Weathervane: A Climate Policy Blog from Resources for the Future

Jun17

International Offsets, Cost Containment and the American Power Act

The new U.S. Environmental Protection Agency (EPA) analysis of the Kerry-Lieberman American Power Act (APA) reveals that EPA is taking the issue of international offsets very seriously, and they have provided an unprecedented level of detail and transparency on how different assumptions and scenarios would affect offset supply and corresponding economic impacts. However, the analysis also presents some mixed messages about the relationship between international offsets and cost containment. This could lead to an undervaluing of international offsets in managing the costs of climate policy, and mean sub-optimal decisions will be made about the allocation of scarce allowance auction revenues.

A casual reader of the analysis would likely take away two messages about international offsets: that they “… have a strong impact on cost containment”, and that, “… if the availability of international offsets to the U.S. is simply delayed 10 years, then allowance prices increase by only one percent.” At first it is difficult to square these statements, since a ten-year delay seems like a plausible “pessimistic” scenario for international offset supply. Can offsets really be said to have a “strong impact on cost containment” if removing them for 25 percent of the program has such a negligible effect?

The devil is, of course, in the details. Closer examination of EPA APA modeling scenarios 2 and 5b reveals that this ten-year delay only produces a 3.5 percent lower supply of international offsets over the 2013-2050 life of the program. This is because offset purchases in the program’s later years increase relative to the core scenario. A 3.5 percent cumulative supply reduction producing a 1 percent average allowance price increase makes a lot more sense than a 25 percent delay producing a 1 percent increase. In contrast, assuming no offsets from reduced deforestation rates in developing countries (EPA APA scenario 5a) lowers cumulative 2013-2050 offset supply by 69 percent and increases average allowance prices 23 percent.

The data appears to show a clear change in firm behavior caused by the low early supply: instead of buying international offsets in earlier years, banking them, and using them when compliance costs rise in later years, firms buy additional offsets in later years to make up for those that were not available to bank (they also do some additional domestic mitigation and purchase more domestic offsets).

This reveals a critical assumption underlying the low-cost ten-year delay case: following the delay annual supply will be greater than if offsets were available from day one, or, stated differently, whatever political, economic and technical factors that caused the delay will disappear immediately and despite limited public investment by the United States. This assumption could be problematic for several reasons. First, the readiness of developing countries to supply compliance-grade offsets could be much more an issue of funding than an issue of time. If external public financing to build capacity and develop measurement, monitoring and verification systems is not provided, some countries may simply never be ready for offset markets, or be both delayed and have a slow, gradual increase in supply. Second, if this financing is provided by the European Union or Japan, who will also likely have a high demand for offsets, developing nations may choose to give preferential market access to countries providing upfront assistance.

How does this all add up? Analysis shows that using some revenues from allowance auctions to build the capacity of developing countries to sell compliance-grade offsets to the U.S. market, particularly in the forest sector, will yield substantial net benefits to households and the economy by protecting against the risk of low supply—even when compared to the option of refunding revenues directly. Previous climate bills have devoted 5 percent of total allowance auction revenues to reducing emissions and building offset capacity in the forest sector, while the Kerry-Lieberman bill devotes 0 percent. This lack of funding introduces substantial new economic risks to climate legislation.

Andrew Stevenson is a research assistant at Resources for the Future.

Published: Jun-17-10 | 0 Comments

Apr21

International Financing Under a Hybrid Climate Bill

International, Offsets, COP-15

Without financing, there would have been no deal in Copenhagen has become a familiar refrain in climate policy circles over the past several months. Pledges from last December’s conference included $30 billion in “fast start” financing from 2010 to 2012 (public funding from developed countries divided between mitigation and adaptation), and the mobilization of $100 billion annually by 2020 (public and private financing, again for both mitigation and adaptation). These funds are critical to addressing the climate problem in a cost-effective manner by helping developing countries reduce deforestation rates, shift towards cleaner sources of energy and adapt to the impacts of climate change. In most cases developing nations have the will to act but are lacking technical expertise and financial support for the incremental costs of growing in a more sustainable manner.

While the United States will approach its share of the $30 billion solely through increased foreign assistance appropriations, the pathway to its contribution to of the $100 billion—expected to be in the range of $20 billion based on other international programs—remains uncertain. While a high-level panel on financing recently convened by the UN secretary-general is exploring innovative ideas that could be implemented at the international level, the clearest path still appears to be through a new comprehensive climate and energy bill.

The Waxman-Markey bill passed by the House of Representatives “set-aside” 7 percent of allowance auction revenues in early years of a cap-and-trade program for international activities and allowed companies to use international offsets for compliance purposes, generating tens of billions annually by 2020 for reducing deforestation, clean technology and adaptation. Since “cap-and-trade” has been declared dead, we examined what types of mechanisms policymakers could consider in a “hybrid” bill that takes a sectoral approach to greenhouse gas regulation.

We analyzed five different policy mechanisms (PDF) under three scenarios that ranged from limited deployment of the most politically feasible mechanisms to more robust deployment of all five mechanisms. The five mechanisms analyzed were:

1) International offsets in a utility and manufacturing cap-and-trade program (private sector funding). Similar to previous climate bills, policy makers could allow regulated entities to submit verified international emissions reductions in lieu of purchasing emission allowances.

2) International set-asides in a utility and manufacturing cap-and-trade program (public funding). Also as in previous climate bills, policy makers could reserve a portion of emission allowance auction revenues for specific international activities.

3) A “strategic reserve” or “safety valve” in a utility and manufacturing cap-and-trade program (public funding). As in previous climate bills, policy makers could use revenues raised from the sale of allowances from a strategic reserve or safety valve to finance international emissions reductions, either re-filling the strategic reserve or closing the gap between actual U.S. emissions and emissions targets in a given year.

4) Tax credits for transportation and other sectors (private sector funding). Analogous to “offsets”, policy makers could reduce a regulated companies’ tax burden for each dollar they invest in international climate activities or each verified emissions reduction they purchase.

5) Tax revenue set-asides from a carbon fee on the transportation and possibly other sectors (public funding). Analogous to cap-and-trade set-asides, policy makers could reserve a portion of tax revenues for specific international activities.

Overall, we found that assuming a carbon price of $22 per ton, allowing international offsets in a utility and manufacturing sector cap-and-trade program at a level consistent with previous legislation could yield $12 billion annually in 2020 for international activities while making the legislation’s emissions reductions more cost-effective. Most of this funding will likely be directed towards tropical forest conservation because it is expected to be the largest source of international offsets or verified emissions reductions.

Under a similar policy scenario, set-asides of revenue from emissions allowance auctions or fees on the transport sector could generate an additional $3 billion annually by 2020 (assuming 3 percent of total revenues are set-aside). Some of this funding will likely also be directed towards tropical forest conservation in order to help countries build capacity to participate in U.S. carbon markets (and ensure a steady supply of cost saving international offsets), with some available for adaptation and clean technology.

Other mechanisms could raise $6-12 billion annually by 2020, including tax credits for international climate investments by the transport fuels sector and using strategic reserve auction revenues for international activities, but depending on overall offset limits and policy scenarios they may compete with rather than supplement revenue for international offsets. This funding would also likely be directed primarily to tropical forest conservation because it is expected to be the largest source of international offsets or verified emissions reductions.

Based on this analysis, in order to meet its projected $20 billion contribution to international funding by 2020 the United States will also need to explore other domestic and international alternatives—such as foreign assistance appropriations, aviation taxes and/or the use of International Monetary Fund Special Drawing Rights—with the largest gaps coming in funding for clean technology and adaptation.

Andrew Stevenson is a research assistant at Resources for the Future and regular contributor to Common Tragedies.

Published: Apr-21-10 | 0 Comments

Apr16

Does Money Grow on Trees After All?

Allocations, Offsets, Forests

Consumers. Households. Citizens. Loyal subjects. The American people. The emergence of cap and dividend as a key piece of the Senate climate debate—either as a stand-alone bill or more likely a core principle of the Kerry-Graham-Lieberman process—can be directly traced to increasing awareness of how climate policy impacts the U.S. economy and the average “Joe Coal.”

However, direct rebate checks are not the only way to make climate policy more economically-friendly. Sens. Cantwell and Collins have acknowledged this by devoting 25 percent of the auction revenues in their bill to clean technology development and other purposes. It does not take a Ph.D. in economics to understand that lowering the cost of key emissions reduction technologies makes it less costly for companies to comply with climate regulations, savings which are then passed on to the broader economy and households in the form of lower allowance prices. Any U.S. government analysis of climate policy that assumes higher costs or delayed implementation of clean technologies shows higher allowance prices and more substantial economic impacts.

Climate policy, costs and international offsets

In bills like the House-passed Waxman-Markey, this is equally if not more true for the supply of international emissions offsets, a majority of which are expected to come from reducing tropical deforestation in developing nations. Indeed, EPA analysis of the House bill shows that average annual allowance prices would be 89 percent higher and average annual net present value costs of climate policy to households would be 75 percent higher without international offsets. In part to help ensure these offsets would be available, policy makers set aside 5 percent of allowance auction revenues to reduce emissions from deforestation and help developing nations prepare for U.S. offset programs.

Since it is such a key driver of costs, why shouldn’t policy makers think of international offsets as just another “technology” that is essential to bring on line in order to manage the costs of climate policy?

While early rumors indicate that the Kerry-Lieberman-Graham bill will allow companies to purchase international offsets for compliance purposes—at least in the electric utility and manufacturing sector cap-and-trade program—the push for returning revenues to households directly is squeezing down the space for a 5 percent set-aside of auction revenues for tropical forests. Removing this set-aside is likely to reduce the supply of international offsets because, without funding to develop measurement, monitoring and verification systems and reform institutions, fewer nations will be prepared to meet U.S. compliance standards.

This raises a number of interesting economic (and political) questions. First, because of a more limited supply of offsets, what would be the impact on allowance prices of removing this set-aside? Second, would the higher allowance prices caused by removing this set-aside make the U.S. economy and households worse off than the benefit they would receive from a direct rebate of auction revenues?

Saving households money by investing in tropical forests

We set out to answer both questions using Resources for the Future and Climate Advisers’ Forest Carbon Index (FCI) model and EPA modeling scenarios of the House climate bill (which can be used as a rough proxy for the electricity and manufacturing sector emissions trading program in the Kerry-Lieberman-Graham “hybrid” bill).

The first step was determining how international offset supply would respond to a reduction in new public funding. Making a qualitative assessment based on the FCI and other studies, we analyzed three possibilities: that reducing public funding would lead to small initial drop in supply and delay in reaching full capacity (“Optimistic” case), that reducing public funding would lead to a large initial drop and longer delay in reducing public funding (“Medium” case), and that reducing public funding would lead to about a ten-year delay in any forest sector offset availability and a slow ramp-up thereafter to full capacity (“Pessimistic” case). These scenarios were intended to be illustrative of a range of possible responses and were based on political and economic judgments about key countries including Brazil and Indonesia.

Across these scenarios, in our analysis eliminating the set-aside could lead to a cumulative reduction in international offset supply of between 6 and 32 percent, which the proportional relationship between international offset supply and allowance prices in EPA scenarios indicates could increase average annual allowance prices by 4 to 27 percent.

Using the proportional relationship between allowance prices and GDP impacts shown by EPA’s modeling scenarios this would lead to a 3 to 24 percent increase in the annual average net present value costs of climate policy (2012-2050). In more concrete terms, even when accounting for the cost of the set-aside, net savings from setting aside new public revenues for tropical forests (in terms of GDP impacts) could range from $317 million to $18 billion per year. This means that under all scenarios each $1 in set-aside spent could yield greater than $1 in savings.

The picture with households is more mixed, and overall the impacts are less significant. Net changes in the average annual net present value cost of climate policy per household range from a $9 per-year increase in costs from eliminating the set-aside under a “Pessimistic” offset supply response case to a $5 per-year reduction in costs under an “Optimistic” scenario. Under a “Medium” scenario households would face roughly the same costs whether the set-aside for forests or a rebate is provided.

Overall, these findings highlight the potential risk to the U.S. economy of not providing a new public funding set-aside for tropical forests. If offset supply is sharply reduced by not providing the set-aside, the economic impacts of climate policy could be much more severe. If offset supply is only reduced a small amount, the annual GDP savings could still exceed the cost of the set-aside. Under either scenario, in economic terms households would be largely indifferent whether they receive these cost savings in the form of a rebate check or in the form of lower allowance prices.

Returning revenues to households or supporting technology development is not the only way to make the American people better off in a cap-and-trade program. Even beyond the vast environmental and foreign policy benefits of investing public revenues in reducing tropical deforestation, it appears to be a winning economic strategy as well.

Read the technical report The Economic Benefits of Public Investments in Tropical Forest Conservation (PDF) here. Andrew Stevenson is a research assistant at Resources for the Future and regular contributor to Common Tragedies.

Published: Apr-16-10 | 0 Comments

Sep14

Counting Forests: Not Quite as Easy as 1,2,3

Forests, Forest Carbon, Offsets

If you’ve recently had a conversation about the world’s forests and climate change, then you’ve probably heard the figure "20 percent" thrown around. That number represents the amount of worldwide emissions currently attributed to deforestation and forest degradation.

If tropical rainforests have been a frequent topic of discussion in your social circles, maybe someone told you that more than 10 million hectares of rainforest were permanently logged or destroyed every year from 2000 to 2005. These figures represent important metrics for policymakers to understand the role forests play in environmental policy issues. Their widespread use is partially based on the assumption that scientists have accurate and consistent measurements of forest attributes from which they can derive such figures.

Forest measures and inventories, however, may not be as accurate and precise as scientists and policymakers would like. In his RFF discussion paper, Paul Waggoner highlights such discrepancies and uncertainties embedded in current forest measures. “Without accuracy, appraisals of timber will be discredited, assays of biomass will be deceptive, and claims of sequestered carbon may be fraudulent,” he writes in “Forest Inventories: Discrepancies and Uncertainties.”

His analysis comes at an opportune time as the Senate gears up to consider climate legislation and agencies like the Commodity Futures Trading Commission look to more closely regulate the nation’s carbon markets. As a major component of H.R. 2454, forest offsets will face more scrutiny about their veracity and quality in the coming months.

Waggoner showcases eleven different cases of major discrepancies in forest measures across the globe, including some within IPCC forest carbon accounting guidelines. One of the reasons for such uncertainty, he writes, is related to how forests are defined. The definition Waggoner cites—the Forest Identity—consists of four measures: area, growing stock density, biomass, and carbon. Uncertainties exist in each of these attributes and as they are combined to form the Forest Identity, their uncertainties aggregate and can result in significantly inaccurate final numbers.

So what’s the solution? Forest measures will never be perfect, nor will they have 0 percent uncertainty, but that is not why it is worthwhile to point out discrepancies. The point is to push toward acceptable levels of uncertainty in forest measures. As Waggoner points out:

Although perfect accuracy might seem the goal, it is not—at least not in the real world of affairs. Rather, the cost of improving accuracy makes good enough the goal. If the costs of surveying, monitoring, and verification exceed the consequent benefit or profit, regulation will fail and transactions abort in the long run…Thus the discrepancies and uncertainties in forest surveys must next be evaluated against standards of good enough for, say, scientific debates, timber sales, or carbon credits. Then economical methods for meeting those standards must be established.

In the mad rush toward using forest offsets to solve the world’s climate problems, voices of warning like Waggoner’s should not get lost in the din.

Daniel F. Morris is a research assistant at Resources for the Future and regular contributor to Common Tragedies.

Published: Sep-14-09 | 0 Comments

Sep14

Monday's Reads

Cap and Trade, Congress, COP-15, Renewables, Offsets, Morning Reads

NYT: West Virginia Democrat Sen. Jay Rockefeller has become the poster child for coal’s paradox—working in the interest of his coal-mining constituents but realizing its only real future in climate legislation is carbon capture and sequestration. CCS is a future many coal companies are banking on.

Reuters: Russian leaders say they won’t sign on to any international climate deal that doesn’t have commitments from other major emitting nations like the U.S. and China. Meanwhile top officials in India say they will be hard pressed to sign on to any binding emission goals, and that it wouldn’t be a disaster if Copenhagen’s negotiations fail.

WaPo: Two former presidential candidates map out different paths forward on climate in the Senate. As Sen. John Kerry runs full throttle, Sen. John McCain has remained largely mum.

NYT: A Massachusetts couple finds that while they may be fine with a wind turbine in their backyard, their neighbors—and many others across the nation—take issue with the noise and appearance of home-use turbines.

FT: As another verifier of CO₂ offsets under the CDM is suspended, some are wondering if banking heavily on the developing world for carbon credit is a good idea.

Reuters: Mexico and Argentina are leading the shift to more carbon-friendly economies, according to a new report from a London-based think tank. The nations are the only two in the G-20 whose carbon output improvements put them on pace to meet the reductions goals necessary to play their part in meeting the global 2 degree goal.

And Ohio State University professor Brent Sohngen sketches some examples of cap and trade past successes.

Did we miss something today? Let us know, leave a comment or email clements@rff.org.

Published: Sep-14-09 | 0 Comments

Aug03

Ecosystem Service Stacking: Can Money Grow on Trees?

Carbon Market, Congress, Forests, Offsets

Future commodity traders may look back on June 26, 2009 as the day that the Congress officially backed ecosystem service markets as the prominent vehicle of environmental conservation in the 21^st Century. It was then that the sweeping American Clean Energy and Security Act of 2009 (H.R. 2454)—legislation in which carbon offset markets play a huge role—passed the House 219-212. Estimates from the EPA suggest by 2030, the U.S. offset market could be worth $4 billion. Forest offsets will likely constitute a large portion of the total market but agricultural lands will also have some significance.

While the ultimate fate of the bill remains uncertain, H.R. 2454 indicates that ecosystem service markets have a critical role in both the fight to slow climate change and the future of ecosystem conservation. In fact, reduced emissions from deforestation and degradation (REDD) and other forestry issues will likely be integral to an eventual agreement at the COP negotiations in Copenhagen this December.

Ecosystem Service Markets

While carbon markets are currently dominating discussions, they are certainly not the only type of ecosystem service market being utilized for environmental benefits. Other examples include water quality or nutrient trading, conservation easements, and habitat banking for endangered species. Section 404 of the Clean Water Act led to the establishment of wetland mitigation banks, which proved to be a successful conservation device. By 2005, 450 wetland banks had been established, with 59 selling out of credits completely.

Current ecosystem service markets have just scratched the surface. Robert Costanza and others estimated the global annual value of ecosystem services was $33 trillion. The voluntary carbon market in 2008 was estimated to be worth about $705 million. The forest carbon offset markets in H.R. 2454 provide an opportunity to expand and refine ecosystem service markets aggressively and incorporate them into the larger economic system domestically and worldwide.

Stacking

Widespread acceptance of carbon-related ecosystem services may present a vehicle for the expanded usage of other types of ecosystem services. Combining the value of these different services is called bundling or stacking, and it allows landowners and indigenous communities expanded opportunities to be compensated for maintaining and enhancing ecosystem functions. It is important to note that services will be stacked or bundled in a single ecosystem, but must be well-defined enough to separate into autonomous markets. The markets themselves will not necessarily be stacked.

One can imagine eventually linking carbon offsets with water quality credits or habitat credits. With a network of robust, functional ecosystem service markets a landowner could manage an entire portfolio on his/her land, balancing forest offsets with increased stream buffers that generate water quality market credits, understory clearing to generate endangered species habitat credits, and other types of natural capital. Such opportunities are a prospective avenue for alleviating poverty among rural or indigenous populations.

Oversight

Stacked but separate ecosystem service markets could possibly create incentives (though not guarantees) for landowners to take a more holistic management approach, looking at the functionality of entire natural systems rather than one specific usage. A fully integrated and functional ecosystem marketplace is currently far from becoming a reality, however. There are a number of issues that must be addressed to ensure the markets are robust and effective. Major concerns include:

Valuation: One advantage carbon has over other ecosystem services is that there are straightforward mechanisms for valuing tons of CO2. Determining accurate values for endangered species habitat credits or water filtration on a chunk of land will require better research and better valuation techniques than are currently available. Significant investments in scientific assessments and monitoring are needed before these markets can be established effectively.

Additionality: One of the major questions carbon markets must answer is how they can establish additionality, or proof that sequestration activities would not have occurred in the absence of the offset project investment. If other ecosystem markets link up with the carbon market on a piece of land, the landowners will likely need to show that actions that can earn other types of credits would not have occurred without additional investment.

Double-counting: If landowners hope to obtain multiple revenue streams, then they must manage for multiple ecosystem services. Selling water quality credits from land that is only being managed for carbon will not generate the correct incentives for landowners and will undercut the effectiveness of the water quality market. Added value of different services must be well-established enough to avoid multiple payments go to one specific type of action.

Capacity-building: International forest carbon offsets will be a sizable chunk of the total offset market, the vast majority of which will come from developing countries that currently lack the capacity to effectively establish, monitor, and certify offset projects. To ensure the veracity and efficacy of the market, massive capacity-building efforts are needed in places like the Congo Basin, Indonesia, and Central America. Other ecosystem service markets will also need similar building efforts, though they may be able to piggyback on the efforts to establish carbon-related infrastructure.

Permanence: What is the value of an ecosystem service credit if the ecosystem is damaged or destroyed soon after investment? This question will need a solid answer for markets to work properly. While permanence is currently a big concern in carbon markets, it will correspondingly affect other ecosystem markets. In order for these markets to grow and thrive, solid governance structures will be needed to establish appropriate risk premiums and other tools that can mitigate the problems related to permanence.

Stacked ecosystem services could prove to be a powerful conservation tool, but are not a silver bullet for protecting natural systems. They are designed to create incentives for people to manage land carefully. If carbon, water quality, endangered species, and other services simply morph into commodities to be traded back and forth without any robustness checks or on-the-ground coordination, then the transformative power of stacked ecosystem services will be lost. Moreover, regional issues will play a key role in determining which markets work and how. Carbon is a global good that can be traded across countries and continents; water quality and species habitat are very region-specific and will require smaller-scale markets that may or may not be trans-national.

Despite these challenges, ecosystem service markets are an innovative and potentially useful approach to conserving and restoring damaged and sensitive parts of the biosphere. The emphasis on forest carbon in H.R. 2454 may provide an opportunity to refine and expand these markets to the benefit of both ecosystems and the people who depend on them.

Daniel F. Morris is a research assistant at Resources for the Future and regular contributor to Common Tragedies.

Published: Aug-03-09 | 0 Comments

Jun15

Experts Explore Challenges in Offset Market Design

Carbon Market, Waxman-Markey, Offsets

As the American Clean Energy and Security Act makes its way through the House Agriculture and Ways and Means Committees, offsets continue to crop up as a major point of contention. While understanding of offset markets matures, RFF continues to identify and address important economic and logistical issues of concern.

Last month, RFF hosted a joint workshop with the EPA entitled “Modeling the Costs and Volumes of GHG Offsets.” Experts in forest, non-CO2 gas, and agriculture offsets came gathered for a technical discussion about the state of offset modeling and how it can contribute to the design and implementation of offset policy. The presentations from each panel are available here. Some of the major themes highlighted by the panelists include:

Forestry

• Forest offsets show huge potential to sequester carbon and control costs, but there are many challenges to implementation.
• Threats to the integrity of offsets include tracking and measuring emissions leakage, establishing clear additionality, and assuring reliable levels of permanence.
• Heavy use of forest offsets suggest major land use changes both in the U.S. and in other countries, though land conditions could substantially affect the potential for offset usage.
• Contracts may be useful in some situations for dealing with leakage, permanence and other issues, but national standards may be needed in other contexts.

Non-CO2 gases

• Non-CO2 gases are major climate forcings and their mitigation costs are often lower than energy-related CO2.
• The economics of individual projects are relatively well-understood, but the sectoral cost curves are less clear.
• More guidance from government is necessary to reduce investment risk and encourage early action on offset opportunities.

Agriculture

• Models indicate that agriculture offsets will not play as big a role domestically as forestry-related offsets, but higher prices will bring more agriculture offsets into the market.
• Agriculture offset opportunities may exist in areas where afforestation or other types of offsets are not realistic.
• Technology may play a key role in providing more offsets.

Daniel Morris is a research assistant at Resources for the Future and regular contributor to Common Tragedies.

Published: Jun-15-09 | 0 Comments