Creating a Robust REDD Offset Market
by Matt Kaufmann -- December 13th, 2009
Today’s proceedings at Forest Day 3 highlighted one of the issues that may hinder the speed with which a robust carbon offset market develops
Overview of Forest Day 3
Today (Sunday) the Bella Center was closed. The Duke delegation took part in the proceedings of Forest Day 3 which discussed Reducing Emissions from Deforestation and Degradation (REDD). Forestry (and other land uses) are distinct from other potential emission offsets in that land management has the potential to both create (decomposition/clearing) and remove (photosynthesis) carbon from the atmosphere. Land management is also interwoven with biodiversity, soil conservation, indigenous rights, and other complex environmental/social issues. Notably, the European Union’s Emission Trading Scheme refrained from including REDD in its current scope – either as a capped entity or as a source of offset credit generation through the Clean Development Mechanism (CDM). However, one of the likely outcomes from COP-15, will be guidelines to address the quantification of emission reduction from forestry activities in the EU-ETS post-2012.
Background on Offsets
A carbon offset is a financial instrument representing a credit for emission reductions (or sequestration) from a project produced by an entity outside of a compliance cap, resulting in less greenhouse gases in the atmosphere than would otherwise have occurred. Effectively, offsets will allow capped entities to reduce a corresponding quantity of their carbon compliance obligations without reducing the emissions of their actual operations. Presumably, some offset projects will be less expensive on a per ton basis than other means of direct abatement.
Offsets are favored by capped industries, as well as some policymakers, as an inexpensive way to reduce global emissions. They are controversial because the methods used to ensure that they are measurable, reliable, and verifiable (MRV) may vary by methodology and methodologies are not universally accepted as ‘additonal’ – contributing to the global reduction in emissions. The availability of offsets could affect liquidity, and in the proposed U.S. carbon market, the triggering of other cost-containment mechanisms such as borrowing/banking and the strategic reserve. Thus, the development of the offset market could have implications for the overall functioning of a carbon market. Forests could be a large source of offsets, particularly if greenhouse gases with large emission factors (e.g. SF6) are excluded in the EU ETS post-2012.
Developing REDD offset markets
One of today’s conversations, from the ‘Mitigation’ panel at Forest Day 3 underscored a potential bottleneck in the creation of forestry credits in an offsets market. Agus Purnomo, the Indonesian Head of Secretariat of the National Council on Climate Change, received a question from a member of the audience representing a group of private-sector investors. The investor asked how governments could create a situation that delivered predictable returns on forestry offset investments, comparable to those realized from other private-sector investments. The Indonesian official responded that there has only been about $20M invested in forestry projects in Indonesia thus far, and that the private sector will have to take risks until the market is larger and has more certainty (arising from reviewing the performance of past investments). Subsequently, a few comments were exchanged, essentially restating their positions.
A market-based solution to climate change requires that the private-sector actually invests. However, the private sector is looking for both a return and a limited amount of risk. Both the returns and the risk can’t be quantified until a number of past projects can be reviewed and the criteria for measurement, reliability, and verification (MRV) have been established. Resources are required to develop these criteria and the institutions that oversee them. However, the investor was saying that they will not invest (provide resources) until risk-diminishing criteria are operational, and the minister was saying the private-sector must invest to provide the resources (that will fund the creation of MRV criteria). So far the EU ETS’ CDM has certified roughly 350M offset credits since its commencement in 2005. For the potential US market, the Kerry-Boxer Bill sets a cap at 2B offset credits annually. For the US market to be robust and liquid, offsets will have to play a significant role in lowering the cost of compliance. Without clear standards for measurement and verification, investment, the development of an offset market, and a cost-effective means for reducing national emissions, will all develop slowly.