MARKETS:

Forest offsets give EPA regulators some tough nuts to crack

If a tree grows in a forest, does it make an emissions offset? What happens if it burns down? Both the integrity and the cost of the legislation working its way through Congress that would put a cap on U.S. greenhouse gas emissions hang on questions like these.

Experts have for the most part applauded the rigorous criteria for offsets in the far-reaching climate and energy bill passed by the House Energy and Commerce Committee last week.

But while the bill, proposed by Reps. Henry Waxman (D-Calif.) and Ed Markey (D-Mass.), lays out a game plan, U.S. EPA would have to answer these and many other questions. The task could be one of the more complicated ones the agency has faced.

"Offsets are really going to allow this bill to get passed," said Shanna Brownstein, a policy associate with the Climate Trust, a nonprofit offset provider. "But implementation is critical, because it could very easily compromise the environmental integrity of the entire program."

The reason is that offsets -- greenhouse gas emissions reductions that occur outside of the overall carbon cap -- can be bought as credits by regulated industries to lower their compliance costs. They could account for up to 2 billion tons of the planned emissions reductions every year.

Half would be sourced domestically and half abroad, although the most recent Waxman-Markey substitute allows that international credits could reach three-quarters of the total in the likely chance that the U.S.-based market falls short.

But, as some are quick to note, offsets are tricky business. The agency is tasked with setting provisions to verify and enforce those reductions, both in the United States and, even harder, abroad. EPA is also to determine what constitutes a "permanent" emission cut that is "additional," or wouldn't have otherwise occurred without a carbon price.

Some consider it an unattainable mandate. "It's impossible to ensure," said Environment America's federal global warming director, Emily Figdor. Others, most notably a number of major environmental groups and businesses that have signed onto the U.S. Climate Action Partnership, have backed offsets that come with rigorous standards.

For regulated industries, they are among the most important components of the bill. Without international offsets, the Waxman-Markey cap-and-trade program could nearly double in cost, EPA estimates.

And although several previous cap-and-trade bills outlined specific projects and sectors, such as forestry and agriculture, that would qualify as offsets, the Waxman-Markey substitute instead would give EPA, advised by an independent nine-member Offsets Integrity Advisory Board, authority to decide which will make the cut.

Much will hang on an advisory board

The latitude left to EPA is largely on purpose. Jake Schmidt, international climate policy director for the Natural Resources Defense Council, said that the move takes a lot of the politics out of the current offsets debate.

But sectors looking to participate in a potentially lucrative market are wrangling to get more specific language back into the bill (ClimateWire, May 20). Rep. Zack Space (D-Ohio), for example, is working with Chairman Waxman to incorporate some certainty for the agricultural community in the offset market into the bill, according to his spokesman.

Others are happy about Congress' hands-off approach and for provisions requiring the agency periodically review its own rules. "The best aspect of the quality controls is that the bill leaves the technical decisions to the scientists," said Figdor.

The result, however, could be to push the political struggle down the chain to the selection and activities of the new advisory board, which the bill's language indicates could have substantial influence on EPA's decisions, said Michael Wara, a law professor at Stanford University.

"Everyone who is regulated or is selling offsets wants as much in as possible. This is the cost-control money, and these people are going to be the gatekeepers," he said.

Conservative regulations could control the supply

At minimum, EPA will have a delicate balancing act on its hands. It could take a conservative approach, limiting itself to projects that unambiguously meet the stringent criteria, but that would likely reduce the offset supply, especially early on in the program, several experts in offset projects and markets said.

One reason is the substantial gray area in deciding whether emissions reductions are additional, especially on the international side and in state-controlled economies like China's, said Wara. That could play out the extent to which EPA approves already-existing projects for the program, an important source for the initial market supply.

For example, the Obama administration could potentially certify some credits from the United Nations' Clean Development Mechanism, a program that has been fraught with controversies over questionable projects, said Alexia Kelly, a senior associate in the World Resources Institute's climate and energy program, although she questioned whether there would be the "political appetite" to do so.

Perhaps most significantly, the bill gives EPA, the State Department and the U.S. Agency for International Development the power to work out sector-by-sector baseline emissions thresholds with foreign countries, under which projects could qualify for offsets in the U.S. market. "It's sort of like a cap-and-trade with training wheels," said Wara.

On the U.S. side, EPA will likely look toward existing programs like the Regional Greenhouse Gas Initiative and the Climate Action Reserve, which has been busy building regulatory quality protocols to approve projects based on sector-wide standards for landfills, livestock and forests.

Today, however, RGGI has not yet approved any offset projects. The Climate Action Reserve recently issued its millionth offset credit, which would still be a small drop in the bucket for an economywide program.

Gary Gero, the Climate Action Reserve's president, is confident that the program could scale up significantly before cap and trade takes effect, and that its standardized methodologies allow for quick approval. He has been urging EPA to adopt its model or even to contract out the process to the Climate Action Reserve itself.

The agency itself already has some experience supervising offsets through voluntary programs and protocols, such as its Climate Leaders program. Those, however, are far less stringent than a regulatory program would be, said Kelly.

Regardless of the overall approach, many agreed that the need for speed is troublesome. Should the bill pass, EPA would have two years after its passage to get regulations into effect and provide an initial supply to the market.

"Look at everything they have to do to approve even a sector of offsets. They are going to be under a lot of pressure to rush, particularly if they are understaffed," said Victor Flatt, a University of Houston law professor and a scholar with the Center for Progressive Reform. Brownstein said it would be difficult for EPA to get a real head start until the legislation passes, since it currently lacks the mandate, funding and staff.

Will a forest fire cause 'havoc' in financial markets?

Flatt worried that the offset program could run into not only environmental trouble but also financial trouble if EPA makes early missteps in approving projects. He's essentially concerned about "toxic offsets."

The bill already incorporates an insurance plan on the international side, a buffer that requires five foreign-bought offset credits for every four emissions allowances awarded, leaving one to a common pool. For domestic offsets, the substitute bill removed this wiggle room, said Flatt. The only insurance is a requirement that carbon sequestration projects reimburse EPA if the project "reverses," or releases its captured emissions.

If a tree in an offset program, for example, is intentionally logged, the bill requires that project developer pay back the offset credit. But if the loss is "unintentional," say, through a forest fire, the project owner only returns half the cost to EPA.

This one provision, said Flatt, has the potential to cause havoc in emissions financial markets. "To the extent that they can, EPA really needs to have some way to make sure they are made whole again."