NAPA, Calif. -- California's market for carbon offsets is limping along as a result of uncertain policies, project developers and customers said last week.

The market is intended to provide emitters with a lower-cost option than the state-issued carbon allowances, which have been sold at quarterly auctions since November 2012. Under the state's cap-and-trade system, businesses are allowed to substitute offsets -- from sectors of the economy that aren't already subject to emissions-capping regulations -- for up to 8 percent of their total emissions.

But a series of moves over the past year have dampened potential supplies of offsets, sending prices for the instruments upward. At around $12 per ton, offsets are barely cheaper than allowances, which have been trading at roughly $12.70 per ton. That makes them less attractive to emitters looking for a way to lower their cap-and-trade costs.

"As far as offsets being a cost containment tool, it's been a bit disappointing, the evolution of the market over the past year," said Mike Emerson, manager of energy and carbon trading at Southern California Gas Co., at a carbon markets conference put on last week by Argus Media.

The supply crunch can be traced to a series of moves by regulators that have made potential project owners lose confidence in offsets. First was the California Air Resources Board's decision last November to cancel 89,000 offsets generated from the destruction of ozone-depleting substances, due to issues with the destruction company's compliance with the federal Resource Conservation and Recovery Act (ClimateWire, Nov. 17, 2014).

The company, Massachusetts-based Clean Harbors Inc., subsequently decided to stop processing ODS projects for the California market, leaving just one remaining facility in the United States that is producing California credits, said Mary Grady, director of business development for the American Carbon Registry, one of two nonprofits that registers and verifies offset projects for the state.

"That was a very unfortunate outcome," she said. As well, CARB is now investigating a project that destroyed methane from livestock operations for potentially violating air quality permitting rules in Indiana.

Risks of invalidation grow

Another blow to the market came earlier this year when CARB revised its protocol for generating offsets from forests, requiring a larger buffer of trees to remain intact in a given harvesting area and potentially expanding the number of credits that can be invalidated in the event of a violation. That could reduce the future supply of forestry credits by 40 to 60 percent, said Kevin Townsend, chief commercial officer for offset developer Blue Source.

Townsend said his company evaluated 40 different potential forestry projects last year that would have generated 24 million tons of offsets, and none of them came to fruition. "They all said no, thank you," he said. "That's a tremendous failure to incentivize emissions reduction projects."

As limited supplies and administrative costs have sent prices upward, eroding the spread between offsets and allowances, some customers are turned off.

"It's been tough to get people within the company comfortable with offsets," Emerson said. "As that benefit shrinks, it's even tougher to make the case for offsets."

Customers are also wary of the potential for CARB to invalidate credits. Environmental credit broker Jackie Ferlita said she spoke to a large oil company recently that was concerned about the public scrutiny they might face if their purchases were invalidated.

"You can trace limited demand almost entirely to invalidation risk," Townsend said.

Supplies could increase if CARB decides to add more offset protocols, particularly from agricultural sectors like wetlands restoration, fertilizer management and avoided conversion of grasslands to crop production, Grady said. Other existing protocols, including reducing emissions from rice cultivation and methane from coal mines, could see a boost if CARB establishes regulations to extend cap-and-trade past 2020, she said.

"I don't really anticipate there's going to be a big uptick until we get a post-2020 signal," Grady said.