Every offset has its own woes. Kyoto units suffer from eligibility concerns, California offsets are in turn undergoing the hot debate about the scale of the invalidation risk.
Four compliance offset protocols are approved for use in the California cap-and-trade:
- U.S. Ozone Depleting Substances (ODS) Projects Protocol: Destruction of ODS from refrigerant and foam-blowing agents sourced from and destroyed within the United States.
- Livestock Manure (Digesters) Projects Protocol: Capture and destruction of methane from anaerobic manure treatment and/or storage facilities on dairy cattle and swine farms within the United States.
- Urban Forest Projects Protocol: Urban tree planting projects by municipalities, educational campuses, utilities, and partner organizations to sequester carbon.
- U.S. Forest Projects Protocol: Increasing sequestered carbon or avoided GHG emissions due to forest management activities in three project types: reforestation, improved forest management, and/or avoided conversion within the United States
On March 13, 2012 “Update on Key Elements of California's Compliance Carbon Offset Market” presentation (by American Carbon Registry, available on the ARB website) noted that offset project operators don’t need to wait for registry approval or verifier accreditation before implementing a project. Thus, when it comes to the question on when compliance offset project can be implemented, the answer recommended by the above document was – now.
There is, however, another question posing significant burden for the nascent California offset market – the said flaw being buyer liability for offset invalidation.
Pursuant to § 95985 of the California cap-and-trade regulations if the California regulator (ARB) makes a final determination that an ARB offset credit is invalid credits are removed from any holding or compliance accounts (after granting parties the relevant cure-periods).
The grounds for invalidation are:
-if an Offset Project Data Report (OPDR) contains errors that overstate the amount of GHG reductions or GHG removal enhancements by more than 5%;
- if project activity and implementation was not in accordance with all local, state or national environmental, health and safety regulations during the Reporting Period for which the ARB offset credit was issued;
- if ARB finds that offset credits have been issued in other markets for the same project area during the same time period for which the project has received ARB credit.
The amount of time during which an offset could be invalidated after issuance is eight years. This term can be shortened if an offset project is reverified by a different verifying body within three years of issuance. In this case, the statute of limitation is shortened to three years for ozone-depleting-substance projects, or three reporting periods for livestock, or urban or US forest projects.
Forestry reversals do not effect in invalidation. If reversal is unintentional but lowers a project’s actual carbon stocks below its baseline, the project will be subject to termination. If, in turn, reversal is unintentional and does not drop the project below its baseline, ARB will retire credits from the forest buffer account in an equal amount. If reversal is intentional, the forest owner is under the obligation to replace the credits.
Different market mechanisms are currently under consideration to mitigate California offsets invalidation risk, however, none of them appears sufficiently certain. The issue whether the relevant insurance products will be widely available on the market is ambiguous, however the first have already appeared (see the Parhelion California ARB Offset Credit Invalidation Insurance).
For the time being the real measures within reach seem to be the appropriate discount relative to the CCA price as well as contractual remedies against counterparty.
It is however foreseeable that the event of offset invalidation will potentially effect in entire chain of contractual claims and that chain can further be broken by insolvencies. This potential occurrence points to the need for establishing credible credit support arrangements.
All the above circumstances indicate that the California offset market has its specificities and there are no simple parallels when it comes to comparisons with Kyoto units CDM an JI infrastructure. California offsets evidently need discount for invalidation risk, but the real question is what that discount should be.
It is clear that the values for the said parameter are set by the market on an on-going basis. But it could be possible to outline the general drivers for these measurements.
Among the said factors first shouldn’t be neglected the stringency of ARB offset protocols, the more stringent given offset protocol, the less risk of invalidation it potentially could generate.
The credibility of the verification infrastructure is also an important circumstance that needs to be analysed when arranging offset deal. This point covers not only general verification regulatory environment but in particular experience and reputation of the verifier examining offset project in question.
The level of contractual representations and warranties as well as credit support offered evidently influence on the extent of the California offset/CCA discount.
Last but not least – the maturity of offset unit is the only parameter that could be easily valued, since, as follows from the construction of the regulatory regime, invalidation risk weights heavily on California offsets only within the time-limits indicated above (which, in turn, can be shortened by the reverification).
So, every offset has its own woes, and every business carries on its own risks. The key is proper risk management.