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Regional Cap-and-Trade Programs Issue Recommendations for Standardizing Offset Programs

June 10, 2010

With the fate of federal climate change legislation uncertain, the Regional Greenhouse Gas Initiative (RGGI), the Western Climate Initiative (WCI), and the Midwest Greenhouse Gas Reduction Accord (MGGRA) continue to collaborate on options for linking their emergent regional cap-and-trade programs. These three programs, which account for over half of the United States’ GDP and over 37 percent of the United States greenhouse gas emissions, are in various states of development. The regional programs may continue to develop if federal climate legislation falters or if the regional programs are not preempted by a federal cap-and-trade program. Late last month, RGGI, WCI, and MGRA published a white paper that recommends standardized guidelines for the use of emission offsets. If these concepts can be translated into a common set of concrete requirements for emission offsets, the resulting link between the three regional programs could begin to frame an alternative to a federal cap-and-trade program.

I. Role of Offset Credits in a Cap-and-Trade Program

The various regional and proposed federal cap-and-trade programs call for incremental greenhouse gas emission reductions. Entities that fall within the emission cap would be required to obtain emission allowances for each ton of greenhouse gases they emit (or is contained in the fuel they sell). Entities could demonstrate compliance by acquiring emission allowances from the government (either through auctions or allocations), or from other regulated entities via a secondary allowance market.

The regional and proposed federal programs would also allow for a portion of compliance obligations to be achieved through offsets. An offset is a measurable reduction, avoidance, or sequestration of greenhouse gas emissions from a source not covered by a cap-and-trade program. Offset programs provide regulated entities with a greater degree of flexibility for achieving their compliance obligations by allowing them to purchase emission reduction credits from non-regulated sources. Similarly to secondary emission allowance trading between regulated entities, offset credits are (at least in theory) intended to provide incentives for low-cost emission reductions while easing compliance at facilities where achieving emission reduction would come at higher costs.

While offset credits may incentivize lower-cost emission reductions, they also pose a number of hurdles for agencies charged with enforcing compliance and overseeing offset markets. To maintain the integrity of an emission cap and send accurate price signals to encourage technology development, offset credits must represent real emission reductions. In other words, the offset credit must be the functional equivalent of an actual reduction in emissions from a regulated entity. Conceptual models for the role of offsets in cap-and-trade programs generally require that offsets be: (1) additional to emission reductions that would otherwise occur (e.g. not already required by regulation); (2) verifiable (both the offset project and the offset compliance credit); (3) permanent (i.e. not reversible); and (4) enforceable. The offset recommendations issued by the regional programs addresses each of these principles.

II. Offsets Under RGGI, WCI, and MGGRA

Twenty three states and four Canadian provinces are participating in the regional cap-and-trade programs. The programs, which are in varying stages of development, provide differing approaches to the use of offsets. Late last year, representatives from RGGI, WCI, and MGGRA met to discuss potentially linking the regional trading programs in the event that Congress is unable to pass comprehensive climate legislation.

A. RGGI

RGGI, which is comprised of 10 Northeastern and Mid-Atlantic states, is the only fully operational greenhouse gas cap-and-trade program in the United States. See Lessons are Learned From First U.S. Carbon Auction, Marten Law Environmental News (Oct. 16, 2008). RGGI is designed to stabilize regional carbon dioxide emissions from coal- and natural gas-fired power plants between 2009 and 2014, and then reduce those emissions 2.5 percent per year between 2014 and 2018. Each participating state is responsible for distributing emission allowances, either through auctions or free allocations, to regulated entities equal to that state’s proportion of the regional cap. The vast majority of allowances are being auctioned rather than allocated for free.

Under RGGI’s offset framework, a regulated entity may achieve up to 3.3 percent of its compliance obligation via offset credits. That amount increases to 5 percent if emission allowance prices exceed $7 per metric ton, and to 10 percent when prices exceed $10 per metric ton. Offsets are limited to five types of projects: (1) landfill methane capture and destruction; (2) sulfur hexafluoride (SF6) capture/recycling; (3) carbon sequestration through afforestation; (4) natural gas, propane, and heating oil energy efficiency; and (5) avoided methane emissions from animal waste management. Offsets generated via domestic projects located outside of RGGI may be used so long as the state or jurisdiction where the project is located has entered into a memorandum of understanding with RGGI, or if has established its own greenhouse gas regulatory program of equal or greater stringency than RGGI. If the $10 per ton price trigger is reached, international offsets via the Kyoto Protocol Clean Development Mechanism (CDM) and Joint Implementation (JI) programs may be used.

B. WCI

Under the WCI, 13 Western states, five Canadian provinces, and six Mexican states, have agreed to reduce greenhouse gas emissions, in the aggregate, by 15 percent below 2005 levels by 2020. See Western Regional Cap-and-Trade System Takes Shape, Marten Law Environmental News (June 25, 2008). The WCI’s cap-and-trade program is scheduled to take effect in January 2012. Unlike RGGI, which is limited to carbon dioxide emissions from approximately 200 power plants, WCI is intended to reduce regional greenhouse gas emissions 15 percent by 2020. The cap covers all sectors of the economy, including emissions attributable to electricity generation, industrial sources, transportation, and residential and industrial fuel combustion.

The WCI’s offset program, which is still in development, will likely be more expansive that RGGI’s. Offset credits may account for up to 49 percent of the total emission reductions from 2012 to 2020, although participating jurisdictions will retain the discretion to adopt more stringent limits. Authorized project types include: (1) agricultural (soil sequestration and manure management); (2) forestry (afforestation/reforestation, forest management and preservation, and forest products); and (3) waste management (landfill gas and wastewater management). The WCI is currently developing standardized protocols for offset project types. Offset projects may be located in participating jurisdictions or elsewhere in the United States, Canada, or Mexico subject to comparably rigorous oversight, validation, verification, and enforcement requirements. The WCI will not accept offset credits for projects in developed (Kyoto Protocol Annex 1) countries from sources that, if located within the WCI, would be regulated entities. But WCI will accept CDM offset credits from developing (Annex 2) countries.

C. MGGRA

The MGGRA commits six Midwestern states and one Canadian province to establish greenhouse gas reduction targets and develop a multi-sector GHG cap-and-trade program. In June 2009, the MGGRA Advisory Group released its draft recommendations for the program’s cap-and-trade program. The draft recommendations call for reducing participating jurisdictions’ greenhouse gas emissions 20 percent below 2005 levels by 2020. Similarly to the WCI, regulated emissions would include electricity generation, industrial processes, transportation fuels, and residential, commercial, and industrial fuel combustion.

Given its early stage of development, many details about MGGRA’s offset program are unknown. Twenty percent of a regulated entity’s compliance obligation may be satisfied via offset credits, and MGGRA may increase that amount if prices rise above certain price thresholds (to be determined). Offset projects may be located in participating jurisdictions, or other jurisdictions that enter into a Memorandum of Understanding with MGGRA, and that have a greenhouse gas regulatory program of equal or greater stringency. MGGRA will consider whether international offsets (beyond Canada), including credits generated by CDM and JI projects, will be available for compliance. MGGRA has not yet defined the types of projects that would qualify for inclusion in the offset program.

III. Offsets Under Pending Federal Legislation

Both the cap-and-trade bill passed by the House of Representatives last summer (Waxman/Markey) and the bill introduced in the Senate last month (Kerry/Lieberman) include provisions regarding the use of offsets. The House bill would allow the use of up to 2 billion tons of greenhouse gas offsets annually, divided pro rata among regulated entities, and up to 50 percent of those credits could come from international projects (or more if the domestic offset supply is inadequate). The Senate bill similarly allows for up to 2 billion tons of emissions to be offset annually, but limits international offsets to 25 percent of the total. Under both bills, jurisdiction over the offset program is split between the Environmental Protection Agency and the Department of Agriculture.

IV. Offset Standardization Recommendations

In May 2010, the regional programs issued a white paper providing recommendations for standardizing offset programs. The white paper “represents a consensus among the three regional programs on key offset policy design and implementation components that are necessary to ensure high quality offsets in a regulatory greenhouse gas cap-and-trade program.” Because future linkage of the programs could include coordinated offset programs and offset reciprocity, comparable offset quality requirements and standards would be needed. The white paper discusses key offset quality concepts, key process requirements, and the importance of a standardized implementation approach.

A. Offset Quality Requirements

The white paper first evaluates the key attributes that ensure that offsets are achieving their central purpose – achieving actual emission reductions. First, an offset credit must represent 1 ton of greenhouse gas emission reduction or removal (i.e. sequestration) from a specific project. Therefore, a project’s emissions or sequestration baseline and subsequent reductions or removals must be accurately quantified using conservative assumptions. Furthermore, offset credits must be recorded in a transparent registry to ensure that each credit is issued only once.

Second, the white paper states that offset credits must represent additional reductions or removals from those that would otherwise occur. In other words, the offset credit must represent an emission reduction or removal that would not have otherwise occurred or that is not required under existing regulations. To satisfy the additionality requirement, the project must also be shown to exceed a business-as-usual scenario (i.e. expected activity that would have occurred in the absence of the offset program incentive).

Third, it calls for offset projects and the ensuing credits to be subject to stringent third-party validation and verification.

Fourth, the white paper provides that reductions or removals from offset projects must be permanent. In other words, frameworks must be in place to ensure that offset reductions or removals are either permanent, or if they are not permanent, that programmatic requirements are in place that ensure permanence.

The white paper articulates the conceptual basis for each of these four principles, all of which have become commonly accepted in policy discussions about emission offsets. When it comes time to translate these principles into specific criteria, however, there is likely to be more room for debate and disagreement. For example, applying the concept of “permanence” to any project that sequesters greenhouse gases – such as through changes in forest practices – will precipitate a discussion of time horizons, the need for buffer accounts, and rules for responding to reversal of the sequestration (such as through a change in land management that results in release of greenhouse gases). There also may be disagreements among the regions as to the types of offsets that will be allowed. For example, RGGI does not currently allow forestry-based emission offsets.

Finally, offset programs must have sufficient regulatory authority and enforcement mechanisms. For projects located outside the jurisdiction where the regulated entity is located, the offset project must voluntarily submit itself to the jurisdiction of the enforcement jurisdiction.

B. Key Process Requirements

The white paper also discusses the need for transparency and high-quality verification in order to ensure offset quality. Offset programs should have transparent and secure tracking systems and related administrative protocols. Offset project proponents should, at minimum, be required to attest that they hold the right to emission reductions or removals or have been assigned such rights. The white paper also notes that high-quality, independent verification is critical to any effective offset program. Administrative frameworks should be in place to ensure that verifiers: (1) do not have financial or other interests in the offset project or regulated entity; (2) have proper accreditation and qualifications for the type of project they are verifying; and (3) provide competent and ethical services.

C. Standardized Implementation

Finally, the white paper calls for standardized requirements (rather than project-by-project) for determining whether specific projects and the resultant emission credits qualify for the program. Each of the three regional cap-and-trade programs has called for a standardized approach to offsets, which differs from the case-by-case offset project evaluation currently required under the Kyoto Protocol’s CDM program.

The white paper states that standardized requirements would need to address the five primary offset quality criteria (real, additional, verifiable, permanent, and enforceable). A standardized offset program would establish program criteria up-front via a regulatory process that includes technical, market, and policy evaluations, as well as public participation. The white paper also says that a standardized approach may require more administrative resources during the design phase, particularly when attempting to design offset criteria applicable across a wide ranger of regions or markets. But over the life of the program, administrative costs are expected to be lower under a standardized approach.

While a standardized approach is attractive in concept, the white paper also signals the types of disagreements that may develop under such an approach. The white paper ends with a discussion of the potential drawbacks of using a standardized emissions baseline as a default in determining the emission reduction achieved by a project, recognizing the trade off between efficient administration and accurate emissions accounting. This is just one of many issues likely to be debated when, and if, the regions move forward in developing common rules for a linked offset market. And if the regional programs are preempted and superseded by federal climate legislation, then that debate will occur within EPA and the Department of Agriculture.

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

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