Overview of Cap and Trade 

and Offsets

Reid Harvey

Climate Change Division, 

Office of Air and Radiation

August 25, 2009
2

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 agriculture
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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 market
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How Does Cap and Trade Work? 
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SO2 Emissions

(million tons)

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Allowable 

Emissions

Actual

Emissions

Without Acid 

Rain Program

National SO2 Trading Program

• Problem: Acid Rain 

• Scope: National

• Target: Reduce SO2

emissions from electric 

generators by 8.5 million 

tons (50% below 1980 

levels)

• Coverage: ~3000 Electric 

Power Units
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Wet Sulfate Deposition

Average 1989 - 1991

Wet Sulfate Deposition

Average 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 ecosystems
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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 effect regardless of where 

they take place.

Advantages of offsets:

Provide incentives for reductions in 

sectors that are not amenable to 

trading.

Potential cost-savings for capped 

facilities.

Challenges

Assessing “additionality” of reductions.
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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

Cap
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Potential offset sources in Agriculture and 

Forestry

Strategy Mitigation Activities Target GHG

Afforestation Convert agricultural lands to forest CO2

Forest management Lengthen timber harvest rotation

Increase forest management intensity

Forest preservation

Avoid deforestation

CO2

Agricultural soil carbon 

sequestration

Crop tillage change

Crop mix change

Crop fertilization change

Grassland conversion

CO2

Fossil fuel mitigation from

crop production

Crop tillage change

Crop mix change

Crop input change

Irrigated/dry land mix change

CO2

Agricultural CH4 and N2O 

mitigation

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

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u

e

s

t

r

a

tio

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E

mis

sio

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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. 28th
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Domestic Offsets in the WaxmanMarkey 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 leakage
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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
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H.R. 2454 Cap

AEO 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

MtC

O2e

Historic 

Emissions

H.R. 2454 Cap and Trade Provisions:

Targets and Timetables

• Declining cap for GHG emissions:

– 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 emissions are 

covered. Coverage is phased in 

between 2012 and 2016 by sector

• Regulations for certain sectors

• Other sectors can provide offsets

– 1 billion tons domestic offsets 

(primarily from agriculture and 

forestry sectors)

– 1 billion+ tons international 

offsets
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US GHG Emissions & Sources of 

Abatement under HR 2454

Covered GHG Emissions

(Net of Offsets)

HR 2454 Cap

AEO 2009 

Reference Case

Historical

Emissions

AEO 2006 

Reference Case

0

2,000

4,000

6,000

8,000

10,000

12,000

1990 2000 2010 2020 2030 2040 2050

MtC

O2e

CO2 - Electricity

CO2 - Transportation

CO2 - Energy Int. Manufacturing

CO2 - Other

NonCO2 - Covered

Offsets - Domestic

Offsets - International

Int'l Forest Set-Asides

Discounted Offsets

NSPS - CH4

HFCs (separate cap)

• The updated reference case for this analysis is 

based on AEO 2009, and the old reference case 

from EPA’s S. 2191 analysis was based on AEO 

2006.

• Cumulative 2012-2050 GHG emissions 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 

methane, and the HFC cap all provide additional 

abatement that does not help to meet the main cap.
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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 CH4 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’).

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Scn 2 - HR 2454 . Scn 7 - HR 2454 - No Int'l

Offsets

MtC

O2e
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Interactions between Climate 

Policy and Agricultural Sector

Climate Legislation

Agricultural Sector

Fossil 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 biofuels
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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 longrun

– 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 positive
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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