Common Tragedies

Thoughts on Environmental Economics

Offsets, offsets, offsets

Posted by Danny Morris on June 16, 2009

Offsets.

Offsets.

(related to) Offsets.

It seems like all anyone can do anymore is talk about offsets (at least in my sheltered life). Partially that’s because they are emerging as the key issue that could make or break the Waxman-Markey bill, and possibly a future Senate bill (which may make a splash before the end of the summer).  The three links above provide a good snapshot of the world of offsets as it stands now.

The first link is a rundown of the lobbying brawls surrounding the amount of offsets in Waxman-Markey. It does a good job of highlighting the difference between industry lobbyists (they heart offsets) and environmental lobbyists (they don’t trust them). One thing the article gets wrong, however, is who decides what is an offset:

Near the top of the lobbyists’ wish list is persuading Congress to specify which projects would be eligible as offsets. The bill creates large categories, then allows third parties to decide what is eligible as an offset. Those third parties probably would be similar to groups in the voluntary offset market like the Chicago Climate Network or the Climate Action Reserve in California.

That is an incorrect statement. Third party standards will probably be followed closely or entirely, but it is the Offsets Integrity Advisory Board (OIAB) that will be housed in the EPA that will be the the final authority that determines what is an offset. Thankfully, the bill itself does not say what counts as an offset, but you can imagine the fury that will burn around the OIAB if they make a decision that enrages a powerful and well-endowed interest group.

Actually, you need not imagine that because it has already occurred, which brings us to the second link above. Way back when Waxman-Markey emerged from committee markup, Collin Peterson (D-MN), chariman of the House Agriculture Committee started throwing a hissy fit about the supposed lack of role for agriculture offsets. He basically threatened to torpedo the whole bill if it gave offset market oversight to the EPA. Peterson is still stewing about an EPA rule that may make biofuel producers responsible for their full carbon footprint, including the possible indirect landuse changes resulting from ethanol production, so his solution is to bring down Waxman-Markey unless he gets his way. Discussions between Peterson and Henry Waxman’s staff have been on-going, but as of today, it sounds like Waxman is done playing with Peterson and House leadership may look to take their chances with a floor debate.

At this point, it can feel like using economic arguments is sort of like sternly yelling at a freight train, but I’ve got a loud voice, so I’ll give it a shot. This bill in no way excludes agricultural offsets. It doesn’t exclude any kind of offsets, nor should it. The point is to establish a market system where offsets can be brought, and let the market decide what makes a good offset. The role of OIAB is essentially quality control and setting standards. If your offset is legit, then you don’t need to worry. If it’s just a play to get make more money for Monsanto without any real carbon benefits, then there’s a chance it won’t make the cut.

Even though the offset language in the bill doesn’t favor a certain kind of offset, it contains a number of additional standards for forest offsets. That’s probably because everyone recognizes landuse and forest emissions are a big slice of the climate pie (20% of global emissions), but it also because we have a ways to go before we figure out how to make international forest offsets and REDD (Reducing Emissions from Deforestation and forest Degradation) work effectively.

The third link connects to the latest and greatest studies related to REDD and offsets. Basically, if we want to keep temperature changes below 2 degrees C, we need forest carbon. In the short term, capacity building, establishing pilot projects, and setting baselines for forests are the priorities. In the long term, international offset markets are going to sustain efforts to reduce emissions, so long that enough revenues make their way to indigeneous communties to compete with other land uses.

How well can these international offset markets work? According the authors of the economics study, offset prices between $10-$30 may capture 1-4 billion tons of CO2 per year, or 12-20% of current global emissions. Additionally, international links between markets may significantly reduce global allowance prices (by about 40%). Not bad. It’s important, however, to view these studies in context of the others. If we don’t get local buy-in and solid capacity building, we don’t get our offset markets. Conversely, if the market benefits don’t make their way down to the people on the ground, then all those forests (and investments) could go up in smoke. An when indigeneous people feel like they are being exploited by foreign investment, it’s none too pretty.

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6 Responses to “Offsets, offsets, offsets”

  1. Thom said

    Danny,

    Can you further elaborate this statement:

    The point is to establish a market system where offsets can be brought, and let the market decide what makes a good offset. The role of OIAB is essentially quality control and setting standards. If your offset is legit, then you don’t need to worry.

    How exactly does the market decide “what makes a good offset”? Is it the case that an offset buyer pays a fee to the seller, and then the OIAB determines how many offsets the buyer receives? Should we expect that offsets of one type (say, promises not to cut down trees in a given region) would be priced differently than offsets of another?

    • Danny Morris said

      Thom,

      I should elaborate because that’s sort of a big statement. I apologize for the vagueness. Basically, Waxman-Markey gives responsibility of determining was is a ‘good offset’ to EPA and the OIAB. One may presume that, depending on all the political wrangling, OIAB sets a standard that all offsets must pass before they enter the market. Additionally, one may presume the quality of these offsets entering the market are pretty heterogeneous and that some will appear more attractive to buyers than others.

      A ton of forest offsets may come in to the market at roughly the same price as a ton of agricultural offsets, but if you add in costs of measurement and verification, plus premiums for risk of not actually sequestering the carbon you’re paying for, (plus whatever else we haven’t thought of yet) then one type may start to look more attractive on both the marginal and aggregate scale. The point I was trying to make was that market forces should decide that, not lobbyists. Does that make things more clear?

      • Thom said

        So, where is the risk in this setup? When do cashflows happen? Does the buyer pay the seller not to emit, and then at some later date verification occurs and the buyer is awarded an offset?

        It sounds like what you are saying is that buyers of offsets don’t exactly know what they are getting ex ante, so that WTP is different for different offset products, even if its possible that two offset transactions might result in the same Waxman-Markey offset values ex post, right?

      • Danny Morris said

        Thom,

        Those are the questions that need answers for offset markets to work. I think risk premiums will have to be embedded in the initial purchase price, which could lead to different prices for similar types of offsets. An example is that if you buy a forest offset in Brazil from an area with low risk of deforestation, it may be cheaper than a similar type of offset in Indonesia that is more at risk for conversion to ag land. Another example is a forest offset with well-established (and verified) carbon sequestration rates may have a lower risk premium than an ag offset with poorly understood sequestration rates that have not been as robustly verified.

        Verification is another issue that will require some serious thought. You can imagine EPA requiring some kind of requirement for ex post verification, some on a per project basis, and others (in the case of forest offsets) on a regional basis or something similar, based on the feasibility of doing it properly.

        Buyers will essentially pay for an amount of sequestered CO2 measurable to an yet-to-be-determined level of accuracy and precision. Some buyers may not get exactly what they pay for, which is one reason people remain so skeptical of offsets.

      • Josh said

        I’ve got to say that your quick picture of offsets and how they will potentially be managed is extremely rosy. Why would you worry about the potential for major corporate interests to sweet deals in legislation but not in regulation? Doesn’t the past eight years of Federal Administration prove that regulation can be a worse beast?

  2. Josh said

    This comment:

    “It does a good job of highlighting the difference between industry lobbyists (they heart offsets) and environmental lobbyists (they don’t trust them).”

    …is oversimplifying a very controversial topic within the environmental community as well as without. Many ‘mainstream’ major national environmental organiztions have had quite a hand in developing proposals in conjunction with major carbon polluters. Also, many of these same organizations often receive and/or have on their boards many major corporate heads, and have international connections to landholdings and governments. However, many environmental justice groups blanch at the notion of offsets, because it just cuts deeper into any potential co-benefits to curbing carbon emissions at home, while also encouraging gaming of the system through unproven, shaky endeavours, but giving companies cover to keep their downstream prices high, thus disproportionately impacting the poor.

    Environmental lobbyists are on both sides of this issue, and many of the big multinational environmental orgs. have come out in favor of a percentage of offsets. Others want zero. This is something that shouldn’t be glossed over in your fine blog.

    Last, your comment about letting the market determine what makes a good offset leaves a lot to be desired. In markets, a good anything is that which most cheaply accomplishes its purpose. An offset’s purpose is to allow otherwise-illegal pollution to continue… therefore a ‘good’ offset would be that which would most cheaply allow a polluter to pollute. This is not the same thing as that which would most cheaply sequester carbon, by the way. The latter is noble, and good in the overall concept of a cap-&-trade, but the former is the real math for individual companies, and has nothing to do with actually removing carbon from the atmosphere, unless it is consistently and vigorously regulated. “Consistent and vigorous” were not hallmarks of the previous administration when it came to environmental regulation… who’s to say who the next administration will be, when this proposal is actually implemented?

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