Key Players Quietly Building Carbon Market Infrastructure

CRT Details Report | The Carbon Challenge - A CNBC Special Report
CRT Details Report | The Carbon Challenge - A CNBC Special Report

While it might seem like a $2 trillion new carbon market will be created overnight with a presidential signature, the current players in this new commodity have been quietly building its infrastructure for several years already.

In addition to the usual specialized brokerage and accounting services any commodity might need, carbon markets also require established standards to ensure all credits are reliably similar, and registries to track all of these credits from birth to retirement.

Work has already begun on those key back office functions, using the nascent American carbon markets, says Katherine Hamilton, managing director of Ecosystem Marketplace, an environmental markets information firm.

“Over the past three years, we have witnessed this market grow rapidly in volume and maturity,” says Hamilton. Her firm co-authored a report on US carbon markets this past summer, pointing out that 2008 saw an entrenchment of existing standards and an advancement in the integration of carbon credit registries.

To understand the process of settling and accounting for carbon markets transactions, you need to start with how an actual carbon credit is created.

Assuming there’s a cap-and-trade market, like those currently proposed in Congress, there would be two types of carbon credits, typically denominated in “tons of carbon dioxide equivalents.” The first are allowances that are distributed among—or auctioned to—the emitting industrial sectors that are regulated, or “under the cap.” These credits can be traded among regulated entities.

The second type of credits are offsets, where non-regulated sectors can create their own emissions-saving initiatives and sell the resulting credits to whatever buyer may want them—whether it’s a firm in a regulated industry, a voluntary-market buyer with a corporate responsibility or marketing reasons to buy carbon credits or a speculator, like a hedge fund or proprietary trading desk.

To ensure they’re compliant and safe from fraud, each of these credits needs to be verified, tagged with a unique CUSIP-like serial number, registered, tracked as it’s traded or held and, finally, retired.

“There’s an entire workflow,” says Reiner Musier, vice president and chief marketing officer of APX Inc., an environmental commodities and energy markets firm that helps clients with this process. “It’s a process that involves lots of documentation...everything needs to be traceable.”

Often a management team’s first step is completing a carbon accounting to estimate their firm’s overall carbon footprint.

The Carbon Challenge - A CNBC Special Report - See Complete Coverage
The Carbon Challenge - A CNBC Special Report - See Complete Coverage

The carbon accounting business has grown dramatically in the last couple of years, and features everything from integrated teams of consultants to simple software package installations. There are over 50 firms in this field, from large players like Microsoft , SAP and Computer Associates , to smaller niche start-ups.

The goal of carbon accounting is to let management see what they’re up against as far as potential emissions assets, or liabilities.

“You can provide the transparency in what you’re doing to reduce that (carbon) inventory,” says Michael Meehan, CEO of carbon accounting software firm Carbonetworks. “Then we can hand off to their consultant.”

That consultant is often the next link in the carbon chain; in the case of offset projects, that could be an originator or project developer.

“Originator is a term of art,” says Erin Craig, CEO of TerraPass Inc., a carbon asset management firm that also does origination.

An origination firm typically seeks out carbon offset projects within certain sectors that are unlikely to be covered by regulation and handles the environmental commodities created by these projects. A developer takes it a step further and designs, builds and transfers the proposed carbon offset project.

For example, any proposed cap-and-trade bill will regulate large emitters like power plants and oil refineries, but other significant emissions sources, like dairy farms, could become potential non-regulated—or offset—entities, or projects.

Managing Manure

Having to convince a dairy farmer about the benefits of commodities markets may seem strange, but Craig says often the biggest hurdle is overcoming the additional effort required to manage a project on an ongoing basis.

“Manure management is a huge issue for a farm,” she says. “It’s just that their [existing] system doesn’t regulate [greenhouse gas] methane. So you’re replacing one way of managing with another.”

Whether by allowance or offset project, once the carbon credits are created, carbon registries then come in, to manage the serialization, verification, tracking, trading and retirement of these carbon emissions. These registries also set the methodologies and calculation standards for various carbon projects.

The Carbon Challenge
The Carbon Challenge

The “Big 3” registries include the Gold Standard, which focuses on renewable energy and energy efficiency projects; the Climate Action Reserve, which focuses on forestry and agricultural projects and the Voluntary Carbon Standard, which has over 100 methodologies covering many different project types.

Emissions in the three top registries make up nearly three-quarters of all American voluntary offset emissions in 2008, according to the Ecosystems Marketplace/ New Carbon Finance report.

“There’s really been a trend in the last year towards registry-based approaches,” says APX’s Musier, whose firm acts a clearinghouse of registries. “You’ve seen a flight to quality in the growth of the Gold Standard, VCS, and Climate Action Reserve."

Another ongoing need of a corporation generating credits includes credit verification. This ensures all credits are complying with whatever standard is set by the registry. Typically this auditor-like role is the domain of accounting and consulting firms, both large—like KPMG and Deloitte—and small.

Then there’s a whole new group of service providers dedicated to managing the value of your emissions portfolio. While firms like TerraPass offer clients like Ford and American Express one-stop, carbon-asset management, new emissions brokerages have sprung up to buy and sell carbon credits from offset projects. In this arena, pure emissions brokers, like White Plains-based Evolution Markets, vie with emissions operations of established firms, like Cantor Fitzgerald’s CantorCO2e group.

The Carbon Challenge - A CNBC Special Report - See Complete Coverage
The Carbon Challenge - A CNBC Special Report - See Complete Coverage

Often these firms piggyback on their expertise in existing emissions markets, like acid rain-related sulfur and nitrogen emissions that were the United States' first foray into a cap-and-trade market, or they become additional services on an existing energy or commodities desk.

Whatever route a management team chooses—to handle as much or as little of the project development and asset management role as they like and farm out the rest—clearing these hurdles with the right partners can provide a real carbon asset in the end.

With or without cap-and-trade legislation, there’s still a vibrant voluntary market if the carbon credits are solid, says APX’s Musier.

"If you have things buttoned down in a high quality registry-based standard, then there’s value in the credit and value in the marketing claim," he says.