Carbon Offsets and the Emerging Climate Coalition

July 9, 2009

With the recent passage of the Waxman-Markey bill in the House, climate advocates are now shifting their attention to the Senate, where the challenges that await climate legislation are even greater. In moving forward, architects of climate policy would do well to heed key lessons from the House debate, recognizing, for example, the role of farm states in carrying any bill over the finish line.

In the context of a cap-and-trade program — the centerpiece of the Waxman-Markey bill and probably any Senate package — farm-state concerns largely boil down to concerns about the treatment of carbon offsets, credits that could be awarded for activities outside of capped sectors, like sequestration of carbon in managed forests or in agricultural soils. Such credits could potentially provide a steady stream of revenue back to regions of the country that have historically been slower to warm to the idea of cap-and-trade.

In fact, advocates of an expanded offsets supply are numerous and extend well beyond the farm belt. This unofficial coalition includes much of regulated industry, which believes that offsets will lower the effective costs of compliance; carbon traders, who believe that offsets will help grease the gears of a new market; and environmentalists, who view offsets as a ticket to ambitious early emissions reductions. These three constituencies are formidable in their own right and cannot be ignored easily in the difficult quest to secure 60 votes.

Substantively, offsets can provide real opportunities to lower the costs of early reductions if they are designed well, but they can also cause real damage if they are not. Keep in mind that, in practice, any number of problems could threaten the integrity of an offset project. For example, carbon could physically leak out if attention to a given project lets up in the future (a problem referred to as “non-permanence”) or the project could shift carbon-intensive activities elsewhere (a problem referred to as economic “leakage”).

In light of these concerns, a sensible approach toward offsets would contain two major components. First, it would grant EPA, in conjunction with other appropriate agencies, like USDA, the authority to develop a comprehensive rulemaking to govern the certification of “high-quality” offsets. These projects would meet well-defined criteria for permanency (the length of time a project would be required to sequester carbon); additionality (protocols that ensure that the activities in question reduce emissions below the anticipated baseline); and verification (physical validation of the first two criteria). Projects certified under such rules, however great or small the actual number, could then generate credits functionally identical to emissions allowances.

Secondly, this approach would deal squarely with projects that fall short of meeting the most stringent quality criteria. This class of projects is likely to be quite large but suffers from neglect in policy discussions due to fears that acknowledging imperfection will fuel opponents of cap-and-trade.

The problem with hiding this issue from view is that it gives project developers, and perhaps even regulators, incentives to misreport the performance of various activities in order to meet a single, black-or-white threshold for certification and to enhance the perception of a successful outcome.

Directly confronting and incorporating the limitations of real projects into the certification process would be far preferable, because it would enhance the scope of the program while reducing corruption, yielding a better overall economic and environmental result. In order to realize this objective, regulators could discount offsets according to well-defined rules that would quantify the risks associated with particular kinds of projects. Of course, not all projects would need to be discounted under this approach; tons of avoided emissions from the highest-quality projects would still be credited one for one.

Under a more ambitious realization of this proposal, the discounting rule could also take into account broader economic conditions, creating a useful authority to stabilize the market in times of stress. If adopted, this approach would confront the limitations of the offset supply head on and transform the certification exercise into a refined and effective mechanism to keep the carbon market in check.

The exact details of this system would need to be developed over time by appropriate regulatory agencies, but the essential point is that a well-designed policy toward offsets could simultaneously enhance three key objectives: It could widen political support for cap-and-trade; it could lower overall costs of the program; and it could implicitly authorize a sensible amount of regulatory discretion. Most importantly, it would do all of these things while preserving and even enhancing the environmental integrity of the policy.