Forest, Ag Project Developers See Opportunity, Concern In California ODS Offset Invalidation

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By Gloria Gonzalez

United States-based forest carbon project developers see potential for increased demand for their offsets as a direct result of California regulators’ decision to invalidate some ozone-depleting substances (ODS) offsets. But they also sympathize with their ODS counterparts over the way the regulators arrived at their decision to invalidate the offsets and expressed concern their projects could face similar scrutiny.

17 November 2014 | California regulators shook the North American carbon markets to their core with their plans to invoke the invalidation provisions featured in the state’s carbon offset program for the first time. While the affected producers of ozone-depleting substances (ODS) offsets and their allies loudly lobbied the regulators to change their minds, developers of forest and livestock carbon offsets quietly mulled what the decision means for them.

The ODS invalidation “could be the most important topic affecting California offsets right now,” said Kevin Townsend, Chief Commercial Officer of Blue Source, which develops forestry and other types of carbon offset projects. “This is immensely important for all California offset types, including forestry.” 

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 4.3 million 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) emissions reductions associated with destroying these materials in the United States and allow these reductions to be used for compliance in its program.

On Friday, the ARB decided to proceed with previously announced plans to invalidate 88,955 offsets generated from a ODS project by developer EOS Climate. This was the first instance of the regulators invoking the so-called buyers’ liability provisions of California’s cap-and-trade program that allow them to invalidate offsets found to be faulty or fraudulent and require regulated entities to surrender replacement offsets for compliance.

However, the ARB backed away from plans to invalidate 142,199 offsets generated under a project by Environmental Credit Corp (ECC). 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 operating permit issued under the Resource Conservation and Recovery Act (RCRA).

The ARB’s final determination clears the way for all but the 88,955 invalidated offsets to be returned to the accounts from which they were removed on May 29 when the investigation launched. 

A new opportunity for forestry?

ODS offsets had been the top choice for California compliance for some time as buyers were reassured by the relative ease of quantifying 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. This could encourage buyers to turn to forestry offsets, according to some developers. 

After a slow start in 2013, the ARB has now issued 6.2 million forestry offsets, accounting for nearly half of all offsets issued and about half a million more than issued ODS offsets, as of November 12. Livestock offsets make up a small percentage of the California program, with only about 665,000 offsets issued to date.

Development of forest carbon projects for California was somewhat constrained initially because the ARB rules governing these projects were incredibly confusing, especially with regard to the buffer pool and the applicability of the invalidation rules to forestry, developers explained. The ARB created a buffer pool to handle unavoidable losses caused by natural disasters such as wildfires, with the pool populated by a percentage of carbon offsets set aside each year after the project is initiated and tapped when such losses occur. And the ARB only recently amended its regulations to put the risk of invalidation on the buyers of forest carbon offsets, rather than the sellers, to ensure consistency in the liability across project types.  

“I think there was a little skepticism of forestry projects when the program first started because buyers did not understand the difference between the different types of reversals and who is liable in each case,” said Sean Carney, President of forest carbon project developer Finite Carbon. “Now buyers understand that intentional reversals are on the landowner, an unintentional reversal is on the buffer pool, and invalidation is on the buyer and they are three separate, distinct acts. Overcoming this confusion was a necessary step for buyers to embrace forestry and I think we are past it now.”

The California offset market has basically been “frozen” since the ARB announced plans to invalidate some of the Clean Harbors ODS offsets, said Steve Baczko, Vice-President of Business Development at ERA Ecosystem Services.

“Forestry hasn’t seen the benefit of this yet in the sense that the market is still not very active because people are still waiting to see how this is going to be handled,” he said. “That said, we have heard from a number of market participants be it buyers or developers that this now puts forestry on more of an even valuation of project performance.”

Blue Source did not perceive a slowdown in demand for its offsets during the investigation or since the preliminary determination was revealed, Townsend said, but he has had more conversations with clients reevaluating what the decision means and whether they want to continue to participate in the California offset market and under what circumstances. “I think it is changing the way some players in the market are thinking about this,” he said. “I think it’s a very big deal.” 

Sharing ODS developers’ pain

But even though they see an opportunity, forestry developers do not relish what happened to their ODS brethren. While not wanting to publicly criticize the ARB for fear of jeopardizing their working relationships with regulators, several project developers expressed concern about the seemingly subjective way the ARB reached its decision and the lack of transparency during the investigation process. They also expressed concerns about the possibility their projects could face invalidation for alleged violations unrelated to a project’s emissions reductions activities and whether their projects could even be managed to mitigate those risks.

The ARB indicated its final determination in the Clean Harbors investigation was guided by 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 ARB interpreted this provision as extending to the operation of the destruction facilities, meaning they must meet all applicable regulatory requirements when the ODS destruction occurs.

However, Clean Harbors handling of byproducts from the incineration process – whether in compliance or non-compliance with RCRA waste-handling requirements – appears to have no connection to offset project activities, said David Williamson, a lawyer representing verifier First Environment, which was not involved in the Clean Harbors situation.

“As an analogy, it would not be warranted under the cap-and-trade rules if ARB were to attempt to invalidate a forestry offset credit where a third-party mechanic were to illegally dispose of oil from trucks used in forest operations, or if offset credits from a livestock methane project were invalidated because of some legal violation elsewhere on the farm such as improperly applying pesticides,” he said. “Any such violations associated with ancillary activities should of course be corrected and would be subject to enforcement by jurisdictional officials, but these activities are not part of the verification process or within ARB’s invalidation authority.”

Unanswered questions 

The final determination did not directly address questions raised by developers of other project types during the public comment period or respond to requests that ARB officials offer guidance on how these projects would be viewed through the invalidation prism. For example, the ARB did not clarify whether it would automatically invalidate all offsets issued during an entire reporting period if it found what appeared to be a limited or isolated cause for invalidation.

Patrick Wood, General Manager of Ag Methane Advisors, raised the point that the reporting period for offsets from ODS projects proposed for invalidation is very short – less than one week. “However, if the reporting period for these projects were a year in length, like for a livestock project, and the permitting violations only lasted three days, it seems it would be unfair to invalidate the offsets from the entire reporting period,” he said. “We understand this is what the regulation currently requires, but also understand that (ARB) has some flexibility in implementation of the regulation.”

This question is relevant to livestock projects in the context of a manure spill, Wood said. Most large farms spread manure on many different fields via trucks and tractors. From time to time due to human or mechanical error, manure from one load on one day may spill while in transit or may be spread at the wrong rate on a field or too close to surface waters bordering a field.

In the case of the ODS projects, although the permitting violation was downstream of the project activity, it was considered related to the project because the violation was related to a by-product of the project activity, he observed. If such as a manure spill happened for a livestock project, would the ARB consider that related to the project and would the ARB invalidate the offsets for the entire reporting period or just the day when the problem occurred?

“That’s kind of the question that remains in our minds,” said Peter Weisberg, Program Manager, The Climate Trust.

For more information on forestry’s role in the California compliance market, please visit the Ecosystem Marketplace website at http://www.forest-trends.org/fcm2014.php  on Friday, November 21 for the State of the Forest Carbon Markets 2014 report. If you are located in or visiting the Washington, D.C. area on Friday, we invite you to join us for our launch event at the World Bank at 4 p.m. We'll present findings from the report, followed by commentary from an expert panel. Forest Trends' President Michael Jenkins will moderate the discussion. If you plan to attend, please email Ben McCarthy at bmccarthy@ecosystemmarketplace.com with your RSVP (please include your name and organization). Details will follow.