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Ozone depleting substances and the Climate Action Reserve: Perverse Incentives?

Some may have noted in the figures in my post from last week that the Climate Action Reserve’s portfolio of issued offsets has a heavy emphasis on the Ozone Depleting Substances (ODS) protocol. To date, about 1/3 of issued Certified Reduction Tons (CRTs) come from destruction of ODS at just one facility in Arkansas. This is also why Arkansas is the origin of the greatest number of issued CRTs to date. There are actually two ODS protocols, one for international and one for domestic ODS. These protocols, particularly the international protocol, illustrate some of the problems with the CAR process as well as some of the potential pitfalls of offsets in general and so bear further examination.

First off, a note on process. The ODS protocols were developed by a working group that included not a single person with an environmental advocacy background (see the acknowledgments to get a sense for participation in the Working Groups). This is neither good from an optics perspective nor a substantive one. Furthermore, the public workshop for this protocol and notice and comment could not have been more poorly timed to elicit participation. The workshop was held on December 7, 2009 and notice and comment period for the draft protocol were from November 20 to December 18, 2009. These dates may not seem like a problem until you consider what else people interested in international carbon markets might have been preparing for and attending at the time (hint: I do not mean Thanksgiving followed by an extended round of work-related holiday parties). So, after the working groups failed to include NGO participation, the process was poorly designed to illicit comment.

Indeed, it might have made more sense, given the international nature of what was under consideration, to hold the public meeting as a side-event at COP-15, either on- or off-site. If memory serves, the CAR was represented in Copenhagen. Now this isn’t to say that the Policy Team at CAR intended anything nefarious with their scheduling; it is to say that the schedule they chose was very poorly designed to attract participation.

Now to substance: the protocols require that a project purchase ODS from a private or public facility, transport it to a RCRA certified or equivalent ODS destruction facility within the US, and then certify the chemical’s destruction. So far so good. The question a thoughtful offsets critic might ask is, how much credit does the developer get for this? And when? The protocols give 100% credit for projected atmospheric emissions over a 10-year period on the day that the ODSs are destroyed. The protocols call this “conservative.” I would argue that it is both extremely aggressive in its GHG accounting and creates potentially perverse incentives for Article-5 (developing country) parties to the Montreal Protocol.

The accounting is aggressive because it assumes that the current legal and regulatory restrictions on ODSs will not get any stricter over the next 10 years. This makes little sense, especially for Article 5 countries, which, under the Montreal Protocol, only stopped producing the ODSs in question as of January 1, 2010. These countries might very well be in the process of developing stricter regulations concerning the capture and destruction of existing, legally produced, stocks of ODSs within their borders. The protocol ignores this possibility, blithely stating that economic incentives favor continued recycling of this material.

That argument may have had merit for non-Article 5 parties to the Montreal Protocol (developed countries) because substitutes were in the process of being invented and phased in for these countries at the same time as the ODSs were being phased out. It is less clear that the same will be the case in major developing economies where the substitutes have been in use for some time. It’s one thing to hoard your Cluorofluorocarbons when there are no competitive substitute gases or substitute compatible equipment. But that is just not the case for Article-5 parties in the present day because of the earlier phase out in the non-Article 5, developed countries.

In short, the protocol makes the most aggressive assumption possible regarding credit for ODS destruction by giving all the credit upfront for tons that might or might not have been allowed to leak over the next decade. A far more conservative assumption would have been to give credit on an annual basis based upon regulatory developments in the ODSs country of origin.

The protocol also creates regulatory incentives that disfavor domestic or international action to deal with ODS banks at agreed incremental cost. One of the key successes of the Montreal Protocol is its Multilateral Fund (MF). The MF has, over the past two decades, paid the agreed incremental costs of conversion from ODSs to safer alternatives in Article-5 nations. It has distributed more than $2.5 billion to more than 6000 individual projects. “Agreed incremental cost” means an agreed upon additional cost of an alternative technology relative to the use of the CFCs. So if for example, CFC production costs $100 million while HCFC production costs $110 million, the MF will kick in $10 million to make the net-cost to the developing country zero. Negotiation and agreement of these costs occurs at the level of the MF Executive Committee. I, amongst others, have proposed that this program might be the appropriate avenue, rather than the carbon market, for especially potent GHGs.

The US government under both the Bush and Obama Administrations, has supported extensions, first proposed by the Maldives, to the Montreal Protocol that are explicitly aimed at reducing the climate impacts of ODS. What does this have to do with the ODS protocols produced by CAR?

Creation of these protocols is, given time, likely to create a strong constituency opposed to further modifications to the Montreal Protocol that might address the existing banks of ODS. It’s worth noting that addressing these banks has been the subject of substantial study and policy analysis, most of which recommends against the use of carbon markets. Thus to the extent that the CAR protocol creates an incentive for a government to cease domestic efforts to deal with its banks of ODS, resources are likely being wasted (via inframarginal rents derived from the carbon market), more effective domestic regulation is discouraged, and international action on this important issue for the ozone layer and climate is likely delayed.

None of this context is even addressed in the protocol’s justification of additionality (of what would have happened in the absence of the carbon offset project). The protocol instead takes the view that the regulatory picture for ODS banks is static, rather than highly dynamic, and elects to freeze the regulatory picture so far as it relates to offset crediting, in the present day. This both discourages what would likely be more cost- and environmentally effective approaches to these ODS and potentially allows the use of these substances within domestic cap-and-trade schemes, thus diluting the environmental credibility of the climate initiatives. Once again, a better solution here would be to allow credit to be claimed for 10 years but to issue credits on an annual basis that takes into account the then-current regulatory picture for these gases.

My personal view is that the CAR needs to do a much better job of incorporating environmental NGOs or advocates into their protocol development process.  This will help to insure both political credibility and that truly conservative assumptions regarding baselines and accounting are built into their offset protocols. Better process can lead to better substantive outcomes. Perhaps this will occur without any action on CARs part: climate policy wonk attention is rapidly shifting to California’s AB-32 implementation and away from Washington DC. But CAR’s Policy Team shouldn’t remain a passive actor in this – the ODS protocols illustrate the need to engage in active solicitation of NGO participants for the offset development process.

One Response to “Ozone depleting substances and the Climate Action Reserve: Perverse Incentives?”

  1. Peter Miller says:

    Michael,

    First, full disclosure. As you may know, I’m a boardmember of the Climate Action Reserve.

    Second, I take seriously your concerns about process and the need to have environmental advocates represented in CAR’s working groups. But, it is not a simple matter to find environmental advocates willing and able to commit the time and effort to help develop CAR protocols, particularly on a highly technical issue like ODS destruction.

    I don’t know if Thomas Grammig, whose comment precedes mine, meets your criteria of having an environmental advocacy background, but he is a strong advocate that was actively involved in the working group process and I very much appreciate and value his involvement.

    More generally, I agree with you that CAR needs to have the active participation of environmental advocates with substantive technical and/or policy expertise in relevant fields in order to be effective. I would like to encourage anyone who meets these criteria to participate. And, if someone has suggestions on how to improve CAR’s process and expand working group participation, please let me know.

    As for the partial overlap of the comment period with COP 15, I’ll simply note that in the current climate policy world conflicts are inevitable. If anyone has trouble meeting a comment deadline, please contact Reserve staff and let them know you will be filing late comments.

    Finally, the suggestion that a COP15 side event would have been a promising venue doesn’t square with the COP15 chaos I remember so fondly. If the public meeting had been scheduled at a side event we might have had a great discussion amongst those few who were tenacious and fortunate enough to get into the Bella Center after waiting in line outside in the cold for eight hours.

    Third (a substantive issue, at last), you argue that freezing a project’s baseline based on regulations in place at the time will create a constituency opposed to future regulatory actions. I would argue that quite the opposite is true. If an offset provider’s credit is linked to future regulations — as you recommend — then the offset providers will oppose future regulations. In contrast, with a fixed baseline existing projects will be indifferent to future regulations and won’t add to the already significant opposition to future regulations.

    Also, while a variable baseline reduces the possibility of over crediting, it also increases risks to project proponents and would likely reduce participation. The argument that we should be willing to forego near term reductions from offset projects for the possibility of greater reductions through future regulations doesn’t strike me as a slam-dunk. I appreciate your optimism that future international action under the Montreal Protocol is likely to make a significant impact on emissions of legacy stocks over the coming decade, but I am not entirely convinced it is warranted.

    Peter Miller, Senior Scientist
    Natural Resources Defense Council
    San Francisco, CA