TheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombatingClimateChangeJosephE.AldyandZacheryM.HalemWorkingPaper22-17September2022ResourcesfortheFutureiAbouttheAuthorsJosephE.AldyisauniversityfellowatResourcesfortheFuture(RFF)andaProfessorofthePracticeofPublicPolicyatHarvard’sKennedySchool.Hisresearchfocusesonclimatechangepolicy,energypolicy,andmortalityriskvaluation.AldyalsocurrentlyservesasthefacultychairoftheRegulatoryPolicyProgramattheHarvardKennedySchool.In2009–2010,heservedasthespecialassistanttothepresidentforenergyandtheenvironment,reportingthroughboththeWhiteHouseNationalEconomicCouncilandtheOfficeofEnergyandClimateChange.ZacheryM.HalemisdirectoroftheLazardClimateCenter.AcknowledgmentsThisresearchhasbeensupportedbytheLazardClimateCenter.WehavebenefittedfromfeedbackfromPatrickBolton,JaeEdmonds,CarolynFischer,NatKeohane,BillyPizer,TimSmith,andRobStavins.TheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChangeiiAboutRFFResourcesfortheFuture(RFF)isanindependent,nonprofitresearchinstitutioninWashington,DC.Itsmissionistoimproveenvironmental,energy,andnaturalresourcedecisionsthroughimpartialeconomicresearchandpolicyengagement.RFFiscommittedtobeingthemostwidelytrustedsourceofresearchinsightsandpolicysolutionsleadingtoahealthyenvironmentandathrivingeconomy.Workingpapersareresearchmaterialscirculatedbytheirauthorsforpurposesofinformationanddiscussion.Theyhavenotnecessarilyundergoneformalpeerreview.TheviewsexpressedherearethoseoftheindividualauthorsandmaydifferfromthoseofotherRFFexperts,itsofficers,oritsdirectors.SharingOurWorkOurworkisavailableforsharingandadaptationunderanAttribution-NonCommercial-NoDerivatives4.0International(CCBY-NC-ND4.0)license.Youcancopyandredistributeourmaterialinanymediumorformat;youmustgiveappropriatecredit,providealinktothelicense,andindicateifchangesweremade,andyoumaynotapplyadditionalrestrictions.Youmaydosoinanyreasonablemanner,butnotinanywaythatsuggeststhelicensorendorsesyouoryouruse.Youmaynotusethematerialforcommercialpurposes.Ifyouremix,transform,orbuilduponthematerial,youmaynotdistributethemodifiedmaterial.Formoreinformation,visithttps://creativecommons.org/licenses/by-nc-nd/4.0/.ResourcesfortheFutureiiiAbstractAsgovernments,firms,anduniversitiesadvanceambitiousgreenhousegasemissiongoals,thedemandforemissionoffsets—projectsthatreduceorremoveemissionsrelativetoacounterfactualscenario—willincrease.Reservationsaboutanoffset’sadditionality,permanence,double-counting,andleakageposeenvironmental,economic,andpoliticalchallenges.Wereviewtheroleofoffsetsinregulatorycompliance,asanincentiveforearlyaction,andinimplementingvoluntaryemissiongoals.Therulesandinstitutionsgoverningoffsetsdrivelargevariationsinpricesandinthetypesofprojectsdeployedtoreduceorremoveemissionsacrossoffsetprograms.Alackofcarbonpriceconvergenceandpotentialinformationasymmetriesmaycontributetolimitedpricediscoveryandmarketsegmentation.Takingintoaccountthefinancialpropertiesofoffsets,anarrayoffinancialandtechnologicalinnovationscouldenhanceoffsets’environmentalintegrityandpromoteliquidoffsetmarkets.Unresolvedquestionsaboutthefutureofpolicywillinfluencetheevolutionofvoluntaryoffsetsmarkets.TheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChangeivContents1.Introduction12.OffsetsasaRegulatoryComplianceStrategy33.MarketDriversforVoluntarySupply&DemandofOffsets74.ComparingtheEnvironmentalRisksofOffsetstoOtherPolicyInstruments95.ChallengesinEvaluatingEmissionImpactsofOffsets116.BuildingaRobustOffsetsMarket147.PolicyImplicationsofGrowingVoluntaryOffsetsMarkets188.References219.Figures27ResourcesfortheFuture11.IntroductionInrecentyears,governments,majorcorporations,anduniversitieshaveissuedambitiousgreenhousegasemissionpledges.Forexample,theEuropeanUnion(2021)hasenshrinedanet-zeroemissionsgoalby2050intolaw,Microsofthasestablishedacarbon-negativegoalby2030,andHarvardUniversityaimstobefossilfuel-neutralby2026(EU2021,Smith2020,HarvardUniversity2018).Ineachcase,attainingthesegoalswillrequiretheuseofemissionoffsets—emissionreductionsoutsideofagovernment’sjurisdictionorthefootprintofacompanyorauniversity.Theseemissionoffsetscouldmakeupforthedifficult-to-eliminateresidualemissionscreatedbytheentityinquestion.Iftheseoffsetsatleastequaltheresidualemissionsforthatentity,thenitwillhavemetitsnet-zerogoal.Emissionoffsetsrepresentanestimatedreductionofgreenhousegasemissionsrelativetoacounterfactual.Aproject,suchastheconstructionofawindfarm,maybeevaluatedforemissionsreductionrelativetoano-projectcounterfactualbaseline.Forexample,iftheprojectdeveloperdemonstratesthatacoal-firedpowerplantwouldhavebeenconstructedotherwise,thentheemissionoffsetsassociatedwiththewindfarmwouldreflecttheavoidedcarbondioxide(CO2)emissionsfromburningcoalatthatcounterfactualpowerplant.Likewise,sequestrationefforts,suchastree-plantingprojects,maybeevaluatedfortheirnetimpactremovingCO2fromtheatmosphereandstoringitinbiomass.TheoffsetsforsequestrationeffortswouldthenrelyonananalysistoshowhowthetreeplantingalterstheoverallcarbonequationandtheestimatedincrementalafforestationwouldthenbetranslatedintotonsofCO2storedbiologically.Emissionoffsetsmayserveasonestrategyforfirmstocomplywithgovernmentregulations,includingemissioncap-and-tradeprograms.Theymayalsoserveasastrategyforabusinessoruniversitythroughitsowninitiativetodemonstrateprogressinattainingavoluntaryemissiongoal.Ineithertheregulatoryorthevoluntarycontext,theeconomicandenvironmentalcharacteristicsofoffsetswilldependonkeyinstitutionalandpolicydesigndetails,asinanyenvironmentalmarket.Suchdesigndetailswillinfluencetheevolutionofthemarketforoffsets,astheyaffectboththesupplyanddemandforemissionoffsets,aswellastheprospectsforfinancialinnovationtoimprovetheliquidityandefficiencyofsuchmarkets.Thepromiseofemissionoffsetsasamitigationstrategyisthatitcanpromotecost-effectiveemissionabatementandbroadenthescopeofparticipationindecarbonizationactivities.Thebuyersofemissionoffsetshaveaneconomicincentivetodosowhenthecostsofreducingemissionsthroughoffsetprojectsarelowerthanwhatthebuyercanachievethroughitsowninvestmentsandactions.Encouragingthesupplyofemissionoffsetsfromotherwiseunregulatedordifficult-to-regulatesectors,suchasforestryandagriculture,orfromdevelopingcountrieswithnascentclimateTheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange2policyregimes,createsopportunitiesforlearninghowtoreduceorremoveemissionsthatcouldpromotemoreambitiouseffortsovertime.Severalchallenges,however,characterizetheestimationof,andmarketfor,emissionoffsets.Voluntaryoffsetscouldrepresentaformofgreenwashingorgreenindulgences,allowingabusinesstoappearlikeitistakingactiontoaddressclimatechange,butwithlittlematerialbenefittotheenvironment(Dalsgaard2022).Anoffsetsprojectcoulddeliver“papertons”—estimatedemissionreductionssoldtoanotherparty—thatresultin“hotair”—anincreaseinemissionsbecausetheprojectwouldhavehappenedanywayanditenablesthepartyacquiringtheoffsetstocontinueitsemissions.Uncertaintyabouttheenvironmentalintegrityofoffsets,resultinginpotentialbuyerslackingsufficientinformationtodiscernlow-qualityfromhigh-qualityoffsetprojects,couldcausethemarkettounravelorfailtogrow.Suchquestionshavepromptedanarrayofpotentialpolicyfixes,buttheseincreasedtransactioncostsmayhaveachillingeffectontheoffsetsmarket.Tobetterunderstandtheeconomic,environmental,financial,andpolicyimplicationsfortheuseofoffsetsinmitigatinggreenhousegasemissions,weturnnexttothelessonsfromtheuseofemissionoffsetsasaregulatorycompliancestrategy.Wethenfocusonthegrowingvoluntarymarketforoffsetsandexaminekeymarketdrivers.Theevolvingregulatoryinstitutionsandemergingvoluntaryinstitutionsgoverningoffsetssetthefoundationforanassessmentofthechallengesinestimatingoffsetsanddemonstratingenvironmentalbenefits.Inparticular,weexaminethethreatstoenvironmentalintegrityassociatedwithoffsetsprojects,drawingfrompolicyexperiencewithoffsetsmarketsandexpostevaluationsoftheirenvironmentalperformance.Weexploreopportunitiesforfinancialandtechnologicalinnovationtoenhancetheintegrityandrobustnessofoffsetsmarkets.Weconcludewithadiscussionofthepolicyimplicationsofagrowingvoluntaryoffsetsmarket.ResourcesfortheFuture32.OffsetsasaRegulatoryComplianceStrategyEmissionoffsetsemergedasawaytoreduceregulatorycomplianceburdensbyprovidingmorecost-effectiveoptionsforattainingenvironmentalgoals.Forexample,considertheimplementationofnationalambientairqualitystandardsundertheU.S.CleanAirAct.Aftersettingastandard,theEnvironmentalProtectionAgencydesignates“non-attainmentareas”thatfailtomeetthestandard,andthelawinitiallyprecludedfirmsfrombuildingnew,emittingfacilitiesinsuchareas.AmendmentstotheCleanAirActin1977enabledfirmstoconstructnewfacilitiesiftheyoffsetthesenewsources’emissionsbycuttingemissionsatexistingnearbysources(Hahn1989;SchmalenseeandStavins2019;ShapiroandWalker2020).Suchemissionoffsettransactionstypicallyrequireregulatorcertificationandapprovalof“permanent”emissionreductions,wheretheoffsetselleroftenmeetsthepermanencestandardbydemonstratingtheadoptionoflong-livedpollutioncontrolequipment.Suchacomplianceoptionhasthepotentialtodeliverenvironmental,economic,andpoliticalbenefits.Byrequiring,insomenon-attainmentareas,firmstofinanceemissioncutsatnearbyfacilitiesthataregreaterthanthenewfacility’sexpectedemissions,suchtransactionscouldreducenetemissionsinthatareaandfacilitateprogresstowardattainingtheairqualitystandard.Enablingafirmtoseekoutlower-costemissionreductionopportunitiesimprovesthecost-effectivenessofcomplyingwiththeairqualityregulationsandmostoftheselocaloffsetsmarketsrealizedmarginalbenefitsinexcessofmarginalcosts(ShapiroandWalker2020).Permittingsuchimplementationflexibilitycanfacilitatethepoliticaldurabilityofairqualitypolicy(CarlsonandBurtraw2019).Thefundamentalchallengewithoffsetsliesindemonstratingthattheemission-reductionprojectwouldnothavehappenedotherwise(Hahn1989).Theenvironmentalbenefitsdependonthe“additionality”oftheactivity;thatis,evidencemustbeproduceddemonstratingthattheinvestmentandassociatedemissionreductionsaremarginalandhencearetheresultoftheoffsetstransaction.Failuretodemonstrate“additional”emissionreductionscouldproduce“papertons,”definedasemissionreductionsrecordedinatransactionthatdonotreducenetemissionsinpractice(Butler1984,DudekandPalmisano1988).Inanefforttoaddressthepotentialforpapertonstounderminetheenvironmentalintegrityofoffsetsandtrading,environmentalregulatorsdevelopedproject-specificreviewandverificationmethods,whichhavealsoincreasedthetransactioncostsassociatedwithoffsettrading.Nonetheless,theseearlyCleanAirActexperiencesinformedpolicyexperimentationinvariousformsofemissionstrading,includingthedevelopmentofoffsetsprogramstoaddressgreenhousegasemissions.The1992UnitedNations(U.N.)FrameworkConventiononClimateChangeestablishednon-bindingemissiongoalsfordevelopedTheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange4countriesandavoluntaryoffsetsprogram,oftenreferredtoas“jointimplementation.”Underjointimplementation,onecountrycouldinvestinanemission-reducingprojectinanothercountry.Suchproject-basedtransactionscouldevolveintoaninformalemissionstradingmarket,sinceneitherpartytothesetransactionsweresubjecttoemissioncaps.Adecisionatthe1995U.N.climatetalkspreventedanationalgovernmentfrominvestinginajointimplementationprojectinanothercountryandusingtheestimatedemissionsreductionsasameanstoshowprogresstowarditsvoluntarygoaltolimitemissionsto1990levelsby2000.Asaresult,onlyafewdevelopedcountriesinvestedinpilotprojectsofjointimplementationtoprovetheconcept,buttheseeffortsresultedinlimitedemission-reductionactivities.Theseearly,modesteffortssetthestageforexpandingtheroleofoffsetsinsubsequentinternationalnegotiations(Wiener1998).The1997KyotoProtocolestablishedthefirst,legally-bindingemissiontargetsforindustrializednationsandenabledthesecountriestoemployanarrayofmarket-basedapproaches—includingemissionstrading,jointimplementationamongindustrializednationswithemissiontargets,andtheCleanDevelopmentMechanism(CDM)indevelopingcounties—asapartoftheirimplementationandcompliancestrategies.TheCDMinstitutionalizedaprocesswhereanemission-reductionprojectinadevelopingcountrycouldberegistered,evaluated,andissuedcredits—offsets,referredtoasCertifiedEmissionReductions(CERs)—thatcouldbesoldtoadevelopedcountryforitsuseindemonstratingcompliancewithitsKyototargets(LecocqandAmbrosi2007;GillenwaterandSeres2011).LikethepossibilityofpapertonsunderCleanAirActproject-basedtrading,CDMprojectsraisequestionsofadditionality.Ifaprojectinadevelopingcountrythatwouldhavehappenedanywayreceivesemissionreductioncreditsthatoffseteffortstocutemissionselsewhere,thenthiscouldresultin“tropicalhotair”—anetincreaseinemissionsoriginatingfromdevelopingcountries(Meyers1999,Philibert2000).TheCDMExecutiveBoard,createdundertheKyotoProtocol,developedrulestogovernthisnewoffsetmarketandattempttominimizesuchtropicalhotair.Thesemarketrulescoveredprojecteligibilitycriteria;processesandmethodsforestimatingemissionreductionsandmonitoringprojectsonemission-relatedoutcomes;registrationandevaluationofspecificCDMprojects;issuanceofoffsetsthatmaybesoldbyregisteredprojects;andcertificationofindependentprojectauditors.Withanobjectiveofdemonstratingenvironmentalintegrity,CDMoffsetsprovidedalow-costwayfordevelopedcountriestosatisfytheirKyototargets.ArobustCDMoffsetsmarketwithbuyersspreadamongthedevelopedworldcouldalsoenablegreaterglobalcost-effectivenessbyindirectlylinkingcountry-specificmitigationprogramsviatheoffsetsmarket:ifdevelopedcountryAboughtCDMoffsetsanddevelopedcountryBboughtCDMoffsets,thenaliquidoffsetsmarketcouldresultincarbonpriceconvergenceamongcountriesAandB(Jaffeetal.2009).SincetheCDMwouldrequireproject-specificverification,thetransactioncostswereexpectedtoresultinlessemissionabatementthanwouldbeexpectedunderacap-and-tradeprogram.Moreover,theCDMeligibilityrulesprecludedsomeformsofResourcesfortheFuture5emissionabatement,suchasbuildingnewnuclearpowerplantsorsector-oreconomy-widepolicies,suchasacarbontaxortradableperformancestandard.EarlyanalysesoftheKyotoProtocolassumedthatdevelopingcountriescouldreduceemissionsundertheCDMat15-20percentofwhatenergy-economicmodelsestimateunderanefficienteconomy-widecarbonprice(TheWhiteHouse1998;WeyantandHill1999).Toputthis“20percenthaircut”assumptionincontext,considerathoughtexperimentinwhichwetaketheaveragerealizedcarbonpriceintheEuropeanUnionEmissionsTradingSystem(EUETS)between2008and2012—theprimarymarketdestinationforCDMoffsetsduringtheKyotoProtocol’sfirstcommitmentperiod—andsimulatewhattheU.S.government’smodelinganalysiswouldhaveestimatedforChina’semissionreductionsundertheCleanDevelopmentMechanism.WithaverageEUETSallowancesofabout€14/tCO2,Chinawouldhavebeenexpectedtoproducemorethan300MMTCO2ofoffsetsperyearviatheCDM.Inpractice,Chinaproducedcertifiedemissionreductionoffsetsofalittlelessthanhalfthisamount—about135MMTCO2peryear—duringthe2008to2012period.1China’sCDMcertifiedemissionreductionsrepresentedalittlelessthan10percentofthereductionsthatwouldhavebeenexpectedfromaneconomy-widecarbonpriceof€14/tCO2.WhilethisgapbetweenpotentialandrealizedreductionsmayreflectexcessivelyoptimisticassumptionsaboutemissionsabatementinChinainlate-1990senergy-economicmodels,theinstitutionaldetails,selectiveeligibilityofemission-reductionactivities,andassociatedtransactioncostsoftheCDMlikelyprecludedemissionreductionsthatwouldotherwisebeeconomicunderlower-transactioncostpolicies.WhiletheKyotoProtocolallowednationalgovernmentstobuyanduseCDMoffsetstodemonstratecompliancewiththeiremissiontargets,thelargestdriverofdemandforsuchoffsetscamefromEuropeanfirmscoveredundertheEU’scap-and-tradeprogram.TheEUETSallowedfirmstoacquireandsubmitCDMcreditsinlieuofETSemissionallowancestodemonstratetheircompliance.Doingsoeffectivelyconvertedtheoffsetsintoacommodityonparwithallowances,whichenhanceddemandamongfirmsforoffsetsandimprovedmarketliquidity.Indeed,CERstradedatpricesfairlyconsistentwith,butatamodestdiscountto,ETSemissionallowancesthrough2011(Ellermanetal.2016).TheresultingrevenuesforCDMprojectsindevelopingcountriesdeliveredononeofthepromisesofmarket-basedapproacheshighlightedinthe1997Kyotonegotiationsbytheiradvocates:theseprojectscouldprovideeconomicbenefitstothesecountrieswithlowcostsofreducingemissions(Aldy2004).Theresultingdemandcatalyzedsubstantialgrowthintheoffsetsmarket:in2012,developingcountries’projectsgenerated350millionmetrictonsofcredits(Figure1).Forthepost-2012period,theEUsetqualitativeandquantitativelimitsontheuseofCDMcredits,reflectingconcernsabouttheenvironmentalintegrityofCDMprojects.Forexample,theEUprohibitedtheuseofCERsfromprojectsthatdestroyedindustrialgases,suchas1TheSubcommitteeonEnergyandPower(1998)includesseveralhundredpages–includingspreadsheetsofmodelingresults–ontheClintonAdministration’seconomicanalysisoftheKyotoProtocol,whichservesasthebasisforthissimulation.TheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange6HFC-23andnitrousoxide,becauseofthelikelihoodthatthesedidnotdeliveradditionalemissionreductions.TheEUalsobegantolimitCDMcreditsfromcountryoforigin—allowingpost-2012creditsonlyfromprojectsregisteredinleastdevelopedcountries—andsetmaximumlimitsontheuseofCDMcreditsforcompliancepurposesbyemissionsourcescoveredbytheETS(EuropeanCommissionn.d.).TheserestrictionsdepresseddemandforCDMcredits,andoffsetsissuedthroughtheCDMdeclinedmorethan80percentbetween2012and2020.BuildingontheexperiencewithoffsetsundertheCDM,severalsub-nationalandsector-specificcarbonpricingpolicieshaveintegratedoffsetsintotheirdesign.Forexample,CaliforniaandtheRegionalGreenhouseGasInitiative(RGGI)cap-and-tradeprogramshaveincludedoffsetsasacompliancestrategyforcoveredfirms,althoughonlybusinessesoperatingintheCaliforniamarkethavetakenadvantageofthisopportunitytodate.TheCaliforniasystem,liketheEUETSbetween2008and2012,effectivelytreatsoffsetcreditsasfullyfungiblewithallowancesforcompliancepurposes.Incontrast,RGGIallowsoffsetstoenterthemarketonlyifallowancepricesexceedapre-specifiedlevel.Thus,theRGGIprogram’soffsetprovisionoperatesasa“safetyvalve”orcostcontainmentmechanismtopreventunexpectedlyhighprices.Offsetsinthisprogramareavailableforcomplianceonlyinhigh-allowancepricestatesoftheworld,whereastherearenosuchlimitationsonoffsetsusedintheCaliforniamarket.In2016,themembercountriesoftheInternationalCivilAviationOrganizationagreedontheCarbonOffsettingandReductionSchemeforInternationalAviation(CORSIA),whichestablishedthegoalof“carbon-neutralgrowth”inemissionsintheinternationalaviationsectorstartingin2020.Afteraninitialvoluntarycomplianceperiod,thegoalbecomesmandatoryafter2027(Larssonetal.2019).Giventhechallengesoflarge-scalecommercializationoflow-carbonaviationfuels,emissionoffsetsfrombeyondtheaviationsectorwillplayacriticalroleinwhethercountries’internationalaviationsectorcansustaincarbon-neutrality.CORSIAcouldrepresentthesinglelargestpolicydriverfordemandforemissionoffsets—ontheorderof100to250MMTCO2peryear—between2021and2035(Warneckeetal.2019).ResourcesfortheFuture73.MarketDriversforVoluntarySupply&DemandofOffsetsInthe1990sand2000s,voluntaryeffortstoreduceemissionsoftenreflectedexpectationsabout,oratleastthepossibilityof,futureregulatorypolicyandthesignalsfrompolicymakersthatfirst-moverswouldreceivecreditforearlyaction.Forexample,PresidentClintoncalledforlegislationto“rewardcompaniesthattakeearly,voluntaryactiontoreducegreenhousegases”inhis1999StateoftheUnionaddress.SomefirmsregisteredemissionreductionsthroughaDepartmentofEnergyvoluntarygreenhousegasreductionregistry(GeneralAccountabilityOffice2008;DepartmentofEnergy2011),whileothersbegantoparticipateinavoluntaryemissionreductionmarketorganizedthroughtheChicagoClimateExchange.TheCaliforniaGlobalWarmingSolutionsActof2006,whichlaunchedthestate’sCO2cap-and-tradeprogram,requiredregulatorstoprovide“appropriatecreditforearlyvoluntaryreductions”2thatenabledemissionoffsetsdatingbackto2004tobeusedforcompliancepurposesstartingnearlyadecadelater.TheAmericanCleanEnergyandSecurityActof2009,whichwouldhavecreatedaneconomy-wideCO2cap-and-tradeprogram,includedprovisionstoallocateemissionallowancesinexchangeforoffsetcreditstofirmsthatcoulddemonstratethattheyundertookearlyactiontoreducetheiremissions.3Afterthefailureoffederalcap-and-tradelegislationin2010,privatefirmsreformulatedtheirexpectationsofpolicy-drivenoffsetsdemand.Thedemandforoffsetsshiftedtouniversitiesandfirmsthatsoughttodemonstrateprogressontheirownvoluntaryemissiongoals.Collegesanduniversitieshaveadoptedemissiontargetsinresponsetosupportfromstudents,faculty,anddonors,aspartofbroaderexperimentationbyacademicinstitutionstoaddressclimatechange(Barronetal.2021).Likewise,somefirmshaveadoptedambitiousemissiongoalsinresponsetoinvestor,consumer,andemployeepressures,aswellastheleadershipofmanagers(LyonandMaxwell2008;MSCIn.d.).Consumerdemandforemissionoffsets—suchasforairlinetravel—alsoemergedasadriverforemissionreductions(SegerstedtandGrote2016).Thesupplyofoffsetshasgrownwiththespilloverfromregulatedmarkets.Thedevelopersofoffset-eligibleprojectsundercap-and-tradeprogramsandtheCDMhavelikewisegeneratedemissionoffsetsforthevoluntarymarket.Theinstitutionaldevelopmentforthird-partyverificationandindependentauditsinthesepublicprogramshavefacilitatedtheemergenceoffirmsandtrainedworkerswhocanlikewiseassesstheenvironmentalintegrityofvoluntaryoffsetprojects.Theactive2§38562(b)(3)ofAssemblyBill32,StateofCalifornia,September27,2006:http://www.leginfo.ca.gov/pub/05-06/bill/asm/ab_0001-0050/ab_32_bill_20060927_chaptered.pdf.3§795,Exchangeforearlyactionoffsetcredits,HR2454,111thCongress:https://www.govinfo.gov/content/pkg/BILLS-111hr2454eh/pdf/BILLS-111hr2454eh.pdf.TheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange8engagementofcivilsocietywiththebusinesscommunityincraftingstandardsforwhatiseffectivelyself-regulationinthevoluntarycarbonmarketreplicatesconventionalregulatorystandarddevelopment.Forexample,theIntegrityCouncilfortheVoluntaryCarbonMarket(ICVCM)—governedbyaboardconsistingofrepresentativesfromenvironmentalNGOs,sustainablefinance,academia,indigenouspeoples,andotherstakeholders—publisheda2022draftassessmentframeworkonwhichitsolicitedcommentfora60-dayperiod,akintowhataregulatoryagencymaydoforaproposedrulemaking.4Theevolutionofremotesensinghasenabledthegrowthinnature-basedsolutions,whichrelyonestimatedcarbonsequestrationfromsatelliteimageryofbiomass(LubowksiandRose2020).Asaresult,thevoluntaryoffsetsmarketgrewtoabout200MMTCO2involumein2020,justshyofthe210MMTCO2annualvolumeoftheCDMduringtheKyotoProtocol’sfirstcommitmentperiod,andjumpedtonearly300MMTCO2in2021(Figure1;ForestTrends’EcosystemMarketplace2021b,2021c).Thevariationinthecompositionofoffsetprojectsamongvoluntarymarkets,theCDM,andtheCaliforniacap-and-tradeoffsetsprogramprovidessomesuggestiveevidenceoftheimpactsofdifferentmarketdriversandinstitutionaldesigns.TheCDMverifiedmorethanhalfofitsoffsetsvolumeinprojectsthatreducedemissionsofmethane,nitrousoxide,andhydrofluorocarbons.Cleanenergyprojects—suchasinstallationofwindandsolarpower—representedamuchsmallerfractionofoffsets,andtheCDMdidnotissueanyoffsetsforbiologicalsequestration(carbonremoval)projects,suchasafforestationandreforestation(Figure2,PanelA).Incontrast,forestprojectsthatcaptureCO2andstoreitinwoodybiomassrepresentmorethanfour-fifthsofoffsetsintheCaliforniaoffsetregistry(Figure2,PanelB).AbouthalfoftheremainingCaliforniaoffsetsreflectprojectsthatreduce(ordestroy)ozone-depletingsubstancesthatalsowarmtheatmosphere.TherearenoCaliforniaoffsetprojectsthatreduceemissionsthroughrenewableenergyprojects.Insharpcontrast,renewableenergyrepresentsmorethanhalfofthevoluntaryoffsetsmarketin2020(Figure2,PanelC).Nearlyone-thirdoftheoffsetsinthevoluntarymarketreflectforestryprojects.Thetypesofprojectseligibleforoffsetsundervariousprogramsdifferconsiderably,asevidencedbytheabsenceofreforestationintheCDM,butitsdominanceinCalifornia’soffsetsregistry,and—conversely—theabsenceofrenewableenergyintheCaliforniaregistry,butitsdominanceinthevoluntarymarket.Determiningprojecteligibility,andhowthatintersectswithemergingclimatepoliciesthatmaymandate,subsidize,orotherwiseresultinthedeploymentofvariousemission-reductiontechnologiesandactivities,willplayacriticalroleinthegrowthinoffsetsovertime.Anarrayofprivatesectorforecastsforthevoluntaryoffsetsmarkethavebeenpublishedinrecentyears.Forexample,theTaskforceonScalingVoluntaryCarbonMarkets(2021)projectedthatthevalueofthevoluntaryoffsetsmarketcouldincreasebyanorderofmagnitudeoverthisdecade,reachingabout$50billionperyearin4Refertothepublicconsultationathttps://icvcm.org/public-consultation/(lastaccessedAugust19,2022).ResourcesfortheFuture92030.BloombergNewEnergyFinance(2022)publishedthreeoffsetmarketscenarios,witha2030annualmarketvalueof$190billionforthemostbullishscenario.Toputthisincontext,thevalueoftheEUETSallowancemarketin2020wasabout€210billion(Refinitiv2021).Inshort,thefutureofvoluntaryemissionoffsetsisuncertain,butpotentiallyquitesignificantasameanstofinancedecarbonizationefforts.4.ComparingtheEnvironmentalRisksofOffsetstoOtherPolicyInstrumentsThepotentialgrowthinoffsetsmarketswilldepend,inlargepart,ontheenvironmentalintegrityofoffsetsprojects.Ifoffsetsdonotappeartoresultinmeaningfulemissionreductionsorremovals,thentheadvocatesforrapiddecarbonization—investorsinpublicly-tradedfirms;students,alumni,andfacultyofuniversities;thepublicandkeystakeholdersweighinginonpublicpolicy—mayopposetheiruseinvoluntaryandregulatorycompliancestrategies.Theinabilitytodemonstrateenvironmentalintegritywouldweakenthebusinessandfinancialcaseforinvestmentinoffsets.Toputtheenvironmentalconsequencesofoffsetsincontext,considerhowoffsetscomparewithotherpolicyinstruments,suchasthosethatsubsidizespecifictypesoflow-andzero-emittinginvestmentsandthosethatmoregenerallypriceemissions.Anoffsetprojectproducesastreamofemissionreductionsandassociatedoffsetrevenuesovertimesimilartoproductionsubsidies,suchastheU.S.productiontaxcreditandotherjurisdictions’feed-intariffsforrenewablepower.Cleanenergysubsidies,likepublicsubsidiesmoregenerally,oftensufferfromatargetingchallenge:makingasubsidyavailableforanobservedinvestmentoroutputrewardsbothprojectsthatwouldhavehappenedanyway(inframarginalprojects)aswellasthoseprojectsthatproceedasadirectresultofthesubsidy(marginalprojects).Largefractionsofinframarginalclaimantscanreducethecost-effectivenessofcleanenergysubsidies(e.g.,HoudeandAldy2017)—thegovernmentmakespaymentstoclaimantsforprojectsandinvestmentstheywouldhaveundertakenregardless—butsuchpoortargetingwouldnotincreaseemissions.Incontrast,anoffsetsprogramwithasubstantialdegreeofinframarginalprojectscouldengenderanetincreaseinemissions;thebuyersoftheoffsetcreditsfromtheprojectswouldnotundertakeemissionmitigationwithinitsownfootprintorfinanceanalternativeprojectthatwouldhavebeenmarginal(additional).Asaresult,grantingcreditsfornon-additionalorinframarginalprojectscouldcrowdoutmarginaloffsetsprojects.Anoffsetprojectgeneratesoffsetsthatcanbeusedonparwithemissionallowancesinsomeemissiontradingprograms.Thisissimilartoavoluntaryopt-intoacap-and-tradeprogram,suchashowPhaseIIgeneratingunitscouldoptintoPhaseIregulationundertheU.S.sulfurdioxide(SO2)cap-and-tradeprograminthe1990s(MonteroTheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange101999).Adverseselectioncancharacterizesuchopt-in:sourceswithloworzero-costofemissionreductions(i.e.,inframarginalemission-reductionprojects)couldoptintothemarketandsellallowances(inthepastSO2marketcase)oroffsets(inthecurrentCO2cap-and-tradeprogramcontext).Ineithercase,theemissioncapeffectivelygrowsbyeithertheallowancesallocatedtothefirmsoptinginortheoffsetssuppliedbyeachoffsetsproject.Theenvironmentalriskthatopt-insourcesmayreceiveallowancesinexcessoftheiremissionsundertheSO2market—andhenceincreaseoverallSO2emissions—waslimitedbythefive-yearwindowforPhaseI.Unlessanoffsetsprojectexpectstobecoveredbyfutureregulation,thereisnotananalogoustimelimitationonthisriskforoffsets.Byconsideringoffsetsasfungiblewithallowances,thebuyeroftheoffsetsbearsnoenvironmentalrisk.TheinstrumenthasthesamecompliancepropertiesasallowancesandeachoffsetconveystheholderwiththerighttoemitonetonofCO2underacap-and-tradeprogram.Incontrast,ifthebuyerbearsliabilityforemissionsoutcomesofanoffsetproject,thentheoffsethaspropertiesmoreakintoabond,inwhichthereturnsareafunctionoftheenvironmentalintegrityoftheproject.Forexample,ifafirmacquiresoffsetsfromaforestpreservationproject,andthentheprotectedlandburnsinawildfirereleasingmuchofthestoredcarbonthatgeneratedtheoffsets,isthebuyingfirmliablefortheenvironmentaldamage?Doestheemergingvoluntaryoffsetsmarketresembleafungible,homogenousallowance-likemarketormoreresembleavariable-qualitybondmarket?Recentevidencerevealssignificantpriceheterogeneityintheoffsetsmarket.PricesforoffsetprojectsinAsiaareaboutone-tenthofthepricesinOceania,andoffsetprojectpricesinEuropearedoublethoseinLatinAmericaandAfrica(Figure3,PanelA).Averageoffsetpricesbyverificationstandard—therulesdeterminingthequantityofoffsetsforagivenproject—likewisevarybyanorderofmagnitude(Figure3,PanelB).Andonthedemandsideofthemarket,theaveragepriceforoffsetspaidbybuyersdiffersbyafactoroffouracrossmajorsectorsoftheeconomy(Figure3,PanelC).In2020,CORSIA-eligibleoffsetsaveragednearly$5/tCO2,withaspreadbetweenminimumandmaximumpricesofnearly$50/tCO2(ForestTrends’EcosystemMarketplace2021a).Suchpricedispersioncould,intheory,reflectsearchcosts,althoughtheavailabilityofsuchinformation(e.g.,afreereportavailableonline,ForestTrends’EcosystemMarketplace2021)suggestsrelativelylowsearchcosts.Thevariationinpricesacrossverificationstandardsillustratestheimportanceoftherulesandprotocolsforprojectevaluation:whatcountsasanemissionoffsetinonestandardmaynotinanother.Tobefair,somestandardsdifferinthetypesofprojectstheyfocuson,andthedifferencesincostsamongprojecttypescouldexplainsomeofthisvariation.Andthecorrelationamongsomeprojecttypesandgeographiesmayalsoexplainsomeofthevariationinpricesacrosscountries.Theabsenceofpriceconvergenceamongbuyers,however,signalsdifferencesintherulesthatindividualcompaniesemploytoidentifyappropriateoffsetsfortheiracquisition.Thesepricedataareconsistentwithasegmentedmarketinwhichsomefirmspurchaseoffsetswithlowerenvironmentalintegrityorgreaterenvironmentaluncertaintythanothers.Theheterogeneityinpricesmayalsoreflectfundamentaldifferencesamongcorporatedecision-makersinResourcesfortheFuture11termsoftheeffectivereservepricestheyarewillingtopayforoffsetsinimplementingtheirvoluntaryemissiongoals.5.ChallengesinEvaluatingEmissionImpactsofOffsetsWhileconceptuallyappealingasalow-costwaytoreduceemissions,implementingoffsetsinpracticeraisesanumberofchallengingissues(AldyandStavins2012).Whatwouldhavehappenedwithouttheproject—thecounterfactualscenario—maybechallengingtoillustrateandimpossibletoguarantee.Thepotentialforoffsetsprojectstoundermineenvironmentalintegrityofregulatoryandvoluntaryschemeshasmotivatedconsiderableeffortamongregulators,civilsociety,andtheprivatesectortodeveloprulestoevaluatetheemissionreductionsandremovalsofoffsetprojects.Demonstratingthataprojectdeliversemissionbenefits,however,isdauntinggiventhatthecomparisonmustbemaderelativetoanunobservedcounterfactualscenario.Incontrasttoacarbontax,cap-and-tradeprogram,oremissionperformancestandardinwhichcompliancereflectsmonitoredandmeasuredemissions,offsetsreflectestimatedemissionreductionsorremovals.Consideranumberofpotentialthreatstotheenvironmentalintegrityofoffsets,whichcantheninformthedevelopmentofrules—privateandregulatory—thatcouldenableamoreliquid,high-integrityoffsetsmarket.First,systematicbiasesinestimatingbaselinecounterfactualscenarioscouldresultinexcessiveestimatesofemissionreductions.Forexample,voluntaryprojectstoreducedeforestationandforestdegradationintheBrazilianAmazonemployedexantebaselineswithhigherratesofdeforestationthanevidentthroughexpost,quasi-experimentalestimationofdeforestation(Westetal.2020).Akeyfactorinthisanalysis,whichwereturntobelow,isthefailuretoaccountfornationalpublicpoliciesthatmayaffectthebaselineactivitythatcharacterizesthepotentialforemissionreductionsandremovalsbyoffsetprojects.ArecentanalysisofCDMwindfarmprojectsinIndiafoundthatmorethanhalfofthecertifiedprojects—representing52percentofthetonsofissuedoffsets—were“blatantlyinframarginalprojects”(Caleletal.2022).TheyfoundthattheseCDM-qualifyingprojectshadmoreprofitablecharacteristicsalongeachofanumberofprojectdimensionsthannon-CDMprojectsthatcameonlineinthesamestateandyear.SincetheCDMoffsetsdonotappeartobenecessaryfortheseprojectstohavemovedforward,theestimatedemissionsoffsetsarenotlikelytobeadditionaltowhatwouldhavehappenedanyway.Relatedtothis,offsetsmaycreateincentivesforfirmstomanipulatethebaseline.RecallfromFigure2that,onaCO2-equivalentbasis,one-quarterofCDMcreditsoverTheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange122008to2020reflectedreductionsinhydrofluorocarbons(HFCs).IntheearlyimplementationoftheCDM,ChinesemanufacturersbuiltexcesscapacityforproducingaspecificHFCbecausetheyfounditfinanciallyadvantageoustothenshutdownthiscapacityinordertogenerateCDMcredits(Wara2007).Ineffect,therevenuesofHFC-basedCDMoffsetsinducedfirmstoinflatetheirbaselinesbyexpandingHFCcapacitythattheywouldthen,inturn,destroytogenerateemissionreductions,onpaperatleast.Understandingwhetheraprojectwouldhaveoccurredintheabsenceoffinancingthroughoffsetsrequiresanassessmentoftheunderlyingfinancesofaproject.Thechallengeliesinthefactthatmanyoffsetsprojects,especiallyintheenergysector,areassociatedwithanactivitywithprivatemarketvalue.Buildingawindfarmmaydisplacecarbon-intensivepowergeneration,andindoingsoitproducesbothelectricityandemissionoffsets.Installingamoreefficientindustrialboilercouldreduceemissionsandenhancethevalueofenergyservicesatamanufacturingplant.Theremaybesomeexceptions;forexample,acarboncaptureandstorageprojectdoesnotdeliveranancillary(orprimary)revenuesourceotherthanthroughtheemission-reductionactivity.Ifsuchaproject,however,receivessubstantialsubsidiesfromotherpolicies(e.g,theSection45QtaxcreditintheUnitedStates[JonesandSherlock2021]),theremaystillbeaquestionofwhetherthefirmwouldhaveundertakentheinvestmentintheabsenceoftheoffsetsrevenuestream.Second,thedesignofoffsetsrulescouldinduceadverseselectionintothemarketandtheresultingcreditingerrorscanundermineenvironmentalintegrity.Commonpracticetoestimateemissionreductionpotentialinimprovedforestmanagement(IFM)projectsrequiresforestdatatobeaggregatedacrossspeciesandgeographies.DesignatingregionsthatlacksufficienthomogeneityoftreetypecancausetheaverageregionalvalueofametrictonofCO2peracretonotaccuratelyreflecttheaveragebenefitderivedfromIFMprojectsinthatregion.Inotherwords,IFMprojectsaroundlowcarbondensityforestsarereceivingcreditforhighcarbondensityforeststhatsharethesameregion.Forexample,Badgleyetal(2022)estimatecreditingerrorsinCalifornia’sforestoffsetprogramhaveresultedintheover-creditingof29percentofoffsetsissuedforcompliancepurposesintheCaliforniacap-and-trademarket.Ineffect,therulesforCaliforniaforestryoffsetsfacilitateadverseselection:byemployingregionalaveragesforestimatingbiologicalsequestration,landownerscanselectthelow-densityparcelsintheirforestswithspecificbelow-averagesequestrationforparticipationintheoffsetsprogram.Effortstoreducetheadministrativeburdenandtransactioncostsforoffsets,inthiscontext,haveunderminedtheenvironmentalintegrityoftheprogram.Thisrepresentsabout30MMTCO2,valuedatmorethan$400million.Third,considerableattentionhasfocusedontheriskofdouble-countingemissionreductionsfromoffsetprojects.Muchoftheconcernisduetothelackofstandardizationofoffsetregistriesandincompletedisclosureontheuseofemissionoffsets.Forexample,iftheconstructionofafacilityortheimplementationofaprojectenablescompliancewiththatjurisdiction’sregulationsorpolicies,thensuchprojectResourcesfortheFuture13wouldnotbeinapositiontoalsoproduceemissionoffsets.Awindfarmcouldgenerateandsellrenewableelectricitycreditsunderarenewableportfoliostandard,thusenablingautilitytocomplywiththepolicy.Ifitalsosoldemissionoffsetsasafunctionofitspowergeneration,thiswouldrepresentaformofdouble-counting.Fourth,emissionoffsettinginvestmentscouldhavegeneralequilibriumimpactsthatunderminetheenvironmentalintegrityofanygivenproject.Securingoneforestparcelforbiologicalsequestrationmayincreasetherentsforclearinganotherforestparcel,andthusreducesomeofthenetenvironmentalbenefitoftheoffsetproject(Mongeetal.2016).Buildingawindfarmtodisplaceacoal-firedpowerplantmayreducedemandforcoal,andthusimprovetheeconomicsofanotherfirmtobuildormaintainacoal-firedpowerplantthattheymightnothavedoneotherwise.Thisrepresentsaformofemissionleakagefromtheoffsetsmarket,anditcouldbecomesubstantialtotheextentthatthevoluntaryoffsetsmarketgrowsfasterthanpublicregulatoryschemesthatcovertheemissionsourcesthatsupplyoffsets.Likewise,usingoffsetstosubsidizethedeploymentofnewenergyprojects,suchaswindandsolarfarms,mayundermineincentivesforconservationandenergyefficiency.Byincreasingthesupplyofelectricity,withoutpenalizingorregulatingexistingfossilenergysources,offsetscouldlowerenergypricesinmarketsrelativetoano-offsetcounterfactual.Thiscouldcountersomeoftheoffsetsprojects’emissionreductionbenefits.Forexample,Calvinetal(2015)employaglobalenergy-economicmodeltoshowthatcleanenergyoffsetprojectssatisfyingproject-specificadditionalitycriteriacoulddeliverlessthanonetonofglobalemissionreductionforeverytwotonsofcreditbecauseofsuchenergysystemimpacts.Fifth,theenvironmentalbenefitfromtheoffset—especiallyinthecaseofafforestationandreduceddeforestationactivities—maydependnotonlyoninvestmenttoday,butthepreservationofthebiomassfordecadesintothefuture(permanence).Aforestfireorfuturedecisiontoclearthelandeffectivelyeliminatesthestreamofoffsetsestimatedintheinterim.Indeed,withgrowingwildfireriskinvariouspartsoftheworldduetoachangingclimate,agood-faithefforttoremovecarbonfromtheatmospherethroughforestprotectioncouldbeunderminedbyforestfires.Thesecausesofenvironmentalrisksinemissionoffsetscanprompt—andinmanycaseshaveprompted—rulesandpoliciestoreducetheserisks.5Exanteprojectassessmentandverificationprotocolscanaddress,tosomeextent,baselinebiasandbaselinemanipulationrisk.Suchprotocolsmayalsoserveasthebasisforexpostauditsofprojectstoensurethattheysatisfythestandardsestablishedinverificationprotocols.Whileverificationandauditingmaybesufficienttodemonstrate5Forrecentexamples,refertotheREDD+EnvironmentalExcellenceStandarddevelopedbytheArchitectureforREDD+Transactionsathttps://www.artredd.org/trees/,whichhasbeenemployedtoassessproposalstotheLEAFCoalition,apublic-privatepartnershipfinancingreduceddeforestation.AlsorefertotheCoreCarbonPrinciplesdevelopedbytheICVCMathttps://icvcm.org/public-consultation/,(websiteslastaccessedAugust19,2022).TheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange14compliancewiththesestandards,experienceindicatesthattheydonoteliminatethepossibilitythatoffsetsdeliverlessthantheirverifiedemissionreductions.Recenteffortsinexpostperformanceevaluation,whichincludeempiricalestimationofthecounterfactualbasedonreal-worldexperience,couldinformfurtherinstitutionalizationofprogramevaluationtechniquestoconfirmtheenvironmentalvalueofoffsetsprojects.Establishingpublicprotocolsforconductingperformanceevaluationsandcommittingtoundertakethemattheoutsetofaprojectcouldensurethecredibilityofevaluationsandprovideanopportunityforpublicandexpertfeedbackonevaluationmethods.Sucheffortscoulddrawfromtheemergingliteratureandpolicypracticeinprogramevaluationandretrospectivereviewofregulations(Aldy2014,2022).Leakagerisk,whetheritreflectsgeneralequilibriummarketincentivesorthelackofpermanenceofnature-basedsolutions,suggeststhepotentialvalueinrisk-managementinstruments.Thenextsectionturnstohowfinancialinnovationcouldinfluencetheevolutionofthevoluntaryoffsetsmarkettoenableenvironmentalintegrityandaccelerateddecarbonization.6.BuildingaRobustOffsetsMarketFinancialinnovationcanemergeinwaystoenhancetheliquidity,integrity,androbustnessofemissionoffsetsmarkets.Asastartingpoint,it’simportanttoaddressthefundamentalfinancialcharacteristicsofanoffset.Isanemissionoffsetsimilartoacommodity,likeemissionallowancesundercap-and-tradeprograms,ormorelikeabond?Ineffect,doesthebuyerbearanyliabilityfortheenvironmentalintegrityoftheoffsetproject?Recentprivatesectorproposalsandinitialpublicpolicyeffortsillustratethevariouswaysofaddressingthesequestions.Forexample,theTaskforceonScalingVoluntaryCarbonMarkets(TSVCM)(2021),spearheadedbyMarkCarney,formerGovernoroftheBankofEngland,andBillWinters,ChiefExecutiveOfficerofStandardChartered,includedmorethan50membersrepresentingvarioussupply,demand,financing,andrelatedmarketinfrastructureofthevoluntaryoffsetsmarket.TheTSVCMrecommendedstandardizedfuturesandspotbenchmarkcontractstofacilitatealiquidmarketinoffsets.Suchbenchmarkcontractswouldbeanalogoustostandardizedfuturescontractsforcrudeoil,suchastheCMENYMEXcrudeoilfuturescontract,whichspecifiesthevolume(1,000barrels),grade(WestTexasIntermediate),deliverylocation(Cushing,OK),pricing(U.S.dollarsperbarrel),andtiming(monthofcontract).Suchstandardizedcontractsforemissionoffsetswouldeffectivelycommodifyoffsetsandcoulddelivertwobenefits:enablepricediscoverythatcanreducepricedispersioninthemarketandprovidequalityscreeningofoffsets.TherecentworkoftheICVCMhasfocusedonestablishingahighResourcesfortheFuture15environmental-quality,standardizedbenchmarkthatcouldserveasthebasisforfuturesandspotcontracts.CBL,amarket-makerinenergyandenvironmentalfinancialproducts,establishedtheGlobalEmissionsOffset(GEO)spotcontract,andCMEGroupoffersafuturescontractbasedontheGEOstandard(CBL2021,CME2021).TheGEOspotcontractspecifiesthevolume(onemetrictonofcarbonreduced),qualityasdeterminedbyoneofthreeverificationprotocols(AmericanCarbonRegistry,ClimateActionReserve,andVerifiedCarbonStandard),pricing(U.S.dollarspermetricton),anddeliveryandtiming(immediateviaelectronicregistryaccount).TheGEOcontractisdesignedtosatisfytherequirementsoftheCORSIAprogramundertheInternationalCivilAviationOrganization.BuyersofGEOcontractscouldusethemtodemonstratecompliancewithCORSIArequirementsortorepresentprogresstowardtheirownvoluntaryemissiongoals.Despiterecentfinancialproductdevelopment,thereexistseverallimitationstostructuringoffsetsascommodities.First,commoditiesmarketsrequireahighdegreeofliquiditytofunctioninarobustmannerandfacilitatepricediscovery.Ongoingdebateabouttheroleofcarbonoffsetsincorporatenet-zeropledges,aswellasthefutureformandambitionofclimatechangepolicies,castashadowofuncertaintyonlong-runprivatedemandforoffsets.Second,benchmarkcontractsneedtodominatemarketshareinordertobeeffective.Akeyunderlyingassumptionincommodifyingoffsetsisthatthereexistsauniformity(ornearuniformity)offirmpreferencetowardhigh-qualityoffsets(thatwouldmeetthebenchmarkcontractstandards).Ifmarketsegmentationemerges—withacohortoffirmsoptingforlow-environmentalquality,low-costoffsets(whichcanoftentradeat$1-2permetrictonofCO2)andanothercohortoptingforhigher-quality,higher-costoffsets,therewouldbedifficultyinestablishingabenchmarkcontractwithsufficientmarketdemand.AsillustratedinFigure3,theabsenceofpriceconvergenceamongregions,verificationstandards,andbuyers,mayprovidesomeevidenceofearlymarketsegmentation.Third,theheterogeneityofcarbonoffsetprojecttypesmaycomplicatestandardizationandposechallengestoimplementingfeasibleandenvironmentallyadequatequalityscreeningcriteria.Forexample,removingCO2fromtheatmospherethroughindustrialdirectaircaptureandstoringitinadeepgeologicalformationmaybemeasurableandlikelyconsideredpermanent.CO2removalthroughnature-basedsolutionsmaybemoreuncertain—requiringestimationmodelsbasedonremotesensingdata—andsubjecttogreaterquestionsaboutlong-termpermanence.AndaCO2-avoidanceproject,suchasbuildingawindfarminsteadofapresumedcounterfactualcoal-firedpowerplant,likewisereliesonestimationandkeyassumptionsaboutthecounterfactualandemissionleakage.ThevariationinpricesbyprojecttypesmayreflectdifferencesincostsofavoidingorremovingCO2,buttheymayalsoreflectdifferencesinenvironmentalcertainty,additionality,andintegrity(Figure4).HowtocompareametrictonofCO2undereachofthesethreeprojectsTheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange16throughverificationprotocolswillplayakeyroleindeterminingthepotentialtocommodifyoffsetsprojectoutcomesthroughspotandfuturescontracts.Incontrast,securitizingoffsetsintobondswouldconditioninvestorcouponpaymentsontheemissionoutcomeofthecarbon-offsettingproject.Undersuchaninstrument,ifaprojectdoesnotdeliverthestatedemissionsreduction,avoidance,orremoval,thebondbuyerwouldbeartheliability,andthusbeexposedtocontractualrisk.Thiswouldbeanalogoustosocialimpactbonds(Liebman2011).Ratingagenciescouldevaluatespecificprojects,oraportfolioofprojectsreflectedinabond,andprovideinformationonlikelyenvironmentaloutcomes.6GroomandVenmans(2022)presentamethodforcalculatingthesocialvalueofoffsetsthataccountsforpermanenceandadditionalityconcerns.Suchquantificationscouldinformbondpricingaswellasoffsetprojectinsurancepricing.TheApril2022proposalonclimate-relateddisclosurebytheSecuritiesandExchangeCommissionindicatesthatpubliclytradedcompaniescoveredbydisclosurerequirementswouldneedtoidentifythefinancialrisksassociatedwithnature-basedoffsetsthatmayneedtobewrittenofforreplacedintheeventofawildfireorotherfactorsreducingtheiremission-removalbenefit.Thisdiffersfrommanyallowancetradingmarketsthathavebeenfairlyliquid(e.g.,theEUETS,U.S.SO2cap-and-tradeprogram)becauseoftheimplicitsellerliabilitycharacterizingtransactions.Theexperiencefrompolicy-createdmarketsillustratessomepitfallswithabuyerliabilityapproach.Forexample,theEnvironmentalProtectionAgency(EPA)implementedtheRenewableFuelStandard(RFS2)throughasystemoftradablecredits(referredtoasRINs).BiorefineriesgenerateRINsasafunctionoftheproductionvolumeandcarbonintensityoftheirbiofuels.Inturn,refineries,blenders,andimportersarerequiredtopurchasetheseRINstosatisfytheirrenewablevolumeobligationssetundertheregulation.TheRINprograminitiallyimposedliabilityforacquiringfraudulentlycreatedRINsonthebuyerswithrenewablevolumeobligations.Afterseveralcasesoffraudemerged,RINmarketliquidityfellasthebuyershadtoundertakeadditionaldiligencetoassessthequalityandvalidityofanygivensetofRINs.Eventually,theEPAimplementedaQualityAssuranceProgramthatverifiesRINsandeffectivelyeliminatesthebuyerliabilitystandardforanybuyerthatacquiredtheQAP-auditedRINs(Aldy2019).TheCaliforniacap-and-tradeprogramallowsregulatedfirmstouseemissionoffsetsforcompliance,someofwhicharesubjecttoabuyerliabilitystandard.Theresultsofthisapproachappeartobemixedtodate.Initially,someoffsetprojectdevelopersexpressedreservationsaboutthebuyerliabilityschemebecauseoftheuncertaintyitwouldintroducetoanewmarket.Advocatesofoffsetbuyerliabilityhaveemphasized6Forexample,thefirmBeZeroprovidesriskratingsonoffsetsusedinvoluntarycarbonmarketsinamanneranalogoustoconventionalcreditratingagencies(refertohttps://bezerocarbon.com/ratings/,lastaccessedAugust19,2022).ResourcesfortheFuture17thelowrateofoffsetinvalidation—about0.3percentoverthefirstsevenyearsoftheprogram—andlargevolumeofoffsetgeneration—about5MMTCO2peryearundertheportionoftheoffsetsprogramsubjecttobuyerliability—asevidenceofaliquid,high-environmentalintegritymarket(RoednerSutter2020).Itisdifficult,however,tosquarethislowrateofinvalidationof0.3percentwiththe29percentestimatedover-crediting,describedabove,forCalifornia’sforestryoffsetsprograms(Badgleyetal.2022).Thisdiscrepancycouldreflectthefactthattheconditionsthatwouldtriggeraliabilityforabuyermaybeasmallsub-setofthefactorscontributingtoless-than-expectedemissionreductionsorremovalsbyprojects.Theemergenceofvariousverificationprotocolshighlightstheimportanceofproducinginformationinoffsetsmarketstoenablebuyerstodiscernlow-qualityfromhigh-qualityoffsetprojects.Tosignalthequalityofoffsetsandimprovetheliquidityofoffsetsmarkets,avarietyoffinancialinstrumentscouldbedeployed.Forexample,bondingandinsurancecouldreducetheuncertaintyassociatedwithandenhancetheriskmanagementofthreatstothepermanenceofnature-basedoffsetsprojects.Iftheglobalvoluntaryoffsetsmarketgrowstoatleast$50billionby2030,thenanassociatedinsurancemarketcouldbeworthatleast$1.3billionglobally(Carretal.2021;Figure5).Existinginsurablephysicalrisksemanatingfromnaturaldisastersandcausescouldbesynthesizedwithadjacentmarket-specificrisksinthecropandtimberfields.HowdenandenergyriskcompanyParhelionalsodevelopedanoffsetinvalidationinsuranceproduct,whichcoversthereplacementcostforoffsetsunderCalifornia’scap-and-tradescheme.Finally,toaddressleakage,anewinsuranceinstrumentcouldberequiredthroughgovernmentregulationofoffsetsmarkets,establishedasaconditionforthird-partyverification,orencouragedbyinvestorsandotherkeystakeholdersforadoptionbyfirmsvoluntarilybuyingoffsets.Thisinsuranceinstrumentcouldpayout,intheformofadditionalemissionreductionprojects,intheeventthatanexpostleakagefromoffsetsprojectsisidentified.Suchanapproachwouldlikelyrequiremonitoringandevaluationmethodstoascertainthescopeoftheemissionslossthatcouldoccurthroughthreatstopermanenceorleakage.Creatingsecuritiesbackedbyportfoliosofoffsetsprojectscouldreducetheriskbuyersfaceofproject-specificenvironmentalfailuresandmaximizematerialimpactthroughdiversificationofprojecttypes(Climate-RelatedMarketRiskSubcommittee2020).Suchinstrumentscouldalsolowerthecostoffinancingthesupplyofoffsets.Enablingthetradingofderivativeproductscouldenhancepricediscoveryinoffsetsmarketsthatcouldfacilitategreaterinvestmentinhigh-integrityoffsetsprojects.Derivativesmarketsalreadyexistinregulatedenvironments:theIntercontinentalExchangeprovidesaplatformfortransactingfuturesandoptionsforcarbonoffsetsassociatedwiththeEUETS,California’scap-and-tradeprogram,andtheUK’semissionstradingscheme(ISDA2021).Swapsarealsocommonlyemployed(ISDA2021).Technologicaladvancementscanalsoimprovethetransparencyandevaluationofoffsetqualityandfacilitategreatermarketefficiency.Fornature-basedsolutions,carbonremovalandstoragequantitiesarederivedbyexaminingtotalbiomass,whichTheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange18mustbeestimatedbasedonthesizeanddensityofforests.SatelliteimageryandLIDAR,inconjunctionwithmachinelearning,canimprovethemonitoringandattestationofmanyoffsetprojects.Thevariationinreportingamongprojectdevelopersandverificationprotocolscanunderminetransparencyinthevoluntaryoffsetsmarket,andthelackofuniformitymayincreasethelikelihoodofdouble-countingofoffsetcredits.Tomitigatedouble-countingrisk,blockchaintechnologycouldplayaroleinmonitoringandtrackingoffsettransactions.Ablockchainsystemhasinformationrecordedinadistributedledgerandisthusdecentralized.Giventhenearimpossibilitytohackintoormodifythedistributedledger,usingblockchainforcarboncredittrackingcanbuttresstheinformationalveracityofoffsets.Additionally,carboncreditscanbetokenizedonablockchain,andtheresultingnon-fungibletoken(NFT)canbetransactedwithaguaranteeduniquenessandverification.Realizingthepotentialforfinancialmarketandtechnologicalinnovationinemissionoffsetswillrequirethedevelopmentofrulesandstandardsforevaluatingoffsetprojects’financialandenvironmentalrisks.Remarkableexperimentationhasemergedoverthepastdecade,withvariousrulesandguidelinesgoverningthird-partyverificationprotocols,spotandfuturescontracts,regulatoryapprovalofoffsets,andfirm-specificoffsetacquisitionprocesses.Enhancingtransparencyandconvergenceoncommonstandardswouldenablegreaterliquidityandenhancetheenvironmentalintegrityofoffsetsmarkets.Thishasimplicationsforreportinganddisclosureonprojects,theparametersofastandardderivativescontract,andthepotentialroleoffinancialregulatoryoversight.7.PolicyImplicationsofGrowingVoluntaryOffsetsMarketsThegrowthinvoluntaryoffsetsmarketsreflects,inpart,thegapbetweengovernmentalgoalsandgovernmentmitigationpolicies.Manyoftheuniversitiesandbusinessesdrivingtheoffsetsmarketsaredoingsoaspartoftheir“Paris-aligned”emissiongoals.TheserepresentmoreambitiousimplementationthanthatofvirtuallyanygovernmentparticipatingintheParisAgreement.Whenandhowgovernmentpoliciescatchupwithgovernments’ambitiousemissiongoalswillhaveimportantimplicationsforthevoluntaryoffsetsmarkets.Weclosebyteeingupquestionsaboutthepotentialinteractionsamongandco-evolutionofvoluntaryoffsetsmarketsandclimatechangepolicies.First,wouldagrowingvoluntaryoffsetsmarketcreatealargerbusinessconstituencyinsupportofanationalcarbonpricingpolicy?Thepoliticaleconomyofcarbonpricinghaslongbeenchallenging.Engagingmoreandmorebusinessesindecarbonization,ResourcesfortheFuture19includingthroughthesupplyandacquisitionofoffsets,mayenablebroaderbusinesscommunitysupportfornationalemissionmitigationpolicy.Moreover,thepricepertonforanoffset—totheextentthatconvergenceinoffsetpricesemergesinvoluntarymarkets—couldserveasafocalpricetoinformthesettingofacarbontaxorindesigningregulatoryapproaches,suchasacleanelectricitystandardoracap-and-tradeprogram,whichcouldincludecarbonpricecostcontainmentmechanisms(e.g.,Aldy2012).Newclimatepolicythatrecognizesoffsetprojectinvestmentwith“creditforearlyaction,”asconsideredinpastU.S.legislativeproposals,couldsecuresupportfromsomeincumbentsinvoluntarycarbonmarkets.Incontrast,thesevoluntaryeffortscouldsimplylock-inoffsetmarketsanddeterthedevelopmentofnationalclimatepolicies.Second,howdoestheevolutionofpublicpolicyinfluenceoffsetprojecteligibilityandthecounterfactualusedtoestimateoffsets?Considerthecaseofawindfarminajurisdictionwithoutanyrenewablepowerregulationsorotherrelatedpolicies,thatgeneratesemissionoffsetsrelativetoacounterfactualcoal-firedpowerplant.Anarrayofpotentialpoliciescouldreducetheestimatedemissionsoffsetsfromthisproject,fromstandardsthatwouldphaseoutcoal-firedpowerplants,torenewablepowermandates,tosubsidiesandtaxcreditsforwindfarmoutput.Thepossibilitythatfuturepoliciesandregulationscouldreducetheoffsetrevenuesofcleanenergyprojectsmayhaveachillingeffectonoffsetsinvestment.Forfirmsthatarealreadyincumbentsassuppliersofoffsetstothevoluntarymarket,thismayinformhowtheywouldengageonandinfluence—andpotentiallyoppose—futureclimatechangeregulationandpolicydiscussedunderthepreviousquestion.Intheeventthatfutureregulatorypoliciesincludeoffsetsasacompliancestrategy,theongoingeffortsofcivilsocietyandthebusinesscommunitytoestablishstandardsandverificationprocessescouldinformthedesignofregulatorystandardsforoffsetsprojects.Thismayreflectpolicyinnovationsatthestatelevel(e.g.,California),nationallevel,andinternationallevel,suchastheagreementatthe2021GlasgowclimatetalksonasuccessortotheCDMandrulesforcross-bordertradingofemissionreductionefforts(UNFCCC2021).Third,howcouldclimate-relateddisclosureregulationsinfluencetheevolutionofthevoluntaryoffsetsmarket?Disclosurerequirementscouldcreateincentivesforgreatertransparencyinthestandardsforverifyingandauditingemissionoffsets,andpotentiallyestablishacommon,minimumstandardforenvironmentalintegrity.Suchrequirementsmayalsoclarifyemissionsaccountingrules,suchasforemissionsbeyondtheboundaryofthefirm(e.g.,scope3emissionsinafirm’ssupplychain),toreducetheprospectfordouble-counting.Transparencyaboutafirm’suseofinternalcarbonpricingintheacquisitionofemissionoffsetsmayalsosendmoreinformationtopotentialoffsetsuppliersandenhancemarketliquidity.Fourth,howcouldinnovationinthedataandmethodsforexpostevaluationofoffsetsprojectsandprogramsinformtheassessmentofenvironmentalintegrityandthedevelopmentofriskmanagementinstrumentsinthefinancialsector?WithgreaterprecisioninmonitoringandmeasurementdataenablingbroaderapplicationofcausalTheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange20inferencestatisticaltools,morerigorousprogramevaluationmethodscouldestimatetheemissionimpactinpracticeofoffsetprojectsandoveralloffsetprograms.Thisrigorousevidencecouldinforminstrumentspremisedonbuyerliability,thepricingofinsurancepolicies,ortheaccountingofprogresstowardnet-zeroandotheremissiongoals.Finally,givenrecentpoliticalinterestincarbonborderadjustments,couldanimporterreduceitscarbontariffobligationsthroughoffsets?Underacarbonborderadjustmentmechanism,acoveredimportedgoodwouldneedtopayatariffasafunctionofitscarbonintensity.Emissionoffsetscouldenabletheproducerofthegoodtoclaimthatitsemissionsarelowerthanestimatedforthatclassofgood.Alternatively,theproducercouldarguethatitacquiredoffsetsatacarbonpricethatwouldbeonparwiththepricethatproducersintheimportingmarketface,thusensuringthelevelplayingfieldandlackofpotentialemissionsleakagethatwouldjustifythecarbonborderadjustmentmechanism.Ineithercase,theproducerwouldfacelowerorzerotariffs,solongastheimporter’sregulatoryagencyrecognizestheoffsets.Allowingsuchanexemptionormodificationtothecarbontariffcouldenablethecarbonborderadjustmentmechanismtospurtheoffsetsmarketinunder-regulatedjurisdictionsaroundtheworld.Doingsomay,asnotedinthefirstpoint,thencreatepositivepolicyfeedbacksformoreambitiousdecarbonizationpoliciesinthoseexportingcountries.ResourcesfortheFuture218.ReferencesAldy,J.E.(2004).“Savingtheplanetcost-effectively:TheRoleofEconomicAnalysisinClimateChangeMitigationPolicy.”PaintingtheWhiteHouseGreen:RationalizingEnvironmentalPolicyinsidetheExecutiveOfficeofthePresident,89-118.Aldy,J.E.(2012).“PromotingCleanEnergyintheAmericanPowerSector:AProposalforaNationalCleanEnergyStandard.EnvironmentalLawReporter,42,10131.Aldy,J.E.(2014).LearningfromExperience:AnAssessmentoftheRetrospectiveReviewsofAgencyRulesandtheEvidenceforImprovingtheDesignandImplementationofRegulatoryPolicy.ReportpreparedfortheAdministrativeConferenceoftheUnitedStates.URL:https://www.acus.gov/sites/default/files/documents/Aldy%2520Retro%2520Review%2520Draft%252011-17-2014.pdf.Aldy,J.E.(2019).“PromotingEnvironmentalQualitythroughFuelsRegulations.”AnnCarlsonandDallasBurtraw(eds),LessonsfromtheCleanAirAct:BuildingDurabilityandAdaptabilityintoUSClimateandEnergyPolicy,Cambridge,UK:CambridgeUniversityPress,159-199.Aldy,J.E.(2022).“LearningHowtoBuildBackBetterthroughCleanEnergyPolicyEvaluation.”HKSFacultyResearchWorkingPaperRWP22-010.Aldy,J.E.,&Stavins,R.N.(2012).“ThePromiseandProblemsofPricingCarbon:TheoryandExperience.”TheJournalofEnvironment&Development,21(2),152-180.Badgley,G.,Freeman,J.,Hamman,J.J.,Haya,B.,Trugman,A.T.,Anderegg,W.R.,&Cullenward,D.(2022).“SystematicOver‐CreditinginCalifornia'sForestCarbonOffsetsProgram.”GlobalChangeBiology,28(4),1433-1445.Barron,A.R.,Domeshek,M.,Metz,L.E.,Draucker,L.C.,&Strong,A.L.(2021).“CarbonNeutralityShouldNotBetheEndGoal:LessonsforInstitutionalClimateActionfromUSHigherEducation.”OneEarth,4(9),1248-1258.Butler,C.(1983).“NewSourceNettinginNonattainmentAreasundertheCleanAirAct.”EcologyLawQuarterly,11,343-372.Calvin,K.,Rose,S.,Wise,M.,McJeon,H.,Clarke,L.,&Edmonds,J.(2015).“GlobalClimate,Energy,andEconomicImplicationsofInternationalEnergyOffsetsPrograms.”ClimaticChange,133(4),583-596.TheEvolvingRoleofGreenhouseGasEmissionOffsetsinCombattingClimateChange22Carlson,A.,&Burtraw,D.(Eds.).(2019).LessonsfromtheCleanAirAct:BuildingDurabilityandAdaptabilityintoUSClimateandEnergyPolicy.CambridgeUniversityPress.Carr,R.,Marshall,L.,Ramesh,K.,Rickets,T.,&Christie-Miller,T.(2021).InsuringNature-BasedSolutionsintheUK.ReportproducedbyBeZero,Howden,andBlackford,September2021.URL:blackfordinsurance.com/media/afanb2ln/insurance-report-insuring-nature-based-solutions-in-the-uk-9-12-21-final.pdf,lastaccessedApril23,2022.CBL.(2021).“GEOProductGuide.”URL:https://pub.lucidpress.com/geo-product-guide/#_0,lastaccessedApril23,2022.ChicagoClimateExchange.(2011).“FactSheet.”IntercontinentalExchange.URL:https://www.theice.com/publicdocs/ccx/CCX_Fact_Sheet.pdf.Climate-RelatedMarketRiskSubcommittee.(2020).ManagingClimateRiskintheU.S.FinancialSystem.Washington,DC:U.S.CommodityFuturesTradingCommission.Clinton,WilliamJ.(1999).StateoftheUnionAddress.January19,1999.Washington,DC:TheWhiteHouse.URL:https://clintonwhitehouse3.archives.gov/WH/New/html/19990119-2656.html.CMEGroup.(2021).“CBLGlobalEmissionsOffsetFutures(GEO)FAQ.”URL:https://www.cmegroup.com/education/articles-and-reports/cbl-global-emissions-offset-futures-faq.html,lastaccessedApril23,2022.Dalsgaard,S.(2022).“TalesofCarbonOffsets:BetweenExperimentsandIndulgences?”JournalofCulturalEconomy,15(1),52-66.DepartmentofEnergy.(2011).“VoluntaryReportingofGreenhouseGases2009:Summary.”Washington,DC:EnergyInformationAdministration,August.URL:https://www.eia.gov/environment/archive/1605/pdf/0608s(2009).pdf.Dudek,D.J.,&Palmisano,J.(1987).“EmissionsTrading:WhyisThisThoroughbredHobbled.”ColumbiaJournalofEnvironmen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