May 2006

Carbon Wildcatting

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2006/10/27)
 

Where will the new energy merchants come from? Can they learn anything from prior merchant history?

There have always been two very different types of drivers of entrepreneurial planning in the merchant energy space: Long run strategic embrace of "big picture" trends and concepts, and "right now" exploration of governmental incentives and trading arbitrage opportunities. Each approach began with a reasonable idea; extended into creative merchant status and then more or less expired of excesses. Pontification on return to basics followed. So it has been in the "big picture" cases of the diversified multi-functional utility; the deregulated functionalized utility ("genco, transco, disco"), of late blessed "right now," the "virtual" (if not virtuous) utility. So it has been for "right now" models like PURPA machines; tax driven renewable deals, and hot trading floors exploiting fuel and market price discrepancies.

The most successful merchant strategies in the past actually took advantage of these ideas in their prime. There is now another chance to do so and revisit the relevance of some of these "big picture" and "right now" strategies in the context of carbon-related developments.

In terms of "big picture" long-term trends, we are at a new juncture of course, in the entrepreneurial energy marketplace. Floor prices for fuel seem to have bolted upward for the foreseeable future. Consumer tolerance for the true prices and therefore operation of deregulated markets seems to be a thing of the past. The barriers to consolidation across energy service territory and international lines are significantly reduced. The push for the utilization of non-imported fuels that are price-competitive is "pumped up" with the passing of every day. And, without direct reference to these developments, the public has moved into acute awareness of a somewhat nebulous but nevertheless emotionally heartfelt, desire to end "global warming" particularly through reduction of the amount of CO2 in the air, by reduction of carbon sources, both stationary and mobile. This is not your grandfather’s Kyoto, to paraphrase an old "gas guzzler" ad. The confluence of these trends is a challenge to nimble (read: merchant entrepreneur) inactivity, whether based in large or small entities.

Their attention is turning from every direction to what may seem an unlikely beacon: carbon. With the consciousness growing that there ultimately will be meaningful US governmental action trailing in the wake of state initiatives, more merchants are checking the angles than ever before. Utilities are, for the most part, simply doffing their caps to the issue by setting emission target caps off in the middle distance; planning ahead with announcements of major new efficient coal plants, built right in the heart of the crowded Atlantic Coast; or issuing solemn "sustainability" reports. But some larger players as well as smaller innovators are doing more.

First, and most visibly, they are becoming advocates of the regional programs for carbon emissions control and trading and for sustainability through efficiency programs. They are suggesting that the renewables’ initiative in support of REC’s trading might be expanded and oriented toward the larger goal of rewarding those technologies which foster carbon displacement and sustainability.

Second, entrepreneurs are seeking to foster greater awareness — already quite clear in Europe — of the high return interplay between energy efficiency measures and carbon savings. The US ESCO "shared savings" market seems to be contracting; the world market for reduced reliance on all fossil fuels seems to be growing. Efficiency Technology improvements and recycling sectors are beginning to find their rationale on the CO2 front. Even the greenest of new fuels, ethanol, now has its proponents of technology producing carbon savings improvements in its manufacturing process.

Third, the electricity renewables sector has begun to emphasize better policy recognition and measurement of its carbon-displacement value. This is particularly true, as it relates to calls for improved recognition of the carbon air quality offset contribution which renewables can make. The appeal of methane gas projects, for example, never has been greater from that standpoint.

Fourth, funds and developers who not so long ago once pursued "distressed power assets" now seek out old coal plant sites which present the possibility of IGCC and possibly even CTL. Optionally, value has been added by the hunt for carbon displacement opportunities.

Fifth, the pursuit of eligible carbon reducing projects for CDM and JI projects has become far more than a hypothetical cottage industry. Substantial commodity trading entities have become involved in the field, and pools of capital which once pursued merchant combined cycle plants now have refocused their sights as well.

Sixth, the forces impelling overseas investment in carbon-displacement energy investments are picking up capital investment reinforcement as the possibilities for trading come into clearer focus. There has been a significant decline in emerging market country power investments over the past few years. The new emphasis on expedition of CDM measurement has begun to somewhat reverse the trend. Many types of projects now have an additional attractiveness, which their economics might not by themselves have provided in the past.

And finally, apart from the legally-created value of carbon-reduction technologies as a result of emerging trading regimens there has been the emerging value driven by impetus toward technology for using CO2 outputs from power, gasification and even prototype hydrogen production from petroleum coke fueled facilities to support enhanced oil recovery. Direct CO2 utilization now has been conjoined with radio frequency technology in proposed oil shale extraction technologies as well. In effect, the pursuit of black gold is leading the way to the pursuit of black-derived gold.

So perhaps the prior "big picture" models for merchant energy can be applied again in the pursuit of "right now" projects related to exploitation of potential sustainability enhancing projects. Carbon wildcatting may be the key to new types of energy entrepreneurs. And perhaps the players to do so are the real successors to the merchants (by whomever owned) of prior years. Public policy makers should be as alert to be helpful to them as they were, for awhile, to merchant power development.

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.