Carbon Credits and the Chicago Climate Exchange Neil Sampson

1. Carbon Credits and the Chicago Climate Exchange Neil Sampson

2. Chicago Climate Exchange - CCX North America’s only greenhouse gas (GHG) trading system. Launched in 2001. Modern web-based trading platform. Only Members can buy and sell on CCX. Trading launched in 2003; Currently trading emissions dated 2003 through 2010. Trading rules managed by expert committees drawn from CCX members. Info at www.chicagoclimatex.com NOTE: While CCX is today’s only GHG trading system, others are likely to emerge. When they do, change this to “first” GHG trading system. The current trading period (thru 2010) is also likely to change. Be aware. The trading rules are often called “protocols”. CCX membership and participation is open to a variety of companies, organizations and public entities. It is formal, legal, and expensive, however, so small businesses, farms, etc. are not likely to be interested in becoming members. NOTE: While CCX is today’s only GHG trading system, others are likely to emerge. When they do, change this to “first” GHG trading system. The current trading period (thru 2010) is also likely to change. Be aware. The trading rules are often called “protocols”. CCX membership and participation is open to a variety of companies, organizations and public entities. It is formal, legal, and expensive, however, so small businesses, farms, etc. are not likely to be interested in becoming members.

3. CCX Membership Members have significant, direct GHG emissions (corporations, cities, states, etc.) Legally commit to reduce 2000 GHG emissions by 6% prior to 2010. If they reduce more than needed, they can sell the excess. If they reduce less than needed, they must buy from the trading platform. Offset Providers – organizations without significant direct emissions can join CCX as offset providers. Aggregators – organizations that pool small projects together for trading on the CCX. This is a formal, legally binding emissions reduction system that mirrors what a public cap and trade system would entail. Members agree to reduce their emissions, then can sell surplus if they wish, but MUST buy offsets if they fall short of their emissions reduction target. It is voluntary in the sense that nobody is required to join, but once they are in, their commitments are legal and binding. An offset provider could be an organization that specializes in methane destruction. It could have no emissions of its own to reduce, but have methane reduction offsets to offer to the market. An aggregator is an organization that serves as the administrative representative for small projects, bundling them together in pools that are large enough for the trading floor, and assuring CCX that each individual project meets all CCX rules. Aggregators have significant responsibility, including legal liability for the failure of individual projects.This is a formal, legally binding emissions reduction system that mirrors what a public cap and trade system would entail. Members agree to reduce their emissions, then can sell surplus if they wish, but MUST buy offsets if they fall short of their emissions reduction target. It is voluntary in the sense that nobody is required to join, but once they are in, their commitments are legal and binding. An offset provider could be an organization that specializes in methane destruction. It could have no emissions of its own to reduce, but have methane reduction offsets to offer to the market. An aggregator is an organization that serves as the administrative representative for small projects, bundling them together in pools that are large enough for the trading floor, and assuring CCX that each individual project meets all CCX rules. Aggregators have significant responsibility, including legal liability for the failure of individual projects.

4. Current CCX Members Industrial Members Ford Motor Co. DuPont Allegheny Energy, Inc. International Paper Public Members City of Chicago State of New Mexico Non-Governmental Members World Resources Institute Offset Providers CNX Gas Corp. Gallo Cattle Company Vessels Coal Gas Inc. Aggregators AgraGate Climate Credits Corporation Carbon Farmers LLC National Carbon Offset Coalition (Red Rock) These are just a few of the several hundred current CCX members, listed to illustrate the kinds of organizations involved. A full listing is available on the CCX web site, and is constantly changing as additional organizations join.These are just a few of the several hundred current CCX members, listed to illustrate the kinds of organizations involved. A full listing is available on the CCX web site, and is constantly changing as additional organizations join.

5. Vintage Years Carbon credits on the CCX are sold by “vintage year.” That means that carbon sequestered in 2008 can be used to offset GHG emissions created in 2008. With proper documentation and proof, landowners can claim some prior year credits on practices such as afforestation. A landowner joining a CCX pool in 2009 can sell credits for 2009 and 2010 under the current market situation. The vintage year concept may throw some people, but its really fairly straight-forward. An emitter that joins CCX must agree to reduce emissions by 6% between 2000 and 2010, in annual increments. If they can’t do it with internal changes, they must buy offsets. If they were over their reduction target in 2004 by 1,000 tons, they have to buy 1,000 tons of offsets that were good in 2004. That could mean a grass or tree planting that was in place that year. It can’t be a conservation tillage practice, because there’s no way to prove that the no-till was effective in 2004. Once a project is in the CCX pool, and if it is being maintained as agreed, it will earn credits in the future years. At the end of each year, the pool will be re-verified and, if OK, the credits for that year will be registered. Thus, a landowner entering CCX now will get additional payments each year until the end of the market period. The current CCX market period ends Dec 31, 2010. They may extend it into future years and, if they do, landowners will have the option to continue selling if they remain in the pool. The main unknown is in the emergence of new federal or state programs that may or may not have different requirements. If a national cap and trade system is installed, the CCX voluntary program will probably fade away. The trading floor at CCX will remain, however, as a trading market for credits under the national system. At that point, existing projects may be “grandfathered” in or they may need to be altered to meet national rules, or they may be disallowed. Nobody can really say at this point exactly how that will work, but it will be the result of long and loud political negotiating, so people active in the market will have a pretty good idea what’s going to happen long before it actually happens.The vintage year concept may throw some people, but its really fairly straight-forward. An emitter that joins CCX must agree to reduce emissions by 6% between 2000 and 2010, in annual increments. If they can’t do it with internal changes, they must buy offsets. If they were over their reduction target in 2004 by 1,000 tons, they have to buy 1,000 tons of offsets that were good in 2004. That could mean a grass or tree planting that was in place that year. It can’t be a conservation tillage practice, because there’s no way to prove that the no-till was effective in 2004. Once a project is in the CCX pool, and if it is being maintained as agreed, it will earn credits in the future years. At the end of each year, the pool will be re-verified and, if OK, the credits for that year will be registered. Thus, a landowner entering CCX now will get additional payments each year until the end of the market period. The current CCX market period ends Dec 31, 2010. They may extend it into future years and, if they do, landowners will have the option to continue selling if they remain in the pool. The main unknown is in the emergence of new federal or state programs that may or may not have different requirements. If a national cap and trade system is installed, the CCX voluntary program will probably fade away. The trading floor at CCX will remain, however, as a trading market for credits under the national system. At that point, existing projects may be “grandfathered” in or they may need to be altered to meet national rules, or they may be disallowed. Nobody can really say at this point exactly how that will work, but it will be the result of long and loud political negotiating, so people active in the market will have a pretty good idea what’s going to happen long before it actually happens.

6. Prices on CCX All prices are quoted in terms of U.S. $ per metric ton of carbon dioxide equivalent. (tCO2e) Prices may change daily as trading proceeds. Prices are posted daily on the CCX web site. CCX has established a futures market that may, as it matures, dampen price variation. Aggregators will decide when to sell their carbon pools, based on when they are registered and how they read the price signals. Landowners agree to let the aggregator make these sale decisions. Landowners in aggregated pools may not always know when and at what price a sale is made until they get their report from the aggregator. There are several steps involved in registering and selling, and the pool can’t be sold until all those have been completed, so its not always possible to tell when the first sale will occur. The aggregator may sell part or all of a pool, depending on the buy orders they are able to receive. Most aggregators will work on a percentage of the sale price, so it is in their interest to get the best available price. Landowners in aggregated pools may not always know when and at what price a sale is made until they get their report from the aggregator. There are several steps involved in registering and selling, and the pool can’t be sold until all those have been completed, so its not always possible to tell when the first sale will occur. The aggregator may sell part or all of a pool, depending on the buy orders they are able to receive. Most aggregators will work on a percentage of the sale price, so it is in their interest to get the best available price.

7. Recent Price Trends CCX chart downloaded June 1, 2009. This chart can be obtained from www.chicagoclimatex.com. Go to Market, Data, Chart on the pull-down menus and select the vintage year desired. This example is 2010 vintage, with an May 23, 2008 price of $7.30 per ton and a June 1, 2009 price of $1.20. You should download a new chart anytime you are delivering this program.CCX chart downloaded June 1, 2009. This chart can be obtained from www.chicagoclimatex.com. Go to Market, Data, Chart on the pull-down menus and select the vintage year desired. This example is 2010 vintage, with an May 23, 2008 price of $7.30 per ton and a June 1, 2009 price of $1.20. You should download a new chart anytime you are delivering this program.

8. Selling Credits on CCX Most landowners will work through an Aggregator that can assist them in meeting CCX rules, and sell the credits on the CCX trading platform. Local Organizations and the National Carbon Offset Coalition can work together to aggregate projects. There will be costs associated with the aggregation and trading, such as: A CCX registration and trading fee (currently $.20 per ton) A CCX verification fee (set by the aggregator) An aggregation fee (set by the aggregator) The current CCX web site lists a lot of aggregators, but it is hard to tell from the list what they specialize in and where they operate. Landowners should shop around a bit until they get testimony from neighbors or some other reliable source to know which ones are working best in their area. It is hard to estimate what some of the fees will be. The verification fee will vary according to the size and “scatter” of the pool to be verified. If it’s a few farmers close together, the travel costs will be less than if it’s a lot of people scattered over 10 counties. Until the pool is developed, and the verifier contracted, that cost will be uncertain. Most aggregators will contract with the best available verifier, pay the verification fee, then pro-rate the costs across all members of the pool and take the money out of the eventual sale proceeds. Others may quote a flat fee. Important for landowners to get those facts before signing the contract. The aggregation fees will vary with the aggregator. No doubt aggregators will compete on this basis, so landowners may wish to shop around. The CCX registration fee is currently fixed at $.20 a ton. CCX could change that in the future.The current CCX web site lists a lot of aggregators, but it is hard to tell from the list what they specialize in and where they operate. Landowners should shop around a bit until they get testimony from neighbors or some other reliable source to know which ones are working best in their area. It is hard to estimate what some of the fees will be. The verification fee will vary according to the size and “scatter” of the pool to be verified. If it’s a few farmers close together, the travel costs will be less than if it’s a lot of people scattered over 10 counties. Until the pool is developed, and the verifier contracted, that cost will be uncertain. Most aggregators will contract with the best available verifier, pay the verification fee, then pro-rate the costs across all members of the pool and take the money out of the eventual sale proceeds. Others may quote a flat fee. Important for landowners to get those facts before signing the contract. The aggregation fees will vary with the aggregator. No doubt aggregators will compete on this basis, so landowners may wish to shop around. The CCX registration fee is currently fixed at $.20 a ton. CCX could change that in the future.

9. General CCX Rules Project must provide explicit documentation on the ownership and rights to the carbon credits. Project owner must submit required reports. Aggregator will provide report formats and rules. Project must place 20% of earned credits in a Reserve Pool, and agree that Reserve Pool credits can be used to cover future shortfalls, if any. Landowner will receive a pro-rated share of remaining pool credits at the end of the trading period. Project owner will provide access to project land and records for verification auditors. A landowner that owns project land can easily demonstrate ownership. A renter will need to show an agreement between landlord and renter saying who owns the carbon credits (or how they will be split). The exact deal between landowner and renter is their business; neither CCX nor the Aggregator cares how they do it. But it must be documented in writing to satisfy the verification audit. Project reports will probably be fairly minimal, but that could vary between aggregators and any future CCX rules. There will be at least an annual report on project condition and continuation, and a clause requiring a landowner to inform the aggregator if there is a catastrophic loss that affects the project’s performance.A landowner that owns project land can easily demonstrate ownership. A renter will need to show an agreement between landlord and renter saying who owns the carbon credits (or how they will be split). The exact deal between landowner and renter is their business; neither CCX nor the Aggregator cares how they do it. But it must be documented in writing to satisfy the verification audit. Project reports will probably be fairly minimal, but that could vary between aggregators and any future CCX rules. There will be at least an annual report on project condition and continuation, and a clause requiring a landowner to inform the aggregator if there is a catastrophic loss that affects the project’s performance.

10. Application Requirements Landowners will need to provide the following information to apply for project status: Proof of ownership of carbon credits Land location and description, acres involved Maps showing lands included in the project Description of land condition and use before the project Description of management planned under the project The “proof of ownership” needs to be either proof of land ownership or, in the case of a tenant, a written agreement between landlord and tenant setting forth how the carbon credit proceeds will be handled. CCX doesn’t care how this agreement is structured; only that it exists and can be verified. The “proof of ownership” needs to be either proof of land ownership or, in the case of a tenant, a written agreement between landlord and tenant setting forth how the carbon credit proceeds will be handled. CCX doesn’t care how this agreement is structured; only that it exists and can be verified.

11. Projects to earn Forest Offsets Afforestation – Planting trees on land that has not been in forest for the previous 10 years or more. A land use change that creates new forest lands. Reforestation – Planting trees on forest land where the forest was destroyed and is not naturally regenerating. Sustainable Forest Management – Changing forest management so as to increase forest biomass and retain it for long periods. Harvested Wood Products – Credit for the amount of wood that will remain in use or in landfills 100 years after it is harvested. Afforestation has been part of CCX since the beginning. It is also the only forestry practice currently allowed by RGGI, although there is work to add more that may result in some expansion of the RGGI rules. Reforestation has been used in CCX with badly fire-damaged lands; it is not currently allowed in the RGGI rules, and is probably not needed in the Northeast. Sustainable forest management and harvested wood products will normally go together. A landowner must be certified under the American Tree Farm System, Sustainable Forestry Initiative, or Forest Stewardship Council in order to qualify for these types of projects. These rules are relatively new; only adopted in December 2007.Afforestation has been part of CCX since the beginning. It is also the only forestry practice currently allowed by RGGI, although there is work to add more that may result in some expansion of the RGGI rules. Reforestation has been used in CCX with badly fire-damaged lands; it is not currently allowed in the RGGI rules, and is probably not needed in the Northeast. Sustainable forest management and harvested wood products will normally go together. A landowner must be certified under the American Tree Farm System, Sustainable Forestry Initiative, or Forest Stewardship Council in order to qualify for these types of projects. These rules are relatively new; only adopted in December 2007.

12. Afforestation (Tree Planting) Trees planted after January 1, 2003 on land that had been un-forested (in another use) prior to that date. Project owner must contract with the Aggregator to keep the land in forest for at least 15 years. Project must not be thinned or harvested in the CCX contract period. If a tree planting project is to be harvested, it should be entered under the sustainable forest management rules. All projects must be accessible to CCX verification auditors. There is a definite bias toward planting native species, but not (at this time) a firm requirement. Tree planting projects that have a seedling survival rate of >250 trees per acre can use the CCX default tables to calculate carbon amounts rather than have to do a cruise that measures tree volumes. While the trees are small, there are few methods that will provide good yield estimates, so the tables may prove helpful to most projects in the early stages.There is a definite bias toward planting native species, but not (at this time) a firm requirement. Tree planting projects that have a seedling survival rate of >250 trees per acre can use the CCX default tables to calculate carbon amounts rather than have to do a cruise that measures tree volumes. While the trees are small, there are few methods that will provide good yield estimates, so the tables may prove helpful to most projects in the early stages.

13. Regional Yield Table (NE) This table gives allowable amounts for the combination of tree carbon and soil carbon, by age group. The CCX protocol lists these two (tree and soil) separately, so it takes a little looking to figure out what the exact amounts will be. Projects can count from year of planting. Again, please point out that these numbers reflect metric tons of carbon dioxide equivalent, not elemental carbon.This table gives allowable amounts for the combination of tree carbon and soil carbon, by age group. The CCX protocol lists these two (tree and soil) separately, so it takes a little looking to figure out what the exact amounts will be. Projects can count from year of planting. Again, please point out that these numbers reflect metric tons of carbon dioxide equivalent, not elemental carbon.

14. Sustainable Forest Management Forests must be certified through American Tree Farm System (ATFS), Sustainable Forestry Initiative (SFI) or Forest Stewardship Council (FSC). Earn credits on the basis of verified annual increases in above- and below-ground portions of live trees. Baseline is carbon in above- and below-ground live trees on December 31 of the year prior to project initiation. Model can be used to project growth from inventory year. Model results are discounted 20%. No discount for projects with annual inventory. These projects need to have a statistically sound forest inventory to establish baseline volumes. The inventory (and the forest certification) must apply to all the forest land in the managed forest. (This is to reduce the opportunity for landowners to include their good forestry in a project and leave out the stuff that isn’t so good!) Once an inventory is complete (i.e. in 2008), a growth and yield model is used to estimate the baseline that would have existed in the prior year. That becomes the starting point from which annual growth increments are estimated. The 2008 inventory gives 2008 numbers, then the model is used to generate 2009 and 2010 estimates. (If the model only works in 10-year increments, take that amount of change and divide it by 10 to get an annual average change estimate.) The intention is to “true up” the model estimates by doing a second inventory in 5-10 years. Right now, with only a 2-year remainder in the CCX market period, it is not certain how/when that true-up will be required.These projects need to have a statistically sound forest inventory to establish baseline volumes. The inventory (and the forest certification) must apply to all the forest land in the managed forest. (This is to reduce the opportunity for landowners to include their good forestry in a project and leave out the stuff that isn’t so good!) Once an inventory is complete (i.e. in 2008), a growth and yield model is used to estimate the baseline that would have existed in the prior year. That becomes the starting point from which annual growth increments are estimated. The 2008 inventory gives 2008 numbers, then the model is used to generate 2009 and 2010 estimates. (If the model only works in 10-year increments, take that amount of change and divide it by 10 to get an annual average change estimate.) The intention is to “true up” the model estimates by doing a second inventory in 5-10 years. Right now, with only a 2-year remainder in the CCX market period, it is not certain how/when that true-up will be required.

15. Sustainable Forest Management Projects must place 20% in Reserve Pool. If subsequent inventory reveals a decrease in forest carbon stock, project must provide additional credits to cover the loss, or use Reserve Pool. In the event of catastrophic loss, owners liability is limited to the credits in the Reserve Pool. If forest land is sold or purchased, the allowable carbon stocks will be adjusted to the new land area. Landowner agrees to maintain forest certification for 15 years and keep forest stocks in the project beyond the contract period. The Reserve Pool is used to cover small, unintentional shortfalls by one or more projects in the pool. The issue of permanence is partially addressed by the agreement to maintain forest certification for at least 15 years. The Reserve Pool is used to cover small, unintentional shortfalls by one or more projects in the pool. The issue of permanence is partially addressed by the agreement to maintain forest certification for at least 15 years.

16. Harvested Wood Products Must come from sustainably managed (certified) forests. Credits are granted for the amount of wood estimated to remain in use or in landfills 100 years after harvest. Forest Service methods and tables used to calculate. For landowners, allowable credits are based on the weight of wood delivered to the sale point, by timber type. Convert from volume measures to weight if needed. Multiply by 0.5 to adjust from green to dry weight Multiply by 0.5 to adjust from dry weight to carbon Multiply by (3.67)(0.9) to convert to tCO2e (metric) In this exercise, the amount of timber sold each year (by timber type) is converted from short tons of green wood into metric tons of carbon dioxide equivalent. A very rough rule of thumb is that, for each ton of green wood delivered to the mill, there will be about .8 tons of carbon dioxide equivalent. There are examples of this calculation in the CCX protocol, as well as in the DOE 1605(b) guidelines. Where landowners sell timber in volume amounts (MBF, cords, etc.), the volumes must be changed to weights before using the formulas above. Examples and tables to assist this are contained in the CCX protocol. In this exercise, the amount of timber sold each year (by timber type) is converted from short tons of green wood into metric tons of carbon dioxide equivalent. A very rough rule of thumb is that, for each ton of green wood delivered to the mill, there will be about .8 tons of carbon dioxide equivalent. There are examples of this calculation in the CCX protocol, as well as in the DOE 1605(b) guidelines. Where landowners sell timber in volume amounts (MBF, cords, etc.), the volumes must be changed to weights before using the formulas above. Examples and tables to assist this are contained in the CCX protocol.

17. Harvested Wood Products For landowners, multiply the tCO2e calculated times the following factors to get the 100-year credits that will be eligible (NE Example): Softwood sawlogs – 0.318 Softwood pulpwood – 0.090 Hardwood sawlogs – 0.316 Hardwood pulpwood – 0.261 To claim HWP credits, landowners should: Include a clause in their timber sale contract that reserves the carbon credit reporting rights Be prepared to provide mill receipts to document sales. CCX only credits the estimated amount of harvested wood that will still be in use or in landfills 100 years after harvest. These factors have been developed through Forest Service research, and full tables and explanations are available in the 1605(b) guidelines or in Forest Service technical publications. Forest landowners who are considering entering into a sustainable forest management project should definitely consider adding the harvested wood products portion as well. Without counting the harvested wood products, the average annual change between two forest inventories will represent the net difference between growth and harvest. In other words, the harvested wood will simply “vanish” from the landowners calculation. If they use these methods to account for it, at least they will get credit for a portion of that loss.CCX only credits the estimated amount of harvested wood that will still be in use or in landfills 100 years after harvest. These factors have been developed through Forest Service research, and full tables and explanations are available in the 1605(b) guidelines or in Forest Service technical publications. Forest landowners who are considering entering into a sustainable forest management project should definitely consider adding the harvested wood products portion as well. Without counting the harvested wood products, the average annual change between two forest inventories will represent the net difference between growth and harvest. In other words, the harvested wood will simply “vanish” from the landowners calculation. If they use these methods to account for it, at least they will get credit for a portion of that loss.

18. Role of Aggregator Maintain a database of all projects at the stand level that reflects management activities, growth and yield, and other forest details. Arrange for verification of project records and lands. Obtain CCX-required reports from landowners; submit summary reports to CCX. Assure CCX that all projects continue to meet CCX rules. Trade offset pools on the CCX trading floor; pay net receipts to project owners. The aggregator organization has a significant administrative role to assure that all projects maintain CCX eligibility and produce and protect the carbon credits that have been registered and sold. The aggregator is contractually responsible to CCX. Most aggregators will, therefore, have a contract with landowners to cover their risks in the event of landowner failure to comply. While these will vary, it is likely that landowners who decide to opt out of the contract will face a pay-back clause that protects the aggregator and, in turn, CCX.The aggregator organization has a significant administrative role to assure that all projects maintain CCX eligibility and produce and protect the carbon credits that have been registered and sold. The aggregator is contractually responsible to CCX. Most aggregators will, therefore, have a contract with landowners to cover their risks in the event of landowner failure to comply. While these will vary, it is likely that landowners who decide to opt out of the contract will face a pay-back clause that protects the aggregator and, in turn, CCX.

19. Role of Subaggregator Manage data, modeling, and reporting system required by CCX. (This is required of the aggregator; in this example, it is done by the local subaggregator) Provide data guidelines for foresters who prepare inventories for participating landowners. Provide baseline inventory and modeling results for each participating landowner, in format for creation of CCX Pool. Incorporate data updates from landowners or foresters.

20. The Subaggregator Will: Work Directly with Landowners Baseline Forest Inventory done to CCX specifications, capable of entry into Forecon model Develop forest management plan if needed Assist with Tree Farm Certification if needed Plan & manage forest harvests if needed Post-harvest cruises on partial harvests Provide data to landowner in professional format.