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Air Supply

Emission regulation is likely to be a reality in the United States by 2013. CFOs need to prepare a strategy for managing emission credits now...or watch that money go up in smoke.
Avital Louria Hahn, CFO.com | US
March 28, 2008

Even though the United States does not have mandatory carbon caps, such companies as Intel and Honeywell that generate qualified emissions credits in a voluntary program may see the value of their credits soar in about two or three years. That is when the United States is expected to start regulating emissions in preparation for joining the Kyoto Accord in 2013, said experts at the CFO Green Conference in New York on March 26.

While the United States is not a signatory to Kyoto, all three Presidential candidates support joining the treaty, and experts are confident that a regulated carbon market is on the way. Once this country establishes a cap-and-trade program to regulate emissions, such as the one already in place in Europe, credits generated here voluntarily according to Kyoto standards will be tradable outside the country and their value will rise, experts believe. The European Union, already a Kyoto signatory, has had a regulated emissions market since 2005. Right now, a ton of CO2 trades in the United States for about $5, while in the European Union it fetches about $30. Josh Harris, a conference presenter who heads the voluntary carbon-markets program at the Climate Group, says carbon credits are expected to trade at about $37 by 2010.

CFOs would therefore do well to start lowering emissions and accumulating credits in preparation for the regulated markets. "Greenhouse emissions credits are a new commodity and are going to be traded as a commodity," says Richard Adcock, senior vice president for origination and investment at the Climate Leaders Fund, which invests in projects that create carbon credits (using methane gas from landfills for energy is one such project).

Adcock says he believes that within a year or so after the Presidential elections, the United States will start a regulatory framework for implementing Kyoto. At the same time, Kyoto will be discussed internationally in preparation for the ending of its first phase and the beginning of its second phase. The next round of Kyoto talks will take place in Amsterdam in September 2009, when the next phase will be planned. At that point, CFOs will have a clearer idea of what the future carbon markets will look like. "We'll see a bump-up in activity in about 18 months," says Adcock. "You have federal legislation geared toward a cap-and-trade regime, which is what we believe is going to happen."

In addition to the Presidential candidates' support for lowering emissions, Congress has several bills for such systems in front of it. One of them, the Lieberman-Warner bill (S.2191) — dubbed America's Climate Security Act of 2007 — is a cap-and-trade system, and is believed to be the most likely to be adopted according to Adcock and other experts at the conference. The bill has already been approved by the congressional committee and the U.S. Senate Environment and Public Works Committee, and is expected to move to the Senate floor for debate.

What Is a Regulated Cap-and-Trade Market?
In a regulated cap-and-trade market, a company has a baseline level of allowable emissions; say, for example, its emissions in 2001. Depending on the country, industry, and other factors, the company may be required under such a system to cap its emissions at 10 percent below its 2001 levels: if it emitted 100 tons of CO2 in 2001, its 2008 cap would be 90 tons. In addition, regulations may require that it reduce its emissions every year by a certain percentage.

Under such a system, a company needs credits equal to its allowable emissions. In a regulated market, the government may give a credit allowance to companies, as the European Union did, or the credits may be distributed to them via another method, such as an auction. CFOs will have to know how much their company emits and secure enough offsets to match their company's emissions at the best prices. Even if the government hands out allowances, companies that pollute more than their share will have to buy credits. However, a company that pollutes less will be a net seller of credits.

Polluting below their baseline is one of two ways that companies can generate credits. The other is project-generated credits. If a company renovates a facility so that it lowers its carbon emissions, it can compare the "before" and "after" emissions and get credit for them.

Do You Know if You Have Assets or Liabilities?
Emission baselines are usually linked to industry standards, so even before the United States formally caps emissions, CFOs would be wise to measure their company's carbon output as soon as possible. "The interesting thing CFOs should know is that greenhouse gas emissions can be a hidden liability or a hidden asset," says Paula DiPerna, a conference presenter and executive vice president for corporate recruitment and public policy at the Chicago Climate Exchange, a greenhouse credits exchange. "They can be an asset if they have reductions that they can monetize, but a liability if CFOs don't know how much emissions they have and where they come from."

CFOs can start by finding out their emissions; translating them to tons; and learning from their industry association the emissions norm for the industry and type of company, as well as the best practices for reducing emissions, says Adcock.


Where to Get Credits Now
There are numerous voluntary carbon markets in this country where companies can register their emissions, commit to a reduction schedule, and buy and sell credits. At the Chicago Climate Exchange, companies sign a binding contract for certain emissions targets. The exchange has 400 members, including Honeywell, Dell, Intel, and the University of Iowa. Members' baselines are set on emissions from 1998 to 2001, and the exchange has a six-year first phase in which companies have to reduce emissions by 1 percent every year, for a total of 6 percent by 2010.

California, too, has an exchange that is open to companies throughout the country, and can be found at www.climateregistry.org Another registry is the Environmental Resources Trust. The Environmental Protection Agency is planning a registry in the coming months.

Buyer Beware
For the voluntary credits to be exchangeable for regulated credits in the future, they have to be of a quality that will be accepted under whatever future standards the United States adopts. These are likely to be identical or similar to the Kyoto standards, says Adcock, who advises CFOs to generate and document the credits according to the Kyoto standard known as the Clean Development Mechanism (CDM). The CDM Website has protocols, standards, and methodologies for documenting projects.

A New Asset Class
Once the United States regulates emissions caps, CFOs will have to prepare enough credits to hedge their companies' emissions in various years. They may well consider starting now to prepare for 2013 and beyond, says Adcock, adding that CFOs will have to have a portfolio of credits to do so. Such a portfolio may include project-based emissions credits (such as the ones a company generates from renovating a facility), as well as other purchased credits such as forward contracts or, if close to the time of a project, those it buys on the spot market.

"This will be a mix of project-based emissions credits and allowances, all for delivery in different years," says Adcock. "As CFO, you may buy forward contracts, or purchase credits on the spot market close to the time you'll need them, all in a way that will try to optimize the mix and minimize the cost to your company."




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