CARBON On July 23, 2009 the Voluntary Carbon Standard Association (“VCSA”) announced it will allow carbon reduction projects hosted in Canada to issue Voluntary Carbon Units (“VCUs”) without a corresponding cancellation of Assigned Amount Units (“AAUs”) under the Kyoto Protocol. The decision reflects the VCSA’s belief that a regulatory framework to implement the Kyoto Protocol is unlikely to emerge in Canada and, as such, Canada is unlikely to meet its reduction commitment under the Kyoto Protocol. Consequently, this decision will allow Canadian projects to qualify for the VCS, where previously the Federal Government was not in a position to provide the assurances necessary to remove worry of double counting.

Background

Prior to this announcement, Canadian projects could not qualify for VCS projects as developers were not able to establish in the manner required by VCSA that they would not be double-counted in a Kyoto Protocol related program. That rationale was based on ensuring the integrity of the international Kyoto Protocol offset system in that no single project should be compensated with offsets twice. The program required assurances from the Canadian government in this regard which were not, as a matter of policy, forthcoming. VCSA has taken the position that, in light of Canada’s lack of a regulatory framework for implementing the Kyoto Protocol, the fear of double counting credits in the Kyoto Protocol system is not credible.

Significance for Project Developers

This decision is highly significant for private sector entities seeking internationally recognized offset credits for Canadian projects. By removing the requirement to establish that reductions are not being double counted under the Kyoto Protocol, Canadian project developers will now be able to qualify for a highly reputable carbon offset. This in turn may make their projects more attractive and thus increase interest in these types of projects, since the credibility and integrity associated with the Voluntary Carbon Standard should give them significant market value and fungibility. Given the growing demand for quality offsets, this change will enhance project development within Canada’s voluntary sphere by helping supply a domestic market that often prefers offsets created in Canada due to their additional public relations and corporate social responsibility benefits.

Some of the recently registered VCS projects include a series of methane capture projects in Brazil, a geothermal project in Guatemala, wind and hydro power projects in various regions, and biogas projects. The inclusion of methane capture projects suggests that carbon capture storage projects under research in Alberta may be VCS compatible in the future. In addition, Canadian project developers could pursue projects similar to those currently registered on the VCS registry, available at http://www.vcsprojectdatabase.org/resources/AccessReports.asp.

Effects on Existing Offset Regimes

Notwithstanding the fact that this change may incentivize increased participation in domestic carbon reduction projects, the question remains as to whether these credits will be fully exchangeable in North American carbon markets and regulatory regimes. To qualify for the VCS, an offset program must qualify under the VCS “gap analysis”, an inquiry used to determine whether other greenhouse gas (GHG) programs are sufficiently compatible with VCS to received VCUs. The VCSA standard is heavily based on ISO 14064-2 so to the extent that other GHG programs wish to qualify for VCUs, their projects will likely need to meet these requirements as well.

To date, both the federal government and the Alberta government have established the details of their respective offset systems and their particular requirements. In the recently released draft documents for Canada’s Offset System for Greenhouse Gases, it was made clear that only domestic reduction projects will qualify for Canada’s offset program and that they will be subject to significant verification requirements. The draft document “Program Rules for Verification and Guidance for Verification Bodies” emphasizes that verification must be completed in accordance with ISO 14064-3, suggesting a significant degree of commonality with the VCS and potentially a strong likelihood of offset compatibility.

On the other hand, Alberta may face greater difficulties in achieving compatibility. Although the current Alberta offset system is certainly compatible with the VCS in spirit (reductions must be real, demonstrable, and quantifiable and subject to third party verification), it may nonetheless require some modification to meet the ISO standard utilized by the VCS. It may be important for the Albertan system to seek VCS compatibility, as Canadian project developers may otherwise choose to pursue VCS offsets rather than Albertan offsets if it is perceived that they will have greater value on the international carbon market. However, it is conceivable that if the Alberta system passes the gap test, then instruments created in Alberta will have both status within Alberta for compliance purposes and be viewed as VCUs. This is important because while Albertan offsets are part of a compliance program, VCU offsets are entirely voluntary.

Consequently, project developers subject to compliance requirements in Alberta may be required to seek Albertan offsets and thus not be in a position to obtain VCU credits through separate projects. Obtaining VCS compatibility could be a significant boost to participation in Alberta’s offset program.

In other provinces, there will likely be a desire to ensure VCS compatibility. Both Ontario and Quebec have expressed a desire for carbon regulation to be harmonized with credits being fungible across regional and even international programs. In these provinces and in Saskatchewan details on offset requirements have not yet been released, leaving the possibility open that they will design their provincial offset programs in a way that can be directly imported into the VCS. If the provincial programs are indeed designed to be VCSA compatible, this could be a strong way of incentivizing carbon reduction projects by linking them to a widely recognized international program, albeit a voluntary one.

Another important consideration will be the extent to which these credits are exchangeable in the United States. Under the provisions of the American Clean Energy and Security Act (ACES), recently passed by the House of Representatives, international emission allowances will only be exchangeable if they are part of a program run by a national or supranational foreign government, impose a mandatory absolute tonnage limit on GHG emissions from one or more foreign countries, or from one or more economic sectors in such a country or countries. The American compliance market will recognize domestic offsets that may include offsets that would otherwise qualify as VCUs. It remains unclear whether Canadian projects obtaining offsets from provincial programs will meet the criteria required to be seen as qualifying international allowances. If they do not, VCU compatibility will become even more important, as obtaining VCUs through the voluntary market may be the best alternative for accessing the American carbon market for compliance grade instruments.

In spite of this limitation, VCUs remain desirable in emerging international carbon markets, even as these offsets may not be available to American entities to meet ACES obligations. In addition, it is highly likely that the Canadian federal government will implement a mandatory absolute tonnage limit on GHGs in the near future for the sake of regime compatibility with the U.S., at which point offsets under the federal program would qualify under ACES.

While some challenges exist for ensuring VCS compatibility with all the different North American offset programs, the easing of qualification requirements for Canadian projects should be welcomed by developers seeking greater access to the international carbon market as it develops.