Offsets in Federal Climate Change Legislation: What You Need to Know Now

What Are Offsets?

In a cap-and-trade program, an emissions source that is covered by the cap is issued a number of "allowances" permitting the source to emit a certain amount of greenhouse gas—typically one allowance for each metric ton of CO2 gas or its equivalent. If, during a given compliance period, the source threatens to have emissions exceeding the number of allowances in its possession, there are a couple of options. First, the source can go to the marketplace and buy additional allowances sufficient to match the excess emissions. Second, as an alternative, the source could purchase offsets matching those additional amounts.

Allowances vs. Offsets

To the source itself, and depending on price, the distinction between allowances and offsets is virtually meaningless. Either way, the source needs to possess the number of credits or offsets sufficient to match its emissions. But to the program as a whole, the distinction is important, because unlike credits, offsets relate to projects that fall outside of the cap. In other words, an offset comes from a project unrelated to any covered source that in some way lowers, avoids or contains overall greenhouse gas emissions. Rather than limiting the emissions of the covered sources, emissions of those sources are "offset" by a reduction in greenhouse gases elsewhere.

Why Are Offsets Important?

Offsets are important to a cap and trade program for two primary reasons. First, they serve to increase the total amount of "permission" available in the marketplace (allowances plus offsets) for achieving compliance. This increase in supply lowers the overall cost of the program to the covered source. All things being equal, the more offsets a program allows, the cheaper the program will be. Second, offsets present an important opportunity for a wide variety of businesses, landowners and others outside of the cap to participate in the carbon markets. And such an opportunity is not one to shy away from. By some estimates, the worldwide carbon markets in 2008 exceeded $100 billion, and the value of a national involuntary market in the U.S. alone could well exceed that.

Where Do Offsets Fall in the Waxman-Markey Bill?

The Waxman-Markey bill recently passed by the House, formally called the American Clean Energy And Security Act of 2009 (ACES), provides a key role for offsets in a federal cap-and-trade program. In particular, the bill provides that a combination of domestic and international offsets can be used to account for up to 2 billion metric tons of greenhouse gas emissions every year. Considering that the U.S. greenhouse gas emissions currently total roughly 7 billion metric tons per year, the importance that offsets could have under a federal cap and trade program is unmistakable.

Creation of Two Separate Offset Programs

Even more, the bill authorizes the creation of a potentially vast array of offset projects that would reduce, avoid or sequester greenhouse gas emissions. Such projects would fall within one of two programs created by the House bill.

First, the bill requires the Environmental Protection Agency to establish a general program governing the generation of offset credits from domestic and international projects. The EPA must issue regulations for the program within two years of the bill's enactment, and the regulations must insure that the offsets are verifiable, additional, and permanent, in accordance with certain requirements. The bill does not list the types of projects that the EPA must include, but rather leaves the development of that list to the EPA, in consultation with an advisory board and other federal agencies. The EPA program has the potential to include projects involving energy efficiency, coal methane, and ozone depleting substance destruction, which are the types of projects currently eligible in existing voluntary offset programs.

Second, under a late amendment, the bill requires another agency, the U.S. Department of Agriculture, to establish a second offset program specific to domestic agriculture and forestry sources. Under this program, the USDA must issue regulations within one year of the bill's enactment, and as with the EPA program, the regulations must ensure the offsets are verifiable, additional, and permanent, in accordance with requirements similar to those governing the EPA. Unlike the EPA program, however, the USDA must include a list of specific project types that fall into three basic categories: 1) agricultural, grassland, and rangeland sequestration and management practices; 2) land use change and forestry activities; and 3) manure management and disposal.

Offset Credits for Current and Existing Projects

The bill also allows both the EPA and the USDA to issue offset credits for projects arising from activities commenced after January 1, 2009. And within certain limitations, the agencies can further include projects dating back to January 1, 2001. As a result, many projects that have already been established or that are currently underway—especially those that qualify under protocols developed by established and generally accepted voluntary offset programs currently operating in the United States—may well qualify for inclusion in the federal program. And because the bill is more specific as to the USDA program, there is even more assurance with respect to agricultural and forestry projects fitting one of the specified project types.

Especially in regard to certain agriculture and rangeland projects, certain voluntary protocols currently in place may not require a radical alteration of land management practices so much as a commitment to maintain existing practices. Obviously, however, whether any of these projects will qualify under a federal program depends upon what Congress and the agencies ultimately do. Although there is some initial indication that the Senate bill will include offset provisions similar to those in the House bill, including the USDA offset program, it remains to be seen what legislation, if any, will get signed into law, and as importantly, when. Likewise, even if the Senate passes a bill including those programs this fall, it still remains to be seen what requirements and methodologies the agencies will adopt, pursuant to Congress's instructions.

Nevertheless, those who may stand to generate revenue from the types of offset projects outlined in the House bill should not overlook the idea of starting those projects now, under existing voluntary programs, or at a minimum, begin to explore the potential costs and benefits of doing so. Even more fundamentally, offsets should be considered now as pieces of value that are tied to lands or other assets that are or may be involved in offset projects, and how that value is allocated should be addressed in any transactions involving those assets.

How Will Offset Projects Likely Affect Agricultural Producers and Landowners?

Early commentary from both houses of Congress and the White House suggest that offsets, including agricultural offsets, are considered a valuable component of cap and trade proposals and will likely remain in any legislation ultimately adopted.

Although many organizations are skeptical of the alleged positive effects of offsets on the agricultural community, just last week the USDA released the study A Preliminary Analysis of the Effects of HR 2454 on U.S. Agriculture prepared by the Office of the Chief Economist, which attempts to document such benefits. The study indicates farmers, ranchers and other landowners can reap economic benefits under the House bill that far outweigh the potential costs. In particular, the study suggests that in both the short term and long term, offset projects will result in significant income for landowners.

Initial feedback on the study, including comments made by the Senate Agriculture Committee, criticizes the study's assumptions and disputes the study's findings of an overall net benefit. However, it seems clear that even if the economic benefits will not outweigh the costs, the potential existence of any benefits merits a landowner's attention.

How Can Landowners and Others Obtain Benefits From Offset Projects?

In a briefing of the Senate Agriculture Committee about the newly released study, USDA Secretary Tom Vilsack gave this example:

"What does this mean for the individual farmer? A Northern Plains wheat producer, for example, might see an increase of $.80 per acre in costs of production by 2020 due to higher fuel prices. Based on a soil carbon sequestration rate of 0.4 tons per acre and a carbon price of $16 per ton, a producer could mitigate those expenses by adopting no-till practices and earning $6.40 per acre. So, this wheat farmer does better under the House passed climate legislation than without it. And, it's quite possible that this wheat farmer could do even better if technologies and markets progress in such a way that allows for the sale of wheat straw to make cellulosic ethanol."

In his comments Vilsack suggests higher costs of fuel, energy and fertilizer under the bill can be outweighed by benefits a farmer can obtain by adopting new farming practices that qualify as offset projects. The study also suggests that further benefits are available if the same farmer can take marginally producing cropland and plant trees to return the land to forest, a practice called afforestation, to increase the rate of carbon sequestration and thereby increase earnings per acre from the sale of those offsets.

Whether farmers and other landowners choose to adopt new practices and land use changes will depend on individual circumstances, but all landowners can benefit greatly now by educating themselves about how changes in land use practices and management could qualify as offset projects under the bill and what protocols must be followed. A landowner can use information about these land use practices and their protocols to prepare for offset projects under any new legislation or to undergo offset projects now under existing voluntary programs. As noted above, the bill provides for offset projects undertaken prior to the passage of the bill to qualify for offset credits under certain circumstances.

For example, the bill proposes to grant offsets for afforestation. To understand how afforestation can result in carbon offset credits, landowners can go to the Chicago Climate Exchange (CCX) for valuable information about the activities that currently qualify for carbon offsets, including applicable protocols. CCX also has information regarding offset programs for agricultural methane and for agricultural soil carbon, both of which are proposed in the House bill as potential offsets.

Reserving Rights to Potential Offsets

Regardless of whether a landowner chooses now or in the future to adopt practices or land use changes that might qualify for carbon offsets, it is critical at any time for each landowner to include specific language in any contract, lease, easement or other legal agreement related to the land that reserves to the landowner the rights to any potential offsets. Failure to include language that clearly states who has the right to offsets could result in a dispute or even litigation over the ownership and use of any available offsets.

Preparing Now to Take Advantage of Benefits

But the legislative process is far from over. Even though offsets appear to be inevitable in any cap-and-trade legislation adopted, the character and process of those offsets remain the subject of heated debate. In the words of South Dakota Secretary of Agriculture Bill Even:

"We as agriculturists need to be actively involved in this discussion if we want to influence the decision-making process. Educate yourself on the issues, engage in the debate, pay attention to congressional hearings, and let your state and national leaders know what you think. By better understanding cap and trade, we can deal with its potential impacts more effectively."

Such advice is not limited to the agricultural sector, but should be heeded by stakeholders in other commercial sectors who may be able to engage in offset programs as well. Those who are informed and have assessed the potential impacts on their individual operations and land holdings will be better prepared to not only participate in the legislative process but also to take advantage of any potential benefits.