1. Rewarding Low-Carbon Innovation Under Cap and Trade: A Question of US Competitiveness September 2009 Climate Neutral Business Network A Project of Strategic Environmental Associates 541 490 2860 www.climateneutral.com

2. Questions Central to Cap/Trade Cost effective, predictable compliance options? Access to low-cost credits? Incentives for low-carbon technology innovation? Technology neutral? Up and downstream of caps? Enhanced US competitiveness? Green jobs? Broader corporate/political support?

3. Current US Cap/Trade Assumptions: Caps Send Carbon Costs Downstream GHG Reductions CO2 Trading Climate Neutral What’s possible here? Or Buy Carbon/ Credits Carbon Cap/Trade Focus: Capped/Upstream Customers/DownstreamConsumers Example: UtilitiesE.g. Supermarkets Refrigerant producers Fuel refineries Value Creation: All Rights Reserved; Copyright: SEA www.climateneutral.com Carbon Cap Electricity Costs Increase Per Carbon Upstream Costs Meet Cap  Reduce Downstream Pay Carbon Allowances: 40%? 100%? Electricity Fuels GHG chems C-$ Price Increases

4. Current US cap/trade system delivers ownership of carbon value from downstream reductions to upstream capped entities GHG Reductions CO2 Trading Climate Neutral What’s possible here? Carbon Cap/Trade Capped entities own carbon as reductions flow upstream All Rights Reserved; Copyright: SEA www.climateneutral.com Carbon Cap Focus: Capped/Upstream Customers/DownstreamConsumers Example: UtilitiesSupermarkets Refrigerant producers Fuel refineries C-$ Carbon reduction Carbon Tech $

5. Incentives for Downstream Transformative Low-C Technology Innovation? 1.Increasing carbon costs can stimulate business as usual technology adoption 2.Transformative technology’s carbon value >> R&D budgets So caps increase costs downstream comparable to innovation budgets Severely constrains access to capital 3.Downstream US innovators do not own this significant carbon value Business case motivating game-changing investment undermined 4.Low-C technology innovation: may relocate? 5.Slows US progress towards lower-cost, lower carbon economy, green jobs 6.US competitiveness is at stake – with concerns addressed internationally

6. Carbon Capital Value Comparable to R&D Investment for Game Changing Innovation GE EcoLocomotives R&D/Innovation capital$400m Fuel savings/loco315,000 Number sold BY 20093000 Carbon Value$10$107m $20$214m Carbon Value as % R&D27-54% Plug In Electric Cars R&D/Innovation capital$1bn Carbon savings/car lifetime* 14 tonnes (wtw) Number sold/year200,000 # years prior to next gen’tn10 Carbon Value$10$300m $20$550m $30$800m Carbon Value as % R&D30-80% SF6-Free Sneaker R&D/Innovation capital$100m Carbon Savings/year7m tonnes Project duration7 years Carbon Value$10$490m $20$980m Carbon Value as % R&D500-1000%

7. Access to This Carbon Capital Transforms the Business Case for Innovation Example: Innovation to Create New Barrier Film to Eliminate SF6 in Sneakers On R&D budgets of up to $100m, accessing carbon capital value (of 7m tonnes CO2/year) transforms business case from a 17 to 1 year payback period Yet such carbon capital value is not currently accessible for 85% of the US economy – that is for innovators located downstream of the capped entities! SF6 InnovationPayback Periods R&D/Innovation capitalUp to $100m SF6 cost savings/year $5.6m>> 17 years Carbon savings/year 7m tonnes CO2 $/tonne CO2$ carbon credit value/year 10$70m 1.3 years Yet currently, only ag/forestry can access carbon capital in this way

8. … Across Many Sectors, Value Chains Example: Refrigeration Leak Detection Systems (RLDS) Payback periods: >> 7 years  far beyond business as usual If carbon value capitalized, bring payback period to < 2 years (at $10/tonne) Potential Revenues from HFC CreditsPayback Periods Average Store Rf charge 4,000 lbs Leak rates 20% to 10% Rf cost savings/year $2800>> 7 years $/tonne CO2$ carbon credit value/year 53200 106400 2 years 2013,000Almost 1 year

9. Unlike in China, US cap/trade proposals shift this carbon value upstream to capped entities, undermining US downstream innovation Example: Refrigeration Leak Detection Systems The R&D/innovation capital must be placed at risk downstream to deliver compliance benefits to the capped entities upstream Material Acquisition Supplier Operations Inbound Logistics/ Packaging Manu- facture Product In Use End of Life Outbound Logistics/ Packaging Raw Material Sourcing ManufactureDistributionUseEnd of Life Location: Capped/Upstream Customers/DownstreamConsumers RiskCAPITAL RISK Reward CARBON REVENUE UPSIDE Carbon Cap New carbon revenue windfall from powerful game changing innovations’ reductions Downstream at-risk R&D/capital makes carbon reductions with no $ reward in US … … while in China, same innovations receive CDM carbon credit revenues to propel success US competitiveness at stake

10. Delineate set asides for low-C tech innovation if located downstream of caps Downstream projects which meet “beyond business as usual” requirements for carbon credit status are qualified to sell set aside credits to market Projects are required to undergo rigorous credit evaluation process which CMB already administers for offset credits to maximize credibility Provided projects’ carbon reductions have been verified as delivered, they qualify for set aside credits from the relevant annual pool as their credits are purchased and transactions finalized through the CMB registry each year, subject to the project’s authorized annual limits Thus set aside credits are matched to both performance and sales If oversubscribed, awarded on a “first come if first sold” basis Consistent with approach for credits under CDM Option to retire credits if consumer low-carbon product benefits to be claimed The Solution: Set Asides for Downstream Technology Innovation

11. Downstream set aside credits can generate attractively priced carbon for capped entities GE EcoLocomotives R&D/Innovation capital$400m Fuel savings/loco315,000 Number sold 2006-93000 Carbon Value$10$107m $20$214m Carbon Value as % R&D27-54% Number sales within 7 years10,000 CO2 capital generated36m tonnes “Breakeven” price/tonne$11/tonne - assuming no contribution to/from product sales Plug In Electric Cars R&D/Innovation capital$1bn Carbon savings/car lifetime14 tonnes Number sold/year in 1 line200,000 # years prior to next gen’tn10 of technology innovation Carbon Value$10$300m $20$550m $30$800m Carbon Value as % R&D30-80% Number auto lines using this same technology 10 CO2 capital generated300m tonnes “Breakeven” price/tonne$3.30/tonne - assuming no contribution to/from product sales

12. Capped entities also gain intriguing financial leverage as these technologies mainstream Example: Utilities Sector While free allowances are allocated Latest UBS report highlights vulnerabilities for generators which cannot readily pass on carbon costs Financial Leverage from Downstream Carbon Reductions Assumed price/kwh 7 cents CO2 emitted 1.32 lbs/kwh CO2/tonne assume$20/tonne Carbon value/cost1.2 cents/kwh Assumed margin10% Margin/kwh0.7 cents/kwh CO2 value as % cashflow175%

13. Set Aside Credits Deliver Strategic Benefits For All Players Downstream Innovators Carbon incentives drive green jobs/competitiveness – but across the entire US economy Technology-neutral approach with pricing transparency for each innovation Creates an economy-wide carbon capital market for game-changing low-C innovations Market-based approach enables investment priorities to shift as/if superior options/priorities emerge (unlike policy mandated solutions selected upfront) Delivers zero-cost of capital resources to low-C innovators on a “pay for performance” basis Capped Entities Diversifies and lowers credit – and thus compliance -- costs for capped entities Offers potential trading advantage for capped entities with transformative downstream innovation, creating a far richer portfolio of carbon credit/innovation/reduction options US Competitiveness Levels playing field with China where carbon credit revenues can already drive to-market success for these innovations Preserves long-term incentives towards low-carbon technology innovation in ways that will not sunset (like free allowances) in an impartial fashion Simple, cheaper, less complex approach than administering caps through entire value chain US Market Integrity Strengthens the integrity of current credit/offset system by addressing growth pressures Strengthens accountability for $00bn annual Federal investments Consumers Could enable consumers’ purchases of lower-carbon products to still deliver a climate benefit

14. Set Aside Credits Can Also Address Low-C Product Marketing Challenges Products’ embedded carbon >> 3/5 th s US consumer impact (20-25 tonnes/capita) 2050 goal of 80% reduction: cannot be achieved without product focus Yet same challenges arise: carbon reductions flow upstream to capped entities So low-C product purchases will not benefit climate beyond compliance with cap FTC issues with marketing low-carbon products arise? Consumer confidence? Option: retire set aside credits to secure low-C products’ benefits

15. Downstream Low-C Technology Innovation: Current Implications Cap/Trade ObjectivesCurrent Implications Green jobs New high growth industrial sectors 21 st Century Competitiveness Leadership in low carbon solutions Technologies, products, services Low cost climate protection Constrained domestically because … Innovation sectors face capital squeeze … Reducing incentives/speed of innovation … Weaker US low-C technology leadership …. Eroding climate promise, cost containment

16. With Set Asides for Low-C Tech Innovation : Achieve Critical Policy Goals Green jobs New high growth industrial sectors 21 st Century Competitiveness Leadership in low carbon solutions Technologies, products, services Low cost climate protection Expand in game changing sectors since … Innovation sectors’ gain zero CoC capital … Deliver innovation in highest impact areas… Increase export potential, retain and attract innovators to US …. Secure climate promise cost effectively

17. Climate Neutral Business Network: Contact Information Sue Hall, CEO, Climate Neutral Business Network sue@ClimateNeutral.com (541) 490 2860 www.ClimateNeutral.com