Sean Penrith, The Climate Trust
Weekly Policy and Finance Update – May 22, 2017
I want to talk about flexibility and the true role of offsets in California’s cap and trade program. But, let’s start with the global picture and revisit Paris together. The Agreement. It permitted 195 countries to submit their INDC (Intended Nationally Determined Contribution)—their roadmap—on how each nation would achieve the goal of holding the increase in global average temperatures to below 2°C above pre-industrial levels. This bottom-up approach was designed to give maximum flexibility to countries to achieve this vital target.
The U.S. ranks number two in global emissions. The central plank for the U.S. INDC is the Clean Power Plan (CPP). While the CPP has a doubtful future under the current administration, a central tenet of the CPP is flexibility for regulated existing power plants. CPP offers three “building blocks” that offer the most effective strategies for a plant to choose from in reducing their emissions.
Article 6 of the Paris Agreement includes the ITMO (Internationally Transferred Mitigation Outcome) mechanism. This is shorthand for emission reduction credits and the Article allows nations to create an international market if any Parties so desire, allowing nations to trade reductions units across borders. This makes economic sense. The World Bank’s 2016 Carbon Pricing State & Trends Report pointed out that greater cooperation through carbon trading could reduce the cost of climate change mitigation by 32% by 2030. The ITMO mechanism offers greater flexibility to nations in achieving their emissions target.
The May letter to President Trump, signed by 12 Governors urging the U.S. to remain committed to the Paris Agreement, recognized “Collective action to limit emissions world-wide is critical; without collaboration, climate change will cost the world’s nations several trillion dollars in damages.”
Let’s regroup for a moment. Globally, flexibility, a sense of collaborative community, and managements of costs are the key themes. Now, back to California. The legislature there has seen a number of bills introduced seeking to extend the cap and trade program post-2020. These include SB 775, AB 151, and SB 378. A key driver in this year’s line up is to balance environmental justice concerns around air quality and economic equity with a functioning program that attains the 40% GHG reduction target for the state by 2030 as dictated by SB 32 while maintaining the state’s competitiveness. A tall order for any bill.
The offset program is a target for elimination. Environmental justice (EJ) proponents contend that offsets inhibit on-site reductions at covered facilities and allow those companies to continue polluting in exchange for paying for environmental benefits (offsets) that are occurring elsewhere.
Whether regulators are considering the installation of automobile seat belts or vehicle fuel efficiency standards, two elements are always at play; compliance cost and the compliance window. Let us recap the design parameters of the cap and trade program the California Air Resources Board (ARB) was charged with managing. ARB had to consider how to manage compliance costs and the associated pass through of those costs to the citizens of California, and how long to give covered entities time to on-ramp towards ever increasing reductions goals.
ARB recognized the import of their program design. The Findings and Declarations section of AB 32 states: “National and international actions are necessary to fully address the issue of global warming. However, action taken by California to reduce emissions of greenhouse gases will have far-reaching effects by encouraging other states, the federal government, and other countries to act.”
ARB could have considered a multitude of cost containment mechanisms to manage compliance costs. What they did with offsets was smart. Voluntary carbon offsets had been maturing over the past decade with many lessons learned from the challenges under the European Union Emission Trading Scheme (EU ETS) and Clean Development Mechanism. Protocols were being bolstered, verification was essential and passing the test of additionality became a central focus for credible voluntary carbon reductions projects.
In ARB’s rigorous compliance program, offsets are screened to ensure that real greenhouse gas reductions are beyond what would otherwise occur, in specific sectors not subject to direct regulatory emission controls. The LULUCF (land use, land use change and forestry) sector is an efficient carbon sink sequestering carbon in the vital bid to arresting global temperature rise. Similarly, destruction of ozone-depleting substances recovered from older refrigeration systems ensure that these powerful greenhouse gases are not re-used and ultimately released to the atmosphere. Offset reduction project activities are more often than not accompanied by a host of co-benefits that include cleaner water, improved biodiversity, and protected watersheds.
ARB integrated the use of offsets to achieve two powerful outcomes. The first was to offer cost containment to compliance entities. An ICIS analysis concluded that without offsets, allowance prices are expected to be 38% higher by 2030.
Regulated entities can use offsets to fulfill up to 8% of their compliance obligation. A key point is that the volume of offsets that can be used in the program decreases commensurate with the declining cap thereby offering cost containment options at the outset that slowly narrows as entities increasingly address direct reductions in response to cap stringency. The second was to offer that cost containment in a way that spurred reductions in sectors that were beyond the cap such as in natural working lands in the state and across America. In ARB’s words, offsets were positioned to “Encourage the spread of clean, low carbon technologies outside California” and to facilitate linkage to other jurisdictions. This in short, is working as intended. This collaboration by California echoes similar efforts in the international community and is sending a clear price signal to impact investors who are eying the conservation sector.
The very design framework carefully laid out by ARB is the one that is being taken to task. In the Preliminary Environmental Equity Assessment brief one of the headers decries this design feature stating: “These offsets were primarily linked to projects outside of California, and large emitters of GHGs were more likely to use offset credits to meet their obligations under cap-and-trade.” Remember, for a covered entity in California, offsets are a substitute for allowances. Without offsets, emitters would simply purchase more allowances until the price of allowances exceeds the cost of direct emission reductions as per the design intent of a cap and trade program. The allowance price drives the decision about whether to reduce emissions at the source. While there is currently an oversupply of allowances, this is about to change as the program contemplates a post-2020 cap and trade program.
A look at the data is prudent when contemplating this Equity Assessment finding. 42% of all offsets surrendered to ARB (as per the public reports on 2013-2015 instrument use data) are from California. To date, ARB-eligible offset projects have reduced greenhouse gas emissions equivalent to over 54 million metric tons of CO2 from 260 projects across the U.S. Importantly, 16 million tons of avoided emissions come from 54 projects developed in California, 22 of which occurred in disadvantaged communities in the state.
A project map of Senator Mike McGuire’s District 02 boasts 34 forestry conservation projects that generated $184 million in offset revenue and sequestered 17.6 million tons of carbon emissions. Senator Ted Gaines’ District 01 map recorded almost $12 million revenue for projects there with emissions sequestered equivalent to the energy use of 120,000 homes for a year. The map for the San Joaquin Valley reflects 8 offset projects that generate renewable electricity for onsite use for PG&E, Calgren, and SMUD while mitigating the release of almost 112,000 tons of carbon emissions.
A report from the Center for Law, Energy and the Environment (CLEE) at UC Berkeley School of Law examined the economic impacts of California’s major climate programs on the San Joaquin Valley, made up of eight counties representing 11% of California’s population. The report points out that the air quality suffers more in this area than in any other place in the state. The authors found that due to the impacts of the cap and trade mechanism, the RPS, and energy efficiency programs, there was an overall net economic gain of $13.4 billion to the Valley. The findings underscore that fears of negative economic outcomes from greenhouse gas reduction programs are unfounded.
There are seven companies that have surrendered more than 500,000 offsets in the 2013-2015 period. Forty-six percent of those offsets are from projects in California. Clearly not all covered entities are choosing the offset path. Over the 2013-2015 period, of all the instruments used for compliance under the cap and trade system, allowances totaled 372 million and offsets totaled just 20 million. Offsets represented just 5.3% of all compliance instruments surrendered to ARB. Until allowance floor prices escalate, the utility of offsets as a cost containment mechanism is yet to take full effect. The larger corporations do use offsets more than smaller ones because they have the resources to manage the associated (invalidation, delivery, etc.) risks of acquiring offsets.
An advocate for California Council for Environmental and Economic Balance pointed out after review of ARB’s co-pollutant emissions assessment that 95-98% air quality pollutants come from sources outside of the capped power facilities. This, not offsets, should be the focus of examination for EJ groups.
A Yale report just completed for ARB board member, Dean Florez, offers an alternative to the EJ view on the impact of offsets on disadvantage communities (DACs). The report concludes that, “making alterations to the offset program to achieve health co-benefits would likely result not only in a disruption of its role in the larger cap-and-trade program, but strong opposition from several stakeholders, including those the changes are meant to benefit most, California’s DACs.”
Al Gore’s Climate Reality carbon pricing handbook states, “Linking carbon markets transnationally is a trend that is only bound to continue. At a minimum, regional linkages will serve to harmonize and stabilize carbon prices across the planet.” Any effort to limit linking or impact the creation and use of carbon credits will isolate us from the rest of the world designing carbon mechanisms that include trading. Offsets, at utilization rates of just 5.3% are delivering real, permanent greenhouse gas reductions. This quest to eradicate them is misguided and the wrong end of the stick to focus on. Reversing course on offsets would undermine both California’s climate leadership—in North America and globally—and the credibility and flexibility of the Program. Regardless of any bill under consideration to extend the cap and trade program post-2020, offsets must be an integral part. California cannot look inwards and inhibit the global partnership needed now.
 ICIS: Altering the Offset Rules: Impact on the pre- and post-2020 program, March 28, 2017.
 https://ejscreen.epa.gov/mapper/ and http://oehha.ca.gov/calenviroscreen
2017 Handbook on Carbon Pricing Instruments
The Climate Reality Project
Is cap-and-trade causing more greenhouse gas emissions in disadvantaged communities?
Kyle C Meng, April, 2017
Implementing Article 6
EDF, IETA, CI, Forest Trends, & TNC, April 2017
Carbon Offsets and Health Co-benefits
Yale University, School of Forestry & Environmental Studies, Environmental Governance & Justice Practicum
California Capitol focuses on environmental injustice—but will it lead to real results?
CalMatters, May 17, 2017
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Image credit: Flickr/Bemep