The Potential Role for Emission Offsets in Climate Change Policy

• Author: Joseph E. Aldy
• Position: Economist on the faculty at the Harvard Kennedy School
• Pages: 15-15

NOVEMBER/DECEMBER 2021 | 15

Reprinted by permission from The Environmental Forum®, November/December 2021.

Copyright © 2021, Environmental Law Institute®, Washington, D.C. www.eli.org.

An Economic Perspective

Governments, big corporations,

and universities have recently

issued ambitious greenhouse

gas emission pledges. e European

Union and a number of its largest

member-states have legislated net-

zero emissions by 2050. e state of

California set a goal of net-zero emis-

sions by 2045, Microsoft aims to be

carbon-negative by 2030, and Har-

vard University has committed to be-

ing fossil fuel-neutral by 2026.

Common to each of these goals will

be the use of emission osets — emis-

sion reductions outside of a govern-

ment’s jurisdiction or the footprint of a

company or a university. ese osets

would make up for the residual emis-

sions for that entity — the dicult-to-

eliminate uses of fossil fuels in some

specialized industrial

purposes, aviation,

building heating, etc.

So long as these emis-

sions osets equal or

exceed the residual

emissions for that en-

tity, then its net emis-

sions would be equal to zero in the rst

case or even less in the second.

Emission osets have long served as

a exible, market-oriented approach to

implement environmental goals. Since

the 1980s, new emission sources can

be built in areas with poor air quality

if they oset their emissions at exist-

ing sources. Starting in the early 1990s,

developers can drain a wetland if they

enhance or create new wetlands nearby.

And osets have played a role in imple-

menting UN climate change agree-

ments.

e 1997 Kyoto Protocol estab-

lished the Clean Development Mecha-

nism, where a project in a developing

country could generate emission re-

duction credits that could be used by a

developed country for compliance with

its emission target. For example, Ja-

pan’s emissions exceeded its Kyoto tar-

get, but it oset its emissions above its

target through the purchase of CDM

credits. e European Union also per-

mitted emission sources covered by its

Emission Trading System to use CDM

credits as a compliance strategy in lieu

of emission allowances. More recently,

emission osets have been used by

sources covered by the California car-

bon dioxide cap-and-trade program.

Emission osets may lower the cost

of attaining ambitious emission goals

by giving businesses covered by a cap-

and-trade or regulatory program the

exibility to invest in emission-cutting

projects beyond their footprint. Such

programs may create incentives to

drive emission reductions in sectors of

the economy or countries of the world

where the political economy precludes

emission regulation. Examples include

the U.S. agricultural

sector and developing

countries under the

Kyoto Protocol. As

more and more com-

panies adopt net-zero

emission goals, the de-

mand for emission o-

sets could increase, with some estimat-

ing a market size as large as $50 billion

a year by 2030.

e potential for osets, however,

must confront a few key implementa-

tion challenges. e estimated emis-

sions reduced, avoided, or sequestered

associated with any given oset project

reects a comparison with a hypotheti-

cal counterfactual, such as a no-project

baseline. is is intended to show that

the emission reductions are additional

or incremental; i.e., that they would

not have happened otherwise.

In practice, this is dicult to dem-

onstrate. ere are cases where oset

project developers gamed the rules,

such as CDM projects in China to

reduce HFC-23, a potent greenhouse

gas. e revenue from selling CDM

credits made it economic for develop-

ers to build HFC-23 manufacturing

capacity for the primary purpose of

shutting it down in order to generate

emission reduction credits.

In other cases, there are legitimate

questions about the permanence of

the estimated emission reductions. For

example, forest conservation and aor-

estation programs may remove carbon

dioxide from the air and store it within

woody biomass and soils. If these for-

ests are cut down or burn down later,

however, then the sequestered carbon

could be emitted, eectively eliminat-

ing the climate benets of the original

project.

Even for well-intended projects,

there may be a form of market leak-

age that reduces the emission-cutting

benets for those projects. Conserving

forests to sequester carbon may increase

the incentive to cut forests elsewhere to

meet lumber demand. Building a wind

farm in lieu of a coal-red power plant

may enable existing coal-red plants to

operate longer by reducing demand for

coal. Installing solar may appear addi-

tional today, but if public policy evolves

— such as through a high carbon tax

or a regulation mandating solar — then

this project should not be considered

additional under these future policies.

Providing cost-eective ways to cut

emissions will be critical for countries

and companies to secure durable po-

litical support along the journey to at-

taining their ambitious net-zero emis-

sion goals. Osets can play a key role,

so long as transparency and rules can

minimize the prospect that this ap-

proach undermines the environmental

integrity of net-zero goals.

e Potential Role for Emission

Osets in Climate Change Policy

Cost-effective ways to

cut emissions will be

critical for countries

and companies

Joseph E. Aldy is an economist

on the facult y at the Harva rd Ken-

nedy School . You can contact hi m at

Joseph_Aldy@hks.harvard.edu.