An Idealized CO2 Capandtrade System with Land Use Sinks

Table 8.1 depicts a completely fictional situation in two imaginary countries. Both have the same fossil fuel CO2 emissions in 1990 and the same projected level of fossil fuel emissions in 2010, a year chosen to be representative of the Kyoto commitment period. Country A is a large net land use sink, and country B is a moderate land use source. In the absence of any policy, country A's sink is projected to rise and country B's land use source is also projected to rise. If we imagine a hypothetical Kyoto-type target of returning to 90% of 1990 emission levels, we can see that in this example the target is different when we apply it only to fossil emissions or to total net fossil and land use emissions. Looking at the row labelled 1, country B appears to gain by including land use emissions because its allowance level based on total net emissions is 99, up from 90, when only fossil emissions are included. Country A gets only 72 allowances compared with 90, and therefore looks worse off with the total CO2 accounting. But comparing the projected situation in 2010 as shown in the row labelled 2, it is actually country A that benefits from the total accounting because it needs to reduce only 23 below projected reference (compared to 30 if applied only to fossil fuels), and country B that is worse off, requiring a reduction of 41 with the total accounting compared with 30. This occurs because in the absence of any policy, sinks are projected to increase in country A, thus reducing the need to lower emissions or further enhance sinks.

In country B, however, the land use source is growing, thus putting more pressure over time to reduce emissions or increase uptake to offset the land use source.

What if, instead of the sink and source growing in these countries, it was projected to fall to a zero net sink and source? The reduction for country A from projected 2010 net total emissions would then be 48 in the total accounting example if they needed to return to 90% of 1990 emissions, whereas for country B the required reduction would be 21.

The first lesson is that moving from a fossil-only accounting to a total accounting including both land use and fossil emissions does not necessarily benefit the country that gets more allowances or the country with the large net sink in the base year. What is important is whether in the absence of policy the land use sink or source is projected to grow or to reduce.

The second lesson is that including sinks in a total accounting framework does not necessarily lower the real reduction. In the situation portrayed in Table 8.1, including sinks results in a real reduction below reference, totalling across both countries, of 64 compared with only 60 if sinks were excluded. Net emissions to the atmosphere in the fossil-only case in 2010 are country A (90 - 25) + country B (90 + 20) = 175, with the total accounting net emissions restricted to country A (72) + country B (99) = 171. In other situations, which readers can invent if they desire, total accounting could lead to an increase in net emissions.

The third lesson is that any effect on net emissions to the atmosphere due to the inclusion of land use sinks can be eliminated by adjusting the target reduction. If one has a projection of land use emissions for 2010, it is easy to calculate an adjusted percentage reduction from 1990 that will lead to exactly the same 'reduction of 30 from reference' in 2010 for each country with a total accounting. Adjusted percentages below 1990 (0.81 for country A; 1.00 for country B) are simply 2010 reference emissions less the 30 reduction from 2010 estimated in the fossil-only policy and then divided by the 1990 total net emissions. This results in a 'differentiated' reduction percentage for the two countries. Even though they are identical in terms of fossil emissions, differentiation occurs because they differ in terms of land use emissions. This assumes that the total reduction of 60 and the equal split of 30 in each country had some special merit.2 The calculation depends on having a pro

Table 8.1. Two hypothetical countries' fossil and land use carbon, 1990 and 2010. Relative units are given.

Country A

Country B

Net land use

Net land

Fossil

emissions (+)

Total net Fossil

use emissions

Total net

emissions

or uptake (-)

emissions emissions

(+) or uptake (-)

emissions

1990

100

-20

80 100

10

110

2010 Reference

120

-25

95 120

20

140

Allowance allocati

ons and real reductions: fossil

-only compared with total net accounting

1. Hypothetical

Fossil-only

Total net Fossil-only

Total net

target of 0.90

of 1990

90

72 90

99

2. Reduction

from 2010

projected

emissions

30

23 30

41

jection of net land use emissions, and so one could argue that you cannot be sure you would get the same reduction in both cases because of this uncertainty. However, the same differentiation concerns arose for fossil emissions where there were recognized differences in projected growth among countries, and those projections were also highly uncertain at the time the targets were set.

To implement a trading system that operates among private parties the countrywide allocation must be distributed to private parties. This raises some additional issues about the implications for land use owners participating in a cap-and-trade system that often seem not well understood. We have thus invented, in Table 8.2, another hypothetical situation, focusing on the domestic situation in country A. Here we imagine two fossil fuel users with identical emissions in 1990, and two landowners: one with net sequestration and one that is a net source. One of the fossil fuel emitters has a projected decline in emissions in the reference for 2010 while the other's reference path will increase substantially. Landowner 1 remains a sink but the sink declines, while landowner 2, a source in 1990, becomes a small sink in 2010.

It is almost inevitable that the gross sink amount in the country (adding together the sink for only those landowners or parcels that are net sinks) is much greater than the country's net sink amount. Earlier, we used the example of the estimated 902 million tonnes as the annual net sink in the USA to illustrate how that could be used to offset US emissions. If one keeps to the simple strategy of measuring all terrestrial sinks and sources, the net sink is the offset. Much of the discussion of sinks credits, at least in the USA and Canada and as expressed in the Kyoto Protocol, focuses exclusively on credits for carbon uptake. This leaves out of the programme those landowners who

Table 8.2. Hypothetical situation for emissions sources and sinks in country A, with a target of 0.90 reduction from 1990 below total net emissions. Units are arbitrary.

Fossil source 1

Fossil source 2

Landowner 1

Landowner 2

Emissions in 1990 and reference emissions projections for 2010 1990 50 50

2010 Reference 40 80

Possible allowance allocation, within parentheses required reduction (+) or excess allowances (-) that could be sold

1. Grandfather to 1990 with proportional reductions

2. Estimate

2010 reference with proportional reductions

3. Proportional responsibility from 2010 reference

4. Credit for 1990 baseline sink, proportional reduction for all sources from 1990

5. Credit for any sink in 1990, allowance to match any land use source, proportional reductions for fossil sources from 1990

are net sources. If that is the background, the amount of sink credit is not limited by the net sink but by the gross sink amount, which is a much larger number. The gross sink amount is not even well defined unless the parcels of land are well defined and unchanging over time. In the example of Table 8.2, consider the possibility that landowner 1 has some land that is a net source, emitting 20 annually in 1990. To have a net sink of 40 in 1990, the remaining areas are thus a sink of 60. If there is an incentive to count only net sinks, landowner 1 might sell the parcel that was a net source, and thus get credit for 60 instead of 40. The ability to divide parcels into sinks and sources is nearly fractal in nature, making the potential gross sink huge.

This issue of deforestation is not ignored in the Kyoto Protocol - reducing deforestation is a potentially creditable action - but the failure to include the entire terrestrial biosphere in tracking compliance with the policy targets creates problems. There is an incentive for those who might reduce deforestation or who have sinks or might increase them to register credits, depending on how the baselines are established, but no accounting in compliance with the target cap of those that are likely to remain a source or become a bigger source. Lack of full coverage creates the problem of leakage - reductions among credited sinks being offset by increases in non-covered land areas. However, allowing landowners to voluntarily register credits when it is in their interest worsens the problem because it is almost certain to enlist mostly those who intended to increase sinks anyway, while producing no incentive to control for those who had intended to become a large source.

In the second part of Table 8.2, some hypothetical allowance allocation principles have been considered. Supposing that a cap would cover terrestrial biosphere sources and sinks as well as fossil emissions. The common implicit assumption in most discussions of sinks allowances is that one can only cap sources, not sinks. Of the five allowance allocation principles in Table 8.2, the first two do not distinguish between sources or sinks in setting allowances, i.e. they give no special consideration of the zero point on the number line.

Principle 1 is essentially the Kyoto allocation rule as applied to a country's emissions, used to allocate the allowances among entities within a country and including both fossil sources and land use owners. Like the Kyoto national allocations, it uses 1990 as a benchmark and allocates the reduction to individual entities proportionally - country A's target is 90% of 1990 net emissions, and thus each entity receives an allocation proportional to its 1990 emissions and/or sinks. For the land use source, this is a reduction of its emissions to 18 from the 20 in 1990. For the land use sink, the allocation is -36 compared with emissions of -40 (i.e. a sink of 40 in 1990). Rather than getting an allowance of zero, 40 more than it 'needs' as of 1990, landowner 1 starts in a debit position but at least as of 1990 there was enough sink to cover this debit (and indeed an excess). The very different rates of growth of emissions and changes in sinks for the 2010 reference conditions reveal the same issue that has plagued the Kyoto national allocations. If the targets are undifferentiated, these different expected growth rates lead to very different burdens. So even though the Kyoto allocations refer to 1990, differentiated reductions for individual countries take into account to some degree expected differential growth in emissions. Here we see that allocation principle 1 results in very different required reductions for individual entities. Fossil source 1 and landowner 2 have allocations well above the projection of reference emissions. They could sell these allowances, and probably reduce further at low cost and sell even more. The burden of buying permits would fall on fossil source 2 and landowner 1, even though landowner 1 is a large sink. How big this differential growth effect can be obviously depends on how differently emissions and sinks are expected to change for different entities.

Allocation principle 2 corrects this differential growth problem by making the allocations proportional to the projected reference for 2010. This reveals a different issue that arises with simply multiplying the base by 0.9. The mathematics works to produce the right national cap of 72 but the rule means that any entity that is a sink will necessarily have excess credits to sell, and this occurs for both landowners in this example. The algebra of this reduction is

National target = %RED * EMISS

where %RED is the required national reduction from reference, EMISS is emissions from fossil sources and SINKS is net emissions (sink or source) from land use.

Allocation principle 3 seeks to make the burden of reduction proportional to the level of emission source or sink by altering Eq. 8.1 slightly:

Knowing the national target, projected emissions and projected sinks, one can then solve this for the %A. This formulation simply generates an allowance allocation that, without trading, would require sources to proportionally reduce their emissions and sinks to proportionally increase their sink. For the example we have created %A = 0.159. Emissions sources get an allowance that is 15.9% below projected reference emissions, and sinks get an allowance debit of 15.9% more than their projected sink. This again leads to an allocation that meets the national cap, but now no entity has allowances that would allow them to sell credits without taking some additional action beyond what is projected to occur in the reference. Each entity bears a 'proportional' burden.

This formulation is far from perfect. Note that landowner 2 has a small net sink, and so the equiproportional change results in a small absolute change. Consider a landowner who coincidentally is at zero, neither a source nor a sink. This landowner would get away without any burden, even though he or she may be in a position to become a significant sink without much effort. At first look, this is not so different from the problem faced by fossil emitters - reductions may be costly and difficult for one and easy for another, and so equiproportional reductions need not imply the same cost burden. However, for landowners it is not unreasonable to imagine an owner of 100 acres and an owner of 1,000,000 acres. If the latter coin-cidentally has zero net emissions, no burden exists under this allowance principle. Yet, other things being equal, there would be much more scope for increasing sinks on the 1,000,000 acres than on the 100.

The principles for allocation rules 4 and 5 are closer to what appears to be the view of the land use community. The implicit equity principle is that coincidentally being a sink means that one should be able to sell all of the sink allowances. In both of these, landowner 1 gets zero allowances rather than a debit as in allocation rules 1-3. Even though this entity's sink is declining, he or she has allowances to sell even without reversing the decline. Allocation principle 4 treats the landowner source symmetrically with the fossil emission source, requiring a proportional reduction in emissions. Again, however, the zero problem is likely to occur. Big landowners with a source approaching zero would have a very small required reduction, with the potential to easily become a large sink. This could be considered an asymmetric treatment with that of fossil emitters but it is a symmetric treatment with landowner 1, the net sink. Being a net source is villainous, but crossing zero on the number line makes you virtuous with a generous allocation of allowances as your reward.

Allocation rule 5 further distinguishes between land use emissions and/or sinks and fossil emission sources by granting landowner sources an allowance equal to their emissions. This is closest to the implicit assumption that landowners would enter a programme voluntarily and have no burden to reduce unless they chose to do so. Thus, landowner 2 could do nothing to change his or her land use emissions, and still would not have to acquire additional allowances. While on the face of it, this is close to current policy approaches to include sinks via a credit system, capping landowner 2 is actually far better. While he or she gets allowances equal to expected emissions requiring them to do nothing, emissions cannot increase without acquisition of permits to cover them. Thus, it prevents spatial leakage, at least within the countries that follow this policy. Of course, the more allowances one grants to landowners, the more the burden shifts to fossil sources. Allocation rules 4 and 5 used 1990 conditions as the basis for establishing allocations. The same principles could be applied to reference 2010 emissions as in allocation principle 2. We are not proposing that one or the other of these allocation rules is preferable, but use these examples to illustrate that there are a number of ways to extend simple allocation principles that might be used for fossil sources to terrestrial carbon sources and sinks with very different implications for burden-sharing.

The problem Kyoto negotiators ran into was that they agreed to the burden on fossil emission reductions first. They then needed to produce language and processes to make sure that sinks credits would really be reductions beyond a baseline; otherwise the situation in which 'hot air' from sinks credits might cover all emissions increases would have been a distinct possibility. As the negotiations occurred in the run-up to signing the Kyoto Protocol in 1997, because they had little data on sinks in 1990 or projected levels in 2010, it was impossible to adjust the allowance levels to take these into consideration. At the time, the chosen approach - caps on fossil emissions and sinks allowed in as credits against the cap - was perhaps the best that could be done. The approach, however, has left us with a legacy of poorly defined categories of land use activities.

A reading of the views of the community that usually discusses sinks and sees profit in them is that they envision allocation rules like 4 and 5. The moral premise for getting this windfall gain appears to be that sequestering carbon is virtuous and it should be rewarded. However, the main reason the uptake is now occurring is that in the past history of this land, deforestation or tillage practices occurred that released carbon. So today's virtue is only erasing yesterday's vice. Thus, most people would not automatically find allocation principles such as 4 and 5 compelling. These are issues of equity or relate to perceptions of what is fair. Potentially being forced to buy additional allowances even though a landowner is a net sink would no doubt strike some as unfair. The issue of credit for past actions is one that also affects combustion sources, whereby firms would like to get credit on the basis of having adopted less emitting practices before adopting the policy. At the start-up of a programme there is an incentive issue beyond the fairness issue: if allocations are based on actual performance in years before the start of the programme, as they have been in most cap-and-trade systems, firms would have an incentive to perform poorly up to the start of the programme or risk receiving a small allocation based on low emissions. Thus, there is some basis for giving such credits to encourage early action, but determining a baseline is difficult. If one begins applying such early action credits, it only makes sense to maintain 'policy neutrality' so that every credit given for past action is balanced by tightening the overall cap. At least one must recognize that generous crediting for prior action may mean that a cap will not achieve the reduction originally planned.

One issue that affects perceptions of fairness with regard to sinks allowances, however, is that any sink is likely to be temporary. Thus, if a landowner receives a permanent annual allocation requiring it to be a permanent sink, eventually it will not be possible to achieve uptake at that level. The landowner would thus need to purchase permits indefinitely even if carbon levels were fully restored to a natural state (or higher through permanent management). Such a permanent liability does not necessarily create an economic inefficiency. The lump sum (negative) allocation would result in a drop in the value of the land reflecting expectations of the cost of the permanent liability, just as a generous lump sum allocation would result in an upward value of the land reflecting the fact that the landowner could have permanent income from the sale of allowances. It should then not affect future production decisions. If one wishes to correct perceived unfairness, one solution is a one-time negative allocation, with an annual requirement of no emissions. The one-time allocation could be based on the difference between an estimated 'steady-state' carbon stock under 'good' practices and the current carbon stock under degraded conditions. The landowner could work off this negative allocation by following good practices, and after that would only need to maintain the stock of carbon.

In showing various principles by which a cap-and-trade system could be extended to sinks and sources related to land use, we have hoped to demonstrate that there is no reason why sink needs to be treated in a widely different manner as a fossil source. A target can be fashioned to achieve the same net effect on the atmosphere with land use sinks and sources included as when they are not. To do so requires an adjustment in the cap level to account for the net land use sink or source, and given different changes over time among countries or entities, their inclusion can have potentially large effects on burden-sharing that can be overcome through differentiation or choice of allocation rule. Blindly excluding land use emissions and sinks, or giving landowners the choice to voluntarily sell credits or not does not make these issues go away. It only eliminates or limits economic incentives to reduce emissions or increase sinks in the most cost-effective manner.

With this idealized system laid out, we turn to issues that have been the subject of considerable investigation regarding the inclusion of sinks with the goal of identifying which of these remain an issue, and which of them largely disappear when the policy architecture is better formulated.

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