Carbon Trading

The carbon offset market is set to take off. But could U.S. businesses end up buying a lot of hot air?
John GoffJanuary 1, 2008

In northern Louisiana, ecologists are creating a new forest — one Beetle at a time. In a floodplain known as the Lower Mississippi Alluvial Valley, nearly 250,000 trees are being planted by a not-for-profit group called Funding for the massive project, however, is coming from a decidedly for-profit outfit: Volkswagen of America.

Like dozens of other businesses in the United States, the VW unit is tying reforestation to a promotional campaign. In Volkswagen’s case, the company claims the planting of the trees, which take in carbon dioxide, will negate the tailpipe fumes for one year for every car VW sold during the past four months. In “greenspeak,” Volkswagen is offsetting its downstream CO2 emissions. In plainer English, the conversion of farmland to forest will — in theory — capture 372,000 tons of CO2, which claims will help combat global warming.

The truth is a bit more cloudy. If tracts of the forest burn, much of the trapped CO2 will go straight back into the atmosphere. What’s more, a recent academic study found that trees planted in the midlatitude regions — such as North America — tend to radiate heat, and therefore may ultimately increase global warming. Although the study hasn’t been peer reviewed, it underscores a basic problem with carbon offsets: they may not do a whole lot of good.

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In the main, finance chiefs seem blissfully unaware of the disconnect. In fact, most CFOs don’t seem to be paying any attention to the emerging complexities of carbon credits. Such ignorance could prove costly to shareholders. A growing number of state emission mandates, such as those imposed in California, are already beginning to create regulatory headaches for some businesses. Federal carbon caps, expected within the next three years, will raise the pain to a whole new level.

A few finance managers, with an eye toward coming national regulations, are already purchasing high-quality offsets at relatively low prices. When federal legislation hits, the clutch of credits could be turned into a source of windfall profits for their companies. Conversely, CFOs who don’t understand the complexities of carbon commodities could find themselves paying high prices for low-quality offsets in a seller’s market. And make no mistake, federal carbon legislation will almost assuredly trigger a steep rise in the price of CO2 credits.

Nevertheless, many CFOs seem content to let other departments deal with the risks that come with carbon credits. Leo Denault, executive vice president and CFO at New Orleans–based utility Entergy, believes that’s a mistake. “Carbon will be a valuable commodity some day,” he predicts. “The last thing you want as CFO is a guy in your environmental engineering group making policy decisions around commodity risk management.”

Managers at some businesses, like VW and, see immediate value in carbon credits. They use the credits to help customers offset the carbon output from products and services. Others, like Green Mountain Coffee Roasters and Timberland, purchase credits to help reach “carbon-neutrality” — CO2 nirvana, where carbon discharges (known as a carbon footprint or profile) are offset by carbon reductions.

This activity has fueled an increase in the trading of offsets. In 2006, trading volume of carbon offsets, such as Carbon Financial Instruments and Renewable Energy Certificates (RECs), jumped 200 percent in the voluntary markets (primarily the United States). Observers believe that market is now worth at least $100 million. Privately, those same observers talk about a $4 billion carbon-trading market once federal caps are approved.

That prospect worries some environmentalists, who argue that purchasers of offsets are simply outsourcing their obligation to combat climate change. Others claim that offsetting enables a company to brand itself “green” without actually being green. Those critics say buying carbon offsets does little to change how carbon-addicted companies operate. “It’s like the medieval practice of buying papal indulgences,” complains Frank O’Donnell, president of the not-for-profit Clean Air Watch. “If sinners throw a few bucks into the pot, they can go back to sinning.”

And who knows what they’re buying? A list of current CO2 trading credits reads like an environmentalist’s eye chart (see “Accounting for Waste” at the end of this article). Derived from an array of carbon-reduction schemes, the credits are often calculated using different methodologies and accounting standards. Third-party brokers don’t necessarily bring clarity to the subject. One study conducted by the not-for-profit Clean Air–Cool Planet rated 30 such firms across seven criteria, including the use of third-party verification. Only eight vendors merited a passing grade, and the report went on to note that “few retail offset providers provide anywhere close to the amount of project-specific information [to allow buyers] to effectively evaluate offset quality.”

This lack of transparency could come back to haunt corporate purchasers. Nancy Hirshberg, vice president of natural resources at yogurt specialist Stonyfield Farm, says the company has looked at scores of offsets. “Many of the projects were simply not verifiable,” says Hirshberg. “It’s definitely buyer beware.”

The potential for purchasing worthless credits explains why a few finance chiefs are already getting into the carbon issue. Denault says Entergy’s finance group examines all offsets the company purchases. “Like any commodity, we want to make sure that the credit will have future value,” notes Denault. “We want to make sure we’re purchasing real securities.”

Limits Are Coming

At this point, the future worth of a carbon commodity is tough to call. What seems easier to suss out: Congress will undoubtedly place some sort of carbon restrictions on corporations in the next three years. Managers who dispute the assertion are misreading the signals now coming out of Washington. As Hirshberg points out, “Businesses now back carbon legislation.”

Most likely is a federally mandated cap-and-trade system, like that proposed by Sen. Joseph Lieberman (I–Conn.) and Sen. John Warner (R–Va.), whereby businesses will be given specific carbon-reduction targets. Such a scheme will likely require businesses to reduce their emissions by a certain percentage from a previous year (known as a baseline year). But at this point, it’s unclear what year Congress will choose as the baseline.

For early movers, such as Stonyfield, that means any credit purchased or produced in the run-up to legislation might end up being worthless. But the yogurt-maker’s commitment to CO2 reductions also serves to emphasize the company’s “green” image among consumers. Managers like Denault understand that industrial businesses — and particularly power providers — produce the most CO2 emissions. They therefore stand to be hardest hit by federal carbon legislation. Stashing credits helps hedge that risk. “Those credits may have value in reducing your [carbon] profile,” says Denault, “but that’s assuming legislation allows for them.”

The uncertainty surrounding carbon credits has not deterred many U.S. businesses from jumping into the offset game, however. Nike has not only purchased offsets, it has produced them. The apparel maker generated the credits through an agreement signed in 2001 with the World Wildlife Fund’s Climate Savers. Under Climate Savers, a voluntary program that both sets reduction targets and verifies participants’ progress, Nike agreed to lower greenhouse gases from company-operated facilities and employee business travel some 13 percent by 2005 (from a 1998 baseline). Notes Sarah Severn, a director in Nike’s corporate responsibility group: “We wanted to go through a registered and verified process with Climate Savers in case there was an opportunity to trade the credits.”

All in, Nike reduced its greenhouse gases by 18 percent from 1998, far exceeding its agreement with Climate Savers. And in the process, Nike has amassed a registered balance of nearly 8 million metric tons of emission reductions. Other companies, including Whirlpool and DuPont, are also sitting on sizable caches of credits.

Nike did end up selling some credits, which came from the company’s reduction of a powerful greenhouse gas called sulfur hexafluoride (SF6). In March, Nike sold 100,000 metric tons’ worth of Verified Emission Reduction credits to Entergy, which has also purchased offsets from, among others, Andarko. So far, Entergy has not applied the Nike credits to reduce its corporate carbon footprint. “We’re not sure what we’ll do with them,” says Brent Dorsey, director of environmental programs at Entergy. “So right now we’re banking the offsets.” Dorsey says the credits, along with in-house carbon reductions Entergy has made, “give us something of a cushion” should federal regulations accommodate banked credits.

What’s Wrong with RECs

One offset those regulators will likely recognize are RECs, which are derived from clean energy sources like wind farms and hydroelectric power plants. While power generators can sell the so-called green tags directly, most rely on third-party aggregators. In some cases, those brokers purchase existing RECs from power producers. In others, they buy the rights to future RECs by financing fledgling alternative-energy projects.

Sales of RECs have taken off, with Whole Foods, FedEx Kinko’s, Starbucks, and Patagonia among a host of corporate buyers. Green-e, which certifies about half the sales of RECs in the United States, reports that sales of Green-e certified RECs doubled in 2006. But purchasers say demand appears to be outstripping supply. “The last two years, the REC market has been workable,” notes Jay Dietrich, climate stewardship program manager at IBM. “But the market is changing. The supply of RECs is slowly being tapped out.”

The certificates present other problems as well. While the not-for-profit Green-e engages an independent public accounting firm to certify, among other things, where a REC comes from and how it is generated, the methodology is far from foolproof. In November, Green-e decertified offsets sold by retailer Clean and Green. And experts say some REC certifiers have less-demanding requirements than Green-e.

Moreover, RECs are expressed in terms of kilowatt hours (one REC equals 1,000 kWh of electricity produced by clean energy sources). A widely accepted standard for translating RECs into a carbon-trading unit does not yet exist. Neither does a true national registry for the certificates, which means the same REC can end up getting sold again and again.

The double- and triple-counting of RECs worries environmentalists. It should also concern corporate risk managers. Executives at Green Mountain Coffee Roasters, for example, began shopping for additional sources of RECs a few years ago. The company soon uncovered one attractive project in which the broker claimed to own 100 percent of the RECs, recalls Paul Comey, vice president of environmental affairs at the Waterbury, Vermont-based company. When a colleague began researching the project, however, a different picture emerged. “As it turns out,” says Comey, “a city in Florida claimed it owned 10 percent of the same RECs.”

Carbon: The New Cash Crop

With RECs getting harder to find, some American businesses have started looking abroad for new sources of offsets. So far, buyers have concentrated on projects in India and especially China, whose reliance on coal creates many opportunities for emission reductions. Since businesses in those countries have no greenhouse-gas targets, any new reduction scheme creates a potential credit to sell. In 2006, global sales of the credits hit $5 billion, twice the volume from the previous year, according to the World Bank.

In many cases, buyers look for credits under the aegis of the United Nations’s Clean Development Mechanism (CDM) — a strict regimen that governs greenhouse-gas reduction projects in developing nations (and produces UN-sanctioned credits, known as CERs). Energy producer AES, for instance, recently announced it will offset 10 million metric tons of its greenhouse-gas emissions by 2010, including purchasing credits that are CDM-approved.

CDM projects tend to be huge, limiting their numbers. They can also take a long time to complete. What’s more, delays in starting the projects, along with reporting issues, can lead to disappointing results. CarbonNeutral estimates that, on average, CDM projects generate only 50 to 60 percent of the greenhouse-gas reductions initially predicted. Contracts can be written, however, that place the onus on the developer to deliver the reductions. “They commit to providing the credit no matter what,” says Naseem Walker, accounting firm KPMG’s UK head of carbon management services. “If need be, they will simply cover the agreement by purchasing a credit in the secondary market.”

Still, the scarcity of CDM projects has led some U.S. companies to invest in overseas emission-reduction projects not governed by the Kyoto Protocol. These so-called voluntary projects often follow more-lax reporting protocols, which supporters say allow them to get projects done quicker. It also means they can invest in creative CO2 plans — plans that would clearly not pass muster under the UN’s Clean Development Mechanism (including some types of reforestation).

This demand in cross-border CO2 projects has led to problems. Stories have already appeared in The Financial Times and elsewhere about manufacturers in India purposely building factories with excessive greenhouse-gas emissions so they can sell the reduction credits. In addition, several reports have documented cases in which sellers of credits have miscalculated carbon baselines, thus bumping up CO2 reductions. “You’ve got guys saying, ‘Hey, we’ll get you an offset if you give us some money,’” says Clean Air Watch’s O’Donnell. “It’s like the Wild West.”

A Derivative as Lovely as a Tree

Given so much uncertainty regarding how carbon markets currently operate and how legislation will ultimately unfold, there is a very real risk that companies will find themselves holding a commodity that’s worth substantially less than what it cost.

That’s especially true if congressional legislation exclude a specific offsets from being used in a national carbon-trading scheme. But that possibility has not stopped U.S. businesses from investing in more-controversial offset programs. In September, Dell Computer launched a plan called Plant a Forest for Me. ABN AMRO, AMD,,, Staples, Targus, and WellPoint partnered on the project. “We see reforestation as a legitimate solution that addresses overall climate impact,” says Mark Newton, environmental policy manager at Dell. “But there is some uncertainty about how to manage it adequately.”

Indeed, uncertainty regarding the accounting for and efficacy of reforestation projects can be seen as a microcosm of the carbon-trading dilemma. Dell management reckons each tree will sequester 1.3 tons of CO2 over a 70-year life span, but that’s assuming the tree survives for 70 years. A tree that dies, or catches fire, will release most of the sequestered carbon, thus negating much of the assigned offset. Costly CO2 credits could literally go up in smoke. As Weston Heide, senior manager for global energy markets at Deloitte & Touche, notes, “Essentially you’re buying a time-option on the carbon issue.”

Green Mountain Coffee Roasters used to purchase forestation-based credits but has since backed off. “Trees are unpredictable,” says Comey. “Will they be there in 20 years? Do you go to Lloyd’s of London to insure the credits from 50 acres of trees?”

John Goff is technology editor at CFO.

The Invisible Inventory

Scoping Out a Carbon Accounting System

While Congress debates exactly how to tackle global warming, many businesses are already preparing for coming federal limits on carbon emissions. For most companies, the first step in the process involves performing a greenhouse-gas inventory.

This is no small task. To begin with, businesses must choose how to conduct the carbon accounting. There’s no shortage of advice on that score. The list of CO2 reporting protocols includes ISO 14064, the Voluntary Carbon Standard, and the GHG Protocol Corporate Accounting and Reporting Standard. Outside of the ISO checklist, none of the protocols appears to be nearly as rigorous as GAAP. The GHG Protocol, devised by a coalition of businesses, government agencies, and pro-green groups, seems to be as much guidance as standard. “It’s deliberately broad,” explains Emilie Mazzacurati, an analyst at research firm PointCarbon. “They want it to cover as many types of projects and companies as possible.”

That may explain why so many U.S. corporations seem to be gravitating toward the GHG Protocol. The standard addresses three areas of emissions. Scope 1 covers direct emissions of six greenhouse gases from things like factory furnaces and boilers. Scope 2 includes indirect emissions — that is, purchased electricity. For now, reporting on Scope 3 discharges (downstream and upstream releases of greenhouse gases) remains voluntary. Says Mark Newton, environmental policy manager at Dell Computer: “The GHG Protocol fairly narrowly scopes to facility and facility manufacturing.”

Assessing the carbon emitted outside a company’s factory walls poses a number of challenges. Little information is available from the many links in a company’s supply chain, and assigning responsibility for emissions can prove tricky. “If everybody counts Scope 3 emissions,” says Mazzacurati, “you’ll end up with a lot of double-counting.”

Most advise starting small. At Green Mountain Coffee Roasters, managers confined the initial inventory to plant operations, then later expanded the inventory to include regional operations, corporate and employee travel, and, more recently, logistics and fulfillment. “Don’t do everything in a year,” advises Paul Comey, vice president of environmental affairs at the coffee maker. “You’ll bury yourself.”

Don’t expect precise numbers, either. Nancy Hirshberg, vice president of natural resources at yogurt specialist Stonyfield Farm, notes that some of the numbers are hardly rock solid. “Carbon footprinting isn’t that advanced,” she says. “You have to estimate a fair amount. It’s not worth taking extra time and money to try and get actuals.” — J.G.

Emission Statement

Businesses struggle to document cuts in CO2 discharges.

Brent Dorsey doesn’t mince words. When asked about the need to rein in carbon emissions, the director of environmental programs at New Orleans–based utility Entergy says flat out: “We are the poster child for the physical risks that climate change can bring.”

Entergy actually began reducing its carbon output years before Hurricane Katrina devastated the company’s service area, which includes Louisiana and Mississippi. Since 2000, the company has slashed its yearly greenhouse output by nearly a third, getting it close to 1990 levels. Entergy has made improvements to its own generation facilities, but a key aspect of its improved carbon profile stems from its power purchases from merchant generators. By shopping the market, Entergy has been able to sign up with generators that produce energy more efficiently. To assess and report on reductions in emissions, the company adheres to the GHG Protocols, methodologies promulgated by the World Resources Institute and the World Business Council for Sustainable Development.

At Entergy, conducting a carbon inventory is a fairly straightforward affair. For starters, Entergy generates a good deal of its electricity from nuclear generators, which do not produce any CO2. Moreover, nearly 95 percent of the company’s CO2 discharges come from its own smokestacks.

The more diverse the businesses, however, the more complicated carbon reporting becomes. At IBM, managers conduct regular reviews of direct and indirect emissions (that is, those from purchased electricity) during the year. About two months after the company’s fiscal year ends on December 31, managers begin rolling up the energy-use and emission-inventory numbers, a process that takes about six weeks. IBM’s energy use accounts for about 90 percent of its greenhouse-gas emissions, and Big Blue collects actual-energy-usage data from more than 85 percent of its owned and leased space. Edan Dionne, IBM’s director of corporate environmental affairs, says the company files its yearly North American inventory with the Department of Energy and the Chicago Climate Exchange, a voluntary carbon commodity trading system. It also sends a full global report to the Environmental Protection Agency’s Climate Leaders program and the not-for-profit Carbon Disclosure Project.

Such reports may help ensure that IBM gets credit for early actions if Congress mandates carbon reductions. Still, critics point out that most U.S. businesses set relative — and not absolute — carbon-reduction targets. Typically, the goals are tied to
key performance indicators, such as revenues or units sold. Green Mountain Coffee Roasters, for example, expresses its CO2 emissions in terms of thermal units per $1,000 of net sales. That’s understandable, given that the coffee purveyor is growing at a 30 percent annual clip. But it’s unclear what effect — if any — relative CO2 reductions will have on global warming. “I did suggest an absolute CO2 reduction once,” says Paul Comey, vice president of environmental affairs at Green Mountain. “But our operations people nearly went into shock.” — J.G.

To see “Accounting for Waste” — a list of entities providing greenhouse-gas credits, and reporting standards underpinning such offsets — click here.