Will there be a shortage of carbon offsets if Waxman-Markey goes through?

The answer is yes, according to the National Commission on Energy Policy: but it’s not the end of the world.

Many of the cost estimates of the proposed Waxman-Markey cap and trade scheme in the US assume that quite a lot of the international carbon offset credits allowed by the legislation – up to 1.5bn tonnes worth per year – will be used. In fact as the EPA estimated, without those offsets, the costs of the scheme would be almost double. (That report, by the way, put the cost at a relatively modest $98 to $140 a year.)

But NCEP, a bipartisan group that advises on policy, says there won’t be enough international offsets to reach that level, particularly in the early years of a US cap and trade scheme. Worldwide carbon offsets created under the UN’s Carbon Development Mechanism, they point out, only add up to 300m tonnes of carbon a year now – and scaling up massively to meet US demand is not going to happen quickly.

The NCEP says it is impossible to know how many international offsets will be available, as it will partly depend on the auditing rules and standards – for example, determining additionality – that a US cap and trade programme would require.

However, they say:

Based on past experience with offset programs, however, we would expect the international offset market to ramp up slowly compared to some of the more optimistic estimates associated with House climate legislation.

The problem remains, they say, that international offsets will not be enough to contain the economic risk of a cap and trade system in the early years.

So, what to do? Other measures should be introduced, they write:

An additional cost containment mechanism, such as a price cap or an allowance auction reserve should be available to manage these risks and limit the potential for extreme price volatility during the critical startup period of a U.S. program. Over, time, we would expect offsets to play a larger role as implementation and policy issues are resolved.

Now, the whole concept of offsets is criticised by some environmental groups and others: mostly because the practice of paying someone to reduce their carbon emissions is rife with pitfalls (see: additionality). The NCEP report points out that offsets have significant advantages, not least of which is reducing the cost of carbon reduction schemes in developed countries, thereby making them more politically palatable. They can also help funnel investment to the developing world – and greenhouse gases are greenhouse gases, no matter where they originates from.

However the NCEP report, mindful of the criticisms and the occasional scandal even in the regulated world of the Carbon Development Mechanism, has stern words on the subject of credibility: the rules and monitoring around offsets must be carefully considered, it says, because:

Past offset programs have shown that even a small number of imperfectly documented offset credits could significantly undermine confidence in the emerging offset market. There is every reason to expect continued controversy, critical media attention, and a high degree of scrutiny by NGOs and oversight bodies. This dynamic has the potential to stifle innovation and slow the learning that is needed to realize the full potential of domestic and international offsets.

So how can more projects be implemented, without risking credibility?

Among the NCEP’s recommendations are a ‘sectoral’ and ‘aggregated’ approach to offset projects. Aggregation is simply accrediting groups of carbon-reduction efforts that are too small to be evaluated as individual projects (see our post on the Harvard Climate Project CDM recommendations).  The ‘sectoral’ approach broadly refers to defining industry-wide benchmarks, which are then used to determine ‘additionality’ (ie, whether the measures being taken really should be paid for, and wouldn’t simply take place anyway). This theoretically makes it more straightforward to invest in bigger investment projects – although coming up with those benchmarks can be mind-bogglingly complex, and the sectoral approach itself presents some challenging incentive problems, as these two post from Grist explain.

The sectoral approach also tends to appeal to the developed countries because it can be used to prevent  ‘leakage’ of business,from countries that charge for carbon, to countries that do not.  Developing countries tend to be less keen.

Related links:

Carbon offsets: money-saving, but difficult (FT Energy Source, 04/08/09)
Crunching the numbers on Waxman-Markey in the Senate (FT Energy Source, 07/07/09)
Waxman-Markey and the 77c gasoline increases (FT Energy Source, 24/06/09)

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