests, organic components of waste, agriculture and livestock residues. The chemical energy in the molecular form is released when biomass is combusted, but biomass processing can create solid (briquettes or logs), liquid (ethanol or methanol), or gaseous (biogas or hydrogen) fuels. Biomass can be used at the individual or facility level. In a biomass combustion facility, the original feed must first be processed by sizing, drying and blending it to specifications for a particular boiler. It is then combusted within the boiler, which uses the generated heat to create high-pressure steam to drive a turbine, which in turn generates electricity. A schematic diagram of this process is shown in Figure 11.

Figure 11: Biomass System Schematic

Biomass combustion can reduce emissions when it replaces other fossil fuels. However, the life-cycle process of biomass combustion includes expending energy related to transportation of biomass to the facility and the energy required by equipment used in the combustion process. In addition, especially for intensive biomass production, mechanical energy utilized in the growth and harvest should be accounted for. Despite these challenges, biomass can be economically competitive and provides a way of increasing efficiency up to 22-37% when the biomass is gasified or liquefied for use as fuel.43

Biofuels are a potential low-carbon energy source, but whether biofuels offer carbon savings depends on how they are produced. Converting rainforests, peat lands, savannas, or grasslands to produce food crop- based biofuels in Brazil, Southeast Asia, and the United States creates a “biofuel carbon debt” by releasing 17 to 420 times more CO2 than the annual GHG reductions that these biofuels would provide.. In contrast,

43 Ibid. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 16

biofuels made from waste biomass or from biomass grown on degraded and abandoned agricultural lands planted with perennials incur little or no carbon debt and can offer immediate and sustained GHG advantages.44

3.5.3 Wind power

Wind power is produced by transferring the kinetic energy from wind to the rotor of a wind turbine. The mechanical energy from the rotor drives a generator, thus producing electricity. In most cases, the wind turbines have a control system that optimizes the generator speed for efficiency purposes when connected to a main power grid. The amount of energy that can be extracted from the wind by a turbine is dependent on the wind speed and the diameter of the rotor. These two factors directly relate to the power rating of turbine units. Wind turbines can be placed both onshore and offshore, with common capacities ranging at 1.5 to 3.0 megawatts.

Wind technology is becoming a more and more reliable option for securing energy and with common technical lifespan now reaching 20 years or more.45 In addition, costs of project investments for wind turbines have steadily declined and technical reliability has increased. The principle advantage of wind generation over other forms of energy is that it hardly contributes to carbon emissions. However, common problems with harnessing wind power include noise, aesthetics and wildlife fatalities. In addition, a main concern relates to the variability of wind speed and thus intermittency in energy supply.

3.5.4 Solar energy

The term solar energy typically refers to the conversion of sunlight into usable form of energy through thermal or photovoltaic (PV) systems. Solar thermal or concentrated solar systems generate heat from sunlight using mirrors and lenses to focus sunlight onto a receiver. The receiver can take the form of a singular “power tower” or a tube, which runs along the center of a parabolic trough. Both use the heat from solar energy to convert liquid to steam and then power a steam turbine-generator. The cost-effectiveness of solar thermal systems, however, is currently low due to technology complexity, cost of the collector and receiver materials, and also the large amount of the land required for the installations.

Solar PV cells are semi-conductor devices composed of a wafer containing a layer of phosphorus-doped (N-type) silicon on top of a layer of boron-doped (P-type) silicon. This semi-conducting material produces an electrical field when sunlight strikes its surface, and generates a strong electrical current by interconnecting several cells. Common commercially available solar PV panels now have capacities of 150- 250 watts.

Solar PV is an attractive technology because it can be used in a variety of locations and installed either as part of a solar farm (a large solar facility) or at the individual level as in the case of rooftop solar. Maintenance and operation costs are traditionally low, but the raw materials required for the production of solar panels still drive up the cost of solar electricity. However, investment in research and development of solar cells in conjunction with market policies have led to cost reductions of 20% for every doubling of volume produced.46

44 Joseph Fargione, Land Clearing and the Biofuel Carbon Debt, http://www.sciencemag.org/content/319/5867/1235.abstract, accessed July 2013. 45 International Energy Agency, Renewables in Global Energy Supply: An IEA Fact Sheet, https://www.iea.org/publications/freepublications/publication/name,3636,en.html, accessed July 2013. 46 Ibid. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 17

3.5.5 Geothermal energy

Geothermal energy transfers the heat and steam stored below the earth’s surface to a turbine that drives a generator to produce electricity.47 Underground heat sources such as hot water or steam reservoirs with temperatures ranging from 122-482°F (50-250°C)48 are accessed by means of drilling through the earth’s layers. Because high temperature steam provides a good source of geothermal power, areas near hot springs and geysers are often targeted for geothermal installations. Geothermal power plants can operate 24 hours per day. In fact, Iceland uses geothermal energy for 66% of the nation’s primary energy use.49 Geothermal energy production results in minimal GHG emissions, and costs for this technology have dropped since the 1970s. However, the accessibility of geothermal power locations and the ability to transport this energy are common obstacles. Moreover, the risk of increased and unpredictable seismic activity resulting from geothermal energy production is only beginning to be understood.

3.5.6 Landfill gas

Landfill gas (LFG) projects collect GHGs emitted by landfills. The gases are filtered and cleaned, and can then be used onsite to generate heat or electricity. In some instances the gas can be piped or collected to be sold as fuel. Landfill gas is composed of approximately 50% methane (CH4), a GHG that is 21 times more potent than CO2. Carbon reductions are achieved by collecting the methane that would otherwise have been emitted from the landfill and using it as a fuel source to offset electricity generation from a more polluting fuel source. Reducing methane emissions at landfills also cuts the exposure to air pollution of the surrounding communities. These projects generate benefits that are important for improving urban living standards, by both preventing health issues linked to noxious gases from the landfills as well as creating access to a stable energy source that allows for private entrepreneurship and income diversifying schemes.

3.6 Forms of carbon sequestration

Carbon sequestration is the permanent storage of carbon that would otherwise be in the atmosphere. As illustrated in Figure 12, carbon can be captured before it is released into the atmosphere, or it can be extracted from the air. In both scenarios the carbon is then stored permanently.

47 United States Energy Association. Handbook of climate change mitigation options, http://pdf.usaid.gov/pdf_docs/pnacj647.pdf, accessed July 2013. 48 Ibid. 49 National Energy Authority of Iceland, http://www.nea.is/geothermal/, accessed August 2014. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 18

Figure 12: Components of Carbon Capture and Storage50

3.6.1 Carbon capture and storage (CCS)

Carbon capture removes carbon from the exhaust flow of large fixed-point sources such as power plants, while air capture technologies remove CO2 directly from the atmosphere and in doing so attempts to reduce the global atmospheric concentration.51 Implementing these technologies has the potential to vastly reduce power plant CO2 emissions in the atmosphere. Although fixed-point carbon capture has been experimented with since the 1970s, carbon storage poses a difficult technical challenge and it has yet to be deployed on large industrial scales; further, there are still uncertainties associated with reliability, permanence and safety of long-term carbon storage. The most promising locations for carbon storage are deep in geological formations and sedimentary basins (geo-sequestration).

CO2 has been successfully stored in depleted oil and gas fields and used in a process known as “enhanced oil recovery” or EOR. EOR is performed by injecting CO2 into the ground, thereby increasing the pressure and forcing up more oil. While some CO2 escapes out with the oil, a significant portion can be trapped inside the oil reservoir. Even considering this slight windfall, CCS technologies on the whole are not commercially viable because of their immense cost. Unless a price is put on CO2 emissions, CCS is unlikely to become a widespread technology.

3.6.2 Air capture

Direct air capture is a process in which carbon dioxide is extracted from the atmosphere in a closed loop 52 system. This extracted CO2 can be used in industrial applications or stored in geological reservoirs. While air capture technology is still in its nascent stages, it has the unique possibility of reversing atmospheric concentrations and must be put on the radar of policy-makers in order to increase funding for further research and development. Air extraction technology can compensate for CO2 emissions everywhere. Ultimately, the hope is that air capture will become a cost-effective technology in the future given its extraordinary potential to address climate change. Currently there is a wide range of estimates related to the costs associated with air capture technology, with even the lowest estimates at several hundred dollars per ton carbon.53

3.6.3 Bio-sequestration and soils

50 Klaus S. Lackner, Energy, Carbon, Climate Options for the Future, Columbia University. 51 David W. Keith, Minh Ha-Duong, and Joshuah K. Stolaroff, Climate Strategy with CO2 Capture from the Air, http://www.keith.seas.harvard.edu/papers/51.Keith.2005.ClimateStratWithAirCapture.e.pdf, accessed July 2013. 52 Carbon Engineering, Air Capture, http://carbonengineering.com/air-capture/, accessed May 2015 53 Ibid., 25. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 19

Vegetative carbon sequestration refers to the removal of CO2 from the atmosphere by agricultural and forestry processes which absorb and subsequently store CO2 in plants and organic matter. Agricultural and 54 forestry lands that absorb CO2 are referred to as vegetative “sinks”. The UNFCCC defines a sink as “any process, activity or mechanism that removes a greenhouse gas, an aerosol or a precursor of a greenhouse gas from the atmosphere”.55 In turn, through the process of decomposition of dead organic matter in soils, CO2 is returned to the atmosphere. As a result, net sequestration of this type only occurs when the amount of carbon uptake into growing plant life exceeds the rate of carbon emitted through decay.56 Points of carbon storage, or pools, can take the form of “living, aboveground biomass (e.g., trees and shrubs), products with a long, useful life created from biomass (e.g., lumber), living biomass in soils (e.g., roots and microorganisms), or recalcitrant organic and inorganic carbon in soils and deeper subsurface environments.”57

Trees make up much larger carbon reservoirs than herbaceous plants. Sequestration in trees occurs while a stand of trees is growing and lessens significantly as the stand reaches maturity. Consequently, non- renewed growing of trees to sequester carbon would result in a one-time benefit over a limited period,58 while growing trees for an energy substitute to fossil fuels and harvesting them periodically before they mature leads to a continuous offset benefit.59 Hence, growth and harvesting must be managed to ensure that emission sequestration levels are sustained. Tropical forests, presently undergoing extreme deforestation, have a carbon sink potential that is nearly eight times that of forests in mid- and northern latitudes.

Soils have a large potential for carbon sequestration. In fact, global carbon content in soils is three times larger than in plants and animals, twice the amount in the atmosphere and a third of the carbon found in fossil fuels. Specifically, the carbon stored in soil organic matter depends on the balance between the annual input of dead plant material and the annual loss of organic matter through decomposition. When ecosystems reach maturity, the carbon content in soils remains constant, although the actual amount varies among ecosystems. Such variation occurs in very large amounts of carbon content in peat lands, where anoxia slows respiration rates, and very small amounts in hot, dry areas where respiration proceeds rapidly and inputs of organic matter are scarce. Physical disturbance of soils (i.e. cultivation, draining, etc.) accelerates soil respiration, originating a carbon source, while practices aimed at increasing productivity (i.e. application of fertilizers) are likely to create a carbon sink.60

Soils that are used for agricultural purposes are particularly valuable as carbon sinks, since agricultural practices promote carbon sequestration by altering land-use, maximizing yield and maintaining more continuous vegetation cover.61 The soil’s ability to act as a sink is dependent on many factors including land-use history, length of growing season, cloudiness, and warm temperature anomalies.62

54 US EPA, Carbon sequestration in agriculture and forestry, http://www.epa.gov/sequestration/, accessed July 2013. 55 UNFCCC (2007). Land-use, land-use change and forestry. http://unfccc.int/methods_and_science/lulucf/items/1084.php, accessed July 2013. 56 British Government Panel on Sustainable Development, Sequestration of carbon dioxide, http://www.sd-commission.org.uk/panel-sd/position/co2/anna.htm, accessed July 2013. 57 US Department of Energy, Carbon sequestration in terrestrial ecosystems, http://csite.ornl.gov/, accessed July 2013. 58 US EPA, Carbon Dioxide Capture and Sequestration, http://www.epa.gov/climatechange/ccs/index.html, accessed July 2013. 59 Ibid. 60 Ibid. 61 United States Energy Association, Handbook of climate change mitigation options, http://pdf.usaid.gov/pdf_docs/pnacj647.pdf, accessed July 2013. 62 Ibid. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 20

CHAPTER 4: POLICY AND REGULATORY OPTIONS FOR EMISSIONS REDUCTION

4.1 Cap and trade systems

Under a cap and trade system, a cap is placed on how much carbon can be emitted into the atmosphere. Once this is established, carbon allowances are distributed; either sold, allocated, or auctioned; and a market for trade is established between companies that wish to emit more and companies that wish to make a profit by selling their leftover carbon allowances.

In addition to shouldering the cost of the purchase of more allowances, companies must perform cost- benefit analyses to determine whether changes in emissions-generating practices are economically more attractive than the penalties levied for non-compliance. This ties into what economists refer to as the marginal cost of abatement that a given entity faces. An example of the marginal cost of abatement under a carbon tax and a cap and trade system is shown below in Figure 13.

Suppose that only two electric companies exist, and company A’s emissions are historically 150,000 tons annually, while company B’s emissions are historically 50,000 tons annually. Suppose that a federal mandate has established that each company may only emit 100,000 tons of carbon dioxide annually from electricity production or face closure for non-compliance. Company A may either purchase unused permits at US$100 per ton from company B to meet its cap, or, it can pay for physical changes in its operations which would yield fewer emissions and ensure full compliance with the new regulations. Company A must determine which option is more cost-effective.

Company A’s cost of retrofitting current operations to be cleaner may cost one payment of US$40M and yield 100,000 tons of annual emission reductions (which complies with current regulations), whereas purchases of permits from company B will cost US$10M annually through a purchase contract. In the 4th year, the two costs will be approximately equal, but until then the cost of purchasing from company B is less than retrofitting, and after the 4th year, the cost of retrofitting would have been cheaper than purchasing from company B. What is unknown to either company is whether or not the mandate will lessen, remain unchanged or even increase.

Additionally, company A cannot be sure that company B will not increase the price of its excess permits after the 4th year. Financial risks that regulated entities will face in their decision-making processes can have upsides, however an initial payout is almost always necessary when shifting away from the status quo of operations. Should company A choose to invest in retrofitting its own operations, the structural change may yield 10,000 surplus permits that can be sold annually to a third company entering the market with highly-polluting practices. Often the company costs associated with regulatory compliance are recovered by increases in operating efficiency, such as in the above example, combined with the transfer of costs to the consumer purchasing the electricity, automobile or paper products that the company produces.

Figure 13: Tax vs. Cap and trade63

From Figure 13 above, it is clear that Firm A and Firm B have different marginal cost of abatement curves. The cost of carbon abatement is much higher for Firm A than it is for Firm B. Therefore, the firm that is least able to reduce emissions due to a higher MCA curve, is firm A. Firm A, facing a relatively high marginal cost of abatement, would pay up to $xA to achieve the optimal level of abatement (as desired by the government), but Firm B will be able to do that at only $xB. Since the marginal abatement cost is higher for Firm A than Firm B, there is an opportunity for the two firms to trade. Firm B would therefore 64 sell permits to Firm A for a price between $xB and $xA.

4.2 Carbon tax

Another method in which the government can implement to restrict the emission of carbon is a carbon tax. Whereas a cap and trade system can be thought of as regulating the quantity of emissions, a carbon tax regulates the price of emissions. Theoretically the same result (reduced emissions) is achievable with either approach. Although a carbon tax is a straightforward way for many companies to assess their current level of emission reductions, setting the level of the tax is a challenge. If the tax is too low, companies might choose to just pay the tax and forgo emissions reductions. If the tax is too high, companies will be rendered unprofitable. If the government is able to set the carbon tax at the proper level, it has the potential to reduce emissions without hurting the overall economy. Although a carbon tax fails to specify the precise amount of carbon emissions, it does generate revenue for the government, which can be invested in clean energy.

63 Econ 101: Carbon Tax vs. Cap and trade, Environmental Economics, http://www.env- econ.net/carbon_tax_vs_capandtrade.html, accessed July 2013. 64 Ibid. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 22

Figure14: The Marginal Cost of Abatement65

In an unregulated economy, firms that are most interested in their profit margins will choose to not abate any units of carbon and will avoid any additional costs (which are shown in the areas, B + C + D, underneath the MCA curve). With no effort at abatement, the firm's profit-maximizing level of emissions is the highest, i.e. at ‘e-max’, the level at which the firm is not abating and hence the marginal cost of abatement is zero.66

To achieve the desired level of abatement (e*) the government sets a per-unit tax ‘T’ on carbon emissions where MB = MCA. It will be cheaper for firms to abate carbon emissions only when the MCA curve is lower than the tax. Graphically, as long as the aggregate tax bill, which is represented by areas A and B is greater than the marginal abatement cost bill, which is represented by the area labeled B, the firm will choose to abate because it is cheaper than paying the carbon tax. The marginal cost (C + D) exceeds the aggregate tax (D). As a result, the firm will opt to pay taxes beyond e* rather than abating emissions.67

It will therefore pay a total tax given by the rectangle labeled D and incur a total abatement cost given by the triangle B under the MCA curve to the left of e*. This cost is less than the tax that the firm would have paid if it did not reduce emissions at all. The total cost (cost of abatement and tax on emissions) to the firm is B + D (considering it is only abating e* and paying a tax on emissions which are greater than e*) and the total government revenue is D.68

It is clear from this model that by implementing a proper carbon tax, the government is able to achieve its goal of lowering emissions as well as increasing revenue. The amount of revenue represented by D could be used to fund a REDD project and reward developing nations that choose to grow in a sustainable manner.

4.3 Renewable Portfolio Standards (RPS)

RPS is a policy mechanism that encourages energy producers to deliver a certain amount of energy that is created from renewables like solar, wind, geothermal, wave and tidal. RPS has already been implemented in several European countries such as Sweden, England, Italy, Poland and Belgium. As of August 2015, 33 U.S. states and the District of Columbia have implemented RPS policies. Within the United States, the designated renewable resources were mostly derived from biomass, geothermal, wind,

65 Ibid. 66 Ibid. 67 Ibid. 68 Ibid. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 23

solar and hydroelectricity.69 Unlike feed-in tariffs, which guarantee the purchase of renewable energy despite the fluctuation in costs, RPS allows for price competition amongst the different renewable energy sources. Proponents of RPS argue that introducing the market will allow for maximum efficiency and increase the speed at which renewable energy can reach parity.

4.4 Feed-in tariffs

A feed-in tariff is a policy measure that incentivizes the uptake of renewable energy sources like solar and wind through long-term contracts that provide monetary payments for every kWh of electricity that is generated. The amount of payment is largely dictated by the cost of producing electricity from the renewable source. Homeowners, small business owners, private investors or even large electric utility companies are eligible to get paid for providing electricity from renewables to the grid. A kWh of electricity produced from wind is usually awarded a lower price compared to a kWh of electricity produced from solar, reflecting the higher cost of producing electricity from the latter.70

China and Germany have had success in implementing feed-in tariffs in their economy and have drastically increased their reliance on renewable energy sources (RES) over traditional fossil fuels. China is projecting that 15% of its electricity will be coming from RES by 2020, while Germany expects to increase its electricity uptake from RES to 30%.71,72

4.5 Tax credits

Tax credits are simply a deduction from the total amount of money that an individual or company owes to the government. Tax credits are provided on investments made in renewables such as solar, wind, biomass, geothermal, hydro, wave and tidal energy. In the United States, a tax credit of 30% of the cost of development is provided “for solar, fuel cells, small wind and PTC-eligible technologies.”73 Investments made in “geothermal, micro turbines and combined heat and power” are eligible to receive a tax credit of 10% of the cost of development. Tax credits for investments made in renewables come in to effect when the facility is completed. It is important to note that a company must have significant tax liabilities in order for it to benefit from tax credits.

4.6 Subsidies

Energy subsidies are policy mechanisms implemented by the government that reduce the cost for consumers to buy energy and for producers to sell energy. Providing subsidies ensures the availability and affordability of energy sources, whether they come from traditional fossil fuels or renewable energy sources. From 2005 to 2009, U.S. energy subsidies for the fossil fuel industry increased from 9.1 billion to 15.4 billion and energy subsidies for renewables increased from 3.4 billion to 18.5 billion.74 On a global scale, in 2013 nearly $550 billion in subsidies were allocated for fossil fuels, down $25 billion from the

69 U.S. Energy Information Administration, Most States have Renewable Portfolio Standards, http://www.eia.gov/todayinenergy/detail.cfm?id=4850, accessed July 2013. 70 Tobey Couture and Yves Gagnon, An Analysis of Feed-in Tariff Remuneration Models: Implications for Renewable Energy Investment, http://www.sciencedirect.com/science/article/pii/S0301421509007940, accessed July 2013. 71 Coco Liu, China Uses Feed-in Tariff to Build Domestic Solar Market, http://www.nytimes.com/cwire/2011/09/14/14climatewire-china-uses-feed-in-tariff-to-build-domestic- 25559.html?pagewanted=all, accessed July 2013. 72 Christoph H. Stefes, The German Solution: Feed-in Tariffs, http://www.nytimes.com/roomfordebate/2011/09/20/why-isnt-the-us-a-leader-in-green-technology/us-should-emulate- germanys-renewable-energy-model, accessed July 2013. 73 Database of State Incentives for Renewables & Efficiency, Business Energy Investment Tax Credit (ITC), http://www.dsireusa.org/incentives/incentive.cfm?Incentive_Code=US02F, accessed July 2013. 74 Maura Allaire and Stephen P. A. Brown, U.S. Energy Subsidies: Effects on Energy Markets and Carbon Dioxide Emissions, The Pew, http://www.pewtrusts.org/our_work_report_detail.aspx?id=85899411349, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 24

previous year. Subsidies for renewable energies totaled $120 billion worldwide in 2013.75

Subsidies given to coal, oil and natural gas can lead to an increase in carbon emissions while subsidies provided for nuclear, biodiesel, solar and wind potentially decrease them. Although subsidies can be used to implement policies that benefit a country as a whole, they usually come with heavy costs. It should be noted, “subsidies” cost taxpayers money, distort energy markets, and give some companies and some forms of energy an artificial advantage at the expense of others.”76 If subsidies given to the fossil fuel industry were to be eliminated, the United States would save on average 12 billion dollars and CO2 emissions from 2005 to 2009 would have been 1% lower.77 In part, lobbyists of wealthy oil companies push through subsidies that serve to benefit their profit margins.

75 IEA, ‘The Cost of Fossil Fuels to and Economy Is Not Reduced by Subsidies; It Is Just Redistributed’, Nov 17th, 2014, http://theenergycollective.com/katherinetweed/2155841/iea-cost-fossil-fuels-economy-not-reduced-subsidies- it-just-redistributed, accessed May 2015 76 Ibid. 77 Ibid. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 25

CHAPTER 5: UNFCCC and The Kyoto Protocol

5.1 Kyoto Protocol

Arising from the United Nations Framework Convention on Climate Change (UNFCCC), the Kyoto Protocol (Kyoto) is the first global treaty created in an effort to mitigate climate change. Ratified in 1997, Kyoto set binding greenhouse gas (GHG) emissions targets to 37 industrialized nations and the European Union so as to reduce their emissions to 5% below 1990 levels over the period 2008-2012. In December of 2012 parties to the Kyoto Protocol adopted an amendment to the Kyoto Protocol, in which 38 industrialized countries set GHG emissions reduction targets for the period 2013-2020.78

5.1.1 Kyoto participants

As of August 2015, 192 parties (191 States and 1 regional economic integration organization) are part of the Kyoto Protocol, and the U.S. has signed but has not ratified it. On December 15th, 2011, Canada withdrew from the protocol. Different countries received different emissions reduction targets based on their contribution to historical emissions as well as their current stage of economic development. Kyoto functions by separating nations into different categories, by order of their stage of development. Annex I countries are most developed, Annex II are “economies in transition,” but essentially nations belonging to the old Soviet bloc, and non-Annex I countries or developing country parties, most notably including India, China and Brazil. Kyoto was founded on the principal of “common but differentiated responsibilities” to dealing with climate change and thus did not formally ask any reductions of developing nations.

5.1.1.1 The non-ratification of the Kyoto Protocol by the United States and Canada

The United States is one of the world’s greatest emitters of GHGs, however it has not set binding reduction targets. In July of 1997, the US Senate voted unanimously (95-0) on the Byrd-Hagel resolution proclaiming to then President Bill Clinton that it was the opinion of the senate that the United States should not ratify the Kyoto Protocol, because of “the disparity of treatment between Annex I Parties and Developing Countries.”79 The worry was two-fold, since Kyoto did not require any reductions by non-Annex I Parties, any attempt at reducing emissions would lead to non-competitiveness of American firms because they would be faced with a cost not incurred by developing country firms.

This sense was further propelled by those who believed that environmental and safety standards already disadvantaged companies trying to produce goods in the United States. Also, if the US signed the treaty any emissions reductions would be negated through “leakage” where carbon intensive industries do not stop their practices, they simply move to unregulated areas. On 15 December 2011, Canada officially withdrew from the Kyoto Protocol, stating that the protocol was flawed because it did not cover all major emitters of greenhouse gasses, the United States and China specifically.80 After signing the Kyoto protocol, Canada was obliged to cut emissions to 6 percent below 1990 levels by 2012. By 2009 emissions were 17 percent above the 1990 levels. Canada would be subject to enormous financial penalties under the terms of the treaty unless it withdrew.81

5.1.2 Kyoto Protocol mechanisms

The Kyoto Protocol stipulates three flexible mechanisms by which countries can reach their compliance targets: Emissions Trading, the Clean Development Mechanism (CDM) and Joint Implementation (JI). In order to implement an emissions trading scheme, participants of Kyoto have established a cap and trade system that imposes national caps on emissions and allows for trading between countries, which reduces

78 Kyoto Protocol, Doha Amendment to the Kyoto Protocol, http://treaties.un.org/doc/Treaties/2012/12/20121217%2011-40%20AM/CN.718.2012.pdf, accessed July 2013. 79 105th Cong. 1st Sess. S. Res. 98 (July 25th, 1997). 80 Kyoto Protocol, Doha Amendment to the Kyoto Protocol, http://treaties.un.org/doc/Treaties/2012/12/20121217%2011-40%20AM/CN.718.2012.pdf, accessed July 2013. 81 Reuters, Canada to pull out of Kyoto Protocol, http://www.reuters.com/article/2011/12/12/us-kyoto-withdrawal- idUSTRE7BB1X420111212, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 26

emissions at the lowest possible cost. Each participant is given a number of emission allowances related to its reduction target. Countries can trade and sell their allowances to either meet their target emission reduction if it exceeds emissions, or earn revenue by selling excess allowances if a country’s emissions are below target levels.

Carbon credits, which effectively serve as extra allowances, can be generated by implementing two project- based carbon mitigation mechanisms: (1) the Clean Development Mechanism (CDM) and (2) Joint Implementation (JI). The UNFCCC established the CDM arrangement under the Kyoto Protocol whereby industrialized countries with a ratified commitment to GHG reductions may invest in emission reduction or carbon sequestration projects in developing (non-Annex I) countries rather than invest in higher cost emission reduction endeavors in their own countries in order to meet their Kyoto compliance requirements. JI projects follow a similar objective, but consist of projects implemented in Annex I countries.

5.1.3 Insufficient participation in Kyoto Protocol

The Kyoto Protocol has had some deficiencies that prevent it from effectively achieving a sufficiently large reduction in greenhouse gases. The United States, which at the time had the highest emissions of any country did not make a commitment, neither did China or India, two countries with some of the highest growth rates in emissions. Canada has withdrawn from the Kyoto Protocol before the first-round deadline. Japan, New Zealand, and Russia have participated in Kyoto's first round but have not taken on new targets in the second commitment period.

5.2 More on Kyoto’s flexible mechanisms In addition to meeting emissions targets through national programs, the Kyoto Protocol created three flexible market-based mechanisms. In addition to emissions trading, the Protocol created the Clean Development Mechanism and the Joint Implementation Mechanism, which allow for investment in emissions reduction projects, which can then be used towards a country’s emissions target.

5.2.1 Clean Development Mechanism (CDM) and Joint Implementation (JI) The Clean Development Mechanism (CDM) allows industrialized countries to transfer various forms of Finance and technology to developing countries while getting credit for reducing GHG emissions through Certified Emissions Reductions (CERs).

The typical CDM project cycle incorporates the design, development and financing of the project, validation and authorization by a Designated Operational Entity (DOE), registration Through the CDM Executive Board, monitoring, verification, and certification of emissions, and the issuance of (CERs). CERs can then be sold or used by Annex I countries for Kyoto compliance purposes.

Figure 15: CDM Project Cycle

JI projects follow a similar cycle. However, validation can be performed by an independent entity and registration is not required.

CDM projects generate Certified Emission Reduction units (CERs) while JI projects generate Emissions Reduction Units (ERUs). One CER or ERU unit corresponds to one ton of CO2e that was not emitted due to the use of a duly approved methodology, or implementation of an emissions reduction project.

An example of a CDM renewable energy project could be the construction of a biomass power generation facility in India or Brazil, which produces electricity to meet increasing demand or replace electricity being generated from the burning of fossil fuel. Other types of CDM renewable energy projects with the same goal would be the construction of wind farms. A CDM forestry project might include, for example, the planting or foresting of land that never before contained forest, or, the reforestation of land that had forest cover prior to 1990 but which does not today. Examples of CDM projects include the installation of biomass power generation facilities or wind farms to meet increasing demand or replacing fossil fuel-based plants. Forestry projects, such as afforestation or reforestation can also produce CERs.

5.2.2 CDM projects and “business as usual”

One of the most difficult CDM approval criteria to establish is additionality. Additionality is the criteria that projects receiving CDM approval and revenues are not “business as usual.” That is, the carbon reduction achieved by the project would not have occurred absent CDM approval.

Figure 16: Determining Additionality82

A project must pass a series of tests to show that it is viable and compliant with CDM requirements. There are typically five steps to determine project additionality. These steps involve the identification and analysis of alternatives to the project activity. Upon successful completion of these steps depicted in the flowchart in Figure 16, a project is deemed to be “additional.”

Note that if the project does not pass ‘Step 2: Investment Analysis’, then a barrier analysis is performed, which, if satisfied, leads into ‘Step 4: Impact of CDM Registration’, or in other words, how will the project relieve the economic and financial hurdles of step 2 and the other various barriers of step 3.

Once steps 0-4 are satisfied, a project is accepted as additional and not part of the baseline scenario.

5.2.3 Measuring carbon emissions from different projects

In the case of Agriculture, Forestry and Other Land Use (AFOLU) projects, the carbon credits are equivalent to the tons of CO2 taken in and stored by vegetation (also called sequestration) above and beyond “business as usual”. With respect to carbon credits from other CDM activities including biomass energy, energy efficiency or landfill gas capture, the credits are the difference in carbon emissions from what is generated by the project versus what would have been emitted in the absence of the project, i.e., the base case scenario or baseline. The issue of monitoring, measuring and verifying actual emissions of reduction projects is a major challenge for credit markets. It has given rise to much debate regarding the need for reliable, widely accepted standards and credit registries.

5.2.4 The International Transaction Log (ITL)

The International Transaction Log, known as ITL, is a software system established by the secretariat of the Conference of Parties serving as the meeting of the parties to the Kyoto Protocol (CMP). Kyoto requires this system for its capability to record the CER transactions of the CDM registry and of national Annex 1 Party registries. These transactions range from issuance, cancellation and replacement to retirement and transfer.83

82 UNFCCC, Executive Board meeting 21 Report, http://cdm.unfccc.int/EB/021/eb21repan16.pdf, accessed July 2013. 83 Shell Trading (2007), International Transaction Log (ITL). Presentation by Shell Trading at CINCS, slide 2 This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 29

The ITL is intended to “verify the validity of transactions undertaken by established registries.”84 It serves as a link between government national emissions trading registries and the Kyoto protocol. The ITL contains all reconciliation and administrative functions specified in the data exchange standards, including notifications sent by the ITL to registries indicating required transactions, and the passing of further information between relevant registries and supplementary transaction logs, such as the Community Independent Transaction Log (CITL) that was established under the EU ETS.85 It is an information- centralizing component of the settlement system helping to address issues like double counting of reductions or multiple sales of the same credits. It provides a reliable source of information regarding the use of registered credits. An overview of the role of the ITL is presented in Figure 17.

Figure 17: The Role of the International Transaction Log (ITL) in Verifying Transaction Validity86

5.2.5 CDM-specific risks and forms of mitigation

In order for a project to qualify to generate CERs, the project must obtain multiple approvals at the host country, independent validator, and UN levels. Denial of approval or requests for review at any of these stages can create delays in the process or prevent the project from qualifying as a CDM project. As projects are only eligible for CERs from the point of registration on, delays can translate into a loss of revenues from CERs.

Aside from regulatory approval risk, there are risks associated with monitoring the actual emissions from the project, necessary for issuance of CERs. If the monitoring technology fails or is not utilized correctly, the project will not qualify for CER issuance. A project also faces market risk, as the price of CERs at the time of issuance is uncertain. Using previously approved CDM technologies lowers the risk associated with regulatory approval while entering into long-term fixed price contracts for CERs lowers market risk for a project.

84 UNFCCC (2007), Progress on the implementation of the international transaction log (UN publication FCCC/SBI/2007/INF.3), Bonn, Germany: United Nations. 85 Press Release: United Nations UNFCCC – Progress on the implementation of the international transaction log, UNFCCC/SBI/2007/INF.3. 86 UNFCCC (2006), Preparing for implementation: Initial requirements under the Kyoto Protocol, UNFCCC information event presentation. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 30

Figure 18: CDM Projects by Category87

The fraction of energy efficiency projects have increased (mostly in EE own generation and in EE industry) and the fraction of CH4 projects have decreased.

5.3 Controversy surrounding Agriculture, Forestry and Other Land Use (AFOLU) projects

Under Article 3.3 of the Kyoto Protocol, greenhouse gas removals and emissions through certain activities — namely, afforestation and reforestation since 1990 — are accounted for in meeting the Kyoto Protocol’s emission targets. Conversely, emissions from deforestation activities will be subtracted from the amount of emissions that an Annex I Party may emit over its commitment period.

The difficulty in estimating greenhouse gas removals from AFOLU projects, as well as challenges in tracking changes to carbon storage over time, has led to some resistance to AFOLU projects as sources of carbon offsets. Current methods of measuring carbon sequestration in trees are cost prohibitive, as they involve manual labor to count individual trees in the field. Cost effective measuring systems for carbon sequestration could have a tremendous impact on the ability for carbon finance to fund forestation and land use activities. Another challenge AFOLU projects face is a concern that greenhouse gases may be unintentionally released into the atmosphere if a sink is damaged or destroyed through forest fire or disease. The EU ETS, discussed in the next chapter, does not allow for inclusion of carbon credits from AFOLU activities because of the difficulties associated with demonstrating additionality and ensuring permanence.

87 UNEP, CDM/JI pipeline overview analysis and database, http://uneprisoe.org/, accessed May 2015. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 31

CHAPTER 6: THE EU ETS

6.1 The EU ETS framework

The European Union established a cap and trade structure called the EU Emissions Trading Scheme (EU ETS) in 2005 as a mechanism for EU countries to achieve their Kyoto targets. This is the single largest compliance regime and the most active market for trading carbon credits in the world. The EU ETS covers the 28 EU member states plus Iceland, Norway and Lichtenstein; and regulated emissions represent about 45% of the EU’s total GHG emissions.88 Transactions within the EU ETS are conducted in units of European Union Allowances (EUAs). CERs and ERUs (project-based credits) can be converted into EUAs and traded within the EU ETS, although CERs and ERUs can only comprise a certain percentage of total EU ETS EUAs. In the EU ETS, each country adopts a National Allocation Plan (NAP) that is approved by the European Commission. Under the NAP, a country allocates countrywide allowances to various installations responsible for the country’s GHG emissions. If these installations exceed their allocated allowances, they must purchase allowances from other installations. Similarly, if an installation does not need all its allocated allowances, it may sell these to other installations. EUAs currently trade in main exchanges, including the European Climate Exchange, Nordpool, PowerNext, the Energy Exchange Austria and the European Energy Exchange. During the first two phases of the EU ETS the cap on allowances was set at national level through National Allocation Plans.

The Union registry, operated by the European Commission, is the centralized accounting of all EU ETS transactions. This registry records national allocation plans, accounts of allowance ownership, transfers of allowances performed by account holders, annual verified CO2 emissions from installations, and annual reconciliation of allowances and verified emissions.89

6.1.1 Greenhouse gases and sectors

The EU ETS covers a number of economic sectors and greenhouse gases. Carbon dioxide is regulated from power and heat generation; energy-intensive industries including oil refineries, steel works and production of iron, aluminum, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids and bulk organic chemicals; and commercial aviation. Nitrous oxide (NO2) is regulated from the production of nitric, adipic, glyoxal and glyoxlic acids. Perfluorocarbons (PFCs) are regulated from aluminum production. 90

6.2. Results: Phases 1, 2, and 3.

The EU ETS is currently in its third phase of operation. Each of the three phases has achieved different goals and operated under different regulatory environments. Phase one (2005-2007) succeeded in establishing a price for carbon, free trade in emission allowances across the EU and the necessary infrastructure for monitoring, reporting and verifying actual emissions from the businesses covered. Due to the lack of the emissions data, caps were set on the basis of best guesses and resulted in oversupply and extremely low price for EU ETS allowances.

During phase two (2008-2012), the proportion of general allowances given away for free fell slightly to at least 90 percent. The penalty for non-compliance was increased to €100 per ton. On the basis of the veriﬁed emissions reported during phase one, the European Commission tightened the cap by cutting the total volume of emission allowances by some 6.5 percent compared with the 2005 level. However, the economic crisis that began in late 2008 depressed emissions, and thus demand for allowances, by an even greater margin. This led to a large and growing surplus of unused allowances and credits, which weighed heavily on the carbon price throughout the second trading period.

88 European Commission, The EU Emissions Trading System, http://ec.europa.eu/clima/policies/ets/index_en.htm, accessed August 2014. 89 European Commission, Union Registry, http://ec.europa.eu/clima/policies/ets/registry/index_en.htm, accessed August 2014. 90 European Commission, The EU Emissions Trading System, http://ec.europa.eu/clima/policies/ets/index_en.htm, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 32

The European carbon market grew dramatically from its origination. In 2005, 321 million allowances, with a value of US $7.9 billion, were traded. In 2011, 7.9 billion allowances were traded, with a value of $147.9 billion. 91

Thus far during phase three (2013-2020), a number of major changes and improvements in the rules have been made. The previous system of national caps is replaced by a single EU-wide cap on emissions. Free allocation of allowances is replaced by auctioning. In 2013, 40 percent of the allowances were allocated through the auction, and this share will increase every year, with the goal of 100 percent auctioning by 2027.92 For the allowances that are given away for free, a harmonized allocation rule applies. The sectors and sub-sectors facing competition from industries outside the EU which are not subject to comparable climate legislation will receive a higher share of free allowances than those which are not at risk of “carbon leakage.” The manufacturing industry received 80 percent of its allowances for free in 2013; the share will decrease to 30 percent in 2020.93 Additional sectors and gases were also included. For instance, emissions from international aviation have been included in the EU ETS.

6.3 Structural reform

The economic recession depressed emissions, which led to the oversupply of emission allowances and weakened carbon prices. At the beginning of 2013 the surplus was at two billion allowances. Rapid build- up is expected to end at the end of 2014, however the overall level of surplus, which is expected to be at two billion, is not anticipated to decrease thereafter. This surplus risks undermining the normal functioning of carbon markets and negatively affecting the EU’s ability to meet its GHG emissions reduction targets in a cost-effective way. In order to reduce the imbalance in the carbon markets, the European Commission proposed two actions: ‘back-loading’ of auctions in phase three, i.e. postponing the release of allowances to limit supply; and structural revisions.

The Commission has taken the initiative to postpone the auctioning of 900 million allowances from the years 2013-2015 until 2019-2020, when the demand is expected to pick up. Back-loading affects only the distribution of auctions throughout phase three, leaving the overall number of allowances unchanged. Back- loading is a short-term solution and structural changes are needed to be done to insure long-term stability. As of now, there is an ongoing debate on lasting solutions to the surplus.

The European Commission has proposed six options:

• Increasing the EU’s greenhouse gas emissions reduction target for 2020 from 20% to 30% below 1990 levels; • Retiring a certain number of phase three allowances permanently; • Revising the 1.74% annual reduction in the number of allowances to make it steeper; • Bringing more sectors into the EU ETS; • Limiting access to international credits; • Introducing discretionary price management mechanisms such as a price management reserve.94

These six options are currently being evaluated and considered, and a series of consultation meetings were held in 2013 to discuss them.

91 European Commission, EU ETS 2005-2012, http://ec.europa.eu/clima/policies/ets/pre2013/index_en.htm, accessed July 2013. 92 European Commission, Auctioning, http://ec.europa.eu/clima/policies/ets/cap/auctioning/index_en.htm, accessed August 2014. 93 European Commission, Free allocation, http://ec.europa.eu/clima/policies/ets/cap/allocation/index_en.htm, accessed August 2014. 94 European Commission, Structural reform of the European Carbon Market, http://ec.europa.eu/clima/policies/ets/reform/index_en.htm, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 33

CHAPTER 7: OTHER NATIONAL AND REGIONAL APPROACHES

7.1 U.S. Federal level regulations Although the United States failed to ratify the Kyoto Protocol during the first commitment period, some progress has been made at both the Federal level and the state/regional levels towards effective climate change policy.

7.1.1. Climate Action Plan

On June 25, 2013, President Obama released the Climate Action Plan, which directs his Administration and the U.S. EPA to use their legal authority to address climate change. The plan includes pledges from the President to reduce U.S. greenhouse gas emissions in the range of 17 percent below 2005 levels by 2020, support adaptation efforts in order to build more resilient communities in the face of severe weather, and to take a leadership position in combating climate change internationally.95

7.1.2 Clean Power Plan

Following from the Climate Action Plan, in 2014 the EPA announced the Clean Power Plan, the nation’s first nationwide plan to regulate GHG emissions from existing stationary sources. The plan aims to reduce nationwide GHG emissions by 30% over 2005 levels by 2030.96 The proposed rule involves federal-state partnerships, by which states much develop plans to meet state-specific goals. Importantly, the rule does not seek to regulate total carbon emissions, but rather identifies a ratio of acceptable carbon emissions divided by total power produced in the state; that is, carbon intensity.

The state-specific goals are calculated based on the state’s current energy mix and requirements such that they are realistic and achievable. States then have a “toolbox” of options for achieving their goals. These tools include making existing coal plants more efficient, using existing gas plants more effectively, increasing use of renewables and nuclear power, and increasing end-use energy efficiency.97

Supporters of the plan note the flexibility with which states can achieve their emissions reductions, and applaud the EPA for finally implementing a federal carbon regulation standard. However some environmentalists argue that the restrictions could be stricter, or that the intensity measure should be altered such that a reduction in total carbon is assured;98 while industry and other detractors are concerned that the economic costs of the plan are already too high.

In August of 2015, President Barack Obama finalized the Clean Power Plan, the most aggressive ever in the US. It requires power plants to cut emissions 32% from 2005 levels by 2030, an increase to 30% renewable energy generation by 2030, and an increase to 28% energy capacity from renewable energy sources by 2030.99

7.1.3 PTC and ITC

The federal Renewable Electricity Production Tax Credit (PTC) is a per kilowatt-hour tax credit for electricity generated by qualified energy resources and sold by the taxpayer to an unrelated person during the taxable

95 Executive office of President, The President’s Climate Action plan, June 2013. 96 EPA, Fact Sheet: Clean Power Plan Overview, http://www2.epa.gov/carbon-pollution-standards/fact-sheet-clean- power-plan-overview, accessed August 2014. 97 http://www.nrdc.org/air/pollution-standards/files/pollution-standards-epa-plan-summary.pdf 98 Forbes, “Why environmentalists should worry about the EPA’s new Clean Power Plan” http://www.forbes.com/sites/realspin/2014/08/11/the-epas-new-clean-power-plan-2/, accessed August 2014. 99 WhiteHouse, https://www.whitehouse.gov/blog/2015/08/03/what-clean-power-plan-means-america, Accessed August 2015. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 34

year.100 Companies that generate wind, geothermal, and “closed-loop” bioenergy (using dedicated energy crops) are eligible for a PTC, which provides a 2.2-cent per kilowatt-hour (kWh) benefit for the first ten years of a renewable energy facility's operation. Other technologies, such as "open-loop" biomass (using farm and forest wastes rather than dedicated energy crops), efficiency upgrades and capacity additions for existing hydroelectric facilities, small irrigation systems, landfill gas, and municipal solid waste (MSW), receive a tax credit of 1.1 cents per kWh. The PTC for incremental hydro, wave and tidal energy, geothermal, MSW, and bioenergy is in place until the end of 2013.101

Section 48 of the Internal Revenue Code provides an investment tax credit (ITC) for qualified commercial energy projects. Solar, fuel cells, and small wind projects are eligible for a tax credit equal to 30% of the project’s qualifying costs. Geothermal, micro turbines, and combined heat and power projects are eligible for a tax credit equal to 10% of the project’s qualifying costs. The ITC is realized in the year in which the project begins commercial operations, but vests linearly over a 5-year period. Generally, the ITC is available to qualified projects that are placed in service prior to the end of 2016.102 American Taxpayer Relief Act (ATRA) of 2012 allows wind and other eligible renewable energy sources to qualify for a 30 percent ITC in lieu of the PTC for facilities that begin construction in 2013 and excludes the use of commonly recycled paper in MSW and bioenergy facilities.103

7.1.4 DOE loans and grants

The U.S. Department of Energy (DOE) has three loan programs: the Advanced Technology Vehicles Manufacturing (ATVM) Loan Program, and the two Loan Guarantee programs, which include Section 1703 and Section 1705. The loans are offered to companies that employ technologies that help to sustain economic growth, yield environmental benefits and produce a more stable and secure energy supply. Currently, the outstanding loans equal to $34.4 billion. Advanced Technology Vehicles Manufacturing (ATVM) loans support the development of advanced technology vehicles (ATV) and associated components in the United States. ATVs must meet higher efficiency standards.104

Section 1703 of Title XVII of the Energy Policy Act of 2005 authorizes the U.S. Department of Energy to support innovative clean energy technologies that are typically unable to obtain conventional private financing due to high technology risks. In addition, the technologies must avoid, reduce, or sequester air pollutants or anthropogenic emissions of greenhouse gases. Eligible technologies include: biomass, hydrogen, solar, wind/hydropower, nuclear, advanced fossil energy coal, carbon sequestration practices/technologies, electricity delivery and energy reliability, alternative fuel vehicles, industrial energy efficiency projects, and pollution control equipment. Technologies with more than three implementations that have been active for more than five years are excluded.

The Section 1705 Loan Program authorizes loan guarantees for U.S.-based projects that commenced construction no later than September 30, 2011 and involve certain renewable energy systems, electric power transmission systems, and leading edge biofuels.

Additionally, the U.S. Department of Energy offers a number of grant programs that support initiatives towards sustainability, energy efficiency and energy security, including:

1. Weatherization Assistance Program

100 EPA, Federal Renewable Electricity Production Tax Credit, http://www.epa.gov/agstar/tools/funding/incentive/USfederalrenewableelectricityproductio.html, accessed July 2013. 101 Union of Concerned Scientists, Production Tax Credit for Renewable Energy, http://www.ucsusa.org/clean_energy/smart-energy-solutions/increase-renewables/production-tax-credit-for.html, accessed July 2013. 102 Ernest Orlando Lawrence Berkeley National Laboratory, PTC, ITC, or Cash Grant?, http://eetd.lbl.gov/ea/emp/reports/lbnl-1642e.pdf, accessed July 2013. 103 Production Tax Credit for Renewable Energy,” Union of Concerned Scientists, http://www.ucsusa.org/clean_energy/smart-energy-solutions/increase-renewables/production-tax-credit-for.html, accessed July 2013. 104 U.S. Department of Energy: Loan Programs Office, https://lpo.energy.gov/programs, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 35

2. State Energy Program 3. EECBG: Energy Efficiency and Conservation Block Grant 4. Energy Efficiency and Renewable Energy Funding Opportunity Exchange 5. Energy Efficiency and Renewable Energy Financial Opportunities 6. Office of Science Contracts and Grants 7. Recovery Act105

7.2 U.S. state and regional regulations

Although the federal government has implemented several programs and regulations, state and regional governments are at the vanguard of climate change policy in the US. There are an increasing number of regional cap and trade programs and more being discussed, and states are exploring other avenues to curb emissions as well. The state-specific goals of the EPA’s Clean Power Plan and the mandated state plans will further this tendency of state and regional action on climate change.

7.2.1 California AB 32

Assembly Bill 32, the California Global Warming Solutions Act of 2006 (AB 32), mandates that California reduce its greenhouse gas emissions to 1990 levels by 2020. The AB 32 emissions target is planned to be achieved through a number of instruments that include Renewable Portfolio Standard (RPS, 20% by 2020), Renewable Energy Standard (RES, 33%), Low Carbon Fuel Standard (LCFS), Energy Efficiency, cap and trade, more stringent efficiency standards from buildings, large scale machinery, and vehicles.106

Figure 19: California's AB 32107

Cap and trade is an important component of AB 32 regulation, as illustrated in Figure 19. An overall cap on GHG emissions is imposed, and covered entities are required to surrender the amount of compliance instruments equal to their emissions. Compliance instruments include California Greenhouse Gas Emissions Allowances and Offset Credits Issued by the Air Resources Board (ARB). The regulation began

105 Funding Opportunities, http://energy.gov/public-services/funding-opportunities, accessed July 2013. 106 CARB, Status of Scoping Plan Recommended Measures, http://www.arb.ca.gov/cc/scopingplan/status_of_scoping_plan_measures.pdf, accessed July 2013.

107 Environmental Defense Fund, AB 32 Cap-and-Trade Rule Fact Sheet, http://www.edf.org/sites/default/files/EDF- CA-CT-Fact-Sheet-August-2011.pdf, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 36

in 2013 and initially covered electric utilities and large industrial facilities. The program will expand in 2015 to cover distributors of transportation, natural gas and other fuels. The initial cap was set at 2% below emissions forecast for 2012, and that cap will decline about 2% in 2014 and about 3% annually from 2015 to 2020.108

7.2.2 RGGI

The Regional Greenhouse Gas Initiative (RGGI) is the first market-based regulatory program in the United States to reduce greenhouse gas emissions. Currently, there are nine states-participants: Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont. The program sets the cap on the CO2 emissions from the power sector.

RGGI provides only administrative and technical services. RGGI is composed of individual CO2 Budget Trading Programs in each participating state, and each state has the regulatory and enforcement authority. Each state's CO2 Budget Trading Program limits emissions of CO2 from electric power plants, issues CO2 allowances and establishes participation in regional CO2 allowance auctions. Regulated entities can use allowances from any of the participated states to demonstrate the compliance. Nearly all allowances are sold through the auctions. Emissions reductions in RGGI will take place over two phases, Phase I (2009- 2015) and Phase II (2015-2018), with an overall greenhouse gas reduction goal of 10% by 2018.109

During the first compliance period, emissions allowance prices dropped to the "floor" price of $1.93 per ton due to the oversupply of the allowances. Demand for the emission allowances dropped due to significant emission reductions of 40 percent compared to 2005 level. In order for the program to work, adjustment to the cap was required. In February 2013, a major change in the RGGI cap was announced, lowering it from 165 million tons to 91 million tons for 2014 with 2.5% annual reductions until 2020.

At this time, five project categories for CO2 offset allowances are eligible under the Program:

• Landfill methane capture and destruction. • Reduction in emissions of sulfur hexafluoride (SF6). • Sequestration of carbon due to afforestation. • Reduction or avoidance of CO2 emissions from natural gas, oil, or propane end-use combustion due to end-use energy efficiency in the building sector. • Agricultural manure management operations.

The use of CO2 offset allowances is limited to 3.3 percent of a power plant's total compliance obligation during any three-year control period. RGGI will allow the use of offset credits from mandatory carbon constraining program outside the United States (e.g., CDM, CER) if certain CO2 allowance price thresholds are reached.110

7.3 Canada

7.3.1 Nation-wide Policies

The Government of Canada is committed to reducing Canada's total greenhouse gas emissions by 17 percent from 2005 levels by 2020 - a target that is inscribed in the Copenhagen Accord and aligned with the United States. Policy will focus on transportation, electricity and renewable fuels. Regulations are limiting emissions from limiting emissions from passenger vehicles, light trucks, and heavy-duty vehicles. As a result of the regulations, it is projected that the average greenhouse gas emissions from 2025 passenger and light vehicles will be reduced by about 50% from those sold in

108 California EPA, “Overview of ARB Emissions Trading Program,” http://www.arb.ca.gov/newsrel/2011/cap_trade_overview.pdf, accessed August 2014. 109 Regional Greenhouse Gas Initiative, http://www.rggi.org, accessed July 2013. 110 Alberta Energy, Talk About Bioenergy, http://www.energy.alberta.ca/BioEnergy/pdfs/FactSheetBioInit.pdf, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 37

2008, and greenhouse gas emissions from 2018 heavy-duty vehicles will be reduced by up to 23 percent. Additionally, as of May 2012, gasoline is required to contain an average five percent renewable alcohol, and diesel fuel is required to contain an average two percent renewable diesel.111

Even though Canada's electricity system is one of the cleanest in the world, further regulations were imposed to develop cleaner electricity grid. In September 2012, final regulations to reduce emissions from the coal-fired electricity sector were released. These regulations apply a stringent performance standard to new coal-fired electricity generation units and to coal-fired units that have reached the end of their economic life.

7.3.2 Alberta

In addition to a national effort, Canadian provinces are also taking action on climate change. For example Alberta was the first province to develop legislation regulating greenhouse gas emissions. Alberta requires facilities that emit more than 100,000 tons of greenhouse gases a year to reduce emissions intensity by 12 per cent, as of July 1, 2007. Companies have four choices to be in compliance:

1. Make improvements to their operations 2. Purchase Alberta-based offset credits 3. Contribute to the Climate Change and Emissions Management Fund 4. Purchase or use Emission Performance Credits

7.3.3 Western Climate Initiative

The Western Climate Initiative was formed in 2007 as a collaborative effort of seven U.S. states (Arizona, California, New Mexico, Oregon, Washington, Utah and Montana) and four Canadian provinces (British Columbia, Manitoba, Ontario, and Quebec) to identify, evaluate, and implement measures to reduce greenhouse gas (GHG) emissions in participating jurisdictions. In 2011, WCI formed Western Climate Initiative, Inc., a non-profit corporation that provides administrative and technical services to for state and provincial emissions trading programs. Today, British Columbia, California, Ontario, Quebec and Manitoba are working together to harmonize their emissions trading schemes through WCI. The cap-and-trade program began January 1st, 2012.112

7.4 Germany - Energiewende

Germany is making a strong effort in transitioning to a low-carbon economy. In September of 2010, Energiewende—a policy document shaping German energy transition—was published. Legislative support was passed in 2011. Important aspects include:  Greenhouse gas reductions: 80–95% reduction by 2050.  Renewable energy targets: 60% share by 2050.  Energy efficiency: electricity efficiency up by 50% by 2050.113

Germany’s share of renewables has increased from around five percent in 1999 to 30 percent in 2015. Renewable energy producers were guaranteed a fixed feed-in tariff for 20 years, guaranteeing a fixed income. Germany's Renewable Energy Act (EEG) specifies that renewables have priority on the grid and that investors in renewables must receive sufficient compensation to provide a return on their investment irrespective of electricity prices on the power exchange. This resulted in a high level of investment security and, subsequently, lower cost of renewables. Energy co-operatives have been created, and efforts were made to decentralize control and profits. EEG is a successful legislation, which was widely copied around the world.

111 Western Climate Initiative, http://www.westernclimateinitiative.org/history, accessed August 2014. 112 Center for Climate and Energy Solutions, Western Climate Initiative, http://www.c2es.org/us-states- regions/regional-climate-initiatives/western-climate-initiative, accessed May 2015. 113 Energy Transition, http://energytransition.de, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 38

Figure 20: German Energy Transition114

7.5 China

115 China is the largest CO2 emitter in the world. It is not bounded to cut emissions under the Kyoto Protocol, however it is taking steps to reduce its carbon footprint. China heavily invests in renewable energy and is a leader in manufacturing of wind turbines and solar PV.

On June 18 2013, China started its first test carbon market in Shenzhen, with the permit prices from 28 Yuan to 30 Yuan ($4.90) a metric ton.116 The Shenzhen exchange is one of seven pilot schemes which was launched in 2013, and will involve 635 local industrial enterprises accounting for more than a quarter of local GDP and more than 33 million tons of CO2 emissions. China’s national emissions target, pledged to the international community, is a 40 to 45 percent reduction in emissions intensity from 2005 to 2020. In 2012, China's industry ministry told firms in sectors like steel to reduce their 2010 carbon intensity rates by 18 percent by 2015.117 The new markets are set to regulate 800 million to 1 billion tons of emissions by 2015. Most of the emissions regulated will be in the power and electricity sectors

In November of 2014, Chinese President Xi Jinping and U.S. President Obama announced a bilateral climate agreement that set CO2 emissions targets for the year 2030. China pledged to peak their CO2 emissions by 2030 and reduce them thereafter.118

114 Energy Transition, http://energytransition.de, accessed July 2013. 115 Environmental Protection Agency, Global Greenhouse Gas Emissions Data, http://www.epa.gov/climatechange/ghgemissions/global.html#four, accessed July 2013. 116 Haas B., Carr M., China Carbon Permits Trade 22% Below Europe on Market Debut, http://washpost.bloomberg.com/Story?docId=1376-MOL0RX6S972801-1AALPT4JJT11F797NJ3DJ3DT6I, accessed July 2013. 117 Stanway D., China takes cautious step towards carbon emissions trading, http://uk.reuters.com/article/2013/06/18/china-carbon-trading-idUKL3N0ET2P220130618, accessed July 2013. 118 The White House, FACT SHEET: U.S.-China Joint Announcement on Climate Change and Clean Energy Cooperation, Nov 2014, https://www.whitehouse.gov/the-press-office/2014/11/11/fact-sheet-us-china-joint- announcement-climate-change-and-clean-energy-c, accessed May 26th, 2015 This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 39

7.6 India

Similarly to China, India has a large poor population combined with a rapidly developing economy. For India and China, growth is a priority; hence the emissions are likely to increase in the future. India, also, does not have binding targets for CO2 emissions reduction; however it has undertaken voluntary actions to reduce emissions intensity of GDP (excluding agriculture) by 20-25% by 2020 relative to a 2005 baseline. Rather than integrative binding legislation, India is developing a policy process to specifically address climate change. India adopted a “National Action Plan on Climate Change” (NAPCC) in 2008 outlining existing and future policies (“missions”) and programs directed at climate change mitigation and adaptation. These missions include:  National Solar Mission (setting a goal of increasing production of photovoltaic electricity to 1,000MW per year and to deploy at least 1,000MW of solar thermal power generation with an overall aim of making solar energy competitive with fossil-based energy).  National Mission for Enhanced Energy Efficiency.  National Mission of Sustainable Habitat.  National Mission for a Green India (focused on increasing forest cover).  National Water Mission.  National Mission for Sustaining the Himalayan Ecosystem to help protect India’s water supply.  National Mission for Sustainable Agriculture.  National Mission on Strategic Knowledge for Climate Change.119

7.7 Japan Japan has set ambitious emissions reduction targets, including reducing emissions by 25% below 1990 levels by 2020 as part of the Copenhagen Accord, and reducing emissions to 80% below 1990 levels by 2050. However, Japan failed to meet its Kyoto protocol commitment of reducing average annual emissions by 6% over 1990 levels for the period 2008-2012, and had to purchase offsets to meet its commitment.120 Japan has not agreed to the second commitment period of the Kyoto protocol, but nonetheless is making progress towards constructing carbon markets within its own borders.

In 2005, Japan launched a voluntary emission-trading scheme (JVETS) as a preparatory tool for firms in case a mandatory scheme were established. Through the voluntary scheme, the Japanese government subsidized installation costs of emission reduction equipment. In return, the companies chosen to participate in this scheme were obligated to reduce emissions by 21% of their average annual CO2 emissions in the base years, fiscal 2002 to 2004.121 Additionally, Japan enacted in 2000 The Law on Promoting Green Purchasing to promote emission reduction in the public sector and specifically aimed at limiting emissions from business activities.122

The Japanese government also planned to create a national mandatory ETS that would launch in 2013 and was set to allow companies that are obligated to lower their carbon emissions to purchase offsets from abroad in order to meet their target levels.123 However the plan was abandoned in 2010, presumably due to the failure of other nations to enact similar programs. After the 2011 tsunami, Japan has struggled to keep up with emissions targets. It is estimated that the tsunami and closing of the Fukushima Daiichi nuclear 124 power plant will generate an extra 74 million metric tons of CO2e. Despite the lack of a national cap-and-

119 National Action Plan on Climate Change, http://pmindia.gov.in/climate_change_english.pdf, accessed July 2013. 120 http://www.ieta.org/assets/Reports/EmissionsTradingAroundTheWorld/edf_ieta_japan_case_study_september_2013. pdf 121 Japan for Sustainability. (2005). Japan launches voluntary emissions trading scheme. Retrieved May 2007 from http://www.greenbiz.com/news/news_third.cfm?NewsID=28866 122 Sekiya, T. (2001). Emission reduction initiatives in the public sector in Japan. Copenhagen, Denmark: Workshop on Good Practices in Policies and Measures, Ministry of the Environment, Office of International Strategy on Climate Change, 8-10 October 2001. 123 Carbon Finance at the World Bank. (2012). State and Trends of the Carbon Market 2012. The World Bank, 102- 103 124 Ibid. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 40

trade program, the voluntary market is still active, as is a Tokyo ETS and an experimental ETS in which companies are encouraged to participate.125

Figure 21: Current and proposed emissions trading schemes worldwide.126

As of April 1st, 2015, emission trading schemes around the world are worth an estimated $34 billion. This is up from $32 billion in 2014. Additionally, the value of carbon taxes is worth $14 billion globally.127

125http://www.ieta.org/assets/Reports/EmissionsTradingAroundTheWorld/edf_ieta_japan_case_study_september_20 13.pdf 126 IEA, Redrawing The Energy Climate Map, June 2013, http://www.iea.org/publications/freepublications/publication/WEO_Special_Report_2013_Redrawing_the_Energy_ Climate_Map.pdf, accessed May 2015 127 Reuters, World has no choice but decarbonize: U.N. climate chief, May 26th, 2015, http://news.yahoo.com/world- no-choice-decarbonize-u-n-climate-chief-161022115.html?soc_src=mail&soc_trk=ma, accessed May 2015 This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 41

CHAPTER 8: THE CARBON MARKET

8.1 Background

“Carbon market” is the general term for the market created by the commodification and trading of carbon- based financial instruments. The Kyoto Protocol, in force since 2005, identified International Emissions Trading (IET) as one mechanism (other than directly reducing emissions) for Annex B countries to meet their emissions reduction targets. Two types of commodities are most commonly traded in carbon markets: carbon emissions allowances and carbon credits (or offsets).

The legally binding national emissions reduction targets specified for Annex B countries that have ratified the Protocol created the demand for carbon emissions allowances. Countries unable to meet their Kyoto reduction targets may purchase allowances on an emissions trading platform; countries with surplus allowances (perhaps as a result of aggressive energy efficiency policies, or a switch to low-carbon fuel sources) may sell them.

The Kyoto Protocol also specified the Clean Development Mechanism (CDM) and Joint Implementation Mechanism (JI) as additional ways for Annex B countries to meet their emissions reduction targets. These mechanisms allow projects in non-Annex B (developing) countries to generate carbon credits that Annex B countries can purchase and apply towards their Kyoto emissions reduction targets.

After ratification of the Kyoto Protocol, the European Union established the EU Emissions Trading System as the key mechanism for EU countries to meet their Kyoto emissions reduction targets; the EU ETS is the largest carbon market in the world, and has its own system for allocating emissions allowances., Several other jurisdictions including Australia, California, and China have announced plans for national or sub- national emissions trading schemes.

Finally, other non-governmental, non-Kyoto standards exist for the commodification of avoided carbon emissions as carbon credits. These carbon credits cannot be used for Kyoto or EU compliance, and so are bought and sold on the “Voluntary Carbon Market,” either through an exchange or “over the counter.” Key purchasers of these credits are often either ethically motivated individuals or companies, or corporate sustainability or social responsibility departments.

8.2 Tradable carbon commodities

In general, one carbon allowance or carbon credit is equal to one ton of CO2e that was not emitted due to use of a duly approved methodology, or implementation of an emissions reduction project. A cap is placed on greenhouse gas emissions and market mechanisms dictate how the allowances are allocated. Tradable carbon commodities provide the flexibility for emissions to be reduced cost-effectively.

8.2.1 The Kyoto Protocol

Under the Kyoto Protocol, emissions allowances allocated to national governments are called Assigned Allowance Units (AAUs). Projects registered under the Kyoto Protocol’s Clean Development Mechanism (CDM) are able to generate Certified Emissions Reduction units (CERs), while projects registered under the Kyoto’s Joint Implementation Mechanism generate Emissions Reduction Units (ERUs). Annex B countries can also generate removal units (RMUs) based on land use, land use change and forestry activities.128

8.2.2 EU ETS

Under the EU ETS, EU countries are assigned European Allowance Units (EAUs). Up to a certain level, countries within the EU ETS can meet their emissions allowances by purchasing CERs and ERUs. The EU

128 UNFCCC, International Emissions Trading, http://unfccc.int/kyoto_protocol/mechanisms/emissions_trading/items/2731.php, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 42

ETS is currently in its third phase (2013-2020), which has introduced some changes from the previous phases. First, there is a single cap on the EU as oppose to individual national caps. Second, the default mechanism of allocating carbon allowances will be through an auctioning system as opposed to simply giving them out for free.129 Due to the global economic downturn that began in the late 2000’s, there has been an increase in allowances, which threaten to undermine the effectiveness of the carbon market.

8.2.3 Voluntary market

Carbon credits issued for projects outside of compliance markets are referred to as Voluntary Emissions Reductions or Verified Emissions Reductions (VERs), and are generated by projects in compliance with one of several VER standards, such as the Voluntary Carbon Standard.

Figure 22: Prices and Volumes for EUAs, CERs, ERUs in Secondary Market, 2008-2011130

The EUA prices reflect daily over-the-counter (OTC) closing prices for EUAs to be delivered at the end of 2012. Figure 23: EUA Prices131

8.3 Primary sources of CERs

Asia and Latin America are two areas that contribute to over 95% of all CDM projects. China is the forerunner for CDM projects and hosts about 56% of CDM projects in Asia. India also supplies a lot of CDM projects as it has approximately 29% of the market share in South Asia. In Latin America, Brazil leads the sell-side in the CDM market as it hosts about 34% of CDM projects in the region.

129 European Commission, The EU Emissions Trading System (EU ETS), http://ec.europa.eu/clima/policies/ets/index_en.htm, accessed July 2013. 130 Carbon Finance at the World Bank (2012), State and Trends of the Carbon Market 2012, The World Bank, 18. 131 European Environment Agency, http://www.eea.europa.eu/data-and-maps/figures/eua-future-prices- 200820132012, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 43

Table 2: Regional Distribution of CDM Projects132

Figure 24: Registered Projects by Region

132 UNFCCC, Regional Distribution of CDM Projects, http://cdm.unfccc.int/Statistics/Registration/RegisteredProjByRegionPieChart.html, accessed May 2015. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 44

Figure 25: Annual CERs by Host Country133

8.4 Primary buyers of CERs and ERUs

There are a variety of carbon credit buyers including corporate and non-corporate purchasers. Corporate purchasers consist mostly of installations regulated by the EU ETS, although some non-regulated firms buy CERs, VERs or ERUs as a means of meeting voluntary emission reduction targets. Financial institutions play a role in the offset markets as traders. They purchase CERs as a way to serve clients who may need CERs for compliance purposes. Non-corporate purchases are made to meet the national Kyoto targets. The utilities sector accounts for a large part of global GHG emissions. Utility companies are interested in CDM projects because they promote energy efficiency and because they can be a powerful mechanism to join governments and corporations in a way that fosters sustainable development and yields business opportunities. The cement sector also participates in creating global GHG emissions. Cement companies are interested in CDM projects because cement production is energy intensive and cement production touches on a wide range of sustainability issues including climate change, pollution and resource depletion. The oil and gas industry play a crucial role in carbon mitigation due to the nature of their operations. This industry focuses on specific projects such as gas flaring reduction, CO2 capture and geological storage, energy efficiency, fuel switching and cogeneration. Metal and mining companies are interested in CDM projects because mining can cause environmental and social degradation in the regions in which it operates. In recent years, the metals and mining industry has faced a wide range of serious sustainability issues and CDM projects can help mining companies to contribute positively to host countries. Agribusiness companies are those whose business is in some way integrally connected to agriculture. This includes manufacturers of agricultural equipment, seeds, coffee producers and beauty product companies. These companies are interested in CDMs as a way to expand the potential market for their products and as a way of helping supplier countries to secure product inputs.

133 Source: UNEP Risoe (2010), http://www.c2es.org/docUploads/clean-development-mechanism-review-of-first- international-offset-program.pdf, accessed July 2015. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 45

Figure 26: Total Expected CERs by 2012134

Figure 27: Primary CDM Buyer Countries135

Figure 27 shows a breakdown of major buyers of CDM projects by country. European buyers bought the majority of CERs that were produced from CDM projects in 2012. European private companies played a 136 major role in the carbon market as they bought 1.5 billion tons of CO2e through CERs and ERUs.

Private companies in Japan have also demonstrated demand for CDM and JI credits as they bought 0.3 137 billion tons of CO2e in 2010. In 2012, Japanese private companies reportedly purchased more than 465 MtCO2e in CERs, ERUs, and AAUs in order to offset the increase in future emissions due to the shutdown of nuclear power plants in Japan.138

8.5 Pricing EUAs

134 Ibid. 135 UNEP Riso Centre, CERs, http://www.cdmpipeline.org/cers.htm#4, accessed Aug. 2013. 136 Ibid. 137 Ibid. 138 World Bank, State and Trends of the Carbon Market (2012), http://siteresources.worldbank.org/INTCARBONFINANCE/Resources/State_and_Trends_2012_Web_Optimized_190 35_Cvr&Txt_LR.pdf, accessed Aug. 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 46

The price of an EUA is driven by a number of supply and demand factors. Supply factors include the number of EUAs allocated relative to annual emissions of greenhouse gases and the number of CERs or ERUs imported into the EU ETS as additional EUAs. Demand factors are elements that increase demand for emissions, for example through increased demand for electricity. Such factors could include unusually warm summers or cold winters. Also factored into the demand for EUAs is the cost of fuels with high carbon contents, such as coal, relative to those with lower carbon contents, such as oil and natural gas. It is assumed that when either oil or natural gas is much more expensive than coal, electricity suppliers will use coal and hence increase their need for EUAs. Figure 28: Price of EUAs from 2004-2009

Regulatory and news events also affect EUA prices. One example is the price drop that occurred in June 2006 immediately after the first officially verified emissions reports showed lower emissions levels than forecast. Error! Reference source not found.shows the price of EUAs from 2004 to 2009. Interestingly, market analysts have found EUA prices relatively disconnected from economy fundamentals, citing mid- 2008 prices for December 2009 EUAs which rallied to around €15 despite the impacts of a global economic slowdown on industrial emissions levels. EUA prices are likely to reflect fundamentals only after generator Phase 3 compliance buying begins.139

8.6 The voluntary carbon market

The voluntary carbon market is a voluntary demand driven market for carbon offsets. Voluntary buyers include companies and individuals that take responsibility for offsetting their own emissions as well entities that practice corporate social responsibility (CSR) in efforts of preserving ethics, reputation and mitigating supply chain risk. Voluntary carbon markets, though still operating at relatively small scale, are flexible and innovative bringing in project finance, monitoring and methodologies that also impact regulatory markets systems.140

8.7 Retail (OTC) Carbon Markets

The over-the-counter (OTC) carbon markets refer to voluntary purchases and sales of carbon credits that are mostly created from emission reduction projects. Since the OTC carbon markets operate outside of the cap and trade system there has always been a lack of rules and regulations. However in recent years a number of third party organizations have developed various methodologies to establish standards for the certification for carbon credits. In addition to the Voluntary Carbon Standard (VCS), there are also several other standards such as VER+, Green-e Climate, CCX, the California Climate Action Registry (CCAR), Voluntary Offset Standard, ISO 140464 (a project design standard), and the Australian government's

139 Euractiv (2009), Carbon Market Seizes on Signs of Economic Recovery, http://www.euractiv.com/en/climate- change/eu-carbon-market-seizes-signs-economic-recovery/article-182377, accessed July 2013. 140 Maneuvering the Mosaic: State of the Voluntary Carbon Markets 2013, http://www.forest- trends.org/documents/files/doc_3898.pdf, July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 47

Greenhouse Friendly certification.141 Certifications provided by the Climate Community and Biodiversity (CCB) Standard and the Gold Standard go beyond the baseline quality and guarantee additional social and economic co-benefits, so credits certified under these standards tend to command a higher price.

Figure 29: Voluntary Carbon Supply Chain

Voluntary offset buyers primarily obtain offsets through decentralized over the counter (OTC) transactions. These are bilateral contracts between buyers and sellers whereby the terms of payment and offset delivery are defined. Small volumes of offsets are also obtained on private exchanges. There are typically three layers in the voluntary carbon market supply chain, namely brokers, project developers and retailers or wholesalers. Figure 30, below, illustrates the voluntary carbon market’s value chain, volumes traded, and market value.142 Figure 30: Historical Offset Demand by Transacted Volume, All Voluntary Carbon Markets143

141 Voluntary over-the-counter (OTC) Offset Market, Ecosystem Marketplace, http://www.ecosystemmarketplace.com/pages/dynamic/web.page.php?section=carbon_market&page_name=otc_ma rket, accessed July 2013. 142 Maneuvering the Mosaic: State of the Voluntary Carbon Markets 2013. http://www.forest- trends.org/documents/files/doc_3898.pdf, accessed July 2015. 143 Forest Trends’ Ecosystem Marketplace. State of the Voluntary Carbon Markets 2014. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 48

8.8 Pricing other tradable carbon units

Factors affecting CER pricing include delivery risk, project timing and CER volume, project value and feasibility, host-country support, validation, certification costs, and investment climate. Prices and price forecasts of EUAs also impact CER prices. The start of the second phase of the EU ETS in January of 2008, successful implementation of the International Transaction Log (ITL), and the possibility of converting CERs into EUAs have heightened the connection between EUA and CER prices. The onset of global economic and financial crises in 2008 caused a worldwide slowdown with effects on power and industry production that many concluded would cut emissions and lead to a drop in EUA prices. As a result, in mid- 2009, CER price forecasts for 2011 and 2012 were revised downward.144 In 2010, analysts continued to predict low CER prices post-2012 due to the uncertainty of what will happen in the future.145 International developments such as increased predictability of issuance and frequency of CER transfers as well as the strengthening of options markets and certainty regarding post-2012 will be reflected in CER and EUA prices. There continues to be a price disparity between the prices of EUAs and CERs. CERs purchased on a forward basis, i.e. when a contract to purchase the CERs has been created before the CERs have actually been generated from a project, are historically priced at a discount to EUAs. According to European Climate Exchange, there is a 79% margin offset that is applied between EUAs and CERs.146 This is due to factoring in various risks, such as the risk that future CERs will not be generated and the risk that CERs will not in fact be convertible into EUAs. In the voluntary market, prices differ based on which standard is used in the verification of VER projects. For instance, projects that have been verified to stringent standards such as the Gold Standard or pre-CDM VERs command the highest prices.147 Sustainable development attributes also bring price premiums for VERs from projects certified under standards that assess those aspects.148 In the now defunct Chicago Climate Exchange (CCX), market prices for its Carbon Financial Instruments (CFIs) reflected the specific supply and demand conditions within the CCX market. Carbon credits accredited to the CCX standard priced lower than those registered under more stringent standards. The CCX market was comprised of public and private entities accredited within the voluntary but legally binding trade exchange. Auctions determine the price for RGGI allowances. The latest auction took place in March 2015 and the market clearing price was $5.41.149

8.9 Lessons from the EU ETS

Future cap and trade schemes can benefit from the example of the EU ETS. A first lesson is the need for establishing accurate emissions baselines calculated from reliable emissions reporting data. The EU failed to do this in Phase I of the EU ETS, which led to an oversupply of emission allowances. This led to a dramatic fall in the trading price of carbon.

A second lesson is the importance of designing adaptive mechanisms in legislation to avoid market interference and volatility related to market actors’ behavior and responses to political decisions. Political uncertainties at national and international levels regarding the future of climate regulation hamper business decisions; indeed, predictability is fundamental for investor confidence and investment decisions. A third lesson is the importance of structuring the allowance allocation mechanism to avoid the transfer of wealth through windfall profits to regulated entities. In the EU ETS Phase I, companies passed on the

144 Point Carbon (2009), Carbon Project Manager Analysis, http://www.pointcarbon.com/trading/cpm/analysis/analystupdates/1.1115327, accessed July 2015. 145 Carbon Finance at the World Bank (2010), State and Trends of the Carbon Market 2010, The World Bank, 60-61. 146 European Climate Exchange (2010), CER/EUA Spread Trade Facility, http://www.ecx.eu/CER/EUA-Spread- Trade-Facility, accessed July 2013. 147 Olivia Fussell, O., Gelb, R., & Kaminker, C., Carbon Credits as a Currency for Project Finance, Carbon Credit Capital LLC, New York, 2009. 148 Ibid. 149 Regional Greenhouse Gas Initiative (2015), Auction Results, http://www.rggi.org/market/co2_auctions/results/auction-24, accessed August 2014. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 49

market cost of allowances to customers, even though these allowances were provided to the companies for free. This led to windfall profits – particularly in the electricity sector.150 Some countries have suggested skewing allocation of allowances from the power to the industry sector to offset increased energy costs and auctioning allowances.

150 Point Carbon, Carbon trading in the US: The Hibernating Giant, http://www.pointcarbon.com/getfile.php/fileelement_86516/CMA_US_ETS_Sept06__hkh9gtpd_1f.pdf, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 50

CHAPTER 9: CARBON FINANCE AND EMISSION REDUCTION PROJECTS

9.1 Carbon finance

Carbon finance is a method of financing emissions reductions projects in which the emission reductions that occur as a result of the project become financial commodities. These instruments, often colloquially referred to as “carbon credits”, can then be sold by the project developer on a carbon market. The “currency” of carbon credits that is specified by the Kyoto Protocol is 1 metric ton of avoided CO2e equivalents (CO2e), but the exact form of a carbon credit depends upon the specific mechanism (such as Kyoto’s CDM) or standard (such as the Verified Carbon Standard) that the project sponsor complies with in order to certify and generate the credits.

While carbon credits are the most well known type of carbon finance, carbon finance also includes tax equity and carbon credit derivatives.

The Kyoto Protocol created both the primary demand and the market for carbon-based financial instruments. Since coming into force in 2005, developed countries that have ratified the Kyoto Protocol and are listed in Annex B of the Protocol are legally bound to limit GHG emissions to their national target levels. Other than meeting their targets through domestic emissions reductions, the Kyoto Protocol also specified the Clean Development Mechanism (CDM), Joint Implementation Mechanism (JI), and International Emissions Trading (IET) as additional market-based tools available to countries to meet their targets.

CDM projects in developing countries (officially, non-UNFCCC Annex 1) generate Carbon Emissions Reductions (CERs); JI projects in developed countries (UNFCCC Annex 1) generate Emissions Reduction Units (ERUs). Together, these two project-based mechanisms provide the supply of Kyoto-compliant carbon credits. These carbon credits, as well as other carbon-based financial instruments, are sold over- the-counter or on IET implementations such as the EU ETS.151

9.2 Formal exchanges

An emissions reduction project is an activity that reduces GHG emissions relative to a baseline case. Often, due to higher upfront capital costs, unproven technology, or political risks, these projects are less attractive to potential investors than projects that would continue “business-as-usual” levels of GHG emissions.

Examples of emissions reductions projects include the production of electricity from renewable energy sources, the installation of more energy-efficient equipment, the use of more energy-efficient production processes, the destruction of fugitive emissions (emissions leakage from industrial processes), and afforestation/reforestation.

Most Kyoto-approved emissions reduction projects are CDM projects utilizing renewable energy technology. As of May 2015, there were over 8,600 registered CDM projects and 761 JI projects; renewable energy projects made up 71% of registered CDM projects.152

9.3 Emissions reduction project participants

The parties involved in this type of project include: Promoter or sponsor - the body initiating the project activity Legal project entity - often structured as a special purpose vehicle Engineering, procurement and construction (EPC) firm - responsible for technical plans and construction of the plant

151 UNFCCC, The Mechanisms under the Kyoto Protocol: Emissions Trading, the Clean Development Mechanism and Joint Implementation, http://unfccc.int/kyoto_protocol/mechanisms/items/1673.php, accessed August 2015. 152 UNEP RISO Centre, CDP Projects by Type, http://cdmpipeline.org/cdm-projects-type.htm, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 51

Equipment supplier - provides the necessary equipment and performance guarantees Power purchaser - often a governmental agency or a private corporation Fuel supplier - private corporation, municipality or independent farmers Lender(s) - local banks, international banks, multilateral financial institutions Equity provider(s) - the promoter, private equity, private corporations, funds Insurer - local or international providers Regulator - government agencies

Figure 31: Typical Parties in an Emissions Reduction Project153

In the case of an energy generation project, it is usually the promoter’s responsibility to bring all of these parties together to plan, finance, build and operate the plant. The interactions between the parties to typical emissions reduction projects are illustrated in Figure 31..

CDM and JI projects also involve the additional actors required for compliance with the Kyoto mechanisms, as well as purchasers of the CERs and ERUs that are generated.

9.4 Project life cycle

Emissions Reduction Projects will go through three stages: planning, construction, and operation. If financing for the project includes revenue from carbon credits using the CDM or another mechanism (such as state-level RECs), then additional steps are added during each stage.

9.4.1 CDM projects

As specified by the Kyoto Protocol, CDM projects must undergo specific steps for CERs to be credited and available to the project developer to sell. These steps include:

1. Creation of Project Design Document (PDD) by project sponsor. 2. National Approval of the project by the Designated National Authority (DNA) of the project’s host country.

153 Typical Parties in an Emissions Reduction Project, Carbon Credit Capital LLC, New York, 2007. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 52

3. Validation of the PDD by a Designated Operational Entity (DOE). 4. Registration of the validated project as a CDM project activity. 5. Monitoring of actual emissions by the project sponsor according to the approved methodology. 6. Verification of the emissions reductions by the Designated Operational Entity (DOE). 7. CER Issuance by the CDM Executive Board.154

Figure 32 shows the Project Cycle of an emissions reduction project with and without CDM components.

Figure 32: Emissions Reduction Project Life Cycle155

The length of time required for each period of the project differs greatly based on technology used, location, management experience, whether or not the project is a CDM project, and other factors.

In terms of CDM projects, the average time from the start of the Comment Period to the Project Registration (i.e. approval by the CDM Executive Board) has decreased from a peak of over 900 days at the end of 2009 to just 100 days at the end of 2014.156 However, prior to registration, significant time will have been spent to create the PDD, obtain Host Country Approval, and obtain Validation by a DOE.

9.5 Typical financing structures

Emissions reduction projects are usually financed using one of three structures: project finance, corporate finance, or lease finance.

A project finance structure means that lenders have recourse only against the assets of the specific project, and cash flows from the project are the source of funds for repayment. Generally, an SPV (special purpose vehicle) is established to legally define the project entity and undertake the project.

154 UNFCCC, CDM Project Cycle, https://cdm.unfccc.int/Projects/diagram.html, accessed July 2015. 155 Capacity Development for the Clean Development Mechanism (CD4CDM), EcoSecurities, UNEP: Guidebook to Financing CDM Projects, http://cd4cdm.org/publications/financecdmprojectsguidebook.pdf, accessed July 2015 156 UNEP RISO Centre, CDM/JI Pipeline Overview, http://cdmpipeline.org/overview.htm, accessed July 2015. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 53

Corporate finance uses internal corporate capital or corporate assets as collateral for loans to finance a project. In this case, the project activity is part of the overall corporation and lenders may have recourse to the corporation’s assets in the case of non-repayment of project debt.

Lease financing occurs when the supplier of an asset required for the project finances the initial use of that asset on behalf of the project sponsor, often in combination with an Operations & Maintenance agreement. In some cases, ownership of the asset is transferred from lessor to lessee (likely, the project sponsor) at the end of the lease agreement. 157

9.6 Available sources of financing

Depending on the size of the project, the technology used, and the experience of those promoting the project, emissions reduction projects will have different sources of financing available to them. Generally, this financing will be one of three types: grants, loans, and equity.

9.6.1 Grants

A grant is money provided to a project by a third party that generally does not need to be repaid. Grants are usually given by non-governmental or philanthropic organizations to projects that are not, or not yet, commercially viable in order to insure that the goals of the project are achieved.

9.6.2 Loans

A loan is an amount of money provided to a project that must be repaid at the end of agreed term, plus interest. While large and proven projects may access debt from local or international sources, smaller projects will most likely obtain debt from local banks or multilateral institutions.

Senior loans are loans that must be serviced before any other debt or equity in the project. Project assets are often used as collateral for senior loans, and because of this, these loans are considered less risky and therefore the cheapest source of capital. Generally, this is a condition of loans from large local or international banks.

Subordinate debts are loans with a lower priority for repayment than senior debt but a higher priority than equity, and are often either unsecured or have a lower priority claim on a corporation’s assets than senior debt. Because of the increased risk, subordinate debt often carries a higher rate of interest than senior debt, and is used to bridge any gap between senior debt and the available equity.

Low-interest loans may be available from multilateral banks for projects that incorporate environmental and social goals. A number of multilateral financial institutions such as the International Finance Corporation (IFC) and the Japanese Bank for International Cooperation (JBIC) have set up programs to finance renewable energy projects either directly or through local banks. In some countries, “soft loans” with either lower interest rates, longer repayment periods or periods of interest only are available for certain technologies, most often renewables.

Other sources of loans for projects may include the equipment supplier and engineering, procurement, and construction (EPC) firm associated with a project, who may provide financing for purchase of their equipment and services.

Upfront payments from the buyer of a project’s output (such as electricity) may also be available. Carbon credit purchasers, including corporate emitters, carbon funds, governments, and multilateral financial institutions may provide upfront financing against delivery of future carbon credits.

157 Capacity Development for the Clean Development Mechanism (CD4CDM), EcoSecurities, UNEP: Guidebook to Financing CDM Projects, http://cd4cdm.org/publications/financecdmprojectsguidebook.pdf, p.32-38, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 54

Power purchase agreements (PPAs) are long-term off-take agreements at a fixed price. While not a form of upfront financing, PPAs can be used to attract additional debt.

9.6.2.1 Solar securitization

Solar securitization involves “taking a portfolio of contracted revenue from solar projects, bundling it, and selling it as individual securities”, creating an asset-backed security (ABS) similar to mortgage bonds. Essentially, this means packaging a regular stream of PPA or solar lease payments into standardized debt with various risk–return profiles. In the future, this structure would allow solar project developers to monetize future payments and provide upfront cash for capital expenditures. The process of securitization would also make solar investments more attractive to institutional investors who demand various risk-return profiles as well as investment sizes larger than the amount normally required for a single solar installation.158

While solar developers have not yet employed securitization for solar rooftop installations, solar provider SolarCity is reportedly planning to securitize its solar lease payments.159

9.6.2.2 Crowd sourced funding

Analogous to the way that solar securitization packages cash flows from solar projects into a format attractive to large institutional investors, crowd funding platforms can provide access to solar projects for smaller, individual investors. These platforms, for example Mosaic, aggregate and vet project prospectuses and provide an online mechanism for investors to invest smaller sums of money and earn a specific return, paid in regular intervals over a fixed term. In January 2013 the platform opened to the public; investments were as small as $25.160 As of May 2015, over $10 million had been invested on Mosaic, with 100% on- time repayments.161

9.6.3 Equity

Equity is capital raised from shareholders. Shareholders have a claim on a project company’s assets only after all other stakeholders have been repaid; they take on the highest risk and therefore demand the highest return. Equity is attractive to project developers because it does not need to be repaid, but is also more expensive than debt. From a project developer’s standpoint, reducing the amount of equity in a project is favorable as it increases the equity rate of return.

Equity investors expect to capture their returns from dividends or from the sale of ownership shares in the project company. In a typical emissions reduction project, the project promoter brings in equity. Besides project sponsors, other sources of equity may be venture capital funds, private equity funds, corporations, multilateral institutions, government agencies, or individuals.162

9.6.3.1 Tax equity

In the US, much government support for renewable energy projects comes in the form of tax credits granted via the US Government’s Production Tax Credit (PTC) and Investment Tax Credit (ITC) programs for

158 Trabish, Herman K., GreenTech Solar, Securitization: Another Innovation In Solar Finance, http://www.greentechmedia.com/articles/read/Securitization-Another-Innovation-In-Solar-Finance, accessed July 2013. 159 Wang, Ucilia, GigaOM Pro, Solar City and Goldman Sachs Create a $500 million Fund to Finance Solar Leases, http://pro.gigaom.com/blog/solarcity-and-goldman-sachs-create-a-500m-fund-to-support-solar-leases/, accessed July 2013. 160 CrowdSourcing.org, Launch of Mosaic Shows Potential of Equity Crowdfunding, http://www.crowdsourcing.org/blog/solar-mosaic-shows-the-potential-of-equity-crowdfunding-getlauncht/23091, accessed July 2013. 161 Solar Mosiac, How It Works, https://joinmosaic.com/how-it-works, accessed July 2013. 162 Capacity Development for the Clean Development Mechanism (CD4CDM), EcoSecurities, UNEP: Guidebook to Financing CDM Projects, http://cd4cdm.org/publications/financecdmprojectsguidebook.pdf, p.30-32, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 55

renewable energy. As a result, tax equity has become an important component of renewable energy project finance.

Tax equity is essentially a reduction in tax liability. Renewable energy project developers able to take advantage of these federal programs and accrue tax equity can sell this to tax equity investors. Tax equity investors are usually banks or large corporations who expect large future tax liabilities, and can use the tax equity generated by renewable energy projects to offset those obligations.163

9.7 Project costs

For a typical emissions reduction project, the bulk of the costs occur during the Construction period.164 The typical costs associated with each period for an energy generation project are outlined in Table 3.

Table 3: Typical Energy Generation Project Costs by Period

Planning Period Construction Period Operating Period  Feasibility study  Purchase equipment  Operate plant  Fuel supply assessment  Construct facility  Purchase fuel  Obtain title to site  Put operating team in place  Pay debt  Obtain licenses  Make insurance payments  Enter into contract with power purchaser  Identify EPC  Secure financing

If a project is registered as CDM project, additional CDM-specific costs will also be incurred during each period.

9.8 Project revenues and cash flows

Different types of emissions reduction projects will earn revenue in different ways. This may include revenue from the sale of what the project produces, from cost savings as a result of more efficient processes, or from the sale of CERs or ERUs.

For renewable energy emissions reduction projects, revenue often primarily comes from the sale of electricity. Ideally, a long-term Power Purchase Agreement (PPA) will be signed with an off-taker at a fixed price, guaranteeing a long-term stable source of revenue for the project’s outputs.

163 UNEP SEFI, Bloomberg NEF, Chatham House, Private Financing of Renewable Energy: A Guide for Policymakers, 2009, http://sefi.unep.org/fileadmin/media/sefi/docs/publications/Finance_guide_FINAL-.pdf 164 Capacity Development for the Clean Development Mechanism (CD4CDM), EcoSecurities, UNEP: Guidebook to Financing CDM Projects, http://cd4cdm.org/publications/financecdmprojectsguidebook.pdf, p.29, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 56

Figure 33: Structure of Typical Project Cash Flows165

9.9 Project risks

There are various risks involved with the successful construction and operation of a project, and CDM projects often encounter CDM-specific risks that should be addressed with their own mitigation procedures. For an energy generation project, the most significant risks are the following: Cost and time over-run risk during construction phase – The risk that the cost of construction, equipment or supplies will be higher than expected or that the project takes longer than expected to become operational. An over-run of either the allocated time or cost will reduce the overall return on investment of the project. Technical risk – The risk that the equipment will not perform up to the standards expected. This can lead to lower than expected output and subsequent loss of revenues. Operational risk – The risk that the plant will not operate up to the standards expected, leading to increased maintenance costs and loss of revenues. Market risk – The risk that electricity prices will drop, leading to lower overall revenues for the plant. Fuel supply risk – The risk that the major inputs for the plant, including fuel supply, will be insufficiently available or more expensive than anticipated, leading to increased costs or an inability to operate to capacity. Counterparty risk – The risk that one or more counterparties to the project, including the counterparty to a power purchase agreement, will default on its obligation to the plant. Political, legal and regulatory risk – The risk of adverse changes in government policy, government expropriation, nationalism or instability.

165Ibid., 41. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 57

Financial risk – The risk that future interest rates will be higher than expected and the project will not be able to cover its debt service. Force majeure – The risk of damaging events such as fire, earthquake, flood or other unavoidable factors that make it impossible to operate the project.

9.10 Risk mitigation

Risk mitigation techniques for projects include contracts and insurance. Cost and time over-run during construction can be mitigated by entering into fixed price contracts for the project materials and a contract with the EPC which rewards or penalizes for timely completion or late completion, respectively. Similarly, the risk of price fluctuations for fuel supply and electricity prices can be mitigated through long-term fixed- price contracts.

Technical risk can be mitigated through equipment supplier warranties and insurance products available to guard against losses from certain operational events, political factors and force majeure. In certain situations counterparty risk can be mitigated through purchases of guarantees, while financial risk can be mitigated by purchase of an interest rate hedge.

Additionally, there are insurance products that protect carbon credit off-takers from the risk that a project will not generate carbon credits in the amount expected due to either operational or political factors.

9.11 Economic feasibility and carbon finance

Carbon finance in the form of CERs can serve as an additional source of revenue to a project, beyond its principle source of revenue.

The most common transaction structure for carbon credits is an Emissions Reduction Purchase Agreement (ERPA). Under an ERPA, a buyer and seller specify the terms of delivery of and payment for CERs or ERUs that are to be generated in the future. These include timing of delivery, timing of payment, delivery volume, price and conditions of non-delivery. As more and more CERs reach the stage of issuance, spot transactions are starting to become more frequent as well.

The sale of CERs, especially through a long- term ERPA with a credit worthy counterparty, enhances debt service coverage, shortens debt payback, and increases the return on investment for the project. Often the revenue from the CERs will change a project from being economically unviable to economically viable.

In addition, the participation in the project of a credit worthy buyer of the CERs improves the project profile for other financing parties.

Figure 34: Project Finance with Carbon Revenue166

However, for projects that wish to sell CERs or ERUs, additional costs will be incurred to complete the UNFCCC process required to register the project as well as actually issue the carbon credits.

Table 4: Typical CDM Cost Ranges167

Activity Large-scale cost Small-scale cost

Upfront cost PDD $20,000-$100,000 $15,000-$25,000 New methodology (if $30,000-$100,000 $30,000-$50,000 necessary) Validation $15,000-$30,000 $9,500-$10,000 Registration fee $12,500-$350,000 $0- $24,500 Total upfront cost $77,500-$580,000 $54,500-$109,500 Annual cost UN Adaptation Fund fee 2% of CERs 2% of CERs Initial verification $8,000-$30,000 $8,000-$15,000 Ongoing verification $8,000-$25,000 $8,000-$10,000 Total annual cost $16,000-$55,000 + 2% CERs $16,000-$25,000 + 2% CERs

Recent data based on the World Bank’s portfolio of CDM projects show that the prices of validation (necessary to register the project as a CDM project) and verification (necessary to ensure that emissions reductions have actually occurred prior to issuing CERs) seem to be increasing over time, with the prices for small projects increasing faster than for large ones.

166 World Bank, 10 Years of Experience with Carbon Finance, http://siteresources.worldbank.org/INTCARBONFINANCE/Resources/Carbon_Fund_12-1-09_web.pdf, page 7, accessed July 2013 167 EcoSecurities, UNEP. Guidebook to financing CDM projects. Roskilde, Denmark: Riso National Laboratory. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 59

Figure 35: World Bank Emissions Reduction Project Validation and Verification Costs168

9.12 Innovative financial products

Certain financial institutions now provide delivery guarantee products. Through these products, the financial institution will guarantee the unconditional delivery of a CER to the purchaser of the guarantee, regardless of whether or not the underlying project was successful in generating the CER. With a delivery guarantee in place, a seller is able to command a higher price for the CER. Similarly, some financial institutions and insurance companies have developed CER insurance products, which insure an entire project against non- delivery of CERs.

Some additional products include CER put and call options, CER linked notes and CER swaps. CER put and call options, allowing option holders to buy or sell at a pre-determined price, have begun being traded, but as the market is still quite young and has limited liquidity, these are quite expensive. Certain financial institutions have created CER linked notes, where the payment on the note is related to the price of CERs. CER swaps, whereby owners of CERs from two different projects swap some or all of their respective projects’ CERs, is a means by which some holders of portfolios of CERs hedge their overall portfolio risk. These products are testament to the continuing development and flexibility of the carbon markets.

168 World Bank, 10 Years of Experience with Carbon Finance, http://siteresources.worldbank.org/INTCARBONFINANCE/Resources/Carbon_Fund_12-1-09_web.pdf, page 8, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 60

CHAPTER 10: THE CORPORATE RESPONSE

10.1 Impacts of climate change on corporations

Climate change is an exogenous change that will impact corporations differently depending upon their business model, geographic location, and policy environment. Climate change presents every corporation with a set of risks and opportunities capable of altering its business-as-usual profitability. Depending upon a corporation’s exposure to climate impacts and its ability to capitalize on new opportunities, the potential impact of climate change to a corporation’s bottom line ranges from beneficial to negligible to catastrophic. Companies must assess their unique profile of climate change risks and opportunities to determine their exposure, and then act to minimize downside risk and capitalize on the changing business environment.

10.2 Corporate response

Climate change considerations continue to be integrated into the strategic, operational, and compensation decisions of many of the world’s largest companies. Of the 379 companies that responded to the Carbon Disclosure Project’s 2012 Global 500 Climate Change Report, 96% say they have established either Board or Senior Executive oversight of climate change concerns, 78% have incorporated climate change into their wider business strategy, and 65% report some form of monetary incentives for staff for meeting climate change-related targets.169

Corporations are aware of the risks from climate change. According to the CDP report, 81% identify physical risks due to climate change, and 37% consider those risks to be current, up from 10% in 2010. 83% identified climate change-related regulatory risk to their business, and 63% noted reputational risks to their brand and risks from changing customer behavior. 170

10.3 Climate-related risk

The most immediate risk to corporations from climate change is physical, i.e. climate-induced damage to assets or employees. This damage may come from sudden extreme weather events such as hurricanes or floods, or from gradual changes such as sea level rise or water scarcity. Climate change may cause damage to a corporation’s direct operations, or indirectly impact a corporation through damage to elements their supply chain. Both direct and indirect physical damage can disrupt a corporation’s ability to produce its goods or provide its services, resulting in financial losses.

While the Earth’s ecological systems are the proximate cause of physical damages from climate change, corporations may be exposed to additional climate-related risk as a result of stakeholder requirements that relate to climate change. These additional risks are:

 Regulatory. The risk that future climate policy will necessitate additional investment and expenditures to maintain compliance.  Litigation. The risk that future litigation will hold companies liable for past greenhouse gas emissions and require significant legal and punitive expenditures.  Brand/Reputation Risk. The risk that increasing consumer awareness of climate change will result in a negative assessment of a corporation’s business-as-usual practices. If a corporation’s products or services are widely perceived as “climate-unfriendly”, this loss of reputation could lead to lower demand, resulting in financial losses.  Innovation Risk. The risk that the changing physical, regulatory, and consumer environment will decrease demand for the corporation’s current products and services in favor of other options more desirable to climate-aware consumers in an increasingly ecologically-challenged, resource- constrained world.

169 Carbon Disclosure Project, Business Resilience In an Uncertain, Resource-Constrained World - CDP Global 500 Climate Change Report 2012, https://www.cdproject.net/CDPResults/CDP-Global-500-Climate-Change-Report- 2012.pdf, accessed July 2013. 170 Ibid. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 61

 Other Stakeholder Risk. The risk that climate change will alter the requirements placed upon a corporation by stakeholders other than government and consumer, for example insurers, investors, banks, professional organizations, and civil society organizations. If professional or civil society organizations determine that a corporation is not following climate best practices, they can increase a corporation’s regulatory, litigation, and brand risk. If Insurers determine that a company has not sufficiently protected itself from physical risks, a corporation’s premiums will rise. If banks or investors decide that a corporation is particularly exposed to regulatory, litigation, brand, or innovation risk, this will raise a corporation’s cost of capital or eliminate its availability entirely.

10.4 Present impacts

In the last decade climate-related impacts and damages to corporations, as well as insurance claims, have increased, indicating that the physical risk to corporations from climate change is growing.

According to the NOAA’s State of the Climate 2014 report, 2014 was the hottest year on record since record keeping began in 1880. 9 out of the 10 hottest years on record have occurred since the year 2000. 171The area of ice covering the Arctic Ocean reached a record minimum in 2012, and the September northern sea ice extent has decreased by an average rate of 13% per decade from 1979 to 2012.172 According to the IEA, sea levels have risen by 15-20 centimeters, on average, over the last decade, and there has also been an increase in the frequency and intensity of heat waves, causing more frequent droughts.173

Weather-related damage to infrastructure, products, and agriculture has increased during the last decades. According to SwissRe, yearly weather-related worldwide-insured losses averaged $5.1 billion from 1970 to 1989, but have averaged $27 billion in the last two decades; in 2011, global weather related insured losses were $60 billion. The record drought in Texas in 2011 cost the agricultural sector at least $7.6 billion, and led to rising cotton prices, cutting earnings for clothing manufacturers. The 2010 heat wave in Russia triggered severe wildfires, and was responsible for losses of $15 billion, approximately one percent of the country’s GDP that year.174 While these losses cannot scientifically be attributed to man-made climate change, Munich Re released a study in 2011 that showed that climactic changes have already had a large impact on losses from US thunderstorms.175

In light of these numbers for insurance claims, insurers are treating climate resilience as an important factor in their policy and pricing decisions. Corporate exposure to physical damage from climate change is also being incorporated into financing decisions by banks and philanthropic organizations. The European Bank for Reconstruction and Development and the International Finance Corporation require that climate risk and resilience be included in the feasibility, environmental and social impact studies done before making investment decisions.176

Investors incorporate climate considerations into investment decisions both for ethical reasons and to determine climate-related bottom-line risk. The number of climate-related shareholder petitions filed with

171 NOAA National Centers for Environmental Information, State of the Climate: Global Analysis for Annual 2014, http://www.ncdc.noaa.gov/sotc/global/201413, accessed August 13, 2015 172 NOAA National Climactic Data Center, Global Snow & Ice – 2012, http://www.ncdc.noaa.gov/sotc/global- snow/2012/09, accessed July 2013. 173 International Energy Agency, Redrawing the Energy-Climate Map, World Energy Outlook Special Report, 10 June 2013, http://www.iea.org/publications/freepublications/publication/RedrawingEnergyClimateMap_2506.pdf, accessed July 2013. 174 Arnado, Jean-Christophe, Adams, Peter, Coleman, Heather, Schuchard, Ryan, PREP: Value Chain Climate Resilience, http://www.oxfamamerica.org/files/valuechainclimateresilience.pdf, accessed July 2013 175 MunichRe, Climate Change Effects Increasingly Influencing US Thunderstorm Losses, http://www.munichre.com/en/media_relations/company_news/2013/2013-04-08_company_news.aspx, accessed April 2013. 176 Arnado, Jean-Christophe, Adams, Peter, Coleman, Heather, Schuchard, Ryan, PREP: Value Chain Climate Resilience, p.5, http://www.oxfamamerica.org/files/valuechainclimateresilience.pdf, accessed July 2012. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 62

public companies jumped between 2009 and 2011,177 with nearly a third of the total filed in 2012 focused on environmental and sustainability concerns.178

Initiatives such as the Carbon Disclosure Project, the Ceres Investor Network on Climate Risk, the Institutional Investors Group, and the Global Impact Investment Ratings System have members with trillions of investment dollars seeking transparent climate and sustainability reporting and assessment. These initiatives aid investors in assessing the climate risks and impacts associated with potential investments.

Regulatory environments can also create the incentive for climate-friendly corporate operations, however these incentives vary considerably around the globe. As of 2010, both the SEC and Canadian Securities Administration provided the means for public companies in the US and Canada to disclose material risks related to a changing climate.179 At COP-18 in Doha in 2012, 38 of 195 countries took on binding targets during the Kyoto Second Commitment Period (2013-2020). The EU ETS regulates some 11,000 power stations and industrial factories in 31 countries.180 However, while Australia and US state of California have recently enacted widespread climate policies, and other nations are expected to follow, world-wide only 8% of global CO2 emissions are subject to a carbon price, while 15% receive an incentive of $110/ton in the form of fossil fuel subsidies.181 While the regulatory risk looms large for corporations in certain sectors and regions, overall it is far from pervasive.

10.5 Sectors at risk

Numerous frameworks exist for assessing corporate exposure to climate change-related losses. The Partnership for Resilience and Environmental Preparedness (PREP), which includes SwissRe, Calvert Investments, and Entergy, has proposed a “Value Chain” approach to assessing risks. This approach identifies three logical components in a corporation’s value chain: its supporting environment, the primary activities it engages in that take place beyond its corporate boundaries, and activities that occur within corporate boundaries.

 Supporting Environment. This includes risks generated by stakeholders external to the business, such as regulators, banks, investors, and insurers. Possible negative impacts include higher regulatory compliance costs, more stringent reporting requirements, higher cost finance or insurance, and increased costs to engage and satisfy civil society.  Primary Activities Beyond Corporate Boundaries. This is the risk of supply chain disruption or altered demand for climate-related reasons. Possible negative impacts include deterioration of necessary ecosystem services, resource scarcity, raw material price volatility, damage to distribution infrastructure, damage to local communities’ socioeconomic structure, and changing consumer preferences.  Primary Activities Within the Corporation. This includes direct risks to corporate operations, and negative impacts include deterioration of necessary ecosystem services, resource scarcity, raw material price volatility, damage to distribution infrastructure, damage to local socioeconomic structure, increased healthy and safety hazards on labor.

Taking a value chain approach leads to the conclusion that “corporations with long and complex supply

177 ibid., 4. 178 Union of Concerned Scientists, A Changing Environment: Corporate Action on Climate Change, 10 September 2012, http://www.sustainablebrands.com/news_and_views/new-metrics/changing-environment-corporate-action- climate-change, accessed July 2015. 179 Arnado, Jean-Christophe, Adams, Peter, Coleman, Heather, Schuchard, Ryan, PREP: Value Chain Climate Resilience, p.5, http://www.oxfamamerica.org/files/valuechainclimateresilience.pdf, accessed July 2015 180 European Commission, The EU Emissions Trading System (ETS), http://ec.europa.eu/clima/policies/ets/index_en.htm, accessed July 2015. 181 International Energy Agency, Redrawing the Energy-Climate Map, World Energy Outlook Special Report, p.11, http://www.iea.org/publications/freepublications/publication/WEO_RedrawingEnergyClimateMap.pdf, accessed June 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 63

chains or long-lived fixed assets, or those businesses under high scrutiny by outside stakeholders, are particularly exposed to climate risks.”182

Clearly, exposure to climate change-related risks varies by sector of the economy. A recent report by Ceres identified the key physical risks of climate change for various sectors.183

Figure 36: Ceres Physical Risks from Climate Change, by Sector

182 Arnado, Jean-Christophe, Adams, Peter, Coleman, Heather, Schuchard, Ryan, PREP: Value Chain Climate Resilience, 06 July 2012, p.8, http://www.oxfamamerica.org/files/valuechainclimateresilience.pdf, accessed July 2013. 183 Oxfam America, Ceres, Calvert Investments, Physical Risks from Climate Change, 2012, p.6-7, http://www.calvert.com/NRC/literature/documents/sr_Physical-Risks-from-Climate-Change.pdf, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 64

Finally, a KPMG Report in 2009 assessed industry exposure based on both perceived industry risk and self-reported level of preparedness. The risk assessment analyzed 50 different reports of sector risk and combined them into one overall score, while preparedness was determined from a 2007 CDP report. When risk and preparedness of each industry was plotted, the results indicated that transport, health care, tourism,

aviation, the financial sector, and oil & gas are particularly financially exposed to the impacts of climate change. Though the underlying risk and preparedness numbers are now slightly outdated, using both risk and preparedness is key to assessing actual exposure.184

Figure 37: KPMG Climate Change Risk Analysis by Sector

10.5.1 The insurance industry and climate change

The insurance industry profitability is directly related to climate change impacts; with both global economic losses and global insured losses from natural disasters on the rise, the insurance industry is taking action to reduce their exposure.

In nominal terms, global economic and insured losses from natural disasters have increased by 7.3% and 10.9% annually since 1980. These increases incorporate the effects of inflation, population growth, increased economic activity, and increased insurance penetration. As a percentage of global GDP, economic and insured losses have increased by 1.1% and 4.6% annually since 1980.185 For an event to be classified as a natural disaster in this data set, it must have met at least one of the following criteria: economic losses of at least $50 million, insured losses of at least $25 million, at least 10 fatalities, 50 injured, or 2,000 homeless/displaced. These totals include losses from earthquakes, which are generally not considered climate change-related.

184 2008 KPMG International, Climate Changes Your Business, 2008, p.48, http://www.kpmg.com/EU/en/Documents/Climate_Changes_Your_Business.pdf, accessed July 2013. 185 AONBenfield, Annual Global Climate and Catastrophe Report, 2014, p.4, http://thoughtleadership.aonbenfield.com/Documents/20150113_ab_if_annual_climate_catastrophe_report.pdf, , accessed May 2015. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 66

Figure 38: Annual Global Economic and Insured Losses from Natural Disasters by Type of Peril186

Figure 39: Annual Global Economic and Insured Losses from Natural Disasters as a Percentage of Global GDP187

Insurance companies are reacting to climate change by managing their financial risk, particularly in regions prone to natural disasters. For example, in the United States Allstate has announced that it will cancel or

186 AONBenfield, Annual Global Climate and Catastrophe Report, 2014, http://thoughtleadership.aonbenfield.com/Documents/20150113_ab_if_annual_climate_catastrophe_report.pdf, Accessed May 26th, 2015 187 Ibid., 4. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 67

not renew policies in many Gulf Coast states, and has decreased its number of homeowners’ policies in Florida from 1.2 million to 400,000.188 Insurance companies are also designing policies with conditions and exclusions that serve to promote behaviors that reduce GHG emissions (e.g. pay-as-you-drive insurance policies) as well as low-carbon energy (e.g. policies that protect wind farm developers from underproduction of power).

At the same time, large global insurers are increasingly advocating for transparency in corporate climate impact and risk reporting, sustainable business practices, and cohesive low-carbon climate and energy policies. For example, Ceres directs the Investor Network on Climate Risks, with collective assets of more than $11 trillion;189 and European reinsurers such as Swiss Re and Munich Re actively support efforts to 190 reduce CO2 emissions. Additionally, 38 insurers from around the world have combined to form the ClimateWise leadership group to “promote a policy and market agenda for proactive responses to climate risks”, and to use their expertise to “better understand, communicate, and act on climate risks”.191,192

10.6 The business case for addressing climate change

Climate-related impacts to corporate assets, supply chains, and brands are becoming increasingly common. Nine out of ten companies suffered weather-related impacts during 2009-2012, and weather- related insured losses are at all-time peaks.193 According to PREP, with both impacts and financial losses increasing, the business case for mitigating this risk and bolstering climate resiliency rests on:

(1) Protecting corporate value at risk. Corporations must act to minimize the risk of costly climate- related damage to their immediate physical assets, workforce, supply chain, and brand. (2) Satisfying stakeholders who are demanding action. Corporations must act to provide insurers, banks, investors, regulators, civil society and professional organizations with proof that climate change action is being taken. Failing to do so can raise financing and insurance costs, as well as tarnish the value of corporate brand or products. (3) Capitalizing on opportunities. Depending upon their sector, corporations must take advantage of the need for new climate-resilient products and the desire for climate-friendly production processes, as well as the need for climate-related insurance and financial instruments. Identifying and filling these needs could create large potential revenue streams; failing to do so allows competitors to capture them.

10.7 Corporate actions

Corporations are acting to both decrease the risks from climate change and harness the opportunities it presents. 82% of CDP respondents have set corporate emissions targets, and 68% report opportunities associated with changing customer attitudes or enhancing their reputation, up from 58% in 2011.194

188 Mills, Evan, Responding to Climate Change: The Insurance Industry Perspective, http://evanmills.lbl.gov/pubs/pdf/climate-action-insurance.pdf, accessed July 2013. 189 Ceres, Investor Network on Climate Risk, http://www.ceres.org/investor-network/incr, accessed July 2015. 190 Eduardo Porter, New York Times, For Insurers, No Doubts on Climate Change, published 14 May 2013, http://www.nytimes.com/2013/05/15/business/insurers-stray-from-the-conservative-line-on-climate- change.html?pagewanted=all&_r=0, accessed July 2015. 191 Mills, Evan, Responding to Climate Change: The Insurance Industry Perspective, p.103, http://evanmills.lbl.gov/pubs/pdf/climate-action-insurance.pdf, accessed July 2015. 192 ClimateWise, http://www.climatewise.org.uk/, accessed July 2015. 193 Arnado, Jean-Christophe, Adams, Peter, Coleman, Heather, Schuchard, Ryan, PREP: Value Chain Climate Resilience, Executive Summary, http://www.oxfamamerica.org/files/valuechainclimateresilience.pdf, accessed July 2012. 194 Carbon Disclosure Project, Business Resilience In an Uncertain, Resource-Constrained World, CDP Global 500 Climate Change Report 2012, https://www.cdproject.net/CDPResults/CDP-Global-500-Climate-Change-Report- 2012.pdf, accessed July 2015. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 68

Additionally, in 2014 48% of S&P 500 companies achieved high performance bands according to CDP, up from only 30% in 2011.195

Corporate action on climate change generally falls into the following categories:

 Mitigating GHG Emissions  Enhancing climate resilience  Capitalizing on business opportunities created by a changing climate.

10.7.1 GHG emissions mitigation

GHG emissions mitigation reduces the cause of climate change – the rising concentration of GHG gases in the atmosphere as a result of fossil fuel combustion. While effective mitigation will eventually decrease the risk of physical damage from a changing climate, because CO2 stays in the atmosphere for decades today’s mitigation actions will not materially decrease today’s physical risks.

However, active and substantive policies to mitigate GHG emissions are an important tool to decrease brand, regulatory, litigation, and stakeholder risk in a regulatory and consumer environment increasingly aware of how corporate activities contribute to climate change. Mitigation actions can also reassure stakeholders and lessen the financial or social returns they deem necessary to compensate them for a corporation’s perceived contribution to climate change.

For many corporations, GHG mitigation is one element of a wider set of Corporate Sustainability or Corporate Social Responsibility policies. According to the Harvard Corporate Social Responsibility Initiative, Corporate Social Responsibility “moves beyond philanthropy and compliance to address how companies manage their economic, social, and environmental impacts,” as well as their relationships with a broader set of stakeholder realms, including workplace, marketplace, supply chain, community, and public policy.196

A recent report on Corporate Sustainability by Ceres identified four key mechanisms for embedding sustainability (including GHG emissions reduction) into corporate culture: governance, stakeholder engagement, disclosure, and performance.197

Ceres recommends:  Board oversight of sustainability, with compensation, operational, and risk management systems connected to sustainability goals.  Substantive stakeholder dialogue from C-level executives on the strategies for sustainability, the risks of non-action, and the potential opportunities that a changing climate can present.  Disclosure of all climate-related risks through standard financial filings as required by law. Additionally, Global Reporting Initiative (GRI) Guidelines should be followed for direct global operations, subsidiaries, joint ventures, products, and supply chains, with numbers independently verified by third parties. Policy positions on climate-related legislation should be transparent.  Setting clear performance targets for sustainability, including GHG emissions reduction, energy efficiency, reducing energy demand, and renewable energy. This also implies requiring members of the supply chain to meet the same requirements the corporation follows itself. Finally, this means designing and delivering products with minimal GHG impact.

195 Carbon Disclosure Project, CDP S&P 500 Climate Change Report 2014, https://www.cdp.net/CDPResults/CDP- SP500-leaders-report-2014.pdf, Accessed May 26th, 2015 196 Harvard Kennedy School of Government, Harvard Corporate Social Responsibility Initiative, http://www.hks.harvard.edu/m-rcbg/CSRI/init_define.html, accessed July 2015. 197 Ceres, The 21st Century Corporation: The Ceres Roadmap for Sustainability, http://www.ceres.org/resources/reports/ceres-roadmap-to-sustainability-2010/view, accessed July 2015. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 69

10.7.2 Enhancing climate resilience

Enhancing organization resilience means preparing for potential climate change impacts that cannot be averted by mitigation, and increasing the organization’s ability to respond to them. The vulnerability of resources—including workforce, ecosystem, and community—are assessed along the supply chain and made more resilient. Physical assets can be modified, bolstered, or relocated, and new infrastructure can be added. New policies can be added to ensure worker safety, community investment, and ecosystem stability.

Financial instruments such as insurance and financial derivatives can be a hedge against physical losses, resource shortages, and price swings and make corporations more financially secure in the face of physical climate change impacts. These actions to ensure financial resilience in the case of physical damage will reassure stakeholders and lower the likelihood that they will apply pressure that will negatively impact a corporation’s financial position.

10.7.3 Capitalizing on opportunities

Capitalizing on opportunities means identifying profitable business opportunities presented by a changing climate. These may include the production and provision of climate-friendly and climate-resilient products and services, or of products that make more efficient use of energy and resources. This could also mean providing services to consumers or organizations particularly at risk from climate change. As consumers in various part of the world begin to change their lives to adapt to climate change, they will be demanding different products.

CHAPTER 11: THE INVESTOR RESPONSE

11.1 Importance of climate change to investors

Climate change presents investors with both risks and opportunities that can affect their rate of return. The impacts of sudden disruptive weather events such as hurricanes, extended weather patterns such as multi- year droughts, or gradual climate changes such as the rise in sea level can quickly destruct or slowly erode the value of investments. Investments in entities that damage the environment or emit high levels of GHGs, or that are perceived to do so unnecessarily, may ultimately lose value as a result of consumer, regulatory, or other stakeholder reactions. For these reasons, investors are increasingly demanding more disclosure and transparency of potential climate impacts and mitigation efforts in order to protect themselves from losses. At the same time, a changing climate will provide opportunities for products and services better adapted to it. Investors in enterprises that meet this new demand have the potential to reap large gains. As investors become more aware of the impact of their investments on the climate, they may also choose to divest for ethical reasons. Impact investors sufficiently concerned about climate or other social concerns are increasingly looking to make investments that yield “blended value” – combined financial, social, and environmental returns. Often, these investors are willing to accept lower financial returns for projects expected to generate significant benefits in other areas, including generating climate adaptation benefits. As it becomes increasingly clear that the planet is warming, private capital to finance climate-related projects is crucial. In 2010 the IEA estimated that an additional $13.5 trillion (roughly $500 billion per year) in clean energy investments and spending, over and above what had already been committed by governments will be needed between 2010 and 2035 to avoid “unmanageable impacts from climate change.”198 Bloomberg New Energy Finance estimated that $270 billion was spent on renewable energy and fuels in 2014, which reversed a two year decline.199

11.1.1 Investor response

In January of 2012, 450 investors representing tens of trillions of dollars in assets convened at the United Nations for the Investor Summit on Climate Risk & Energy Solutions. They issued an Investor Action Plan, which calls for “greater private investment in low-carbon technologies and a tougher scrutiny of climate risks across their portfolios.”200

Additionally, numerous institutional investor networks; such as the Investor Network on Climate Risk (INCR), Institutional Investors Group on Climate Change (IIGCC), Investor Group on Climate Change (IGCC), and the Asia Investor Group on Climate Change (AIGCC); have been formed to jointly engage businesses and governments on climate and sustainability issues. According to INCR, its members are:

 “Changing their practices throughout the investment value chain to address climate and sustainability risks and opportunities.  Engaging with companies in their portfolios on climate and sustainability issues  Advocating for strong climate and energy policies at the international, federal, regional and state levels.”201

198 IIGCC, INCR, IGCC, UNEP Finance Initiative, Investment-Grade Climate Change Policy: Financing the Transition to the Low-Carbon Economy, http://www.ceres.org/files/press-files/2011-global-investor-statement-on-climate- change/investment-grade-climate-change-policy-investment-grade-climate-change-policy, accessed July 2013. 199 Bloomberg Business, Investors Spent A Record $2 Trillion on Renewable Energy, March 31st, 2015, http://www.bloomberg.com/news/articles/2015-03-31/investors-spent-a-record-2-trillion-on-renewable-energy, Accessed May 26th, 2015 200 Ceres, Investors Are Acting on Climate Change, http://www.ceres.org/files/investor-files/investors-climate-change, accessed July 2015. 201 Ceres, Investor Network on Climate Risk, http://www.ceres.org/investor-network/incr, accessed July 2015. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 71

The umbrella group for these organizations, called the Global Investor Coalition on Climate Change, formed as an international platform for dialogue between and amongst investors and governments on international policy and investment practice related to climate change.202

11.2 Climate change-related investments

Investors believe that best practices for managing climate risks and access to stable investment returns are projects that focus on clean energy, energy efficiency and green bonds. These can include projects such as wind and solar plants and cutting down on wasteful consumption of energy by managing it in a more organized and structured manner. Green bonds are tax-exempt bonds issued by federally qualified organizations or municipalities for the development of brownfield sites. Brownfield sites include low pollution emitting industrial sites that have undeveloped or semi-developed buildings.203

11.3 Current investments

Investment in global clean energy has been rising in the past decade. It rose to a record $269 billion in 2012, which was an 11% decrease from 2011, but a considerable increase relative to the $54 billion figure in 2004.204 Twenty-nine states in the US have good renewable standards. Macquarie Infrastructure and Real Assets (MIRA) has forecasted investment opportunities up to $400 billion by 2030. Since 2004, cumulative clean energy global investments hit the $1 trillion mark in December 2011. Energy efficiency garners healthy returns for investors by cutting energy costs and emissions, while simultaneously creating jobs.

Figure 40: Global Total New Investment in Clean Energy, 2004-2014 ($BN) 205

202 Ceres, Global Investor Netowrk on Climate Change, http://www.ceres.org/investor-network/gic, accessed July 2015. 203 Investopedia. http://www.investopedia.com/terms/g/green-bond.asp, accessed July 2015. 204 Michael Liebreich, Bloomberg New Energy Finance Summit, http://about.bnef.com/presentations/bnef-summit- 2013-keynote-presentation-michael-liebreich-bnef-chief-executive/, accessed July 2013. 205 Grist, Clean energy rebounds big time in 2014, Jan 12th, 2015, http://grist.org/climate-energy/solar-wind-power- investment-china/, Accessed May 26th, 2015 This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 72

11.4 Investor types

Climate change has altered the investment landscape for many companies and there has been a major shift in recent years to take steps to improve profit margins while preserving the environment. Large companies such as Wal-Mart and PepsiCo are actively pushing sustainable measures by cutting waste, conserving water, abating carbon and “greening” their supply chain. Even investment banks such as Morgan Stanley and Goldman Sachs have actively taken stakes in wind farms, solar plants and tidal-energy projects.206 Even though 2012 saw a 34% drop in private investments in clean energy, firms on Wall Street are continuing to invest in businesses that they deem will become profitable as the planet becomes warmer.207 Evidence of this can be seen in 2014, when global investments in clean energy increased by 16% from the year prior.208 The notion behind these investments is that climate change is inevitable.

Environmentally motivated investors are similar to traditional investors in that their near-term investment interest is profitability. Where these two types of investors differ is in their long-term interests of responding to climate change through their investment strategy.

The environmental investor looks for two main criteria: a management team that is prepared to tackle climate-related risks now, while also poised to confront more in the future; and company transparency in reporting. Increasingly, shareholders view credible environmental management as a measure of overall management performance within a corporation.

As environmental awareness has grown in importance among investors, their investment vehicles have begun to incorporate these evaluative criteria. There are several investment options for the environmentally minded investor, apart from investing directly into one company; a few examples are listed below:209

Theme Funds: funds that invest solely in companies in the climate change mitigation market.

Venture Capital Firms and Private Equity Funds: entities that seek out and invest capital into climate change responsive technology companies.

206 Matthew Campbell & Chris V. Nicholson, Investors Embrace Climate Change, Chase Hotter Profits, http://www.bloomberg.com/news/2013-03-07/investors-embrace-climate-change-chase-hotter-profits.html, accessed July 2013. 207 Ibid. 208 Bloomberg, Rebound In Clean Energy Investment in 2014 Beats Expectations, Jan 9th, 2015, http://about.bnef.com/press-releases/rebound-clean-energy-investment-2014-beats-expectations/, accessed May 22nd, 2015 209 UBS. (2007). Climate change: beyond whether. UBS Research Focus, 31 Jan 2007. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 73

Socially Responsible Investment Funds & Indices: entities with the investment methodology of more than two decades, which takes into account economic, social and environmental performance of companies.

Carbon Funds: funds presently unavailable to an individual investor that buy and sell in a specific market associated CERs within the Clean Development Mechanism and Joint Implementation markets.

Green Hedge Funds: hedge funds that are dedicated to “green” investments, for example alternative energy projects, and sugar for trading to ethanol producers.

11.5 Barriers and risks to climate change mitigation projects

One of the biggest challenges to investing in climate change is that a company must require several concurrent and separate initiatives to adhere to the long-term concerns raised above, while realizing profits for their investors and shareholders in the near-term. Various public disclosure opportunities exist for a company to demonstrate consideration of climate change in business decisions, i.e. emissions data and environmental performance, management teams and company boards that are committed to environmental affairs, impacts of the physical risks of climate change to the business’ operations and supply chain, as well as implications of the changing regulatory environment.210 Figure 41 provides a general overview of the possible barriers and risks of investing in climate change mitigation projects.

Figure 41: Barriers and Risks to Climate Change Mitigation Projects211

210 CERES (2006), Global framework for climate risk disclosure, Boston, MA: CERES. 211 Steven Gray and Nicholas Tatrallyay, The Green Climate Fund and private finance: Instruments to mobilise investment in climate change mitigation projects, http://www.climatechangecapital.com/images/docs/publications/ sep_2012_-_the_green_climate_fund_and_private_finance-_instruments_to_mobilise_investment_in _climate_mitigation_projects_(2).pdf, accessed July 2013. This document is Copyright of Carbon Credit Capital®, LLC, 2015 and contains data and opinions compiled by Carbon Credit Capital. Carbon Credit Capital is not liable for information or data herein that changes daily with market trends or the study of climate change. 74

Additionally, shareholders have several underlying concerns, which may include:  What are the company’s GHG emissions? Are they recorded and reported transparently? If the levels are high, what mitigation strategies or emission reduction options are there? Does the company need to reduce or offset them, and if so, what is being done?  Is the company investing in renewable energy as part of their energy portfolio?  Is the company currently regulated by policies or plans, and if not, how proactive and prepared is the company for regulations? Is the company leading the pack or will it have to pick up ground, at the expense of the company at a later date? How much investment will be necessary?  How is the company at risk geographically for the impacts/implications of climate change and/or is the company prepared for climate change-related natural disasters?  Can the company cost-effectively, profitably and with environmental concern, develop and deliver products and services to compete with its competitors?  What is the company’s reputation and how vulnerable is the company to litigation? If a company has good environmental practices, does it publicize them and is the resulting public awareness positive?

11.7 Investor Platform for Climate Actions Three Main Areas: - Measurement (e.g. carbon footprinting of portfolios) - Engagement (e.g. with fossil fuel and energy intensive companies) - Reallocation (including investment in low carbon assets and shifting capital from emissions intensive activities)

With many plans for action against climate change being initiated globally, investors are confident that this will create momentum for an global climate deal in Paris in December of 2015.

Action taken by investors will be vital toward reaching a truly low carbon economy. The Investor Platform for Climate Actions, is a joint project of IIGCC in Europe, Ceres’ Investor Network on Climate Risk (INCR) in North America, IGCC in Australia/New Zealand, ASrIA’s Asia Investor Group on Climate Change (AIGCC), PRI, CDP and UNEP FI.

This platform provides transparency to identify how investors are helping accelerate the shift to a low carbon economy. The launch of the platform follows the call last September to world leaders by more than 360 investors managing over $24 trillion in assets for a strong global climate deal.212

212 Investor Platform For Climate Actions, Global investors launch platform for climate actions and commitments, May 19th, 2015 http://investorsonclimatechange.org/global-investors-launch-platform-for-climate-actions-and- commitments/, accessed May 21st, 2015