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Renewables and Carbon Markets

Allowance structures will influence project economics.

Fortnightly Magazine - May 2009

Carbon-reduction policies are being designed and implemented across the country. Currently, 24 states are moving forward with carbon regulations and the U.S. Congress might pass comprehensive climate-change legislation during this legislative session. One common feature of these regulatory programs is a carbon cap-and-trade system— i.e., a carbon emissions market.

Renewable energy clearly will affect, and be affected by, carbon-reduction policies that assign a price to carbon emissions. The most probable and direct benefit will be the increase in electricity prices caused by carbon-related costs, which would make renewable energy more cost competitive. The degree to which carbon costs affect electricity prices will depend on the confluence of political choices ( e.g., setting the level of the cap or allocating compliance targets among regulated sectors) with various regional market situations ( e.g., the generation mix and electricity market structures). Regardless of regional differentiation, carbon costs will move forward the timing of grid parity for renewable ßenergy applications. For utilities, renewable energy can aid in potential carbon compliance costs by providing zero carbon generation.

Renewable energy installations also will be affected by the ability to participate in carbon trading. However, precisely how and whether renewable energy installations will be able to trade carbon assets often is misunderstood. In many respects, this confusion is tied to the vernacular of carbon markets and the difference between carbon assets.

Renewable-energy installations will not be allowed to generate and sell carbon offsets from displaced conventional power generation under a system-wide carbon cap. These same installations could, however, receive carbon allow-ances akin to a subsidy that then could be sold on the open market. The elemental difference between the two is how each carbon asset is created.

This issue is not as pedantic as it seems and could result in flawed assumptions about future economic benefits accruing to renewable energy facilities. How each asset is created influences the risk factors affecting its future value, and therefore is important to investors and developers considering carbon revenue for renewable energy projects. Carbon revenue stemming from an allowance allocation represents a policy risk similar to what happens with other subsidies such as the federal tax credits, and therefore should be discounted accordingly.

A cursory examination of this complex subject can help to clarify some of the issues surrounding the intersection of renewable energy’s place in carbon markets.

Two Types of Carbon Assets

GHG regulations that rely on emissions trading will create an entirely new asset class that can be broken down into two categories—allowances and credits. A carbon credit (sometimes also known as a “carbon offset”) is a legally separate asset from allowances and is commonly defined as a quantified emission reduction stemming from the prevention, destruction or sequestration of greenhouse-gas (GHG) emissions generated from projects outside the system cap. GHG-offset credits represent tradable carbon assets that result from qualified projects that reduce GHG emissions against a predetermined baseline. Thus, carbon offsets are created as a