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.

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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  1. Matt - August 4, 2006

    I think the most salient argument raised in the article pertains to issues of CCX being a private rather than a public market.

    The piece about AES does certainly raise eyebrows: Sandor on the board, AES is an early member of the CCX, establishes favorable baselines due to a bump in the prior year’s emissions…indeed it certainly appears that Sandor’s interests may well have been somewhat muddled.

    With many “traditional” enviros skeptical of using tradable emissions markets (the whole “license to pollute” argument) even the appearance of exploiting the environment for private gain may well, as Mark Trexler says in the article, undermine “the integrity and effectiveness of the very system he presumes to advocate.”

  2. Brian Rice - August 17, 2006

    Tom’s philosophy that ‘sharp critisism of CCX is welcome’ is on point. This market and the entire field is still in an experimental phase; no doubt 5 years from now the rules will have changed dramatically. Critisisms and feedback of all type is crucial to genuine success.

    Regarding the issue of CCX being a private vs public market; 1) that is not entirely true 2) in the absence of enforceable laws there is no alternative.
    1) The CCX is regulated by the NASD and the CFTC. These regulatory institutions are the ones who regulate every other free ‘public’ market or exchange in the US, such as Nasdaq or Chicago Mercantile Exchange.
    2)There is an old saw that the US is a bottom-up society while Europe is more top-down. Right or wrong (another discussion in itself) the US will tend to allow industry to innovate, then the govt will copy or adopt what appears to work. In the world of carbon markets this certainly seems to be the case; the Europeans passed laws first, forcing their industry to adapt. In the US, our govt seems to be watching & waiting.

  3. Andrew - August 17, 2006

    I can understand the concern about potential conflicts of interest in a private exchange such as the CCX, which basically makes its own rules. I also appreciate the criticism of some from the environmental movement and some NGO’s who are wary of a system developed by traders for profit, rather than by governement policy makers to promote the public welfare.
    But the CCX is just one of many baby steps that have to be taken to get this nation on track to having carbon constraints as part of daily living, and imbedding the cost of such constraints in our products and services.
    The criticism that the CCX and carbon tradng generally is getting should be welcome. Such discourse is vital to making proper use of the market system to protect a public good like our atmosphere.

  4. Karen Blythe - August 23, 2006

    Any cap-and-trade program—even one politically supported and developed—will have shortcomings. None developed to date have escaped serious criticism for their shortcomings and political expediency, even the European exchange which built on much past experiences!

    Voluntary programs are a poor alternative to appropriately designed market-based regulations. But the worst approach is to do nothing while waiting for a perfect solution to appear.

    Members of CCX are not increasing their emissions. Some companies may simply not be reducing their emissions as fast as required by CCX rules. So, they purchase allowances from members (or in a very few cases offsets from certain qualifying farmers, which are real reductions).

    What probably upsets critics is that the price of these “allowances” is lower than they might otherwise have been without the availability of these additional (no-tilling) emission reductions. In a politically-designed system that probably wouldn’t be allowed; but it is in this voluntary system of GHG-emission reductions.

    Secondly, these critics prefer state-mandated cap-and-trade programs, just after, one could presume, a federal program. Who doesn’t? But, the RGGI program, for example, doesn’t start until 2012 and won’t achieve any reductions until 2014.

    CCX will be way ahead in reduced emissions by then. So, these critics seem to suggest that it’s preferable to do nothing but develop/support such programs until 2012.

    What this doesn’t consider is that city-relevant-emissions are not included in the RGGI programs (unless they own a power plant and even if they did own such a plant they might choose to exempt themselves, which often happens). In fact, that program only includes utilities—not chemical plants or any other manufacturers.

    Thirdly, these critics try to make cities feel guilty for reducing their cost of energy efficiency programs by selling their “credits” through the CCX. For sure, if they had an RGGI-like program they couldn’t sell portions of their emission reductions in that market because of the “additionality” rules such programs (would?) have. Only entities included in the program (by law) can sell and those (to date) are power-plant-only programs. Note however, that the program being contemplated in CA has three tiers of members that reaches beyond power plants.

    CCX may not be without fault. But a program with fault is better than no program, especially when its existence informs the design and operations of future programs. So let cities, corporations, unviersities, retail offset providors, aggregtors, etc join CCX and back federal or state cap-and-trade programs. I think they can walk and chew gum at the same time.