XBRL: the Solution for Carbon Credit and Smart Grid Accounting

By Kurt Cagle
February 26, 2009 | Comments: 2

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During the State of the Union speech, President Obama made formal an assumption that had been emerging since his candidacy - his support for a carbon market as a vehicle for capping carbon emissions:
But to truly transform our economy, protect our security, and save our planet from the ravages of climate change, we need to ultimately make clean, renewable energy the profitable kind of energy. So I ask this Congress to send me legislation that places a market-based cap on carbon pollution and drives the production of more renewable energy in America.

Carbon trading systems have existed for some time. In such a system, large and medium-sized carbon and other greenhouse gas pollution emitters such as electricity production companies, manufacturers, mining companies and even agricultural concerns purchase a certain number of carbon credits allowing them to do so. However, the supply of such credits is strictly limited, and other concerns, including environmental groups, municipalities, and even independent traders, may also purchase such shares.

Additionally, at least in certain plans, organizations can actually introduce carbon credit offsets by creating carbon sinks such as selling forested lands into public trusts or reforesting developed land. Such carbon sinks, or so current research indicates, act as natural scrubbers, removing carbon dioxide and related gases from the atmosphere and sequestering them within living trees.

It should be noted that there are additional motivations for creating emissions systems beyond the putative one of ameliorating global climate change. The emissions in questions are pollutants that affect the quality of air, in some cases quite seriously, and a formal scheme to cap these emissions will have as a significant side effect the reduction of air pollution in increasingly urban regions, which should also provide significant health benefits globally.

The first large scale carbon trading system was the European Union Greenhouse Gas Emission Trading Scheme (EU ETS), which was begun in 2005 due to EU Directive 2003/87/EC (established in 2003). The initial experiences with ETS were ... chaotic, to say the least - it took some time to calibrate the values of emissions warrants, speculation introduced a number of variables that at one point nearly caused the system to collapse before safeguards were put into place, and the political processes involved in coordinating ETS across the participating member nations frequently became contentious and heated.

However, over time, these problems and differences were ironed out, to the extent that in late January 2009, the European Commission made a call to other first tier economies, most notably the United States, to establish a formal ETS system of its own or to expand and participate in the European ETS.

That this call was made after the change of administrations in Washington is likely not coincidental - the Bush administration had been deaf to the pleas of establishing any kind of caps, even market-based ones, on energy producers, and had actively worked to stifle state establishment of automobile emissions standards, one of the first policies reversed by the incoming Obama administration.

There are a number of private carbon networks in North America, but no formal national system, and even in the wake of interest in establishing such networks, there are some significant challenges to adoption of a network that are less political than they are economic. One of the problems that the EU ETS currently faces comes from the timing of their program ... at the height of the commodities boom. Large scale polluters were granted generous allotments of credits in the expectation that it pushed the point where such polluters would need to deal with the problems far enough into the future to give them time to retool.

However, as the EU economy has collapsed, so too have many of these carbon markets, which are now awash in credits that have effectively lost 60% of their value in the last four months. This has provided a buying opportunity on the part of the largest polluters to extend their pad (and hence the window that they have before making improvements) by several years. In essence, EU carbon credits are now suffering from significant inflation because too many of them were created.

This has raised cries by environmentalists (and some financial analysts) saying the a direct tax on emissions may be a more effective mechanism to control emissions, albeit one that is far more opposed by large emitters. It's likely that the exact mechanism for controlling this market will end up being a mixed solution, one where caps are used to effect a ceiling, but that governmental restrictions and emission taxes may be applied beyond a certain level.

In the case of either market caps or emissions, however, one of the central questions that needs to be asked is how in effect the accounting on these systems is performed. Measuring carbon emissions is not always a straightforward proposition - especially in situations (as is usually the case) where you have a systemic pipeline of production each of which may contribute in someway to a carbon footprint. In order to develop a standards for such emissions trading, then, you need to have some way of providing a consistent measure across different jurisdictions and even markets for what a carbon credit warrant specifically looks like.

One solution, and one that's being scrutinized at both the private and public levels, is a standard that is already in use for business financial reporting elsewhere - the XML Business Reporting Language, or XBRL. The XBRL standard uses an XML-based language to specify a given business accounting vocabulary. XBRL made headlines recently with the announcement by the Securities and Exchange Commission (the SEC) that the largest 500 publicly traded companies by market cap would be required to submit XBRL by 2009, and that all companies that followed either generally accepted accounting principles (GAAP) or the International Financial Reporting Standards (IFRS) by 2010 and 2011 respectively.

Because of this adoption, many see XBRL strictly as a reporting language. However, its worthwhile to understand that XBRL is in fact an accounting language standard. It was originally conceived of as an XMLized version of GAAP, though it has evolved considerably since then. What this means is that XBRL is ideally suited for the task of transmitting the "state" of a business - or a market transaction - between participants in a market.

This has huge implications both for a credit market and an energy smart grid. In both cases, it can be useful to think of each participant as a node in a network. At any given point, the state of that node - how much energy they have available for transmission at that point in time, how much energy they currently need to fulfill demands upon them - can be represented as an XBRL accounting document.

Any intelligent network in turn should be seen as a series of contracts made, fulfilled or cancelled. As demand increases at a particular node in the network, that node can negotiate new contracts for immediate supply that would be in force only for a limited period of time (perhaps a day, or even an hour). A supplier in turn would be able to ascertain its price based upon both its own capacity as well as upon other demands acting upon it.

Currently power supply prices are usually set up well in advance of actual usage, simply because the number of primary providers is relatively small. In the worst case scenario, this can lead to a situation much like what occurred with Enron, in which the state of California was essentially held captive to a market monopoly that was artificially manipulated. In a distributed "smart grid" however, the power providers may be wind farms, solar arrays, geothermal sinks, hydroelectric power and so forth, in addition to primary natural gas, coal, oil or nuclear providers.

Most of these smaller players (perhaps even down to the level of individual with solar panels on her house) have in the past been kept out of the grid not so much because of engineering considerations (though those do arise) but because of the lack of ability to negotiate contracts into the grid - the process was simply not open to them because they were too small.

The dynamic is similar, if somewhat slower moving, in a carbon credit market. For many companies, the lack of a smart grid for emissions has meant that they would need to stockpile carbon credits in order to handle stress periods, and if demand dropped off to quickly, then they would be left holding more credits then they would need at the time, representing capital that could probably be used more efficiently elsewhere.

By creating a consistent mechanism for representing their current state - "I'm needing to burn more credits for a smelting project this week, and am seeking sellers for x credit warrants", they could get by with far fewer credits. This in turn means that you need far fewer credits in the system ... making it more difficult in general for independent rogue traders to speculate within the system by setting up large positions, and reducing carbon market crashes.

There is no doubt that some standard will arise to be able to accomplish these ends. The advantage of XBRL is that it already exists, is extensible, has been proven in projects worldwide, and is becoming the de facto accounting standard not just for the United States but for the governments of major economies in Europe, Asia, South America and elsewhere.

Moreover, XRBL is an open standard - no one company has a monopoly on the standard, no tool vendor controls the only tools to view, create or manipulate it. It is in fact relatively easy to create XBRL manipulation tools using open source software, even to the extent of incorporating such software into social network mashups. One potential of this in either the carbon credit or smart grid network is that it also becomes possible for something as simple as a Firefox extension running JavaScript to put together, in real time, a map of where power usage is currently highest throughout the US, or where carbon credits are most heavily needed. In essence, it turns such networks into the stuff of mashups.

That it may also open up the door to micro-power systems should be self-evident. As one scenario, consider a neighborhood solar grid, where many of the houses have solar power-enabled roofs that actually produce more energy than they need in most cases. A smart-grid system could distribute powers between the houses collectively as needed, with the excess then sold to a grid nexus that would see the collective usage as a power provider with 20kW of power to sell, on average.

Algorithms at the collector would determine the best power sales distribution, in order to try to maximize the profits to the collective, using XBRL contracts to determine these. Every financial transaction would then be logged into an account, and when the transactions are finally settled, the resulting profit is credited automatically to each household in turn based upon their ability to provide excess power.

This distributed power arrangement makes it possible to get by with fewer large, centralized power providers, cutting down significantly on costs to taxpayers, carbon costs (since power providers tend to be the largest carbon producers), reduces the strain on the grid and hence reduces the chance of brownouts or blackouts, and provides a more resilient and energy efficient system. Micro-providers profit, providing an incentive for investment in such systems, and because all of these transactions occur in an open format, it makes it far easier both to monitor the system and to reduce the chance for market manipulation.

XBRL is not a panacea - even its proponents would agree with that - but it is undeniably a critical first step in the development of smart energy and carbon networks, a first step that we now have the political will to take.

Kurt Cagle is Online Editor for O'Reilly Media. Feel free to subscribe to his news feed or follow him on Twitter.


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2 Comments

Carbon Trading etc has been brought to us by the same 'masters of the universe' who brought us credit derivatives, sub-slime lending and obscene bonus systems.

The vast majority of the 'transfers' to the LDC's find their way into the Swiss Bank Accounts of the corrupt regimes that by and large keep the poor subjugated in the LDC's.

In theory, XBRL would appear to be an excellent choice. It is extensible, built as an open standard, and is getting adopted for different purposes. There are two challenges, however, that seem to dampen the enthusiasm to use XBRL in these kinds high volume, transactional scenarios. One, is the impression, perceived or otherwise, that XBRL has a larger payload and would, therefore, not be usable without impacting performance. Two, and again probably a wrong perception, is that XBRL is mainly a reporting language, not an accounting language. The author has rightly pointed out this fact and the energy market would certainly benefit from the use of XBRL. Even though it appears that the carbon credits exchange model has now lost its momentum, the smart grid will likely become a reality. Whether the US or some other country will gets there first is debatable. However, it is certainly tough to predict if XBRL will become the lingua franca.

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