The driving force underlying climate change initiatives worldwide is the emergence of a lucrative greenhouse gas emissions trading scheme whereby carbon credits are becoming a market commodity for large industry emitters. As a result market prices for carbon credits are rising and creative ways to benefit from this market are emerging. But how can carbon credits be used in the leasing context? In the first of a two-part series, we will explore this issue, offer a definition of terms and raise some questions, which we'll tackle in part two.
Carbon Credits - Background
Since the Kyoto protocol was entered into force in 2005, there has been a global movement towards creating "green" and "carbon-neutral" economies by reducing greenhouse gases emissions in an effort to curb global warming. To date, 182 parties, including Canada, have ratified the protocol, including 36 developed countries that have agreed to reduce greenhouse gas emissions. For example, the European Union (EU) has committed to reduce its overall emissions to at least 20 percent below 1990 levels by 2020 by a cap-and-trade system implemented through the European Union Emissions Trading Scheme (EU ETS).
A cap-and-trade system operates by a government or international body setting a limit or cap on the amount of greenhouse gases that can be emitted. The cap will vary by industry and depend on national budgets for reaching carbon emission reduction targets (CERTs). Companies are issued allowances or credits, representing the right to emit a certain amount. Companies that exceed their emissions cap must buy credits from those who pollute less. This cap coupled with high CERTs, has created a commodity for carbon credits in Europe resulting in the emergence of emissions trading. Each carbon credit represents a reduction of one metric tonne of carbon dioxide, or its equivalent in other greenhouse gases. Similarly, Renewable Energy Certificates (RECs), are tradable commodities which represent proof that 1 megawatt-hour of electricity has been generated from an eligible renewable energy resource.
Emissions trading can occur bilaterally between counterparties or on an exchange such as the European Climate Exchange (ECX) or its sister company, the Chicago Climate Exchange (CCX). In Canada the Montréal Climate Exchange (MCeX), a joint venture of the Montréal Exchange and the CCX, officially launched the trading of carbon credits on May 30, 2008. Currently, carbon credits are being exchanged worldwide at a rate of between CAN$15-25, with projected increases as the Kyoto protocol is more widely established and the demands thereunder increase.
Status in North America
In North America, the cap-and-trade system has not yet been implemented except in a few jurisdictions. Further, those jurisdictions that have established cap-and-trade programs (such as the Province of Alberta in Canada) have adopted an intensity-based system.
This means that instead of capping the number of units of carbon industry can emit, companies will be capped based on their emissions intensity level, allowing for increases in emissions as production increases. Generally speaking, a hard cap, rather than an intensity-based one creates a greater demand for carbon credits to offset emissions and as such, the value of a carbon credit is likely to not have the same value as under a pure cap and trade system. Unlike the EU, the North American carbon market is currently a voluntary one. This means that while no national regulatory system is in place, commercial and individual customers are purchasing credits in order to lower their carbon footprint on a voluntary basis. These are either purchased directly from the stock exchanges or from companies who are in the business of buying credits that can be sold to the individual in order to offset their carbon footprint. As a result, even in Canada the market demand for credits is growing and possession of carbon credits is becoming an increasingly valuable asset for companies to acquire.
If a finance company wishes to obtain a "green" or "carbon neutral" label, then one method may be to finance equipment that will reduce the lessee's/borrower's carbon footprint and then as part of payment for the use of the equipment under the lease have the lessee transfer those credits acquired with the equipment to the lessor. The lessor could then either apply the credit to reduce its own carbon emissions or trade the credit on the market. The finance company could also be in a position to "trade" the credits themselves within their client base.
The Issue of Ownership
Under the EU ETS, carbon credits are an asset that can be traded between individuals and corporations. In the leasing context, the question becomes whether the company who leases equipment to be used for either carbon reduction techniques or green energy projects, or the lessee who undertakes those techniques or projects, owns the carbon credits acquired.
In part two of this article, we'll explore ownership issues, and take a look at the factors both lessors and lessees whould consider before taking the carbon credits plunge.