Do the 2 billion offsets allowed in Waxman-Markey gut the emissions targets? Part 1

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"Do the 2 billion offsets allowed in Waxman-Markey gut the emissions targets? Part 1"

The flaw in the Waxman-Markey bill is not the too-many offsets that domestic polluters are (potentially) allowed to purchase in lieu of actually reducing their own emissions. The flaw in Waxman-Markey is the too-mild 2020 target — a 17% reduction from 2005 levels — which will be so easy to achieve with various low-cost clean energy strategies that it’s hard to see why polluters would avail themselves of the higher-cost offsets option.

Yes, my thinking on rip-offsets has evolved, primarily because I have spent the last few months talking to leading experts, domestic and international, including the chief climate negotiator for a major European country.  Also, I’ve actually started to look closely at the international offsets market — and at how Waxman-Markey would dramatically change the domestic rip-offset market — something that the journalists and think tanks who have written critiques of the offset provisions do not appear to have done.  And I’ve looked closely at the lowest cost clean energy strategies — again, something the critics don’t appear to have done.

Since Waxman-Markey is the vehicle by which President Obama and Congressional Democrats have decided to pursue action on clean energy and global warming — and since it will take all of our efforts just to ensure it is not substantially weakened by the time it reaches the president’s desk — I think progressives need to understand exactly what they are getting here.  More importantly, we need to understand what is worth fighting hardest to preserve or change in the bill, and what is not worth expending significant political capital on.

As I think will become clear, trying to curtail the quantity of offsets allowed in the bill is simply not a high priority (or even medium priority) activity.   Keeping the 2020 target as strong as possible is.

As I wrote back in January, a U.S. climate bill should set a target of reducing U.S. greenhouse gas emissions 20% to 30% below 1990 levels by 2020 (see “Is 450 ppm politically possible? Part 8: The U.S. needs a tougher 2020 GHG emissions target“).  I won’t repeat that science-based analysis here, since, if anything, the science has only gotten more urgent (see recent posts in “Uncharacteristically Blunt Scientists“).  One point I will elaborate on is the assertion from that earlier post that the United States has the technology and resources to reduce its emissions levels substantially below 1990 levels by 2020.

After all, if a much tougher target was straightforward to achieve, then the relatively mild target of Waxman-Markey, which takes us just a tad below 1990 levels by 2020, must be pretty damn easy.  And when you throw in the huge clean energy push in the stimulus, Obama’s aggressive fuel economy standards decision, peak oil, the provisions of Waxman-Markey that accelerate clean energy into the marketplace, and the apparently much greater domestic supply of natural gas than anyone thought even a few years ago — suddenly the target because very easy to meet indeed.

The analysis that I am going to present is not something that any major economic/energy model can reproduce because none of them — including EPA’s — model clean energy well nor are they designed to look at things like the full impact of peak oil or how the electric grid’s dispatch order will change  with even a modest carbon price.  These models have historically overestimated the cost of reducing pollution and are doing so again.  Because there is no reliable model, my analysis is necessarily approximate, and it will take a number of posts to spell out exactly how the U.S. energy and economic systems will respond to Waxman-Markey.  This post will serve primarily as an overview of the key issues of how we will meet the 2020 target.  Later posts will explore individual issues — such as fuel switching from coal to natural gas — as well as what I think will happen in the 2020s and beyond.

OFFSETS — DOMESTIC AND INTERNATIONAL

Let’s start with this basic critique of Waxman-Markey — that the 2 billion offsets it allows polluters to buy in lieu of actually reducing their own emissions will vitiate the targets, a concern that I myself held until I looked into the issue closely.  The Breakthrough Institute (TBI) was among the first to detail this critique with “Waxman-Markey Climate Bill’s Emissions ‘Cap’ May Let U.S. Emissions Continue to Rise Through 2030,” which asserts “If fully utilized, the emissions “offset” provisions in the American Clean Energy and Security Act would allow continued business as usual growth in U.S. greenhouse gas emissions until 2030.”  That critique was picked up in Time, the WSJ, and NPR.  Independently, Reuters wrote a piece asserting:

The United States and European Union can pay to transfer to developing countries more than three-quarters of proposed carbon cuts over the next decade, draft and approved rules show.

These critiques are less alarming than they appear because they are, of course, hedged.  TBI uses phrases like “may let” and “if fully utilitized.”  Reuters used the word “can.”  After all, just because American companies can purchase international offsets to replace their own emissions, that doesn’t mean they will.  [I will also (ultimately) address the separate question of whether even Reuters’ hedged claim is true.]

Yet offsets aren’t free nor are they unlimited in quantity.  The important question is NOT how many offsets the bill permits.  The question is will the offsets will be available at a quantity and price that makes them more attractive than the vast amounts of moderate-cost near-term domestic emissions reductions strategies.  Answering that second question requires an understanding of

  1. How many million of tons of emissions will be required to meet the gap between the Waxman-Markey targets and what emissions would have been in lieu of those targets?  That is, how many allowances and/or offsets will emitters need to buy in 2020?
  2. What will be the price of international offsets available in quantity by 2020?
  3. What will be the price of low-cost domestic clean energy strategies available in quantity by 2020?

Neither of these critiques — or any I’ve seen — bothered to look at any of those questions.  Neither looked at the actual international offsets market.  And TBI did not avail itself of the existing analysis by EPA of the likely domestic offsets market.  Now TBI in general is not known for strong analysis — see “Memo to media: Don’t be suckered by bad analyses from the Breakthrough Institute the way Time, WSJ, NPR, and The New Republic have been.”  That doesn’t mean they are wrong this time — broken clocks and all that.  But anything coming from TBI should be viewed as suspect based on their track record.

I have previously explained at length why the domestic offsets provision does not undermine the target (see here).  In a regulated market with a cap, many of the domestic offsets will represent real reductions of US greenhouse gas emissions, and the total supply of cheap domestic offsets will be limited for a long time.  A recent EPA analysis of Waxman-Markey came to precisely the same conclusion.  TBI’s analysis never mentions this at all.

The EPA believes, as do I and many other people — including the moderates who pushed for changes in the Waxman-Markey bill from the first draft — that domestic offsets will be more expensive and less plentiful than international offsets.  That’s why the revised bill allows the EPA administrator to crank up the limit for international offsets to as high as 1.5 billion (with the domestic offsets limit dropping to 0.5 billion).  This isn’t a terribly surprising belief since the potential pool of international offsets is vastly larger than the potential pool of domestic offsets.

In its analysis of the first draft of the bill, EPA projected that some 100 million tons of domestic offsets would be used — although that rises in subsequent years.  Since that analysis did not model most of the bill’s other clean energy provisions, since the 2020 target was weakened, and since the EPA model has various flaws some of which I’ve mentioned, I would doubt that emitters would waste their money buying even 50 million tons in 2020.  The full reasons why will only become clear when we look at the clean energy alternatives in some detail.

I will discuss the international market — including the very legitimate concerns about the quality of those offsets — at length in a later post.  But here are the key points.  There is a market for international offsets aka the Clean Development Mechanism, an “arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment (called Annex B countries) to invest in projects that reduce emissions in developing countries as an alternative to more expensive emission reductions in their own countries.”  Certified Emission Reductions (CERs) are “climate credits (or carbon credits) issued by the Clean Development Mechanism (CDM) Executive Board for emission reductions achieved by CDM projects” and independently verified by a third party under the rules of the Kyoto Protocol.

Point Carbon, which closely tracks and reports on the market for European allowances and CERs, noted last week (subs. req’d) that CER “prices in 2008 averaged ‚¬17.50 and last July were changing hands for as much as ‚¬22.90.”  The average exchange rate to dollars for the year was 1.47.  So the average price of CERs for the year — including the price crash that inevitably accompanied the economic crash — was about $25/ton.

In a separate article, Point Carbon reported on May 15, “Data released by the EU today showed factories and companies regulated by the region’s cap-and-trade market used 81.7 million certified emission reduction (CER) credits last year.”

So when the market was about 80 million tons of CERs, the price averaged $25/ton.  It is certainly true that the quantity of CERs is likely to grow significantly in coming years.  But then again, so is European demand (since just as our 2020 target isn’t especially demanding, their 2008 to 2012 target wasn’t either — but their subsequent targets will start to bite).  I think it is fair to say that if the United States swoops into the market and purchases tens of millions of CERS (let alone much larger quantities), the price is not going to go down. This is not the place to do a full potential market analysis.  But I’m going to assert that the price for CERs in 2020 will, to first approximation, not be significantly below $25/ton — and could be considerably above it depending on just how many CERs are demanded by the Europeans and the Americans (and Australie and anybody else who joins the market).

This post has already gotten long enough, but I think you can see where I’m going.  In subsequent posts I will look at

  • How big the 2020 “gap” is — how many millions of tons will polluters have to reduce emissions in 2020 given likely economic and energy policies and conditions.
  • What are the lower-cost domestic clean energy alternatives to buying international offsets that will be available in quantity in 2020 — namely energy efficiency, conservation, biomass cofiring, and fuel switching from coal to gas (i.e. all of the emissions reduction strategies that don’t require building new power plants or siting new power lines).

I think it is quite safe to say that there will be an over abundance of such clean energy alternatives below $25 a ton.  Indeed, I think the market clearing price for those alternatives collectively in 2020 will be closer to $15 a ton, as I’ve said before (see here).

And so I doubt even 150 million tons of offsets will be used by emitters in 2020.

One final note:  Fence-sitting members of Congress who think the 2020 target will be hard to hit, who don’t believe my analysis that large quantities of clean energy strategies will be available at low cost by then — you have no reason to fear Waxman-Markey.  After all, larger amounts of international offsets are very likely to be available at moderately higher prices.  Even better, of course, is the clever “strategic reserve” cost containment measure in the bill, which is all-but-certain to ensure that the permit price is 2020 is not higher than about $20 — again, without resorting to offsets (see WRI’s bill summary here for a discussion of the reserve).

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14 Responses to Do the 2 billion offsets allowed in Waxman-Markey gut the emissions targets? Part 1

  1. Ken says:

    Why are domestic emission reductions ($15/ton) so much cheaper than international reductions ($25/ton)? Is the basic issue that competition from the EU is effectively taking international offsets out of the U.S. market?

    [JR: I think there are several reasons. First, as I’ve tried to make clear in recent posts — this is the United States of Waste. We simply have lots more low cost strategies — a vastly bigger renewable resource and a vastly bigger efficiency resource. We have more coal to gas switching opportunity, as I’ll show. Also, the EU is burning through the cheapest (and most dubious) offsets. For instance, no projects involving HFCs are no longer allowed. Finally, the future EU target is tougher than ours (since they started earlier and did the easy stuff). That necessarily means future prices will be higher.]

  2. hapa says:

    in another lifetime i would have worried that even with all the easy ways to physically address the problem, companies would try to offset those fees financially. based on recent insanity.

    now i think: if ten years from now we’re playing games like that, mathemagically erasing carbon — and columbus and copernicus — eh, we’re nature’s junk bonds, all hype. so what’s it to me. trying to redeem my species in the eyes of some eternal judge?

    ability to live in dreamland is our blessing and curse, right. makes us stronger, makes us stupid.

  3. Ken says:

    I think the $25/ton CER price is just an indication that the Europeans, being more serious about climate policy than we are, would be out-bidding us in the international offsets market. It doesn’t necessarily mean the cost of international reductions is high — it just means the alternative marginal cost of making the reductions in the EU is $25/ton. The actual cost of making the reductions outside the EU could be quite low, e.g. $5 or $10/ton, but because the supply of cheap offsets is limited it is a seller’s market and they can charge a higher price.

    One question in my mind is this: Suppose the market price without international offsets would be $30/ton, and with the offsets it is $25/ton. Is the EU better off economically paying the lower price? All of the offset money would be exported to other countries, but at the higher $30/ton price all of the money would be recycled back into local economies. 80 million tons times $5/ton (the difference between 25 and 30) comes to $400 million savings, but 80 million tons times $25/ton equates to a $2 billion export deficit.

    Another question: What would happen if the countries supplying the offset credits were to adopt binding greenhouse gas regulations? Would they have let the cheaper emission-control options go to industrialized countries, leaving their future generations straddled with high-cost options? If so, the offsets will deter developing countries from adopting stringent emission targets, and the offsets will therefore not meet the additionality requirement. Alternatively, if those countries can appropriate the offset credits to meet their own compliance obligations, then the EU and U.S. will be stranded without offsets upon which they have become economically dependent, even as they are trying to tighten their emission targets. In that case, the EU and U.S. would have have an interest in not encouraging other countries to adopt binding GHG targets.

    Finally, the high-cost emission reductions that are being displaced by offsets are not being avoided — they are only being deferred, because those reductions will still need to be made later to achieve longer-term (2050) reduction requirements. A policy of procrastination is not necessarily the most cost-effective long-term strategy. Offsets and cap-and-trade only function to minimize the cost of achieving near-term mandated caps; the policy rationale for cap-and-trade gives no consideration to longer-term reduction requirements. Program design elements like offsets and banking can actually undermine longer-term policy objectives.

  4. Jason says:

    “Evolved” is an interesting way of putting it.

    I would phrase it differently:

    By endorsing a bill which will give the appearance of significant reductions in emissions without actually doing so, Joe Romm has proven himself to be one of the delayers.

    [JR: How will it give the appearance of significant reductions to anyone if the reductions aren’t actually made? Like I said, the reductions will be made because they are so cheap. They aren’t enough, but they certainly are significant. You propose no alternative to this bill. Since this is the only game in town, and as I’ve explained, if it crashes and burns then we have no chance of stabilizing between 350 and 450, your argument, such as it is, falls to pieces.]

  5. Jim Beacon says:

    You’ve nailed it. This is why I and so many others were “sniping” at Waxman-Markey when it was in committee — the bill was clearly being weakened to the point where it wasn’t going to come close to doing the job. But from a purely political standpoint, you were right that when the bill was in committee and struggling to get out onto the floor and up to the Senate was not the right time to be “attacking” it. The real law will be made in the Senate, when the final specifications get laid down. That’s where some of these lopsided “compromises” are going to have to be undone.

    Targeting only a 17% reduction of CO2 emissions for 2005 levels by 2020 just ain’t gonna cut it. Nor is giving away more than 50% of the allowances for free. As was pointed out, 50-50 is the very definition of compromise. Giving away 85% is a bad joke that guts the program of any real teeth.

    [JR: Just to be clear, lots of the allowances are given away to very worthy causes. And we gave away 97% of the sulfur allowances under the clean air act. But if you have a fundamental problem with giving away so many allowances to regulated utilities, which I don’t, then you certainly aren’t going to like this bill. But from an economic standpoint, giving away allowances doesn’t gut the program of any teeth, much as it didn’t for the clean air act.]

  6. Jim Beacon says:

    Proximity clarification: By saying “you’ve nailed it” I meant Joe nailed some of the most critical considerations of Waxman-Markey in his article, not that Jason nailed anything, as his knee-jerk accusation that Joe Romm is a delayer is absurd on the face of it. Although I did not necessarily agree with Joe’s rationale at the time, what he was endorsing was getting a bill, *any* bill, out of committee and into the hands of the Senate where the real provisions of the law can be hammered out. Killing the bill in a House Committee with too much criticism would have been exactly the result that denier Representative Shady Joe Barton of Texas wanted. Because then the whole process would have had to start over again from square one with a new bill — now that would have been some REAL delay.

  7. john says:

    Joe:

    The implicit assumption in your analysis is that utilities and large generators will behave rationally, choosing lower cost clean energy options over offsets.

    I hope you are right, but history is chock full of examples where utilites chose suboptimal strategies; technological lock-in is a powerful force.

    But the target is a big concern — 17% below 2005 by 2020 is one reason I gave it a C. I believe caps need to be front end loaded to avoid triggering self-amplifying feedbacks. It really doesn’t matter how ambitious the goals for cutting anthropogenic emissions are in the outyears if we’ve started a precess which would inevitably and irrevocably unleash 3000 gigatons of “natural” methane from the Arctic permafrost in a self reinforcing feedback in the near term. If we start this phenomena, we could set 0 carbon by 2030 and it would make little or no difference. And methane levels have been up for the last 2 years, and sattelite data shows its origin is the Arctic. Bad news.

    [JR: I gave it a B- so I don’t see a big difference there.

    But if you are going to assume people act irrationally than most climate bills will fail. A lot of people here love a carbon tax. Well, what’s to stop companies from simply paying the tax and continuing to pollute?

    I have never oversold the likelihood that this bill will avoid catastrophic global warming. I have merely argued that failure to pass this bill (hopefully after it is strengthened) reduces the small chance of doing so to zero.]

  8. Jason says:

    If I understand you correctly, you are claiming that before 2020 at costs less than $25/ton, “significant reductions” in emissions improvements can be had from:

    energy efficiency
    conservation
    biomass cofiring
    and fuel switching from coal to gas

    that give us a chance of stabilizing at 450ppm or less. I look forward to the promised forthcoming article showing your math.

  9. Justin Felt says:

    I think it bears repeating that the US domestic offset supply is going to be very limited. At the moment, Point Carbon’s database of carbon offsets has a pipeline of between 10-15 million tons of CO2 equivalents likely eligible for 2012. Taking into account the likelihood that credit prices for CDM projects (CERs) will remain high, this means that the effective offset supply will be much less than expected. So in other words, I agree with you on your argument.

    However, one point is that it isn’t necessarily true that domestic offset markets will be of higher quality than CDM from a climate perspective. The CDM market, for all it’s faults, is a very rigorous process. It remains to be seen how the EPA will approach this market, especially if agricultural soil sequestration projects are included.

  10. David B. Benson says:

    An Excess Carbon Dioxide Removal Fee (a tax with proceeds directed to removing CO2 permanently) would have to be big enough to pay the average cost of sequestration. Suppose this currently costs $100 per tonne of C, that’s (44/12)X100 = $367 per tonne of CO2.

    Big enough to frighten them away, methinks.

  11. Joe; please tell us how the foreign offsets are certified. I imagine a foreign government certifying an offset and local people continuing to cut down and sell trees. Who is policing those billions of offsets?

  12. john says:

    Joe:

    I oppose a carbon tax — in fact, the NYT recently published a letter to the editor I wrote explaining why they were wrong to endorse a carbon tax.

    As for whether people and institutions behave as rational agents, it’s not my assumption — in the last 10 years, 3 of the nobel prizes in economics went to people demonstrating why the assumption was wrong and or how it undermines economic assumptions.

    This has important implications for climate policy and law, and for the design of a cap and trade system. Those who point to the success of the sulfur cap and trade need to study how and wy it succeeded — there were several factors, such as changes in freight law that made transporting coal cheeper and the availibility of low sulfur coal. Such a confluence can be there for low carbon fuels, but only if we’re smart enough to include policies that make their costs low.

  13. Chelsea says:

    I’m not confident that the US entry into the international offset market is a bad thing. It’s frustrating to me that this issue is being discussed – in typical US political form – in a manner that is primarily US-centric, when there are so many international implications to this issue and this bill.

    Something that has been completely overlooked in every critique of the bill has been the importance of GLOBAL reduction of GHG emissions. Until this point, the US has made no commitment to capping or lowering GHG emissions. It is important to keep in mind that with ANY legislation in place that caps those emissions, we are better off than we are currently.

    As for the offsets, these credits are generated by reducing GHG emissions somewhere else in the world – thus the net effect on global GHG emissions is the same (assuming the credits are derived in a robust way; and as Justin commented above, the process is quite rigorous but of course, not perfect). So from a purely scientific point of view, global ppm are still the same, regardless of where the reduction is being made.

    Furthermore, the CDM and other international offsetting mechanisms can have an exponential effect on reducing GHG emissions into the future. Since the credits under the CDM are derived in countries that aren’t regulated by the Kyoto protocol, any “clean development” replaces development that could have otherwise occurred in a climate-harmful way (think about installing scrubbers at a coal plant in China – that counts, and would not happen without a mechanism like the CDM). It encourages the transfer of technology, knowledge and human resources to countries that are not financially able to develop these things independently, improving these countries’ ability to adapt to climate change and contribute to future global agreements on climate change.

    Many people’s critiques of the CDM are lodged in the fact that offsets seem to go against the “spirit of the law” – capped countries should have to reduce their emissions, period. However, this is often not the most efficient way to reduce global emissions, nor is it the most globally beneficial way to reduce emissions.

    I encourage people to consider the global benefits to a rigorous international offset market, the powerful impact of knowledge and technology transfer between developed and developing countries, and consider the fact that right now, the US has absolutely ZERO requirement to engage in GHG reductions of any sort.

  14. John Davidson says:

    The real problem I have with Waxman-Markey is that it is just another cap and trade scheme that depends on “putting a price on carbon” and artificial capacity restraints to drive down emissions. Sure, cap and trade appears to have been an appropriate response to the complexities associated with controlling SO2 emissions. However, this doesn’t mean that we have found the answer to everything.

    For example, consider investment in clean electricity: This investment can be encouraged by pushing the price of dirty electricity high enough to justify investment in clean electricity. The problem here is that there will be a sudden, potentially destabilizing jump in the average price of electricity before investment starts. By contrast, if the price of dirty electricity is left unchanged and investment is encouraged by negotiating price and sales guarantees for clean electricity, the average price will only ramp up slowly as the percentage of clean electricity increases – A FAR BETTER OUTCOME that will cost consumers less while giving investors much more certainity than a price on carbon set by a volatile market.

    Other strategies may be more appropriate for different industries. Regulations, subsidies, offset credit trading etc. may be the best option in these cases.

    Before Waxman-Markey is passed, the desirablility of dealing with some major sources of emissions outside of any cap and trade system should be seriously considered. Artificial price increases and capacity restraints should be the last option considered.