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Sandor and the Chicago Climate Exchange: Build it and they will come?

This week’s New York Times Sunday Magazine has a fascinating article profiling Richard Sandor, the founder of the Chicago Climate Exchange (CCX), which is the trading platform that TerraPass and others use to purchase our carbon credits.

The article has a lot to say about the CCX, much of it positive, and much of it sharply critical. You might think the criticism would alarm us. After all, we’re a member of the exchange and in some sense we run our business on top of it. But in fact we welcome the scrutiny that the carbon trading industry is receiving from the mainstream press. Scrutiny is necessary to a well-functioning market, and we want our customers to be as informed as possible.

More to the point, the criticisms center on issues we have long been aware of and have made great efforts to address through the design of our carbon portfolio. Let’s walk through some of the questions raised in the article.

Project quality
Here we have a charge that goes to the heart of the TerraPass mission: some of the third-party offset projects are of dubious quality. For example, the author visits no-till farms that sell agricultural carbon offsets and discovers that the offset themselves don’t bring about any incremental carbon reductions.

This is serious stuff. TerraPass buys third-party offsets, and the entire purpose of those purchases is to bring about reductions in carbon emissions. Have we or our customers been duped?

Fortunately, the answer is no. And the reason is simple: we aren’t just buying any offsets. When you buy a TerraPass, we are very clear about what projects your purchase supports. As our product content label shows, 33% of your TerraPass is Green-e certified renewable energy credits (RECs) and 67% of your TerraPass is carbon credits from biomass and energy efficiency.

The projects we support on the CCX are structured with a mechanism called “bilateral agreements.” What does that mean? Well, rather than just blindly buying on the exchange, we go find a project that we want to support. We learn all about it, get a thick verification report (electronic, of course) and layer on our own analysis of the project. We work with the project owner to write a contract, agree on a price, and then we execute the contract on the CCX. In addition to hand-selecting the project, we get all the benefit of a beautiful trading platform, NASD oversight, zero counterparty risk, and auditable third party records.

TerraPass pioneered the use of bilateral agreements on the CCX. Although the mechanism had been available all along, we were the first company in the exchange’s history to make use of the provision to provide quality offsets to the market.

Emissions baselines
One of the most important issues in the design of a carbon market is choosing a baseline from which to measure emissions reductions. For example, members of CCX are required to reduce their emissions by 1 percent per year through 2006. The question is, 1 percent of what? Carbon emissions fluctuate all the time based on a number of factors, so one of the things a carbon market must do is establish firm criteria for establishing a baseline by which future reductions are measured. CCX has come under criticism for creating a baseline that some allege show favoritism toward certain companies.

The reality of baselines is that there is always a party upset with the allocation. We tend to see this as a much less important issue than the proper functioning of the market once the baseline has been established. More importantly, this issue doesn’t affect TerraPass. When we buy offsets from corporate members of the CCX, we buy blocks from specific projects. For example, Waste Management submits to TerraPass a lengthy verification report for the Tontitown landfill which shows a documented reduction in CO2 emissions. We review this report, write a contract, and again use the handy tool of bilateral agreements to subsidize this project and this project only.

Additionality
A criticism of the CCX is that the reductions from corporate members aren’t really a result of membership on the exchange. The reductions are simply the actions of good corporate citizens who would have cut emissions anyway, and membership in the exchange is basically a way for those corporations to get credit for their good deeds.

Again, this is an entity-wide issue. When you are dealing with individual projects you can much more easily apply classic series of additionality tests that concern the individual carbon-reducing project you are sponsoring.

But it is a serious matter for the CCX more generally, and will remain so as long as membership in the exchange is voluntary. Eventually the day will come that all U.S. companies will operate under a mandatory cap-and-trade system, this adverse (or positive) selection bias will disappear, and make for a nice unfair competitive advantage for the companies that first learned how to integrate carbon economics into their operations.

An evolving standard
While we do support the goals of the CCX, we also believe that some carbon offsets on the CCX are more credible than others, and our purchases reflect this belief.

We were the first retailer to bring neutral third party oversight into our carbon offset program. Our partnership with The Center for Resource Solutions is a prototype for how to verify retail carbon products. The Center for Resource Solutions is developing a carbon retail standard which they plan to launch this fall. The development of that standard will include participation from leading environmental NGO’s and a public comment period for stakeholders. We’re excited to hear what people have to say about what we are doing now and how we can do it better. And most of all, we look forward to bringing our customers on the journey with us.

Clear as mud? Send us your questions and we’ll try our best to answer any issue the article raised for you.

Disclosure: We were interviewed for the NYT article and provided feedback on a number of these issues and a real world purchaser’s perspective.

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