1. WRI J. Pershing, RGGI, May 2004 Use of GHG Project Offsets Reviewing Existing Programs Jonathan Pershing World Resources Institute 2 nd Stakeholder Meeting of the Regional Greenhouse Gas Initiative Boston, MA Thursday, May 20, 2004

2. WRI J. Pershing, RGGI, May 2004 Overview Rationale for/against offsets Alternatives to offsets Review of existing programs with consideration of key issues Conclusions

3. WRI J. Pershing, RGGI, May 2004 Rationale for using GHG offsets Pro Reducing individual and system costs by extending compliance options – adds compliance flexibility Brings in new/ uncovered sectors and facilities Allows industry outside of capped sectors to “test” working of system Creates opportunities for innovation May make political agreement on cap easier – now and in future Some sources that are difficult to quantify in cap-and- trade can be accurately measured in offset program

4. WRI J. Pershing, RGGI, May 2004 Rationale for using GHG offsets Con Adds administrative complexity and costs Assuring quality/ environmental integrity of offsets is difficult Reduces incentives for new entrants to join trading system

5. WRI J. Pershing, RGGI, May 2004 PRO: Cost reductions can be significant with project offsets * unlimited CDM regional marginal costs, US$ per ton of carbon Source: IEA Analysis of Kyoto compliance with US, no transactions costs

6. WRI J. Pershing, RGGI, May 2004 CON: Undermines environmental integrity “… most of the projects would have been realised even without CDM-finance, which implies that the …support has no added value….It would certainly be optimal to prove unambiguously that non-feasible projects would turn into feasible, due to CDM-finance. Unfortunately, this "financial additionality" appears to be a very weak selection criterion. Practice shows that such forecast calculations could be adjusted in favour of any desired outcome.” -- VROM (Netherlands), review of NGO critique

7. WRI J. Pershing, RGGI, May 2004 Alternatives to Offsets (1) Opt-ins –Allows facilities not covered initially to become covered (capped) and receive and trade allowances –Implies participation in emissions monitoring/reporting/inventory requirements –Determining stringency of opt-in caps challenging –Used in acid rain program – but problematic here, as only sources already reducing opted in

8. WRI J. Pershing, RGGI, May 2004 Alternatives to Offsets (2) Set-asides (under a cap) –Provide allowances to owners of non-covered facilities –Allowances may be banked or traded –Rules for set-asides have elements similar to those of offsets: Project is not otherwise required or generate other compliance/ permitting credits Project operates in the years it receives credits Project should reduces/displaces emissions Emissions reductions are measurable/verifiable –Do not change overall emissions (come out of cap) –Used in NO x Budget Trading Program

9. WRI J. Pershing, RGGI, May 2004 GHG Offsets Programs International programs –UNFCCC/Kyoto Protocol (JI, CDM) –EU Emissions trading system (through its linking directive) –World Bank – Carbon Finance (PCF and others) National programs –Dutch CERUPT/ERUPT Programs –Canada –Denmark –Japan –US Activities Implemented Jointly, State programs (e.g., Oregon Climate Trust) Private sector programs –Chicago Climate Exchange (CCX) – project offsets Non-GHG offsets programs (such as NOx, SO 2 and others) nor CO 2 adder programs are considered here

10. WRI J. Pershing, RGGI, May 2004 Key Issues (1) Offsets location –Issue: inside or outside of the region where cap applies? –Conflict: reduced permit price vs. administrative costs, potential loss in environmental integrity and sending revenues out of region Allowed Sectors –Issue: which sectors, which gases –Conflict: reduced permit price vs. lack of certainty in emissions quantification (includes issues of double counting and indirect emissions) LULUCF –Issue: whether to allow forest/agriculture/soils offsets –Conflict: reduced permit price and added industries vs. lack of certainty in emissions quantification and permanence concerns Limits to allowable use –Issue: Share of reductions to be allowed from offsets –Conflict: reduced permit price vs. promoting local emissions reductions

11. WRI J. Pershing, RGGI, May 2004 Key Issues (2) Timing –Issue: what are the start/end dates for project crediting –Conflict: allowing more projects vs. additionality Verification –Issue: How stringent/what procedures to be used –Conflict: transactions costs vs. environmental integrity Special treatment for renewable energy –Issue: Should offsets promote RE –Conflict: least cost options vs. technology push incentives as well as accuracy of offset calculation vs. simplicity and feasibility Baseline rules –Issue: What rules for ensuring additionality –Conflict: limiting project numbers vs. environmental integrity of each project (limiting leakage, successful monitoring over time)

12. WRI J. Pershing, RGGI, May 2004 Offsets locations CDM Outside UNFCCC Annex I (capped) Parties JI Within/ between UNFCCC Annex I (capped) Parties EU Allows JI or CDM credits (i.e., both inside and outside EU and accession countries) PCF Both developed (primarily EIT) and developing countries ERUPT/ CERUPT ERUPT: Annex I (capped) countries CERUPT: Developing countries (uncapped) CCX US, Canada, Mexico and Brazil only; others may be added

13. WRI J. Pershing, RGGI, May 2004 Allowed Sectors CDM Any sectors with agreed methodologies; “refrain” from nuclear JI No limits set; “refrain” from nuclear EU No nuclear; hydro allowed but to be reviewed, sinks restricted, double counting constraints could limit projects (particularly energy efficiency and renewables) in EITs PCF Emphasis on renewable energy; limits on specific technologies, sinks and countries in portfolio of projects ERUPT/ CERUPT ERUPT: Renewables, biomass, cogeneration, efficiency, transport/distribution loss, fuel switching, waste management, afforestation and reforestation CERUPT: Renewables, efficiency, transportation, fuel switching, waste management CCX Methane and forestry offsets (US, Canada, Mexico and Brazil); fuel switching an renewable energy (US, Brazil); changes as agreed by offsets committee

14. WRI J. Pershing, RGGI, May 2004 LULUCF Treatment CDM Modalities under consideration, restricted to reforestation and afforestation (no conservation) JI No restrictions established (but likely to apply CDM rules) EU No LULUCF project banking; other modalities under consideration (likely to apply CDM rules) PCF Not LULUCF projects allowed ERUPT/ CERUPT ERUPT: Afforestation/reforestation projects only CERUPT: No forestry projects allowed CCX Forestry offsets (including reforestation, afforestation and conservation) allowed in US and Brazil

15. WRI J. Pershing, RGGI, May 2004 Limits to Allowable Share of Offsets CDM Up to 1% of base year emissions X 5 JI Any activity to be “supplemental” to domestic action although no limits yet set (track 2 may impose limits, note that “green investment” constraints may apply in some cases) EU Review at 6%, reconsider at 8%; must be “supplemental” PCF Not applicable ERUPT/ CERUPT Only 50% of total reductions required to be achieved through use of offsets (expected to be 1/3 through projects in capped countries, 2/3 through projects in uncapped countries) CCX Only 0.5% of the reductions in first year may be satisfied with offsets; this increases each year (to 1%, 1.5%, and 2%); no more than 5% of the total 4-year reduction from offsets

16. WRI J. Pershing, RGGI, May 2004 Timing CDM Credit for certified projects undertaken post-2000 JI Projects begun post-2000; project credit from 2008 EU Projects allowed for credit from 2008 PCF Credit for any acceptable projects undertaken post- 2000 ERUPT/ CERUPT AAUs to 2008, ERUs 2008-2012 CCX Mitigation realized from 2003-2006 on forestry projects begun from 1990, and on other projects from 1999;

17. WRI J. Pershing, RGGI, May 2004 Verification CDM Establishes operational entities and external 3 rd party certification and verification procedures; EB maintains registry JI Not yet established; track 2 likely to be based on CDM rules EU Through JI/CDM accreditation/verification processes PCF Initial verification that project built according to design specs; follow-on verification of project operation ERUPT/ CERUPT 3 rd party registration/certification following CDM rules CCX Requires registration, independent 3 rd party verification

18. WRI J. Pershing, RGGI, May 2004 Special Treatment for Renewable Energy CDM Special provisions (“fast-tracking”) for small scale RE projects (>15 MW) JI None set EU No special dispensation PCF Fund focus is on renewable energy (60% of portfolio) ERUPT/ CERUPT No special provisions CCX No special provisions

19. WRI J. Pershing, RGGI, May 2004 Baselines determine crediting levels Baseline level and crediting lifetime determine maximum number of credits from a project time emissions project emissions baseline potential credits

20. WRI J. Pershing, RGGI, May 2004 0 100 200 300 400 500 600 700 800 900 1000 tCO2/GWh 108 426 675 808 All sources Natural gas only North-Isolated region Fossil fuel only WindNatural gas (BAT) Possible emission credits under different multi-project baseline options Natural Gas (BAT) 382 Brazil: possible implications of standardised baselines in the electricity sector

21. WRI J. Pershing, RGGI, May 2004 Baseline Procedures CDM Defined case-by-case basis: (a) Existing actual or historical emissions; (b) economically attractive technology taking into account investment barriers; (c) average emissions of similar project activities in the previous 5 years, with performance in top 20% of category. Leakage addressed by inclusive project boundaries. QA/QC monitoring procedure JI Two track approach: (1) determined by host country government; (2) under auspices of supervisory committee that will develop operational rules (not yet selected); latter likely to be based on CDM rules. Former choice only allowed if host country satisfactorily complies with inventory and registry information EU Uses JI/CDM modalities, rejects projects that would lead to double counting PCF Project specific baselines using investment analysis (supply side) and control group (demand side), uses standard World Bank data for country level baseline information, use “filters” to reject projects otherwise legally required. For grid, baseline plus power expansion over time, requires assessment against plausible alternatives ERUPT/ CERUPT As with CDM, but also focus on financial and economic additionality as well as barriers test. Uses standard emissions factors for electricity, all direct and indirect sources more than 1% of baseline emissions CCX Forest and soil offsets quantified according to project size and on-site and formulaic approaches; methane from control measurements, other additionality rules still to be developed

22. WRI J. Pershing, RGGI, May 2004 Offset Program Prices Offset PriceTrading Price EU N/A~ €12/ton CO 2 * PCF ~$3 – 4/ton CO 2 N/A ERUPT/ CERUPT ~$4 – 5/ton CO 2 N/A CCX NA~$1/ton CO 2 Source: CO2e, Natsource, PCF, CCX * EU price has declined in the past few weeks as national allocations priced in market

23. WRI J. Pershing, RGGI, May 2004 Criteria for Program Evaluation Broad coverage, incentivizing lowest cost reductions wherever they occur –CDM is relatively high Assuring environmental integrity of cap (limiting “non- additional” projects); requires methodology with high confidence –CDM is unclear (projects rejected by EB – and criticized by NGOs; more projects recently passing screening) Reducing uncertainty for developers –CDM is low (note numerous project proposal rejections) Minimizing transactions costs for developers –CDM is low (estimates run to several hundred thousand $ ) Minimizing oversight costs for program managers –unknown

24. WRI J. Pershing, RGGI, May 2004 Some very generic conclusions While the rationale for offsets has prevailed (in that many systems are being explored), the difficulties in operationalizing programs has meant relatively slow starts However, level of industry interest has been quite high (number of applications rapidly increasing and suggests that offsets have mobilized innovation A review of the existing programs suggests that several solutions have been found to minimize environmental integrity loss; it is still too early to assess success in this domain. Prices suggest that offsets are less expensive than trades within and between capped parties.

25. WRI J. Pershing, RGGI, May 2004 References UNFCCC Clean Development Mechanism; COP-7 Report, part 2, p. 20-50 http://unfccc.int/resource/docs/cop7/13a02.pdf UNFCCC Joint Implementation: COP-7 Report, part 2, p. 5-19: : http://unfccc.int/resource/docs/cop7/13a02.pdf EU Offsets Program: Greenhouse gas offsets: an introduction to core elements of an offset rule; Discussion Paper C3 – 05; October 2002: http://www.climatechangecentral.com/info_centre/discussion_papers/GHGoffsets.pdf World Bank Prototype Carbon Fund: http://carbonfinance.org/pcf/router.cfm?Page=DocLib&Dtype=4&ActionType=ListItems #Les5 Dutch ERUPT Program: Dutch JI Program, Senter, http://www.senter.nl/asp/page.asp?alias=erupt&id=i001003#ERUPT/CERUPT Dutch CERUPT Program: Implementation of the Clean Development Mechanism by The Netherlands, VROM, http://www2.minvrom.nl/docs/internationaal/CDM%20Implementation%20document%2 029%20May%2003%20def_1.pdf and Dutch CDM Program, Senter http://www.senter.nl/asp/page.asp?id=i001236&alias=erupt# CCX Chicago Climate Exchange Rulebook: http://www.chicagoclimateexchange.com/about/program.html