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Fundamentals: Scaling a Market | Scorcher

Published: June 13, 2017 by Editorial Team

Sean Penrith, The Climate Trust
Weekly Policy and Finance Update – June 12, 2017

Competitive markets, not competitive grant making.

Some seemingly well-intentioned legislators in California are contemplating an edit to the offset mechanism for the post-2020 cap and trade program without apparent regard for the vital need to harness markets. This was highlighted in a recent legislative briefing on offsets last week, which raised a common misconception related to GHG reduction project finance. The discussion posed whether or not the offset mechanism is a more effective method to leverage private finance than a new, potential alternative in which the Greenhouse Gas Reduction Fund (GGRF) make payments to “offset-like” project-types on a competitive grant basis. Grants have a needed place in the world but as a stand-alone tool do not support market scaling. Sending a long-term market price signal for verified reductions that is sector-neutral (not determined by Government in advance) empowers the offset mechanism to leverage needed private capital to deliver emission reductions for all types and sizes of projects.

Conservation finance flows are currently at $50 billion a year. We need to tap the private capital market to release at least $400 billion a year to ensure that the conservation sector contributes its part to arresting climate change. A GGRF grant program addressed at offsets on a grant basis cannot achieve this desired scale. We need to offer a solid market value proposition to the impact investment community. The cap and trade mechanism that includes the use of offsets offers an effective pathway in this regard. As managers of a carbon impact fund, we ourselves are channeling impact capital under the current cap and trade program.

Any mechanism that seeks to efficiently leverage private capital for making payments to offset project-types must send a long-term price signal that can be reliably anticipated, make payments for verified emission reductions (“pay-for-performance’), and incentivize the most cost-effective emission reductions regardless of what sector they occur in while never losing sight of how to support scale. Regardless of what sector the reductions occur in, offset funding will flow to the most cost-effective reductions available. Offset funding relies upon a market to determine which sectors hold the most promising opportunities.

GGRF funding, by comparison, is distributed to sectors through annual allocations from the legislature and must be spent within the fiscal year. This relies upon the legislature to determine which sectors hold the greatest potential. Private finance therefore must wait until specific projects and programs have been awarded funding from the GGRF (if co-financing opportunities are available and other revenue streams exist to generate a return). The quantity, timing, and structure of that funding are uncertain. GGRF funding is susceptible to auction results. Eligible projects that had already qualified for GGRF funding last year were unable to move forward because actual GGRF revenues were less than anticipated due to auction performance.

The Air Resources Board has carefully crafted the offset mechanism to leverage private finance in uncapped sectors with the greatest promise to generate real and cost-effective reductions. Redesigning GGRF to play this role will face significant regulatory and political hurdles.

With an extension of cap-and-trade that includes the use of offsets for cost containment purposes, the offset market will invest in verified emission reductions through 2030. Investors and lenders can finance projects immediately based on the knowledge that a long-term market exists for the resulting credits. This is how the market is efficiently harnessed to scale and arrest real greenhouse gas emissions from unregulated sectors.

Research and Resources

State of Private Investment in Conservation 2016
Ecosystem Marketplace, January 2017

Mobilizing Conservation Finance
The Climate Trust, April 2015

Markets vs Regulation Impacts in US
MIT Joint Program on the Science and Policy of Global Change, May 2014

Top News Headlines

USDA Announces More than $22 Million in Conservation Innovation
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Image credit: Flickr/Bemep