CFO Magazine

Carbon Trading

The carbon offset market is set to take off. But could U.S. businesses end up buying a lot of hot air?

January 2008
by John Goff/CFO Magazine

In northern Louisiana, ecologists are creating a new forest — one Beetle at a time. In a floodplain known as the Lower Mississippi Alluvial Valley, nearly 250,000 trees are being planted by a not-for-profit group called Carbonfund.org. Funding for the massive project, however, is coming from a decidedly for-profit outfit: Volkswagen of America.

Like dozens of other businesses in the United States, the VW unit is tying reforestation to a promotional campaign. In Volkswagen's case, the company claims the planting of the trees, which take in carbon dioxide, will negate the tailpipe fumes for one year for every car VW sold during the past four months. In "greenspeak," Volkswagen is offsetting its downstream CO2 emissions. In plainer English, the conversion of farmland to forest will — in theory — capture 372,000 tons of CO2, which Carbonfund.org claims will help combat global warming.

The truth is a bit more cloudy. If tracts of the forest burn, much of the trapped CO2 will go straight back into the atmosphere. What's more, a recent academic study found that trees planted in the midlatitude regions — such as North America — tend to radiate heat, and therefore may ultimately increase global warming. Although the study hasn't been peer reviewed, it underscores a basic problem with carbon offsets: they may not do a whole lot of good.

In the main, finance chiefs seem blissfully unaware of the disconnect. In fact, most CFOs don't seem to be paying any attention to the emerging complexities of carbon credits. Such ignorance could prove costly to shareholders. A growing number of state emission mandates, such as those imposed in California, are already beginning to create regulatory headaches for some businesses. Federal carbon caps, expected within the next three years, will raise the pain to a whole new level.

A few finance managers, with an eye toward coming national regulations, are already purchasing high-quality offsets at relatively low prices. When federal legislation hits, the clutch of credits could be turned into a source of windfall profits for their companies. Conversely, CFOs who don't understand the complexities of carbon commodities could find themselves paying high prices for low-quality offsets in a seller's market. And make no mistake, federal carbon legislation will almost assuredly trigger a steep rise in the price of CO2 credits.

Nevertheless, many CFOs seem content to let other departments deal with the risks that come with carbon credits. Leo Denault, executive vice president and CFO at New Orleans–based utility Entergy, believes that's a mistake. "Carbon will be a valuable commodity some day," he predicts. "The last thing you want as CFO is a guy in your environmental engineering group making policy decisions around commodity risk management."

Managers at some businesses, like VW and Expedia.com, see immediate value in carbon credits. They use the credits to help customers offset the carbon output from products and services. Others, like Green Mountain Coffee Roasters and Timberland, purchase credits to help reach "carbon-neutrality" — CO2 nirvana, where carbon discharges (known as a carbon footprint or profile) are offset by carbon reductions.

This activity has fueled an increase in the trading of offsets. In 2006, trading volume of carbon offsets, such as Carbon Financial Instruments and Renewable Energy Certificates (RECs), jumped 200 percent in the voluntary markets (primarily the United States). Observers believe that market is now worth at least $100 million. Privately, those same observers talk about a $4 billion carbon-trading market once federal caps are approved.

That prospect worries some environmentalists, who argue that purchasers of offsets are simply outsourcing their obligation to combat climate change. Others claim that offsetting enables a company to brand itself "green" without actually being green. Those critics say buying carbon offsets does little to change how carbon-addicted companies operate. "It's like the medieval practice of buying papal indulgences," complains Frank O'Donnell, president of the not-for-profit Clean Air Watch. "If sinners throw a few bucks into the pot, they can go back to sinning."

And who knows what they're buying? A list of current CO2 trading credits reads like an environmentalist's eye chart (see "Accounting for Waste" at the end of this article). Derived from an array of carbon-reduction schemes, the credits are often calculated using different methodologies and accounting standards. Third-party brokers don't necessarily bring clarity to the subject. One study conducted by the not-for-profit Clean Air–Cool Planet rated 30 such firms across seven criteria, including the use of third-party verification. Only eight vendors merited a passing grade, and the report went on to note that "few retail offset providers provide anywhere close to the amount of project-specific information [to allow buyers] to effectively evaluate offset quality."

This lack of transparency could come back to haunt corporate purchasers. Nancy Hirshberg, vice president of natural resources at yogurt specialist Stonyfield Farm, says the company has looked at scores of offsets. "Many of the projects were simply not verifiable," says Hirshberg. "It's definitely buyer beware."

The potential for purchasing worthless credits explains why a few finance chiefs are already getting into the carbon issue. Denault says Entergy's finance group examines all offsets the company purchases. "Like any commodity, we want to make sure that the credit will have future value," notes Denault. "We want to make sure we're purchasing real securities."

Limits Are Coming
At this point, the future worth of a carbon commodity is tough to call. What seems easier to suss out: Congress will undoubtedly place some sort of carbon restrictions on corporations in the next three years. Managers who dispute the assertion are misreading the signals now coming out of Washington. As Hirshberg points out, "Businesses now back carbon legislation."

Most likely is a federally mandated cap-and-trade system, like that proposed by Sen. Joseph Lieberman (I–Conn.) and Sen. John Warner (R–Va.), whereby businesses will be given specific carbon-reduction targets. Such a scheme will likely require businesses to reduce their emissions by a certain percentage from a previous year (known as a baseline year). But at this point, it's unclear what year Congress will choose as the baseline.

For early movers, such as Stonyfield, that means any credit purchased or produced in the run-up to legislation might end up being worthless. But the yogurt-maker's commitment to CO2 reductions also serves to emphasize the company's "green" image among consumers. Managers like Denault understand that industrial businesses — and particularly power providers — produce the most CO2 emissions. They therefore stand to be hardest hit by federal carbon legislation. Stashing credits helps hedge that risk. "Those credits may have value in reducing your [carbon] profile," says Denault, "but that's assuming legislation allows for them."

The uncertainty surrounding carbon credits has not deterred many U.S. businesses from jumping into the offset game, however. Nike has not only purchased offsets, it has produced them. The apparel maker generated the credits through an agreement signed in 2001 with the World Wildlife Fund's Climate Savers. Under Climate Savers, a voluntary program that both sets reduction targets and verifies participants' progress, Nike agreed to lower greenhouse gases from company-operated facilities and employee business travel some 13 percent by 2005 (from a 1998 baseline). Notes Sarah Severn, a director in Nike's corporate responsibility group: "We wanted to go through a registered and verified process with Climate Savers in case there was an opportunity to trade the credits."

This article was excerpted from CFO.com. Read the full article here.

John Goff is technology editor at CFO.

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