Much Ado About Carbon Offsets

Catalyst / by Maywa Montenegro /

Five experts debate if carbon offsetting is the quick, efficient way to decarbonize the global economy, or the loophole that will derail such efforts.

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Buying carbon offset credits has become one of the hottest ways for corporations, government agencies, cities, and well-to-do individuals to build enviro cred. From Coldplay planting trees to cover their airline travel to Intel subsidizing wind farms, these offsets allow the polluting parties to pay others to make their carbon reductions for them.

Much of this flurry of carbon offsetting is voluntary, whether out of concern for the planet or company image. For industries and governments facing carbon caps, however, offsets represent a crucial means to meet emissions targets.

Many will buy their offsets through the UN Clean Development Mechanism, where credits go to finance projects in the developing world that reduce greenhouse gases. Bogotá’s TransMilenio bus system, for instance, has reportedly slashed the city’s fuel use by more than 59 percent.

Still, offsets—both domestic and international—are undergoing increasing scrutiny from environmentalists and policy analysts. Europe’s heavy use of CDM offsets to meet its Kyoto emissions target has drawn particular fire, as it has been extremely hard to verify if additional carbon cuts were occurring as a result of offset-subsidized projects. Further, European-based polluters bought so many of the credits‚ as Michael Wara of Stanford University has pointed out, that EU industries likely emitted roughly 1 percent more greenhouse gases in 2008 than they did in 1990.

Many experts fear that the US is about to blunder down the same path. The Waxman-Markey bill contains provisions for 2 to 2.5 billion tons of CO2 in offsets. A recent analysis by the Breakthrough Institute showed that this volume of credits could allow “continued business-as-usual growth in US greenhouse gas emissions until 2030.”

Others, however, argue that offsets allow emission cuts to be made in the sectors where they inflict the least economic damage. And that revenue from their sales provides capital to developing nations looking to jumpstart growth in green technology.

So, do offsets provide an efficient way to decarbonize the global economy, or will they be a loophole that will derail such efforts? Do they have a valid place in a global emissions policy?


Offsets Make Cutting Carbon Cheaper and Faster

Paul Kelly is global head of J.P. Morgan Environmental Markets Sales and Origination. He is responsible for building the company’s environmental markets sector and has in-depth experience in carbon emissions, commodities sales and trading, principal investing and emerging markets.

Over recent years, policy makers globally have embraced carbon trading as an important and cost-efficient means of reducing greenhouse gas (GHG) emissions. However, the vision of a truly global carbon market is many years away. In the meantime the international community has to pick its way through a difficult and uncertain transition period, where different countries have differing obligations, or no obligations at all, and negotiations are fraught with political and economic sensitivities.

Carbon offsets provide an attractive and effective means of easing the world’s governments, businesses, and individuals through this transitional period, and have a valuable purpose in a global emissions policy for two critical reasons:

First, carbon offsets are cost-effective. The world has learnt very quickly that cutting carbon dioxide emissions at the scale required to mitigate global climate change comes at a price. It is because of this cost that the principle of offsetting has grown in popularity—if we didn’t have to worry about the costs involved in cutting emissions, we could simply get on with making reductions in our own backyard. Yet, in the real world of competitiveness, jobs, and investment, we have to think about the outlays required when we reduce emissions. Those developed countries who have taken on the first obligations to stabilize and start reducing their emissions have therefore embraced the “outsourcing” of offsets to less-developed countries. An example of this is J.P Morgan’s Gold Standard Improved Cook-Stove projects, which are associated with an array of other benefits such as the transfer of technology and capital, along with the promotion of health benefits and sustainable development.

Second, offsets can be implemented much faster than many other greenhouse gas-reducing measures. Offsets are exceptionally good at revealing low-cost ways of reducing emissions in the short run. Trading offsets is about finding, and then sharing, the low-hanging fruit. That doesn’t, of course, mean we don’t need to be building a ladder at the same time so that we can reach the higher fruit when the low-hanging fruit is gone. However, building that metaphorical ladder will take time, money, and research.

What is needed is the creation of policies that complement the aggressive use of offsets, to help get us through this “transitional period” before a global carbon market is realized, and to help cut emissions at a cost that economies, industry, and business can afford. A case in hand is the US: One of the most commonly heard expressions used by pragmatist proponents of a US cap-and-trade market is, “We just have to get this thing started.” To get it started, it is hard to believe that in the short- to medium-term the US can take on ambitious emissions reduction targets without the extensive use of carbon offsets.

This is not to suggest, however, that offsets’ shortcomings shouldn’t be addressed in the interim. Of course some offsets are better than others—Kyoto’s Clean Development Mechanism (CDM) and Joint Implementation (JI) schemes, for example, have been criticized as being unwieldy and are associated with a cumbersome and non-transparent decision-making process. Permits generated by the CDM also reveal a carbon price too low to stimulate the research and infrastructure necessary to develop a truly low-carbon economy. In some ways, the voluntary carbon market is more effective and is one of the few ways that people can take action to compensate for the weak national and international agreements to reduce greenhouse gas emissions. These limitations will need resolving post 2012, although it will be important to protect the underlying ability of the CDM to promote private-sector investment in emission-reducing technologies globally.

To summarize, although carbon offsets have their limitations, they are at present the most effective means we have of managing a smooth transition between the fossil-fuel dependent society of today and a low-carbon vision for the future. It is also worth remembering that cap-and-trade, including offsets, is not the only approach to incentivize action on climate change and reducing emissions. The consideration of other means, such as fiscal incentives and regulation, will be necessary if an effective and inclusive carbon market is to be realized.


Post-Modern Judgments and Crazy Arithmetic

Roger Pielke, Jr. is a professor of environmental studies at the University of Colorado and fellow of the Cooperative Institute for Research in Environmental Sciences (CIRES).

As a contribution to stabilizing global concentrations of carbon dioxide, carbon offsets are part of the problem, not part of the solution. Ironically, just as many economists are recognizing the failures of the efficient market hypothesis in global finance:

Environmentalists are rushing headlong to create carbon markets based on the idea that such markets will efficiently allocate costs for reducing emissions. However, carbon offsets have already shown that they have a very limited role to play, at best, in efforts to decarbonize the global economy.

The first problem with offsets is that they typically do not reduce actual emissions. Instead, they reduce emissions from some counterfactual baseline of how events would unfold absent the offsetting activity. This baseline game means that offsetting schemes can have the bizarre effect of increasing total global emissions while they are claimed to have reduced emissions. More problematically, the baseline game creates a need for a highly regulated (and thus game-able) accounting system. To work, that system depends upon experts rendering judgments on post-modern topics such as counterfactual futures and the allocation of responsibility for causes and effects for particular actions in those counterfactual futures. Was a particular Chinese wind farm built to reduce emissions or to provide energy, or perhaps both, or perhaps just to make money? Would it have happened in the absence of investor X putting up some money? 

Offsets also fail a test of basic emissions reduction arithmetic, as has been pointed out by George Monbiot of the Guardian. He argues that if all developed countries relied on offsets to “reduce” their own emissions at the level planned by the UK, it would require that developing countries reduce their on emissions by more than the rich countries, a bizarre result. In the United States, offsets could be used to account for anywhere from 50 percent to 100 percent (depending on the analysis) of required US emissions reductions in coming decades (which is higher than the value assumed by Monbiot for the UK). What this means in practice is that the United States would not have to depart very much if at all from a business as usual energy path due to the offset provisions. 

A reliance on offsets is why Congressman Rick Boucher (D-VA) explained that offsets secure the future of coal burning in the US: “We provide 2 billion tons of offsets each year during the life of the program (i.e., the Waxman-Markey bill). Those offsets would enable electric utilities like AEP (American Electric Power) to invest in forestry, agriculture, and projects like tropical rain forest preservation in order to meet their CO2 reduction requirements under legislation. Therefore, they can comply with the law while continuing to burn coal.” Germany’s Environmental Minister Sigmar Gabriel went ever further in discussing the European offsetting scheme: “You can build 100 coal-fired power plants and don’t have to have higher CO2 emissions.” Think about that for a second. You don’t have to ponder the issue very deeply to understand that any mechanism that allows for the expansion of coal burning is not going to contribute much to efforts to stabilize concentrations of carbon dioxide, no matter how the numbers are arranged.

The lack of effectiveness of the EU offsetting scheme under the Kyoto Protocol (i.e., the Clean Development Mechanism or CDM) has been well documented by Michael Wara of Stanford who testified before Congress earlier this year that the scheme “presents both an unacceptable risk to investors and a portfolio of projects of dubious environmental credibility.” The CDM has been plagued by corruption (e.g., HFC-23) involving taking full advantage of the complexities of the program’s byzantine accounting and oversight mechanisms. In spring 2008, I calculated that under the best-case scenario where all CDM carbon dioxide offsetting projects were successful and additional, that the sum total of projects in the pipeline would have deferred emissions by six days in 2012. That is, the cumulative emissions that would have occurred on January 1, 2012 will now occur before noon on January 7, 2012.  This seems like a lot of effort for very little potential gain.

So what should the role of offsets be in international and national climate policies? The answer is as small as possible. Offsetting schemes will delay decarbonization and thus should be limited as much as possible.

Leadership on this issue was shown in June when Yahoo announced that it was abandoning the use of carbon offsets in favor of directly improving its energy efficiency, expressing the view that, “creating highly efficient data centers will have a greater long-term, direct impact on the environment and gives us the best opportunity to play a leadership role in addressing climate change.” Yahoo’s calculus about the value of offsets reflects a recognition that you simply can’t pay someone else to reduce your own carbon emissions, and their focus on direct efficiency gains is a valuable lesson for businesses and governments around the world. A direct approach to decarbonization will always be preferable to indirect approaches that allow a lot of accounting games to be played. If there is one thing we have learned from efforts to implement offsetting schemes is that there is no easy way to decarbonize a major economy.


Leapfrogging on Offsets

Glenn Hodes is a senior energy economist at the United Nations Environment Program (UNEP) Risoe Center at the Risoe National Laboratory on Sustainable Energy of Denmark. He manages technical assistance programs on CDM and develops public-private partnerships that support offset project development investments.

Numerous economic studies and empirical analyses have shown that offsets play an important role in controlling the overall cost of a long-term transition to a low-carbon economy. Seen from another angle, promoting international offsets can also help drive behavioral and technological changes. Offset investments can leverage new infrastructure development projects and equipment exports, both at home and abroad. Offset projects themselves can also have a powerful demonstration effect, allowing other countries (particularly the rapidly developing ones whose GHG emissions growth trajectories are already beginning to overtake those of the US and whose assent to a new global climate deal is crucial) to be convinced firsthand of the win-win benefits of accelerating their own low-carbon transitions. India, for example, rapidly increased its total wind power capacity and established a globally competitive turbine manufacturing company on the back of hundreds of new projects in the last few years—a large number of which were only realized with the benefit of financing from the UN-regulated Clean Development Mechanism (CDM).

Beyond a meaningful “cap,” or quantitative absolute limit on the amount of emissions, effective measurement, verification, and certification approaches are the foundation of a successful cap-and-trade system—particularly one that includes offsets. Since the main aim of offsetting is to deliver a quantified amount of carbon abatement, it is crucial that the offsets bought and sold in the market are both genuine and verifiable. This applies equally to offsets used by regulated entities or institutional “compliance” buyers to fulfill their mandated reduction targets as to offsets purchased by individual consumers seeking to do their part to reduce their own carbon footprint.

America still lags behind Europe, both in terms of the size of carbon-trading markets and in terms of the sophistication of structures at multiple levels to regulate this new “green” commerce. For example, the UK was one of the first countries to scrutinize the veracity of advertising claims linked to retail sales of offsets to consumers as well as carbon-neutral products and services. The UK government subsequently enacted a “code of conduct” for all nationally registered offset providers and established a national offset quality assurance scheme. Meanwhile, the US has played a limited role in developing or utilizing the CDM, which many consider to be the gold standard of offset protocols in the marketplace. US policymakers can learn much from the early experiences of the EU and the CDM on how to make carbon credits work. One clear lesson is that establishing strong protocols and standards is essential for offsets to become an effective instrument for companies and individuals to fight climate change.

Beyond carbon offsets, which are obviously not a long-term solution to climate change but will play an important temporary role, domestic investments in energy efficiency should be a priority: It is the low-hanging fruit in addressing climate change. The United States, as indeed most countries, has only just begun to leverage information technology to identify patterns of energy consumption and carbon pollution and to adopt real-time strategies to optimize energy and minimize greenhouse gas emissions.


A Transitional Strategy

Brian Murray is the director for economic analysis at the Nicholas Institute for Environmental Policy Solutions and a research professor at the Nicholas School of the Environment at Duke University.

A unique characteristic of greenhouse gases (GHGs) is that they disperse uniformly about the earth’s atmosphere, in contrast to other pollutants that are found in higher concentrations near their sources. As a result, an emission reduction delivers the same benefit no matter where it takes place, whether it is from an electric power plant in the Ohio Valley, a cement plant in India, or a forest in the Amazon. This provides an underlying rationale for emissions trading across sources in general and offset trading in particular.

The basic economic argument that underlies both GHG emissions trading and offsets is that allowing regulated actors more flexibility in how they reduce emissions will result in cost savings for any given level of reductions. More specifically, rather than design a policy that designates which parties must undertake which reductions to achieve a collective target, it is more efficient to allow parties to contract among themselves to find who can achieve these reductions at the lowest cost. Capped entities can achieve compliance in one of three ways: by decreasing internal emissions, by trading emissions allowances with other capped entities, or by obtaining emissions reduction credits generated through offset projects at uncapped sources.

The summary above cites a Breakthrough Institute study suggesting that offsets could lead to no departure from business-as-usual emissions until 2030 under Waxman-Markey. This may be arithmetically possible, but makes little sense economically. Continuing on with business-as-usual suggests that entities would undertake no costs at all to abate emissions internally in response to the cap and meet all their compliance with offsets. But offsets will not be free; firms will have to purchase them. Firms will therefore develop a compliance strategy that is a mix of internal reductions, the purchases or sale of allowances to other capped entities, and offset purchases. The most efficient solution is for them to make internal reductions up until the cost of doing so exceeds the cost of procuring allowances from other facilities or offsets. So if offsets cost $15/ton (initial EPA estimate under Waxman-Markey and roughly the price of CDM credits in the EU), capped firms will undertake all internal reductions that are less than $15/ton and purchase offsets for the rest of their compliance obligation. As the cap tightens, both capped reductions and offsets will become more expensive. Most economic analyses of the Waxman-Markey bill show that offsets do play an important role, but the majority of the abatement must come from capped sectors. 

I have mostly defended offsets on economic efficiency grounds, but my own work describes many legitimate concerns about offsets that could undermine both their economic efficiency and environmental effectiveness. For one, it is critical that any reductions paid for from an offset project create a real reduction that is additional to any emission reductions that would have happened anyway. In other words, you should not pay a party in an uncapped entity for generating electric power with natural gas rather than coal if natural gas is emerging as the most practical alternative anyway. Another critical phenomenon to avoid is leakage, wherein, for instance, a landowner is paid to avoid deforestation, but this just shifts deforestation to a neighboring tract. These problems are well-understood, if difficult to control, and policies are emerging in both the global and US policy arenas to ultimately tie offsets to the performance of entire uncapped sectors, rather than individual projects. But precaution is appropriate until these concerns are fully addressed and various mechanisms such as credit discounts and buffers have been proposed to address these problems for the time being.

In the end, a long-term solution to the climate change challenge will likely require that many of these uncapped sources become capped at some point in the future. Therefore, offsets should best be viewed as a transitional strategy that enhances flexibility in the initial years of the program.     


Is the Offset Real? And Who Says So?

Eric Carlson is co-founder and president of Carbonfund.org, a nonprofit carbon offset and climate solutions organization that enables individual, businesses, and organizations to offset their climate impact through renewable energy, energy efficiency, and reforestation projects.

The idea of fighting climate change is to reduce overall emissions. A company that sustains substantial growth requires more energy, so it is realistic that increases may occur; the goal is to ensure the entire system reduces emissions. Carbonfund.org promotes the idea of: Reduce what you can, offset what you can’t.

A cap-and-trade system promotes the most cost-effective carbon reductions, whether internally or externally. Cap-and-trade allows us to tackle climate change in the most cost-effective and fastest way possible. A real example of this could be the following: Mercedes-Benz has been known to be a very efficient company with the latest high-tech production methods. Squeezing more efficient and reduced emissions from their factories would be very costly. Some Ukrainian power plants, on the other hand, have been viewed as inefficient, old, and polluting. Very simply, $1 million is going to reduce a lot more CO2 in the Ukrainian power plant than the MB factory. Since the planet does not care where we reduce our emissions, it makes most sense for MB to pay the power plant to upgrade their technology or switch their fuel use and gain the carbon credits.

The key question about a carbon offset is: Is it real, and who says so? Carbon offset providers should offer, and purchasers should look for, offset projects that are third-party verified to the highest international standards and project portfolios that are third-party audited. The annual audit should also be made publicly available. Providers should not self-verify or self-audit. Moreover, providers should not self-define what constitutes a real offset, nor the criteria for standards such as the additionality of the emission reductions by a project. Third-party standards, verification and auditing are the hallmarks of real and high-quality offsets.

Originally published August 13, 2009

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