In the last post, we described the differences between carbon offsets and RECs: How the former are financial instruments based upon physical commodities, and the latter are more of a bundled concept.

But what impacts do these differences have in the burgeoning markets for these somewhat competitive products?

Regulations and restrictions (whether governmental or self-imposed) are having a significant impact on the early evolution of the markets for carbon offsets and RECs.

In Europe, where they are operating under the requirements of the Kyoto Protocol and other climate change-focused mandates, an EU Emissions Trading Scheme has been implemented. This is essentially a region-wide "cap and trade" carbon emissions scheme, with specific requirements as to what kinds of emissions credits can be traded, and with limits as to the total amount of region-wide emissions. Thus, in the EU carbon emissions rights are a scarce commodity. As Charles Morand at AltEnergyStocks has described in this very helpful column, the EU ETS market was estimated to be about $27B in 2007.

In the U.S. the major mandates made to date are on utilities, and are geared around "green energy" generation requirements. Most states are adopting Renewable Portfolio Standards (RPS) which require local utilities to source up to 25% of the electricity they sell from renewable sources by certain dates ("20 by '20" appears to be a popular political phrase in state legislatures right now). As utilities scramble to find those sources, the market for RECs has taken off.

In terms of carbon markets, on the other hand, the U.S. still remains at a very early stage of development. The Chicago Climate Exchange has been making headway, and efforts like the Regional Greenhouse Gas Initiative (RGGI) are starting to come together. But in the absence of commonly-acknowledged definitions of acceptable carbon emissions reductions projects, not to mention the absence of a national limit on carbon emissions, offset credits are not a scarce commodity. Thus, the price remains significantly lower for a ton-reduction of carbon emissions in the U.S. versus much the same ton-reduction in the EU ETS. That seems strange, given the fact that carbon is a global pollutant, but as the experts at last week's NEEIC event pointed out, it's not really an apples-to-apples asset comparison, since there are different standards/ definitions/ certifications/ etc.

So does this mean that in the US investors should pay more attention to RECs, while in the EU they should pay more attention to carbon emissions credits? There are several reasons to believe that the long-term end point for both regions is a vibrant carbon emissions credits market and a less trafficked market for RECs.

First of all, RECs are subject to a lot more subjective definitions than are carbon emissions credits. Granted, right now definitions vary widely for both. But in the end, a ton of carbon is a ton of carbon -- it's a physically-defined commodity. Whereas RECs bundle together a lot of other factors. Therefore it will be harder for large-scale stakeholder negotiations to arrive at commonly held definitions of RECs (say, at a national level) than for carbon. While regional carbon emissions trading schemes are coming together even in the US, RECs remain a state-by-state defined market, dependent upon the specifics of each state's RPS definitions. For example, in some markets waste coal is counted as a legitimate source of RECs, whereas for other states that's not allowed. Such fragmented markets stymie efforts to create a large, liquid market. Europe helps prove this point -- there are national RPS schemes there and a variety of REC markets that all pale in comparison to the EU ETS.

Secondly, carbon emissions are easier to offset (yes, an offset of an offset) against all existing forms of electricity generation. Heat rate, utilization and fuel mix are all well-understood factors by energy traders, and when a viable consistent financial product which can be geographically arbitraged against transmission-constrained generation assets is available to these traders, they will jump on such assets and drive up the liquidity in such markets. It's tougher to think about such traders being able to trade off a solar REC against utilization of a coal-fired plant. Liquid fuels markets are also easier to integrate into a carbon market than a REC market, further lending potential liquidity to a future carbon market. And the thing about financial markets is that liquidity drives even more liquidity, due to positive network externalities.

Thirdly, given all the emphasis now being put on climate change at a federal level, it's becoming more likely that industry will soon have to operate under some form of cap-and-trade scheme or other limitations on carbon emissions, whether it's a national mandate, a region-level mandate, or even voluntary schemes within certain industries. As these limitations gain more teeth, carbon emissions will become a scarce commodity in the U.S. as it has been in Europe.

Finally, RECs have a hard time dealing with energy efficiency "sources" of carbon emissions reductions. So-called "white tags" have been established in some RPS systems that would allow for a separate set of products for negawatts via energy efficiency projects, but it's tough to gel these different green tags and white tags, etc., into a single viable market (is there going to be an exchange rate for green tags versus white tags?). But again, a ton of carbon emissions reduction is a ton of carbon emissions reduction. And energy efficiency is perhaps the most feasible form of carbon emissions reductions, so it can't be an ignored factor.

So it would appear that, given the increasing concerns about climate change and the resulting political pressures, we can start to plan for a long-term market for carbon emissions credits that will grow more quickly than the market for RECs. Maybe. Of course, this is all based on assumptions that might change -- a national RPS with federal-level definitions for RECs, for example, could change a lot of the analysis from above. But you can see why investors are paying close attention to the development of the carbon market in particular, even if RPS schemes and other incentives have driven adoption of green generation technologies to date.

In the next post, we'll see what all this means for investors.

Also in the news:

• More information on the Solyndra financing first scooped by New Energy Finance.

• VentureWire reported that hybrid vehicle manufacturer Aptera has raised "under $20mm" in a new round of financing from Idealab and an undisclosed angel investor. Nifty-looking car, expected to be available sometime in 2008...

Other news and notes: Interesting thoughts from Paul Holland of Foundation Capital... Interesting thoughts from David Hochschild on the solar market... And interesting thoughts from Xzibit and the Governator... Finally, a Fortune article on the "green bubble".

Investors and entrepreneurs have been having a lot of conversations lately about the carbon offset and green tag markets and where they're headed. For example, last week NEEIC organized a very well-organized event at Foley Hoag's Waltham office with several expert speakers, who addressed a room full of investors about the general topic. It seems like most cleantech investors are trying to get smart on what exactly carbon credits and RECs are, and what they could mean for their investments. This week's supreme court ruling on the subject (note: pdf) just added further fuel to the fire (so to speak)...

To start with -- what are carbon credits, and what are RECs, and why are they different? It's a confusing issue right now. You can get some useful descriptions here, but let's break it down into the differences from an investor's perspective:

Carbon credits ("offsets") are a representation of a physical commodity (albeit in this case a "negative" one). If you own a 1 ton carbon emissions reduction credit, you literally own that physical attribute -- one ton of avoided emissions of carbon into the air. In this way, they're similar to NOx, SOx and other pollution emissions credits. Or like selling a ton of corn or metals or any other physical commodity. Now, measuring and verifying an absence of a physical commodity like atmospheric carbon emissions is tougher than measuring a ton of corn or metal, but the principle remains the same.

Renewable Energy Certificates ("RECs" or "Green Tags") are a representation that the electricity you are using came from green power. That's a very different proposition -- essentially, the REC is a way of branding the electricity. Indeed, in most cases the kwh you actually consume came from a blended mix of fossil fuel-based and renewable sources (mostly the former), so buying a REC is a way of paying extra money that then gets transferred back to the renewable generators in particular (and through other hands along the way...). It's not a physical commodity you're buying. You're buying a label that shows your money went toward something you want to encourage.

It may seem like an esoteric difference, but one way to think about it is this: Carbon credits are related only to climate change; RECs bundle in a lot of other issues as well, such as local air pollution, energy independence, etc. The various differences (physical commodity versus labeling, and climate change-focused versus broadly conceptual) are important for investors, as we'll discuss in the next post on this topic. (Part Two) (Part Three)

In other news this week:

• We've talked before about the rise of online green media. This week came announcements of two more fundings in the space: PE Week Wire reported that SustainableCircles (d/b/a SustainLane) raised a $3.5mm Series B. Also announced this week was that PointOV (d/b/a EthicalSuperstore.com, which aims to be the "ethical Amazon") raised 800k GBP -- 500k GBP from the NorthStar Equity Investors, and 300k GBP from angels. NSEI had previously backed the company with a 200k GBP investment in June, 2006. PointOV reports that they now have a 1mm GBP annualized gross revenue rate.
  

• Jon Shieber at VentureWire reported earlier this week that Biodiesel Technologies has raised "under $5 million in an institutional round of funding." Adirondack Venture Fund and Roberts Mitani LLC provided the financing, and the company expects to raise a larger round later this year. The company estimates their modular approach could provide 4mgpy biodiesel plants at a cost of $1.25mm per plant (full production costs were not provided).
  

• In a bit of corporate restructuring, publicly-traded cleantech investor GreenShift is merging with GS (for "GreenShift") Cleantech Corp. and GS Carbon Corp.
  

• SJF Ventures (f/k/a Sustainable Jobs Fund) announced successful fundraising, with $28mm of new capital, about half of which is to be devoted to cleantech investments. Interesting quote from David Kirkpatrick on the topic of rising cleantech startup valuations: "That's why I'm glad we're not cleantech only."
  

• In other news of cleantech investors, here are some nice profiles of several leading investors in the space -- although I've never seen Tucker with "lab coat in hand!" Someone should explain to the reporter that the semi-mandatory, unofficial VC uniform is grey slacks, blue shirt, blue jacket... Other "people" news: Wilson Sonsini is expanding their cleantech practice... And Steven Turner has joined Ventures West with a specific focus on cleantech.
  

Other news and notes: Upcoming conferences to take note of -- Cleantech Forum XIII in Frankfurt, Germany... and the Clean Energy Venture Summit in Austin, TX... Congrats to the Kellogg MBA team in the recent Sustainable Venture Capital Investment Competition... And finally, the quote of the week: Rex Tillerson, CEO of Exxon Mobil, on the subject of biofuels: "I don't know much about farming, I'm not an expert on biofuels and there's not a lot of technology I can add to moonshine."

Only a few announced new deals over the past week:

• Enzyme-based fuel cell developer Akermin raised $3.5mm in funding (VentureWire indicates that it was the second tranche of a Series A) to add to a $3mm round from 2005. The company's alcohol-based system has been proven out at a lab level. Someday you might recharge your laptop's fuel cell power supply at the airport bar... Investors in the round included Chrysalix, OnPoint (see more on them below), Prolog Ventures, and the St. Louis Arch Angels.
  

• The appropriately-named Thin Battery, which is developing ultrathin carbon zinc batteries, raised a $6.2mm round of financing. SunBridge Partners led the round, which also included Early Stage Partners, Key Capital, Orix Capital, and individual investors. Powering RFID tags and medical devices are the first targeted applications for the company's technology, which can use "traditional printing equipment". The company, which was spun out of Eveready in 2002, has raised "nearly $8mm."
  

• Here's a neat marriage of solar power and IT: United Villages is using wifi-enabled buses (or motorcycles, or even a donkey, according to AlarmClock) to drive through rural areas, downloading and delivering emails to and from solar-powered computer kiosks that have been installed in isolated villages (residents pay per use of the kiosk). Omidyar Network, Cambridge Light & Power, and Gray Matters Capital Foundation provided $2mm in Series A financing for the endeavor.

Cleantech investors in the news:

• Emerald Technology Ventures announced a final close on their 135mm euro cleantech-focused venture fund. LPs in this latest fund included Caisse de dépôt et placement du Québec, GIMV of Belgium, Rabobank of The Netherlands, Axpo Holding of Switzerland, Springbridge Limited (Advised by Consensus Business Group) of UK, Credit Suisse of Switzerland, Deere & Co., DSM Venturing of The Netherlands, Dow Chemical Co., KPC Energy Ventures, Inc. of Kuwait, Piper Jaffray Private Capital, Suncor Energy Inc. (Canada), Unilever Technology Ventures Advisory Company LLC, and Volvo Technology Transfer AB of Sweden. Emerald has already made two investments out of the fund, in Identec Solutions AG and Vaperma.
  

• It may be impossible to find a conference these days that Vinod Khosla isn't keynoting, but you have to admit he's putting his (firm's) money where his mouth is. Here's a helpful list of his 26 portfolio investments thus far. It's especially interesting to note the internal distinction made between "sugar/corn fuels", "cellulosic", and "future fuels."
  

• A new venture group, Physic Ventures, is being formed, according to VentureWire. And as part of the new group's functions, it will be taking in the venture investment efforts of Unilever Technology Ventures, which has been investing in clean technology startups (in addition to other categories) such as Pionetics and Kreido Biofuels.
  

• Regular readers of this site will have noticed how active OnPoint Technologies has been in the energy technology space recently. So it's interesting to note the top column on this PE Week Wire from Tuesday...

• Major i-banks haven't just taken notice of the cleantech revolution -- they're actively putting money at play. Here's a good column on Goldman Sach's efforts. And here's Morgan Stanley getting in on the action (tip of the hat to Sahir Surmeli of Mintz Levin for the heads up on that one). Speaking of Goldman Sachs, they've already had their first cleantech exit -- and it was a very successful one ($2mm per MW of installed capacity, $100k per MW of projects in the development pipeline).

• A new nanotech-focused firm, NanoDimension, closed on a $60mm first fund. Nanotech, as we've discussed before, has a lot of potential cleantech-related applications.

• "Venture capitalists will destroy value in alternative energy"... Oh, but "venture capital is behind a lot of the innovation happening in alternative energy." More hyperbole from mass media coverage of cleantech investing...
  

Other news and notes: More good analysis of the challenges of water tech investing... More and more students looking to get into cleantech (which probably explains why readership of this site is pretty high these days) -- so check out this column, which is still pretty relevant... Finally, here's a good cleantech April Fool's Day joke.

Interesting numbers released today from NEF, who track dealflow alongside other efforts we've discussed here before (Cleantech Venture Network, Nth Power, etc.):

• $2.2B total private equity financings into clean energy worldwide in Q1. That's 58% above Q1 2006 totals and 60% higher than Q4 2006.
• Helpfully, they note that the big totals were driven in large part by three major transactions: Silicium de Provence ($394mm) and Solyndra ($79mm) in solar, and Imperium Renewables ($113mm) in biofuels.
• Differentiating between VC and private equity, "early stage venture capital" was tracked at $303mm (23% higher than Q1 2006), with Series A and seed tracked at $80mm -- "almost double" Q1 2006, but around half of Q4 2006's $159mm.
  
• Interestingly, PIPEs grew sharply, at $446mm, about triple from a year ago.
  
• Also a little bit of a dampening in the IPO market, with $899mm raised in initial offerings.

Lots more info found here (note: opens a pdf).