Addressing Permanence and Leakage of GHG Benefits from Forest and Agricultural Projects

1. Addressing Permanence and Leakage of GHG Benefits from Forest and Agricultural Projects Brian C. Murray Environmental and Natural Resource Economics Program RTI International Third Forestry and Agriculture Greenhouse Gas Modeling Forum October 12-15, 2004 Shepherdstown, WV

2. Funding and Collaborators • Funding: US EPA • Collaborators: • RTI: Allan Sommer, Brent Sohngen*, Martin Ross, Laurel Clayton • Texas A&M: Bruce McCarl, Dhazn Gillig, Heng-chi Lee, Mankeun Kim • EPA: Ken Andrasko, Ben DeAngelo * On sabbatical from Ohio State University

3. What is Permanence? • Permanence: Time over which sequestered carbon is removed from the atmosphere. • If its forever, its “permanent” • Typically assumed that an emission reduction is permanent, and sequestered carbon is not Q: What is the value of temporary storage?

4. What is Leakage? • Leakage: Emissions that occur outside the project boundaries as a result of the project activities themselves • It is caused by the shifting of emitting activity elsewhere in response to reductions (sequestration in the project area) • Spatial • Local: aka “primary” • Distant: aka “secondary” or “market” • Sectoral/life cycle: • GHG effects up and down the supply chain

5. Why do we care about permanence and leakage? • They erode the GHG benefits of a project over time (permanence) and space (leakage) • Can be difficult to measure • Difficult to enforce due to incomplete contracts • Potential to undermine a project-based offset system

6. Accounting for Permanence

7. Permanence Issue 1: “Saturation” Terrestrial C flux is dynamic over time • Initial gains taper off • C reaches new equilibrium (aka “saturation”, a misnomer)

8. Dynamics of Soil Carbon Sequestration • Soil C sequestration over time after a change from conventional to zero-tillage operations (West and Post 2002)

9. Dynamics of Forest Carbon Sequestration - Afforestation

10. Dynamics of Forest Carbon Sequestration – Forest Management

11. Permanence Issue 2: Reversibility • Carbon storage is volatile • Can easily be released in the future if practice is discontinued or natural disturbance occurs • Practices need to be maintained to avoid release

12. Soil carbon reversal: reversion to conventional tillage

13. Even More Complicated: Timber Harvesting, Releases, and Carbon Stored in Products

14. Permanence Issue 3: Contractual Terms • Limited duration contracts • Liability for carbon replacement • Throughout the contract • At the end of the contract

15. Process for Addressing Reversal Risk in Carbon Sequestration

16. Methods for Permanence Adjustments • “Pay as You Go” system • Carbon credits (sequestration) and debits (emissions) as they occur • Temporary crediting • Credits expire at the end of a contract period • Potentially re-sellable • Ton-year accounting • Creditable portion grows with permanence • Ex ante discounting • Deduct expected debits at the outset of the project

17. Q: How much is temporary storage worth relative to permanent reduction? • Assuming carbon prices are constant over time * • Afforestation = 80-95% • Ag Soil/Tillage Change = 50-65% • Worth more if C prices decline over time • Worth less if C prices rise over time • If prices rise at the discount rate, temporary storage has no value Also see Gordon Smith presentation for duration-dependence values * Ongoing work: McCarl and Murray

18. Accounting for Leakage

19. Leakage as an issue in forestry and agriculture projects • Induced by economic forces: Supply/demand supplanted by the project is met elsewhere • Formal markets • Other institutional arrangements • Leakage is not unique to forest and ag projects • But, features of forestry and agriculture make them somewhat susceptible to leakage • Fixed land base: Land use change has spillover effects • Commodity markets are often broad in scope (regional, national, global)

20. Leakage as a Spatial Concept Local shifting: observable and contractable “Primary” Project “Secondary” Regional, National, Global Markets

21. How to Address Leakage at the Project Level

22. Project Leakage in a Market Context Market A (Commodity i, region x) S1 S0 P1 P0 Project Leakage Q’0 Q1 Q0 Market B Market C Market D

23. Simple comparative statics of individual market equilibria Estimating Leakage through Market Modeling L´ = Where e, E, γ, Φ, and Ci are market parameters • Sector models • Forest (e.g., Sohngen, Sedjo, Mendelsohn) • Forest and Ag (e.g., FASOMGHG) • CGE models

24. Leakage Estimates from Market Models • International emissions leakage/energy: ~10-20% • Forest carbon leakage Afforestation Program Leakage Estimates by Region (All Quantities Are Percentages) Source: Murray, McCarl, Lee. 2004. Estimating Leakage from Forest Carbon Sequestration Programs. Land Econ: 80(1):109-124

25. Leakage Estimates from Market Models (II) • Forest preservation (avoided deforestation, no harvesting) Source: Murray, McCarl, Lee. 2004. Estimating Leakage from Forest Carbon Sequestration Programs. Land Econ: 80(1):109-124

26. Some recent leakage results comparing different forestry and agriculture activities* Leakage Estimates by Mitigation Activity at a GHG Price of $15/t CO2 Eq.All quantities are on an annualized basis for the time period 2010–2110. * Ongoing work, Murray and McCarl

27. Regional dimensions of leakage * * Ongoing work, Murray and McCarl

28. Leakage over Time Effect of varying the time horizon over which leakage is quantified. Afforestation program paying $15 per t CO2

29. How much could leakage and reversibility cut into project proceeds? [rule dependent] DISCOUNT ADJUSTMENTS (%) * Bottom line: perhaps a third to a half or more of credit can be attenuated by these factors, depending on program rules *Preliminary central tendency estimates, based on my ongoing work with Bruce McCarl and colleagues

30. How is leakage being handled in project accounting protocols • California Registry Draft Protocol (2004) • WRI/WBCSD: Screening, mitigation, quantification of primary and secondary leakage are prescribed but no specific requirements in place • Chicago Climate Exchange: leakage not explicitly considered • 1605(b) guidelines still in development

31. Conclusions • A project-based offsets/trading system seeks assurance that the emissions allowance correctly corresponds to the reduction by the project • For Carbon sequestration projects, the main factors that may disrupt this correspondence are • Permanence • Leakage • Additionality • Methods are now being developed to address each of these factors, but there is debate about how far to go

32. Conclusions (II) • Early empirical evidence suggests • ~1/3 to ½ of Ag Soil C offset credits may need to be adjusted for permanence and leakage combined, depending on program accounting rules • Other factors to deduct: baselines, uncertainty and transaction costs • Q: Is this enough to make these investments uneconomic? • Depends on the price and on the discounts applied to other offset credits • Design projects to minimize these factors • Centralized efforts needed to harmonize approaches to these issues