Potential Offset Supply in a Cap-and-Trade Program

Potential Offset Supply in a
Cap-and-Trade Program
October 14, 2008
Jonathan L. Ramseur
Analyst in Environmental Policy
Resources, Science, and Industry Division

Potential Offset Supply in a Cap-and-Trade Program
Summary
If allowed as a compliance option in a greenhouse gas (GHG) emission
reduction program (e.g., a cap-and-trade system), offsets have the potential to provide
considerable cost savings and other benefits. However, offsets have generated
considerable controversy, primarily over the concern that illegitimate offsets could
undermine the ultimate objective of a cap-and-trade program: emission reduction.
An offset is a measurable reduction, avoidance, or sequestration of GHG
emissions from a source not covered by an emission reduction program. An estimate
of the quantity and type of offset projects that might be available as a compliance
option would provide for a more informed debate over the design elements of a cap-
and-trade program. It is difficult to estimate the supply of offsets that might be
available in a cap-and-trade system, because the supply is determined by many
variables, including:
Mitigation potential. Mitigation potential estimates are the raw data that feed
into models estimating offset use in a cap-and-trade program. Recent estimates
contain considerable uncertainty.
Policy choices. The design of the cap-and-trade system would be critical to
offset supply. Particularly relevant design choices include which sources are covered;
which types of offset projects are allowed; whether or not offset use is limited; and
the degree to which set-aside allowances are allotted to activities that may otherwise
qualify as offsets. Policymakers’ treatment of international offsets would play a
major role.
Economic factors. The development and market penetration of low- and/or
zero-carbon technologies would likely have substantial effects. These technologies
could lower the costs of the cap-and-trade program, making fewer offset projects cost
effective.
Emission allowance price. The allowance price would determine the supply
and type of offsets that would be economically competitive in a cap-and-trade
system. As the price increases, more (and different types of) projects would become
cost effective. Allowance price estimates are difficult to predict, as they are
dependent on numerous variables, including offset treatment.
Other factors. Non-market factors, such as social acceptance, may influence
offset use. In addition, information dissemination would likely be an issue, because
some of the offset opportunities exist at smaller operations, such as family farms.
Several studies have generated estimates of offset use within a defined policy
framework. Although the studies’ absolute values should be viewed with skepticism,
relative differences generated by varied offset scenarios may be instructive to
policymakers. For instance, the results indicate that international offset treatment —
i.e., whether or not they are allowed (and to what degree) — would have substantial
impact on domestic offset use and availability.

Contents
In troduction ......................................................1
Factors Affecting Offset Supply......................................2
Mitigation Potential............................................3
Elements of Uncertainty.....................................4
Estimates from Agriculture and Forestry Activities...............6
Estimates from Other Activities...............................9
Policy Choices...............................................10
Design of the Cap-and-Trade Program........................10
Actions in Other Nations or U.S. States.......................11
Other Policy Influences....................................12
Economic Factors.............................................12
Emission Allowance Price .....................................13
Other Factors................................................13
Offset Use in a Cap-and-Trade Program...............................14
List of Figures
Figure 1. Illustration of Inputs and Variables That Affect
Potential Offset Supply.........................................3
Figure 2. Estimated Offset Use Under S. 2191 If International and
Domestic Offsets Limited to 15% of Allowance Submission...........17
Figure 3. Estimated Offset Use Under S. 2191 If Domestic and
International Offset Use Unlimited ..............................17
Figure 4. Estimated Offset Use Under S. 2191 If Domestic Offset Use
Unlimited and International Offset Use Limited to 15%...............17
List of Tables
Table 1. EPA and USDA Estimates of Mitigation Potential for Afforestation
and Soil Sequestration (in 2025)..................................8
Table 2. EPA Estimates of Mitigation Potential for Other Agriculture and
Forestry Activities (in 2025).....................................8
Table 3. EPA Estimates of Mitigation Potential from Other Activities
(in 2010).....................................................9

Potential Offset Supply in a
Cap-and-Trade Program
Introduction
If Congress enacts a greenhouse gas (GHG) emission reduction program, such
as a cap-and-trade system, the treatment of offsets would be a critical design element.
For example, EPA found that different offset scenarios — e.g., unlimited offsets¹
versus no offsets — generated significant variances in cap-and-trade program costs.
However, offsets have generated considerable controversy, primarily for the concern
that illegitimate offsets could undermine the ultimate objective of a cap-and-trade
program: emission reduction.²
An estimate of the quantity and type of offset projects that might be available
would provide for a more informed debate over the design elements of a cap-and-
trade program.
An offset is a measurable reduction, avoidance, or sequestration of GHG
emissions from a source not covered by an emission reduction program. From a
climate change perspective, the location of the reduction, avoidance, or sequestration
does not matter: a ton of CO² (or its equivalent in another GHG) reduced in the
United States and a ton sequestered in another nation would have the same result on
the atmospheric concentration of GHGs. If a cap-and-trade program includes offsets,
covered sources would have the opportunity to purchase them to help meet³
compliance obligations.
Offset projects vary by the quantity of emission credits they could generate and
the implementation complexity they present. In general, agriculture and forestry
activities offer the most potential, but these projects often pose multiple

¹ This assessment comes from EPA’s sensitivity analysis of the Lieberman-Warner Climate
Security Act of 2008 (S. 2191). Compared to the core scenario (S. 2191 as written),
unlimited offset use would lower the emission allowance price by 71%; a scenario with no
offsets use would raise the price 93% compared to the core scenario. EPA, EPA Analysis
of the Lieberman-Warner Climate Security Act of 2008 (2008).
² For a discussion of these issues, see CRS Report RL34436, The Role of Offsets in a
Greenhouse Gas Emissions Cap-and-Trade Program: Potential Benefits and Concerns, by
Jonathan L. Ramseur.
³ In this way, offsets would complement the more traditional emissions trading that can
occur between two covered sources. For example, a covered source (e.g., power plant) can
make reductions beyond its compliance obligations and then sell these reductions as credits
to other covered sources. This type of transaction represents the “trade” component of a
cap-and-trade program.

implementation challenges. This may create a tension for policymakers, who might
want to include the offset projects that provide the most emission reduction
opportunities, while minimizing the use of offset projects that pose more
implementation complications, or have the potential to be invalid.

What Is a Cap-and-Trade System?
A cap-and-trade system would create an overall limit (i.e., a cap) on GHG
emissions from the emission sources covered by the program. Covered sources
may vary, but are likely to include major emitting sectors (e.g., power plants and
carbon-intensive industries), fuel producers/processors (e.g., coal mines or
petroleum refineries), or some combination of both. Covered entities that face
relatively low emission-reduction costs would have an incentive to make
reductions beyond what is required, because these further reductions could be sold
(i.e., traded) as emission credits to entities that face higher emission-reduction
costs. Instead of making internal reductions or purchasing credits from other
covered sources, a cap-and-trade program may allow parties to purchase offsets as
a compliance option.
The emissions cap is partitioned into emission allowances. Typically, one
emission allowance represents the authority to emit one (metric) ton of carbon
dioxide-equivalent (tCO²-e). In general, policymakers may decide to distribute the
emission allowances to covered entities at no cost (based on, for example, previous
years’ emissions), sell the allowances through an auction, or use some combination
of these strategies. At the end of each established compliance period (e.g., a
calendar year), covered sources would be required to surrender emission
allowances to cover the number of tons emitted. If a source did not have enough
allowances to cover its emissions, the source would be subject to penalties.

How many offsets would be available as a compliance option if Congress
enacted a cap-and-trade program? The first section of this report addresses this
question by discussing the multiple variables that help shape offset supply. The
second section discusses estimates of offset use within the policy framework of the
Lieberman-Warner Climate Security Act of 2008 (S. 2191).⁴
Factors Affecting Offset Supply
It is difficult to estimate the supply of offsets that might be available in a cap-
and-trade system, because the supply is determined by many variables, including
policy choices. Figure 1 illustrates the various inputs and variables that would affect
the potential supply of offsets in a cap-and-trade program. These factors —
mitigation potential, policy choices, economic factors, emission allowance price, and

⁴ S. 2191 was reported out of the Senate Committee on Environment and Public Works
December 5, 2007. Several agencies and other interested stakeholder groups conducted
economic modeling of the legislation. Some of these studies are used in this report, because
they represent the most recent analysis of effects from a federal cap-and-trade program.

other factors — are each discussed below. As Figure 1 indicates, the factors do not
act in isolation, but interact in a complex manner.
Figure 1. Illustration of Inputs and Variables That Affect
Potential Offset Supply

Policy Choices
Economic
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Mitigation ^of^C^a^p-^aⁿ^d-^T^r^ade
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Mitigation Potential
Mitigation potential is not synonymous with potential offsets supply (Figure 1).
Some of the activities included in mitigation potential estimates would not qualify
as offsets in a cap-and-trade system. A striking example is biofuel production, which
is projected by some studies to play a substantial role in GHG mitigation in later
years. A cap-and-trade program’s emission allowance price is expected to increase
biofuel and biomass production. For example, if a power plant substitutes a carbon-
intensive fuel (e.g., coal) with a less carbon-intensive fuel (e.g., biomass, such as
switchgrass), the plant’s GHG emissions would decrease. These emission reductions
would be counted directly by the power plant. The increased biofuel use would
mitigate GHG emissions, but would not count as an offset in a cap-and-trade
program, because the reductions (from the fuel substitution) would be made directly
by covered sources.
Mitigation potential estimates are often used as inputs for other economic
models. For example, EPA’s 2005 mitigation potential estimates were used in the
EPA and Energy Information Administration’s (EIA) analyses of S. 2191

(Lieberman-Warner Climate Security Act of 2008).⁵ Both of these analyses
generated estimates of the number and type of offsets that would be used by covered
sources for compliance purposes. However, these offset supply estimates are
potentially flawed, because the underlying data — mitigation potential estimates —
are rife with uncertainty.
Elements of Uncertainty. Estimates of mitigation potential are derived by
assigning a price for GHG emissions and sequestration. Under an EPA 2005 model,⁶
for example, landowners would “receive payments for increasing sequestration and
reducing emissions and would make payments for increasing emissions or reducing
sequestration.” As with all models, the mitigation potential simulations include
numerous assumptions, including behavioral responses to economic incentives and
disincentives. For example, actors (e.g., farmers) in the 2005 EPA model are
assumed to have “perfect foresight.” Perfect foresight assumes that “agents, when
making decisions that allocate resources over time (e.g., investments), know with
certainty the consequences of those actions in present and future time periods.”⁷ EPA
recognizes that this assumption, which the agency states is used by most of the
climate economic modeling community, does not reflect reality. The use of this
assumption likely yields an overestimation of mitigation potential: in reality, market
participants make imperfect judgements and leave some financial opportunities on
the table.
Mitigation potential models must necessarily include certain technical
assumptions, such as land availability and sequestration rates of various activities.
Different models often use different underlying assumptions to generate results.
Indeed, there is often disagreement within the modeling community, particularly for
forestry sequestration simulations, over the use of various modeling inputs.
In addition to the above limitations — which are generally inherent to some
degree with all economic modeling — the next two sub-sections discuss elements of
uncertainty that are particular to agriculture and forestry activities.
Competition for Land Use. A critical factor for agriculture and forestry
mitigation opportunities is land availability. More projects would become
economically competitive as the emission allowance price rises. At certain price
levels, one mitigation activity may replace another. For example, agricultural soil
sequestration projects (e.g., conservation tillage practices) are expected to present
cost-effective opportunities at relatively low prices. As the allowance price rises,
afforestation projects are expected to become (1) cost effective in more places and

⁵ EPA, EPA Analysis of the Lieberman-Warner Climate Security Act of 2008 (2008); EIA,
Energy Market and Economic Impacts of S. 2191, the Lieberman-Warner Climate Security
Act of 2007 (2008).
⁶ EPA, Greenhouse Gas Mitigation Potential in U.S. Forestry and Agriculture (2005), at
[http://www.epa.gov/sequestration/green house_gas.html].
⁷ EPA, Greenhouse Gas Mitigation Potential in U.S. Forestry and Agriculture (2005).

(2) more cost effective than ongoing soil sequestration activities.⁸ Thus, lands that
once generated soil sequestration, while growing traditional commodities, may be
replaced with afforestation projects (tree farms).
Other activities — preservation, recreation, fuel production — may compete for
limited land resources. Some activities (e.g., biofuel production, discussed further
below) may preclude options for resource use, such as traditional crop production or
afforestation. In other cases, more than one practice that reduces or sequesters CO²
may be possible. For example, conservation tillage may be conducted in concert with
biofuel production.
It is very difficult for most modeling tools to keep track of these competing or
compatible activities, although some models may have the capability to account for
some of these interactions. Thus, different analyses will produce varying results.
A related factor is that land uses change over time. For example, changes in
product demand, seed use, cultivation technologies, and — importantly — regulatory
or financial incentives can influence land use and/or crop choice. As discussed in the
following sub-section, biofuel policies provide a striking example of this type of
development.
Biofuel Production. In this discussion, biofuels include alternative energy
sources in both the transportation sector — e.g., ethanol (corn-based or cellulosic)
and biodiesel — and the electricity sector — e.g., biomass, such as switchgrass.
Biofuels are likely to play a substantial role in determining the mitigation potential
of other agriculture and forestry projects, because biofuel production is expected to
strongly compete with other mitigation activities for land resources. Indeed, the 2005
EPA study projected that biofuels would out-compete other GHG mitigation options
in later years (around 2030) and at higher carbon prices. By contrast, in 2015, EPA
estimated that biofuels would account for 1%-2% of the mitigation portfolio, and
only at prices above $30.
However, the 2005 EPA mitigation model did not include the most recent
federal policies that currently influence biofuel production and the land base it uses.⁹
In 2005, Congress established a renewable fuels standard (RFS) under the Energy
Policy Act of 2005 (P.L. 109-58). The RFS mandated a specific level of biofuels use

⁸ This is because afforestation can generate more CO2 sequestration per acre than soil
sequestration.
⁹ The federal government promotes biofuel production through a range of mandated fuel use,
tax incentives, loan and grant programs, and certain regulatory requirements. Arguably, the
most significant federal programs for biofuels have been tax credits for the production or
sale of ethanol and biodiesel. However, with the establishment of the renewable fuels
standard (RFS) under the Energy Policy Act of 2005 (P.L. 109-58), Congress has mandated
a specific level of biofuels use. This level was significantly increased with the Energy
Independence and Security Act of 2007 (P.L. 110-140). For more on these incentives and
other policies see CRS Report RL33572, Biofuels Incentives: A Summary of Federal
Programs, by Brent D. Yacobucci.

in transportation fuels. This level was significantly increased with the Energy
Independence and Security Act of 2007 (P.L. 110-140).
These new policies may affect mitigation potential in several ways. First, the
mandatory biofuel production levels may require land resources that could be used
for other mitigation activities, such as soil sequestration or afforestation. Second, the
required production levels may stimulate growth in infrastructure relating to biofuel
use in the transportation sector. This may increase demand, which could lead to
increased production (above the required threshold) of biofuels for the transportation
sector.
It is unclear how the new federal policies would affect the mitigation potential
for biomass in the electricity sector. With mandatory thresholds in place, biofuels for
transportation could reduce the acreage available for biomass production. However,
a federal renewable portfolio standard (RPS), requiring a percentage of electricity
generation from renewable energy,¹⁰ could alter the calculus.
Estimates from Agriculture and Forestry Activities. In recent years,¹¹
several studies, including separate reports from EPA (2005) and USDA (2004),
have produced estimates of mitigation potential from agriculture and forestry
activities. These study results vary. As EPA stated, the “differences can be expected
based on differences in the models and assumptions embedded in the estimates. In
some cases, estimates of comparable categories vary substantially (Table 1). For
example, EPA estimates a dramatically greater mitigation potential for soil
sequestration activities. USDA’s lower overall estimate for soil management
activities is comparable to a more recent estimate that was produced by McCarl in

2007.¹²

¹⁰ See CRS Report RL34162, Renewable Energy: Background and Issues for the 110th
Congress, by Fred Sissine.
¹¹ EPA, Greenhouse Gas Mitigation Potential in U.S. Forestry and Agriculture, November
2005, at [http://www.epa.gov/sequestration/green house_gas.html]; USDA, Economics of
Sequestering Carbon in the U.S. Agricultural Sector, April 2004, at [http://www.ers.usda.
gov/ publications/tb1909/].
¹² The 2007 McCarl estimate is significant, because McCarl was a co-author in EPA’s 2005
study, and it was his model that provided the underpinnings for the 2005 estimates. See
Bruce McCarl, “Agriculture in the Climate Change and Energy Price Squeeze: Part 2:
Mitigation Opportunities,” February 2007, at [http://www-agecon.ag.ohio-state.edu/
resources/docs/Br uceMcCarlPaper.pdf].

Mitigation Potential Estimates in Context
It may be instructive to compare the mitigation potential estimates with
current sequestration levels, emissions caps, and offset quantity limits from recent
legislative proposals.
— The agriculture and forestry sectors currently sequester approximately 810
mtCO²-e per year (EPA, Inventory of U.S. Greenhouse Gas Emissions and Sinks:

1990-2005 (2007)).

— In 2015, the emissions cap in S. 2191 would be 5,456 million emission
allowances: each allowance equals 1 mtCO²-e.
Several of the proposals would limit the use of domestic offsets in some
fashion. S. 2191, for example, would allow covered sources to use domestic
offsets to satisfy up to 15% of the covered source’s allowance submission.
However, the calculation is not simply 15% of 5,456 mtCO2-e. By allowing
domestic offsets and international credits to satisfy separate 15% blocks of the
allowance submission, the cap could effectively represent 70% of actual emissions
permitted at covered sources. For instance, if there was only one covered facility
in the United States and it emitted 7,794 mtCO2-e in 2015, the facility could be
in compliance with the cap by submitting 5,456 million allowances, 1,169 million
tons of domestic offsets, and 1,169 million tons of international credits. However,
if the covered source does not use either compliance option to the maximum level
(i.e., less than 15%), the calculation is altered. For example, if a covered source
does not use any international credits, domestic offsets would be limited to 963
million tons. The calculation is further complicated by a covered source’s ability
to bank emission allowances for submission in subsequent years.

Although the estimates include a high degree of uncertainty and are outdated for
various reasons (discussed above), the estimates may be informative in some
capacity. For instance, the estimates indicate the relative differences between offset
supply and offset type by price and time. Regardless of the differences in absolute
values between the EPA and USDA models, both agencies’ results demonstrate the
influence of price. Moreover, both models indicate that afforestation activities may
provide more mitigation potential than carbon soil sequestration (Table 1).

Table 1. EPA and USDA Estimates of Mitigation Potential
for Afforestation and Soil Sequestration (in 2025)
Source and Mitigation$3-5 / $13-15 /$30-34 /
Activity mtCO² -e mtCO² -e mtCO² -e
(mtCO² -e )
USDA Model
Afforestation0 - 31105 - 264224 - 489
Agriculture Soil Carbon0 - 4 3 - 3013 - 95
EPA Model
Af f orestation 12 228 806
Agriculture Soil Carbon149204187
^Source:^EP^A^,^Gr^eenhous^{e Gas}^{Mitigation Potential}^{in U.S. For}^e^s^t^r^y^and^Agrⁱ^cultur^e^{(2005), T}^a^bl^e
^4-^{10, ci}^tⁱⁿ^g^U^S^D^A^,^Economⁱ^c^s^of^Seques^t^erⁱ^{ng C}^a^r^{bon i}ⁿ^t^h^{e U}^.^{S. Agr}ⁱ^cul^t^u^r^a^l^Sect^or^(2004).
^No^te:^USDA^’^s^s^t^u^d^y^pres^en^ts^es^tim^ates^as^a^ran^g^e^of^ou^tcom^es^uⁿ^d^{er dif}^f^e^ren^t^param^e^ters^{. USDA}
^es^tim^ates^are^aver^{age annual}^m^itig^ation^f^o^{r a 15-}^y^{ear prog}^ram^(2010-^{2025); it is}^uⁿ^c^{lear w}^h^eth^e^{r EP}^A
^es^tⁱ^m^at^es^{are f}^o^{r t}^h^{e y}^{ear 2025 (as}ⁱⁿ^di^cat^{ed i}ⁿ^T^a^bl^{e 4-}^{10), or w}^h^et^h^e^{r t}^h^{e es}^tⁱ^m^at^es^repres^en^t^a^nnua^l
^av^erag^{e v}^a^l^u^es^f^o^{r t}^h^{e dec}^a^d^{e 2020-}^{2029 (as}^des^c^ri^{bed on}^pag^e^4-^{3). T}^h^{e pri}^cesⁱⁿ^t^h^{e t}^a^bl^{e are i}ⁿ
^coⁿ^s^tan^t^d^o^llar^s^{, ad}^j^u^sted^f^o^rⁱⁿ^f^l^atioⁿ^.
EPA’s study also generated mitigation potential estimates for four other
agriculture and forestry activities. These estimates are provided in Table 2 to
demonstrate the range of potential for different activities.
Table 2. EPA Estimates of Mitigation Potential
for Other Agriculture and Forestry Activities (in 2025)
$5 /$15 /$30 /
mtCO² -e mtCO² -e mtCO² -e
Mitigation Activity
(mtCO² -e )
Forest Management89156250
Fossil Fuel Reduction183249
from Crop Production
Agriculture Methane173676
(CH⁴) and Nitrous
Oxide (N²O) Mitigation
Biofuel Production0021
^Source:^EP^A^,^Gr^eenhous^{e Gas}^{Mitigation Potential}^{in U.S. For}^e^s^t^r^y^{and Agr}ⁱ^cultur^e^(2005),^T^a^bl^e
^4.A^.^1.
^No^te:^I^tⁱ^s^uⁿ^c^l^e^a^r^w^h^e^t^h^e^r^E^P^A^e^s^tⁱ^m^a^t^e^s^a^r^e^f^o^r^t^h^e^y^e^a^r²⁰²⁵^(as^s^ugge^st^e^d^b^y^T^a^b^l^e⁴^.^A^.¹⁾^,^o^r
^w^h^ether^{the estim}^{ates r}^e^p^r^{esent a}^{nnual aver}^{age values}^f^o^r^{the d}^ecad^e^2020-^{2029 (as}^des^c^ri^{bed on}^pag^e
^4-^{3). T}^h^{e prices}ⁱⁿ^th^{e table are in}^coⁿ^s^tan^t^d^o^llar^s^{, ad}^j^u^sted^f^o^rⁱⁿ^f^l^atioⁿ^.

Estimates from Other Activities. Other potential mitigation activities —
e.g., methane abatement from landfills or the natural gas sector — are generally
considered to be less complicated in terms of measurement than agriculture and
forestry projects. These types of mitigation projects are typically not subject to
competition for land resources. However, these estimates are only mitigation
potential, not potential offset supply. Other factors, identified in Figure 1 and
discussed below, would likely constrain or exclude their development as offsets. For
instance, some of the activities identified below would be covered under the cap of
some legislative proposals.
Table 3. EPA Estimates of Mitigation Potential
from Other Activities (in 2010)
$0 /$15 /$30 /
Mitigation ActivitymtCO²-emtCO²-emtCO²-e
(mtCO² -e )
CH⁴ from Landfills135353
CH⁴ from Natural Gas202739
Sector
CH⁴ from Coal Mines254444
N²O from Adipic Acid088
Production
N²O from Nitric Acid01414
Production
^Source:^EP^A^,^{Global Mitigati}^{on of N}^on-C^O^{2 Gr}^eenhous^{e Gas}^e^s^{(2006), D}^a^t^a^Aⁿⁿ^e^x^e^s,^at
^[^h^t^t^p^:^/^/^www.^e^p^a^.^g^o^v^/^c^lⁱ^m^a^t^e^c^h^aⁿ^g^e^/^e^c^oⁿ^o^mi^c^s^/ⁱⁿ^t^e^rⁿ^a^tⁱ^oⁿ^a^l^.^h^t^ml^]^.
^No^te:^T^h^{e em}ⁱ^s^sⁱ^on^al^l^o^w^aⁿ^{ce pri}^ce^va^l^u^e^s^aⁿ^d^t^h^{e y}^{ear (2010) are di}^f^f^e^ren^t^f^r^om^prevⁱ^o^u^s^t^a^bl^es^,
^becau^s^e^th^{e data}^are^f^r^om^{a dif}^f^e^ren^t^s^o^u^r^{ce. T}^h^{e data s}^o^u^r^{ce (EP}^A^{, 2006) als}^o^prov^{ided es}^tim^ates
^f^o^{r 2020.}^F^o^r^t^h^e^m^o^s^t^part^,^t^h^es^{e es}^tⁱ^m^at^es^{are s}ⁱ^mⁱ^l^a^{r t}^o^t^h^{e 2010 v}^a^l^u^es^{. T}^h^{e pri}^cesⁱⁿ^t^h^{e t}^a^bl^e
^ar^{e in}^coⁿ^s^tan^t^d^o^llar^s^{, ad}^j^u^sted^f^o^rⁱⁿ^f^l^atioⁿ^.
Several of the mitigation activities in Table 3 are projected to occur at
$0/mtCO²-e.¹³ EPA states that these figures “represent mitigation options that are
already cost-effective given the costs and benefits considered (and are sometimes
referred to as “no-regret” options) yet have not been implemented because of the¹⁴
existence of nonmonetary barriers.” These are discussed below in “Other Factors.”

¹³ The lowest emission allowance price ($0/mtCO2-e) in Table 3 is different from previous
tables, which began at or about $5/mtCO2-e. The data from Table 3 are from a different
EPA study than was used in previous tables.
¹⁴ EPA, Global Mitigation of Non-CO2 Greenhouse Gases (2006), p. I-14.

The fact that parties are not acting in the most economically efficient manner at
$0/mtCO²-e, calls into question the estimates for higher emission allowance prices.
This demonstrates the uncertainty contained in mitigation potential estimates.
Policy Choices
Policy decisions from Congress, U.S. states, and foreign governments would
directly and indirectly affect the supply of offsets in a cap-and-trade program. The
primary factor would be the design of the cap-and-trade system. Other policies
would also help shape the pool of offsets that could be used for compliance purposes.
These policy choices are discussed below.
Design of the Cap-and-Trade Program. Programmatic design elements
could affect offset supply in several ways, from the overall structure of the cap (e.g.,
which sources are covered) to specific logistical details (e.g., monitoring and
measuring protocols). Another critical element would be the program’s use of set-
aside allowances.
Scope of the Cap. The wider the scope of the cap, the smaller the offset
universe. In other words, as more source categories are subject to the cap, the fewer
the number of uncapped sources, thus the number of eligible offset project types
decreases. For example, S. 2191 would not cover N²O emissions from adipic or
nitric acid production, whereas S. 1766 (Bingaman-Specter) would include these¹⁵
emissions under its cap.
Eligible Offset Types. Policymakers may choose to restrict the types and
locations (domestic versus international) of offsets eligible for use by a regulated^th
entity. For example, some cap-and-trade proposals in the 110 Congress would
allow a wider range of biological sequestration activities than other proposals.
Biological sequestration generally offers the most potential, but these projects present
substantial challenges. In addition, the degree to which international offsets are
allowed would have considerable impact on domestic offsets.
Offset Protocols. The protocol established for measuring and verifying
offsets would affect supply. A more stringent protocol would likely reduce supply.
Offsets that are questionable — for instance, in terms of their additionality — would
likely be excluded or discounted (also reducing supply). Additionality determinations
(i.e., would the project have happened anyway) typically require some subjectivity
in the decision process. A protocol with more constraints could remove some of the
subjectivity, which, if left in place, could lead to an influx of questionable offsets.
Some protocols may include more conservative parameters for measuring tons
of CO² sequestered for a particular project type. For example, one protocol may
stipulate that carbon saturation for a given plant or tree species occurs in a shorter
time frame, thus fewer offsets would be produced through the project.

¹⁵ For a comparison of cap-and-trade proposals, see CRS Report RL33846, Greenhouse Gas
Reduction: Cap-and-Trade Bills in the 110^th Congress, by Larry Parker, Brent D.
Yacobucci, and Jonathan L. Ramseur.

Moreover, the stringency of the protocols would likely affect the costs of
developing, implementing, and verifying an offset project. These costs might be
described as transaction costs. For example, a protocol that required independent,
third-party verification would entail higher costs for offset projects. If transaction
costs increase, the number of cost-effective offset projects would decrease.
The proposed (and enacted) systems of measurement and verification vary. In
many cases, legislative proposals direct various agencies to develop the protocols. In
these cases, the level of protocol stringency would be uncertain at the bill’s passage.
Set-Asides. If the cap-and-trade program provides set-aside allowances for
specific activities, these activities would be removed from the potential supply of^th
offsets. Several of the cap-and-trade proposals from the 110 Congress would give
emission allowances (set-asides) to non-covered entities to promote various¹⁶
objectives, including biological sequestration. Set-aside allowances are taken from
within the cap, so if the set-aside allowances do not lead to further emission
reductions, abatement, or sequestration, the cap remains intact. Indeed, one strategy
for policymakers is to allot set-asides for activities whose emission reductions,
abatement, or sequestration may carry more uncertainty than other potential offset
activities.¹⁷ However, a project that receives a set-aside cannot also qualify as an
offset. Thus, set-aside allowances would reduce the pool of offsets available for
compliance with the cap.
In some of the recent proposals, set-asides would substantially reduce the offset¹⁸
pool. For example, S. 2191 (as reported) would set aside the following emission
allowances in 2012:
^!289 mtCO²-e (5% of total allowances) for domestic agriculture and
forestry emission reduction/sequestration projects, and
^!58 mtCO²-e (1% of total allowances) for landfill and coal mine
methane projects.
Actions in Other Nations or U.S. States. As other nations or U.S. states
establish emission controls or climate-related policies, the pool of offsets would
shrink. International offsets, particularly in the developing nations, are projected in
models to provide numerous opportunities for compliance.¹⁹ However, these
projections assume that these nations are decades away from requiring GHG
emission reductions or other regulations (e.g., technology standards) that would
exclude these projects as offsets.

¹⁶ For more information, see CRS Report RL34502, Emission Allowance Allocation in a
Cap-and-Trade Program: Options and Considerations, by Jonathan L. Ramseur.
¹⁷ For example, methane reduction from landfills is generally considered a more certain
offset than methane reduction from rice cultivation. See Lydia Olander, Designing Offsets
Policy for the U.S. (2008), Nicholas Institute for Environmental Policy Solutions.
¹⁸ The number of set-asides in the as-reported version of S. 2191 is different from the
version (S. 3036) that included the revenue neutral amendment.
¹⁹ EPA, EPA Analysis of the Lieberman-Warner Climate Security Act of 2008 (2008).

Climate-related policies in U.S. states may also affect offset supply. A number
of states have taken actions that directly address GHG emissions.²⁰ For example, 23
states have joined 1 of the 3 regional partnerships that would require GHG (or just
CO²) emission reductions. A state or regional emissions cap might cover more
sources than a federal program, thus disqualifying emissions from these sources as
potential offset opportunities. However, it is uncertain how these state actions would
interact — e.g., whether or not they would be pre-empted — with a federal ap-and-
trade program.
Regardless of whether state and regional emission caps are subsumed into a
federal cap-and-trade program, other state policies could play a role. For example,
California is developing methane emission performance standards for landfills.²¹ If
this policy is finalized, methane capture from California landfills would not be
available to qualify as offsets in a federal program.
Other Policy Influences. Policies not directly related to a cap-and-trade
program could also affect the potential supply of offsets. A comprehensive review
of policies that could affect offset supply is beyond the scope of this report.
However, several federal policy options stand out. As mentioned above, Congress
has enacted energy legislation requiring certain levels of biofuel use in transportation
sector. This policy affects the amount of land potentially available for agriculture and
forestry offset projects.
If enacted by Congress, a federal renewable portfolio standard (RPS) may affect
offset supply. A federal RPS would stimulate the production of biomass for
electricity generation. As discussed above, biomass for electricity generation would
not qualify as an offset, but would instead compete with other offset projects for land
resources.
Economic Factors
The potential supply of offsets would ultimately be affected by how the
economy responds to a federal cap-and-trade program. Such a complex analysis is²²
beyond the scope of this report. A critical factor is the development and market
penetration of low- and/or zero-carbon technologies. These technologies could lower
the costs of the cap-and-trade program. Federal policies — e.g., funding or tax
incentives — could stimulate these technologies. If these technologies are available
earlier than predicted (by models), the emission allowance price (discussed below)
would likely decrease, making fewer offset projects cost effective.

²⁰ See CRS Report RL33812, Climate Change: Action by States To Address Greenhouse Gas
Emissions, by Jonathan L. Ramseur.
²¹ See [http://www.arb.ca.gov/cc/landfills/landfills.htm].
²² For information on these matters, see CRS Report RL34489, Climate Change: Costs and
Benefits of S. 2191/S. 3036, by Larry Parker and Brent D. Yacobucci.

Emission Allowance Price
The supply and type of offsets available would be largely dependent on the
emission allowance price in a cap-and-trade system.²³ The market price — sometimes
referred to as the price of carbon — of a tradeable emission allowance would be
influenced by several factors, discussed above. The central factor would be the
structure of the emission reduction program, particularly the program’s scope (which
sources are covered) and stringency (the amount and timing of required emission
reductions).
In addition to the core structural design of the cap-and-trade program, the
allowance price would be dependent on the program’s treatment of offsets: which
types would be allowed; whether international offsets could be used; whether covered
sources would be limited (e.g., as a percentage of their allowance submission) in their
use of offsets. Indeed, EPA’s analysis of S. 2191 (as reported) indicates that different
offset treatments yield the greatest range in emission allowance prices. For example,
if the use of domestic and international offsets are unlimited, the emission allowance
price would be 71% lower than under the as-written conditions of the bill.²⁴
The supply of offsets would fluctuate as the allowance price changes. If the
allowance price is relatively low — i.e., $1 to $5/mtCO²-e — only the “low-hanging
fruit” projects would be financially viable. If the allowance price is higher, more
offset projects would become economically competitive.
It is impossible to predict with confidence what an allowance price would be in
a cap-and-trade system. Although multiple studies have provided — through
economic modeling — estimates of allowance prices under the proposed cap-and-
trade regime that would be created by S. 2191 (the Lieberman-Warner Climate
Security Act of 2008), the results vary considerably among studies. For more
information on these issues, see CRS Report RL34489, Climate Change: Costs and
Benefits of S. 2191/S. 3036, by Larry Parker and Brent Yacobucci.
Other Factors
An EPA study stated that “[o]ther nonprice factors, such as social acceptance,²⁵
tend to inhibit mitigation option installation in many sectors.” For example,
farmers engaged in dairy operations for many generations may be hesitant to convert
their land to forests, even if this would be the most profitable use of the land. In
addition, institutional factors have been observed in the forestry sector, which was
initially expected to play a much larger role in the CDM. A report from the
Intergovernmental Panel on Climate Change (IPCC) stated that although the forestry
sector can make a “very significant contribution to a low-cost mitigation portfolio ...
this opportunity is being lost in the current institutional context and lack of political

²³ Offsets could potentially be a design element of a carbon tax regime as well.
²⁴ EPA, EPA Analysis of the Lieberman-Warner Climate Security Act of 2008 (2008).
²⁵ EPA, Global Mitigation of Non-CO² Greenhouse Gases, p. 1-23 (2006).

will to implement and has resulted in only a small portion of this potential being
realized at present.”²⁶
Two other factors that may limit or slow offset supply are information
dissemination and transaction costs (discussed in a subsequent section). Many of the
emission abatement and sequestration opportunities, particularly in the agricultural
sectors, may be widely dispersed and under the control of relatively small operations
(e.g., family farms). Similarly, many of the agriculture and forestry offset projects
may present technical challenges, depending on requirements to measure emissions
and verify projects. To generate offsets at these locations, parties would need to
know that opportunities exist and are financially viable (based on the carbon price).
In addition, the smaller operations may need technical support in order to initiate,
measure, and verify the projects.
Offset Use in a Cap-and-Trade Program
Several studies, including separate reports from EPA and EIA,²⁷ have generated
estimates of offset use within a defined policy framework — the cap-and-trade²⁸
program that would be established by S. 2191. Although the absolute values should
be viewed with skepticism, relative differences generated by varied offset scenarios
may be instructive to policymakers.
The absolute estimates of offset use in the EPA and EIA models are inherently
flawed — at least for the agriculture and forestry sectors — because both models
used EPA’s 2005 mitigation potential estimates as underlying data. As discussed
above, this underlying data is outdated and embedded with its own uncertainty.²⁹
EPA and EIA use different economic models, with different underlying
assumptions, in their S. 2191 studies. For example, EPA and EIA make different
adjustments to the mitigation potential data, which provide the foundation for offset
estimates. For its model of S. 2191, EIA reduced EPA’s mitigation potential
estimates by 25%.³⁰ Arguably, the value of the adjustment factor is somewhat

²⁶ Intergovernmental Panel on Climate Change, Climate Change 2007: Mitigation.
Contribution of Working Group III to the Fourth Assessment Report, p. 543 (2007).
²⁷ EPA, EPA Analysis of the Lieberman-Warner Climate Security Act of 2008 (2008); EIA,
Energy Market and Economic Impacts of S. 2191, the Lieberman-Warner Climate Security
Act of 2007 (2008).
²⁸ A number of studies provided economic analysis of S. 2191. For more information on
these studies see CRS Report RL34489, Climate Change: Costs and Benefits of S. 2191/S.

3036, by Larry Parker and Brent D. Yacobucci.

²⁹ In particular, the soil sequestration estimates in EPA’s 2005 study are dramatically higher
than estimates produced by USDA in 2004 and more recent analysis in 2007 (McCarl,
Bruce, “Agriculture in the Climate Change and Energy Price Squeeze: Part 2: Mitigation
Opportunities,” (2007)).
³⁰ EIA stated in its analysis of S. 2191 that it “applied the same methodologies and data
(continued...)

arbitrary, but EIA explained that it accounts for various obstacles — e.g., unidentified
costs, information diffusion, and social acceptance — that were not reflected in the
mitigation potential data. EPA did not make similar adjustments.
In the studies’ core scenarios, the agencies’ models yielded different estimates
for emission allowance prices. Emission allowance price is a key factor in
determining offset supply. In 2015, EPA estimated an emission allowance price range
of $29-$40; EIA estimated a price of approximately $21.³¹
As one may expect, the different models and underlying assumptions led to
different estimates of offset use and, in particular, when the 15% offset limitation
(imposed by the bill) would be binding. EPA estimated that the separate 15%
thresholds on domestic offsets would be binding almost immediately: in 2015 or
2017.³² The EIA model estimated that the 15% limitation would not be binding until

2025.

Although the absolute values provided by the studies of S. 2191 contain a large
amount of uncertainty, the relative differences yield some insights. Because the EPA
and EIA analyses of S. 2191 both use EPA’s 2005 mitigation potential estimates, the
relative differences — e.g., relationships between emission allowance price and
offset quantity and type — that were observed in mitigation potential are also seen
in the S. 2191 analyses. For example, higher allowance prices make more offset
projects and different types of offset projects economically competitive. However,
higher allowance prices may make other mitigation activities — such as biofuels for
electricity — more competitive as well.
An additional insight provided by the S. 2191 analyses is the impact that
international offsets have on domestic supply. EPA modeled scenarios with different
quantity limitations for domestic and international offsets. In the core scenario,
which matches the 15% limitations in the bill, both international and domestic offsets
are restricted to 15% of emission allowance submissions almost immediately (Figure
2). One may expect the combined offset use columns to demonstrate more of a
decline, to coincide with a declining emissions cap. This is not observed in the
model, primarily due to the bill’s application of the 15% limitation for offset use. In
S. 2191, the 15% limit would apply to each covered source’s annual allowance
submission, in which a covered source must provide (or surrender) to EPA an
emission allowance for each unit of GHG emissions (mtCO²-e) generated in the

³⁰ (...continued)
sources described in its evaluation of S. 280, the Climate Stewardship and Innovation Act
of 2007.” The 25% adjustments are described in EIA, Energy Market and Economic
Impacts of S. 280, the Climate Stewardship and Innovation Act of 2007 (2007).
³¹ The relationship between allowance price and offset supply is complicated, because they
are interrelated. EIA’s lower allowance prices may be partially explained by the agency’s
treatment of the underlying mitigation potential data.
³² In its study EPA used two separate computable general equilibrium models: Applied
Dynamic Analysis of the Global Economy (ADAGE) and Intertemporal General
Equilibrium Model (IGEM). The 15% offset threshold was reach in 2015 with ADAGE and

2017 with IGEM.

previous year.³³ Although the emissions cap would decline under S. 2191, EPA
projects annual allowance submissions to remain fairly constant until 2030, largely
due to the opportunity for covered sources to bank emission allowances and submit
them for compliance in later years.
In an alternate scenario, the use of domestic and international offsets is
unlimited. Under this policy framework, international offsets dominate, and total
offset use is considerably greater than under the core scenario. However, domestic
offset use is substantially less than under the core scenario (Figure 3). Although
domestic offset use is unlimited, fewer projects are developed because the emission
allowance price increases at a much slower rate under this scenario. For example,
in the core scenario the allowance price is $83 in 2030, but only $24 in the unlimited³⁴
offsets alternative. The influx of unlimited international offsets keeps the allowance
price relatively low, thus fewer domestic offset projects are cost effective.
In a third scenario (Figure 4), domestic offset use is unlimited, while
international offsets are restricted to 15% of allowance submission. In this situation,
domestic offset use, not surprisingly, is greatest, but total offset use is well below the
estimates in Figure 3.
As Congress continues to discuss ways to address GHG emissions and the
complex array of alternative approaches, understanding the potential effects of offsets
will provide for a more informed debate. The treatment of offsets is one of the more
critical design elements for policymakers to consider when developing a GHG
emission reduction program, such as a cap-and-trade system.

³³ In contrast, the so-called “Boxer Amendment” (S.Amdt. 4825) would limit offsets to a
percentage (e.g., 15% for domestic offsets) of the aggregate quantity of allowances under
the cap in a given year.
³⁴ By comparison, in the “no offsets” scenario, the allowance price is $160 in 2030.

Figure 2. Estimated Offset Use Under S. 2191
If International and Domestic Offsets Limited to 15% of
Allowance Submission
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Figure 4. Estimated Offset Use Under S. 2191
If Domestic Offset Use Unlimited and
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