An estimate of the quantity and type of offset projects that might be available in a cap-and-trade system would provide for a more informed debate over the design elements of a cap-and-trade system. (See text box below, "What is a Cap-and-Trade System?") 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 CO 2 (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 to submit offsets (in lieu of emission allowances) to meet 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 implementation challenges. These contrasting attributes 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. 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. Economic models of cap-and-trade legislation have generally demonstrated that different offset scenarios—for example, unlimited offsets versus no offsets allowed—lead to significant variances in program costs. However, offsets have fueled considerable debate, primarily for the concern that illegitimate offsets could undermine the ultimate objective of a cap-and-trade program: emission reduction. How many offsets would be available as a compliance option if Congress enacted a cap-and-trade program? Although economic models have generated estimates of offsets developed and used in a cap-and-trade system, the estimates are rife with uncertainty. This report examines the multiple variables that help shape 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 other factors—are each discussed below. As Figure 1 indicates, the factors do not act in isolation, but interact in a complex manner. Mitigation potential is not synonymous with offset supply potential ( Figure 1 ). Some of the activities included in mitigation potential estimates would likely not qualify as offsets in a cap-and-trade system. A striking example is biofuel production, which has been projected by some studies to play a substantial role in GHG mitigation in later years. By placing a price on carbon, a cap-and-trade program is expected to increase biofuel and biomass production. 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 economic models of cap-and-trade legislation. For example, EPA's 2009 mitigation potential estimates were used in the EPA and Energy Information Administration's (EIA) analyses of H.R. 2454 . 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 imperfect, because the underlying data—mitigation potential estimates—contain considerable uncertainty. Modelers derive estimates of mitigation potential by assigning a price for GHG emissions and sequestration. Under the widely used Forest and Agriculture Sector Optimization Model (FASOM), for example, "landowners would receive annual payments for increasing sequestration and reducing emissions relative to their base case (additionality), but face the cost of having to 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) 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." 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 judgments and leave some financial opportunities on the table. Mitigation potential models must necessarily include certain technical assumptions, such as 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—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 (2) more cost effective than ongoing soil sequestration activities. 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 may preclude options for resource use, such as traditional crop production or afforestation. In other cases, more than one practice that reduces or sequesters CO 2 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. Over the past decade, several studies, including reports from EPA (2005 and 2009) and USDA (2004), have produced estimates of mitigation potential from agriculture and forestry activities. The estimates from these studies vary, in some cases considerably. For example, Table 1 lists the different results between EPA's 2005 and 2009 models. As the table indicates, the estimates of mitigation potential from the agriculture and forestry sectors decreased substantially in the 2009 model. In particular, estimates of agricultural soil sequestration activities decreased by 100% (or almost 100%) at several price scenarios. The explanation for these varied estimates is complex and beyond the scope of this report: for a comprehensive discussion of these estimates, see CRS Report R40236, Estimates of Carbon Mitigation Potential from Agricultural and Forestry Activities , by [author name scrubbed], [author name scrubbed], and [author name scrubbed]. In short, the different estimates reflect different modeling assumptions, such as emission/sequestration baselines (or business-as-usual scenarios). The dramatic differences between the 2005 and 2009 estimates ( Table 1 ) highlight the uncertainty that pervades mitigation estimates. Regardless, both models demonstrate the influence of price. And both models indicate relative differences between the project types, with forestry projects providing much of the potential, particularly at higher price scenarios. Other potential mitigation activities—for example, methane abatement from landfills or the natural gas sector—are generally considered less complicated in terms of measurement than agriculture and forestry projects. In addition, 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. Several of the mitigation activities in Table 2 are projected to occur at $0/mtCO 2 -e. 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 the existence of nonmonetary barriers." These are discussed below in " Other Factors ." The fact that parties are not acting in the most economically efficient manner at $0/mtCO 2 -e, calls into question the estimates for higher prices and further demonstrates the uncertainty contained in mitigation potential estimates. 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. 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), including which agency or agencies would be responsible for developing the logistical details. Another critical element would be the program's use of set-aside allowances. The wider the scope of the cap, the smaller the offset universe.