Economic Incentive Instruments & Carbon Offsets

1. Economic Incentive Instruments & Carbon Offsets Environmental Economics Harvard University Summer School Jennifer Janisch Clifford July 6,2011

2. Market Incentives to Pollute • Firms are encouraged to pollute when resources are free. • Need to make it more profitable not to pollute than to pollute. • 95% of current air & water pollution could be eliminated by known & available technology.

3. Internalizing External Costs • Goal is to close the gap between private & social costs. • 2 General Approaches toward this goal: • 1) Direct Government Regulations (Command & Control) • 2) Economic Incentive Instruments

4. Economic Incentive Instruments (EIs) either: • 1) Put financial burdens on the polluters – these costs provide an incentive to reduce pollution, or • 2) Polluters are offered financial incentives, for example subsidies if they reduce pollution or their environmental impact.

5. EIs are considered desirable for: • Expected Efficiency • Expected to provide incentives for innovation • Perceived as a more appropriate set of instruments in the preventative phase of environmental policy

6. EIs have in common: • The existence of financial stimuli • The possibility of voluntary action • The involvement of government (or related) authorities • The intention of directly or indirectly maintaining or improving environmental quality by applying the instrument.

7. EIs can be: • Charges • Subsidies • Deposit- Refund Systems • Market Creation • Financial Enforcement Incentives

8. Market Creation: Cap & Trade • Parties may buy “rights” for actual or potential pollution & may sell pollution allowances when they exceed compliance. • Trading Systems “Cap & Trade” • Advantages: • Each time a permit is sold the limit decreases • Incentive to invest in pollution control equipment (present economic value). • Efficient: minimizes overall cost.

9. Carbon Offsets • A carbon offset is a financial instrument representing a reduction in greenhouse gas emissions. • 1 carbon offset = reduction of 1 metric ton of carbon dioxide or its equivalent.

10. 2 Markets for Carbon Offsets • 1) Compliance Market: industry & government need to buy carbon offsets to comply with caps on total carbon emissions. • In 2006 $5.5 billion of carbon offsets were purchased in the compliance market = 1.6 billion metric tons of CO2 reductions. • 2) Voluntary Market: individuals, companies, & governments purchase carbon offsets to mitigate their own greenhouse gas emissions. • In 2006 $91 million of carbon offsets were purchased in the voluntary market = 24 million metric tons of CO2.

11. Kyoto Protocol • The Kyoto Protocol sanctioned offsets as a way for governments & industry to earn carbon credits. • Projects are validated and measured by the Clean Development Mechanism (CDM). • To comply with the Kyoto Protocol if emission levels are higher than the allowable standard they may offset their emissions by purchasing “CDM-approved Certified Emissions Reductions.”

12. 30 industrialized countries, signatories to Kyoto, have been legally bound to meet quantitative targets for greenhouse gas reductions to below 1990 levels between 2008 & 2012. • EU implemented Cap & Trade system in 2005 to reach Kyoto targets. • Kyoto expires in 2012 (signed in 1997, became binding in 2008).

13. Climate Conference • Next international climate conference will be held in Durban, South Africa beginning on November 28th. • Necessary to secure concrete, legally binding, verifiable agreements on carbon reduction from industrialized & emerging economies. • High expectations for the Copenhagen conference but it ended in disappointment: No legal agreement reached, concluded with a political statement.

14. December 2009 Copenhagen Conference on International Climate Change Agreements & Standards to replace or extend the Kyoto Protocol. • American House & Senate was motivated to pass climate change legislation to cap greenhouse gas emissions before December conference but failed. • The House passed the Waxman-Markey Bill June 2009 • Climate Legislation (Kerry-Lieberman) failed in the Senate (July 2010) • Read “As the World Burns” by Ryan LizzaNew Yorker 10/11/10 • Issues with Cap & Trade legislation: • Whether allowances will be given away or auctioned. • President favors auctioning of permits; budget has projected $646 billion in revenue generated between 2012 & 2019. • Companies that have been polluting for free do not want to start paying for it. • Utilities will pass on higher costs to consumers. • Revenue generated from auctions will be used for clean energy projects and assistance for low & middle income families.

15. Cap & Trade Timeline • Cap & Trade was designed & tested in the United States in 1990 as part of the Clean Air Act Amendments. • In the 1990s the US acid rain cap & trade program achieved 100% compliance in reducing SO2 emissions (22% below mandated levels). • The $2 billion annual cost of the acid rain controls is a quarter the initial estimates.

16. Savings from Cap & Trade Acid Rain Reductions: • 17,000 deaths a year prevented in the U.S. • 100’s of 1000’s of respiratory illnesses lessoned. • Acid Rain Program is saving $108 billion annually in healthcare costs.

17. Benefits of Climate Change Legislation • Strengthens energy security • Improves air quality • Increases competitive advantage in trade and technology innovation • Increases resource efficiency • It is in countries’ own self interest to enact climate legislation.

18. Projection is that Cap & Trade plan would reduce emissions 80% by 2050 • European emissions decreased 3% in 2008 alone. • Australia has delayed Cap & Trade legislation to 2012. • Prime Minister has promised more ambitious targets.

19. Progress • U.S.: American Recovery & Reinvestment Act included $80 billion for clean energy development & $16.8 billion for renewable energy programs. • China: 12th 5-Year plan (just released) includes significant targets for reducing carbon intensity (amount of carbon emitted per unit of economic output) 40-45% from 2005 levels by 2020. • India: Expert Group for Low Carbon Strategy for Inclusive Growth. • Mexico: Looking at energy laws and climate change legislation.

20. Progress • Brazil: Pledged to reduce deforestation in the Amazon by 80% by 2020. (still an annual loss of 3,250 sq. km a year) • Brazil policymakers talk of ending deforestation by 2030. • Brazil: Legislation on deforestation • Expansion of rainforest land designated as National Park or Indigenous Reserve. • Greater enforcement of laws against illegal logging, cattle ranching and slavery. • Government discouragement of sugarcane cultivation in the Amazon. • Land registry & formalization of land holdings.

21. REDD: Reducing Emissions from Deforestation & Degradation • Payments for carbon sequestration in forests and avoided deforestation. • Idea: Rich countries should pay poor Not to cut down trees. • Goal: Cut deforestation in half by 2020. • 6 Wealthy Nations have pledged $4.5 billion to launch REDD by 2012 • > 70 Developing Forest Countries could be eligible for P.E.S.

22. REDD: Reducing Emissions from Deforestation & Degradation • Proposed at Kyoto in 1997: industrialized countries be allowed to offset their own emissions by paying developing countries not to cut down their forests. European environmental groups opposed the idea – rainforests since have been disappearing at a rate of 20 – 30 million acres a year. • Concern is that credits will flood the market and drive allowance prices down, decreasing incentives to invest in clean technologies.

23. Benefits of REDD credits • Allowing REDD credits to be used for compliance carbon in cap & trade: • 1) Would provide incentive for protection of tropical forests • 2) Change the dynamics for forest protection • 3) Help to avert disastrous global warming. Deforestation accounts for approximately 20% of anthropogenic greenhouse gas emissions. • 4) Will put a value on standing trees. Trees may be worth more alive than dead. • Environmental Defense Fund study

24. Value of Rainforest • Most of the values are public goods that are not counted in national output. • In the national accounts forest clearance is recorded as progress. • U.N. Millennium Ecosystem Assessment identified 24 main ecosystem services, most of which are found in forests (almost none of which are priced on markets). • “Forests are disappearing because they are undervalued.”

25. Forests • About half the Earth’s original forest area has been cleared. • According to FAO approximately 10 billion acres of forest remain worldwide (31% of Earth’s land surface). Only one third of which is primary & FAO counts as “forested” areas with as little as 10% forest cover. • Deforestation contributes 15 -17% of World’s total emissions (> all transportation combined). • Worldwide forests absorb one quarter of all carbon emissions.

26. The Economics of Ecosystems & Biodiversity • The Economics of Ecosystems & Biodiversity (TEEB) found: • Contribution to the livelihood of poor forest dwellers at $500 mil to $1 billion a year (based on estimated market value of fish & thatch). • Rainforest’s role in avoiding siltation in hydro-power reservoirs valued at $60 mil to $600 mil annually. • Contribution to South America’s agricultural output (through regulating the water cycle): $1 - $3 billion (Head of research team thinks the real value may be 10 Xs higher). • Value of Bio-prospecting unknown but potentially tremendous. • The negative externalities from forest loss and degradation cost $2 – 4.5 trillion a year.

27. Local PES Schemes • In response to Yangzi River flooding, China pays farmers $450 a year per reforested hectare. • Costa Rica has paid $45 – 163 per conserved hectare since 1997. • U.S. & Australia markets for “Habitat Banking” or biodiversity offsets.