# Overview of Cap and Trade **and Offsets**

Reid Harvey Climate Change Division, Office of Air and Radiation August 25, 20092 

# Outline

• What is cap and trade and how does it work?

• US acid rain experience with cap and trade

• What are offsets and how do they work?

• EPA analysis of House cap - and - trade legislation

• Implications for agriculture3 

# What is Cap and Trade?

• A cap - and - trade program sets a mandatory limit on the aggregate emissions of all affected sources to achieve emissions reductions • The government distributes emission allowances — either freely (allocation) or by sale (auction) — that total no more than the cap • Allowances may be traded (purchased and sold) creating a market for allowances and establishing a price. This creates an incentive to reduce emissions • Control requirements are not specified under a cap - and - trade program • Each affected source must surrender allowances for compliance equal to its actual emissions • The cap ensures achievement of the emission reduction goal while also providing flexibility to sources and predictability for the allowance trading market4 

# How Does Cap and Trade Work?5 

### SO **2** 

### E **mi ssi**  **ons (m**  **illio n**  **to ns)** 

**0 5**  **10 15**  **20 25**  **30 1** **9 8** **0 1** **9 8** **5 1** **9 9** **0 1** **9 9** **5 2** **0 0** **0 2** **0 0** **5 2** **0 1** **0 Allowable**  **Emissions Actual**  **Emissions Without Acid** 

**Rain Program** 

# National SO **2** 

# Trading Program

• **Problem:** Acid Rain • **Scope:** National • **Target:** Reduce SO 2 

## emissions from electric generators by 8.5 million tons (50% below 1980 levels) • **Coverage:** ~3000 Electric Power Units6

**Wet Sulfate Deposition Av**  **erage 1989 -**  **1991 Wet Sulfate Deposition**  **Av erage 2001**  **– 2003**  

# Major Reductions in Acid Rain

• Sulfur deposition and concentrations down 40% across the Eastern U.S. • Signs of recovery are evident in some acid sensitive ecosystems7 

# GHG Offsets **Offset Project Type Examples**
 **Methane capture**  Landfill, manure, coal mines
 **Agriculture and Forestry**   Afforestation, forest management, increasing agriculture soil C 

#  Others? **What are offsets?**   Emission reductions occurring at sources that are not capped (e.g., a landfill).  With GHGs, emission reductions have the same ef

fect regardless of where they take place.  Advantages of of

fsets:  Provide incentives for reductions in sectors that are not amenable to trading.  Potential cost - savings for capped facilities.  **Challenges**  Assessing “additionality” of reductions.8 

# How do offsets work?

Landfill Emissions (without

methane collection/combustion) Power plant Emissions (no cap)
Landfill Reduction (with methane collection/combustion) Power plant Emissions (with cap) 

## No Offset/No **Cap**
**Offset/Cap** Cap9 

# Potential offset sources in Agriculture and **Forestry**

**Strategy Mitigation Activities**  **Target GHG Afforestation**  Convert agricultural lands to forest CO 2 

### Forest management Lengthen timber harvest rotation Increase forest management intensity Forest preservation Avoid deforestation CO 2 

### Agricultural **soil carbon sequestration**  Crop tillage change Crop mix change Crop fertilization change Grassland conversion CO 2 

### Fossil **fuel m itigation**  **fr om**  **crop pr oduction**  Crop tillage change Crop mix change Crop input change Irrigated/dry land mix change CO2 

### Agricultural **CH4 and N2O mi**  **tigation** Crop tillage change Crop mix change Crop input change Irrigated/dry land mix change Enteric fermentation control Livestock herd size change Livestock system change Manure management Rice acreage change CH4 N2O**S e** **q u** **e s** **t r** **a t** **i o** **n E** **m i** **s s** **i o** **n s** **R e** **d u** **c t** **i o** **n**10 

# House and Senate bills

• House energy and climate bill (Waxman - Markey) passed the House on June 26, 2009 • Extensive process: • Discussion draft released March 31 • Legislative hearings in April (over 70 witnesses) • Bill introduced May 15, marked up May 18 - 21, voted out of committee May 21 • Senate Committees developing bills by Sept. 28th11 

# Domestic Offsets in the Waxman   ** Markey Bill: Highlights**
• No explicit project types designated

– To be determined by USDA (agriculture and forestry offsets) and EPA with input by Offsets Integrity Board


# • Initial eligibility list after 1 year • Additional project types within 2 years • Application of a standardized methodology for establishing baselines
• Account for and address reversals and leakage12 

# EPA analysis of H.R. 2454 **Major findings**

• Energy consumption levels that would be reached in 2015 without the policy are not reached until 2040 with the policy
• The share of low - or zero - carbon primary energy (including nuclear, renewables, and CCS) rises substantially under the policy to 18% of primary energy by 2020, 26% by 2030, and to 38% by 2050

― without the policy the share would remain steady at 14%
• Largest sources of emissions abatement: electricity sector, offsets
• Offsets lower costs significantly
• Relatively modest impact on consumers, assuming bulk of revenues from program are returned to households ($80 - $111/household/yr NPV) **June 23, 2009**13 H.R. 2454 Cap AE O 2009 Reference Forecast

0 1, 000 2, 000 3, 000 4, 000 5, 000 6, 000 7, 000 8, 000 9, 000

1990 2000 2010 2020 2030 2040 2050**M t** **C O** **2 e**  Historic Em issions 

# H.R. **2454 Cap and Trade Provisions: Targets and Timetables** 

• Declining cap for GHG em issions:

– 97 percent of 2005 level in 2012

– 83 percent of 2005 level in 2020

– 58 percent of 2005 level in 2030

– 17 percent of 2005 level in 2050
• 85 percent of GHG em issions are covered. Coverage is phased in between 2012 and 2016 by sector


## • Regulations for certain sectors
• Other sectors can provide of fsets

– 1 billion tons dom estic offsets (prim arily from

a griculture and forestry sectors)

– 1 billion+ tons international offsets14 

# US GHG Emissions **& Sources of Abatement under**  **HR 2454**

Co ver ed G HG Em is si ons (N et of O ffs ets ) HR 2454 C ap AE O 2009 Re ferenc e C as e
Hi st oric al Em is si ons AE O 2006

Re ferenc e C as e

0 2, 000 4, 000 6, 000 8, 000 10, 000 12, 000

1990 2000 2010 2020 2030 2040 2050**M t** **C O** **2 e**  CO2 - Elec tric ity CO2 - Trans portation CO2 - Energy I nt. M anufac tur ing CO2 - O ther No nC O2 - C over ed Of fs ets - Dom es tic Of fs ets - I nter national In t' l Fores t Set-A

si des Di sco unted O ffs ets NS PS - CH 4 HF Cs (s eparate c ap)
• The updated reference case for this analy sis is based on AEO 2009, and the old reference case from EPA’s S. 2191 analy sis was based on AEO 2006. • Cumulative 2012 - 2050 GHG em issions are 14% (51 bmt) lower in the AEO 09 baseline compared to the AEO 06 baseline in ADAGE due to the inclusion of EISA, lower initial (2010) GDP ($13.2 trillion in AEO 09 vs $14.6 trillion in AEO 06), and a lower projected GDP growth rate (2.5% in AEO 09 vs 3.0% in AEO 06). • International forest set - asides, discounted offsets, NSPS provisions for landfill and coal mine me thane, and the HFC cap all provide additional abatement that does not help to m eet the m ain cap.15 

# Domestic Offsets Usage **H.R. 2454 Scenario Comparison**

• The annual limit on the usage of domestic offsets is non - binding.
• In our analysis, we assume that landfill and coal mine CH 4 are covered under new source performance standards (NSPS) and are thus not available for offsets.
• Restricting the use of international offsets, as in “ scenario 7 – H.R. 2454 No Int’ l Offsets ” has a large impact on allowance prices (89% increase relative to ‘ scenario 2 – H.R. 2454’ ).
0 100 200 300 400 500 600 700 800 900 1,0002015202020302040205020152020203020402050

Sc n 2 - H R 2454 . Sc n 7 - H R 2454 - N o I nt'l Of fs ets**M t** **C O** **2 e** 16 

# Interactions between Climate **Policy and Agricultural Sector** Climate Legislation

Agricultur al Sector Fo ssil Fuel Markets Offset Markets

• Higher costs • Source of Income • Drives up ag prices

- Shrinking land base, land moves to forest 

### • Drives up ag prices

- Increased demand for low carbon biofuels17 

# Implications for agriculture

• There is substantial GHG offset potential in agriculture and forestry • Potential increases in bioenergy crops and changes in agricultural land base could stimulate commodity prices • Some increases in fuel and energy prices in long run

– Small change for transportation fuels

– Natural gas (10%) and electricity (13%) by 2030 

# • After accounting for bioenergy and offsets, USDA analysis shows net impact of climate policy scenarios on net farm income is positive18 

# For more information

Reid Harvey Chief, Climate Economics Branch Climate Change Division U.S. EPA, Office of Air and Radiation Harvey.reid@epa.gov http://www.epa.gov/climatechange