Carbon Offsetting Here and Abroad: A Comparative Analysis

Carbon Offsetting Here and Abroad:A Comparative Analysis

A Discussion Paper Prepared for the Canadian Centre for Policy Alternatives – BC Office.

By Mathew Huff

10/08/2014

Climate change represents the definitive public policy challenge of our time. Human activity is altering the climate, with potentially disastrous, widespread and long-term consequences. Governments around the world are beginning to acknowledge the threat to global prosperity represented by climate change, and are implementing policies to reduce their own greenhouse gas (GHG) emissions. Among these various policy proposals, offset mechanisms have proven both popularand controversial. This paper will examine issues surrounding offsetting regimes. There are two varieties of offset markets: compliance markets, where offsets purchased are put towards an emissions limit set by regulation, and voluntary markets, where government, businesses or individuals purchase offsets without being obligated to by regulation. These voluntary purchases occur for a variety of reasons, including a desire to mitigate the negative climate impact of personal behaviour, a government-level commitment to carbon neutrality, or an attempt to frame one's business as more “green” and thus capture greater market-share. Generally speaking, voluntary markets are small, and loosely regulated. The vast majority of offsets that are bought and sold are done so on the compliance market, either to comply with national standards, or with standards imposed by the Kyoto Protocol. This paper deals with compliance offsets, as they constitute the majority of offsets traded today, and arebetter regulated, allowing us to deal with more fundamental conceptual issues, rather than loose regulation.

Part I will outline the theory behind offsets, in an effort to define what an “offset” is, how offsets are intended to contribute to combating climate change, and some issues relating to the effectiveness, transparency and efficiency of offsetting. Part II will delve more deeply into offsetting inpractice, focusing internationally on the Clean Development Mechanism of the Kyoto Protocol, and on the Pacific Carbon Trust (PCT) in British Columbia, formerly a Crown Corporation empowered to buy and sell carbon offsets on behalf of public institutions in BC. Significantly, offsetting in BC differs from its international counterpart, the Clean Development Mechanism (CDM) of the Kyoto protocol, inthat it allows for Reducing Emissions from Deforestation and Forest Degradation (REDD) activities to be considered valid offsets, while the CDM does not. As a result, offsetting in BC has largely focused on forestry and land-use management. This section will analyze, and add to, these debates. Part III discusses the costs and benefits of offsetting, both through the CDM and PCT. Finally, Part IV suggests potential policy options for offsetting in BC, including weighted offsets to better account for the potential of “free-riders” and to more accurately account for emissions sequestered over long time-lines, transitioning from an offsetting system that awards money based on per tonne CO2e “offset” to one that awards money based on the cost of abatement measures, scrapping offsetting entirely and extending the carbon tax and using some of its revenue to funding carbon abatement projects, and finally, reanalyzing the appropriateness of market-based policies and potentially relying more on traditional regulation.

Part I: Theoretical Discussion In the simplest of terms, “offsetting” is when government, businesses or individuals finance

carbon reductions elsewhere to “make up” for their own emissions. Theoretically, in doing so, an overall reduction of emissions will occur at a lower cost, as offsetting lets industry finance reductions elsewhere when it would be an undue burden to further reduce their own emissions.

At its strictest conceptualization, an offset would directly and immediately remove carbon from the atmosphere and sequester it, either underground, in the ocean, or chemically. However, in order to create a wider scope and a market for offsetting activities, the definition has been broadened to include preventing emissions that otherwise would have occurred in the future. Particularly with respect to forest-based offsets, a market could not be created without this broader definition of an offset. Some have challenged this broadening, stating that it limits the effectiveness of offsets, as it changes the analysis “from one of strict physical measurement (carbon emitted, carbon extracted) to one of forecasting,”1 with the inherent uncertainty of estimating the impact of an offset investment over very long time-frames.

Source: Jaccard, Effective Climate Policies and Faking It Climate Policies, presentation to Resilient Cities conference,October 2009.

Ecological services are of immense importance to sustaining life on earth. The value provided by these services has largely been at odds with the market value of the products that can be made by converting them to other uses, such as making products from timber, or felling trees for development, or to raise live-stock. Incorporating forestry and land-management within offsetting is part of an attempt to incorporate unaccounted for ecosystem services into the market system, by providing “payments for ecosystem services (PES),” which provide monetary compensation to land-owners for the intangible but integral services provided by their property in exchange for them to not convert it to products or destroy it for development. In the case of carbon offsetting, the intangible service paid for is the sequestration of carbon within living biomass (plants).

1 Jaccard, M., & Griffin, B. (2011). BC’s Carbon Neutral Public Sector: Too Good to be True? Energy and Materials Research Group, 3.

General Criteria for Valid OffsetsGenerally speaking, for an offset to qualify, it must be quantifiable, validated, verified,

additional and permanent.2 These criteria will be discussed in detail below.3

Quantification: Simply put, it must be possible to meaningfully and accurately measure the sequestration potential of an offset project. For example, the relationship between soil and carbon sequestration is not well understood, and thus is not allowed under the CDM.4

Validation: Under most offsetting regimes, a Project Design Documents (PDD) is required to outline the methodology used to determine the carbon reductions that the project is expected to yield. After this document is produced, it is subject to validation, where auditors examine the methodology used to see if it is appropriate. Generally, this includes establishing a baseline emissions level for the project tojudge future emissions reductions against. To put it another way, the baseline forms the “business-as-usual” (BAU) scenario, which represents the emissions that would be theoretically released if the offsetting project did not occur. This baseline is used later, during verification, to determine the amountof emissions reductions fostered by the project.

Verification: After validation, the project is monitored by an independent third-party to ensure that themethodology outlined in the PDD is being followed, and to assess that actual level of carbon sequestration before credits can be issued. Verification is a highly-technical, costly, and time-consuming process, and can be a barrier to small-scale projects. In the CDM, for example, the sheer volume of projects in the verification pipeline has overwhelmed the Executive Board (EB), which has the final authority to approve projects, and caused significant lags in the disbursement of permits.5 Smaller projects generally rely on permits as their main source of income, and this lag has put some in financial jeopardy. Verification costs may discourage small-scale projects from getting involved in offsetting regimes, as “smaller projects my not be able to afford the increase valuation costs relative to the net gains to be made in picking up the extra carbon.”6 Eventually, as projects are evaluated and data gathered, default values based on similar cases could be applied to smaller projects to lessen their financial burden.7 However, applying default values could make estimates inaccurate, carries the potential to overstate carbon sequestration, and thus needs to be extra-conservative in its estimations, orsubject to a discounted rate, to ensure unwarranted permits are not issued in error.

Additionality: Establishing additionality is of key importance to the validity of an offsetting project. There are several key criteria that must be met if a project is to be considered additional. A project must reduce emissions more than the baseline scenario. As mentioned earlier, the baseline is established in the PDD, and represents the emissions level that would have occurred without the offset investment. The baseline is therefore the counter-factual that the progress of the project is measured by, as it cannot be known definitively what would have happened if the offsetting project had not occurred. Secondly, for a project to be additional, it must be proven that the project would not have happened without offset funding. Put another way, offset funding must be the tipping point to make a

2 Schmidt, C. W. (2009). Carbon Offsets: Growing Pains in a Growing Market. Environmental Health Perspectives, 117(2), a64.

3 Note that these criteria apply to compliance markets, which have strict regulation regarding what constitutes a valid offset. The voluntary market is generally much looser with what it allows as an offset.

4 CDM methodologies viewable by sector here: http://cdm.unfccc.int/DOE/scopes.html5 Wara, M. W., & Victor, D. G. (2008). A Realistic Policy on International Carbon Offsets. PESD Working Paper #74, 16.6 Brinkman, D., & Hebda, R. J. (2009). Credible Conservation Offsets for Natural Areas in British Columbia. Land Trust

Alliannce of British Columbia - Summary Report, 21.7 Ibid 21.

project financially viable. This is to reduce the potential for “free-riders;” actors who derive benefit from government regulations or incentives to do something they were going to do regardless.8 Further, a project must prove “regulatory additionality,” meaning that, for the project to be valid, proponents must prove that they are not already obligated by legislation or other means to reduce their emissions via the same method which they applied for offset credits..9

Proving additionality has been a significant source of controversy within offsetting regimes. Asbaseline estimates are counter-factual in nature, it is never possible to know what actually would have happened if the offset project hadn't occurred. Further, it can be immensely challenging to demonstratethat a project meets all the above criteria. Critics claim that a large proportion of offset projects approved by the CDM Executive Board could not prove their additionality. In some cases, experts estimated that at least 40% of projects were approved when they should not have been.10

Scholars note two potential issues with the concept of demonstrating additionality. Firstly, the problem of asymmetrical information, where the project proponent will always have access to more detailed information about the additionality of a project, including its financial viability without offset funding, than regulators or auditors will. A project proponent could withhold crucial information that verifiers fail to request explicitly and capture unwarranted offset funding. Secondly, there is the issue of adverse selection which refers to the fact that. when a subsidy is offered, all firms will vie for it, even those who did not actually need it. A firm that already intended to reduce its energy usage now claims that subsidy (offsets) is required to make it viable. Thus, offsets have the potential to encourage “free-riders.”11

Permanence: A project must establish permanence, meaning that the emissions reductions generated by the project must not be reversible, and remain for a period of time. Generally, the standard is 100 years, as is the case in BC.12 This is a particularly difficult criteria to meet when it comes to forest carbon offsets, as it is basically impossible to guarantee that nothing will release that carbon at a later date. BC is an informative example, with relatively stable and protected forest ecosystems recently being ravaged by the mountain pine beetle, transforming our forests from net carbon-sinks into carbon sources.13 Other Canadian examples include the increasingly severe and widespread forest-fires that have swept across BC and the Prairies. Events like these challenge the idea that forest carbon offsets can be guaranteed permanent with certainty. Some standards have put in place measures to control for this risk somewhat. The Verified Carbon Standard (VCS)14 requires project proponents to place a certain amount of non-tradable permits in a “buffer account,” to cover unforeseen events that might release carbon, meaning that some measure of impermanence is expected, and that a certain portion of credits will not be used to “offset” emissions elsewhere.15 While regulation in BC does not explicitly require buffer credits, it does require a risk assessment that determines the likelihood of the sequesteredcarbon being released, as well as outlining what actions will be taken to mitigate the risk of carbon release, such as installing fire-breaks and fire suppression infrastructure as well as forest-management techniques to prevent pests and disease, and what the contingency plan is in the event of a natural or unavoidable release of carbon in the project area, such as maintaining an adequate contingency fund or pool of contingency permits, as well as potentially maintaining insurance on the land in the event of unavoidable release.16

8 BC Forest Carbon Offset Protocol, 13.9 Wara, M. W., & Victor, D. G. (2008). A Realistic Policy on International Carbon Offsets. PESD Working Paper #74, 16.10 Schapiro, M. (2010, February). Conning the Climate. Harper's, 34. 11 Ibid 4.12 BC Forest Carbon Offset Protocol, 132.13 Parfitt, B. (2010). Managing BC’s Forests for a Cooler Planet. Canadian Centre for Policy Alternatives,19.14 Formerly known as the Voluntary Carbon Standard.15 Personal Communication, Elizabeth Silverstein, Verified Carbon Standard, July 2nd, 2014.16 BC Forest Carbon Offset Protocol, 134-5.

Leakage: In addition to the above, there are other concerns that offsetting standards generally address.Many are concerned with the issue of leakage. Leakage refers to the potential of an offset project stimulating emissions elsewhere. For example, an offset project is created in an area of forest deemed important. Permits are registered and the forest is purchased for conservation. In response, the loggingcompany who owned the forest simply logs another plot of land, emitting greenhouse gases elsewhere, while benefiting from the revenues of carbon offsetting at the project site. In the BC Forest Carbon Offset Protocol (FCOP), this type of leakage is specifically referred to as internal leakage, which is leakage between different plots of land owned by project proponents. The FCOP addresses this issue by asking the proponent to prove that leakage will not occur on their other properties (by showing that their other properties have different uses, i.e., not forests), by showing that their other property has some sort of legal restriction preventing it from similar activities (“covenants, existing right of ways, orother restrictions”), or to demonstrate that demand for the product will be satisfied in other ways that do not lead to leakage. If project proponents cannot demonstrate the above, then they must

“justify an appropriate geographical area for assessment of land-use shifting,considering economic and other relevant factors affecting demand for baselineland-use types affected by the project, given that land use demand is typicallylocal in nature (e.g. demand for housing, commercial land, etc.)”

and in addition must “report on any deforestation activities that have occurred within the assessment area where the new land use is equivalent to the project's baseline land use.” When such deforestation is identified, any decreased net carbon storage that occurred as a result would be included in the carboncalculations of the offset project.17

Further, there is the possibility of external leakage, which refers to leakage outside of the proponents control. In BC, external leakage must be addressed only in cases of forest conservation/averted deforestation. It must be shown by the project proponent that demand for the products derived from the newly conserved forests is met in other ways that does not result in a net increase in deforestation.18

Another example of external leakage in relation to forestry conservation is that, by limiting the supply of wood for building construction, it encourages more buildings to be constructed out of concrete, which has a much higher carbon-intensity than wood. Proponents are not held responsible forthis type of external leakage in BC.

Theoretical Critiques of OffsettingThere are two issues cited by critics that call into question the value of offsetting. Firstly, there

is a potential for significant “moral hazard” within offsetting. Moral hazard “arises because contract compliance is costly to enforce and contract recipients take private unobservable actions to shirk their contract obligations.”19 Particularly with respect to forest carbon offset projects of larger size, it can be very difficult for third-party auditors to ensure compliance over the entire project area. Secondly, offsetting in the CDM has been found to create a significant “perverse incentive” for project proponents to continue with behaviour that nets them offset permits, such as capturing and storing greenhouse gases, rather than to find ways of eliminating the processes that create the gases in the first place.20

Some have taken issue with the idea that the impact of offsets can be meaningfully determined

17 BC Forest Carbon Offset Protocol, 115.18 BC Forest Carbon Offset Protocol, 116-7.19 Ferraro, P. J., Lawlor, K., Mullan, K. L., & Pattanayak, S. K. (2011). Forest Figures: Ecosystem Services Valuation and

Policy Evaluation in Developing Countries. Review of Environmental Economics and Policy, 17 footnote.20 Wara, M. W., & Victor, D. G. (2008). A Realistic Policy on International Carbon Offsets. PESD Working Paper #74, 11.

at all. Climate change happens over decades and centuries, not years, and some have noted that it is challenging, if not impossible, to determine if a project truly offsets emissions over that time-frame. AsKevin Anderson elaborates upon in his Nature op-ed,

“For an offset project to be genuinely low-carbon, it must guarantee that itdoes not stimulate further emissions over the subsequent century. Althoughstandards and legislation around offsetting and the CDM sometimesconsider 'carbon leakage' in the projects' early years, it is impossible toquantify with any meaningful level of certainty over the timeframes thatmatter. To do so would presume powers of prediction that could haveforeseen the Internet and low-cost airlines following from Marconi's 1901telegraph and the Wright brothers' 1903 maiden flight.”21

Anderson challenges the feasibility of forecasting offset emissions over such long time-lines, and thus claims that offsets cannot meaningfully be factored into a plan to reduce climate change. Anderson is particularly critical of voluntary offsetting regimes, with their looser regulation, and wider range of activities incorporated as offsets.

Other critics have challenged the value of offsetting in combating climate change. Noted climate scientist, James Hansen, in Storms of my Grandchildren, strongly states that offsetting activities, activities that remove carbon from the air, must happen in addition to reductions, rather than in lieu of them. He notes, from his time on the IPCC, that the plan for getting back to 350ppm CO2e “assumes major reforestation, but that is in addition to the fossil fuel limit, not instead of.” He further notes that “forest preservation should be handled separately from fossil fuels.22

Part II: Offsetting in PracticeIn order to better understand the offsetting regime in BC, it would be instructive to discuss the

Clean Development Mechanism, due to the fact that it was the first established offset market in the world, and has influenced the development of all other offsetting regimes.

The CDM represents the largest offset market, having issued, to date, 1.45 billion Certified Emission Reduction credits (CERs).23 In 2011, the World Bank estimated that the CER market was valued at nearly 22.5 billion USD, making them secondary only to EUAs, the emissions permits traded in the EU cap-and-trade regime.24 The CDM was borne from negotiations between Developed (“Annex1”) countries and developing (“non-Annex 1”) countries during the Kyoto process. Developing countries refused to adopt binding emissions targets, citing both the greater wealth, and vastly larger contribution to total anthropogenic GHG emissions, of developed nations. Developed nations, on the other hand, were concerned about the steadily increasing share of global emissions released by developing countries, and also on the potentially significant competitiveness disadvantage that Kyoto targets could place on their respective economies, if their competitors in developing countries remainedunregulated. Thus the bargain was struck that developed countries would be able the invest in emissions-reducing projects in developing nations, and apply those reductions to their own domestic targets. This allowed increased flexibility and lowered cost in emissions abatement for Annex 1 countries, as reductions might be cheaper abroad as domestic industry becomes less emissions intensive, and also brought developing countries into the fold, and hopefully on the path to accepting

21 Anderson, K. (2012, April 04). The inconvenient truth of carbon offsets. Nature, 484(7392). 22 Hansen, J. (2009). Storms of my Grandchildren. Bloomsbury Press. 20623 UNFCCC, Issuance Certified emissions reductions. (2014). Retrieved from http://cdm.unfccc.int/Issuance/cers_iss.html24 World Bank, Carbon Offset Unit (2012), Retrieved from

http://siteresources.worldbank.org/INTCARBONFINANCE/Resources/Executive_Summary_S_andT_2012_FINAL_120528.pdf

binding targets later on.

Projects Under the CDMThe CDM is unique in that it has twin goals. Firstly, it is intended to reduce emissions in

developing countries by facilitating investment in low-carbon projects. Secondly, it is intended to promote “sustainable development,” ostensibly marrying poverty alleviation and international development with GHG reductions. This, plus the international character of the CDM, makes the project approval more complex than other offsetting regimes.

CDM Project Approval Process 25

Project Design: Project proponents must make a CDM Project Design Document (CDM-PDD), explaining the project, and either applying an existing methodology or creating, and submitting for a review, a new methodology.

National Approval: Participant countries in the prospective CDM project must submit a letter indicating that it has ratified the Kyoto Protocol, is voluntarily participating in the project, and in the case of the host country, that the project “actively contributes to sustainable development.”

Validation: A Designated Operational Entity (DOE) must validate the CDM-PDD and ensure that it follows an accepted methodology. A DOE is an independent third-party auditor which must be certified by the CDM Executive Board (EB).

Registration: After validating the project, the DOE submits it to the EB for formal registration. At this stage, the project is vetted by the CDM Secretariat and the EB. If three members of the EB, or either one of the project parties, requests project be put under review, the project is put under review and its registration is delayed.

Monitoring: The project proponent is responsible for monitoring actual emissions reductions in accordance with the approved methodology.

Verification: The DOE verifies that the emissions reductions did occur and that the project has proceeded according to the approved methodology. If there are no issues, the DOE certifies the project.

CER Issuance: Finally, the DOE submits the project to the EB for final vetting and approval. Again, if three members of the EB request a review, the project must submit to a review process. If not, the project is approved and CERs are disbursed.

The CDM invests in a wide range of project activities. All CDM projects fall within the following consolidated categories: Destruction or capture of industrial gases (HFCs, PFCs, SF and N20), Renewable Energy Projects, CH4 (Methane) reduction or capture including Cement & Coal Mines/Beds, Supply-Side Energy Efficiency, Afforestation and Reforestation, and Transportation.26

25 CDM Project Cycle, adapted from https://cdm.unfccc.int/Projects/diagram.html26 CDM Project Types, cdmpipeline.org/cdm-projects-type.htm#2

As one can see from the diagram above, the majority of CER issuances have gone towards disposal of industrial gases, with significant investments in renewables as well. Capture of Methane (CH4) from cement and coal represent another large subset of CDM investments. Afforestation and Reforestation, the only Land-Use, Land-Use Change, and Forestry (LULUCF) activities allowed under the CDM, represent an insignificant proportion of CER issuances, at roughly one percent of the total.

In addition to the above, the CDM is looking into “programmes of activities” as potential investments. A programme of activity refers to the “coordinated implementation of a policy, measure or goal that leads to emission reduction.”27 Proposals include the “distribution of efficient solar powered cook stoves to replace biomass cooking or the distribution of compact florescent light bulbs asalternative to inefficient incandescent lamps.”28 These projects have a greater potential for contributingto poverty alleviation, as they prove benefit to a wide range of individual actors, as is the case with solar ovens, that are difficult for large corporations to capture.

Issues in the CDMThe CDM process is not without flaws. The international character of CDM investments, the

sheer volume of projects in the pipeline, and the chronically underfunded, understaffed state of the Executive Board challenge the effectiveness of the CDM.

Commentators have been critical regarding the effectiveness of the CDM in both credibly reducing emissions and contributing to sustainable development. In terms of sustainable development, the emphasis on verifying GHG reductions, but the lack of any stringent vetting by outside agents regarding the contribution of the project to sustainable development in its host country, has led to CDMprojects overwhelming favouring easy emissions-reducing investments, such as “end-of-pipe” projects in industrializing countries, and passing over regions that have a less concentrated potential to reduce emissions, which would contribute more to sustainable development.29 Moreover, CDM projects are overwhelmingly found in the rapidly industrializing BRIC countries, with the lion's share located in China. While this makes sense in terms of offsetting emissions, it also means that regions that could reap immense sustainable development benefits from CDM investment are often passed over for regions that have a more developed industrial base and thus more opportunity for generating CERs.

27 UNFCCC, Programmes of Activities, http://cdm.unfccc.int/ProgrammeOfActivities/index.html.28 Wara, M. W., & Victor, D. G. (2008). A Realistic Policy on International Carbon Offsets. PESD Working Paper #74, 19.29 Kneteman, C., & Green, A. (2009). The Twin Failures of the CDM: Recommendations for the “Copenhagen Protocol.”

The Law and Development Review, 2(1), 231.

CDM CER Issuances by Activity

HFCs, PFCs, SF, and N2O

Renewables

CH4 reduction & Cement & Coal Mine/bed

Supply-side Energy Efficiency

Fuel Switching

Demand-side Energy Efficiency

Afforestation & Reforestation

Transportation

Sub-Saharan Africa, arguably the region that would benefit most from CDM investment in sustainable development, has a miniscule portion of CDM projects, accounting for just 2.9% of the total, and having the lowest CDM investment per capita.30 The new emphasis on programmatic investments, however, might address this concern somewhat.

Outside of criticism regarding its impact on sustainable development, scholars have contested its purported impact on emissions. Wara and Victor examine various projects that have received CERs,and find several problems. In the initial stages of the CDM, much of the market consisted of projects that disposed of HFC-23; a greenhouse gas that is 11,700 times more potent than CO2. While this seemed like an ideal case for CDM investments, Wara and Victor note that,

“Unfortunately, close scrutiny of the economics of HFC-23 projectsrevealed that they were, in many senses, too good to be true. Our work andthe work of others showed that the sale of carbon credits generated fromHFC-23 capture is far more valuable than production of the refrigerant gasthat leads to its creation in the first place. Thus, refrigerant manufacturerswere transformed overnight by the CDM into ventures that generated largevolumes of CERs, with a sideline in the manufacture ofindustrial gases.”31

The perverse incentive created by large influxes of CERs to these firms made it more lucrative to continue producing, and subsequently disposing of, HFC-23, rather than find a way to eliminate it from the production process altogether. Wara and Victor claim that this perverse incentive is present both at the firm level, where firms manipulate the system to capture a greater share of CERs, and at the state level, where developing nations have little incentive to engage more fully with Kyoto (or any successor agreement) and adopt binding emissions targets, when the current situation sees huge sums of money being transferred to them with little obligation at the state level.32

Issues of adverse selection exist in the CDM as well. States have an incentive to claim all low-carbon development is additional and is only marginally viable with CERs included. For example, energy projects in China that have a lower emissions potential than traditional coal-fired generation are submitted as additional. While this may make sense on an individual level, as these projects might facechallenges competing with coal, when viewed in light of recent Chinese energy policy, which has madea strong commitment to increasing the pool of renewable energy available, it is challenging to believe that all these projects would qualify as additional.33 This has been described as lacking “regulatory additionality,” meaning that, absent CERs, the project would have likely continued on regardless with governmental support.34

Further, there is potential for moral hazard on both sides of the CDM transaction. Host countries have an incentive to overlook issues with additionality with CDM project to continue to receiving revenue from them. Developed countries have little incentive to push the issue as well, as less stringently enforced standards mean that more inexpensive CERs will be on the market to put towards their own obligations.

Much of the problem with accurately determining additionality stems from the chronically understaffed and underfunded condition of the CDM Executive Board (EB), which is responsible for the issuance of CERs. The CDM EB receives thousands of requests for CER issuance annually from several large, and hundreds of smaller-scale, projects. The sheer volume of work required to vet each

30 UNEP CDM Pipeline Analysis and Data (2014), http://cdmpipeline.org/regions_7.htm31 Wara, M. W., & Victor, D. G. (2008). A Realistic Policy on International Carbon Offsets. PESD Working Paper #74, 11.32 Ibid 24.33 Ibid 12-13.34 Schmidt, C. W. (2009). Carbon Offsets: Growing Pains in a Growing Market. Environmental Health Perspectives, 117(2), a65.

of these projects almost guarantees that some will approved without being truly additional.35 The long time it takes to verify a given project and the volume of projects in the CDM pipeline have led to a large lag between application for, and issuance of, CERs. This limits the effectiveness of the CDM in financing truly marginal projects, as CERs arrive too late to make a project viable to investors. This has led to more pressure for the CDM to speed up its verification process, which would likely lead to “lowering of the bar” in assessing smaller projects.36 The CDM is moving towards “bundling” similar small-scale projects as one CDM project in an effort to make certification more manageable.37

Further, some have criticized the opaque and inconsistent functioning of the CDM Executive Board, and have cited it as a potential barrier to investors getting involved in CDM projects. Lin and Streck note several issues with how the EB functions that limits its effectiveness in promoting low-carbon investment, including the lack of an appellate or review body for investors to challenge CDM decisions, staff who lack experience in market and financial regulation, no requirement to substantiate decisions to affected parties, and the tendency towards closed sessions and limited outside attendance atEB meetings.38 Investors are less likely to involve themselves in marginal investments that rely on CER issuance to be profitable while the EB lacks transparency and guaranteed due process.

Finally, CDM DOEs are not at arms-length from project proponents. Verifiers are paid by project proponents to review their projects, and there is a fierce competition among DOEs to perform verifications. The EB frequently refers DOE verifications to supplementary review, because they often not believe the DOEs report.39 This reduces the overall effectiveness and efficiency of the CDM. The situation where the watchdogs are paid by those they are monitoring calls into question the projects they certify, and increases the time and administrative costs of project certification.

Part II: Offsetting in BCThe offset regime in British Columbia was created as part of a broad policy package aimed at

the reduction of greenhouse gases, the Greenhouse Gas Reduction Targets Act (GGRTA), which came into force January 1st, 2008. This package included a carbon tax, a low-carbon standard in the electricity sector, stricter regulations for the oil and gas industry, and a pledge for a carbon-neutral public sector. To achieve carbon neutrality, the Emissions Offsets Regulation (ERO) was drafted and came into force in December of that year. It was amended in 2010. This was supplemented by the BC Forest Carbon Offset Protocol (FCOP), which outlined the methodologies for assessing forest-carbon offset projects. Offsetting formed a cornerstone of governmental strategy to achieve carbon-neutrality. To this end, the Pacific Carbon Trust (PCT) was established; a Crown Corporation charged with purchasing and selling carbon offsets in BC. Public Sector Organizations (PSOs), such as schools, hospitals, and core government facilities, would receive $75 million dollars in funding, through the Public Sector Energy Conservation Agreement (PSECA), over three years for energy efficient and otherretrofits. Emissions not reduced this way must be offset through purchasing credits from the Pacific Carbon Trust.

35 Wara, M. W., & Victor, D. G. (2008). A Realistic Policy on International Carbon Offsets. PESD Working Paper #74, 16.36 Ibid 14.37 UNFCCC, Guidelines for Bundling, https://cdm.unfccc.int/EB/021/eb21repan21.pdf38 Lin, J., & Streck, C. (2009). Moblising finance for climate change mitigation: Private sector involvement in

international carbon finance mechanisms. Melbourne Journal of International Law. 87-9.39 Wara, M. W., & Victor, D. G. (2008). A Realistic Policy on International Carbon Offsets. PESD Working Paper #74, 5-

24. 19

The PCT invested in four key activities intended to reduce emissions: fuel switching, energy efficiency, improved forest management, and sequestration. The majority of project activities funded by the PCT were related to fuel switching, which encourages the transition from a more carbon-intensive to a less carbon-intensive type of fuel. Energy-efficiency, which funds projects that reduce energy usage, was the next highest. Sequestration activities increase the amount of greenhouse gases stored in natural carbon sinks, usually through conservation, or captures emissions and stores them in other ways. Finally, improved forest management relates to changing forest management practices on aplot of forested land to increase its carbon sequestration potential.

PCT Projects By Activity

Fuel Switching:

Energy Efficiency:

Improved Forest Management:

Sequestration:

PCT Current Projects by Sector

Forestry/Wood Products:

Transportation:

Oil/Gas:

Agriculture:

Building Material/Efficiency:

Waste/Landfill:

Forest Management/Conservation:

In terms of projects per sector, forestry/wood products had eight projects which received permits, oil and gas had seven, transportation and waste/landfill had one, agriculture, building material/efficiency and forest management/conservation all had four.

Offsetting in BC breaks significantly from the CDM, due to the fact that the vast majority of permits issued have gone towards forest carbon offset projects, as opposed to the destruction of industrial gases and renewable energy installations, as is the case in the CDM. These projects include conservation of old-growth forests on Vancouver Island, via the Timberwest Strathcona Ecosystem Conversation Project40, which would see logging company Timberwest conserving otherwise marketable wood in exchange for offset credits, and The Great Bear Forest Carbon Project,41 which saw forest-use and land-management changing which designated forest areas which were formerly designated for logging changed to conservation and eco-tourism.

BC Offset Approval ProcessThe approval process for offset projects in BC is similar in many ways to the CDM, with the

exception of not having the Designated National Authority step, as the whole process occurs within BC. Also, projects that commenced prior to November 29, 2007 are ineligible as offsets.42

Project Design Document: Proponents must submit a PDD, which outlines the protocols (methodologies) used to determine emissions reductions, a description of a conservative baseline scenario, and proof of additionality. If the project involves the capture, storage or sequestration of

40 Project document available at: http://mer.markit.com/br-reg/public/project.jsp?project_id=10000000000070641 For documents related to the North and Central-Mid Coast Project: http://mer.markit.com/br-reg/public/project.jsp?

project_id=103000000000143For documents related to the South Central Coast: http://mer.markit.com/br-reg/public/project.jsp?project_id=103000000003094

42 BC Emission Offset Regulation, 5.

Total PCT Permit Issuances by Sector

Forestry/Wood Products:

Transportation:

Oil/Gas:

Agriculture:

Building Material/Efficiency:

Waste/Landfill:

Forest Management/Conservation:

greenhouse gases, removals by controlled sinks, or avoided emissions from controlled reservoirs, the proponent must also provide a risk-mitigation and contingency plan, ensuring that the emissions reductions achieved by the project last for either a period equivalent to other legitimate offset projects that are not sequestration or storage projects, or at least 100 years.43

Validation: Much like with the CDM, PDDs are examined to ensure compliance with offset regulations. The EOR requires that the validation team include a licenced auditor and one qualified professional or “a body accredited, in accordance with ISO 14065, by a member of the International Accreditation Forum to use ISO 14064-3.”44 Validated reports must come with a cover sheet, signed bythose doing the validation, outlining their education and qualifications with respect to validating the project, and signifying that it is consistent with government regulations and the ISO-14064-3 standard.45 The BC Emissions Offset Regulation was amended in 2010 to require validation and verification activities to be carried out by different parties46, and a directors order in 2011 requires forest-based carbon offsets to be re-validated every 25 years.47

Registration: The project plan is formally accepted by the program authority. This process includes public awareness and input on the project as well.48

Monitoring and Project Reports: The project proponent must submit a report and a copy of the validated PDD to a verification body. This report must include assertions confirming the assertions made in the PDD are true, and that the project was carried out in accordance with the PDD. If there were deviations, the report must explain what they were and why they happened.49

Verification: A verification body examines the project and ensures that it has reasonably adhered to what was outlined in the PDD. If there are no discrepancies, then the project is verified. If problems are found, then the aggregate impact of the issue or issues is calculated. If the aggregate impact is found to be great enough to have changed what would have been asserted by the project report, are found to have potentially resulted in an overestimation of project reductions by more than 5% or if the impact is determine to be “material” as determined by a director, then the project is not verified.5051

Permit Issuance: If everything is satisfactory, the project is issued offset permits.

BC Offsetting in PracticeThe PCT, as a crown corporation, was short-lived. Operating from 2008 until 2013, the PCT

was the subject of a scathing review by the Auditor-General of BC. In that report, the Auditor-General stated that the PCT had failed to purchase credible offsets, and thus the BC Government, who had claimed to have achieved carbon-neutrality in 2010-11, had actually failed in that goal. The PCT was dissolved as a Crown Corporation in 2013, its staff significantly reduced, and its operations folded into the Ministry of Environment.

43 Ibid, 4-7.44 Ibid 3.45 Ibid 8.46 BC Emissions Offset Regulation 2010 Amendment, 3.47 BC Emissions Offset Regulation Directors Order, http://www.env.gov.bc.ca/cas/mitigation/ggrta/pdf/Director

%27s_Order__Validation_Period__Forestry%20Projects__LT-Apr-26.pdf48 CAS Offset Consultation49 BC Emissions Offset Regulation, 9.50 BC Emissions Offset Regulation, 10-11.51 The ISO is the International Standards Organizations, and ISO-14064-3 is their standard for verifying greenhouse gas

reductions. http://www.iso.org/iso/catalogue_detail?csnumber=38700

The Auditor-General's report examined two projects accounted for the vast majority of permits at the time, the Encana Underbalanced Drilling Project and the Darkwoods Forest Project. Together, they accounted for approximately 70% of permits issued at the time. The Auditor-General's report claimed that both projects could not demonstrate additionality. The former could not prove that offset funding was the deciding factor in going forward with the project, and the latter could not prove that the project would not have otherwise been financially viable.

In the case of the Darkwoods project, the Nature Conservancy of Canada (NCC), a non-profit organization mandated with purchasing and conserving sensitive land, had decided to buy the forest in 2006, prior to the establishment of BC's offset regime. This drew some criticism, as the Emissions Offset Regulation stipulates that projects cannot have commenced prior to November 29th, 2007, and some might say the decision to purchase the land “commenced” the project. Others might note that the sale did not close until 2008, which could also be reasonably construed as when the project commenced. However, a carbon offset feasibility study wasn't completed until 2009, which could indicate that offset funding was not a significant factor in proceeding with project.52

Further, the report stated that the NCC did not use conservative baseline estimates in determining the total emissions that would be released if offset funding did not occur, and the forest was sold to a commercial logging company. Instead, the NCC submitted a scenario which had an unfeasibly aggressive “liquidation logger” purchase and log the majority of the forest rapidly. The Auditor-General determined that there were several social and regulatory reasons why this scenario wasexaggerated and unlikely to be the case, including backlash from the community, the preference of the seller to sell to a buyer that is committed to responsible management, and a legal obligation under the Federal Ecogifts program to conserve the land.53 Thus, the overstated deforestation estimates led to the NCC capturing more offset revenue than they would have been entitled to in a more conservative scenario. Subsequent study of the Darkwoods Project concluded that not only did the management plan submitted by the NCC result in slightly less carbon sequestration than leaving the forest as wilderness, but that sustainable commercial management yielded greater sequestration potential over the long-term.54

Similarly, the Encana Underbalanced Drilling Project, under the scrutiny of the Auditor-General, failed to demonstrate additionality. In an underbalanced drilling project, pressure differentialsbetween the natural gas deposit and the bore-hole causes natural gas to flow over the drill and into the atmosphere. Typically, this escaped gas would be flared (ignited) to convert the methane to less harmful CO2. The Encana project applied for offset credits to capture the escaped gas altogether, and pump it into the pipeline. However, the Auditor-General's report noted that there was significant financial incentive for Encana to move ahead with the project regardless of offset funding, as the captured natural gas could be sold for profit.55 Further, some would claim that the Encana project failedto demonstrate regulatory additionality – that it was reducing emissions outside of what was already mandated by regulation – due to the fact that the B.C. Energy Plan mandated that all routine flaring be eliminated by 2016.56

Further, the PCT was criticized in several other aspects of how it functioned. The PCT maintained a standard price for selling its own offsets at $25 per tonne CO2e. However, in a recently released list of purchase prices, it was revealed that the PCT was paying significantly less when purchasing offsets for its own inventory, ranging from $9 per tonne for forest conservation and

52 BC Auditor General, “An Audit of Carbon-Neutral Government.” March 2013.http://www.bcauditor.com/pubs/2013/report14/audit-carbon-neutral-government, 20.

53 Ibid 21-24.54 Van Kooten, G. C., Bogle, T., & De Vries, P. P. (2012). Rent Seeking and the Smoke and Mirrors Game in the Creation

of Forest Sector Carbon Credits: An Example from British Columbia. Resource Economics and Policy Analysis Research Group Working Paper, 20.

55 BC Auditor General, “An Audit of Carbon-Neutral Government.” March 2013, 25.56 B.C. Energy Plan, http://www.energyplan.gov.bc.ca/bcep/default.aspx?hash=9.

sequestration in the Great Bear Project, up to $19.11 to Encana for the previously discussed underbalanced drilling project.57 According to its financial statements, the PCT had an accumulated surplus of almost $25 million dollars by March 31st, 2013.58 A story run in the Vancouver Sun on July 12, 2013 claims that the surplus grew to close to $30 million dollars.59 This surplus was derived from governmental funding and profits made on selling offsets, and was expected to grow annually. Given that must of this surplus was derived from selling credits to public sector organizations, some criticizedthe PCT for taking money from schools, hospitals, and universities and doing nothing with it. This surplus also points to the possibility that there were simply not enough quality offsets in BC to spend this money on. To be fair, it is generally prudent to keep enough cash on hand to cover future demand for offsets. The PCT was allowed to purchase up to 1,000,000 offset tonnes per year to satisfy the government's mandate of carbon neutrality. However, at the average price the PCT paid at $13.955 for offsets, it could cover the total possible demand for permits for over two years without any additional sales or funding. Even at the top price paid of $19.11, the PCT would still be able to meet its maximumpotential obligation for a little over a year.

Further, Van Kooten et al notes that “in the case of carbon markets, rent seeking on both sides of the market has created vibrant trade in carbon offsets that has little to do with the problem of global warming, but everything to do with the pursuit of (short-run) profits and objectives unrelated to climatechange.”60 The rise of financial intermediaries and brokers in offset markets increases the potential for rent-seeking behaviour, and challenging the effectiveness of the system.

The FalloutThe repercussions of the Auditor-General's report were dramatic. The Pacific Carbon Trust,

barely a few years old, was dissolved as a crown corporation, much of its staff transferred to other departments, and it activities assumed directly by the Climate Action Secretariat, under the Ministry of Environment. Offsetting in BC had taken a substantial blow to its credibility, particularly in light of theAuditor-General's scathing accusation that vested interests and senior management at the PCT had broken confidence with the auditing process and disclosed information to developers and brokers in thecarbon marketplace.61

Industry RespondsIndustry operating in the offsets market fired back, stating that the Auditor-General's report was

conducted by staff without any expertise in carbon market verification, and that both projects were validated and verified by third party experts with years of experience. In a series of articles, Steve Zwick, Managing Editor of Ecosystem Marketplace, an online industry news site, challenged the Auditor-General report on a number of points in relation to the Darkwoods project. Throughout these articles, Zwick characterizes the auditing process as chaotic, with inexperienced auditors either “gettingin over their head or intentionally trying to discredit the program.” Further, he states that, through

57 Pacific Carbon Trust, Offset Pricing List 2009-2012, http://www.pacificcarbontrust.com/assets/Uploads/Pricing/PCTpricing2009-2012.pdf

58 Pacific Carbon Trust - Auditor General Opinion Letter and Financial Statements – 2012-2013, 29, retrieved fromhttp://www.pacificcarbontrust.com/assets/Uploads/Auditor-General-Opinion-Letter-and-Financial-Statements-2012-13.pdf

59 Hoekstra, G. (2013, July 12). Pacific Carbon Trust’s growing surplus approaches $30 million, fuelling calls for its elimination. Vancouver Sun. Retrieved from http://www.vancouversun.com/business/Pacific+Carbon+Trust+growing+surplus+approaches+million+fuelling+calls+elimination/8649076/story.html

60 Van Kooten, G. C., Bogle, T., & De Vries, P. P. (2012). Rent Seeking and the Smoke and Mirrors Game in the Creation of Forest Sector Carbon Credits: An Example from British Columbia. Resource Economics and Policy Analysis Research Group Working Paper, 5.

61 BC Auditor General, “An Audit of Carbon-Neutral Government.” March 2013, 4.

interviews of people “close to the project”, the audit lacked transparency, with Auditor-General John Doyle “refusing to disclose which outside experts he’d contracted to support the audit and no known carbon experts being identified as participants.” Further, Zwick states that Doyle disregarded the generally-accepted principles of carbon auditing, instead creating his own standard; a move that Zwick compares to “a corporate auditor discarding generally-accepted accounting principles and instead writing his own.” Finally, potentially the most serious claim Zwick puts forward, is the accusation that Doyle flat out ignored evidence, “going so far as to conclude the discovery phase of the audit before allquestions were answered.”62

Outside these general criticisms, Zwick responds to specific claims made by the report regarding the Darkwoods project. He notes a fundamental difference in understanding between the Verified Carbon Standard – the verification standard used by independent auditors to assess Darkwoods– and the office of the Auditor-General regarding the role that offset funding played in the acquisition of the Darkwoods forest by the NCC. As mentioned above, the Auditor-General's report determined that offset funding was not a critical factor in moving forward with the project. Zwick contends that the NCC did, in fact, consider offset funding critical to the project, noting that, “although not explicitly stated in the Project Description, NCC has long said that carbon credits were the final piece in the funding puzzle and made it possible for them to purchase the property.”63 Finally, Zwick claims that the auditors misunderstood or misconstrued the EcoGifts program, stating that, contrary to the auditors assertions, the forest became protected via the Ecogifts program, as opposed to being previously protected by it, and thus was not subject to a priori legal constraints that would have prohibited the selling of the land to a “liquidation logger.”64

Part III: Costs and Benefits

The Benefits of OffsettingWhile offsetting has been controversial in BC, there have been several benefits stemming from the

activities financed by the PCT. Forest conservation is an important tool in managing Canada's overall carbon budget, encouraging fuel switching from high- to low-carbon sources is a good near-term step to reduce emissions, and promoting new technologies to reduce emissions in the oil and gas industry is important. Additionally, PriceWaterhouseCooper, commissioned in 2012 to quantify the economic impact of PCT activities, noted that the investments made by project proponents and facilitated by the PCT had a net benefit on the economy. They found that the combined direct, indirect and induced impact of PCT activities added $242.6 million in GDP to the economy, $48.8 million in total government tax revenues, and a total of 2,836 jobs.65

Although, unlike the CDM, there is no explicit requirement that projects contribute to sustainable development or poverty alleviation, the Great Bear Forest Carbon Project features an innovative initiative marrying the sustainable management of an important ecosystem and the sustainable development of First Nations communities through Atmospheric Benefits Sharing Agreements (ABSA). An ABSA divides ownership of any carbon permits sold from a particular offset project between the Provincial Government and First Nations people. Three ABSAs have been signed betweenthe Government of BC and various First Nations groups; the Coastal First Nations agreement, the Haida Nation agreement, and the Nanwakolas agreement. These agreements also covenant the two

62 Zwick, S. (2013, March 27). Canadian Carbon Audit Report Delayed Amid Charges Of Bias And Overreach. Retrieved from http://www.ecosystemmarketplace.com/pages/dynamic/article.page.php?page_id=9654§ion=home

63 Zwick, S. (2013, March 28). BC And The Baseline Brouhaha Part One: Dissecting The Darkwoods Documents. Retrieved from http://www.ecosystemmarketplace.com/pages/dynamic/article.page.php?page_id=9657&section=home

64 Zwick, S. (2013, April 12th). Documents Back Nature Conservancy Over BC Auditor General On Darkwoods Retrieved from http://www.ecosystemmarketplace.com/pages/dynamic/article.page.php?page_id=9678&section=home

65 PriceWaterhouseCoopers, (2012). Economic Analysis of British Columbia Carbon Offset Projects, 4.

parties to manage the forest in line with the principles of Ecosystem-Based Management (EBM).66 This ensures a more collaborative, community-driven approach to forest management.

The Coastal First Nations agreement stipulates that 78% of the “annual quantum” of atmospheric benefits – of the total assessed carbon sequestration potential – from the Great Bear Central and North Coast Project can be sold as carbon permits. The Coastal First Nations is able sell a percentage of that total and the rest goes to the provincial government. In 2009-10, that percentage was 77%. After April 1st 2012, it shrank to 50% of the total calculated from the previous year. On June 15th 2015, and every five years afterwards, the parties negotiate the distribution of any extra available atmospheric benefit that may arise from additional carbon sequestration potential that develops in the project area.67 This agreement was amended in 2012, granting the Coastal First Nations an additional 13% of the 2009-10 available atmospheric benefits and commencing on April 1st 2012 until 2016, and additional 30% of thetotal available benefits.68 It was further amended to include the Haisla Nation.69

The Haida ABSA is similar. Between 2012-16, it allows First Nations groups to sell 81% of the annually calculated atmospheric benefits for the previous calendar year, and on April 1st 2017, percentage as agreed to by both parties. The project area incorporates all of the Haida Gwaii area in northern British Columbia, with protected coastal areas excluded.70

Finally, the Nanwakolas ABSA gives the Nanwakolas First Nations part of a percentage of the atmospheric benefits from both the Central Coast and South Coast Projects; 5% and 42% respectively. Of the aggregated total of the above benefits, the Nanwakolas First Nations could sell 83% of the 2009-10 total, and after April 1st 2012 and every year thereafter, 50% of the annually calculated benefit.

At this time, 300,000 carbon credits were purchased from the Great Bear Initiative, representing the Coastal First Nations, at $9 per tonne, for a total of $2,700,000 in revenue. The Nanwakolas CarbonCredit Limited Partnership, sold 150,000 carbon credits, again at $9 per tonne, for a total of $1,350,000in revenue.71 It does not appear that the Haida Gwaii agreement has generated any offset projects.

Covenants such as the ABSAs are an innovative approach to forest stewardship, and have value in that they incorporate local communities within the management framework of forests that are importantto them, and shares the benefits of conservation with those who are in the position to manage the forest best. This concept could be particularly useful when exported internationally. While Canada does not have any significant problem with illegal forest harvesting, in many developing nations, such as Brazil and Indonesia, illegal logging and tree-clearing for farmland is a major source of deforestation and greenhouse gas emissions. By sharing the financial benefits of conservation with local inhabitants, it allows them to forgo the economic benefits derived from harvesting materiel from the forest without a loss in welfare. Further, such a community-driven conservation utilizes locally-developed knowledge about how best to conserve the ecosystems in the area which, when combined with scientific rigour, could lead to more effective management. Proponents of including REDD activities in the CDM, for example, note that “94 percent of deforestation of the Amazon could be avoided at a cost of less than $5 / tCO2e.”72

Further, the huge sequestration capacity of forests in British Columbia, and Canada generally, has the potential of bringing in large sums of revenue, should the BC emissions offset regime become integrated with those of other jurisdictions, such as California, through the Western Climate Initiative,

66 Defined in the Coastal First National ABSA as “the adaptive systematic approach to managing human activities that seeks to ensure the coexistence of healthy, fully functioning ecosystems and human communities.” Coastal ABSA 3

67 Coastal First Nations Atmospheric Benefits Sharing Agreement, 3-7. 68 Coastal First Nations Atmospheric Benefits Sharing Agreement Amendment.69 Coastal First Nations Haisla Amendment.70 Haida First Nations Atmospheric Benefits Sharing Agreement. Detailed map available on p971 Pacific Carbon Trust, Offset Pricing List 2009-2012,

http://www.pacificcarbontrust.com/assets/Uploads/Pricing/PCTpricing2009-2012.pdf72 Kneteman, C., & Green, A. (2009). The Twin Failures of the CDM: Recommendations for the “Copenhagen Protocol.”

The Law and Development Review, 2(1), 242.

or through the European Trading System.

The Costs of OffsettingCosts relating to offsetting can divided into a few categories. Firstly, the effectiveness of the

project in actually reducing emissions is important. If projects that are non-additional get verified, thenmoney was wasted funding projects that either a) do not reduce emissions (or reduce less than claimed)or b) would have happened without offset funding. Much discussion has been given earlier to problems related to additionality within both the BC context, and within the CDM. Secondly, the economic efficiency of offsetting in comparison with other available policy options. Is putting a price on carbon the best way to ensure conservation of forests or to foster energy-efficiency improvements? The social and regulatory framework comes into play here, as it influences potential alternatives to carbon pricing. Finally, the opportunity costs of not utilizing a resource. This is particularly relevant with forest carbon offset projects. Generally, the focus with conservation activities is on the benefits ofnot harvesting forests for products or clearing the land for other uses. However, there are economic costs to conservation, as well as concerns about external leakage, as outlined earlier.

Obviously, non-additional projects have a high-cost. Both the CDM and the PCT have been criticized for funding projects that are not credible. This has been dealt with earlier and does not need to be revisited here.

In comparison with other policy options, offsetting has variable value. The regulatory environment that governs the project is of key importance. Command-and-control style regulation has generally proven very effective in Canada, with a low-net deforestation rate, strong local enforcement of regulations, and very little illegal logging.73 By contrast, command-and-control regulation has proven very ineffective in Brazil, with widespread illegal deforestation in the Amazon. In a situation such as this, creating a financial incentive through offset funding might be a more feasible option to prevent deforestation.

Finally, opportunity costs of forgoing the economic benefit of clearing forests in favour of conservation vary. In Canada, the vast majority of forest remains inaccessible, and cannot be harvested. Thus the opportunity cost for those forests is effectively zero. The opportunity cost for accessible forest land in Canada can be fairly accurately calculated. By determining the range of economic activities that the land could be otherwise used for, incorporating environmental, regulatory, and social constraints, we arrive at the Net Present Value (NPV) of a piece of land.74 Taking this NPV calculation and subtracting the NPV determined under a conservation scenario (sustainable logging for example) allows us to determine the total opportunity cost.

For example, in BC, average coastal area timber prices are outlined by species in the table below.75

Species Hembal76 ($/m3)

Cedar($/m3)

Cypress($/m3)

Fir($/m3)

Spruce($/m3)

Pine($/m3)

2013 51.38 146.13 97.71 92.91 129.39 55.38

Opportunity costs for a given area of forest land would be the yield under a typical commercial

73 Natural Resources Canada, “Legality and Sustainability”, http://www.nrcan.gc.ca/forests/canada/sustainable-forest-management/1330 3.

74 Barton, D. N., Bernasconi, P., Blumentrath, S., Brouwer, R., Oosterhuis, F., Pinto, R., & Tobar, D. (2013). Assessing therole of economic instruments in policy mixes for biodiversity conservation and ecosystem services provision. Policy Mix, (11), 7.

75 Prices determined by averaging rates from first growth timber sales averaged across all categories of timber quality Forestry BC, Market Pricing System (2013), https://www.for.gov.bc.ca/hva/parameters_coast.htm?2013.

76 Hembal is the combined price of hemlock and balsam.

logging scenario minus the yield from the same plot of land under a conservation scenario. Often, exact calculations are not feasible due to time and information constraints, but proxy values for similar plots can serve as an acceptable substitute, within reason.77 Generally, land-sale values of the surrounding area are good proxies.78 An example of this type of calculation is present in Schneider et al(2010), where they calculated the cost of projecting the threatened woodland caribou and the habitat needed to sustain them in the range of $10,000 to 11.5 million dollars (CAD) per square kilometre.79 This wide range of valuation stems from the development potential for oil and gas in some areas of caribou habitat.

Calculating opportunity costs in developing countries is much more complex. Forests have a number of benefits to local inhabitants that are difficult to quantify in terms of a market price, includingfood, building material, medicinal plants, and fuel. Some have taken a different approach to PES, surveying local inhabitants about what they would be Willing to Accept (WTA) to forgo the benefits they derive from the forest.80 Substituting subsistence activities with carbon financing does still have a potential for moral hazard, as there is temptation to both accept the money and still harvest materiel from the forests. Designing programs to carefully account for this is important.

Part IV: Looking towards the FutureChallenges exist with offsetting in BC. This is a critical time to examine the place of offsetting

within our framework to combat climate change. Despite the controversy surrounding the Auditor-General's report, the BC government still claimed that it had achieved its 2012 interim target of a 6% reduction below 2007 levels, with offsetting accounting for a significant portion of that claim.81 As the province aggressively pushes for the expansion of liquified natural gas production in Northern BC, offsetting might be heavily relied upon to meet our emissions targets outlined in the GGRTA. Further, oil and gas companies might rely on offsetting as a significant source of “social license,” framing their activities as carbon neutral. The credibility of offsetting is of paramount importance going forward.

The question is whether offsetting is the most effective and efficient way to encourage the transition to a low-carbon economy. As mentioned earlier, significant issues exist with free-riders and offsetting. Energy-efficiency improvements in particular have this issue, as energy-efficiency is often the financially smart choice for business, as it reduces operating costs.82 For forest conservation and sequestration projects, issues exist in demonstrating additionality and permanence over long periods of time.

There are several options available with respect to offsetting in BC. On the critical end of the spectrum, some might claim that the issues with determining additionality, permanence, and cost-effectiveness are reason enough to scrap offsetting altogether, and replace it with other measures. Others more supportive of offsetting might acknowledge some of the issues outlined above, and suggest ways to improve offsetting practices, rather than discarding them altogether. In this section, wesurvey some of those options.

Option #1: Weighted OffsetsResearch on the CDM suggests that a significant portion of approved projects are free-riders;

77 Barton, D. N., Bernasconi, P., Blumentrath, S., Brouwer, R., Oosterhuis, F., Pinto, R., & Tobar, D. (2013). Assessing therole of economic instruments in policy mixes for biodiversity conservation and ecosystem services provision. Policy Mix, (11), 5.

78 Ibid 7.79 Ibid 3.80 Ferraro, P. J., Lawlor, K., Mullan, K. L., & Pattanayak, S. K. (2011). Forest Figures: Ecosystem Services Valuation and

Policy Evaluation in Developing Countries. Review of Environmental Economics and Policy, 11.81 BC Ministry of Environment, “Climate Action in British Columbia: 2014 Progress Report”, 4-5.82 Jaccard, M., & Griffin, B. (2011). BC’s Carbon Neutral Public Sector: Too Good to be True? Energy and Materials

Research Group, 6.

projects that are non-additional, but were approved anyways. Similar concerns exist in BC, where regulators are accused of allowing a number of non-additional projects to be approved when they oughtnot to have been. This can happen due to inexperienced regulators or auditors, or proponents enjoying a significant “asymmetrical information” advantage over regulators, knowing more about the additionality (or lack thereof) of offset projects, and selectively divulging information that casts the project in a better light. To account for systemic flaws that allow free-riders to be approved, some havesuggested “weighted offsets” as a corrective measure. Broadly speaking, this method involves adding amultiplier or a discount on credit issuance’s based on various criteria. Regulators could apply a broad discount to the amount of permits issued to projects to account for the lesser value of offsets compared to reductions, based on how long it will be before the offset is expect to remove CO2e from the atmosphere, or add a multiplier to projects that have contribute to other societal goals, such as poverty alleviation, sustainable development, or the economic empowerment of rural and aboriginal communities. Also, the total amount of permits could be broadly discounted to account for an assumedpercentage of projects that get approved but lack actual additionality, or specific project-types can have discounts applied to them to reduce perverse incentives.83

Option #2: Transition to a cost-based/ market value reimbursement systemCurrently, offsetting systems set a price per tonne CO2e and sells offsets based on that price.

Proponents of offsetting projects then apply for financing based on the total estimated reduction in CO2e the project is anticipated to have. Thus the funding formula is the total estimated CO2e removedmultiplied by the offset price. This is meant to incentivize maximum CO2e removal. However, the fact that payments are based on CO2e removed, rather than the cost of the measure that removed the CO2e, means there is the potential that taxpayers are paying more for reductions than necessary. Examples of this are present in the CDM. Wara and Victor noted earlier that the advent of CDM offsetting transformed certain refrigerant manufactures into CER generating ventures. As HFC-23 is roughly 11,700 times more potent than CO2, the international community, through the CDM, was paying much more than was needed to eliminate these emissions. The inefficiency of this is well summarized by Wara and Victor,

“In the case of HFC-23 abatement, the CDM was also a startlinglyinefficient means for achieving emissions reductions in the developingworld. Payments to refrigerant manufacturers, the Chinese government(which heavily taxes these CDM projects), and to carbon market investorsby governments and compliance buyers will in the end total approximately€4.7 billion while estimated costs of abatement are likely less than €100million.”84

This drives at the heart of the issue. By basing payments on the amount of carbon reduced, as opposed to the cost of abatement, offsetting systems have the potential to be an inefficient method of reducing emissions. When firms apply for offset funding, a key aspect of determining the eligibility of the project is whether or not the project would be financially viable without offset credits. If the issue with a project is that reducing emissions would drive up the cost outside of what would be marginally viable, perhaps a better option would be to base funding on the cost of abatement measures, rather thanon a set price per unit of CO2e. This would ensure that the public is only paying for the cost of measures to reduce CO2e, and not delivering unwarranted windfalls to proponents. Firms would still see benefit from these measures, as improvements that limit emissions often provide other benefits,

83 Francois, M., & Hamaide, B. (2011). Certified Emission Reductions Weights for Improved CDM Projects. Environmental Policy and Governance, 21, 33-37.

84 Ibid, 11-12.

such as reduced energy consumption, even if alone those benefits wouldn't be enough to make the project viable. Those benefits plus a cost-based reimbursement would still provide enough incentives for firm to participate, while being more efficient than traditional offsetting. In this scenario, the price of offsets would likely be lowered, to reflect to smaller disbursements to private firms.

Option #3: Eliminate offsetting entirely, extend the carbon tax to all sectors, remove the “revenue-neutral” requirement, and invest a portion in emissions-reducing projects.

PSOs are not exempt from the carbon tax, currently priced at $30/tCO2e. This, combined with the offset price of $25/tCO2e set by the PCT, means that PSOs are paying $55/tCO2e, more than any other sector in BC. Economists have noted that this differential price is inefficient, placing an undue burden on PSOs. Particularly, Mark Jaccard and Brad Griffin, highly critical of offsetting programs, suggest eliminating both offsetting and the carbon neutral government requirement, and instead extending the carbon tax to cover all emissions where possible. In areas where a tax is not feasible, they suggest reducing emission via regulation, as has been done in BC's energy sector.85 Jaccard and Griffin suggest the tax remain revenue-neutral broadly with respect to PSOs.

There is a strong case for revenue-neutrality being desirable from a political and economic standpoint. Research suggests a net-benefit to the economy if funds raised through carbon-taxation arereturned in a progressive fashion back into the economy.86 However, policy can be designed to prioritize greater impact on emissions, rather than political optics or economic efficiency. By eliminating the revenue-neutral requirement, funds raised via the tax can be earmarked for investments to reduce emissions where the market might not be fast or efficient enough. These investments could include improved public transit service, rolling out charging facilities for electric vehicles, forest conservation and management, energy-efficiency retrofits, and so on.

Option #4: Regulate with penalties for non-compliance. Some have noted potential issues with using market-based policies to encourage forest

conservation. Carbon offset regimes aim to conserve forests or encourage more sustainable logging practices by putting a monetary value on the ecosystems services provided by the forest, in this case, carbon sequestration. However, this does not guarantee the conservation of the forest. If the economic value of timber increases dramatically for some reason, (housing boom, lumber shortage caused by natural disaster elsewhere, etc.) then the forest is still at risk of being logged. There will always be a fundamental conflict between the market-value of lumber, set by supply and demand, and the value of carbon sequestration, which is set in BC at $25/tCO2e.87 The only way to guarantee conservation is to remove a forest from the market system entirely. That said, conservation is one part of a larger forestrystrategy to maximize the role that our forests play in combating climate change. Responsibly logging forests increases their carbon sequestration potential and limits the potential for disaster or pests to release greater amounts of greenhouse gases by removing older trees, which are more susceptible to infestation and have reached near-maximum sequestration potential. Regulation mandating longer rotations for logging and encouraging solid wood products over chip-board and pulp would increase thevalue of wood products in sequestering carbon, as solid wood products continue to store carbon after being harvested and longer rotations ensure forests have a chance to become net-carbon sinks before being harvested.88

85 Jaccard, M., & Griffin, B. (2011). BC’s Carbon Neutral Public Sector: Too Good to be True? Energy and Materials Research Group,7

86 Rhodes, E., & Jaccard, M. (2013). A Tale of Two Climate Policies: Political Economy of British Columbia’s Carbon Taxand Clean Electricity Standard. Canadian Public Policy - Supplement, 39, s42.

87 Farley, J. (2010). Conservation Through the Economics Lens. Environmental Management, 45, 26.88 Parfitt, B. (2010). Managing BC’s Forests for a Cooler Planet. Canadian Centre for Policy Alternatives,22, 29.

Conclusion:Offsetting represents one of many policy inventions to combat climate change, and British

Columbia has been at the forefront of innovation in emissions governance, particularly in its inclusion of forest carbon sinks. That issues exist with respect to verifying emissions reductions and proving their additionality is undeniable. However, offset investments have had many positive impacts as well, including stimulating GPD and job creation, as well as conserving forests. Offsetting is a new policy innovation, and as such, expecting perfection after a few years of operation might be unreasonable. However, outside of functional issues surrounding the specifics of how the PCT operated, are the theoretical concerns surrounding offsetting enough to discredit it? Should the bar be raised to only include offsets that directly and immediately remove CO2e from the atmosphere? Would the market beable to function if this was the case? Is there a place for offsetting in a modified form in the greater strategy to reduce emissions? This paper set out to outline the issues surrounding offsetting in BC to assist policy-makers to answer that very question.

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