Gold from Landfill Gas

Michael Fickes

While they traditionally have made money based on what they take in, landfills can get paid based on what goes out, thanks to a new trading system.

Landfills soon may get paid to help defray the cost of reducing greenhouse gas emissions.

As an indication of this, last October, an Avon, Conn.-based company, Zahren Alternative Power Corp. (ZAPCO) sold the rights to emit about 2.5 million tons of carbon dioxide to Ontario Power Generation Inc. in Canada.

According to news reports, the value of the deal approached $25 million, or $10 per ton.

Perhaps even more interesting, the source of the rights sold by ZAPCO comes from 119,000 tons of methane gas collected from a number of landfills based in the United States.

ZAPCO collects methane gas from landfills and sells it to utilities and industries that burn the gas to generate power. In the process, it claims emission reduction rights for reducing the amount of methane, a designated greenhouse gas, in the atmosphere.

Over the past few years, an international system for buying and selling greenhouse gas emission reductions has begun to evolve. In this system, a single ton of methane counts as much as 21 tons of carbon dioxide - because science has established that the effect of methane on the atmosphere is 21 times greater than the effect of carbon dioxide. Traders value all greenhouse gases in relation to 1 ton of carbon dioxide.

In the ZAPCO-Ontario Power example, the two companies valued the methane by multiplying 119,000 tons of methane by 21. The result, approximately 2.5 million tons, represents the equivalent effect of carbon dioxide on the atmosphere.

While the details of the Ontario Power deal remain confidential, observers say the approximate price of $10 per ton stands below the price of a handful of previous transactions made in this fledgling system. In other words, the price of greenhouse gas reduction rights will vary according to the values placed on those rights by buyers and sellers. This is characteristic of a commodities trading system, which this new trading system has begun to emulate.

Landfill gas, of course, is 50 percent methane, and industry observers say the Ontario Power transaction illustrates an emerging and potentially valuable source of income for landfills around the world.

Where did this trading system come from? And when will it begin to prove useful to landfill operators?

A Tall Tale The complicated story begins with the Clean Air Act of 1990, which created an opportunity for industry to buy and sell emission reduction credits - ERCs - keyed to atmospheric pollutants.

When a company builds a power generation or manufacturing plant, the process being used may generate one or another of a half dozen criteria pollutants. These include substances such as sulfur dioxide (SO2), nitrous oxide (NOx), carbon monoxide (CO), particulate matter, lead and volatile organic compounds (VOCs).

Experts in this area carefully distinguish between pollutants and greenhouse gases. Pollutants poison the atmosphere. Greenhouse gases may warm the atmosphere.

The Clean Air Act only addresses pollutants. No legislation deals with or controls greenhouse gases in any way - yet. But more on that later; an evolution of ERCs trading system is on its way.

"Suppose a new plant emits 500 tons per year of VOCs into the environment," says Jim Walsh, senior vice president with SCS Engineers in Cincinnati, Ohio. "You have two choices. You can pay for emissions control equipment, or you can find someone who has generated 500 tons of VOC emission reduction credits or ERCs by shutting down a plant or by installing emission controls.

"Usually these credits must trade within a given non-attainment area. In other words, a company in the Baltimore area that emits a criteria pollutant would have to find someone from its designated non-attainment area."

A landfill operating within a non-attainment area theoretically could generate and sell ERCs. "If you collect and flare landfill gas, or sell it for a beneficial use as an energy source, then you are removing certain pollutants that would otherwise enter the atmosphere," Walsh says.

Three problems generally prevent landfills from doing this directly: government regulations, state administration and finance.

While creating a market for ERCs rooted in criteria pollutants, the Clean Air Act and the regulations that accompany it also created restrictions based on New Source Performance Standards or NSPS. A power generator, manufacturer, landfill operator or any entity operating a site subject to NSPS regulations must reduce emissions of criteria pollutants and cannot claim ERCs.

"If you are complying with the Clean Air Act, have a migration or odor problem and are forced by a regulator to install a gas system and flare landfill gas, then you cannot generate ERCs," Walsh says.

On the other hand, a landfill operator that takes the initiative in the absence of regulations may claim and sell credits.

Then again, not always. Another wrinkle in the ERC market involves the administrative ERC framework. The federal government created ERCs in the Clean Air Act but left the states to implement the concept. "Most ERC programs are done through the states where the federal regulations are implemented," says Greg McCarron, a project manager with SCS in West Nyack, N.Y.

States that have implemented these programs usually contain a large city facing ozone problems. Massachusetts, for instance, has a program called the Innovative Market Program for Air Credit Trading, or IMPACT. The program includes only emission reductions for credit from three pollutants: NOx, CO and VOCs, and prohibits "interpollutant" trades. In other words NOx ERCs only offset NOx emissions, not CO emissions.

A landfill operator interested in trading credits usually must make deals in relation to a state program, if one exists.

The third problem arises from financial realities. Creating ERCs by installing a LFG collection system, quantifying what is collected and certifying the numbers may cost more than the investment will return to individual landfills.

The ERC concept comes with a lot of ifs, a lot of capital expense, and a lot of red tape to gain the relatively small return a single landfill might generate.

Enter companies that develop projects to collect and sell landfill gas to energy producers. "We seek out landfills that can provide an energy source for our customers," says Michael Carolan, president of ZAPCO Development in Bloomfield Hills, Mich.

A group of landfills that satisfies ZAPCO Development's criteria in terms of gas volume may provide enough volume for the company to gain financial benefits from criteria pollutant ERCs, the emerging market for greenhouse gas emission reduction rights, and a federal tax credit program [see "Tax Credits Past and Future" on page 69]. "If we can aggregate a lot of incentives, a project becomes more economical for us," Carolan says. "A single landfill by itself may not have the size, patience or sophistication to put together a legal package to monetize these incentives. The role we play is in aggregating several landfills into a package that spreads the fixed costs of production."

Today, a company may pay a royalty to a landfill for the rights to develop a gas collection system and to sell the gas to power generators. In some cases, a landfill may need a gas collection system and simply assign the rights to a landfill power development firm.

According to Walsh of SCS, about 300 landfills in the United States host landfill-gas-to-energy installations. Third-party contractors own and operate about 80 percent of those installations and may claim and sell ERCs that flow from them.

Most observers generally agree that the value to landfills of ERCs generated from the collection of criteria pollutants contained in landfill gas has been and will remain limited. Landfill gas, after all, contains only relatively small amounts of criteria pollutants.

The significance of criteria pollutant ERCs lies in the trading system that has evolved around these credits and how that system appears to be shaping the emerging market for greenhouse gas emission reductions.

If there is any significant financial value in all of this for landfills, it lies in the future. And the future began to take shape in a model created by ZAPCO'S sale of greenhouse gas emission reduction rights to Ontario Power.

On to Kyoto In 1997, a United Nation's conference held in Kyoto, Japan, adopted a plan to reduce emissions of greenhouse gases. Called the Kyoto Protocol, the plan urges developed countries to cut greenhouse gas emissions between 2008 and 2012 by an average of 5.2 percent from 1990 levels.

Vice President Al Gore signed the Protocol, which specified that the United States, as the largest emitter of greenhouse gases, would reduce its emissions to 7 percent below the levels measured in 1990.

Representatives from other developed countries made similar commitments.

None of this, however, carried the force of law. In the United States, for example, only Congress can enact legislation designed to meet the goals agreed upon in Kyoto. For a variety of reasons, Congress so far has refused to ratify the Protocol or seriously consider legislation designed to implement its goals.

Other countries also have resisted ratifying the Protocol.

"It can take a long time for a group of governments to ratify and enforce a multilateral protocol," says Garth Edward, a principal on the greenhouse gas desk with Natsource LLC, a New York City-based broker of gas, coal, power and emissions instruments.

Nevertheless, industries around the world view the Protocol as a wakeup call. Companies such as Ontario Power cannot afford to ignore the possibility that their governments soon may enact legislation requiring significant reductions in greenhouse gas emissions.

As a result, these companies express increasing interest in purchasing the rights to emit greenhouse gas.

Edward recommends distinguishing between emission reduction credits related to pollutants and emission reductions related to greenhouse gas. "The term credit specifies credit against some legislative requirement," Edward says. "Because no legislation controls greenhouse gas emissions, there is, right now, no such thing as a greenhouse gas emission credit."

What is being bought and sold in this area is the right to emit greenhouse gases in the future. Traders operate under the assumption that legislation that may be enacted in the future will adopt the recommendations made in the Kyoto Protocol following the model of emission reduction credit trading.

Companies like Natsource have brokered a small but growing number of transactions related to greenhouse gas emissions rights. "Our sense is that there have been just under 100 such transactions around the world over the past two or three years," Edward says. "About 20 of these transactions have involved North American landfills. Trades we have participated in have run to seven figures."

How do these trades work? Edward says a landfill might collect 50,000 tons per year of carbon dioxide equivalent emission reductions from a landfill site not covered by existing legislation requiring emissions reductions. "There are buyers who would be happy to find a forward stream of 50,000 tons per year of reductions over five years," he explains. "Right now, a reasonable price for these reductions might be $1 per ton to $2 per ton. Suppose the seller is lucky and gets $2 per ton. If the buyer agrees to pay in full up-front, the seller would receive $500,000 for a five-year stream of reductions totaling 50,000 tons per year, or 250,000 tons overall.

"In reality, though, the buyer won't fork over $500,000 today for something he won't receive until later. The buyer will want to pay on delivery. The seller wants cash up front. The position in the middle is called an option. The buyer may agree to buy an option to purchase those reductions at 50 cents a ton or $125,000."

The agreement also might stipulate that the option to buy reductions will run from 2008 to 2012, the period covered by the Kyoto Protocol. During those years, the buyer could exercise the option and purchase tonnage reductions for $2 a ton. If the transaction eventually went through, the seller would essentially receive a premium based on the amount of the option sale plus the agreed upon price per ton for the emission rights themselves.

Edward and other industry observers call the greenhouse gas emissions reduction market a considerable opportunity for the landfill industry, but qualify their enthusiasm by noting that the rules may change if and when the governments that signed the Kyoto Protocol ratify the agreement and enact related legislation.

"If you're a buyer, you look at these transactions as a way to manage risk," Edward says. "Currently, there is no greenhouse gas law. But you may project having to comply with a law in the future. If you're a large power generation source coughing out a million tons a year of carbon dioxide, you would have to imagine that you are an elephant in the sites of regulators planning to do something about greenhouse gas emissions."

Still, governments have yet to weigh in on the issue. Views expressed vary greatly, leading to uncertainty about the future.

Japan, for example, recently drafted a plan to comply with the Kyoto Protocol. The draft calls for reliance on domestic efforts to reduce greenhouse gas emissions and recommends against allowing international purchases of emission rights.

On the other hand, U.S. observers anticipate heavy reliance on national as well as international market mechanisms, should Congress ratify the Protocol and enact legislation. Frank Loy, Under Secretary of State for Global Affairs and a key U.S. negotiator on climate change issues, recently said that the United States cannot meet its Kyoto Protocol obligations without trading emission rights with other countries. In fact, according to Loy, the economic boom in the United States has raised emissions to a level that will require a 30 percent cut to satisfy the provisions of the Kyoto Protocol.

If Loy is right, U.S. landfills may discover that landfill gas is worth its weight in gold.

Owners of qualified landfill gas gathering systems may continue to claim tax credits under Section 29 of the IRS Code until 2008.

To qualify, a gas gathering system must have gone on-line before June 30, 1998, under a binding contract signed before December 31, 1996.

A facility also must sell the gas to an unrelated party, says Bill Fields, president of Montauk Energy Capital Inc., a Pittsburgh- based company that buys landfill gas systems and markets the gas. The company owns 26 landfill gas systems, many of which collect gas qualified for Section 29 tax credits.

The value of the tax credit changes slightly each year (It currently sells at $1.035 per million Btus). A seller receives revenue from buyers and then reduces its tax bill by $1.035 per million Btu of gas sold at the end of the year, raising the effective revenue by the dollar value of credits claimed.

Why has Congress decided to eliminate Section 29 tax credits for landfill gas? According to industry observers, Section 29 of the IRS Code generally covers tax matters related to fossil fuels. Landfill gas fits better into the categories of alternative and renewable energy sources. Political opponents of alternative energy initiatives managed to remove landfill gas from Section 29 on that basis.

When Section 29 landfill gas tax credits come to an end, landfill gas sellers may not lose their tax credits. "As an industry, we're trying to extend the concept of Section 29 tax credits under Section 45 of the IRS Code," says Jim Walsh, senior vice president with SCS Engineers in Cincinnati, Ohio. "Section 45 provides tax credits for renewable energy sources such as wind and solar power. Landfill gas is a renewable energy source, and we think it would be logical to add it to Section 45."

What are the prospects for this? Observers believe the issue may receive a sympathetic review next year, following the retirement of a strong political opponent from the Ways and Means Committee in the House of Representatives.