I am in the process of researching an article about the impossibly complex topic of using carbon credits to finance small-scale energy ventures in the developing world. The experience reminds me of a religion course I took in college on the Old Testament. I was confident that my five years of Hebrew school (I graduated when I was 12) would be sufficient to land me a high grade without much effort. Unfortunately, I found out (too late) that there are, in fact, six five books of the Old Testament and I was familiar with a very small part of one those books (Genesis). Likewise, trying to learn more about this topic has led me to everything from arcane parts of the Kyoto Protocol to how the global market for carbon has fluctuated in the downturn. I wish I had chosen an easier topic, but the damage is done and now, hundreds of articles later, I know something about it.
Basically, there are two types of carbon markets, both of which were created as part of the Kyoto Protocol in 2005. The first is a highly-regulated formal market that is controlled by the United Nations Framework Council on Climate Change (UNFCC). Every country in the world, with the exception of the United States, Afghanistan, Mauritania, and Somalia (solidarity is key), signed the Kyoto Protocol, which stipulates that participating countries will agree to cap greenhouse gas emissions by limiting the amount of CO2 key industries can pump into the atmosphere. If those companies don’t feel like scaling back their emissions, they can buy carbon credits via a “flexibility mechanism” defined by the Kyoto Protocol. The Clean Development Mechanism (CDM) allows developed countries to buy carbon offsets from developing countries, which produce them by building wind farms, biogas facilities, geothermal plants, and other large-scale projects. The value of a carbon credit is determined by the theoretical amount of carbon that would have been produced had the status-quo alternative been maintained.
Alternatively, there is a much smaller voluntary market for carbon credits, which consists of countries, companies, organizations, and individuals. Purchasing credits on this market is exactly as it sounds – voluntary. Last year I went to the Lollapalooza music festival in Chicago, where I decided to pay an extra $5 for a “BeGreen” wristband, which said that I could both rock out and remain carbon neutral for the weekend. I didn’t know it then, but I was participating in the voluntary carbon market. Any time you agree to offset your carbon footprint when you buy a plane ticket, you are doing the same thing. It is from these two markets that most of the development projects utilizing carbon financing turn to for subsidies.
As far as I can gather, the CDM is incredibly complicated and bureaucratic, making it difficult for most organizations to access the financing. It costs a minimum of $100-200K and more than a year to implement a carbon offset program in the developing world, requiring field visits to evaluate the carbon impact and constant monitoring to make sure the products are being used as directed. You have to calculate (scientifically) exactly how much carbon is being neutralized by the project. For example, environmental cookstoves reduce carbon emissions by consuming less wood fuel, which comes from cutting down forests, which contain trees, which sequester carbon from the atmosphere. In addition, these stoves burn more efficiently than a traditional three-stone stove, which also reduces the amount of carbon that is released. Using a clean-burning cook stove saves an estimated 0.8 tons of carbon every year. Similarly, a solar lantern emits no carbon into the atmosphere, compared with one ton every seven years for the alternative, a kerosene lamp. You can bolster your case by showing co-benefits for the people involved. In the example of cookstoves, the people save money by using less fuel and are protected against indoor air pollution (IAP), which kills 1.6 million people per year. On top of all this, you have to demonstrate that the program would not be financially viable without carbon financing, and monitor it periodically to ensure that the products are still functioning.
Once you do all of this, you can start aggregating carbon credits, which can then be sold to companies that will securitize them and sell them on the global carbon market. Most of these projects participate in the voluntary market, which has less stringent requirements and lower transaction costs to pay up-front. On the voluntary market, the credits credits are sold to car companies, airlines, and other polluters who can talk of their good deeds in the “Letter From the Chairman” in their annual statement to shareholders.
Carbon financing is not without controversy, with many in the development world viewing it as “fool’s gold” that distracts from the important process of design, implementation, and marketing. But there are a lot of examples of companies successfully implementing programs. Most partner up and down the value chain, from the microfinance institution selling the cook stove to its clients all the way up to Goldman Sachs and JP Morgan, who agree to buy the carbon credits ahead of time at a fixed price and then trade them in the global marketplace.
My brain is full of useless knowledge about carbon markets in the developing world, so I have much more to write on this topic. In my next post, I will talk about some organizations that are using carbon credits to subsidize the cost of their products and distribute them to the developing world. It is Independence Day in the Philippines (from the Spanish, not the Americans) and time for a celebration, meaning I can’t think about this anymore. In the meantime, here is a good overview of how one company, E+Co, has helped a manufacturer of clean-burning cook stoves scale up from a couple hundred units five years ago to over 70,000 today.
Correction: There are five books in the Old Testament, not six