Calculating the Carbon Return on Investment

1/14/2009 11:06 AM EST

There's no question that controlling greenhouse gas (GHG) levels attributed with climate change is high on the list of priorities for today's world leaders. However, agreement on the best way to reach stable atmospheric levels of GHGs is yet to be determined. The cap and trade system leads the debate as it utilizes a free-market system to determine the cost of reducing emissions. The argument goes that free markets are the most efficient way to determine the lowest marginal abatement cost or the cost of reducing emissions by a certain unit, a ton for instance.

In the U.S., a federally mandated system does not currently exist. However, individuals, organizations, and businesses have taken it upon themselves to create a voluntary market where emission allowances are sold in the form of carbon offsets. A true carbon offset is a reduction that would not have happened without independent financing from these voluntary sources, otherwise known as "additionality."

The validity of carbon offsets is widely disputed. The U.S. voluntary market is commonly referred to as the 'wild west' of carbon trading. The most highly criticized aspect of the U.S. market is the concept of additionality. For an interesting article on how carbon offsets can be exploited see the NY Times article on the Chicago Climate Exchange, a voluntary carbon exchange (NY Times). Additionality in projects is the corner stone to carbon offsets. Without it, the financing is unnecessary and a real reduction would not occur.

Another issue with offsets is what people are willing to pay for these allowances and what the projects need in terms of financing in order to exist. Certain methodologies of carbon financing do not provide enough financing on a year to year basis for a project to be justified economically. For instance, Farmer Joe has the land and wind resources for a turbine but he cannot afford the full cost of the turbine which has the potential to pump renewable energy into the grid for decades to come. Carbon financing can help Farmer Joe because his turbine's energy will displace fossil fuel emitting sources off the grid. However, how much and when should he be paid for the offsets generated for his project? Should he be paid for the offsets when they are generated? What if that financing is not enough?

A solution to Farmer Joe's problem is in the form of forward stream carbon offsets. Forward stream offsets are the estimation of the amount of emissions that would be reduced over the life expectancy of the project. Each year the wind turbine generates electricity and reduces the dependence on fossil fuel emitting energy but the cost of the project is incurred upfront. So, a solution would be to pay Farmer Joe for the offsets generated over the life time upfront so he can develop his turbine. Otherwise, without that financing, his project is not economically viable.

Think of it as a carbon return on investment. Just as you invest in other efficiency measures at your firm, you are expecting a return on investment that will be generated over time. The cost of the project is incurred up front but your savings from the project will benefit your firm in the long run. Farmer Joe's turbine incurs a cost upfront which your carbon financing will help fund and over time you will be repaid in the form of offsets that will be generated. But you can claim these emission reductions now because you helped finance the project now.

Forward stream carbon offsets allow for more projects to be built with the lowest marginal abatement cost. Using the forward stream model allows for more reductions to be accounted for, and thus, more financing to be applied to a project. Accounting for more emission reductions makes the cost per offset cheaper and more economically viable for an individual, organization, or business to invest in.

Given current technology, it is almost impossible to reduce your carbon footprint to zero in a cost effective way. As firm's become more interested in reducing their environmental impact, offsets can be a tool to reduce greenhouse gases as the least marginal abatement cost. In the end, the goal is to reduce atmospheric concentration levels of greenhouse gases to a sustainable state. In order to reach this goal, we will need options that allow us to grow as an economy. Offsets provide a medium through which we can reduce those concentrations cost effectively.

Owen Glubiak is a regular blogs contributor to Green SupplyLine. He lives and works in Burlington, Vermont. You can contact Owen at info@greensupplyline.com.