Offsets For Greenhouse Gas Emissions: Clarifying the Role of Forestry and Agriculture

Agriculture and forestry, like most sectors of the economy, would experience higher operating costs under a GHG cap-and-trade program like that contained in H.R. 2454, passed by the House earlier this summer and now under consideration in the Senate.[1] But backers of the legislation, including the Obama Administration, argue that farmers and timberland owners can make money off this program, by changing their practices to sequester carbon and selling the resulting emission reductions to offset emissions from regulated sources.[2] At a recent Senate hearing, Secretary of Agriculture Tom Vilsack and EPA Administrator Lisa Jackson testified that their agencies’ analysis showed agriculture and forestry offsets could generate nearly $3 billion a year in 2020, increasing to as much as $20 billion annually by 2050, with revenues divided about evenly between the two sectors.[3]

This sounds promising for America’s farmers and timberland owners, but will not be so easy to actually achieve. One of the biggest challenges is striking a balance between the flexibility landowners need to succeed in their primary business venture – farming or timber harvesting – and the certainty GHG legislation seeks that carbon sequestered by offsets in soil and trees will remain in place indefinitely.

This tension was central to the negotiations that resulted in the House bill shifting oversight of agricultural and forestry offsets from the Environmental Protection Agency to the Department of Agriculture and creating a new category of “term offset credits.[4] It also will play out in the Senate, where the Agriculture Committee is expected to expand upon the agriculture and forestry provisions in the House-passed climate change bill.[5] Despite the difficulties, the final bill is likely to include a robust role for offset credits from the agricultural and forestry sectors.

The Role of Offsets Within a Cap-and-Trade Program

The House-passed climate change bill, H.R. 2454, would impose a cap on GHG emissions that would start in 2012, when the producers and importers of fuels such as gasoline, diesel, jet fuel, and fuel oil would be required to acquire emission allowances for the GHG content of the fuels they sell, and electric utilities would need allowances for their burning of coal and natural gas.[6] The cap would expand to industrial sources in 2014, and to natural gas distributors in 2016.[7]

Sources that fall within the cap would be required to obtain authorization for each ton of GHG that they emit (or that is contained within the fuels they sell). They would be able to meet this obligation by acquiring emission allowances from the government, or from the secondary market for government-issued allowances. The government will distribute the total number of allowances authorized by the cap applicable to a given year. Sources also would be able to meet part of their obligation by buying emission offset credits that are generated domestically or internationally, and which also would be traded in a commodity-type market.

Two precepts are central to the legislation’s approach to emission offsets: (1) there are significant sources of GHG that will remain outside the cap, either for policy reasons or because they are difficult to regulate; and (2) these unregulated sources nevertheless can, if properly motivated, reduce their GHG emissions more cost effectively than many sources that will be regulated within the GHG cap. The legislation would provide that motivation by allowing unregulated sources to voluntarily commit to emission reductions and to sell the resulting offset credits. This feature is expected to bring down the overall cost of the cap-and-trade program,[8] but adds another layer of complexity to its implementation. For a general discussion of the role of offsets and the issues they present, see Cap and Trade Proponents Struggle with Role of “Offsets”, Environmental News (June 19, 2009).

Offsets in the Agriculture and Forestry Sectors

Changes in land use practices can increase the amount of carbon stored in agricultural and forest lands. For example, EPA has estimated that shifting farm land from conventional tilling practices into “no till” agriculture can increase the amount of carbon stored in the soil by about 0.75 to 1.1 metric tons carbon dioxide-equivalent (“CO2e”) per acre annually.[9] For forestlands, lengthening harvest rotation could increase carbon storage by 2.2 to 2.9 metric tons CO2e per acre annually.[10] Other practices that can increase carbon storage include reforestation, increased conservation or riparian buffers, changes in grazing practices, and avoiding conversion of timberlands (deforestation).

Committing to use these practices could translate into a meaningful revenue stream under a GHG cap-and-trade program. EPA’s analysis of H.R. 2454 suggests that offset credits in the early years of the program could be worth $15/ton,[11] meaning a change in tilling practices could gross $11-$16 per acre per year, and changes in harvest practices could gross $30-$45 per acre per year. Of course, achieving these levels of carbon storage comes at a cost, which is likely to include reduced yield. There also are the transaction costs of participating in an offset credit program, which remain uncertain. But more importantly, to qualify for an offset credit, the project developer would have to commit to carbon sequestration that is effectively permanent.[12]

As the climate change bill was working its way through the House, Representatives from farm states were concerned that the Environmental Protection Agency, which under the bill would be responsible for implementing the offsets program as well as for enforcing the emissions cap on regulated sources, would make the program too restrictive or burdensome, reducing participation by farmers and timberland owners. To garner votes from these Representatives, the final version of the bill splits responsibility for oversight of the offsets program.

H.R. 2454 gives the Environmental Protection Agency general responsibility for administering emission offset credits.[13] But for agriculture and forestry offsets, that responsibility is assigned to the Secretary of Agriculture.[14] For the most part, the Agriculture Department provisions mirror those applicable to EPA-administered offsets,[15] but they also provide direction on issues more specific to forestry and agriculture. Chief among these is direction to the Secretary of Agriculture to develop methods for accounting for and hedging against “reversals” – the release of sequestered carbon through intentional or unintentional changes in the condition of farms or timberland.

The Impact Of Reversal Risk on Forestry and Agriculture Emission Offsets

Embedded in the concept of an emission offset credit is the requirement that the emission reduction it represents is effectively permanent. In this regard, H.B. 2454 directs the Secretary of Agriculture to identify mechanisms to assure that offset credits are only issued for practices that result in “a permanent net increase in sequestration of greenhouse gases, and that full account is taken of any actual or potential reversal of such sequestration, with an adequate margin of safety.”[16]

Because of the nature of the agricultural and forestry practices involved, it would be fairly easy for later changes in land use to release sequestered carbon. Carbon stored by adopting no-till practices could later be released by changes in farming methods; carbon stored in trees can be released by changing harvest practices, or by a forest fire. This risk of reversal is common to any carbon sequestration scheme – similar concerns apply to the emerging technology of capturing and sequestering carbon from power plant emissions through deep underground injection. But the relative ease with which a reversal could occur in these sectors has drawn particular attention.

The issue of what constitutes “permanent” sequestration for agriculture and forestry projects will no doubt spark debate. California’s Climate Action Reserve (“CAR”) has wrestled with this issue in setting criteria for forestry-based emission offsets under California’s GHG control laws. Initially, CAR would only issue offset credits to a landowner that agreed to a permanent conservation easement restricting land use to conform to CAR’s protocol.[17] More recently, CAR has proposed that a landowner commit to comply with protocol requirements for a minimum of 100 years, with monitoring and verification continuing for 100 years after the last year in which it receives offset credits.[18] While providing an outer boundary, that time period still is so long as to be effectively permanent, even considering the long rotations over which timberlands are managed. If the Department of Agriculture were to adopt a similar approach, that probably would limit participation in the program.

H.R. 2454 also expands on the idea of an “adequate margin of safety” against potential reversal risk. It directs the Secretary of Agriculture to require those participating in the program to contribute some of their offset credits to a reserve account, which can be drawn upon to compensate for reversals.[19] Alternatively, it would allow participants to obtain insurance that would fund the purchase of sufficient allowances or credits to replace the sequestered emissions released by a reversal.[20] If a reversal occurs, the Secretary would retire reserved credits equal to the tons that are no longer sequestered.[21] The project developer would then be required to restore to the reserve fund a volume of credits that would vary depending on whether the reversal was intentional or not. If intentional, such as a reversion to prior land use, then the developer would have to replace the credits one-for-one. But if unintentional, such as a forest fire, the developer would have to replace only the lesser of one half the credits expended from the reserve, or one half of those already reserved from the project.[22]

H.R. 2454 does not tell the Secretary what percentage of a project’s credits should be placed in reserve; that judgment is left to the agency’s discretion. California’s CAR also has done work in this area, which may or may not be useful to the Department of Agriculture if and when it takes up this question. In its revised Forest Projects proposal, CAR recognizes several different types of reversal risk that could affect forestry offset projects, including financial failure, overharvest, conversion of forestlands, wildfire, disease or insect outbreak, or other catastrophic events. There is some controversy, however, over the weight CAR assigns to these risks, as this determines what share of the offsets generated by a project must be allocated to a reserve “buffer” account.

In particular, CAR has put great weight on the risk that financial difficulties could cause harvest practices to change before the end of the 100-year term of a project implementation agreement, particularly if those difficulties result in the property changing hands. This weighting seems to reflect a continued reluctance to accept anything short of permanent land use restrictions, despite CAR’s step away from requiring conservation easements.

Earlier drafts of CAR’s revised Forest Projects Protocol would have required project developers to subordinate all future debt and property transactions (deeds, leases) affecting the property to their offset project commitments. It later softened the proposal somewhat, allowing developers to avoid subordination, but only if they reserved as much as 20 percent of the credits generated by the project. In contrast, a developer who agrees to subordination or accepts a perpetual conservation easement on the property would only have to allocate 1-3% of their credits to the reserve based on this factor. When financial risk is combined with the other risk factors, CAR’s current proposal would require between 12% and 33% of the credits generated by a project to be reserved against all future risk of reversal.

Timberland owners and companies looking to market forestry offsets have commented negatively on this and other aspects of CAR’s proposal. Their main concern is that banks are unlikely to agree to subordinate future debt secured by the property, which often is the timberland owner’s major asset. This would substantially constrain not only future property sales, but also ongoing financial transactions. The alternative of reserving a large share of the projects offsets is similarly unattractive, as it would deprive the project developer of much of the benefit of the offset project.

Other issues with CAR’s current proposal include its bias against intentional reversals and early termination, reflected in restrictions in the types of credits that could be used to offset an intentional reversal and the premium of 5% to 40% in replacement credits required for early termination. H.R. 2454 is much less restrictive in this regard, as discussed above.

These and other issues with the CAR Forest Project Protocol illustrate questions the Department of Agriculture would face if H.R. 2454 were to become law. They also help explain why Representatives from farm states wanted to shift agricultural and forestry offsets away from EPA, which, rightly or wrongly, would be expected to put greater weight on avoiding reversal risk and give less consideration to landowner flexibility. The clear hope is for an offset program for these sectors that is less “regulatory” and more user-friendly, perhaps accepting more risk of sequestration reversals in return for broader participation in the program.

Term Offset Credits

Another late addition to H.R. 2454 – and another take on the reversal issue – is the creation of a class of “term” offset projects that may extend up to 5 years for agricultural practices, and to 20 years for forestry practices.[23] The Secretary would be authorized to identify the types of projects that qualify for term offsets, as well as whether particular project types can be renewed at the end of their initial terms. If a project is issued a “term offset,” the developer need only account for a reversal if it occurs during the specified term.[24] Thus, a farmer could obtain a 5-year term credit for changing tilling practices, without being bound to use those practices for more than 5 years.

Regulated sources would be able to use term offset credits to meet their compliance obligations just as they would regular offset credits, except that there would be an additional financial assurance requirement.[25] They would have to demonstrate to EPA that they have the financial resources to acquire regular allowances or credits when their term credits expire. If, as seems likely under H.R. 2454, both regular and term offset credits would have a vintage – reflecting sequestration during a particular year – then there otherwise would be little difference in their use.

The term offset credit concept seems like a good fit for farmers or timberland owners seeking greater flexibility and no (very) long term commitment. It is not so clear how term offsets fit with the legislation’s goal of permanently reducing GHG emissions. For example, there should be no objection to releasing a farmer at the end of a five-year term from an obligation to sequester additional carbon. But that does not resolve the fate of the carbon stored by the farmer during the preceding five years. If later changes in farming practices release that carbon, then the benefit of the “term offset” may be lost. The intent of the House sponsors is not clear, as the “term offset” concept was inserted in H.R. 2454 during floor deliberations, sothere is little legislative history; perhaps the sidebars for term offset credits will be clarified in the Senate.

Other Implementation Issues

Agricultural and forestry offsets also present other issues that are common to most other types of offset projects, including “additionality” (meaning the GHG reduction would not otherwise have occurred), “leakage” (meaning that the emitting activity will not simply shift to a different location), and “verification” (confirmation, most likely by a third party, that the practices committed to are being implemented, or that the projected emission reductions actually have occurred).

There are some twists on applying these concepts to the agriculture and forestry sectors. For example, both agriculture and forestry deal in an international market for commodities that are produced in many countries, which makes it difficult to evaluate the potential for “leakage.” If an offset project reduces production of some commodity, it could be a fairly complex question whether that production is replaced elsewhere in the market. As a practical matter, a change in production attributed to one offset project is unlikely to affect world markets. But widespread participation in the offset program might, and the Department of Agriculture may have to consider how to handle this cumulative effect. Similarly, in much of the country forestry is subject to a variety of regulatory restraints, requiring a finer grained analysis of whether a project offers “additional” GHG reductions, beyond what would otherwise occur due to regulatory constraints. CAR has, for example, proposed that voluntary, reversible restrictions on harvest practices – like habitat conservation plans under the ESA – would not be part of a project’s baseline emissions and would not affect “additionality.”

H.R. 2454 would charge the Department of Agriculture with setting standardized methods for determining additionality, leakage, baseline sequestration rates, and the rate of sequestration attributed to a project.[26] EPA would be given the same charge for all other types of offset projects.[27] No doubt the agencies would work together on this rulemaking, and many of the provisions would be identical or quite similar. Still, some of the peculiarities of agriculture and forestry offsets likely would warrant special treatment in the Department of Agriculture’s rules.

Finally, there is a real risk that rules for forestry offsets are likely to include provisions that have more to do with land management philosophy than climate and carbon storage. For example, H.R. 2454 contains provisions that specify “environmental considerations” in forestry offset projects, such as “conservation of biological diversity.”[28] The bill also contains extensive provisions designed to slow deforestation and encourage reforestation in developing nations.[29] These provisions incorporate land management restrictions that are unrelated to sequestering carbon or avoiding GHG emissions.

Conclusion

Emission offsets generated in the agricultural and forestry sectors could help control the cost of a national GHG cap-and-trade program. Supporters of the legislation are touting the potential economic benefits to farmers and timberland owners, in a bid to woo votes from farm-state Senators, who could decide the fate of the legislation. But implementing this program would bring challenges. Chief among them would be to strike a balance between limiting the risk of reversing carbon sequestration and leaving landowners enough flexibility for offset projects to be profitable, and so attractive to the wide audience of potential participants that the Obama Administration and others envision.

For more information about offset credits and other aspects of climate change legislation, please contact Svend Brandt-Erichsen or any member of Marten Law Group’s Climate Change practice group.