Legislative Action Brings Carbon Market Insurance to Forefront

National and regional action may require thousands of American companies to acquire new insurance coverage for future projects. Both the Regional Greenhouse Gas Initiative—which went online earlier this year in ten Northeast and Mid-Atlantic states—and the American Clean Energy and Security Act of 2009 (ACES)—passed by the House of Representatives on June 26—directly contemplate the need for public companies to acquire insurance for carbon offset projects.

These legislative actions underscore the need for public companies to evaluate how pending legislation will expose them to emerging areas of carbon market liability.

Since the Kyoto Protocol went into effect in February of 2005, insurance companies have been offering various products to manage the risks associated with carbon market participation. AIG, Zurich North America, Alliant Insurance Services, RNK Capital LLC, Swiss Re and others have developed carbon offset insurance to manage Kyoto Protocol-related risks in carbon credit transactions. These risks can be especially pronounced with novel technologies such as geologic carbon sequestration (e.g., capturing carbon dioxide gas present in the atmosphere and storing it in geological formations below the Earth's surface), where investors may be uncertain of the project's ability to deliver the expected credits.

Although these insurance products have been designed for Kyoto Protocol projects, emerging cap and trade regimes such as RGGI and ACES create the need for similar insurance products in the United States. For example, under the RGGI model rules, carbon sequestration projects are subjected to a mandatory 10 percent discount on carbon offset calculations to guard against the long-term escape of sequestered carbon. This discount may be avoided, however, if the project sponsor retains long-term insurance guaranteeing the replacement of any lost sequestered carbon for which offset allowances were awarded.

More significantly, ACES mandates that carbon sequestration projects guarantee against future loss of sequestered carbon and potential long-term consequences of the sequestering process. Specifically, the EPA must prescribe a mechanism to ensure that any sequestration project for which an offset credit is issued results in a permanent carbon offset. H.R. 2454, 111th Cong. § 734(b)(2) (2009). Among the allowed mechanisms is insurance. Id. And a separate provision requires the maintenance of some form of long-term insurance for emergency and remedial response at the site of the geological sequestration well. H.R. 2454, 111th Cong. § 813(e)(2) (2009).

Both RGGI and ACES have the potential to substantially alter how fossil-fuel-burning electric utilities and large factories such as oil refineries, cement, iron, steel, paper, and glass plants and other carbon-producing industries do business. In fact, the Congressional Budget Office estimates about 7,400 facilities nationwide would be affected by the cap-and-trade programs in ACES. For these businesses and others, carbon offset insurance products may become necessary elements of sound long-term financial planning.