Helping Utilities Address Impacts of Climate Policy in Strategy

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					Design and Analysis of Offsets as Part of a
         GHG Emissions Trading Program

               EEI GCC Subcommittee Meeting
                              Portland, OR
                              July 17, 2007




                                Anne E. Smith
                              asmith@crai.com
                                 202-662-2872
Outline of Presentation
1. How offsets can affect GHG policy outcomes
    –   Definition of offsets; types of offsets possible
    –   How different GHG bills have provided for offsets
    –   Who gains from offsets?
    –   Thoughts on good policy design for offsets

2. How to include offsets in policy impact modeling
    – What is a “marginal abatement cost curve (MAC)?
    – How an offsets supply curve relates to a MAC
    – Illustration of concept of creating offsets supply curves from MACs
        -   Approach used by EPA in its 2006 Carper Bill analysis
        -   CRA recommendation for improved approach




2
    How Offsets Can Affect GHG Policy Outcomes




3
What are GHG offsets? Why use them?
• Projects to reduce GHG emissions that are not otherwise
  regulated, even while other GHG sources are capped
    – The regulation accepts that emissions sources it does not cover can gain
      offset “credits” that capped companies can used just like allowances for
      their compliance
    – Discrete “projects” -- must be shown to provide “additional” reductions
       - If the offset is truly “additional”, then total GHG emissions are same as they would
         have been under the cap but without offsets allowed
    – Subject to project approval, monitoring, & regulator verification
• Creation and sale of offset credits effectively loosens the cap on
  the capped sectors
    – Each offset reduces the need for one extra ton of reduction of the capped
      emissions
    – Shifts some of the control activity from capped sources only to other parts of
      the economy -- but this does not shift any of the control burden


4
Provisions for Offsets in Various GHG Bills
-- Offsets are a policy design choice, not a fundamental source attribute --

               Burning ex Agric, Services,




                                                                                                                                                                                                                 Non-energy CO2 (process
                                                                                             Adipic and nitric acid plant
                                             Fossil Fuel CO2 in Agric,




                                                                                                                                                                Nat gas and oil methane
                                                                                                                                                                                          Other methane (e.g.,
               Elec Gen Fossil Fuel




                                                                                                                                                                                                                                                                                                              Forest management
                                                                         Coal mine methane




                                                                                                                                                                                                                                                                                                                                    Soil sequestration
                                                                                                                            High GWP gases
                                             Services, Homes




                                                                                                                                             Landfill methane




                                                                                                                                                                                                                                            Agricultural N2O
               Non-Elec CO2




                                                                                                                                                                                                                                                                              All other N2O

                                                                                                                                                                                                                                                                                              Afforestation
                                                                                                                                                                                                                                                                Mobile N2O
                                                                                                                                                                                                                 emissions)
               Homes




                                                                                                                                                                                          Agric)
                                                                                             N2O

Bingaman      C                C                     C                   C
                                                                         F                            C                     C                F                  F                                F                       F                  F                   F             F               F               F                   not F


Lieb/McC      C                C                     F                   C                            C                     C                C                  C                                F                      C                   F                   F             F               F               F                    F
Sanders/B
                                                      C
oxer (*)      C                C                                         C                            C                     C                C                  C                               C                       C                  C                   C             C                F               F                    F


Carper        C                F                     F                   F                     ???                          F                F                  F                                F                 ???                     ???                 ???           ???              F               F                    F

    “C”=covered by Bill’s cap
    “F”=allowed to offset capped emissions
    (*): Sanders/Boxer does not guarantee any ET, and the “C”s here indicate only that the US
    GHG target is specified such that emissions of all these gases are clearly counted/covered.

5
     How Do Offsets Affect CO2 Prices?
                                                       Costs       Costs
Equilib.                                               without     with 5 tons
Price of                                               offsets     zero-cost
CO2e                                                               offsets
($/ton)
            5
    Pno offsets
            4

            3
    Pwith offsets
            2

            1
                                                  Required
                                                                      Tons of CO2e
                          10               20      tons of    30      Reduced
                                                  reduction

          Offsets reduce equilibrium carbon price to meet a given cap, but
          carbon price does not necessarily fall to the cost of the offset.
6
Who Gains from Allowing Offsets? -- Sellers
• Offset sellers may experience very large profitability
    – Unless supply of offsets is larger than the cap’s demand for reductions
    – High profitability for offset sellers is enhanced by regulatory limits on
      quantities of offsets that may be used for compliance


          Profits of
          the offset
          seller




• BUT who is the “seller” that gains those profits?
    – The emitter of the gas that is reduced under the project?
    – The consultant that helps perform the project?
    – The lawyers/consultants that perform the negotiations/verification tasks?
    – The government of the originating country (in the case of international
      sales)?
7
Who Gains from Allowing Offsets? -- Buyers

• Capped companies that cannot generate offsets in-house are
  likely to experience little reduction in costs of control
    – Carbon prices will be reduced somewhat. (Amount depends on degree to
      which offsets supply actually “loosens” the cap.)
    – Compliance may be shifted from extra expenditures on own assets and/or
      inputs towards purchasing paper offsets (effectively, a tax collected by non-
      government entity).
                                                                   Net gains
                                                                   of offset
             Payments                                              buyer
             by offset
             buyer                                                 Avoided
                                                                   costs of offset
                                                                   buyer


• Offsets will offer large cost reductions only for those capped
  company that can find offsets projects within their own corporate
  boundaries.
8
Who Gains from Allowing Offsets? -- Consumers

• For a fixed cap and fixed set of capped sources, the “average
  consumer” would be a net gainer
    – At least somewhat lower carbon prices to meet cap
    – Presumably same overall emissions outcome

• BUT:
    – If emissions that are the sources of potential offsets were capped directly,
      consumers would be even better off for any particular selected cap level
       - because transactions costs of the projects would be avoided
       - because a wider array of potential GHG control projects would be economical
       - because direct capping imposes a direct carbon price and not just an opportunity
         cost of failing to voluntarily participate – greater likelihood of seller participation
    – And if these controls can be had so cost-effectively, this might be a case for
      just having a tighter cap (and more overall GHG reduction)




9
Who Gains from Allowing Offsets? -- Regional

• The “average consumer” may not be a actual consumer,
  depending on regional locations of buyers and sellers
     – To the extent that offsets come from regions outside of the capped region,
       consumers inside the capped region would see as little financial benefit as
       companies that are purely offset buyers.
• Use of offsets may produce large inter-regional flow of funds
     – In case of nationally-supplied offsets under a regional cap, will see regional
       funds flowing out to the benefit of economic activity outside of the capped
       region.
     – If international offsets are allowed, compliance will look like a transfer of
       funds to developing countries rather than like emissions reductions.
       Benefits to sellers may be experienced outside of the U.S.




10
Provisions for Offsets in Various GHG Bills
-- Offsets decrease policy coverage & concentrate policy burden --

                Burning ex Agric, Services,




                                                                                                                                                                                                                  Non-energy CO2 (process
                                                                                              Adipic and nitric acid plant
                                              Fossil Fuel CO2 in Agric,




                                                                                                                                                                 Nat gas and oil methane
                                                                                                                                                                                           Other methane (e.g.,
                Elec Gen Fossil Fuel




                                                                                                                                                                                                                                                                                                               Forest management
                                                                          Coal mine methane




                                                                                                                                                                                                                                                                                                                                     Soil sequestration
                                                                                                                             High GWP gases
                                              Services, Homes




                                                                                                                                              Landfill methane




                                                                                                                                                                                                                                             Agricultural N2O
                Non-Elec CO2




                                                                                                                                                                                                                                                                               All other N2O

                                                                                                                                                                                                                                                                                               Afforestation
                                                                                                                                                                                                                                                                 Mobile N2O
                                                                                                                                                                                                                  emissions)
                Homes




                                                                                                                                                                                           Agric)
                                                                                              N2O

Bingaman       C                C                     C                   C
                                                                          F                            C                     C                F                  F                                F                       F                  F                   F             F               F               F                   not F


Lieb/McC       C                C                     F                   C                            C                     C                C                  C                                F                      C                   F                   F             F               F               F                    F
Sanders/B
                                                       C
oxer (*)       C                C                                         C                            C                     C                C                  C                               C                       C                  C                   C             C                F               F                    F


Carper         C                F                     F                   F                     ???                          F                F                  F                                F                 ???                     ???                 ???           ???              F               F                    F

     “C”=covered by Bill’s cap
     “F”=allowed to offset capped emissions
     (*): Sanders/Boxer does not guarantee any ET, and the “C”s here indicate only that the US
     GHG target is specified such that emissions of all these gases are clearly counted/covered.

11
Some Thoughts on Offset Policy Design
• If policy goal is to maximize GHG reductions within limits of
  acceptable costs,
     – the number of GHG sources under cap should be maximized
     – the number of GHG sources set as offsets should be minimized.
• Even if it is difficult to subject an emissions source to a market-
  based mechanism, it may be possible to control it more
  efficiently than leaving it to the inefficiencies of having to be an
  “additional” project under offsets
• Recognize that any divergence from the above principles shifts
  the burden of emissions reduction more heavily onto a subset of
  emitters, while creating clear gains from the policy for another
  subset of emitters
     – Comparable in financial significance to taking allowance allocations from
       capped sector and giving them to the uncapped sources.
     – The clearest loser is the environment, because in shifting the burdens and
       flows of funds, the cost of meeting any given emissions target is
       increased.
12
     How to Include Offsets in Policy Impact Modeling




13
How Most Models Simulate Controls of All Types of
GHGs under GHG Caps
 • All CO2 emissions from fossil fuel use are directly modeled
     – Model identifies cost-effective changes that would occur in technology, fuel
       choice and consumer behavior to reduce emissions under varying caps
 • “Supply curves” are added to the model for all other emissions
   reductions (and for any fossil fuel-based CO2 offsets)
     – A “supply curve” defines the quantity of emissions reduction that is cost-
       effective at each CO2 price for each available type of reduction (by year).
 • Model run set up:
     – Specifies which fossil fuel uses are covered or exempted from the cap
     – Identifies other non-CO2 gases covered by the cap by providing a “MAC”
     – Identifies allowable offsets by providing an appropriate “offset supply curve”
 • At any CO2 price, model selects all incremental emissions
   reductions costing less than that price from changes in modeled
   energy sector operations, from the provided MACs, and from the
   provided offsets supply curves.
14
     Difference between a “MAC” & an “Offset Supply Curve”
 • If category of emissions is covered by the cap, the supply curve is
   a pure “marginal abatement cost” (MAC) curve:
      – A summary of cost-reduction relationships derived from a detailed model
         - Based on results of a detailed model under a range of different carbon prices
         - A MAC is a like a condensed version of a detailed model; a “meta-model”
      – Adding a MAC as a supply curve inside an energy sector model provides an
        approximation of actually linking the two very complex types together
      – EPA has developed a number of MACs (http://www.epa.gov/airmarkets/mp,
        see Excel file titled “Marginal Abatement Cost Schedules”)
 • If a category of emissions not capped but allowed for offsets, its
   MAC is adjusted before it is used as an “offsets supply curve”:
      – Project-related transactions costs (e.g., feasibility studies, negotiations,
        regulatory, monitoring, verification)
      – Profit hurdles to engage the voluntary participation of potential sellers (e.g.,
        personal effort of seller, risk to seller)
      – Time lags associated with offset program development
15
Types of Reductions for Which MACs Are Already
Available
 • Those for which we already have relevant MACs
     –   Adipic and nitric acid plant N2O reductions
     –   Landfill methane capture
     –   Coal mine methane capture
     –   High GWP gas reductions
     – Afforestation and forestry management changes
     – US soil sequestration
 • Categories for which MACs may not be readily available
     – Agricultural methane
     – Agricultural N2O
     – Mobile N2O
     – CO2 process emissions
     – Specific subcategories of fossil fuel combustion



16
  Total Potential Reductions in EPA MACs of US
  Non-CO2 GHGs and Terrestrial Sequestration -- by Type
  (i.e., Total Available at Any Price)
      2,500
                                                                               Afforest
Millions
short
tons 2,000                                                                     Forest Mngt
CO2e
                                                                               Soil Seq

      1,500
                                                                               Nat Gas/Oil
                                                                               methane

                                                                               Coal mine
      1,000                                                                    methane

                                                                               Landfill
                                                                               methane
       500
                                                                               N20


                                                                               Hi GWP gases
         0
              2010   2015     2020   2025   2030   2035   2040   2045   2050
                            Year (assuming rules finalized 2009)
 17
Examples of Two Ways of Developing the Inputs for
Modeling Offsets Supply
• EPA Approach                                      • CRA-Proposed Alternative to EPA
  (in 2006 Carper Bill analysis)                      Approach
     – Aggregate all types of MACs for a              – Model CO2 from fossil fuel directly,
       region (including CO2 from fossil fuel)          not as part of supply curves
     – Apply single estimate of transaction           – Make adjustments tailored to each
       cost to all projects                             individual type of MACs
        - Used $0.33/st CO2e, which is the            – Apply range of transactions and
          weighted average from past projects           hurdle costs to each MAC
        - Mostly for voluntary offsets projects
                                                         - (e.g., low hurdles for High GWP
        - Includes only direct buyer transactions          projects, higher hurdles for soil
          costs (e.g., feasibility studies,
                                                           seq.)
          negotiations, regulatory, monitoring,
          verification)                               – Apply discount rates for
        - Ignores wide range of costs underlying        impermanence (i.e., soil
          the average cost                              sequestration)
     – Assume some fraction of projects will          – Apply lags for delay in physical or
       never materialize                                behavioral response
        - E.g., for 2010: 0% in Kyoto countries,
          50% for US, 90% in CDM countries

18
Illustrative Example of Total Non-CO2 GHGs and
Sequestration Offsets Supply with CRA’s Category-
Specific Adjustments (US Sources of Reductions Only)
          $100         2010 2015         2020       2030          2050
           $90

           $80

           $70

           $60

           $50

           $40

           $30

           $20

           $10

            $0
                 0        500         1,000       1,500        2,000       2,500


     Note: Non-CO2 gases are included as MACs (i.e., as if covered under cap
     rather than as offsets). Only soil & forestry seq. are treated as offsets for the
     above aggregate supply curves.
19
 Comparisons of Offset Supply Curves & Original MAC
 – Soil Sequestration in the US
(CRA offsets supply has temporal lag in reaching potential; eventually exceeds
EPA’s assumed offsets supply curve)
        $40
                       CRA                  EPA
        $35
                       supply               supply
                       curve                curve
        $30            2010; 2020
$/ton
CO2     $25


        $20


        $15                                                 MAC

        $10


         $5


         $0
              0   20      40    60     80    100     120   140   160   180
                        Millions of short tons sequestered CO2
20
Comparisons of Offset Supply Curves & Original MAC
– High GWP Gas Reduction in the US
     (CRA offsets supply close to the original MAC, due to assumed low transactions/
     hurdle cost for this category; exceeds EPA’s assumed offset supply immediately)
         $40

                             EPA
         $35                                         CRA
                             supply
                             curve                   supply
         $30                                         curve
$/ton                        2020
CO2                                                  2020
         $25


         $20
                                                              MAC 2020
         $15


         $10


          $5


          $0
               0   20      40     60    80     100     120     140   160
21
                        Millions of short tons sequestered CO2
     US Offices: Boston, Washington DC, New York, Chicago, Houston, Philadelphia,
       Salt Lake City, Cambridge, College Station, Dallas, Oakland, Silicon Valley

        International Offices: London, Brussels, Toronto, Mexico City, Wellington,
                   Melbourne, Mexico City, Sydney, Dubai, Hong Kong


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