EM Quarterly Newsletter | Summer 2021

Thoughts from Quentin Hicks, Chief Financial Officer

Greetings,

I have the privilege of being the newest member of the executive team at Element Markets and I’m thrilled to be here.  After spending most of my career in the traditional energy sector, Element Markets is a refreshing change.

I am a Houston native, and I started my energy career in oil and gas more than fifteen years ago while the domestic shale revolution was entering its peak.  Access to capital was plentiful and growth was the name of the game.  The work environment was fast-paced and fun and I learned a lot about capital markets, M&A, and how to grow a business effectively.

I decided to leave oil and gas and join Element Markets and the energy transition sector for a number of reasons.  First, I saw that investors and capital were shifting their energy investment dollars away from fossil fuels and into the energy transition.  I learned early on that “following the money” makes a lot of sense as a business leader and I expect more and more capital to come into this sector in the coming years.  Additionally, many of the skills I developed in oil and gas translate well to this sector, including capital markets expertise, strategic M&A evaluation and creative financing solutions.  Last, but certainly not least, I also have young children and believe I have a responsibility to do my small part in helping to decarbonize the world’s economy for the benefit of future generations.

Element Markets is the right company for me because it has incredible visionary leaders in Angela Schwarz and Randy Lack who have assembled an energetic and innovative team with a passion for success.  We also have industry-leading positions in the renewable natural gas and voluntary carbon credit sectors which are poised for significant growth.  Finally, Element also has excellent financial backing and a growth mandate from one of the world’s premier private equity funds in TPG’s The Rise Fund, which recently announced the first close of $5.4 billion for the TPG Rise Climate Fund.

I value this opportunity to bring my skills to bear in supporting Element Markets’ continued successful growth for years to come, and I look forward to meeting all of our clients and business partners very soon.

Best Regards,

Quentin Hicks

Partner News

DroneSeed Offers Innovative, Technology-Enabled Reforestation Solutions

Forests and their ability to sequester carbon are powerful tools in the fight against climate change, and forestry project carbon offsets appeal to many organizations seeking nature-based decarbonization solutions. Element Markets recently formalized an agreement with DroneSeed to market the offsets generated by their innovative reforestation technology, which uses heavy-lift drone swarms equipped with biotechnology-enabled seed pucks to reseed native tree species in wildfire-impacted areas.

In recent years, forests have come under dire threat from record-breaking wildfires, and reforestation solutions have gained even greater urgency not only from the perspective of GHG removal but as key to restoring ecosystem function and wildlife habitat and reducing soil erosion. Following forest wildfire events, such as those that continue to devastate large areas across the American West, traditional replanting efforts can be complicated by remote and difficult to access landscapes and may take as long as 2-3 years. DroneSeed’s proprietary technology can reduce the time required for replanting to as little as 90 days while generating opportunities for the private sector to support reforestation and its carbon removal benefits.

DroneSeed is currently working with forestland manager and sponsor EFM on a pilot project to reforest 300 acres of the Henry Creek watershed in western Oregon, an endeavor intended for expansion to over 1000 acres by 2022. In addition to the CO2 removal benefits from this replanting effort, the project co-benefits include restored wildlife habitat, and improved biodiversity and water quality. This project will be listed under the Climate Forward program managed by the Climate Action Reserve, the premier carbon offset registry for the North American carbon market.

TPG Announces $5.4 Billion First Close of TPG Rise Climate Fund

On July 27, TPG Rise Climate announced the first close of $5.4 billion in connection with its inaugural fund. TPG Rise Climate is the climate investing strategy of TPG’s global impact investing platform TPG Rise. According to the release, “By delivering impact-driven capital and business building capabilities at scale, TPG Rise Climate is designed to grow the wide range of commercially viable climate technologies that have been incubated by the research community, early-stage investors, and other climate innovation accelerators.” Areas of focus include clean energy, enabling solutions, decarbonized transport, green industrials, and agriculture and natural solutions, and the anchor investors include more than 20 global companies along with some of the world’s largest institutional investors.  Jim Coulter, who is TPG Founding Partner and Executive Chairman, is Managing Partner of TPG Rise Climate, and Former U.S. Treasury Secretary Hank Paulson serves as TPG Rise Climate’s Executive Chairman.

RNG Updates

Release of 2021 and 2022 RVO Reportedly Delayed

Reuters reported on July 20 that the Biden Administration has delayed the release of the 2021 and 2022 Renewable Volume Obligation (RVO) blending mandates. According to Reuters, the administration is looking into a solution that works for constituents in both biofuel and oil-producing states. Officially, the White House declined to comment on whether it delayed the rule-making process but did say they were not involved in the specific rule-drafting process. Speculation around the administration’s involvement comes after expected blending proposal targets from the Environmental Protection Agency (EPA) to the Office of Management and Budget (OMB) did not arrive in their usual June timeframe.  

Supreme Court Reverses Tenth Circuit on Small Refinery Exemptions 

On June 25, the U.S. Supreme Court issued an opinion reversing the Tenth Circuit’s ruling in HollyFrontier Cheyenne Refining, LLC et al. v. Renewable Fuels Association et al. (948 F. 3d 1206 (2020)) that small refiners must obtain continuous exemptions to remain eligible for relief. The Court’s decision centered on the interpretation of the term “extension” as used in the relevant section of the Renewable Fuel Standard (RFS), 42 U.S.C. § 7545(o)(9). The Court’s majority opinion noted that nothing in the RFS “commands a continuity requirement,” meaning that a refiner remains eligible for an exemption even if a small refinery exemption (SRE) was obtained in a previous year and lapsed. The opinion, however, did not address the Tenth Circuit’s other holdings in the case, including the requirement that EPA’s decisions with respect to SREs reconcile consistent findings that refineries recover the cost of compliance with the RFS and that EPA may only consider hardship caused by the RFS when determining whether to grant an exemption. Read more. 

California’s Renewable Natural Gas Vehicles Turn Carbon Negative in 2020 

In 2020, vehicles in California running on renewable natural gas (RNG) removed more carbon dioxide from the atmosphere than they emitted. The milestone was ushered in by the continuing decrease in the carbon intensity (CI) scores of RNG projects. In addition to the benefit associated with lower CI scores, use of RNG as a vehicle fuel has also increased, especially in fleet trucks and buses, marked by a 25% rise from 2019 to 2020, and an increase of over 170% in the past five years. 

New Program in Washington State

Washington Enacts Clean Fuels Program, Expanding West Coast Market For Low-Carbon Transportation Fuels 

On May 19, 2021, Washington State established a Clean Fuels Program (CFP) when Governor Jay Inslee signed HB 1091 into law. The CFP seeks to reduce greenhouse gas (GHG) emissions from transportation fuels sold in Washington by 20% of 2017 levels by 2038. The rules will be administered by the Washington Department of Ecology and must be implemented no later than January 1, 2023.   
 
Key provisions include: The establishment and implementation of low carbon fuel standard (LCFS) credits which allow fuel producers to meet carbon intensity requirements, utility credits and expenditures to help support the electrification of transportation, contingency milestones to ensure an increase of in-state biofuel production, fuel exemptions for aviation, watercraft, and some off-road agricultural and industrial vehicles, the creation of carbon credits, and alignment with other states’ CFP programs to create a region-wide market for low-carbon fuels and credits.

Carbon News

U.S. Compliance Markets Update – End of Q2

Throughout the second quarter, California Cap-and-Trade saw rapid, historic gains in allowance pricing while the Regional Greenhouse Gas Initiative in the Northeast saw mixed price growth. Overall, both programs have seen varying degrees of bullish pressure throughout Q2.

California Carbon Allowances (CCAs) started March with slow, steady growth then experienced rapid price gains in the following months. CCAs started Q2 trading at $17.90/MT and ended at $21.62/MT, historic program highs. The beginning of July saw continued growth as CCAs rose to nearly $24.00/MT then settled back down to $22.20/MT toward the end of the month. California Carbon Offsets (CCOs) also saw notable growth. The CCO price strength comes as the deadline to surrender compliance instruments for 2020 emissions approaches in November and this is the final year in which entities can use CCOs for up to 8 percent of their compliance burden. Starting with this year’s emissions, compliance entities may only use CCOs for up to 4 percent of obligations, half of which must stem from projects that provide Direct Environmental Benefits (DEBs) to the state. Due to limited DEB CCO supply, price increases are expected to continue, as is a widening spread between CCAs and CCOs.

In the Northeast, RGGI allowances began Q2 settling after reaching historic program highs in the first quarter of 2021. Allowance prices dipped in the first few weeks of April, then recovered quickly and rose to $8.50 per ton. This growth was short-lived and RGGI prices dropped to $7.75 per ton by the end of May. In June, prices rallied and have continued to do so in July, trading around $8.70 per ton.

New States Considering Cap and Trade Linkages

In 2021, several states have made moves to either solidify a linkage with a regional cap-and-trade program or take significant steps toward joining. In Pennsylvania, RGGI legislation passed through the Department of Environmental Protection (DEP) clearing the way for the state to join the Northeast cap-and-trade program in Q1 2022. While the rulemaking is facing some pushback from GOP legislators, interception with Pennsylvania’s linkage is not anticipated. Second, the North Carolina Environmental Management Commission (EMC) met in mid-June to discuss a RGGI linkage and the state is set to take its next steps toward joining the program. A vote will be held mid-July to decide whether the state will draft legislation to join RGGI. Finally, Washington’s legislature passed a bill in mid-April creating a cap-and-trade program for greenhouse gas emissions that is modeled after California’s program and has potential for a Western Climate Initiative (WCI) linkage. The program, which is based on the goal of achieving statewide net-zero emissions by 2050, will only come into effect in 2023 if the Washington legislature passes a new statewide transportation spending package within the next two years.

Emissions News

ERC Markets Experience Increased Volatility from Stroke-of-the-Pen Events

A complex web of factors impact emissions markets across the country. Informed stakeholders participating in the emission markets, balance in-depth understanding of regulation and policy, technical data, capital project horizon, portfolio optimization, risk tolerance, and transactions.

Emissions markets inherently have “stroke-of-the-pen” risk and are subject to substantial price movements. We have seen this dynamic play out recently in several markets across the country.  A ready example is the previously covered D.C. Circuit Court of Appeals Ruling that vacated the ability for companies to rely on interprecursor trading (IPT) to satisfy offsets. Vacating IPT optionality poses substantial challenges to regulated entities like the Houston-Galveston-Brazoria (HGB) Nonattainment Area, which includes a sizable petrochemical and refining industrial complex.  Element Markets has seen a run on VOC ERCs in the HGB with this flexibility removed, with petrochemical and refining companies aggressively entering the market to cover their outstanding VOC needs. VOC prices in HGB have increased almost 100% in less than four months, and it would not seem surprising to us if this trend continued in the short-to-medium term.

While a 100% increase in four months sounds extreme, that outcome pales compared to the “stroke-of-the-pen” impacts we see in other markets.  For example, the wake of the EPA’s revised Cross State Air Pollution Rule (CSAPR), finalized on March 15, 2021, resulted in a 10x multiplier in pricing for NOx allowances in this seasonal market.

The emission reduction credit market within the San Joaquin Valley Air Pollution Control District (SJVAPCD) was also dramatically impacted by a similar “stroke-of-the-pen” event.  Historically, SJVAPCD’s ERC program has been distinct from federal offsetting requirements required by the Clean Air Act. This difference was permitted by the EPA insofar as SJVAPCD’s ERC program was at least as stringent as the federal requirements for criteria pollutants (VOC, NOx, SOx, PM and CO) as it pertains to offset quantity and surplus value.

As of late 2020, SJVAPCD is not able to demonstrate equivalency with offset quantity and surplus value tests for VOC and with surplus value tests for NOx. As a result, all VOC and NOx used for compliance/offset purposes must be surplus at the time of use. SJVAPCD estimates that only around 21% of existing VOCs and 16% of existing NOx in the bank meet federal surplus requirements. This dramatic, ~80%+ reduction in supply has resulted in a 15x increase in VOC prices since December 2020. NOx prices have been slower to react but will likely see large increases unless SJVAPCD can pass federal equivalency tests for surplus value for both pollutants.

HGB Ozone Air Quality Update

It seems fair to characterize Covid-19 and its associated international shutdowns as a “black swan” event in 2020.  One secondary effect of Covid-19 having curtailed economic activity is that it appears to have improved air quality in areas such as the HGB area.

As shown in the chart below, the transportation sector was impacted as well.

Source: https://www.dallasfed.org/research/mei

Based on the data, it seems safe to say that overall emissions into the airshed were reduced, as reflected by the area air monitors.  An important metric in this area is the 4^th High reading. The 4^th High reading for each area air monitor is what is relied upon to determine a three-year average ozone concentration. It is a critical value to determine compliance with the National Ambient Air Quality Standards (NAAQS). The highest 4^th High ozone reading in HGB in 2020 was 75 ppb.

Fast forward to 2021, and it appears the area is trending back to pre-Covid-19 levels of activity, including industrial activity and mobility levels, which looks to correspond with pre-Covid-19 levels of emissions.  Not surprising is that the HGB area has already registered several data points above the 75 ppb threshold, with the 4^th High ozone reading for 2021 (as of July 26, 2021) reported as 78 ppb (see table below).

As of July 20, 2021, the HGB area has missed the deadlines to meet the 75 ppb three-year average, passing the threshold to be “bumped up” to Severe Nonattainment status for the 2008 Ozone Standard. However, areas can request (as TCEQ has done) extensions if in the deadline year the 4^th High for that year is at or below the NAAQS threshold.  This dynamic may create a potentially tricky scenario for stakeholders, including regulatory agencies, to navigate. For example, questions could center on how an air-quality extension could be granted for a Covid-19 depressed activity year when the current year shows air quality has returned to pre-Covid levels, including ozone levels above the NAAQS standard. Element Markets will continue to monitor the situation as it evolves.

Infrastructure Bill Progress

President Biden’s infrastructure bill as originally drafted included climate action at a large scale. The initial draft included implementation of a Clean Electricity Standard that would require power companies to gradually increase the portion of their electricity sourced from renewables. It also dedicated large investments to tax incentives for solar, wind, and other clean renewable energy sources. However, when Biden and the Senate reached an agreement on infrastructure bill spending, the $579 billion in newly allocated funds was a significant reduction from the Administration’s original climate promises. The deal does include funding for public transit, electric vehicle infrastructure, and rail improvements and assigns $47 billion to increase community resilience to natural disasters that are becoming more common due to climate change. This represents a fraction of the initiatives and budget dollars originally allocated to fight climate change (which President Biden has labeled an “existential threat”), but Biden has plans to include further investments in clean energy in the second package of infrastructure spending.

Carbon 101 – Understanding Carbon Offset Project Development

Carbon offsets under both voluntary and compliance programs are generated by adherence to protocols or methodologies approved and listed by the carbon registries or compliance programs. These protocols undergo rigorous scientific review and stakeholder input before receiving approval and listing on the registries. Each approved type of carbon offset project, such as landfill methane capture or improved forest management, has its own protocol.

Before generating carbon offsets, a project must comply with a registry-approved protocol in developing and administering the project activities that generate emission reductions or removals. If a particular project activity does not qualify under an existing protocol, a new protocol can be developed through an applicable registry. In any case, greenhouse gas reductions must be proved according to the criteria covered in the first Carbon 101 installation (permanent, additional, verifiable, enforceable, and real).

Upon protocol publication and project development, a project must be validated and verified by an accredited third party in order to qualify offset generation. First, the verifier determines that the project is eligible according to the relevant project protocol. Second, the verifier annually reviews the project’s monitoring, recordkeeping, and quantification methodologies to verify the accuracy of reported greenhouse gas reductions.

Once compliance with the protocol is approved by the verifier, carbon offsets are issued to the project developers by the applicable registry. These offsets can then be transacted  in the carbon market.

This quarter’s installment concludes our Carbon 101 series. See the prior two installments here and here, and stay tuned for additional resources in future Element Markets newsletters.

Element Updates

Introducing RenewRNG

Element Markets is pleased to announce the launch of renewRNG.  This innovative offering allows our clients to reduce or offset 100% of carbon emissions from natural gas use, delivering the benefits of RNG while overcoming its traditional cost barriers. In conjunction with the launch, Element Markets went live with the renewRNG portal, an online platform that allows users to customize their renewRNG product to match their sustainability targets, price point, or other needs. To learn more about renewRNG and experience how the portal can facilitate a carbon-neutral natural gas option for utilities and commercial/industrial natural gas users, contact David Elpers at delpers@elementmarkets.com.

CFO Transition

On July 1, 2021, Element Markets announced the hiring of Quentin Hicks as the Company’s new Chief Financial Officer. Mr. Hicks is an experienced energy finance executive with expertise in capital markets, mergers and acquisitions, accounting, and financial planning. He assumes the CFO role as long-time Element Markets executive, Leslie Ward, steps back from the Company following a distinguished 13-year tenure. Read more here.

Element Markets Hires Michele Olson

Michele Olson has joined Element Markets as the Director of Renewable Fuels, tasked with helping the Company continue its pursuit of new and innovative ways to deliver low carbon fuels to the market. With over 20 years of environmental commodities trading experience at ExxonMobil, Ms. Olson most recently oversaw ExxonMobil’s renewable identification number trading portfolio.

New Faces

Over the past quarter, Element Markets welcomed a number of new employees to key roles as we continue to grow:

• Quentin Hicks, CFO
• Michele Olson, Director of Renewable Fuels
• Brooke Donohue, Head of People and Culture
• Kirsten Higgins, Manager of Structured Products
• Kevin Daniel-Hamberg, Emissions Analyst
• Jennifer Brown, RNG Account Manager
• Amy McConnel, Contracts Manager
• Angela Maynor, Accounts Payable Specialist
• Taufik Raharjo, Analyst
• Adam Shvartzapel, Analyst

Our offices are abuzz with activity and collaboration as we incorporate these talented new additions into the team!

EnergyRisk Emissions House of the Year

On July 12, Element Markets was honored by Energy Risk Magazine as Emissions House of the Year for the fifth time in eleven years, extending our unprecedented winning record within that category and recognizing our continued progress and innovation in environmental commodities markets. This year’s award followed our 2020 win, as well as prior Emissions House of the Year awards in 2010, 2014, and 2018, and Environmental Products House of the Year in 2019.  We’re proud to share the news of this achievement, and especially thank our employees, partners, and clients as we pursue even greater reach and impact. Read more here.