World Energy Prepares for Nation’s First Carbon-Allowance Auctions

5/19/08Follow @wroush

A Massachusetts energy-trading startup is gearing up to host the nation’s first auction for greenhouse gas emissions allowances. The details are still being worked out, but if all goes according to plan, World Energy Solutions (TSX: XWE) of Worcester will conduct the online auction—in which power-plant owners will buy and sell the rights to emit certain quantities of carbon dioxide into the atmosphere—on September 10.

Carbon-emissions auctions aren’t a new concept. A carbon trading market has been in operation in the European Union, where most member states are Kyoto Protocol signatories, for three years. But greenhouse emissions trading is an untested idea in the United States, where the federal government has so far failed to enact policies limiting emissions of carbon dioxide and other gases that contribute to global warming. This federal inaction has led some individual states and regions to come up with their own ways to reduce CO2 emissions. And we live in one of them: Massachusetts is one of 10 Northeastern and Mid-Atlantic states participating in the Regional Greenhouse Gas Initiative (RGGI), which is about to impose a cap-and-trade system that will force the region’s power providers to either lower their own carbon emissions below pre-defined limits or buy enough carbon “allowances” from other plant owners to cover their excess.

A key premise of cap-and-trade schemes is that they’re more efficient at reducing emissions than rigid pollution caps, since the opportunity to sell carbon allowances gives companies an incentive to get below their own emissions cap by innovating—for example, by installing better pollution-control equipment or switching to non-fossil-fuel energy sources. A national cap-and-trade system for sulfur dioxide emissions, run by the Environmental Protection Agency, has brought about drastic reductions in acid rain, at a cost-per-ton far below what analysts and industry expected.

But cap-and-trade systems only work if there’s a transparent marketplace where polluters can buy and sell carbon allowances. And to create that marketplace, the RGGI states have turned to World Energy.

The company, which went public in 2006 on the Toronto Stock Exchange, is one of many businesses that sprang up to capitalize on the wave of deregulation that swept the nation’s electrical markets in the 1990s. It specializes in online reverse auctions where clients in deregulated states who want to buy power—say, city governments looking for the best rate on electricity for streetlights—can invite potential suppliers to bid against each other in real time. Until recently, most electricity customers turning to competitive suppliers sent out paper requests-for-proposals (RFPs) and compared bids by hand—a process that was like a “butter knife” compared to the “scalpel” that the company’s online auctions provide, in the words of World Energy president and COO Phil Adams.

Features such as “last bid blind”—meaning participants can’t see each other’s bids in the final minutes of an auction—lead suppliers to underbid competitors (and often even themselves) to win a contract, securing the lowest possible rates for their power buyers, Adams says. World Energy likes to quote one supplier who commented—a bit ruefully, perhaps—that the company’s platform is “brutally efficient at squeezing margins to the bare minimum.”

But even if they have to lower their bids more than they might like, suppliers appreciate World Energy’s services, Adams says. That’s mainly because the company is so meticulously organized about the processes leading up to, including, and following the actual auctions. “Utilities can pull up all the data on what they’re bidding on, and have a week to digest it before they come to the auction,” says Adams. “We hold host-bidder conferences, which we record and transcribe so that everyone has full information. Basically, in these markets that are so opaque and illiquid, our process brings transparency and liquidity, so you get an economic outcome that makes sense.”

Recently, the company has branched out beyond power-contract auctions to help clients sell the slightly more slippery commodities known as renewable energy certificates (RECs) and voluntary emission reductions (VERs), also known as carbon offsets. Some U.S. states and Canadian provinces create incentives for companies to invest in alternative-energy projects by allowing them to sell RECs along with the power their facilities generate; a wind farm or an animal-waste methane capture facility, for example, can sell both energy and RECs. (Indeed, projects like the methane-producing manure digesters being built by Portsmouth, NH-based Environmental Power wouldn’t be economical unless the company could also sell RECs.)

Up to now, the buyers of RECs and VERs in World Energy’s auctions have mainly come in two varieties—big companies such as AIG looking for opportunities to be socially responsible (and perhaps acquire a “green sheen” marketing boost in the process) by offsetting their own carbon-dioxide emissions, and wholesalers such as NativeEnergy that repackage the RECs and VERs in smaller quantities for purchase by consumers. The carbon-allowance trading that World Energy will handle for RGGI will be very different. For one thing, the purchases won’t be voluntary: polluters in RGGI states who aren’t able to reduce their own emissions must either buy emissions credits or pay big fines.

But Adams believes World Energy won the contract to run the auctions because of its experience in the world of voluntary carbon offsets. “They wanted somebody who knows procurement and contracting, somebody who knows auctions, and somebody who knows green,” says Adams. “We know all three—but my guess is that knowing how to talk green was the most important.”

Unlike the company’s other auctions, the point of the RGGI’s emissions trading scheme won’t necessarily be to optimize the price of the commodity for either buyers or sellers, but rather to reduce overall carbon emissions in the region. To do that, RGGI still has to work out a number of questions—including how to minimize “emissions leakage,” the possibility that RGGI’s scheme will actually lead to increased emissions outside of the RGGI states as power customers within the region turn to outside suppliers who can offer lower prices because they aren’t bound by the carbon cap-and-trade rules.

“They’ve got economists at the University of Virginia and elsewhere wrestling with the final design—questions like what are the right prices, and how this all should work,” says Adams. “While RGGI is thinking about the public policy questions, our main job is to structure the whole process in a fair and transparent way—getting the bidding process organized, making sure everyone’s paperwork is online, making sure nobody corners the market, transferring certificates—the whole back end.”

While World Energy is the only auction company working with RGGI, it doesn’t have the electronic energy auction market to itself. Boston’s EnerNOC is moving aggressively into the energy procurement services market, and has developed its own reverse-auction system, called the EnerNOC Exchange. “We’ve used World Energy’s online auction platform in the past, before we developed our own,” EnerNOC CEO Tim Healy. “We think they’ve got an impressive platform.”

But Healy believes EnerNOC’s consulting services and its direct relationships with commercial and industrial electrical consumers, many of whom participate in its demand-response pools, may give it an edge. “I would call World Energy a tools provider, whereas we’ve decided from day one to be a tools and service provider,” Healy says. “You can’t do one without the other.”

Or maybe you can: World Energy reported last week that its first-quarter revenues in 2008, $3.1 million, were double those of the same quarter in 2007. “RGGI is our big, important, market-validating contract,” says Adams. “This emerging green market looks a lot like energy markets. It’s information-rich, but opaque and not that liquid. We’ll see what happens when we apply our processes.”

Wade Roush is a contributing editor at Xconomy. Follow @wroush

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