Boxer-Kerry an Improvement over ACES on Offsets

by Victor Flatt

September 30, 2009

This post is first in a series from CPR Member Scholars examining different aspects of the Boxer-Kerry bill on climate change, which was released today.

With respect to offsets, the Boxer-Kerry bill is a distinct improvement over the ACES. It allows a relatively strong approach to offset integrity, avoiding negative social or environmental effects, and facilitating possible integration with other systems. It also addresses some issues that will be important to the functioning of a trading market, but still leaves some uncertainties that could cause problems in the market.

Probably the most important difference between the bills is that the Boxer-Kerry bill does not specify which agency would be in charge of administering and ensuring the integrity of any offset program. In the House bill, a last minute compromise switched all of the administration of biological sequestration offsets to the USDA from the EPA, a change widely criticized by environmentalists because of the belief that the USDA would not be as effective in regulation. The Boxer-Kerry bill doesn’t specify any agency, instead referring to the executive branch actor only as “the President” (which means it could be delegated to one or more different agencies). Of particular interest is that in the 801-page draft which leaked out yesterday, the program was administered by the EPA, but that this provision was dropped from the proposed bill. This might indicate that Senators Boxer and Kerry prefer the EPA as the offsets administrator, but that they are willing to have some ambiguity on the issue if it helps win farm state votes.

With respect to offset integrity, Boxer-Kerry makes accounting for offset reversals (when the anticipated amount of offsetting fails to occur) a key part of the bill; and unlike the Waxman-Markey bill, reversals are to be avoided and accounted for in all offset categories, not just biological sequestration. This is very important as it closes a huge loophole which could have destabilized the system and market. Though expanding the accounting for reversals to all offset categories, Boxer-Kerry does generally follow the lead of Waxman-Markey in dealing with offset reversals. Section 734(b) requires that the President require offset developers to either contribute offset reserve amounts to a central account registry equal to the probability of reversal times the total offset credit amount, or to hold insurance that would allow for the purchase of offset or emission allowance credits for any offset failure. The offset reserve option also features the requirement that the reserve be replenished by the project offset developer with half of the lost credits for an unintentional reversal or all of the lost offset credits if an intentional reversal. One could suppose that since unintentional reversals could be fully accounted for in the initial reserve requirements (since unintentional offsets should coincide with statistically likely failures) having a replacement of only one half of the loss would be more than sufficient to preserve the integrity of the system. The truth is that reversal probability calculations are so unknown at this time that we cannot be sure about the ratio of reserves to failures. Requiring a one-half replenishment might be more than sufficient or not enough. It is really a guess at this point, and though the statutory requirement of one-half is pretty specific, other provisions of the bill would allow the President to take actions to preserve the integrity of the required reductions.

The bill also embraces the notion that offsets should not cause impacts on the environment or other important social interests in many different bill sections. Just as in Waxman-Markey, the offsets advisory board, which is to make recommendations on offset categories, is to also give advice and recommendations to the President on “ways to improve or safeguard the environmental integrity of the programs.” (731(c)(6)). But in addition to considering environmental issues with respect to offset categories, the bill also requires the president to act (including rejecting individual projects) “to avoid or minimize, to the maximum extent practicable, adverse effects on human health or the environment resulting from the implementation of offset projects under this part.” (Sec. 732(c)). This gives the President or implementing agency authority to create regulations about environmental harms from offsets or reject offsets outright, and this is a very important recognition that offsets may create environmental or other harms. The President is also given broad leave to require that project developer’s applying for offset credit provide information about environmental or other effects of the offsets, by having a catchall phrase that the President can require all offset verification reports to have “any other information” that he believes necessary to fulfill the requirements of the Act. (736 (c)(6)).

With respect to the emissions allowance market, the offset parts of the bill have some positive attributes. It pulls back from the initial offering in Waxman-Markey of whole categories of already approved offsets (which the project developers wanted), replacing it with a requirement that the advisory board come up with the first set of categories within a year, but does then specify particular categories which the advisory board should consider. This basically ensures that the Advisory Board can approve these initial categories very easily without too much delay, which should increase the overall market liquidity. There is still the problem that the President is given power to assign offset reversal compensation to anyone (734(b)(1)), which means that in theory, the underlying inherent (not speculative) value of an offset could be decimated without warning, creating a toxic asset which could infect other commodity classes. However, when read with the other reversal provisions, which require insurance or reserves of the offset project developer, it seems unlikely that the holder of an offset would be required to account for reversals. Even if this is true, since it is so important to the market that holders of approved offsets do not bear the risk of arbitrary reversal, the bill should be changed to specifically hold only the offset developer responsible.

This bill comes a long way in ensuring integrity, recognizing relations to international systems (a provision requiring that forestry offset credits be able to meet international standards under the UNFCCC), and accounting for the important environmental impacts that offsets can cause. If it can make corrections to assist the market, this will be an excellent offset system to work with.

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Victor B. Flatt is the  Dwight Olds Chair and Faculty Director of the Environment, Energy and Natural Resources Center, University of Houston Law Center, and a Distinguished Scholar, Global Energy Management Institute at the University of Houston.

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