Analysis - High California CO2 prices to spur offset scramble

LOS ANGELES, Oct 28 - California will in 2013 likely launch an emissions trading scheme with a CO2 price far higher than the EU or NZ markets, a move that could trigger a gold rush for cheap offset projects.

Under rules approved last week, companies covered by the state's scheme will be able to use carbon credits from emission reduction projects, instead of state-issued permits to cover up to 8 percent of their emissions.

Analysts say California's aim of returning state-wide emissions to 1990 levels by the end of the decade could potentially create demand for about 221 million offsets over the next 8 years.

And with Californian CO2 permit prices already fetching around $19 -- 30 percent more than prices in the EU -- the rules could spark a scramble to develop emission reduction projects that can produce credits that the state's emitters can use.

So far, eligible credits can come from four project types endorsed by regulators -- those that cut emissions of ozone depleting substances, methane from agriculture and others that store carbon in trees.

They currently fetch around $12 and are already in demand due to the $7 discount they fetch below permit prices, but the number of approved projects is set to expand.

"Yes, we do expect a significant bump in offset projects with many of the nearly 500 projects already in our system now getting the green light to go ahead to verification and lots of new projects coming in," said Gary Gero, president of the Climate Action Reserve, which approves project types on behalf of the state.

"I think the former will become quite apparent in the short term while new projects take time to identify and enter into contracts so we're not likely to see that bump start to form until later in the first quarter 2012," he said.

ENTICING

A minimum floor price of $10 a tonne at the first 2013 auction of permits will also provide some certainty for emission reduction project developers, who are having a tough time globally.

While the price of carbon offset credits that EU companies can use to meet targets hit a record low of just $9.40 last week, investment bank Barclays Capital predicts there will not be enough California-eligible credits to meet demand.

To bridge the demand-supply gap and keep compliance costs down, regulators have suggested they will allow companies to use other types of credits, a prospect that is enticing developers.

Trevor Sikorski, a carbon analyst at Barclays Capital, said the expectation that offset prices will rise in the second compliance period in 2015 and third compliance period of 2018, will attract capital to fledgling projects.

"Certainly the expectation of higher prices should encourage plenty of investment in the offset space," he said.

California officials have suggested they will allow three additional project types to count for compliance, but even if that happens, the market may still need more credits.

Chris Easter, director of the professional services group for FirstCarbon Solutions, a firm that helps others manage their carbon portfolios, said he has already seen an increase in interest from companies expected to be covered by California's ETS, and that offsets are a part of their strategies.

He said 60 percent of the companies he deals with now are looking for help with cutting their emissions on a voluntary basis, while the remainder face caps under California's system, a trend he expects to continue.

STRICT RULES

But Olga Chistyakova, a senior analyst with Thomson Reuters Point Carbon, said draconian regulations will likely hinder any kind of imminent gold rush for offsets.

The state wants buyers of credits to replace them if they later turn out to be faulty - a move that could cost them millions of dollars and drive buyers to the relative safe haven of the permit market.

She added power companies may have an appetite to develop their own offset projects, a move that has seen big utilities in Europe snap up staff from developers as they seek to cut out the middle man.

But with the price of U.N.-backed offsets on its knees and supply set to outstrip demand, investors in offsets could be looking across the Atlantic.

"It is possible that investors previously active in the CDM could enter the CA market with the purpose of using their experience to make speculative wins," she said.