Israeli clean-tech companies can attain financing and generate income not only through the sale of innovative technologies but also through the sale of carbon credits in the carbon emissions market, a market whose value was $118 billion in 2008, and one that is expected to reach $670 billion by 2013.

Even in the midst of the current global economic crisis, the clean-tech field was actually one of the few areas that experienced growth during the past year. Venture capital investment in clean-tech in the United States reached $8.4 billion in 2008, and, in the third quarter of 2009, the sector became the venture capital investment leader in the United States.

As a result, the carbon market has grown from $727 million in 2004 to, according to estimates, $118 billion in 2008, to what experts project will be $670 billion in 2013, the year that a new global climate regime is expected to replace the expiring Kyoto Protocol, assuming that the Copenhagen Accord will be transformed into a legally binding international treaty. Israeli clean-tech companies can benefit from the development of the market as explained below.

After many years of research, it is now generally acknowledged in the scientific community that certain gas emissions (including carbon dioxide, nitrogen, methane, and others), known generally as "greenhouse gases," have a negative impact on the Earth’s climate. The use of coal and oil, and the products produced from them, have increased the emission of greenhouse gases believed to be the central factor in human-induced climate change. In light of these findings, the reduction of greenhouse gas emissions has become a rallying point in efforts to combat global climate change.

The Kyoto Protocol, which was drafted at the end of the 1990s and calls on industrialized nations to reduce their greenhouse gas emissions, was the central turning point in these efforts. Currently, 187 nations have signed and ratified the Kyoto Protocol, but its implementation has encountered numerous difficulties, including the politically biased oversight of Kyoto Protocol regulations, the exemption of some high volume emitting countries from greenhouse gas emissions limits (e.g., China and India), and the refusal of the United States to ratify it. Criticisms aside, however, the Kyoto Protocol requires 38 industrialized nations to reduce meaningfully their greenhouse gas emissions by 2012, the year the Kyoto Protocol is set to expire.

In December of 2009, 120 world leaders attended an international conference convened in Copenhagen with the goal of establishing a new emissions regime and building on the progress of the Kyoto Protocol. The conference exposed major differences between developed and developing countries with respect to what they see as their respective responsibilities, and ended with a nonbinding agreement that urges—but does not require--major polluters to make deeper emissions cuts.. Although this accord was not all that was hoped for, further international efforts to combat global warming will continue. The next annual UN Climate Change Conference will take place towards the end of 2010 in Mexico City, preceded by a negotiating session in Bonn, Germany in the spring of 2010.

A common method of regulating greenhouse gas emissions, and the method adopted by the Kyoto Protocol, is by use of a mandatory cap and trade system. Under this method, industrialized nations that ratified the Kyoto Protocol require industries that emit significant levels of greenhouse gases to set limits on such emission via a “cap.” A plant or industry that does not meet its cap is subject to heavy fines or even closure by the relevant authorities. However, emission allowances, also known as Certified Emissions Reduction Units, or CERs, approved by and registered with the regulatory body that oversees the Kyoto Protocol, are available through mechanisms such as government auctions and distributions, sales, and trading markets to achieve regulatory compliance.

Over time, the number of such emissions allowances distributed by a regulatory body typically diminishes and the greenhouse gas emissions limits also become more stringent. Thus, a point is reached at which the number of emissions allowances distributed may become insufficient to enable a particular source to maintain its emissions limits below the established cap. Accordingly, the source is compelled to reduce production (which results in the emissions), improve the efficiency of its production (via investment in new technologies that better control emissions or cause less pollution), purchase additional emissions allowances from plants that have an excess, or purchase CERs on a trading market. Thus, by setting caps, a market is created whereby carbon allowances, or CERs, are used as currency, the price of which rises and falls based on the demand.

Outside the framework of the Kyoto Protocol, industrial plants or private entities also can voluntarily produce carbon credits (known as Verified Emission Reduction Units or VERs) by investing in projects or new technologies designed to reduce the emission of greenhouse gases. The VERs are valued according to the standard by which they are verified. They are then sold in the voluntary market, usually to corporations seeking to satisfy shareholder pressure or to companies preparing to fulfill anticipated mandatory emission limits. Since the VERs are not “certified” under the Kyoto Protocol and cannot be used to achieve greenhouse gas emission limits in countries that have not ratified the Kyoto Protocol, the price of VERs is usually lower than the price of CERs that are sold to compliance buyers. The determination of whether carbon credits will be deemed CERs or VERs, as well as the method of certifying them, depends on factors such as the nature of the technology, the methodology of the project and its oversight, the geographic location where the project occurs, the target audience, and the impact on the reduction of greenhouse gas emissions.

It is quite possible that restrictions on greenhouse gas emissions will become more stringent following the expiration of the Kyoto Protocol in 2012 even if such restrictions end up being adopted unilaterally by individual nations rather than imposed via a binding international regime. One example of such potential unilateral action is the possibility that, over the next year, the U.S. Congress will adopt a cap and trade system as a measure to counteract global climate change. Both of these developments will increase the demand for new technologies to reduce the emission of greenhouse gases. Israeli companies that develop alternative energy sources or other solutions to reduce emissions can benefit from these developments, provided that they know how to overcome the obstacles encountered by most start-up companies, and how to succeed in raising sufficient financing to complete the development and marketing of their products.

Through their involvement in the cleantech and renewable energy sectors, venture capital investors have come to favor companies that have developed so-called “disruptive technologies” (e.g., a technology initially developed for one purpose that has been adapted to serve another function). Many of the Israeli companies that develop alternative energy technologies fit this paradigm. For example, we advise companies that have devised cutting-edge waste-to-energy and wastewater-to-energy technologies using a variety of bio-mass feedstock to generate renewable energy sources. Originally developed as a response to serve Israel’s unique energy and water resource needs, the technologies are now linchpins for renewable energy and energy efficiency projects worldwide.

Naturally, investors prefer to finance technologies that contain the potential to produce diverse income streams and technologies that can be adopted and replicated easily. Alternative energy companies can improve their financial position while also increasing their attractiveness to potential investors by adding another revenue source through the production of carbon credits. Companies whose technologies support the inclusion of a carbon credit component can sell the credits that are generated either in the free market or directly to other companies that are not meeting their “cap” requirements or otherwise seek to decrease their carbon footprint. The development of a carbon credit-generating technology, however, is a complex process; therefore, it should be considered within a company’s overall strategy and technology development at an early a stage.

Yair Estline, Esq., is a partner and is the head of the firm’s U.S. law department.

Jeff Karp, Esq., is a partner in the Washington office of ZAG/S&W and is the head of the firm’s clean-tech and green energy practice group.

Ben Armour, Esq., is an associate in the Boston office.

James Perlin, Esq., is an associate in the U.S. law department.