We had a chance to connect with Logan Downing from Carbon Assessors to discuss some hot button topics in western Canadian carbon markets.
What is Carbon Assessors and how did it start?
Carbon Assessors is an intelligence company that helps to demystify the various compliance carbon markets across Canada and was founded by a group of individuals who recognized the opportunity carbon markets present. My background is in refined products trading and marketing and the rest of our team is comprised of individuals with experience in physical commodities. To give some perspective, in Canada alone, there’s about 43 billion liters of product that’s moved physically every single year. Now that’s around 250 different sale point locations so, you have to have the right market incentives, right market structures, price signals – what I like to call market infrastructure. None of this exists in the carbon markets. That’s what our team likes to do – creating market indexes and providing research and consulting services to help these markets work more efficiently. We take a traditional approach as we look at the markets from a physical commodity trading perspective. That’s a competitive advantage for us as we’re predominantly competing against think tanks, academics and environmental scientists in this space who don’t have the same commercial background.
Why do you think carbon markets are so difficult to penetrate and understand? Is there a reason they’re so opaque?
First, there’s currently about 10 different carbon markets across Canada all with different rules and regulations. They’re not fungible, they’re regional and they’re immature. They require a lot of economic experience in order to navigate as well as a good understanding of the regulations.
Second, is that carbon is a very difficult thing to embed into our market-based system which is predicated on direct value-add. This is an externality that we’re trying to price into a market system and it’s very difficult to do. If you do it poorly, it turns into a retarder on your economy without providing any benefits. If you do it well, you can help reduce the amount of inflation that this causes, and you can bolster some innovative products that reduce the carbon intensity of fuels and different things. So, it’s tricky to get right and two levels of abstraction make it difficult to understand because it doesn’t have that physical commodity, tangible value component to it.
That said, do you think there is an opportunity here?
Yes, absolutely. The hallmark of new markets is the inefficiency. If you showcase the opportunity in the spreads, then you have more actors step in. What we see in the compliance credit space is there’s aggregation possibilities. If you aggregate various small tranches of credits, and you earn your cut on that and you go and sell it to a large integrated company – that’s one way that folks make money. There’s also brokering. There’s the production of credits or offsets which can be sold. There are all sorts of engineering services that will be required to do natural reductions on facilities and all the technical trades required to implement that. Then, on the voluntary side of things, there is the production of offsets to then take it and market and sell the spreads. So, there are lots of revenue opportunities. Our goal though is to make sure that the markets operate efficiently. We’d like to see those spreads narrow and for this to look more like a commodity every year.
For those people who don’t know, what is a compliance credit and how does it differ from a voluntary credit?
The compliance markets are government mandated or regulatory in nature. I like to think of them as high quality and expensive. The government, through their carbon tax and through the pollution pricing framework, can basically create a government mandated contango. In trading terms, that just means the future price is higher than the present price, which causes a lot of different distortions. But the fun part is it is increasing the price for compliance markets, which is increasing supply. This forces the government to tighten rates in the carbon market so that we meet those price signals that the federal government wants us to backstop. Voluntary markets fall under what I like to call “social license to operate” and are not mandated or regulatory in nature. They are effectively a voluntary way for actors to participate in carbon reductions. For example, if you made a public target to meet net zero, but the engineering reality of it is pretty difficult, you can go out to the voluntary market and buy offsets so that you can then claim your net zero obligations have been fulfilled.
If supply is constrained, are you seeing derivative products being created in respect of those compliance credits yet?
I haven’t seen carbon derivatives yet in Canada. I think there’s been attempts, but there’s some more preliminary steps that have to be made to do so. If you don’t have a screen on over the counter (OTC) transactions, it’s pretty hard to create any instruments. And then there’s not even a spot index or even a monthly spot price to point to. We do price discovery to create a public spot price in Alberta. It’s all about the foundational elements – if you don’t have an OTC spot price, well, it’s going to be hard to do anything else. Once that’s in place, then the next conversation is some kind of futures contract but we need more market sophistication before that can be successful.
What are the major hurdles for any organization that might not know the ins and outs of these markets?
It’s always starting with where your position is today. Understanding if you are net long or net short. Even if you’re not engaging in these markets, you should understand if you will be net long or net short in the future. Likewise, you may have a position and not know it, smaller facilities can typically opt into participating in these markets even when not mandated. It’s just a function of do you know that or not. If you know that you’re short that means you probably need to start working with your internal engineering teams to figure out natural or organic ways to reduce emissions. And then again when they start to hit plateaus or cost curves that require increased carbon tax price to initiate them. Until that point you then can go to the marketplace to buy offsets within the compliance system. You’re going to have to get embedded with the marketplace and understand who the actors are, what they’re worth, what their positions are, get familiar with the regulations, which are substantial, just because it’s a new market. These are not obvious commodities.
There’s also the transaction component of this, including figuring out who your direct counterparty could be and how to mitigate any kind of risks with these instruments. The compliance market is a little more safe from the transaction perspective, just because you’re dealing with local counterparties and they’re usually pretty large. This is in comparison to the voluntary market, where it’s global actors of all scale and all levels of due diligence. Voluntary is a bit more of a low trust environment. Compliance is a little higher. Helping navigate these issues are all services that Carbon Assessors provides.
What are two things that you think producers should be aware of in this market?
Quality is a really important feature to the environmental market across the board. Again, compliance markets are a lot more regulated, so you can be surer of the quality, and you can also get invalidation insurance. If they step into the voluntary markets, they need to be very mindful of quality. If you can demonstrate quality, you can receive almost two times the price that you’re going to receive. If you can’t and its poor quality, then it’s going to be a lot less. There’s a lot of associated branding issues with that. If you buy poor quality units and you get caught with that, people will accuse you of greenwashing and they will go public with it. There’s precedent for using consumer protection regulations to sue companies. We always say just start early. Now is the time to start. If you start now, there’s many ways outside of just purchasing offsets from the marketplace that you could leverage to essentially manage your environmental exposure. And we’re happy to work with clients to navigate those.
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