Environment: Turning Carbon Into Cash With Offsets

When foreign investors visit Suraj Wahab in the Ghanaian capital of Accra, where he manufactures energy-efficient stoves, he likes to point to a tree on the dusty roadside just outside his business's building. He tells them that before investors were willing to back him, his company's headquarters were housed in the shade of that very tree. There, he'd work in the dirt with his hands, molding household cooking stoves. Wahab's company, Toyola Energy Limited, has grown out from under the shade and into a five-building main complex with eight other factories and distribution centers around the country. He used to make just five stoves a week. In 2010 his 150 employees could make 75,000. And if this week’s Copenhagen talks have a meaningful outcome, his business could really heat up.

Wahab's entrepreneurial success is a product of the complicated world of carbon finance. Wealthy bankers at the Goldman Sachs commodities desk in New York are helping to make the Nigerian-born Wahab's dream a reality. After unsuccessfully shopping his idea around to local banks, Wahab came across E+Co, an American nonprofit company that invests in clean-energy businesses in the developing world. E+Co saw the potential for his project to generate carbon offsets, an increasingly valuable commodity that corporations purchase to help neutralize their own emissions. Toyola's stoves usually replace older ones that burn wood and charcoal less efficiently and that pollute the homes of Ghanaians and release greenhouse gases. Each stove that Wahab sells to replace less-efficient one prevents the release of about the same amount of greenhouse-gas emissions over its useful life (about three years) as is released by driving a Honda Civic for one year. That reduction in carbon emissions is then monetized and sold as an offset. And in this case, the offsets are being snapped up by Goldman Sachs.

At present, it's difficult to determine the size of the U.S. carbon-offset market. Goldman Sachs estimates put it at between $100 million and $130 million a year. But, with emissions-reduction plans working their way through both the U.S. Senate and the United Nations Climate Change Conference, the market is set to expand rapidly. Forecasters such as New Energy Finance and Point Carbon anticipate that with regulation, the U.S. cap-and-trade market could balloon to anywhere from $300 billion to $1 trillion.

Offsets are currently a voluntary purchase in the U.S., unlike in Europe, where cap-and-trade laws limit greenhouse-gas emissions and force polluters to offset their consumption by purchasing carbon credits. So why would U.S. firms buy carbon offsets now? Their motivations are partly altruistic and partly commercial, says Gerrit Nicholas, head of the North American Environmental Commodities Sales Team at Goldman Sachs. Companies can claim a premium on products billed as "carbon neutral." Some like to create a green brand image, while others have corporate social-responsibility objectives or plans to achieve carbon neutrality simply out of good will. But for big energy companies that see regulation on the horizon that would potentially burden them with an enormous carbon liability, the main driver is cost. "If you expect [prices] will change once regulation comes into effect, you can buy something at a fraction today of what it might cost you even a year from now," says Nicholas. He anticipates that once regulation is in effect, demand for offsets like those offered by E+Co will rapidly outstrip supply.

Where Toyola's stove business differs from most carbon-offset projects is that it has "co-benefits," an industry term meaning that the project has other positive development outcomes. According to World Health Organization estimates, more people in the developing world die each year from conditions related to indoor air pollution—mostly from inefficient, solid-wood-burning stoves—than tuberculosis or malaria. In Ghana, about 85 percent of the population is exposed to indoor air pollution. Although Toyola's stoves still employ traditional cooking techniques, their efficiency means a dramatic reduction in smoke and a marked improvement in air quality.

Toyola's stoves are also efficient to manufacture. They're made largely from scrap metal clipped off the edges of steel roofs at construction projects across Ghana. Wahab has dozens of scouts collecting the scraps for use in his plants. Competition for the metal has become so intense that some of his workers, who are paid by commission, literally catch the falling steel as it is snipped from buildings.

And the product comes cheap. Toyola sells the stoves, which cost about $7 to $10 to manufacture, to Ghanaians at just above cost. E+Co estimates the useful life of the stove to be three years, and that each year the stoves reduce about 0.8 tons of greenhouse gases. That means, depending on the price of carbon, that each stove generates more than $20 of carbon value. Once Goldman Sachs purchases its first batch of offsets from E+Co—likely in the first quarter of 2010—every stove owner will receive a rebate, which means they've ultimately spent less than the stove costs to make. As the project continues, the rebate scheme will be eliminated and the stove price will simply drop, as each stove's carbon value outweighs the cost of manufacture. "If you have the right financial mechanisms in place, you can drop the price as low as you want and still make money," says Erik Wurster, carbon finance manager for E+Co.

Unfortunately, though, small-scale projects like this are relatively rare in the world of carbon finance. "Kyoto has been great for selecting projects that do a really good job of curbing greenhouse-gas emissions, but they don't always do so well at abating poverty," says Wurster. When seeking offset projects, cap-and-trade systems naturally tend toward those with the lowest marginal cost, which often end up being large-scale initiatives, like overhauling industrial gas facilities or capturing methane from sewage plants. "These things are very good for general infrastructure, but tend not to trickle down to the poorest third of the world's population in terms of everyday benefits and quality of life," says Wurster.

The fate of many of E+Co's projects is linked in many ways to the outcome of this week's Copenhagen conference. "In the absence of some sort of legislative or regulated framework, you don't have demand for these products. Copenhagen is all about creating a global consensus around what that framework should be," says Goldman Sachs's Nicholas. "For a small group like E+Co, which is doing extraordinary things, that means that you're providing that necessary stimulus, that requisite incentive, that enables investment." And what does Goldman Sachs get in return? "A highly salable financial asset that didn't exist three years ago, and they get to say that they are investing in something that gives back to the world's poorest people," says Wurster.

As for Wahab, he's got a thriving business. But he doesn't just sit in his office making calls all day. He still gets his hands dirty, loading his pickup truck and driving over Ghana's rutted, unsealed roads to sell his stoves. He's usually greeted by swarms of locals, and most times, his truck is completely empty within minutes.

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