Episode 8 of the Reversing Climate Change podcast. You can listen on Spotify (subscribe there for ad-free), Apple Podcasts, or wherever else you listen. Paid subscribers get the ad-free version right here on the page.
Why don’t voluntary or compliance carbon offset markets work? The numbers simply don’t add up. A lack of connection between the certificates and the physical inventory means that both parties—the seller and buyer—take credit for a reduction in emissions. And this double counting (issuing two certificates for a single credit) leads to a surplus of certificates under which the associated markets crash and burn. The good news is, the blockchain will allow us to start over and do the math correctly.
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Full Transcript
Announcer: listening to the Reversing Climate Change Podcast by Nori, the world's first carbon removal marketplace. Here are your hosts, Ross Kenyon and Christophe Jospe.
Ross Kenyon: We're up in Vancouver, Canada, which is great. We always like coming up here. We eat a lot of sushi. It's not that different from Seattle, I feel like, in terms of weather, but it was very foggy today. More fog than I've probably seen. What would you say?
Christophe Jospe: Is that normal for Seattle? I'm not up there yet, really.
Ross Kenyon: It seems foggier than Seattle, yeah, for sure. We had a nice lunch and supposedly could have seen across the water there the downtown but we didn't.
Christophe Jospe: Yeah, I could see like 100 feet out onto the water. I couldn't see anything else really at all.
Ross Kenyon: But we're here with Aldyen Donnelly and she is our carbon economics. Is that the correct term we've landed on? It is not producer Paul scolding me across the water. She's actually a Director of Carbon Economics and I am very jazzed for this podcast. I know that we're going to go in a lot of different places. I think it's nice to maybe kick it off of how we got in contact with you in the first place. So, Aldyen.
Aldyen Donnelly: It's one of those funny social media success stories. I tend to tweet quite dense [unclear] and Pol Knops from the Netherlands responded to one of my tweets one day and just said that they're trying to design a different carbon offset system in the Netherlands. And we got into an exchange. We moved off tweet to direct mail and then email and then conversation and I've never met face to face but we've had I think a very constructive interaction that both of us very much appreciated. So by the time he learned what you were trying to do, he introduced me or you to me and me to you and that came right off Twitter.
Ross Kenyon: And then you guys also met on Twitter, Paul Gambill and Christophe, right?
Christophe Jospe: Yeah, we have a lot to thank Twitter for really. That's the only time Twitter.
Ross Kenyon: Oh, is it?
Christophe Jospe: Yeah. I just knew Paul. I just knew you from meatspace.
Ross Kenyon: They get no credit for that one.
Christophe Jospe: No, no, no. So I remember this was back in September when Paul and I had a very long phone call with Aldyen and it blew our mind on many, many levels, both because of your background and also what you're saying. Let's start with the background. It's awesome that you're part of Nori, but how did you get to being where you are here, sitting in your living room with this podcast?
Aldyen Donnelly: I don't know, it's a crazy tale. A number of things led to me bringing together a consortium of ultimately 14 of Canada's 20 largest emitters. And we decided the exercise we had come together to do was to pretend that existing carbon markets, regulated carbon markets, work. And to seek emission reduction in those days in emission removal, potential project directors to enter into contracts with them where we would [unclear] long-term purchase agreements, 12 to 15 year terms, where we would purchase then what we called offset credits.
The objective was not to become players in the nascent market but the objective that we all signed on to was. We'd never had any cap and trade in Canada unlike the US. And so the objective was to actually [unclear] and my positions on cap and trade by actual real practical experience instead of just sort of theory and going to conferences and hearing stuff.
Ross Kenyon: And we're going to have to inquire here, what is cap and trade in the broadest, most layperson sense?
Aldyen Donnelly: It's quota-based supply management.
Ross Kenyon: What is quota-based supply management?
Aldyen Donnelly: Government picks a sector and creates a production or [unclear] quota limit and then decides who the winners and losers are.
Ross Kenyon: So the government will say we can produce a set amount of CO2 and then people will have allocations and they'll jockey and sell them to people who need it more than they do.
Aldyen Donnelly: That's right.
Ross Kenyon: That exists for other things too. We're talking about the acid rain markets of that.
Aldyen Donnelly: But I would want to go back to first principles, what I find is almost every leading academic in the world would tell you categorically that quota-based supply management when used to manage dairy or chicken or other agriculture markets is highly inefficient. And the same economists who advocate for cap and trade are saying quota-based supply management is really efficient if you're using it to manage energy and building product markets.
Ross Kenyon: Do people do this for dairy?
Aldyen Donnelly: We have supply management in Canada for dairy, chickens, and other ag products. We're going to produce this amount of chickens. Every year the federal government decides what the maximum amount of dairy products and chickens are that should be produced to attain a certain minimum price for the Canadian producers. They convert that into a quota supply which is auctioned now to all of the producers and you can't supply those products in Canada unless you've got quota.
Ross Kenyon: So I hate that, but I think cap and trade is
Aldyen Donnelly: Exactly the same. It's just. By the way, it only took me 20 years to figure that out. So cap and trade is to energy and building products, iron, steel, aluminum, cement, as quota-based supply management is to, in Canada, milk, butter, fat, and cheese. And it's bizarre that it took me 20 years to figure it out, but it's more bizarre that most of the leading economists in Canada and the U.S. haven't. I figured that out.
Ross Kenyon: Yeah, and how did you get to this point too? I know you have some things that you're able to name drop quite successfully like being at Kyoto right now.
Aldyen Donnelly: I wasn't at Kyoto, but I was at other other COPs, but Kyoto was a
Ross Kenyon: You were in Osaka, you're in Tokyo, you were in suburbs. Sorry, COP?
Aldyen Donnelly: Conference of the party. So there's something called the United Nations Framework Convention on Climate Change, which is an underlying international treaty. And at Kyoto in 1997, the parties to what we call the UNFCCC agreed to moving forward to what is kind of a global cap and trade, a version of global cap and trade to manage at the time developed nation, primarily carbon emissions. After all of the meetings of the nations that agreed to embrace targets in Japan, in Kyoto in 1997, those meetings are called conferences of the party. So it's a subset of the original treaty group, which we call COPs and we're on like [unclear].
Christophe Jospe: Aldyen, I'd like to take it back a little bit. So you're an economist, and you found yourself in a very interesting position in 1997. But how did you get there? And what sort of principles did you bring that were unique to the carbon offset accounting issues that weren't in the other markets?
Aldyen Donnelly: Well, to start and up until that time, my focus for years had been always working at that intersection between innovation, new technology, and big companies struggling with the impacts of innovation on their standard business or adoption, without reference to necessarily to pollution or carbon. My chosen profession was working with either innovators trying to break into new markets or traditional companies trying to bring innovation and deal with disruption due to new technologies without sort of thinking about consciously by the mid-80s, I was mostly working in the environment space, and by the early 90s I rightly or wrongly formed the opinion that if we were to be operating efficiently, we'd focus on greenhouse gas emissions.
Generally at the time, the cost-effective methods for reducing the acid rain precursors and some other key pollutants we were focused on. If you ranked the, say, the five most cost-effective methods for reducing those pollutants. Typically, number one, two, and three, increase greenhouse gas emissions. But if you turned your focus to reducing greenhouse gas emissions, eight times out of ten, you're also reducing other pollutants. So I got it in my head that if we could move people's focus to reducing greenhouse gas emissions and then say, okay, when it comes to strategies for reducing greenhouse gas emissions. Let's just not proceed with those limited 20% of strategies that increase criteria pollutants, and wouldn't it be much more efficient? This is where I started. Wouldn't it be much more efficient to just have that focus on greenhouse gases and then be able to dump all of the other criteria pollutant regulations out of the policy mix because we're efficiently focusing on the one factor qualifier. So that's sort of got me focused on greenhouse gases to start.
Ross Kenyon: When is this going on?
Aldyen Donnelly: 1994, 1993, around there.
Christophe Jospe: And so you're focused on greenhouse gases professionally and then somehow this starts leading to the Kyoto Protocol that is being generated.
Aldyen Donnelly: No, we were working really independent of the Kyoto Protocol, so in 1995. The truth is, as a consultant, I was doing similar work for a number of competing energy companies, mostly but not only utilities. So after a while I decided that was stupid, so I said to everybody, "Why don't you just all come together and I work for all of you together and not just do the same work and create a process where you're learning from each other, not just from me." And that became what we called the Greenhouse Emissions Management Consortium, which we thought was going to be a learning by doing exercise, which I thought would have an operating life of about two or three years, and it ran for 12 years.
Ross Kenyon: And what became of that and what you learn by doing there.
Aldyen Donnelly: We decided the way to learn about how carbon markets were likely to work was again, sort of all go to work every day and pretend we now had a regulated obligation to reduce emissions, but we had no constraints on how we did it and go out and finance projects and have the exercise of actually doing it and form our opinions so that we actually had experience. We had not planned on being a particularly large player in the nascent carbon markets, but by 2002, I'm told by many others that I was acting on their behalf, the largest private sector buyer of carbon credits in the world at the time.
When we were doing that, the companies were learning a lot and it was informing their policies. My objective wasn't to get all of the companies to come down and say, "Yes, cap and trade is it," but have each of the companies have the experience when you combine it with their business plan and their reality, inform their policies, get them ahead of the curve. When we put our early contracts together in that experiment, we, in those contracts, adopted a bunch of very common normal business principles, which is, for example, an offset credit was supposed to represent a reduction in a physical inventory.
Ross Kenyon: So, yeah, duh.
Aldyen Donnelly: So in our contracts, before you could sell me your credit, you had to produce your physical inventory and you had to agree to publish it. And if you sold me real interest in a minus one, you had to add a balancing plus one to your inventory so that when we were doing trades in the marketplace everything was properly accounted for, everything added up.
Ross Kenyon: And that's called double blind accounting. Or double entry bookkeeping sometimes. Which didn't happen in the housing market either.
Aldyen Donnelly: To my shock and surprise when governments and other players sort of jumped in to take over the carbon market, they decided no double entry bookkeeping. So even if every other discipline in a traditional kind of market was applied, which is not the case. By definition, that meant at a minimum, every offset credit out there was being credited twice. That's still true today in voluntary and compliance markets.
And I was sitting there with this big portfolio working on behalf of my investors, which was again, primary for learning, but I didn't want them to lose money. I realized I had no capacity to get the market to see the difference between what I called our real Gucci bags versus the knockoff Gucci bags that were the markets that were being built by the establishment.
Ross Kenyon: Why do they not want to be able to keep track of this? Why would they want this double counting to occur?
Aldyen Donnelly: To tell you, I don't think it was a case of want or not want, I [unclear] ways of doing things just sort of took off and we didn't have that sort of sit down and say, "Well, wait a second. We are technically creating a derivative instrument, a certificate that represents a change in a physical inventory, and we've let this take off and there's no connection between the certificate physical inventories." It never occurred to me that we would do
Christophe Jospe: This seems like a pretty big deal and kind of an egregious error on the part of carbon markets.
Aldyen Donnelly: I thought, where is this coming from? I thought it was so unusual. Then if you looked, you saw that's exactly what was happening in the secondary mortgage market. So it was actually standard practice in certain financial markets. I just was unfamiliar with those markets or the fact of those standard practices at the time.
Ross Kenyon: Yeah, and then how did that play out in things like the Chicago Climate Exchange?
Aldyen Donnelly: Well, as you know, the Chicago Climate Exchange didn't survive. And in fact, when I looked back in history, there were a lot of cap and trade type, we didn't call them cap and trade, but cap and trade type markets that regulators, particularly in the US, but not only in the US, had set up over the years since the 1960s, pretty much every such market, there's one exception, crash and burn under the weight of surplus excess compliance certificates in anywhere from three to, I often say three to five years maybe, to be fair, I should say three to seven years. And the Chicago Climate Exchange died in right on schedule.
Ross Kenyon: So there is just too much supply of these credits?
Aldyen Donnelly: Always every time.
Ross Kenyon: I feel like Nori, we're kind of worried about the opposite problem of just making sure that the demand is able to be met
Aldyen Donnelly: I could be wrong. This is just 2020 hindsight. But I think if we had been more successful at building a market where there was that contractual connection between the tradable instrument derivative and the physical inventory, it purports to represent. I think we'd be a lot farther along in terms of real carbon markets and greenhouse gas reductions today than we are.
There was a lot of money ready to play. I think there is today too, but it's different money and it's for different reasons. If you can look at the Chicago Climate Exchange, which claims some successes and I won't say there weren't some. Just go look at who the registered members of the Chicago Climate Exchange were and it's a long list. Does it include more than two of the 20 largest utilities in the United States or any of the 20 or 30 largest emitters in Canada? No. In my view, those guys were willing to play, but they didn't know what maybe right should look like, but they knew that wasn't it and we slowed things down.
Ross Kenyon: So we're talking about markets, some of the markets crashing, market design. What are the elements of a good market? What are the elements of a market that's destined to crash?
Aldyen Donnelly: Well in a good market, if your inventory is 10 and my inventory is 10, pay you to reduce by 2 and you sell real interest in the minus 2 to me before we did the deal. If we looked at your Sustainable Development Report or Annual Report, before we did the transaction yours said 10, mine said 10, they added up to 20. And in a good market, after we do the transaction, your report says 8.
Ross Kenyon: you're not on twelve and you're a
Aldyen Donnelly: Well, your report says
Ross Kenyon: paid you to go down to eight. Oh, right. Okay, so I am eight. You are eight
Aldyen Donnelly: And I'm 10, but I've bought minus 2 from you, so when the minus 2 is transferred to me, you go to plus two because after we've done the deal, the total between us is 18. It is down two. In every carbon market in the world right now, including California's, if that allowance or credit crosses a border, you report 8 and I report 8. So the total physical total is 18 and we're reporting 16.
Now you don't do that for very long over very many balance sheets in combination. Before the certificate you've got floating around is just in massive surplus, right? The market has to crash. It isn't about market manipulation or anything like that. You're just always creating at least two certificates for every minus one and you can't do that for very long before you gotta start over.
Christophe Jospe: Accounting seems like a pretty big part of this then.
Aldyen Donnelly: Yeah.
Christophe Jospe: This is what gets you excited about blockchain technology.
Aldyen Donnelly: Yeah, I think it's going to be easier to start over with blockchain and I am really excited about that.
Christophe Jospe: What else do you think makes a good market in carbon?
Aldyen Donnelly: In a good market and carbon, I'd, you know, still open to opportunities to trade in certificates that represent real emission reductions, but it's now 2017. I started having these discussions in 1993-94. Too much time has passed. We can't achieve the environmental objectives that we are talking about through reduced energy use and reduced fossil fuel use. And I don't think it's a. I just think it's physically impossible to make the numbers work.
So the only viable path forward is to focus on removing carbon from the atmosphere, which should be exciting to people because certainly not in every case, but in many cases, farmers can remove carbon from the atmosphere, increase the amount of carbon stored in their soil while they increase their food production and their profitability. There are very significant opportunities to really focus on carbon removal, to get back on track towards our 2030-2050 goals in a way that actually isn't asking people to give up stuff is actually potentially increasing the profitability of food producers and food supply. And that's just one example. There are many. So I'm pretty excited about just focusing on that side.
Ross Kenyon: part of the opportunity.
Aldyen Donnelly: environmental discussions as a whole. Things that surprised me when the government and voluntary markets started to emerge. All of those markets today have something for the farmer, for the offset producer, the carbon offset producer, something called an additionality test, an additionality to the right to list your carbon credit on both these compliance and voluntary exchanges. First, have to satisfy the market administrator that you wouldn't make a profit or a reasonable return on your project without the revenue from the carbon credit sales.
Ross Kenyon: What? The motivation there, it seems very odd.
Aldyen Donnelly: You'll have to ask them. I don't get it. I mean, don't you want removing carbon from the atmosphere, reducing emissions to be highly profitable? Don't you want the guys who figured out how to make money on this to go first and show the way?
Christophe Jospe: That's the key.
Ross Kenyon: No, no, it's the environment. Everything's gotta just feel good and be charitable, right?
Aldyen Donnelly: I know. I mean, I was still, still [unclear].
Christophe Jospe: Was that you being sarcastic, [unclear]?
Ross Kenyon: No, I just, I think people get kind of squeamish about it, but I like that if you can satisfy both of those things, I feel like everyone wins and we should be happy.
Aldyen Donnelly: If you're saying to that portion of the market, you can only play as long as you prove to me that every project you're bringing to the market is seriously uneconomic without the carbon revenues, then you're not building anything that represents the sustainable or rational new economy. If it doesn't make money or at least break even, it's definitely not sustainable. And you want them to be incentive to figure out more ways to make more money as opposed to having to come to approval bodies and verifiers and prove that they would lose their shirts if they kept doing again back when I was doing our first contracts, I thought. I never anticipated we would be doing stuff like that. That just sounds so weird.
Ross Kenyon: So maybe we should just come up with some words and say them now that we don't use them at Nori, like additionality, seems like a good one. Instead, we've got a baseline.
Aldyen Donnelly: That's right.
Ross Kenyon: And then we've got the activities after your baseline that are removing carbon. And those are the things that we count.
Aldyen Donnelly: Well, and for example, in one of the projects I did before any of this world that I didn't anticipate appeared when we were using carbon credit purchase to incent building owners to invest in energy efficiency in the buildings, it's not like we paid them to do what they were already doing. But it was pretty clear in the market I was looking at that under normal circumstances, building operators in aggregate were generally increasing their energy efficiency for the whole population at a rate 2% per annum. Wasn't that hard to say, okay, baseline is you improve your efficiency 2% per annum, might pay you for doing better than that.
That sounds arbitrary, but it still, again, leaves it to the market to get creative and say, let's figure out a way to and let's get people chasing us making money on this, while I'm still getting incremental gains in aggregate for the economy in terms of emission rates. And I would argue both voluntary market and compliance market, I don't see much difference. So bureaucracies came into play, you know. It just got weird.
Ross Kenyon: So can you talk a little bit about what is a voluntary market? What is a compliance market?
Aldyen Donnelly: There are a number of markets where companies with no obligation to reduce or offset their emissions in as buyers and proponents of projects can reduce emissions, register and list their reduction achievements for sale to those companies. Probably most familiar to sort of normal people who aren't nerds like us, totally focused on this
Ross Kenyon: Speak for yourself.
Aldyen Donnelly: [unclear] is when you offer the opportunity to offset your emissions when you get on an airplane. That's a voluntary market, you don't have to do it. And in most of those voluntary markets, as I said, it's not like the market administrators are irresponsible. They're actually employing procedures and principles that we see in compliance market.
Now what's a compliance market? The European carbon market, the California cap and trade markets are where there are a number of companies that have an obligation in theory to reduce their emissions or buy credits from other companies. And the other companies go through an approval process to list carbon credits for sale in that context. And in both that voluntary and compliance context, you've got this additionality test, which is you basically can only list your project if you can prove to us it's not economic.
Christophe Jospe: So if you were to jump into one of these markets and you're a buyer, you're saying that there's a disconnect between the inventory and the certificate.
Aldyen Donnelly: The certificate reports represent a change in the inventory, but there's no contractual link.
Christophe Jospe: So if I bought a credit in a voluntary market of California, how exactly does that work?
Aldyen Donnelly: If, for example, someone plants trees in California and it's a forestry project and they're legitimately sequestering more carbon in the forest soil and in the trees. There's a real tradable credit there. In the California market, that credit gets sold to a emitter in Ontario. The emitter in Ontario and the Ontario government again [unclear] their actual inventory and then do minus one because they imported. California doesn't add plus one to its inventory. So credit may conceptually have some link to the inventory, but as soon as you start trading it, it doesn't anymore.
Ross Kenyon: So, you know, when a. The double entry bookkeeping is out the door.
Aldyen Donnelly: Out the door. So what's the result of that? The result of that is that client certificates, whether you call them allowances or offsets. Face them, say 1 tonne CO2e, but their underlying value can be much less than 1 tonne CO2e. And so you've got your trading certificates that suggest a market price for carbon of 15 bucks when if you actually look at what people are paying for their certificate and what its real underlying value is, they might be actually paying the equivalent of 30, 60, 90 bucks a tonne, but they think the market's only willing to pay 15 bucks for a tonne of carbon. It's because the instrument doesn't reflect one tonne.
Christophe Jospe: the market mechanics are not really in place.
Aldyen Donnelly: And again, who'd have thunk if you're Boeing and you make planes and you pre-sell two planes to Air Canada or Southwest, your inventory shows those two planes are in your inventory but it also shows they're spoken for. How to do this right.
Ross Kenyon: This is pretty like
Aldyen Donnelly: We know how to do this, right? We just
Ross Kenyon: I think double entry bookkeeping was invented by the Venetian traders like 100 years ago.
Aldyen Donnelly: So when we did, say, we did a lot of different deals, when we did a deal where we paid a natural gas processor in Texas to capture their flue gas and inject the CO2 into the ground, our contract stipulated that when they go to report their emissions, I've bought the real interest in the reduction, right?
So our contract stipulated that when they go to report their emissions voluntarily in their Sustainable Development Report or even for regulatory compliance under EPA rules, which didn't exist at the time but we anticipated would come at some point in time, they have to add to that inventory report all the reductions that they've sold to me. We didn't have any problem putting deals in place with those kinds of contractual requirements because that was rational. But then all this irrational behavior
Christophe Jospe: Real-time fact check. Double entry bookkeeping has been around since the 13th century.
Ross Kenyon: Yeah. Oh, [unclear] older. Was it Venetians?
Christophe Jospe: The Venetians were around in the 13th century too, I think.
Aldyen Donnelly: So again, it never occurred to us that there would ever be carbon markets that didn't have those kinds of provisions in the trading structure. Then all of a sudden there were, everywhere worldwide in the system sponsored by the UN, in the system launched by the European Union for now.
Ross Kenyon: I want to talk about the Vancouver Stock Exchange. At some point you got involved with them, yes?
Aldyen Donnelly: I was a public governor, so there was for a couple of years. The Vancouver Stock Exchange had governors who were like a board of directors. And all of the brokerages that were essentially owners of the exchange had a person on the board and then there were eight public governors. So we were outside and not part of the brokerage community and the stock exchange had that governance model for a long time.
Christophe Jospe: What were you doing there exactly?
Aldyen Donnelly: I was brought in by some executives and [unclear] who actually at the time, this was late 90s, that my experience in carbon markets would be beneficial to them because maybe the exchange should set up to be also trading carbon instruments. I was a public governor and I had a lot of other due diligence sort of obligations. Short version of a long story is it was an interesting experience and the Vancouver Stock Exchange ceased to operate about three years after I served on the Board of Governors.
Ross Kenyon: I don't want to impugn either organization, but there are parallels. I know we've talked in the Vancouver Stock Exchange is noted for penny stocks that are involved in mining oftentimes. And then there's often like a lot of market manipulation that would happen and crash it once in a while.
Aldyen Donnelly: Yeah, but it's a cautionary tale that we should all think about. I mean, the Vancouver Stock Exchange was originally founded in 1903. And from 1903 to I don't know what would be the right date but think maybe early 70s. If you were a mining company, you couldn't sell shares on a legitimate stock exchange. Most of the very significant mining companies that we think of today got their first round of funding on the Vancouver Stock Exchange, regardless where we think they're located. So that Wild West venture market that it was was really important for a really, really long time. But when it was time to evolve, to stay really important, that proved too hard to do.
Ross Kenyon: I guess you use either example, either in the Vancouver Stock Exchange or in carbon markets, how do they do pump and dumps or how do operators do things that may not be in compliance or may not be in the interest of the organization that they're using their underlying commodity.
Christophe Jospe: I'm sorry, Ross, could you define pump and dump, please?
Ross Kenyon: I mean, I think Aldyen actually is the expert here.
Aldyen Donnelly: Well, what would you say it is?
Ross Kenyon: Well, and
Christophe Jospe: That's called punting, ladies and gentlemen.
Aldyen Donnelly: Let's do it as if we're trading shares. I own a bunch of shares and you and I enter an agreement where in the agreement it says that I'm going to sell 10,000 shares to you for a dollar a share. Contract also stipulates that you are going to deliver 10,000 shares back to me for a dollar 50 cents a share on or before March 31st. Now if one small player or only one set of two kind of small players do that, we for a short term create the illusion of an increase in demand and a significant future price.
Ross Kenyon: That's the pump.
Aldyen Donnelly: That's the pump. And if you get a lot of players involved or a small number of large players, you pump and pump and pump. And then when you're ready, you do what they call a sell short, which is you artificially manufacture the timing of an apparent reduction in demand, which results in a reduction in price. And when you sell short, you sell your shares to third parties. You commit to sell today, today's price, but not to deliver till, say, next week, at which point in time, in theory, because you've manufactured the withdrawal of demand, you're pretty sure you can pick up the shares you've got to deliver in the sale for a significantly less cost than the market price the day you entered into the agreement. So typically in that kind of situation, it's what we call the innocent or the not inside investors that end up losing value.
Ross Kenyon: Yeah, we see this in cryptocurrency, a fair amount too. If you're on one of the big exchanges, you'll see the troll box, which is the little chat window. And people will be like, X coin or X coin might even be a thing.
Aldyen Donnelly: So another place you'll see an extreme amount of pump and dump was the US acid rain SO2 [unclear], because it's fully unregulated and nobody was breaking any laws doing that.
Ross Kenyon: I don't think anything in cryptocurrency like that is against the law. People will sometimes do that or you'll have what are called whales, which are very big holders of a certain thing. They'll start buying up and then by the time the lowly people hear about it, it's of course already gone up 300% and then they're buying it. And then of course everyone else is selling out of the market and it crashes. And sorry to that little guy who got FOMO, the fear missing out.
Aldyen Donnelly: Cryptocurrencies markets don't have to be regulated to contain that activity. I don't think you'll ever eliminate that activity. To contain that activity to a level that it's not destroying, we can structure the Nori cryptocurrency market in a responsible way. But be real clear that that's what we're trying to do. And pump and dump will never ever disappear.
Christophe Jospe: seems like psychology. People see something rising and they go for it.
Aldyen Donnelly: That's right. So just the question is how do you build your market so it's not creating that potential for big swings and big volatility. I think we. You know, we just have to
Ross Kenyon: One of the ways that we're combating that with the Nori marketplace is one Nori token purchases one tonne removed, one carbon removal credit. And that rate of exchange is always fixed. And as soon as the carbon removal credit is sold to a buyer, it's retired and can no longer be sold. So I think we're going to be doing something really special. Again, you're not going to completely eliminate the activity, but
Aldyen Donnelly: as long as that link between the token and the underlying physical commodity that we're creating, which is a commodity and physical because it is going to be contractually linked to an inventory, unlike the regulated carbon markets, our design has a strong enough link between the token and the underlying commodity and what we are creating is a commodity as opposed to a theoretical concept that will be okay in that regard. But be. It's not just venture stock markets that I've never seen a market as dominated by pump and dump as the SO2 allowance market was before it crashed after seven years because all those markets crashed.
Ross Kenyon: When you talk about commodities, I got my Series 3 recently, so I've been very interested in reading about this. You think a derivatives market for Nori tokens could be a very useful thing for people to plan around the dynamic nature of prices inside of a carbon removal credits?
Aldyen Donnelly: Yeah, again, as long as we have the discipline. We're talking about commodities, but the example that comes to mind is the S&P Index Future.
Ross Kenyon: We should define this to futures and options and even just what is the derivative overall?
Aldyen Donnelly: A derivative is a piece of paper that can represent a bunch of things. When you buy that piece of paper, you're saying, I'm betting that the price or this index will be $1.50 in 15 days. You can only sell that bet if somebody else is betting. It won't be a buck 50. But those bets are tracked to actual real tradable commodities and securities and the trail, the accounting trail to those real physicals is very clear.
Ross Kenyon: Yeah, it's derivative in the sense that it isn't the underlying asset itself. It's derived from it. They're still very, very tight.
Aldyen Donnelly: There are other derivatives where they aren't just like I complained about a lot of the existing carbon markets where you've got certificates to represent a one tonne change in an inventory but the accounting isn't stringent. Their underlying value isn't one tonne. You can make a derivatives market where there isn't that strong connection and you can make a derivatives market where there is that strong connection. When there isn't, it's a market that usually turns into a bubble and crash.
I don't hear anybody saying they're worried the S&P index futures market is going to crash. There's a strong, I call it physical, but it's not physical, there's a strong contractual ledger link. So we can create a carbon market that looks more like an S&P index future than a secondary mortgage derivative, which failed to meet that stringency test.
Ross Kenyon: Let me paint this scenario here that I imagine derivatives market for Nori tokens could be useful. So if you're a big institutional buyer of Nori tokens and you have committed through your corporate social responsibility statement that you are going to remove a thousand tonnes of carbon and the market right now is $30 per Nori token. You're essentially hoping that it doesn't go down from there, right? Because then you could have bought it a little bit later. You could short in the futures market the Nori token. And then if it did go down, your average price between what you bought at and then what it is now would average out a little bit. So you'd be able to go back to the other VPs or your colleagues and would look like less of a fool potentially, or you got less of a good deal than you could have. But another, and again, if we had.
Aldyen Donnelly: securities and exchange officials, people define derivatives different ways depending on where they come from. You know, and I'm using derivative in the true technical sense of the word. We're trading a certificate that is derived from an underlying transaction, commodity or securities trading.
Ross Kenyon: Like an example where you're like short futures for Nori tokens, is that not an example of what you're
Aldyen Donnelly: No, it is. But I'm saying that I also include in my definition of derivatives which some finance officials would not agree with an option. So if you're that company, you could pay consideration to buy an option to buy Nori tokens in the future at $40. It doesn't mean you're obliged to buy those Nori tokens. So when the time comes, you might give up the consideration you paid for the option because Nori tokens might be trading for 25 and you'll just go to the market and pay for 25.
When you can introduce options which are another form of derivative into the trading spectrum, into the buying and selling spectrum, a company can say, you know, I really, really, really know I want to offset my emissions. I really know this is the way I want to do it. But I also really know that if the cost of doing that exceeds 50 bucks a tonne, I've got other plans and so you allow them to use that instrument to hedge.
Ross Kenyon: The way I've always put it is that commodities or equities markets are about the allocation or distribution of ownership and then derivatives markets are about the allocation or distribution of risk.
Aldyen Donnelly: I think that's a really good way to put it. I think it's a really good way to put it. But if we, again, going back to the pump and dump and how things can go sideways, to have a really useful lasting living derivatives opportunity, we have to have that. It's easier to do with blockchain too than to, I mean also, actually easier to do this right on the foundation of blockchain than try to fix the existing compliance and voluntary
Ross Kenyon: Do you have something? Because I have something, but it might be a little far afield
Christophe Jospe: Yeah, I just wanted to pick up on you mentioned it's easier to do that piece with the blockchain. I wanted to bring it back to other parts of blockchain technology that also will make it easier to do what we're trying to do. You know, we mentioned earlier on this podcast that you have the experience working with a bunch of farmers and interestingly enough we're also working with farmers now so we've kind of gone full circle and are building better accounting methodologies into recording these physical assets into the digital assets as carbon removal credits. But what about the blockchain makes that whole piece easier that wasn't there before?
Aldyen Donnelly: creates new opportunities to recognize both short-term and long-term carbon sequestration potential in land, and when we're talking carbon renewal, removal. The challenge for making this into a vibrant market has always been that there are some farm practices that we know will substantially increase the amount of carbon that's stored in the soils, remove that carbon from the atmosphere. We also know that [unclear] cost landowners a lot of money upfront for various reasons. When I was first looking at this, 50% of farmers who adopted the better practices were quitting between year three and five after initial adoption because it was just too hard. But if you can get them to year seven, they become more profitable farmers.
Christophe Jospe: So when we've got blockchain as the support of our. They don't even need to get paid for carbon sequestration. They're just making more money because the soils are more productive.
Aldyen Donnelly: Yeah. For many farmers, sort of by year seven, worst case scenario, by year 12. So the question is how do you get them through that? When you've got chain it seems to me easier to introduce a commodity, some of which is tradable, some of which is held in reserve, that everybody can see that is potentially for the farmer an asset they can borrow against. There it's theirs, it's apparent. In a way that enables them to raise the financing, they need to get through that.
And I'm skipping a bunch of details, but it's the transparency of the accounts in blockchain that creates opportunities for them to borrow against an asset that might not be tradable till they get to year 7 but is there, is in their name and is a real physical asset. My hope is that this becomes a lot easier to work through on the blockchain platform than in these other more changing carbon markets.
Christophe Jospe: I don't know about you Ross, but I don't think Aldyen's allowed to plead ignorance anymore when talking about blockchain. Seems like she knows what she's talking about.
Ross Kenyon: You know enough at least to be dangerous at a cocktail party and I think a lot more than you let on sometimes. Quite into soil. I know you've been running a lot on the methodology of removing through soil.
Aldyen Donnelly: Again, there are many, many ways to achieve carbon removal and regenerative farming practices is not the only way. I just love being at the forefront of a space where the right thing to do for the environment is over time increasing credibility for food producers and food production. So that's why I love the soil story. It's certainly not the only story.
Ross Kenyon: But you're a businesswoman, so that's an easy sale, right? You're just like, you're gonna make money and do a good thing.
Aldyen Donnelly: Yeah. All we're trying to do is make getting through that really tough time easier. If we can get that right, which I'm confident we can, then
Ross Kenyon: I had a question that goes back to the derivatives market. Aldyen, do you think that if there were a derivatives market for Nori tokens that it should settle in Nori tokens or should it be in like a Bitcoin or something else?
Aldyen Donnelly: I'd like it to settle at Nori token because I think Nori token is a sustainable long-term currency.
Ross Kenyon: Is that the reason why some transactions are cash settled like the Bitcoin derivatives market, cash settled?
Aldyen Donnelly: Again, this might be betraying my ignorance. I'm not saying I'm pessimistic about Bitcoin, but I'm much more likely to be confident that those cryptocurrencies out there that are, again, utilities attached to a fundamental deliverable are going to survive and there's other cryptocurrencies that don't meet that test that might survive but I'm less confident. I'm pretty confident that once we proceed the Nori token design concepts that we've talked about to date, we're going to be creating one of those cryptocurrencies that is surviving.
Ross Kenyon: I think the worry though is that if it settles in Nori tokens, that means that there's a level of insulation if it settles in a different currency rather than the underlying commodity. If you shorted a huge short in the Nori token market, settles in Nori tokens could have a bigger effect than if it was in Bitcoin.
Aldyen Donnelly: You know, you're right, but guess what? The decision about how they're going to settle is up to the buyers, not us anyway.
Ross Kenyon: So I'm just maybe exposing like I shouldn't, maybe how I would play it.
Aldyen Donnelly: You know what the good news is? Nothing we do is going to dictate how the participants
Ross Kenyon: This is all sort of a little bit navel-gazy and just sort of curious about theoretically how might this work. But yeah, okay, I'll kick it back over to you then.
Christophe Jospe: Final question, Aldyen. The name of this podcast is the Reversing Climate Change podcast, and that's what we're talking about. So you are queen of the world and have world domination to reverse climate change. How does it happen?
Aldyen Donnelly: If I was queen of the world, I would have one worldwide rule. Which is if you sell energy or building. Now I would be a dictator.
Ross Kenyon: Okay, fair.
Aldyen Donnelly: I wouldn't, you know, which is, Nori stands for the exact opposite of this, but you just made me queen of the world, so I'm gonna be a dictator. Worldwide, everybody who sells what I call energy and building products convert their sales into a million BTU or gigajoule, depending on what country our equivalents. And they would report their global fossil carbon content per [unclear] delivered to the world market. And they would be obliged to reduce it at a rate of 3% per annum and have the option of buying carbon removal credits as a compliance option so they can reduce in their supply chain and/or buy carbon removal credits and I wouldn't put any other compliance options on the table.
Ross Kenyon: Sounds good.
Christophe Jospe: Yeah, I agree there. Let's do it.
Ross Kenyon: Well, this has been a lot of fun. Thank you, Aldyen. Looking forward to taking these ideas and moving them forward in our marketplace.
Aldyen Donnelly: Okay, thanks.
Christophe Jospe: Yeah, thank you.
