Understand Your Carbon Credits Contracts

By James L. Pray | January 03, 2009
The recent election may clear the way for new greenhouse gas emissions legislation. This legislation may also embolden efforts already underway to convince ethanol producers to sign complex long-term contracts to trade their carbon credits. Ethanol producers should consider several important attributes of carbon credit contracts before signing. This article discusses these issues.

Brokerage or sale? Carbon trading contracts offered to ethanol producers take very different approaches. Some of the contracts are modeled after conventional brokerage service agreements. After the credit is issued, the ethanol and trading companies split the net revenues according to the agreed formula and depending on the type of credit sold. Other contracts take the "property" approach. Once the credit is converted into a tradable security it is owned by the carbon trading company. The producer is paid a portion of the proceeds when the security is sold. In the end, either approach can accomplish the same thing. However, if a party to the carbon trade fails, a producer may be in a better legal position as an owner of the credit if it is trying to get its credit back.

Contract length: Some carbon credit brokerage contracts have 10-year terms. Given the uncertainty surrounding the coming legislative debate over how carbon emissions will be regulated, most ethanol producers should avoid a decade-long contract.

Commissions: The commissions in the contracts are much higher than what are usually encountered in a commodity business, sometimes as high as 50 percent. Because this is a fairly new and evolving market, it is important for companies to carefully review these rates, especially if the contract is long term. Be sure to shop around.

Ownership of carbon offsets: Marketers of carbon credits from the ethanol industry argue that ethanol is "carbon negative" as the ethanol replaces fossil fuels that would otherwise enter the atmosphere. Until legislation or the free market adds some clarity, some carbon traders suggest that they are unlikely to buy or sell this kind of carbon credit from an ethanol producer. They argue that it is not the producer that generates the credit but the consumer or distributor who makes the decision to buy or sell the product. It is possible that future legislation may clear up this uncertainty. Until then, producers may want to anticipate future regulatory changes in the contract.

Carbon reduction technology: The sulfur dioxide and nitrogen oxides emissions trading market is a model for how ethanol producers may generate credits with emission reduction technology. All ethanol producers already have emission reduction technology in place. Some of this technology may also reduce carbon dioxide or other greenhouse gases. Note that carbon trading contracts can capture any credits generated by an ethanol producer from the use of this equipment. The availability of this credit is independent of the status of ethanol as a carbon negative or positive product.

Thus, the high commission may be unwarranted. Also, some contracts may inadvertently give the carbon credit trader an interest in certain pollution reduction equipment or give the trader the right to modify equipment. Avoid this language. Most manufacturers will not warrant the performance of equipment that is modified by third parties.

Carbon credit trading is an evolving market segment. Ethanol producers should investigate the opportunity but be aware of the unknowns.

James L. Pray chairs the environmental practice group at BrownWinick, a Des Moines, Iowa-based law firm serving the renewable fuels industry. Reach him at pray@brownwinick.com or (515) 242-2404.