Mik McKee

California extended its cap-and-trade program through 2030, but the the extension will make it harder for forest owners – especially those outside California – to earn carbon offsets after 2021. That’s bad for landowners and could raise the cost of compliance for industrial emitters, writes Mik McKee of The Climate Trust.

16 August 2017 | On July 17, California legislators voted to continue the state’s cap and trade program until 2030. With this 10-year extension, the California Air Resources Board will oversee a program that reduces greenhouse gas emissions 40% below 1990 levels by 2030. Notably, eight Republicans joined with Democrats in support of the bill.

Though widely touted by the press as a victory in the fight to reduce greenhouse gas emissions, AB 398 makes several significant changes to the program, and in doing so adds a bitter element into the mix.

Perhaps the bitterest pill was handed to forest owners through the change in how carbon offsets can be used by capped industries (called covered entities) to achieve required emissions reductions. Under the current program, which runs through 2020, covered entities can use carbon offsets to meet 8% of their emissions—the other 92% comes from the sale of allowances, which are periodically auctioned off by ARB.

Among approved offset sectors, forestry dominates with more than 65% of offsets being generated from U.S. forest projects. While not surprising given the role forests play in sequestering and storing carbon, this is also no small achievement. Specifically, forest projects have issued 43.2 million offsets since the program has been in place, and as the price of offsets has increased, more and more forest owners have started to look at carbon offsets as a real source of revenue.

Most of the forest projects that have been developed to date have carbon stocks that are well above the defined baseline levels. This means that the projects are issued a large volume of offsets during the first crediting period. This in turn provides the project owners with a substantial amount of revenue early on in the project lifespan.

However, over the last 6 months, The Climate Trust has been approached by a number of forest owners who have property where carbon stocks are at the regional baseline. These projects are not eligible for a quick payment, and instead have to generate carbon revenue through annual forest growth over the 25-year crediting period. In other words, these land owners are interested in reducing harvest levels in order to increase carbon sequestration and storage in their forests.

The reasons behind this vary. In some instances, a decline in markets is motivating landowners to look for additional sources of revenue. As carbon offsets increase in value, growing trees for carbon becomes competitive with harvesting them for low-value wood products.

In other cases, landowners have been open to discussing how carbon revenue might help pay for forest thinning projects. Big trees store substantially more carbon than small trees, so while thinning small diameter trees does not have a big impact on carbon stocks, it does promote forest health and reduce the risk of catastrophic wildfire.

Still other forest landowners have been looking at carbon offset revenue as a possible way to help with intergenerational land planning. The appeal lies in the potential for offset revenue to provide modest annual income. The encumbrance that comes with the 100-year commitment to the program may reduce the tax value of the land as well.

Unfortunately, the changes in AB 398 will likely make it more difficult for most forest owners to pursue carbon projects. Under the new bill, which goes into effect in 2021, covered entities can only use offsets to meet 4% of their emissions reductions (just half of what was previously permitted). Furthermore, half of this reduced limit must come from California-based projects.

To a large extent the evolution of this policy is understandable, as payments for California offsets will be more likely to stay within California. The problem is that this reduction is likely to have an extremely negative impact on the offset market and risks undermining the program itself, as offsets will have a reduced role as an upfront cost containment tool, as originally intended. Early analysis suggests that the program will be significantly more expensive and that there is already enough supply from existing projects to meet the 2% out-of-state volume. If this proves to be the case, it is unlikely new projects will commit to the program in the face of such market uncertainty.

Furthermore, the changes leave current out of state forest projects in the lurch. Forest owners agreed to a 100-year commitment to maintain or increase carbon stocks. The ability to sell those offsets for the duration of the 25-year crediting period factored into that decision. Despite their willingness to sign on to California’s program, currently there is no guarantee they will be able to continue selling offsets to covered entities in California.

At the end of the day, the decision to extend the cap and trade program to 2030 is a big win in the fight to mitigate climate change. However, California legislators failed to see the positive ecological impacts associated with forest offset projects. In an effort to compromise with different stakeholders, they significantly weakened a program that was just beginning to reach a point where it could have meaningful ecological benefit on a landscape scale.