Carbon Trading Law and Practice ppt

My conclusion was that opportunity existed to those who understood carbon markets because states in the United States had or were developing greenhouse gas regulatory systems based on an

Carbon Trading Law

and Practice

Carbon Trading Law and Practice

Scott D Deatherage

1

Oxford University Press, Inc., publishes works that further Oxford University’s objective of excellence

in research, scholarship, and education

Oxford New York

Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Madrid Melbourne Mexico City Nairobi New Delhi Shanghai Taipei Toronto

With offi ces in

Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore South Korea Switzerland Th ailand Turkey Ukraine Vietnam

Copyright © 2011 by Scott D Deatherage

Published by Oxford University Press, Inc

198 Madison Avenue, New York, New York 10016

Oxford is a registered trademark of Oxford University Press

Oxford University Press is a registered trademark of Oxford University Press, Inc

All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or

transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of Oxford University Press, Inc

Includes bibliographical references and index

ISBN 978-0-19-973221-0 (pbk : alk paper)

1 Emissions trading—Law and legislation 2 Emissions trading—Law and legislation—United States

3 Carbon off setting—Law and legislation 4 Carbon off setting—Law and legislation—United States

Th is publication is designed to provide accurate and authoritative information in regard to the subject matter covered It

is based upon sources believed to be accurate and reliable and is intended to be current as of the time it was written It is sold with the understanding that the publisher is not engaged in rendering legal,

accounting, or other professional services If legal advice or other expert assistance is required, the services

of a competent professional person should be sought Also, to confi rm that the information has not been aff ected or changed by recent developments, traditional legal research techniques should be used, including checking primary sources where appropriate

(Based on the Declaration of Principles jointly adopted by a Committee of the

American Bar Association and a Committee of Publishers and Associations.)

You may order this or any other Oxford University Press publication by

To Violet, my wife, and my two children, Brett and Ashley

P A R T O N E The Emergence of Carbon Markets

1 Prelude to Regulation—Th e Development of Climate

A Typical Process of Regulation Following Science 4

C Th e Science of Climate Change 5

1 Conclusions of Scientifi c Institutions 5

a Th e International Panel on Climate Change 5

b National Academies of Science of the Major Emitting

Developed and Developing Countries 8

c In the United States: the National Research Council

and the National Academy of Sciences 11

D Th e Policy Impact of the Conclusions of the National

E Controversy over Climate Science 12

F Future Policy Development Based on Climate Science 15

2 Th e Emergence of Emissions Trading Concepts 16

A Economics vs the Environment 16

B Evolution of Environmental Regulation and Emergence

C Emissions Trading as a Means of Bridging the Divide

between the Economy and Environment 17

D Basic Concepts of Emissions Trading 18

E Cap and Trade “Made in America”—Th e Advent of U.S

Emissions Markets with Sulfur Dioxide and

F Examples of Working Carbon Markets 21

2 Th e European Union Emissions Trading Scheme 24

G Environmental Markets Are Alive and Well 24

A Defi ning the Regulated Gases 25

B Determining the Th reshold Amount of Emissions

C Determining the Regulated Sources 28

E Permitting Emissions of Greenhouse Gases 30

N Supplementarity and Linkage to Other National

and International Trading Systems 35

Q Regulatory Agency or Agencies 37

1 Regulation of Greenhouse Gas Emissions 37

2 Regulation of Trading of Allowances and Off sets 37

C O N T E N T S | ix

P A R T T W O Regulatory Structures

A Th e UN Framework Convention on Climate Change 41

2 Th e Clean Development Mechanism 43

4 Emissions Trading and Trading in Assigned

Amount Units and Removal Units 45

5 Th e European Union Emissions Trading Scheme 52

A Th e EU Policy on Climate Change 52

2 Defi ning the Regulated Sources 55

3 Permitting Emissions of Greenhouse Gases 55

12 Supplementarity and Linkage to Other National and

International Trading Systems 57

14 New or Expanded Facilities 57

6 Emissions Programs among Other Kyoto Countries 59

7 Th e Emergence of National and International Carbon Markets 64

A Compliance or Mandatory Markets 64

1 Voluntary Carbon Standards and Markets 64

2 Source of Demand for Voluntary Carbon Credits 65

3 Development of Voluntary Standards, Registries,

a Chicago Climate Exchange 66

b Voluntary Carbon Standard 66

c American Carbon Registry 68

d Climate, Community, and Biodiversity Alliance 69

C Pre-Compliance Markets and the Transition from

Voluntary to Compliance Markets 69

D Survival of Voluntary Markets aft er Establishment of

8 Developing Laws in the United States—State Laws 74

A State Climate Change Programs 74

o New or Expanded Facilities 83

p Regulatory Agency or Agencies 83

o New or Expanded Facilities 88

p Regulatory Agency or Agencies 88

k Off sets 93

m Supplementarity and Linkage to Other Trading Systems 94

o New or Expanded Facilities 95

p Regulatory Agency or Agencies 95

D Midwestern Greenhouse Gas Reduction Accord 95

E Cooperation and Potential Linkage among the

9 Developing United States Law—Th e Courts 99

A Federal Statutory Litigation 100

1 Th e U.S Supreme Court Landmark Decision in

2 Background—How Did the Matter Reach the

3 Standing—Could the Court Hear the Matter When the

Emissions and Eff ects of Climate Change Are Global and Infl uenced by Emissions from Other Countries? 102

4 Th e Merits of the Case—Does the EPA Have the

Authority to Regulate, and, if so, the Ability to Defer

Regulation of Greenhouse Gases under the

5 Implications of the Court’s Decision—Regulation

under the Clean Air Act and Other Federal Statutes,

Corporate Environmental Disclosure, and Litigation

Alleging Climate-Related Damages 106

a Symbolic or Political Signifi cance 106

b Greenhouse Gases Are Air Pollutants and the

EPA Has the Authority to Regulate Th em 106

c Eff ect on Other Vehicle-Related Greenhouse

d Eff ect on Challenges to the EPA’s Decision

Not to Regulate Greenhouse Gases from

e Eff ect on Cases Filed under the National

Environmental Policy Act, Challenging Governmental Action Th at Causes or Leads to

f Eff ect on Tort Suits Filed by Individuals

Claiming Damages from Greenhouse Gas Emissions 108

C O N T E N T S | xiii

g Broadening Standing for States to Challenge Federal

Administrative Agency Action 109

C Federal Common Law Litigation to Impose Emission

Reductions on Greenhouse Gas Emitters 109

D State and Federal Common Law Litigation to Obtain

Damages from Greenhouse Gas Emitters 111

10 Developing United States Law—Th e Environmental

A Federal Greenhouse Gas Reporting Program 115

2 What Facilities Are Covered? 117

a Specifi c Source Categories 118

b Other Facilities Th at Emit 25,000 Tons per

Year or More of CO2e of Combined Emissions from Listed Source Categories 118

c Facilities Th at Do Not Meet the First Two Source

Categories, But Th at Emit 25,000 Tons of

CO2e per Year from Stationary Fuel

d Entities Th at Sell, Import, or Export Fossil Fuels,

Industrial Greenhouse Gases, and CO2 119

e Entities Th at Manufacture or Sell Vehicles or

Engines in the United States 120

3 Monitoring and Measurement 121

4 Certifi cation and Verifi cation 121

5 Information Th at Must Be Reported 121

a Facilities Th at Emit Greenhouse Gases 121

b Suppliers of Greenhouse Gases or Materials

Th at Produce Greenhouse Gases When Used 122

6 Public Availability of Information Submitted

7 Exiting the Reporting Regulation Requirements 123

8 Enforcement Actions and Penalties for Failure to

Comply with the Greenhouse Gas Reporting Rule 123

B EPA Regulation of Greenhouse Gas Emissions

1 Th e EPA’s Endangerment Finding 124

2 Th e EPA’s “Johnson Memo” 125

3 Th e EPA’s Mobile Source Rule 126

4 Th e EPA Tailoring Rule 126

a Application of the Prevention of Signifi cant

Deterioration to Regulation of Greenhouse

c Phases of Coverage, Beginning with Larger Sources 129

i Step 1: January 2, 2011 to June 30, 2011 129

(b) Title V permitting applicability 130

ii Step 2: July 1, 2011 to June 30, 2013 130

(a) PSD applicability 130

(b) Title V permitting applicability 130iii Step 3: July 1, 2013 to April 29, 2016 131

d Best Available Control Technology 131

e State Implementation Plans 132

11 Developing United States Law—Congress and

Proposed Federal Climate Change Legislation 133

A Defi ning the Regulated Gases 133

B Emission Th resholds for Facilities Th at Emit

C “Covered Facilities”: Determining What Emission

1 Emitters of Greenhouse Gases 136

2 Producers or Importers of Greenhouse Gases or

Materials Th at Emit Greenhouse Gases When

E Permitting Emissions of Greenhouse Gases 139

G Allocation of Emission Allowances 140

3 Small Business Refi ner Reserve 143

I Auctioning Allowances for Other Entities 144

1 General Issues Relating to Off sets 145

2 Carbon Off set Creation—Rules Relating to Off set

a Basics of Off set Creation 147

11 Environmental Considerations for Forestry or

c Credits Issued by an International Body 159

d International Forest Off sets 160

ii State- or Province-Level Programs 162iii Program for Low-Emitting Countries 162

iv Project-based Deforestation Reduction Credits 163

v Forested Wetlands and Peatlands 163

L Compliance with Greenhouse Gas Emission

P Safety Valve International Competitiveness 167

1 Program to Provide Additional Allowances for

Industrial Sources Facing

2 Use of Sectoral Approach for the Importation of

International Off set Credits 168

Q Supplementarity and Linkage to Other National and

International Trading Systems 169

R Early Action 170

S New or Expanded Facilities 171

T Regulatory Agency or Agencies 171

1 Regulation of Greenhouse Gas Emissions 171

2 Regulation of Trading of Allowances and Off sets 171

P A R T T H R E E Carbon Project Development

and Carbon Finance

12 Carbon Credit Project Types and Methodologies 175

A Introduction to Carbon Credit Project Types and

3 Landfi ll, Oil and Gas, and Other Methane Projects 178

4 Natural Gas Production and Distribution Projects 179

6 Agriculture, Forestry, and Land Use 180

a Avoided Deforestation and Reforestation 180

i Th e Voluntary Carbon Standard Agriculture, Forestry, and Other Land Use Guidance 183

iii CDM Reforestation/Aff orestation Methodology 190

7 Carbon Capture and Storage 190

13 Carbon Credit Project Development 193

A Project Development Generally 193

C O N T E N T S | xvii

B Basics of Carbon Credit Project Development 194

D Th e Carbon Credit Approval Process 196

1 Th e Process under the Clean Development Mechanism 196

a Project Feasibility Study 196

c Project Design Document 196

d Stakeholder Participation 197

f Validation by a Designated Operational Entity 197

h Implementation and Monitoring 198

i Verifi cation and Certifi cation 198

2 Th e Voluntary Carbon Standard Process 198

E Carbon Credit Project Risks 199

a Solar Projects Generally 201

b Free-Standing or Utility-Scale Solar Projects 201

c Non-Utility-Scale Solar Projects 202

1 Basic Elements of Carbon Finance 211

D Carbon Credit Project Lenders and Investors 214

1 Multilateral Banks and Associated Carbon Funds 214

P A R T F O U R Other Credits That May be Generated

From Carbon Credit Projects

15 Other Environmental Attributes, Including Renewable

Energy Credits and Energy Effi ciency Credits 221

A Environmental Attributes and Other Credits

Th at May Enhance Carbon Credit Projects 221

B Renewable Portfolio Standards 222

D Energy Effi ciency Credits 225

E Credits for Traditional Pollutants 225

G Contractual Issues in Selling RECs Outside California 226

8 Representations and Warranties 228

9 Eff ective Date and Termination 228

H Contractual Issues in Selling RECs Inside California 229

16 Ecosystem Services: Wetlands and Biodiversity Credits 230

A Wetlands Credits and Banking 231

A Increasing Water Demand and Decreasing Water Supply 236

B Why Water Is Becoming a Potential Tradable Commodity 236

C Water Credits and Markets as a Means of Conserving a

D Carbon Credit Projects and Water Credits 238

P A R T F I V E Government Incentives—Stimulating

Carbon Projects

18 Government Incentives for Renewable Energy and Other

Types of Projects Th at Generate Carbon Credits 243

C O N T E N T S | xix

A Th e Use of Government Incentives to Enhance

3 Grants in Lieu of Tax Incentives 248

4 Government Loan Guarantees 250

5 Property-Assessed Clean Energy Programs 250

P A R T S I X Carbon Trading—Selling Credits

and the Carbon Markets

19 Fundamentals of Carbon Trading 255

B Th e Various Types of Carbon Credits 255

C Primary or “Over-the-Counter” Markets and Bilateral

Agreements 256

D Secondary Markets and Exchanges 256

H Fungible Commodity vs Diff erentiation 258

I Voluntary and Compliance Buyers 258

K Carbon Credit Risk and Price 259

M State of the Global Carbon Markets 259

20 Contractual Issues in Carbon Trading in the Primary Market 261

G Obligations of Buyer 263

H Representations and Warranties 264

I Share of Proceeds and Taxes 265

Assets and Liabilities

21 Th e “Carbon Ledger” and Carbon Credit Accounting 271

B Defi ning Carbon Assets and Liabilities 272

C Forming a Carbon Ledger as Part of a Carbon Strategy 273

D Financial Accounting Treatment of Carbon

A Corporate Climate Change Liabilities 279

B Securities and Exchange Commission Regulations

Governing Environmental Financial Disclosure 281

1 Overview of Existing Disclosure Requirements 286

2 Climate Change-related Topics Th at May Require

Disclosure 287

a Impact of Legislation and Regulation 287

C O N T E N T S | xxi

c Indirect Consequences of Regulation or

d Physical Impacts of Climate Change 289

G Voluntary Climate Change Disclosure Protocols 291

H Voluntary Standards Evolving into Legal Requirements 292

I Offi cer and Director Liability Environmental and

Acronyms and Abbreviations 297 Index 299

Th is book could not have been written without the support of certain people

My wife Violet Deatherage has supported me in my career and business endeavors for these last 25 years, and supported me throughout the long process

of conceiving and writing this book My children Brett and Ashley have ported me in the excitement of their father writing his fi rst book Without my family’s encouragement, this book would not have been possible

sup-I would also like to acknowledge the support of friends such as Greg Rogers and Ted Benn who have supported me in my endeavor to develop a practice in the areas of climate change, greenhouse gas regulation, renewable energy, and energy effi ciency Others I would like to thank are my friends and clients at Incenergy, primarily Barry McConachie, Jeff Smith, and Liz Cunningham, who have also supported me and encouraged me in this endeavor and inspired me with their development of a demand response company that will become a sig-nifi cant player in this space I would like to acknowledge the assistance of Jane Peck Hay, Head of the Commodities Legal Team for Direct Energy, who pro-vided guidance and review of the chapter on renewable energy certifi cates, which was very helpful to me in preparing the important discussion of such an impor-tant element of renewable energy projects

Preface

Th e origins of this book date back to my attendance of Carbon Expo, a carbon credit conference in Cologne, Germany in 2006 My goal was to learn about the the European Union’s Emissions Trading Scheme and the activities surrounding the Kyoto Protocol I wanted to understand the development of emissions markets for greenhouse gases I was expecting a conference of a few hundred, but to my surprise found a large conference of several thousand people in atten-dance In attendance were regulated industries, banks, investment houses, and entrepreneurs as well as government agencies and ministers focused on the European and international carbon markets and a for-profi t mechanism for reducing greenhouse gas emissions It appeared at that time, that international developments and the science—as stated by the national academies of science of the major— were leading developed and developing nations supported the view that anthropogenic greenhouse gas emissions were leading to climate change and potentially devastating results It appeared that in time some form of greenhouse gas regulation would evolve in the United States, and the international trading of carbon credits would continue My conclusion was that opportunity existed to those who understood carbon markets because states in the United States had or were developing greenhouse gas regulatory systems based on an emissions trading scheme, or what we refer to as “cap and trade.”

During the writing of this book, the U.S Congress fi rst moved toward adopting climate change legislation, and then the legislation stalled in the Senate and appeared to have little chance of passage in the short term Th e course of the political debate took several strange turns As a group of politicians developed their attacks on regulation of greenhouse gases, an unfortunate

strategy evolved Th ey began to attack the concept of emissions markets, that is, the concept of cap and trade Th e issues of whether or not to regulate greenhouse gases, and what method would be best to carry out such regulation once the decision to regulate was made, were not separated

It does not appear that a national emissions trading market for greenhouse gases will be instituted in the United States, but the concept of emissions markets has and continues to invade various aspects of environmental regulation, and has spread around the world to both developed and developing countries

It has become a part of ongoing economic evolution Markets that have grown

in so many areas, from commodities to fi nance, and have reached global tions, have now become part of regulatory programs

What I have discovered is that market-based programs are in fact for the most part considered benefi cial and preferable to regulated industries once the decision is reached by governments to regulate a particular environmental issue While industry likely will try to avoid regulation in the fi rst instance, once the regulatory decision is made to regulate greenhouse gases, industry will likely favor using market-based systems in jurisdictions around the world, rather than a command and control style system where little fl exibility exists among industry and third party carbon credit project developers through emissions markets Even where mandatory regulation does not apply, the development of voluntary systems for trading voluntary reductions has already spread globally, with devel-opment of international voluntary standards for carbon credits and carbon credit exchanges in China and Brazil among other countries around the world

Th us, this book is focused on the foundation of greenhouse gas emissions markets and what has occurred at the federal and state level in the United States and internationally Th e decision of whether to regulate in a sense precedes the discussion in this book My interest is focused, once the regulatory decision is made by governments in a particular jurisdiction, in the fundamental structural aspects of greenhouse gas emissions markets and how diff erent jurisdictions have addressed these fundamental aspects, and how the markets have functioned Since the markets are products of the evolution that occurs once the legal or regulatory structure is established, the legal aspects are of critical importance in terms of the statute and regulations that are issued by regulatory agencies once the general law is established

What I have discovered in researching and writing this book is that the use

of market-based systems as a means of regulating emissions and other mental pollution or degradation is a growing phenomenon As nations and states appear to be responding to scientifi c pronouncements regarding the existence and causes of climate change, environmental markets appear to be one of the main tools that will be used to address greenhouse gas emissions I have been

environ-P R E F A C E | xxvii

amazed as to the power of environmental markets to lead to the emergence of private entrepreneurs who create new technologies, new business plans and com-panies, and develop new projects to reduce greenhouse gases all with a for-profi t motive—a sort of greenhouse gas and energy entrepreneurialism I have discov-ered that if these systems are created with enough profi t potential, private capital

in terms of angel investors, venture capitalists, private equity, and banks and other lenders will fi nance these new entrepreneurs Th e incredible self-organizing power of the marketplace can make great strides in energy effi ciency, renewable energy, and other means of reducing greenhouse gas emissions—all without gov-ernment planning or control, but merely the establishment of general rules that then result in the emergence of a private system of greenhouse gas reductions Adam Smith would be proud of such a system

As a result of the power of environmental markets in lieu of the traditional command and control regulatory systems, carbon trading will continue in some form at the state level in the United States and at an even larger scale in the European Union, Japan, New Zealand, and perhaps China, which will drive an international carbon market for off sets It appears that both a voluntary carbon market and a carbon market based upon regulatory obligations will continue in the coming decade Whether the international system will be focused on a United Nations program or bilateral arrangements, or perhaps the G20 and “plus

fi ve,” meaning China, Brazil, India, Mexico, and South Africa, will form their own trading program remains to be seen Th e UN negotiations for a successor

to the Kyoto Protocol continue, but an agreement seems unlikely in the short term

However the international, national, and subnational developments play out in terms of the reach of carbon markets, it is intended that this book will provide a fundamental explanation of the underlying legal systems that serve to create and sustain carbon credit creation and the trading of these credits, as well

as a discussion of a series of related practical and business issues

Introduction

“Carbon trading” is a term that has come to be used to refer to trading of greenhouse gas emission allowances needed in jurisdictions that require they

be submitted by regulated entities for each ton of greenhouse gases emitted under

a regulatory program, or, alternatively off sets from reducing greenhouse gas sions, whether under a mandatory regulatory system or a voluntary program

emis-Th is book is designed to provide a discussion of the fundamental legal and ness issues that relate to the regulatory and voluntary programs driving green-house gas reductions and the trading of allowances and off sets under both regulatory systems and voluntary programs It is hoped that it will provide the reader a basic understanding of the climate science that is driving emissions reduc-tions, whatever controversy exists, the basic elements of emission markets and cap and trade programs, and the concepts underlying carbon credits and carbon trading

Th is book is not intended as a “science book,” but it is important to lay out the science that is driving the regulations that have been evolving over the last twenty years or more regarding international treaties, national regulatory pro-grams in most of the industrialized countries, and evolving programs at the state or provincial level Th e chapter on climate science attempts to lay out the conclusions of the national academies of science, including the U.S academy, and the International Panel on Climate Change, the United Nation’s group of scientists enlisted to provide reports regarding climate change and its potential impacts Not surprisingly, all scientists do not necessarily agree with all of these conclusions or studies Controversy has erupted at the political and business association level as to the potential economic impacts

Th e reality is that science issues are addressed by the national academies, and their conclusions tend to drive public policy As many in various industries have concluded, it is probable that in time all developed countries will have some form of national regulation of greenhouse gases Even though no legislation has been passed at the national level in countries such as the United States or Australia, programs have been established at the state or subnational level Th us, regulation exists or is developing in both countries In the United States, the U.S Environmental Protection Agency has issued regulations governing greenhouse gas emissions following a Supreme Court decision interpreting the current fed-eral Clean Air Act Historically, when the scientifi c academies reach conclusions regarding environmental matters, then in time, regulation to address those conclusions tends to follow Whatever the ultimate decisions by local, state, national, and international entities may make regarding climate change and greenhouse regulation, this book is intended to provide an explanation of how environmental markets can be used to reduce the costs of greenhouse gas regula-tion if in fact regulations are established in any particular jurisdiction to regulate these emissions

Th is book is dedicated to reviewing the regulatory systems that have emerged and continue to emerge to address climate change and greenhouse gas emissions Emission markets, and how they evolved and then were applied to greenhouse gas emissions, is a fundamental background that needs to be explored Initially, environmental regulation focused on setting reductions in emissions or environmental degradation In the United States, this led to thou-sands of pages of state and federal regulations across all fi ft y states that proscribed actions and prohibited other actions mostly of business and industry to reduce environmental impact Th is approach has come to be known as “command and control.”

Over time, economists and lawyers began formulating concepts that applied market principles to environmental regulation One of the most famous

of which is the emission market for sulfur dioxide emissions from coal-fi red power plants established in the United States under the Clean Air Act Th is pro-gram has largely been seen as a success in achieving the emission-reduction goals

at lower cost than either industry or the government predicted Emission markets have been applied to air pollutants of other types such as volatile organic com-pounds and nitrogen oxides that are the precursors to ground-level ozone that creates smog and particulates that can cause health problems and that are usually problematic in urban environments

Environmental markets have been established for other environmental cerns as well Wetlands, water quality and quantity, species, habitat, and biodiver-sity are some of the markets that have emerged or that are beginning to emerge

con-I N T R O D U C T I O N | xxxi

and evolve Markets for renewable energy and energy effi ciency credits have emerged to increase the percentage of electricity produced from renewable energy sources Th us, in addition to carbon credits, a variety of other environmental credits known as “environmental attributes” can be produced and sold and, thus, through a market system, drive the increased environmental performance and achieve the goals of environmental regulation with more fl exibility than the traditional command and control approach

When the international community began developing an international treaty to address greenhouse gas emissions, it is not surprising that the United States that had pioneered the use of emission markets to address sulfur dioxide emissions in the 1990 Clean Air Act Amendments would argue for a cap and trade system and emission markets as a critical part of addressing climate change and reducing greenhouse gases on a global basis

Th e Kyoto Protocol was draft ed to meet these goals, and emissions trading was a central part of the treaty Since its beginning, billions of dollars in trading has occurred Th e European Union established the European Trading Scheme that was designed to implement the Kyoto Protocol in Europe Th is program has resulted in hundreds of billions of dollars in carbon trading

Other nations are considering emissions trading programs and exchanges, including Australia, Japan, China, Brazil, and South Korea Th us, the concepts of emissions trading have spread throughout the global economy Th e adoption of these programs still face opposition as a concern about costs and global competi-tiveness have led to many companies and industry associations opposing their adoption

On the other hand, many groups that would manufacture energy ment that drives a low carbon energy source, such as solar photovoltaic panels, wind turbines, LED lights, and other renewable and energy-effi cient projects, are advocating for legislation to drive a low carbon economy

In any event, the current legal systems that impose a cap and trade program are explained in the book Th e elements of a cap and trade program are explained generally and then specifi c adopted or proposed systems internationally and in the United States Th ese chapters will orient the reader to the fundamentals of the legal requirements applying to regulated entities and the establishment of the parameters of an allowance and off set market

For greenhouse gas emission off sets, the necessities of established off set methodologies governing the ability to obtain off sets for particular types of projects are explained Forest projects are explained in particular detail as they provide the largest potential source of carbon off sets and provide a means of reducing the deforestation and degradation of the world’s forests, particularly the remaining rainforests of the Amazon, Asia, and Africa Th e fi nancing of these

projects is outlined with discussion of the particular challenges in attracting both debt and equity fi nancing for carbon credit projects

Once projects are fi nanced, they must go through a rigorous process from governmental or nonprofi t standards boards in order to obtain approval of the project as meeting a particular established methodology and then obtaining approval of the amount of greenhouse gases reduced and then the number of carbon credits issued Th e challenges of the existing programs of the Kyoto Protocol and the United Nations’ implementation of the off set programs are discussed

Th e purchase and sale of carbon credits is explained In particular, the contracts and the provisions typically included in those contracts are detailed

Th e bilateral nature of initial sales of credits along with the secondary market for trading carbon credits on a spot basis and in terms of futures contracts are presented

Both before and aft er the recent economic recession, government tives have been provided for projects that reduce greenhouse gas emissions Renewable energy and energy effi ciency receive much of these incentives, but other activities such as carbon capture and storage below ground are discussed

incen-as well Many of these projects may qualify for governmental or utility incentives

in the United States and potentially other countries

Accounting for greenhouse gas emissions and carbon credits has become

a signifi cant issue for companies with operations in jurisdictions with house gas regulatory systems Th e state of the still evolving accounting standards

green-of U.S and international accounting boards is discussed A strategic approach

of preparing a “carbon ledger” is proposed for consideration by aff ected companies

Financial disclosure related to climate change and greenhouse gas tion has become a critical issue to companies as well Th e U.S Securities and Exchange Commission has recently issued guidance for companies in applying the agency’s rules to climate change and greenhouse gas issues in terms of how legislation impacts the physical and fi nancial operations of the company, to corporate reputation In the European Union and the United States, mandatory greenhouse gas monitoring and reporting programs have been instituted Many companies participate in voluntary disclosure in environmental, sustain-ability, or greenhouse gas programs Climate change disclosure has likely become

regula-a permregula-anent fi xture in corporregula-ate disclosure, both in terms of mregula-andregula-atory fi nregula-anciregula-al disclosure and voluntary disclosure protocols

Th e development of a cap and trade program in the United States presents uncertainty for U.S and global carbon markets, and the availability of debt and equity investment as a result of this uncertainty and the general state of domestic

I N T R O D U C T I O N | xxxiii

and international economies presents challenges to carbon credit project developers and the market for credits they produce Prices have fallen signifi -cantly for carbon credits in the European market, the largest market for carbon credits Th ese prices refl ect uncertainties to some extent in future regulatory pro-grams but also the general economic, business, and fi nancial uncertainty facing national and global economies and markets

One of the remarkable developments in the context of economies and kets related to greenhouse gas emissions and carbon credits is that industries and businesses in the United States, where a national carbon credit program has not yet emerged, are still looking for a means of monetizing reductions in greenhouse gas emissions that they are asked to implement by customers, share-holders, or corporate reputation, and as entrepreneurs they are accomplishing this through renewable energy, energy effi ciency, and other products or services that reduce greenhouse gas emissions Th is is one of many indications that carbon trading has spread into the economy, and businesses are looking for opportunities to obtain fi nancial reward for their emission reductions Th e con-cept of environmental markets and of carbon credits specifi cally has in a sense entered the marketplace It is diffi cult to remove these concepts from the market once they have been introduced In the future, whether emissions of greenhouse gases, sulfur dioxide, mercury, or nitrogen oxides, environmental markets provide a means of achieving the regulatory goal of reducing emissions at the lowest cost and giving industry the greatest fl exibility

Carbon credits and emission markets as a means of addressing climate change and greenhouse gas emissions appear to be a fi xture in current and future economies Th e extent of the application of cap and trade programs and emission markets to greenhouse gas emissions appears to be growing, but elections and votes in state and national legislatures will determine to what extent these pro-grams expand around the globe It appears clear that Europeans will continue their Emissions Trading Scheme, and a $100 billion market or more will continue

to grow and evolve over the next fi ve to ten years At least some state carbon market programs in the United States appear to be set to begin in 2012 Th us, this book will hopefully serve to educate those who are looking for a fundamental understanding of carbon trading law and business

P A R T O N E

The Emergence of Carbon Markets

1

Prelude to Regulation — The Development of Climate Change Science

To understand the purpose of carbon trading, one fi rst has to understand the basic science underlying the concern with climate change Carbon markets evolved as a response to a policy decision to reduce the impact of climate change It is important to keep in mind the eff ort to engage governmental organi-zations, whether at the international, national, or subnational level, to develop a regulatory system, to reduce GHG emissions, and to fi nd alternative means of producing energy, fueling vehicles, and increasing energy effi ciency, derives from scientifi c institutions that caution these governments that action is necessary

to reduce the risk of potentially signifi cant damage to people, economies, and societies

While there is much controversy over climate science, as will be discussed below, the scientifi c academies of the major developed and developing nations are largely in agreement on climate change and its causes Th e actual climate trends over the coming decades and further scientifi c research of what it causing these trends will eventually show whether current views of scientifi c academies are correct In the near term, the question is to what extent the conclusions of the national academies and other scientifi c institutions will impact policy such that the United States at the national or state level will enact climate change statutes and GHG regulations, and the countries of the United Nations will adopt an international treaty to follow on or as an extension of the Kyoto Protocol, and what actions other major emitters in the developed and developing world will take as a result of the conclusions of the major scientifi c institutions

If a decision is made to regulate and reduce GHG emissions, then the best means of reducing the impact on industry, the economy, and consumers is a critical issue Much of the controvery over GHG regulation centers on the eco-nomic impact of climate change and GHG legislation Th us, the use of emissions markets can provide a major contribution to reducing these impacts Th is chapter will address the scientifi c issues and controversies as an introduction, but in the remaining chapters will mainly focus on carbon trading law and trading systems, and their use to reduce economic impacts of GHG regulation

A Typical Process of Regulation

Following Science

In human systems, whether political, social, or economic, change through tation and innovation occurs as a result of a change in the surrounding circum-stances Here, substantial change has occurred as a result of the conclusions of the scientifi c institutions that the emission of GHGs is causing signifi cant changes to the climate Th e process has followed the evolution of other areas of environmen-tal regulation over the last forty or fi ft y years

Historically, in the United States, evolution of a new environmental law typically occurs as follows:

A scientifi c discovery leads to a specifi c environmental concern;

•

Th e scientifi c discovery is reviewed by multiple scientists and peer-reviewed

•

by scientifi c journals and state and national scientifi c academies;

A social or political movement regarding the issue emerges and lobbies

•

for state and federal action;

Legislative activity at the state level leads to state laws governing the issue; and

agricul-to attempt agricul-to harness the power of the marketplace agricul-to reduce the GHG sions, which the scientifi c academies, as explained below, have concluded are causing climate change

emis-P R E L U D E T O R E G U L A T I O N — T H E D E V E L O P M E N T O F C L I M A T E C H A N G E S C I E N C E | 5

B The Greenhouse Eff ect

Th e fi rst step to understanding climate science is to understand the greenhouse eff ect Th e greenhouse eff ect is the basis for identifying and reducing emissions of gases that contribute to an increased greenhouse eff ect

To understand the greenhouse eff ect, it is fi rst necessary to comprehend that the Earth’s surface would be expected to be about –19 ° C on average Actually the Earth’s surface (the global mean surface temperature) is about + 14 ° C “Th e reason the Earth’s surface is this warm is the presence of GHGs, which act as a partial blanket for the long wave radiation coming from the surface Th is blanket-ing is known as the natural greenhouse eff ect.” 1 Th e greenhouse eff ect allows life as we know it to exist on Earth; without it, the surface would be too cold for current life to have evolved and survived

Th e two most important natural GHGs are water vapor and carbon ide Carbon dioxide is the most signifi cant GHG emitted from human activity Methane and nitrous oxide are GHGs that are both emitted by human activity and occur in nature, while other GHGs such as perfl uorocarbons and sulfur trifl uoride are now being emitted by human activity that may not occur in nature

diox-or are uncommon in nature

C The Science of Climate Change

Scientists have been measuring temperature in the atmosphere for many decades According to the national academies of science and other scientifi c institutions, observations and measurements show that the climate is in fact changing, from melting glaciers, to other eff ects that could have signifi cant impacts on cities, states and provinces, and national governments, as well as the people who inhabit these areas

1 Conclusions of Scientifi c Institutions

a The International Panel on Climate Change

Th e International Panel on Climate Change (IPCC) is the international tion created by the United Nations to study climate change and its causes It has concluded that climate change is in large part being caused by human emissions

institu-of GHGs

Over the last hundred years the concentration of carbon dioxide in the environment has steadily risen Th e IPCC in its 2007 report stated, “Human activities intensify the blanketing eff ect through the release of GHGs

1 Intergovernmental Panel on Climate Change, Fourth Assessment Report, Chapter 1: Historical Overview of Climate Change Science, at 97 (2007) (hereinaft er Climate Change Science)