GAO Report Rips Readiness of Carbon Offset Market for Cap-and-Trade

March 16, 2011

WASHINGTON D.C. – Oversight and Government Reform Committee Chairman Darrell Issa today made the following statement about a Government Accountability Office (GAO) report on the readiness of the current carbon offset market to facilitate additional and verifiable results:

“This study casts further doubt on the ability of carbon offset markets to play an effective role in any energy tax law or regulation. Paying for carbon reduction that might have taken place anyway and results that aren’t verifiable means higher energy costs and nothing to show for it.”

Highlights from the GAO report requested by Chairman Issa:

GAO on Verification of Offsets:

According to our review of literature, verification may be challenging because sellers of carbon offsets may have little incentive to report information accurately to program administrators, and buyers may have little incentive to investigate the quality of offsets. Unlike buyers of other commodities, like oil or corn, buyers of offsets may not care about the quality of the offsets they buy and may be primarily interested in lowering their compliance costs by purchasing lower-cost offsets. This is partly because under some designs, buyers may not be liable for the quality of offsets they purchase after those offsets have been issued by a program. (p.14)

GAO on the Permanency of Offsets:

As we have previously reported, projects that store, or “sequester,” carbon carry the risk that the stored carbon will be re-released into the atmosphere, known as a reversal. The risk of reversal is most commonly associated with projects involving forestry and agricultural soil sequestration. In these types of projects, reversals can occur as a result of human activity, such as logging or changes in tilling practices, or from natural events such as fires, storms, or insect infestations. (p.13)

GAO on Additionality of Offsets:

Although each program we examined took steps to ensure the additionality of offsets, evidence suggests that non-additional offsets have nonetheless been awarded under some existing programs. For example, the CCX, a voluntary program, awarded offsets to farmers who had practiced the credited activity for years. (p.8)

Difficulty of setting a baseline. Assessing additionality involves comparing a project’s expected reductions against a projected baseline of what would have occurred in the absence of the program … it may involve a number of assumptions that are uncertain. For example, some programs approve offsets for forest management practices, such as lengthening harvest cycles to allow forests to store carbon for longer periods. An offset program could establish a baseline for these projects by assessing historical data about how forest owners respond to changes in timber prices and other economic variables. However, it may be difficult to account for the variety of decisions a forest owner may make that affect the amount of carbon stored—for example, not all forest owners may want to maximize the amount of timber produced. Assumptions regarding this and other factors that affect the amount of carbon stored can have a significant impact on the number of offsets awarded, according to some studies. For example, one study suggested that the number of offsets awarded for a hypothetical forest management project could vary by an order of magnitude, depending on the approach used to set baselines. (p.9)

Asymmetric information. To evaluate the additionality of a project, program administrators must often rely on information provided by applicants, and in some cases, this information may be difficult to evaluate. One additionality test used by the CDM requires wind power developers, for example, to establish that a project either is not financially feasible without the revenues from offsets or is not the most economically attractive option. This can involve a complex analysis including assumptions about the internal rate of return for the project, the cost of financing, the relative costs of fuels, and the lifetime of the project. Research suggests that it can be difficult to verify these assumptions, especially since applicants know more details about the project than program administrators or verifiers, and may present data selectively to support claims of additionality. (p. 9)

Misaligned incentives. Some experts suggested that an offset program may create disincentives for policies that reduce emissions. For example, under an offset program that allows international projects, U.S. firms might pay for energy efficiency upgrades to coal-fired power plants in other nations. According to our previous work, this may create disincentives for these nations to implement their own energy efficiency standards or similar policies, since doing so would cut off the revenue stream created by the offset program. For example, some wind and hydroelectric power projects established in China were reviewed and subsequently rejected by the CDM’s administrative board amid concerns that China intentionally lowered its wind power subsidies so that these projects would qualify for CDM funding. In addition, our review of the literature suggests that in some cases an offset program may unintentionally provide incentives for firms to maintain or increase emissions so that they may later generate offsets by decreasing them. This potential problem is illustrated by the CDM’s experience with industrial gas projects involving the waste gas HFC-23, a byproduct of refrigerant production. Because destroying HFC-23 can be worth several times the value of the refrigerant, plants may have had an incentive to increase or maintain production in order to earn offsets for destroying the resulting emissions. (p.10)

Click here for the GAO report Options for Addressing Challenges to Carbon Offset Quality