The draft bill released by Henry Waxman and Edward Markey on 31 March 2009 is nothing if not comprehensive. Running to some 600 plus pages, it maps out detailed proposals for not only a domestic cap and trade scheme but also the promotion of clean energy and energy efficiency.

This brief note considers the various provisions that will promote the reduction of deforestation. Two key points can be drawn from those provisions. First, the financial mechanism envisaged for promoting reduced deforestation should, if implemented, ensure predictable long term financial flows. Secondly, the deployment of those financial flows will operate primarily through encouragement and recognition of international offsets arising from reduced deforestation. A word of warning though: considering the complex political currents associated with the US response to climate change, there is no guarantee this bill will ever become law or, if it does, whether it will contain similar provisions as this draft. In the short term, one of the main benefits form the bill will be to track the nature of the debates it initiates and thus gauge the political appetite in the US for such mechanisms.

Key elements of the draft bill relevant to REDD include:

  • Establishing the principles for a long term commitment to reducing deforestation via bilateral or multilateral agreements with selected developing countries under which a US body will issue ‘international offset credits’ for emission reductions measured against a national deforestation baseline.
  • Creating a financing mechanism that will generate funds in a predictable fashion from the start of a domestic US cap and trade scheme. Those funds will be dedicated to the purchase of the ‘international offset credits’ mentioned above. Thus, as the complex and difficult work is taken forward to enable such credits eventually to be issued, significant funds will have already started accruing. In essence, the funding mechanism involves: (i) placing specified volumes of the US emission allowances to be used in the US domestic cap and trade scheme into a strategic reserve that will be auctioned regularly; (ii) using the monies raised from these auctions to purchase the international offset credits mentioned above; and (iii) retiring the purchased credits and replacing them with a volume of US emission allowances amounting to 80 per cent of the volume retired (which will then be available for further auctions from the strategic reserve).
  • A near term programme focused on developing the standards, tools and capacity to deliver on these aspirations. That programme will attempt to achieve emission reductions of 720 million tonnes of CO2e in 2020 and a cumulative total of 6 billion tonnes of CO2e by the end of 2025. There is a particular focus on developing national deforestation baselines. Importantly, there is also a recognition that pilot projects during this period may be sub-national. To assist this, emission allowances from the domestic US scheme will be reserved for transfer to developing countries that enter into an arrangement with the US and achieve emission reductions through these pilot projects.

Understanding the above elements in more detail requires some brief background on the operation of the cap and trade scheme proposed under the draft bill. In particular, understanding the operation of the proposed strategic reserve of emission allowances is key to understanding how funds will be generated to promote reduced deforestation.

US Reduction Targets and the Strategic Reserve

The bill proposes a linear reduction of US greenhouse gas emissions from 2012 through to 2050. Measured off a 2005 baseline, the reductions proposed start at 3 per cent below 2005 levels in 2012 and then progress to 20 per cent by 2020, 42 per cent by 2030 and 83 per cent by 2050. This approach results in the bill specifying the emission allowances available for allocation in each year from 2012 to 2050 (along with a formula for adjusting those figures in light of updated information regarding the actual emissions in 2005 and the percentage to which sectors covered by the scheme were responsible for such emissions). Importantly, the bill also provides for the establishment of a strategic reserve of allowances that will underpin quarterly auctions to entities with compliance obligations. Those auctions will include a minimum reserve price that is locked in for 2012 to 2014 and thereafter tied to a rolling 36 month average traded carbon price. In the period from 2012 to 2019, 1 per cent of the allowances available for allocation will be transferred to the reserve. This percentage will increase to 2 per cent for the period for 2020 to 2029 and then 3 per cent from 2030 to 2050. The reserve will be further topped up with emissions allowances offered for sale but not sold at allocation auctions.

Use of Strategic Reserve Funds

Hopefully, the effect of this is that it may be possible to make fairly robust predictions of the funds that could be generated through strategic reserve auctions. This is important as, critically, those funds are to be used to purchase “international offset credits issued for reduced deforestation activities”. The international offset credits that will be purchased are ones issued by the administrator pursuant to a bilateral or multilateral agreement or arrangement to which both the US and the relevant developing country are a party. The international offset credits acquired will then be retired and US emissions allowances issued equalling 80 per cent of the number of credits retired. Those US emissions allowances will then be available for later auctions from the strategic reserve.

There is also an interesting mechanism to allow holders of international offset credits from reduced deforestation to request for those offsets to be sold by the US administrator via the strategic reserve auctions. Those conditions include: (i) the international offset credits will only be sold once the emission allowances being sold under the auction are depleted; and (ii) the administrator determines it is highly likely that the permitted usage of other allowed offsets (i.e. the domestic and international offsets allowed to be used for compliance under the scheme) will exceed 80 per cent of 2 billion tonnes of CO2e. Importantly though, the amount that a seller using this mechanism can receive is capped at the average daily price for international offset credits sold on a recognised exchange during the six month period prior to the auction. Revenues in excess of that figure will be retained by the Treasury.

  International offset credits from reduced deforestation

The draft bill provides some key principles regarding the elements of a scheme whereby international offset credits can be issued but leaves much to be developed. Some of those principles include:

  • the activity to reduce deforestation has to occur in a country listed by the administrator (having regard to factors such as the technical capacity of the country to monitor and measure forest carbon stocks and necessary institutional capacity such as strong forest governance);
  • the quantity of international offset credits is determined by comparing the national emissions from deforestation relative to a national deforestation baseline for that country established in accordance with the relevant bilateral or multilateral agreement or arrangement. The baseline will take account of average deforestation rates for at least 5 years and establish a trajectory that would result in zero gross deforestation by no later than 20 years after establishment of the baseline);
  • issuance occurs only after emission reductions have been achieved; and
  • the administrator has made appropriate adjustments such as a discount for uncertainty.

Capacity building and reward of for supplemental emission reductions

The bill establishes a near term goal of using reserved US emission allowances to achieve the reduction of emission from deforestation in developing countries. The supplemental emission reductions sought to be achieved through this program are 720 million tonnes of CO2e in 2020 and a cumulative total of 6 billion tonnes of CO2e by the end of 2025. In the period 2012 to 2025, 5 per cent of US emission allowances available for allocation will be reserved for this purpose. This percentage will decrease to 3 per cent for the period 2026 - 2030 and then to 2 per cent for the period 2031 to 2050. The goal is to not only preserve existing forest carbon stocks (particularly in developing countries with largely intact native forests) but also build capacity to reduce deforestation and participate in international markets for international offset credits from reduced deforestation. Programme activities include:

  • subnational deforestation reduction activities, including pilot projects;
  • development of measurement, monitoring and verification capacities;
  • development of governance and enforcement capacities; and
  • development of standards to ensure supplemental emission reductions are additional, measurable, verifiable, permanent and account for leakage and uncertainty (including the requirements for national deforestation baselines).

Although there is limited detail, the bill intends that the reserved US emission allowances that can be used as an incentive for this programme can only be provided after supplemental emission reductions are achieved and verified. The emission allowances can be distributed not only to the relevant developing country that is participating in the program under a bilateral or multilateral agreement but also private or public groups or an international fund. It is intended that the support provided through the programme will only last for five years from the date of entry into the agreement with the developing country (with the potential to extend by a further 5 years if sufficient progress is being made). The bill does not clarify how recipients will monetise US emission allowances received through achieving supplemental emission reductions. For instance, as drafted, it appears that the funds from the strategic reserve auctions will only be used for the purchase of international offsets credits from reduced deforestation.

Comment

If the bill (or at least the elements discussed in this article) receives wide-spread political support, it may act as an important catalyst for international negotiations relating to REDD. In particular, in the context of international negotiations which have, to date, failed to generate detailed proposals, these mechanisms will act as an important template for long term financial mechanisms utilising carbon credits as the preferred deployment vehicle. However, this remains a bill that faces significant hurdles before it can become law. As mentioned earlier, rather than assuming the bill is the shape of the US response to climate change, it is better to use it as a political barometer. It also contains some innovative design ideas that international negotiators would do well to consider.