Despite Market Outcry, California Voids Some Carbon Offsets

14 November, 2014 | California regulators rejected pleas from carbon market stakeholders to abandon their effort to invalidate ozone-depleting substances (ODS) offsets generated at an Arkansas facility, but limited the invalidation to one particular carbon offset project.

The California Air Resources Board (ARB) the agency tasked with overseeing the state’s cap-and-trade program and its offset component in May began reviewing offsets issued for ODS destruction events at the Clean Harbors Incineration Facility in El Dorado, Arkansas. These substances, which include foam-blowing agents and refrigerants, are much more potent than carbon dioxide in terms of their global warming potential, so the ARB adopted a process to count the greenhouse gas (GHG) emission reductions associated with destroying these materials in the United States and allow these reductions to be used for compliance in its program.

In October, the ARB issued a preliminary plan to invoke the so-called buyers liability provisions that allow the regulators to invalidate offsets found to be faulty or fraudulent and require regulated entities to surrender replacement offsets for compliance. The ARB ruled the offsets generated by two ODS projects one developed by Environmental Credit Corp (ECC) and the other by EOS Climate should be invalidated because the Arkansas facility was out of compliance with its operating permit issued under the Resource Conservation and Recovery Act (RCRA). Of the 231,154 offsets the ARB is seeking to invalidate, 142,199 were generated by ECC’s offset project and 88,955 from the EOS Climate project.

On Friday, the ARB decided to proceed with the invalidation of the offsets generated by the EOS Climate project. But the regulators backed away from plans to invalidate the offsets generated by the ECC project because the ARB ultimately concluded that the destruction activities related to that project occurred outside of the timeframe when the Clean Harbors facility was purportedly out of compliance with its RCRA permit. ECC and EOS Climate could not be reached for immediate comment.

“It’s not good news, but I don’t think it’s market-destroying news either, said Peter Weisberg, Program Manager, The Climate Trust.

The ARB’s final determination clears the vast majority of the 4.3 million compliance offsets it was investigating to be returned to the accounts from which they were removed on May 29 when the investigation was launched.

A Shocking Turn of Events

While expressing support for the regulators efforts to protect the environmental integrity of the program, in the weeks following the preliminary determination, stakeholders painted a picture of the market chaos created by what they called a subjective and error-prone investigation.

For example, the ARB’s seizure of the 4.3 million offsets before determining the validity of the offsets was called “improper and unlawful by Nicholas van Aelstyn, a lawyer representing ECC, a comment echoed by many other stakeholders in more measured terms. He also alleged serious errors by the ARB, including the fact that the ODS destruction related to the ECC project occurred several hours after the alleged RCRA violation was resolved, meaning the offsets should not have been subject to invalidation at all.

The preliminary decision was shocking to market participants for many reasons, not the least of which was that ARB seemingly had the discretion based on the language in the regulation to decide not to invalidate the offsets because the alleged violation was unrelated to generation of the offsets. By the ARB’s own admission, the offsets generated during the time when the facility was allegedly in non-compliance with its RCRA operating permit met the ARB’s criteria of representing real, quantified and verified emissions reductions. Market stakeholders lobbied the ARB not to invalidate the offsets given that their environmental integrity was not in question.

The preliminary decision was also surprising because ODS had been the top choice for compliance offsets for some time as buyers were reassured by the accuracy of the emissions reductions created by these projects a critical consideration when California regulators retained the right to force buyers to replace invalidated offsets. But the preliminary determination demonstrated the inherent risk associated with developing ODS projects when there are only seven commercially available destruction facilities, according to some developers.

Responding to complaints about a lack of clarity and transparency in its preliminary determination, the ARB laid out its argument for invalidation in the final determination. The ARB cited the language of the ODS protocol, which states that offset projects are ineligible to receive ARB or registry offset credits for GHG reductions that occur as the result of collection or destruction activities that are not in compliance with regulatory requirements. The regulatory compliance requirement extends to the operation of destruction facilities where the ODS is destroyed. All destruction facilities must meet all applicable regulatory requirements during the time the ODS destruction occurs, according to the language of the protocol.

The cap-and-trade regulation and the ODS protocol are complementary regulatory documents that “must be read in harmony with each other according to the ARB’s final determination. The regulators interpreted these provisions to require that both the project activities associated with the destruction of ODS as well as other activities at the facility in question must be in “accordance with all local, state, or national environmental and health and safety regulations. ARB interpreted this provision to be applicable to all requirements that have a bearing on the integrity of the generated offsets; and environmental and health and safety requirements associated with the collection, recovery, storage, transportation, mixing, and destruction, including the disposal of the associated post-destruction waste products.

The Fallout

The invalidation rules are often blamed for a lack of transactions in the California offset market and there is a general consensus that the ARB’s decision could only further dampen what little liquidity currently exists.

The investigation disrupted commercial processes in the offset market because of its length and lack of clarity, remarked Mark Krausse, Senior Director for State Agency Relations for Pacific Gas & Electric, during the public comment period. The ARB’s investigation took more than four months and was characterized by a lack of transparency, according to several stakeholders.

And the ARB’s approach raises questions about potential scenarios under which forestry or livestock offsets other project types eligible for California’s cap-and-trade program could be invalidated, Weisberg said.

“There’s so much uncertainty in these markets, he said. “It’s very difficult to convince investors that it’s worthy investing.

The ARB should consider alternatives to buyers liability such as a buffer account to cover these types of losses, Krausse, Weisberg and other stakeholders suggested. Quebec the Canadian province partnering with California on carbon trading via the Western Climate Initiative established a buffer pool that sets aside 4% of offsets to cover reversals or invalidations.

In discussions with Oregon and Washington, which are both considering options to comply with upcoming federal carbon regulations, Weisberg has encouraged them to follow Quebec’s model or the approach of voluntary standards in ensuring offset integrity rather than California’s approach. However, he also noted that there are potential solutions to the risk created by California’s buyers liability provisions, including insurance policies designed specifically to cover the invalidation risk.

“It’s definitely an unfortunate risk, he said. But “we still think this is a risk that can be managed.

Gloria Gonzalez is a Senior Associate in Ecosystem Marketplace’s Carbon Program. She can be reached at [email protected].