Four Things You Should Know about Carbon Offsets
Last week, Ontario and Quebec announced that they’d be collaborating on a carbon offset system as part of their respective cap-and-trade policies. What’s an offset, you ask? And what are the implications of this provincial tag-team, you wonder? As usual, the Ecofiscal blog has you covered.
1. What a Carbon Offset is and How it Works
As the name implies, a carbon offset lowers emissions in one part of the economy to make up for or “off set” increased emissions somewhere else.
It works something like this: A firm takes some action to reduce emissions in a way that is not covered directly by a basic carbon pricing policy. For example, a firm could capture methane emissions from a landfill that would otherwise have been added to the atmosphere. Projects like this can get “credits” for the emissions they reduce. And this credit can be bought and sold within the existing carbon market. So a company that is having a hard time reducing its own greenhouse gas levels can purchase a credit produced by one of these projects to “offset” its emissions.
2. Why Include Offsets in Carbon Pricing Policies
Offsets are a practical way of broadening coverage of a system, beyond the emissions that can be priced directly. In practice, some emissions are tricky to include under a carbon pricing policy. Methane emissions from landfills, for example, are powerful greenhouse gas emissions. But unlike emission from fuel combustion (which are generally a function of the type of fuel being burned), quantifying landfill methane emissions accurately is challenging.
Similarly, pricing emissions doesn’t create incentives for actions or projects that remove GHG emissions from the atmosphere—such as planting trees, or using alternative agricultural practices to sequester emissions in soil.
In the world of carbon pricing, broader is better. Creating incentives for a broader set of potential emissions reductions (for example through the kinds of project mentioned above) means that more low-cost emissions reductions are realized. It creates more flexibility for driving the lowest cost emissions reductions overall, and minimizing costs of policy, both for individual emitters and the system overall.
3. What it Takes to Get Carbon Offsets Right
So how do you get offset programs right? Two main questions matter.
Would the emission reduction have happened anyway, even if no policy existed? If the answer is “yes,” than the project should not count this as an offset and should not reward it with a credit. It’s sort of like paying your kids to do their homework: giving someone a financial incentive to do something they have to do, or are going to do, anyway is not a good use of money. British Columbia’s Auditor General identifies this problem in B.C.’s offset program, which was used to help government facilities achieve carbon neutrality.
Is the emission reduction permanent? If an offset is granted for planting trees, only to have those trees cut down later, fewer true emissions reductions are associated with the credits.
Strong and transparent governance of offsets can help address these concerns. Offsets in Alberta’s Specified Gas Emitters Regulation, for example, are verified by independent third parties; offset protocols pass through technical, stakeholder, and public reviews.
In response to these risks, carbon-pricing systems sometime limit the extent to which offsets can contribute to overall compliance with the policy. The table below, from our report The Way Forward, summarizes the role of offsets in existing carbon pricing systems in BC, Alberta, and Quebec.
4. Why Create a Common Offset Market
That brings us back to the recent announcement from Quebec and Ontario. Given the importance of strong governance, cooperating makes sense. Detailed protocols or methodologies for different types of offset projects are required to ensure that the emission reductions they represent are credible. And because making good protocols takes time, collaboration is efficient.
It also creates an early signal to offset projects in Ontario, even in advance of the carbon pricing policy being finalized. By indicating that Ontario’s offset system will work in parallel with Quebec’s existing system, developers of potential offset projects have some level of certainty as to what the rules of the game will be. And helps them to get moving.
Finally it also could also represent another subtle step toward coordination. The expectation is that Ontario and Quebec will link their cap-and-trade systems, allowing permit trade between emitters in Ontario, Quebec, and California. But a common offset market is another way to indirectly link different carbon pricing systems, even ones with very different policy designs.
Sooner or later, Canadian provinces will have to have serious conversation about coordinating sub-national carbon pricing policies. And common offset markets are one part of the coordination tool-kit.