The carbon credit origination business is one that is established within the framework of the Kyoto Accords, and is growing as an underpinning of the U.S. Voluntary Market.  Its use has been fit into project finance, and funds have emerged to exploit the opportunities created.  Proposed U.S. legislation appears likely to fit offsets’ origination into it, in some measure.

But we have arrived at a time when the carbon credit origination rules need to be reexamined.  The four pillars that support the structure of GHG regulation--faith in market solutions, globalization, energy agnosticism, and green consumerism--are becoming shaken.  Improved carbon origination rules can create an “offset column” which can protect the edifice from upcoming shocks.

The first pillar of carbon “cap and trade” is, of course, that effective markets will create innovative technological responses to the increased prices imposed on carbon emissions;  in short, economically created necessity will be the mother of invention.  The “offset” concept simply globalizes the thought:  it salutes effective markets being the mother of invention even if in practice necessity they are not the mother of invention, but of adoption, utilizing more or less proven technical fixes.  Almost all of the Environmental Defense Fund’s recommended carbon offset projects are variants of the same technology.

The “globalization” column may also be somewhat off center since it salutes the market as mother of invention even though the child is born elsewhere.  But GHG reduction of, say, hydrofluorocarbon emissions in China may not be the path to systematic reduction of concentrated emissions in Germany.  That is an issue that has been raised with respect to other “cap and trade” programs.  Obviously it remains to be seen whether the whole world will adopt the same carbon standards so that there is some symmetry in the ratcheting down of emissions.  From a long term standpoint, the scheme may not only be rewarding the wrong technologies, but in the wrong places.

The third column effectively leans on the principle that the energy production route which leads to carbon compliance is the best route regardless of its “energy security” consequences.  Indeed many leading analysts don’t think that, under the new “cap and trade” regime, new coal plants can play a significant role in meeting the future foreseeable growing power needs.  That field is left to renewables (if possible) or by default to gas or nuclear--the availability of which is somewhat problematic.  Reduction in use of foreign transportation fuel sources also is an unaddressed goal.  Such energy agnosticism has its national security risks.

It also endangers the fourth pillar, which embodies the assumption that green consumerism is a sustainable faith, i.e., that consumers will inevitably pay for the creation of the carbon-diminishing marketplace.  Indeed, the price of offsets for carbon origination is predicated on the assumption that the consumers will pay the passed-through “carbon tax” on energy and consumer goods.   But will reality sustain that assumption?  Already leading market survey firms are reporting that consumers turn away from “green” when it costs more, even though they like the idea of “green” in principle.  The column of green consumerism is thus a shaky one.

The offsets scheme today does not go very far to address the problem of keeping upright the four columns which sustain the edifice of global climate control.  It is but one small element of the present ”cap and trade” order.

But, with a little imagination, it could be significantly more.  If offsets were treated not as a quirk of Kyoto, or a VER of the soon-to-be-atavistic voluntary market, but as a source of policy support to help the pillars stay upright.

The starting point for this line of thinking has to be a return to the first principles:  carbon emission reduction has economic value as “currency” only because a legal scheme directs that this be the case.  The difference between an allocated allowance and an offset emission reduction is defined and equilibrated only by the rules of the legal market framework in which they operate.  Allowances are awarded or auctioned value “currency”;  offsets are another form of value “currency” to pay the price of pollution.

Consequently, if the columns are to keep standing, some carbon value “currency” must be awarded to the activities which bolster them.  Absolute GHG reduction is the goal, but we need more than arithmetical addition and subtraction of value “currency” for carbon to influence, in a practical way, positive development sustaining the occurrence of innovation, globalization, energy security, and consumer acceptance.

For example, consideration should be given to modifying the operative definition of “offsets,” which should be scrutinized in terms of the following guidelines:

1.                  Offset possibilities should be maximized, regardless of the emitting source.  Covered parties, e.g., types of emissions generators, should be permitted to obtain offset rewards (excess “allowances”) for further improving the management of their systems, whether by abatement, renewables, or efficiency.  (This is essentially contrary to the approach to covered persons taken, for example, by the recent Warner-Lieberman legislation.)

2.                  Offset “dumping” should be precluded.  Carbon reductions by different technologies qualifying as offsets are not necessarily all equal.  There may be several technologies whose development deserves and requires differential support for a variety of possible policy reasons.  A case can certainly be made, for example, that offsets should not be a permissible “export” product for countries which are otherwise net contributors to GHG pollution through their other activities.  Globalization of GHG limitations will not just happen for the simple reason that cost avoidance creates competitive advantage.  It’s a case of Gresham’s Law in action:  value “currency” that is the result of insufficiently rigorous rules will drive out better quality value “currency” if permitted to do so.

3.                  Offset technology development support should be targeted.  Special offset support, analogous in purpose to special tax code incentives, should be given to certain technologies which promise to facilitate needed energy technology development.  For example, carbon capture and sequestration must be developed if clean coal development is to actually occur, with extraordinary importance for long term energy security.  Either CCS use or the development of CCS infrastructure should be the beneficiary of special offset rights if it meets progressive performance tests.

4.                  Regional consumer impacts of carbon regulation should not be ignored.  Offsets should be available in some form as a mitigant to the costs to consumers of the pass through of carbon charges, at least on a transitional basis.  In areas where there is concentrated location of generators’ emissions, local consumers should not have to effectively bear a disproportionate share of the economic burden of the “carbon tax” or the stranding of costs of coal-fired generating assets.

In sum, the future of the carbon credit offset generation business depends on the abiding strength of a global GHG scheme.  If availability of offsets is not viewed as a support for those columns, which require sophisticated engineering, the global GHG program and with it the carbon credit origination business, may become one in the dust with other great economic schemes whose flared impacts were not adequately thought through pragmatically, like power deregulation.  The result:  Stonehenge.

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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.