Carbon Trading Law and Practice ppt

Carbon Trading Law
and Practice
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Carbon Trading
Law and Practice
Scott D. Deatherage
1
1
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Copyright © 2011 by Scott D. Deatherage
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_____________________________________________________________________________
Library of Congress Cataloging-in-Publication Data
Deatherage, Scott.
Carbon trading law and practice / Scott D. Deatherage.
p. cm.

Includes bibliographical references and index.
ISBN 978-0-19-973221-0 (pbk. : alk. paper)
1. Emissions trading—Law and legislation. 2. Emissions trading—Law and legislation—United States.
3. Carbon o setting—Law and legislation. 4. Carbon o setting—Law and legislation—United States.
I. Title.
K3593.5.C37D43 2011
344.04’634—dc22 2010045984
___________________________________________________________________________________
1 2 3 4 5 6 7 8 9
Printed in the United States of America on acid-free paper
Note to Readers
 is publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It
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To Violet, my wife, and my two children, Brett and Ashley
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Contents
Acknowledgments xxiii
Preface xxv
Introduction xxix
PART ONE The Emergence of Carbon Markets
1 Prelude to Regulation— e Development of Climate

Change Science 3
A. Typical Process of Regulation Following Science 4
B.  e Greenhouse E ect 5
C.  e Science of Climate Change 5
1. Conclusions of Scienti c Institutions 5
a.  e International Panel on Climate Change 5
i. Africa 7
ii. Asia 7
iii. Latin America 7
iv. North America 8
v. Europe 8
b. National Academies of Science of the Major Emitting
Developed and Developing Countries 8
c. In the United States: the National Research Council
and the National Academy of Sciences 11
D.  e Policy Impact of the Conclusions of the National
Academies of Science 12
E. Controversy over Climate Science 12
F. Future Policy Development Based on Climate Science 15
viii | CONTENTS
2  e Emergence of Emissions Trading Concepts 16
A. Economics vs. the Environment 16
B. Evolution of Environmental Regulation and Emergence
of Environmental Markets 17
C. Emissions Trading as a Means of Bridging the Divide
between the Economy and Environment 17
D. Basic Concepts of Emissions Trading 18
E. Cap and Trade “Made in America”— e Advent of U.S.
Emissions Markets with Sulfur Dioxide and
Other Emissions 20

F. Examples of Working Carbon Markets 21
1.  e Kyoto Protocol 22
2.  e European Union Emissions Trading Scheme 24
G. Environmental Markets Are Alive and Well 24
3 Fundamentals of Cap and Trade 25
A. De ning the Regulated Gases 25
B. Determining the  reshold Amount of Emissions
to Be Regulated 28
C. Determining the Regulated Sources 28
D. Setting the Cap 30
E. Permitting Emissions of Greenhouse Gases 30
F. Emission Allowances 31
G. Allocation of Emission Allowances 31
H. Trading Allowances 33
I. Banking Allowances 33
J. Borrowing Allowances 33
K. Safety Valve and International Competitiveness 34
L. O sets 34
M. Additionality 35
N. Supplementarity and Linkage to Other National
and International Trading Systems 35
O. Early Action 36
P. New or Expanded Facilities 36
Q. Regulatory Agency or Agencies 37
1. Regulation of Greenhouse Gas Emissions 37
2. Regulation of Trading of Allowances and O sets 37
R. Enforcement 38
CONTENTS | ix
PART TWO Regulatory Structures
4 International Law 41

A.  e UN Framework Convention on Climate Change 41
1. Conference of the Parties 42
B.  e Kyoto Protocol 42
1. General Principles 42
2.  e Clean Development Mechanism 43
3. Joint Implementation 44
4. Emissions Trading and Trading in Assigned
Amount Units and Removal Units 45
5. Kyoto Units 46
C.  e Marrakesh Accords 46
D. Bali, Copenhagen, and Cancun: Negotiations for a
Post-Kyoto Treaty 47
1.  e Bali Action Plan 47
2.  e Copenhagen Accord 48
3. Cancun 48
E. Alternatives to the UNFCCC 49
5  e European Union Emissions Trading Scheme 52
A.  e EU Policy on Climate Change 52
B. Phase I—2005 to 2007 53
C. Phase II—2008 to 2012 53
D. Phase III—2013 to 2020 54
E. Fundamentals of the EU ETS 54
1. De ning the Cap 54
2. De ning the Regulated Sources 55
3. Permitting Emissions of Greenhouse Gases 55
4. Emission Allowances 55
5. Allocation of Emission Allowances 55
6. Trading Allowances 56
7. Banking Allowances 56
8. Borrowing Allowances 56

9. Safety Valve and International Competiveness 56
10. O sets 56
11. Additionality 57
12. Supplementarity and Linkage to Other National and
International Trading Systems 57
13. Early Action 57
14. New or Expanded Facilities 57
15. Enforcement 58
x | CONTENTS
6 Emissions Programs among Other Kyoto Countries 59
A. New Zealand 59
B. Canada 60
C. Australia 61
D. Japan 61
E. China 63
7  e Emergence of National and International Carbon Markets 64
A. Compliance or Mandatory Markets 64
B. Voluntary Markets 64
1. Voluntary Carbon Standards and Markets 64
2. Source of Demand for Voluntary Carbon Credits 65
3. Development of Voluntary Standards, Registries,
and Exchanges 65
a. Chicago Climate Exchange 66
b. Voluntary Carbon Standard 66
c. American Carbon Registry 68
d. Climate, Community, and Biodiversity Alliance 69
C. Pre-Compliance Markets and the Transition from
Voluntary to Compliance Markets 69
D. Survival of Voluntary Markets a er Establishment of
Compliance Systems 70

E.  e Current State of the Voluntary Market 70
F.  e European Market 71
G.  e Kyoto Protocol and the Clean Development
Mechanism Market 72
8 Developing Laws in the United States—State Laws 74
A. State Climate Change Programs 74
B. Individual State Programs 74
1. California 74
a. Regulated Gases 75
b. Regulated Sources 75
c.  e Cap 77
d. Permitting Emissions of Greenhouse Gases 77
e. Emission Allowances 77
f. Allocation of Emission Allowances 77
g . Trading Allowances 79
h. Banking Allowances 79
i. Borrowing Allowances 79
j. Safety Valve and Competitiveness 80
k. O sets 80
CONTENTS | xi
l. Additionality 82
m. Supplementarity and Linkage to Other
Trading Systems 82
n. Early Action 83
o. New or Expanded Facilities 83
p. Regulatory Agency or Agencies 83
q. Enforcement 83
2. Florida 84
3. New Mexico 84
C. Multi-State Programs 85

1. Regional Greenhouse Gas Initiative 85
a. Regulated Gases 85
b. Regulated Sources 85
c.  e Cap 85
d. Permitting Emissions of Greenhouse Gases 86
e. Emission Allowances 86
f. Allocation of Emission Allowances 86
g . Trading Allowances 86
h. Banking Allowances 86
i. Borrowing Allowances 86
j. Safety Valve and Competiveness 87
k. O sets 87
l. Additionality 87
m. Supplementarity and Linkage to Other
Trading Systems 87
n. Early Action 87
o. New or Expanded Facilities 88
p. Regulatory Agency or Agencies 88
q. Enforcement 88
2. Western Climate Initiative 88
a. Regulated Gases 90
b. Regulated Sources 90
c.  e Cap 90
d. Permitting Emissions of Greenhouse Gases 91
e. Emission Allowances 91
f. Allocation of Emission Allowances 91
g . Trading Allowances 92
h. Banking Allowances 92
i. Borrowing Allowances 92
j. Safety Valve and Competitiveness 92

xii | CONTENTS
k. O sets 93
l. Additionality 93
m. Supplementarity and Linkage to Other Trading Systems 94
n. Early Action 94
o. New or Expanded Facilities 95
p. Regulatory Agency or Agencies 95
q. Enforcement 95
D. Midwestern Greenhouse Gas Reduction Accord 95
E. Cooperation and Potential Linkage among the
Multi-State Programs 96
9 Developing United States Law— e Courts 99
A. Federal Statutory Litigation 100
1.  e U.S. Supreme Court Landmark Decision in
Massachusetts v. EPA 100
2. Background—How Did the Matter Reach the
U.S. Supreme Court? 101
3. Standing—Could the Court Hear the Matter When the
Emissions and E ects of Climate Change Are Global and
In uenced by Emissions from Other Countries? 102
4.  e Merits of the Case—Does the EPA Have the
Authority to Regulate, and, if so, the Ability to Defer
Regulation of Greenhouse Gases under the
Clean Air Act? 104
5. Implications of the Court’s Decision—Regulation
under the Clean Air Act and Other Federal Statutes,
Corporate Environmental Disclosure, and Litigation
Alleging Climate-Related Damages 106
a. Symbolic or Political Signi cance 106
b. Greenhouse Gases Are Air Pollutants and the

EPA Has the Authority to Regulate  em 106
c. E ect on Other Vehicle-Related Greenhouse
Gas Lawsuits 107
d. E ect on Challenges to the EPA’s Decision
Not to Regulate Greenhouse Gases from
Power Plants 107
e. E ect on Cases Filed under the National
Environmental Policy Act, Challenging
Governmental Action  at Causes or Leads to
Greenhouse Gas Emissions 107
f. E ect on Tort Suits Filed by Individuals
Claiming Damages from Greenhouse Gas Emissions 108
CONTENTS | xiii
g. Broadening Standing for States to Challenge Federal
Administrative Agency Action 109
B. State Statutory Litigation 109
C. Federal Common Law Litigation to Impose Emission
Reductions on Greenhouse Gas Emitters 109
D. State and Federal Common Law Litigation to Obtain
Damages from Greenhouse Gas Emitters 111
10 Developing United States Law— e Environmental
Protection Agency 114
A. Federal Greenhouse Gas Reporting Program 115
1. What Gases Are Covered? 117
2. What Facilities Are Covered? 117
a. Speci c Source Categories 118
b. Other Facilities  at Emit 25,000 Tons per
Year or More of CO
2
e of Combined Emissions

from Listed Source Categories 118
c. Facilities  at Do Not Meet the First Two Source
Categories, But  at Emit 25,000 Tons of
CO
2
e per Year from Stationary Fuel
Combustion Sources 119
d. Entities  at Sell, Import, or Export Fossil Fuels,
Industrial Greenhouse Gases, and CO
2
119
e. Entities  at Manufacture or Sell Vehicles or
Engines in the United States 120
3. Monitoring and Measurement 121
4. Certi cation and Veri cation 121
5. Information  at Must Be Reported 121
a. Facilities  at Emit Greenhouse Gases 121
b. Suppliers of Greenhouse Gases or Materials
 at Produce Greenhouse Gases When Used 122
6. Public Availability of Information Submitted
to the EPA 122
7. Exiting the Reporting Regulation Requirements 123
8. Enforcement Actions and Penalties for Failure to
Comply with the Greenhouse Gas Reporting Rule 123
B. EPA Regulation of Greenhouse Gas Emissions
under the Clean Air Act 124
1.  e EPA’s Endangerment Finding 124
2.  e EPA’s “Johnson Memo” 125
3.  e EPA’s Mobile Source Rule 126
xiv | CONTENTS

4.  e EPA Tailoring Rule 126
a. Application of the Prevention of Signi cant
Deterioration to Regulation of Greenhouse
Gas Emissions 127
b. Covered Gases 129
c. Phases of Coverage, Beginning with Larger Sources 129
i. Step 1: January 2, 2011 to June 30, 2011 129
(a) PSD applicability 129
(b) Title V permitting applicability 130
ii. Step 2: July 1, 2011 to June 30, 2013 130
(a) PSD applicability 130
(b) Title V permitting applicability 130
iii. Step 3: July 1, 2013 to April 29, 2016 131
d. Best Available Control Technology 131
e. State Implementation Plans 132
11 Developing United States Law—Congress and
Proposed Federal Climate Change Legislation 133
A. De ning the Regulated Gases 133
B. Emission  resholds for Facilities  at Emit
Greenhouse Gases 135
C. “Covered Facilities”: Determining What Emission
Sources Would Be Regulated 136
1. Emitters of Greenhouse Gases 136
2. Producers or Importers of Greenhouse Gases or
Materials  at Emit Greenhouse Gases When
Used or Burned 138
D. Setting the Cap 138
E. Permitting Emissions of Greenhouse Gases 139
F. Emission Allowances 139
G. Allocation of Emission Allowances 140

H. Auctions 141
1. Main Allowance Auction 141
2. Market Stability Reserve 142
3. Small Business Re ner Reserve 143
I. Auctioning Allowances for Other Entities 144
J. Carbon Registry 144
K. O sets 145
1. General Issues Relating to O sets 145
2. Carbon O set Creation—Rules Relating to O set
Methodologies and Projects 147
a. Basics of O set Creation 147
CONTENTS | xv
3. Eligible O set Project Types 148
4. Methodologies 150
a. Additionality 151
b. Activity Baseline 152
c. uanti cation Methods 152
d. Leakage 152
5. Accounting for Reversals 153
6. Crediting Periods 153
7. Approval of Projects 153
8. Monitoring, Reporting, and Veri cation 154
9. Issuance of Credits 155
10. Early O sets 155
11. Environmental Considerations for Forestry or
Land-Management Projects 156
12. Recordkeeping 157
13. International O sets 157
a. General Issues 157
b. Sectoral Credits 158

c. Credits Issued by an International Body 159
d. International Forest O sets 160
i. National Programs 160
ii. State- or Province-Level Programs 162
iii. Program for Low-Emitting Countries 162
iv. Project-based Deforestation Reduction Credits 163
v. Forested Wetlands and Peatlands 163
L. Compliance with Greenhouse Gas Emission
Requirements 163
1. Compliance Obligations 163
2. Phase in of Compliance Obligations for Certain
Covered Entities 164
M. Trading Allowances and O sets 166
N. Banking Allowances 166
O. Borrowing Allowances 167
P. Safety Valve International Competitiveness 167
1. Program to Provide Additional Allowances for
Industrial Sources Facing
International Competition 168
2. Use of Sectoral Approach for the Importation of
International O set Credits 168
Q. Supplementarity and Linkage to Other National and
International Trading Systems 169
xvi | CONTENTS
R. Early Action 170
S. New or Expanded Facilities 171
T. Regulatory Agency or Agencies 171
1. Regulation of Greenhouse Gas Emissions 171
2. Regulation of Trading of Allowances and O sets 171
U. Enforcement 172

PART THREE Carbon Project Development
and Carbon Finance
12 Carbon Credit Project Types and Methodologies 175
A. Introduction to Carbon Credit Project Types and
Methodologies 175
B. Methodologies for Developing Carbon Credit
Project Types 176
C. Carbon Credit Project Types 177
1. Renewable Energy 177
2. Energy E ciency 178
3. Land ll, Oil and Gas, and Other Methane Projects 178
4. Natural Gas Production and Distribution Projects 179
5. Fuel Switching 180
6. Agriculture, Forestry, and Land Use 180
a. Avoided Deforestation and Reforestation 180
i.  e Voluntary Carbon Standard Agriculture,
Forestry, and Other Land Use Guidance 183
(a)  e baseline 185
(b) Additionality 185
(c) Leakage 186
(d) Permanence and Related Carbon Bu er 186
(e) Monitoring 186
ii. Climate Action Reserve Forestry Methodology 187
(a)  e baseline 188
(b) Additionality 188
(c) Leakage 189
(d) Permanence and Related Carbon Bu er 189
(e) Monitoring 190
iii. CDM Reforestation/A orestation Methodology 190
7. Carbon Capture and Storage 190

13 Carbon Credit Project Development 193
A. Project Development Generally 193
CONTENTS | xvii
B. Basics of Carbon Credit Project Development 194
C. Feasibility Study 194
D.  e Carbon Credit Approval Process 196
1.  e Process under the Clean Development Mechanism 196
a. Project Feasibility Study 196
b. Project Idea Note 196
c. Project Design Document 196
d. Stakeholder Participation 197
e. Host Country Approval 197
f. Validation by a Designated Operational Entity 197
g . Reg istration 197
h. Implementation and Monitoring 198
i. Veri cation and Certi cation 198
j. Issuance of Credits 198
2.  e Voluntary Carbon Standard Process 198
E. Carbon Credit Project Risks 199
F. Examples of Projects 200
1. Land ll Methane 201
2. Solar Projects 201
a. Solar Projects Generally 201
b. Free-Standing or Utility-Scale Solar Projects 201
c. Non-Utility-Scale Solar Projects 202
3. Forest Carbon Projects 203
14 Carbon Finance 207
A. Financing Carbon Projects 207
B. Project Finance 207
1. Equity 209

2. Debt 209
3. Types of Agreements Typically Involved in
Project Finance 210
4. Managing Political Risk with International Projects 211
C. Carbon Finance 211
1. Basic Elements of Carbon Finance 211
D. Carbon Credit Project Lenders and Investors 214
1. Multilateral Banks and Associated Carbon Funds 214
2. Private Banks 217
3. Private Carbon Funds, Private Equity Firms, and
Hedge Funds 217
4. Utilities and Other Compliance Investors 217
xviii | CONTENTS
PART FOUR Other Credits That May be Generated
From Carbon Credit Projects
15 Other Environmental Attributes, Including Renewable
Energy Credits and Energy E ciency Credits 221
A. Environmental Attributes and Other Credits
 at May Enhance Carbon Credit Projects 221
B. Renewable Portfolio Standards 222
C. Renewable Energy Credits 224
D. En ergy E ciency Credits 225
E. Credits for Traditional Pollutants 225
F. Forward Capacity Markets 225
G. Contractual Issues in Selling RECs Outside California 226
1. Type of Credit 226
2. Vintage of Credit 227
3. uantity Being Sold 227
4. Pricing 227
5. Transfer Mechanism 227

6. Payment 227
7. Delivery 228
8. Representations and Warranties 228
9. E ective Date and Termination 228
10. Remedies and Damages 228
11. Change in Law 228
H. Contractual Issues in Selling RECs Inside California 229
16 Ecosystem Services: Wetlands and Biodiversity Credits 230
A. Wetlands Credits and Banking 231
B. Biodiversity Credits 232
C. Credit Stacking 234
17 Water Credits 236
A. Increasing Water Demand and Decreasing Water Supply 236
B. Why Water Is Becoming a Potential Tradable Commodity 236
C. Water Credits and Markets as a Means of Conserving a
Scarce Resource 237
1. Water uantity Trading 237
2. Water uality Trading 237
D. Carbon Credit Projects and Water Credits 238
PART FIVE Government Incentives—Stimulating
Carbon Projects
18 Government Incentives for Renewable Energy and Other
Types of Projects  at Generate Carbon Credits 243
CONTENTS | xix
A.  e Use of Government Incentives to Enhance
Carbon Credit Projects 243
B. Government Incentives 245
1. Government Grants 245
2. Government Tax Incentives 245
a.  e EESA 246

i. Renewable Energy 246
ii. Energy E ciency and Conservation 246
iii. Carbon Capture and Storage 246
iv. Transportation and Domestic Fuel 247
b.  e ARRA 247
3. Grants in Lieu of Tax Incentives 248
4. Government Loan Guarantees 250
5. Property-Assessed Clean Energy Programs 250
6. Development Bonds 251
C. Utility Incentives 251
PART SIX Carbon Trading—Selling Credits
and the Carbon Markets
19 Fundamentals of Carbon Trading 255
A. A Regulatory “Commodity” 255
B.  e Various Types of Carbon Credits 255
C. Primary or “Over-the-Counter” Markets and Bilateral
Agreements 256
D. Secondary Markets and Exchanges 256
E. Future vs. Spot Markets 257
F. O -Take Agreements 257
G. Carbon Indexes 257
H. Fungible Commodity vs. Di erentiation 258
I. Voluntary and Compliance Buyers 258
J. Investors and Speculators 258
K. Carbon Credit Risk and Price 259
L. Other Price Drivers 259
M. State of the Global Carbon Markets 259
20 Contractual Issues in Carbon Trading in the Primary Market 261
A. De nitions 261
B. Conditions Precedent 261

C. Price 262
D. uantity and Delivery 262
E. Payment 262
F. Obligations of Seller 263
xx | CONTENTS
G. Obligations of Buyer 263
H. Representations and Warranties 264
I. Share of Proceeds and Taxes 265
J. Default 265
K. Termination 266
L. Remedies 266
M. Choice of Law and Venue 266
N. Dispute Resolution 267
O. Force Majeure 267
P. Limitation of Liability 267
Q. Miscellane ous Issues 267
PART SEVEN Carbon Accounting—Carbon
Assets and Liabilities
21  e “Carbon Ledger” and Carbon Credit Accounting 271
A. Carbon Accounting 271
B. De ning Carbon Assets and Liabilities 272
C. Forming a Carbon Ledger as Part of a Carbon Strategy 273
D. Financial Accounting Treatment of Carbon
Assets and Liabilities 275
22 Climate Risk Disclosure 279
A. Corporate Climate Change Liabilities 279
B. Securities and Exchange Commission Regulations
Governing Environmental Financial Disclosure 281
1. Item 101 282
2. Item 103 282

3. Item 303 283
4. Item 503(c) 283
C. Accounting Rules 283
D.  e Sarbanes-Oxley Act 284
E. SEC Enforcement 284
F. SEC Guidance Regarding Disclosure Related to
Climate Change 285
1. Overview of Existing Disclosure Requirements 286
2. Climate Change-related Topics  at May Require
Disclosure 287
a. Impact of Legislation and Regulation 287
b. International Accords 289
CONTENTS | xxi
c. Indirect Consequences of Regulation or
Business Trends 289
d. Physical Impacts of Climate Change 289
G. Voluntary Climate Change Disclosure Protocols 291
H. Voluntary Standards Evolving into Legal Requirements 292
I. O cer and Director Liability Environmental and
Climate Risk Management 293
J. Conclusion 295
Acronyms and Abbreviations 297
Index 299

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Acknowledgments
 is book could not have been written without the support of certain people.
My wife Violet Deatherage has supported me in my career and business
endeavors for these last 25 years, and supported me throughout the long process
of conceiving and writing this book. My children Brett and Ashley have sup-

ported me in the excitement of their father writing his  rst book. Without my
family’s encouragement, this book would not have been possible.
I would also like to acknowledge the support of friends such as Greg Rogers
and Ted Benn who have supported me in my endeavor to develop a practice in
the areas of climate change, greenhouse gas regulation, renewable energy, and
energy e ciency. Others I would like to thank are my friends and clients at
Incenergy, primarily Barry McConachie, Je Smith, and Liz Cunningham, who
have also supported me and encouraged me in this endeavor and inspired me
with their development of a demand response company that will become a sig-
ni cant player in this space. I would like to acknowledge the assistance of Jane
Peck Hay, Head of the Commodities Legal Team for Direct Energy, who pro-
vided guidance and review of the chapter on renewable energy certi cates, which
was very helpful to me in preparing the important discussion of such an impor-
tant element of renewable energy projects.
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