Can Carbon Credits Slow Global Warming?

Legal limits on greenhouse-gas emissions are coming fast, with a $1 trillion carbon market emerging. At the core: A cadre of young, idealistic Yale forestry grads. But will carbon offsets do anything to slow global warming?

Camille Rebelo talks fast, with an intimidating British accent. The Kenyan-raised daughter of an Indian father and English mother, she's back from Indonesia and on her way to Mozambique when we meet at a coffeehouse near Yale University, where she earned a master's from the School of Forestry & Environmental Studies last year. Rebelo's devotion to tropical forests dates to her gap year after high school, which she spent doing wildlife surveys and sleeping in a hammock in Belize. "I went to university to study biology and figured I wanted to be back in a forest as soon as possible," she says.

But today she's no pith-helmeted biologist or furry eco-warrior eking out a living at a nonprofit. Instead, Rebelo has joined an elite for-profit field that barely existed eight months ago: carbon forestry. "I focused my courses at Yale around independent studies to look into this stuff," she says. "Back then, in 2005, it was still unknown." Now, "it's growing like crazy, and pretty much any forestry student you speak to at the moment wants to do [carbon credits]." In fact, a network of recent Yale forestry grads like Rebelo, many of them with joint MBAs, have been finding careers in the unlikely worlds of hedge funds, private equity, asset management, and corporate consulting. They are exerting tremendous influence over the brand-new market in greenhouse-gas credits, which is projected to reach $1 trillion in the United States alone. The work is prestigious, it's trendy, and it's surprisingly well paid. "I'm making five times what I ever thought I'd be making as a tropical forester," Rebelo says.

The word "forester" evokes a spotted-owl census taker or maybe Julia Butterfly Hill camped in a redwood. And in the course of its history, stretching back over a century to the early days of the National Park Service, Yale's School of Forestry & Environmental Studies (FES) has pumped plenty of those types out into the world. But as another recent grad explains, "There aren't nearly as many communists in the forestry school as there were 20 years ago." Maybe money really does grow on trees.

"Capitalism, long the alleged enemy of the environment, is today giving new life to the environmental movement." That was one of California Governor Arnold Schwarzenegger's applause lines at a speech he gave at Yale this past April. It's also the basic philosophy behind cap-and-trade policies -- that government should set the rules and step back, letting a market emerge, as the best way to fight global warming.

The theory is that the invisible hand of the markets will find the fastest, cheapest, most efficient way to make the necessary reductions in greenhouse gases. Under a cap-and-trade system, pioneered in the United States for acid rain, a government sets a national ceiling on emissions (the cap), which lowers annually. The clever CEO will, in principle, figure out a way to reduce her company's emissions to below her allotment. By carefully measuring how much carbon dioxide she's saving, she can sell the difference to someone who is unable or unwilling to meet his own goal (the trade).

In Europe, legal limits to greenhouse gases were put in place under the United Nations' Kyoto climate treaty, which the United States refused to sign; the resulting cap-and-trade market, launched in 2005, is the world's biggest. No such cap exists in U.S. law -- yet. But with both John McCain and Barack Obama publicly endorsing cap and trade and several bills circulating in Congress outlining different models, U.S. companies are beginning to see that legal limits on carbon are simply a matter of time. Looking to shape national policy, a coalition of powerful corporations -- heavy hitters such as Alcoa, BP America, GE, and Shell -- have formed the United States Climate Action Partnership, joining with big enviro organizations to lobby for cap and trade. To get a jump on potential liability, U.S. companies are buying carbon credits in anticipation, creating a voluntary carbon-offset market here.

The likes of Goldman Sachs, JPMorgan, and Morgan Stanley, along with specialized environmental-investment firms such as EcoSecurities and Natsource, have begun buying, selling, managing, and advising on hundred-million-dollar portfolios of carbon-offset projects. They're developing an array of sophisticated financial instruments that can be bundled, sliced, and swapped -- with each transaction bringing in a tidy fee. U.S. trade in offsets doubled in 2005 and 2006, and nearly tripled in 2007 to a total of $330 million. The worldwide market in carbon, dominated by Europe, already tops $64 billion.

In the speculative frenzy of a market like this, just as with the dotcom boom 10 years ago, the paradox is that the leading experts tend to be kids in their twenties fresh out of grad school. While Michigan's and Duke's programs are players too, Yale grads are at the top of that list. "When I go to these carbon conferences, if eight names are mentioned, maybe six of them are joint degree or FES," says Radha Kuppalli, a 30-year-old Yale FES grad with an MBA. Kuppalli's career stretches back about as far as the carbon market itself. Just out of college in 2002, she worked at Natsource, where she helped write the World Bank's official annual report on the carbon market. "Back then, it was small enough that you could follow every single trade," she says. Now, she tells me with a wide, excited grin, "we're really market leading -- we're making this stuff up as we go along."

The idea of carbon credits can be traced through a single corporation, AES, one of the world's largest power companies. Back in the late 1980s, AES began planting trees and preserving existing forests in Central America, and calculating the CO2 that would be absorbed from the air as a result. "We did those as social-responsibility projects," says Bill Lyons, now president of AES's Climate Solutions Business, "before Kyoto was a twinkle in anybody's eye." By last year, the company had entered into a partnership with GE to bring the largest single portfolio of carbon credits to market: 10 million tons, expected to grow to 34 million by 2012. The credits come from offset projects around the world, including trapping methane from animal waste, landfill gas, and palm-oil mill effluent; lighting efficiency (in India); and coal-mine ventilation (in Africa and Asia). "We view this as a long-term business," Lyons says.

How does a lagoon of cow manure become a ton of internationally tradable carbon? Through a combination of experimental finance and experimental project development -- all dreamed up and implemented by supersmart, often Yale-trained, ecologists. Rebelo, for example, works as an independent consultant for power and timber companies. Her clients are buying or planting huge tracts of trees, calculating the amount of carbon they absorb from the atmosphere each year, and then certifying that "removed" carbon as credits, one ton at a time. "My role is the carbon," she says. "I do all the baseline studies, put the methodology together, and do the monitoring and documentation required for certification."

The trickiest part comes in the third-party verification, to which all such projects must submit. In setting the "baseline," Rebelo must prove that the tree she's "saving" would otherwise be cut down. She must also somehow ensure that saving one tree won't lead to two trees being cut down somewhere else and that a tree she is saving one year won't burn down the next. Such assumptions suggest why some observers distrust the offset concept altogether: There's a lot of room to fudge.

Yale forestry grads didn't go from counting Ponderosa pines to pricing risk overnight. They needed shrewd businesspeople to open their eyes to the larger opportunity -- people such as John Forgach. A Brazilian millionaire with a courtly manner, Forgach spent three years teaching at FES, just as the international carbon market was heating up, and his classes, especially a business-plan class he taught with the former head of private equity at JPMorgan, were oversubscribed. He was considered a "bit of an itinerant preacher," as one of his former students puts it, whose sermons focused on the glories to be won by combining environmental expertise with financial acumen. And through his connections in international finance, industry, government, and academia (he has also taught at the London School of Economics and Madrid's Instituto de Empresa), Forgach helped get a few dozen students, including Kuppalli, jobs or internships. The FES and joint-degree MBA grads who sat in his classes are now in Argentina, Brazil, Ecuador, Indonesia, Papua New Guinea, and South Africa, brokering carbon deals.

Forgach traded oil before he traded trees. In fact, he made millions selling oil and petro-products all over West Africa, so it should come as no surprise that his interest in carbon is more than ecological. Still, he has abundant charisma and enough lefty patter to win over most Yalies. (Full disclosure: I too graduated from Yale, but not the FES.) "I was a philosophy student in Paris in '68, on the barricades," he tells me over lunch at an Indian restaurant. "Then I went to Harvard for my BA; we invaded the administration building and set on fire a few other things." Unlike most counterculture heroes, Forgach studied finance with John Kenneth Galbraith and government with Henry Kissinger, and moved on to a post in commodities trading with the famously Clinton-pardoned Mark Rich, leaving before there were any indictments. "I come from a very old European family," he says. "They paid for my education, but my fortune I made myself under the old moral standards -- meaning, you take the most advantage of all the hanky-panky in business and government."

In 1994, ensconced in his estate on Lake Geneva, Forgach had a midlife crisis. He'd discovered that "my friends were just friends of my assets," so after nearly 30 years as an expatriate, he returned to Brazil to devote himself to his passion for tropical birds. While founding sanctuaries for macaws rescued from international trafficking, he discovered the still-nascent concepts of sustainable forestry and environmental investing, and ended up managing the first World Bank biodiversity venture fund. The plug was pulled at the start of the Iraq War (thanks, he says, to "that ass in the White House"), but immediately afterward, his friend Gus Speth, the dean of Yale's FES, offered him a teaching fellowship. "My job was to be a trampoline for these students," Forgach says. "Before, the environment-school guys would graduate as biologists in the fields with the butterflies. And the business-school guys, all they wanted to do was make a killing at a hedge fund and buy a house in Greenwich. This program put a heart in the business executive and a head on the forestry-school guy."

Forgach himself seems to possess both a head and a heart, but ultimately, he emphasizes, he's a banker. "My argument is that we in business are the best equipped to handle these issues. The environment was much too serious a business to give to a bunch of bureaucrats who couldn't get a job in the real world," he says. "And I have a big bone to grind with [nonprofits]. They are interested in doing Indiana Jones in the forest, which is much more fun than shaping consumer opinions."

It's no surprise that his former students volunteer statements such as, "I don't think wealth is inherently bad. I philosophically feel like, unless markets value the environment, it will be destroyed," as Kuppalli puts it. Says another Forgach disciple from Yale, now in private equity: "True sustainability has to depend on economic performance."

Forgach helped goose the growth of the carbon market by populating the field with like-minded, energetic evangelists. And then he followed them back into the marketplace. "I was getting bored [at Yale]," he says, "and I was getting poor." When Baker & McKenzie, a leading international law firm, came to FES on behalf of a client looking for experienced environmental executives to start up a carbon business, Forgach stepped forward. He's now the chair of a private-equity firm, Equator Environmental, with a $170 million fund for sustainable forestry assets, including carbon credits from timber. "These guys half my age said, 'The environment? This is ninny business for faggots and fairies. For girls.' I said, 'No, this is the future. If you don't do it, you'll be out of business.' "

With sons and daughters of Eli at the heart of the emerging carbon markets, one of the clear beneficiaries is Yale itself. While Harvard may lead its rival in the size of its endowment, Yale has staked a claim as the green Ivy of the future. The school has a brand-new Center for Business and the Environment and a high-profile campus-sustainability initiative, and president Richard Levin is being honored worldwide as an environmental leader. Yale's new philosophy could be summarized by the title of the best-selling book by Daniel Esty, founding director of the Center for Business and the Environment: Green to Gold. (Esty himself serves as a paid consultant for corporations such as BP, Coca-Cola, Honeywell, Shell, and Unilever.) "Our program at Yale reflects an understanding that the critical point of leverage for management of natural resources is the business world," Esty tells me. "I think it's very exciting to see how students are jumping right into that space."

Katherine Hamilton (FES class of '06) is the carbon-market manager at financial-information firm Ecosystem Marketplace, the Bloomberg of the carbon market. Kevin Tidwell ('06) is an associate at the Global Environment Fund, which is making several $30 million to $60 million investments in South American and African forests. Marc Hiller ('07) works for a $500 million shop called International Forestry Investment Advisors. Bo White ('09) has researched forest-carbon-credit proposals for Papua New Guinea. Monica Araya, who earned a PhD from FES in '06, is now at $1.5 billion Climate Change Capital. The list goes on.

A whole generation of Yale's leading young environmentalists are becoming investors and analysts, with a faith in the power of capitalism that seems as idealistic as their passion for nature. "I love trees; they're so tangible!" says Kuppalli, who is now the U.S. director of New Forests, an Australian investment-management firm with $350 million in assets and capital commitments that develops carbon credits and other revenue from forests. "You can go somewhere and say [clapping her hands], 'There's my forest! There's my carbon!' "

For some, though, doubts have begun to seep in about what exactly their impact is. "Everyone can agree that maintaining forests is good for biodiversity, good for climate change; it's like apple pie," says Lex Hovani ('06), who is helping to create a national forest-carbon-credit program in Indonesia for the Nature Conservancy. "But then when you get into the details, people are starting to realize they're not always talking about the same thing."

The uncertainty looms especially large with forest-preservation projects. Under existing UN standards, you can create carbon credits by raising plantations of trees, as Forgach's firm is doing. But the destruction of the world's existing forests, particularly tropical forests, accounts for some 20% of greenhouse-gas emissions. So this past December, at the UN climate negotiations in Bali, a consensus coalesced around a proposed certification standard called Reduced Emissions from Deforestation and Degradation, or REDD. A REDD project involves buying forest land in a developing country, or making a deal with its owners, and creating a nature preserve. You attempt to prevent logging or slash-and-burn agriculture by hiring guards or offering the locals a better living doing something else. Then you sell carbon credits based on the deforestation thus avoided. The UN estimates that the market for REDD credits alone could reach $100 billion. According to a 2006 U.K. study, just 1.5 acres of tropical forest land could be worth as much as $25,000 in carbon credits at a CO2 price of $35 to $50 a ton. (The E.U. market price in May was $39.)

Forgach would prefer to see his trees turned into "fungible" carbon credits without a lot of regulatory hoo-ha. "I think forestry is a utility," he says. "Forest investments are tainted by NGOs that show the butterflies and the naked Indians." For others, though, the butterflies and natives are as much the point as global warming. Tropical forests are the world's richest centers of biodiversity, and more than a billion of the world's poorest people rely on them for fuel and food. Should REDD certification include requirements for biodiversity and sustainable development alongside carbon limits?

Rebelo believes so. A project she's working on in Mozambique includes training locals in forestry and providing seedlings for villagers to cultivate for firewood. "I'm doing what I've always wanted to do," she says. Yet she acknowledges that since the REDD discussions in Bali, new projects have been popping up so fast -- with locals and investors impatient to make money from carbon -- that well-rounded development programs are harder to execute. "It was all ass backward," she says. "It all just moved really fast." Today, she's helping to manage and develop more than 750,000 acres of forest in Indonesia and Africa for various European companies and nonprofits. "We're seeing a big series of field expansions -- massive projects all over the world. Between January and the end of March, I don't think I spent more than seven nights in one place."

The United States is responsible for about a fifth of the world's greenhouse-gas emissions. A serious carbon cap here at home -- 80% below 1990 levels by 2050 is widely considered the minimum to avoid the worst consequences of global warming -- is therefore crucial. Yet the rising clamor that we do something, anything, about greenhouse gases has swamped debate about what that something should be. The success of the American cap-and-trade system for acid rain is held up as proof that market dynamics can take care of our global carbon problem. But there are differences between acid rain and carbon.

The system for acid rain worked in part because the trading of credits was limited to a set of industrial polluters in one country. They exchanged permits to emit the gases among themselves -- and under the auspices of a then-powerful Environmental Protection Agency and effective courts. In other words, it was more or less a closed, monitored system.

But global warming is, of course, a transnational problem. And the attempt to create a global carbon market by using offsets in developing countries makes the whole system infinitely more porous. Even assuming that new emission standards are laid down here in the United States, allowing companies to outsource their compliance to the planet's hinterlands means that we are making rules vastly more difficult -- if not impossible -- to enforce. As Rebelo says, "These are all developing countries with poor governance structures and a lot of corruption."

Plus, the more offsets a company like AES creates in faraway lands, the less it invests in upgrading or replacing its coal-fired power plants here at home, as it might if it had to pay a carbon tax or reduce its emissions directly. That's why rich corporations are so interested in offsets in the first place -- they're less of a threat to business as usual.

The clock is ticking. The Intergovernmental Panel on Climate Change (IPCC), the scientists who along with Al Gore took home the Nobel Prize last year, are saying we have until 2009 at the latest to put a serious curb on emissions. That's next year. In Europe, where they're still tweaking the cap-and-trade model after three years, the scheme has not significantly cut carbon emissions; the price of carbon even crashed in April 2006, partly because too many credits were handed out.

It should be cause for concern that not a single person interviewed for this article, on either the investment or the carbon-project side, would assert with confidence that the rules currently being written for a U.S. cap-and-trade market will actually reduce overall carbon emissions. When it comes to carbon forestry especially, the simple economics just may not work out. "People are suddenly starting to see that carbon forestry is not the silver bullet," Rebelo says. "There's this big idea that it's going to save the world's forests, and I don't think it is. Carbon credits are one revenue stream among many. It's never going to counteract logging or oil-palm conversion." China, for example, is leveling Southeast Asian rainforests and planting oil-palm plantations to feed its ravenous appetite for biofuel. "I was looking at a potential project in Papua New Guinea," Rebelo explains. "Carbon credits could produce maybe $100 to $150 per hectare per year versus logging at $500 to $600, or conversion to oil palms, which is even higher."

"I haven't seen meta-analysis that says, 'Yes, this is working,' " says Bo White, who is founding a new company with Rebelo and another FES grad to sell carbon offsets to U.S. consumers. "I think it's really important to find ways of determining if these markets are actually helping the problem or just transferring money from here to there."

When Schwarzenegger was asked to speak at the Yale Conference of Governors on Climate Change in April, the occasion was billed as a "celebration of state environmental leadership." In the end, though, it became as much an indictment of the federal government's failure to act on global warming. For all of Schwarzenegger's free-market nods, California's environmental success has hinged on tough, activist regulations that forced businesses to adapt -- and not the messy, self-interested dynamics of a market. Markets may be the most powerful forces in our society, but they are hard to control. The long-term impact of a market in carbon is impossible to predict.

Yet that seems to be the only course offered by our national leaders. Today, the smart money is anticipating a legal carbon cap and thus a formal U.S. offset market not long after 2010. That transformation can only be compared with what started when Anthony Lucas struck oil at Spindletop a century ago. That black gusher eventually gave birth to the world's biggest multinational corporations; this green version is set to transform not only the energy sector but the way business is done, period. Here's hoping the kids at the core of this new green market, from Yale and elsewhere, figure out how to make it work.

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