New AB 32 Lawsuit Challenges Use of Offsets — Our Analysis

By Prof. Alan Ramo and Luthien Niland, 3rd year law student (revised and reposted 4.9.12).

Non-profit groups Citizens Climate Lobby and Our Children’s Earth Foundation recently filed the next challenge to the California Global Warming Solutions Act of 2006 (known as AB 32), the greenhouse gas regulatory regime, in the Superior Court of California, San Francisco County.  Their complaint (retrievable here) challenges the offset program in the Cap-and-Trade regulation recently promulgated by the California Air Resources Board (ARB), the Act’s implementing agency, specifically asserting that allowing these offsets will undercut the greenhouse gas emission reduction goals of AB 32.  See California Health and Safety Code sections 38500-99.

The authors of this blog believe the plaintiffs may have uncovered a potential flaw in AB 32’s Cap-and-Trade program design.  Whether this flaw will have practical consequences is discussed below.  Further, whether this flaw rises to a legal dimension prior to the actual awards of offsets is also discussed below.  (This is a long article, for a blog, but the importance of the issue and the complicated Cap-And-Trade regulatory concepts make it unavoidable.)

The Cap-and-Trade program establishes an overall declining cap on greenhouse gas (GHG) emissions for California, which is then met by limiting annual emissions of GHGs from major sources.  In order to monitor and enforce emission reductions, sources are required to obtain and submit to the ARB “allowances” that equal their total emissions.  If a source is going to exceed its allotted emissions in a particular year, the source may purchase allowances from other entities or use allowances that it saved, or “banked,” from previous years.

Sources that are unable to meet their GHG emission reduction obligations can also use other “compliance instruments” to meet their required limits.  These “compliance instruments” take the form of offsets, which are “voluntary greenhouse gas reductions made by entities not otherwise participating in the Cap-and-Trade Program.”  To encourage GHG emission reductions in a variety of sectors and reduce the cost of compliance, the ARB’s regulations allow facilities to meet up to 8% of their compliance obligations with offsets.  17 CCR § 95854(b)

Allowing sources to meet their AB 32 obligations using practices besides direct GHG emission reductions requires careful scrutiny to ensure that the practices are indeed reducing GHG emissions, rather than creating a smokescreen of regulations to give the appearance that GHG emissions are being reduced.  To ensure that this was occurring, the legislature mandated that all market-based compliance mechanisms, such as offsets, be “real, permanent, quantifiable, verifiable, and enforceable.”  Health and Safety Code § 38562(d)(2).  Just as importantly, and what serves as the basis of this complaint, is that GHG reductions achieved by the program must be “in addition to any greenhouse gas emission reduction otherwise required by law or regulation, and any greenhouse gas emission reduction that would otherwise occur.”  Id.

The ARB has defined “in addition” to mean exceeding GHG reductions that would occur in a :conservative-business-as-usual scenario”, or in the absence of the financial incentives provided by offset credits.  17 CCR 95802.  In other words, reductions are in addition to GHG reductions that would otherwise occur, and therefore eligible for offset credits, if they would not have occurred without the financial incentives provided by the the ARB offset program.

Plaintiffs are alarmed by what they view as the subjective nature of these definitions.  Further, on their face, the regulations seem to acknowledge that there is a  risk that there will be offsets that are in fact not additional.  “Conservative” is defined, for example, to mean “in the context of offsets, utilizing project baseline assumptions, emission factors, and methodologies that are more likely than not to understate net GHG reductions or GHG removal enhancements for an offset project to address uncertainties affecting the calculation or measurement of GHG reductions or GHG removal enhancements.” 17 CCR § 95802(a)(60).

To make the offset program consistent, the ARB approved four offset protocols, each describing different scenarios under which offsets can be created and used by sources that cannot meet their compliance obligations.  17 CCR  §§ 95802(a)(3), (36), (60), and (93); §§ 95970-97.  The plaintiffs argue that these protocols allow GHG emission reductions that are not in addition to reductions that would otherwise occur.  Instead, the plaintiffs assert, sources are able to use activities that are already slated to occur or presently occurring, thus cheaply meeting their compliance obligations in theory, but never resulting in true net GHG emission reductions.  The complaint outlines how each of these protocols can produce GHG emission reductions that are not truly “additional,” therefore undermining the integrity, effectiveness, and legal requirements of the program.  The complaint alleges:

  • Livestock Digester Protocol: This protocol “provides offsets for emissions avoided by the installation of anaerobic digesters used to treat manure at dairies and hog farms.”  Plaintiffs allege that such avoided emissions qualify as offsets even if this is an existing practice at a facility and even if the practice would have been adopted in the absence of any financial incentives from the offset program.  Plaintiffs cite the U.S. Department of Agriculture’s finding that many facilities around the United States could use livestock manure digesters profitably without the money provided by the offset program.  The complaint alleges that given these existing financial incentives, such offsets are not truly “additional” if farmers would adopt them anyway as independently profitable measures.  Additionally, many farms are sued for their odors and run-off and are required to pay large judgments or settlements; farmers wishing to avoid potential liability in such suits also have an incentive to install digesters, apart from the offset program.  As a result, plaintiffs assert that this protocol allows sources to satisfy their compliance obligations using emission reduction projects that are existing, ongoing, and would otherwise occur – not additional.
  • Ozone Depleting Substances Projects: This protocol “provides offsets for any destruction of ozone depleting substances removed from appliances and allows existing and ongoing activities and projects to count as offsets.”  While the ARB asserts that only 1.5% of ozone depleting substances from appliances nationally was destroyed in 2003-2004, plaintiffs allege that this data is inaccurate, and refer to U.S. Environmental Protection Agency findings that more than ten times this quantity was destroyed at that time.  Additionally, plaintiffs point out that General Electric and other manufacturers have identified the destruction of ozone depleting substances as a profitable endeavor, even without any offset profits, due to consumers’ preference to purchase appliances produced by companies that support responsible disposal.  Plaintiffs argue that between the current destruction practices and the appeal of this profitable practice, there will be offsets produced by this protocol that are not additional and in violation of the integrity of AB 32.
  • Urban Forest Projects: The Urban Forest Protocol provides “offsets for tree planting projects which are undertaken in municipalities, on educational campuses, or by utilities.”  By its very nature, according to plaintiffs, this protocol does not even make any claims that it only allows offsets for additional projects; rather, every single tree planted under such a program is considered “additional” and generates offsets, even if the trees are planted to replace those removed by utilities and other industries.  By assigning this blanket application of the offset program, evidence of past individual urban forest projects and existing plans for forest projects are explicitly not disqualified.  This is the case even though many urban forest programs are already in progress around the country, resulting in the planting of millions of trees, and benefits including energy savings, air quality improvement, and others are proclaimed by many cities.  Plaintiffs argue that given the benefits of urban forest programs and their prevalence nationwide, communities will continue to promote these activities, even without offsets.  Therefore, they say, many offsets will not be “additional,” as required by law.
  • U.S. Forest Projects: The U.S. Forests Projects protocol provides offset credits for three types of forest projects: reforestation, improved forest management practices, and avoided conversion.  With each of these projects, the ARB must decide whether the forest project would have occurred irrespective of the offset program, or if it is additional to what would have occurred if offsets were not sold.  The criticisms in the complaint of this particular protocol flush out an overarching paradox with offset programs: allowing agencies to make their subjective, “best guess” estimates of what would have happened in the future in order to satisfy a standard of ensuring real, additional GHG emission reductions.  Reforestation projects, for example, produce offsets if the net present value of the expected timber is projected as a loss, such that under business-as-usual conditions no one would invest in the project because it was not profitable.  Yet even these estimates are subjective and uncertain, as they are characterized by the ARB as “expected” and the variables assessed are easily manipulated to produce desired results, according to the plaintiffs.Another project that is part of this protocol, improved forest management practices, is claimed to be similarly uncertain.  Whether or not forest management practices are “improved” is based upon “average” forest management practices as a class.  As a result, according to the plaintiffs, entities that have already implemented “above average” forest management practices for years can now convert these practices into offsets, even though no actual additional reductions have occurred.Finally, “avoided conversion” is a practice that is based solely on future promises.  To meet this protocol and create offset credits, one must merely assess a piece of land to find that it is suitable and profitable for a particular type of development and then vow not to develop the land in this way.  This protocol does not protect, however, against the inherent subjectivity in an analysis making future projections about profitability.  Additionally, no regulations exist to prevent someone from “preserving” a particular parcel of forestland to obtain offset credits, only to then convert another parcel to satisfy the market demand for the converted use.  These problems skew the concept of “additionality” and again undermine the goal to reduce GHG emissions, the plaintiff allege.

Plaintiffs made similar claims in numerous comments as these protocols were developed.  The ARB responses in many cases were based upon the theme that in awarding individual offsets it will be very careful to assure the offsets are “additional” and the protocols incorporate numerous conservative assumptions and performance standards to assure unnecessary offsets will not reasonably occur.

The ARB relies upon so-called “performance standards” that only guarantee a “significantly better than average GHG production for a specified activity, which, if met or exceeded by a project developer, satisfies the criterion of ‘additionality.’” See Staff Report and Compliance Offset Protocol for Livestock Manure Projects, 10/28/10, p. 5, retrievable  here.

An example of a performance standard in the forest protocol is that if a piece of land had less than 10% tree canopy cover for ten year, then any project to increase trees must be due to offset incentives, not business as usual.  The ARB admits it will assume that the piece of land would persist in its present state but for an offset inspired new project, regardless of whether economic conditions might have led the owner to add trees anyway.  Final Statement of Reasons, October 2011, p. 22 retrievable here.

Another problem is leakage.  If an owner of land stops logging, but the demand for that logging is unabated, in theory all that would occur is that leakage will cause increased logging in other areas.  All the ARB in its response to comments could say was:  “We recognize the need to use the most scientifically defensible and up-to-date quantification methods, especially as it relates to accounting for leakage risks. At this time there are relatively few published articles that have explored leakage risks, and while there is broad recognition that the risks of market leakage exist, there is also high uncertainty associated with available estimates. We determined not to modify the factors adopted by the stakeholder workgroup that developed version 3.0 of the Climate Action Reserve Forest Project Protocol at this time, and expect that leakage risk will be one of the areas to be evaluated in more detail and updated based on the latest science when the protocol is updated in the future.”  Id. at P. 1043.

If plaintiffs are reading the regulations correctly, it does seem that at least some offsets will not be additional, such as the offsets that are based on subjective projections of future events in the U.S. Forest Protocol, for which no amount of care by the ARB would be able to correct.  Further, awarding offsets based upon the assumption that projects will continue their carbon storing function for 100 years, as required by the regulations, and will be withdrawn or penalized if they do not, seems quite ambitious.  (100 years ago in California, Wyatt Earp was running around Hollywood trying to get into the movies). Protocols that sanction at least some non-additional offsets would seem to conflict with a statutory command that would prohibit “any” offsets that are not additional.  CA Health & Safety Code § 38562(d)(2).

Plaintiffs do not allege that it is impossible to have any additional GHG emission reductions under these protocols (though as mentioned later, they are seeking an injunction against any offset program).  Instead, they assert that, because it is almost always cheaper to implement a program or practice for which the infrastructure is already in place, sources will justifiably back these programs first, thus meeting their compliance obligations with reductions that would have occurred even without AB 32.  In addition, the flaws in these protocols allow sources to take advantage of practices that are profitable even without the offset regulations, thus likely undergoing practices that any business looking to make a profit would have done regardless of AB 32.  These easy cost-benefit analyses have the potential to overrun the offset program, to a point where AB 32 is essentially nullified because its obligations are met almost entirely by reduction measures that would have occurred even without the law.  Indeed, since sources can satisfy up to 8% of their total emissions with offsets, up to 85% of all GHG emission reductions required by the Cap-and-Trade program could be met with offsets, rather than actual reductions, according to plaintiffs.

This 85% figure especially caught the attention of the authors of the blog.  Plaintiffs reference a New York Times article where an official with the ARB said the percentage of offsets compared to the expected reductions could in theory reach 85%, though it was unlikely.

That’s kind of an astounding figure.  It makes getting the offset protocols correct pretty much the whole ball game as to whether Cap-and-Trade will have any value for reducing greenhouse gases.  However, our investigation suggests the figure is actually even higher, 100%.  Here is our analysis, so get ready for a lot of math (for an excellent article on much of this math, though he may not agree with where we took it, see Rheed Enion’s excellent piece on the Legal Planet blog.)

The cap on total GHG emissions from capped industries per California regulations for 2020, the last year of the compliance period under AB 32, is 334.2 million tonnes of CO2 equivalents.  17 CCR 95841, Table 6-1.  Under 17 CCR § 95854(b), the cap on offsets is 8% of facilities’ total greenhouse gas emissions (a change from the original 4% meant to compensate for the withdrawal of allowances for a reserve to assure industry that prices would not be high).  That means the amount of offsets can only be around 27 million tonnes.  One might leap to the conclusion that offsets are a very small part of the greenhouse gas budget.

However, to get to 334.2 million tonnes, the capped industries have to reduce from the anticipated business-as-usual level of 409 tonnes.  Still, that suggests there needs to be about 75 million tonnes of reduction over the next eight years, of which only 36% can be achieved with offsets.

But the key is to compare the total offsets that could be available, 27 million tonnes, with the amount of reductions required from Cap-and-Trade that will not already occur due to other mandated measures, that is, the “additional” reductions expected just from the Cap-and-Trade’s market mechanism.  ARB appears to have let the cat out of the bag when it published its Final Supplement to the Scoping Plan Functional Equivalent Document ([FSuppFED) to address a prior lawsuit. In a new “no-project” analysis, the ARB admits that these “capped” sources will have to reduce anyway under what are called “complementary” measures so that all that is left for Cap-and-Trade to accomplish is a final 18 million tonnes.  See FSuppFED at 12.  The ARB refers to a number of mandatory measures from the Renewable Energy Portfolio Standard, building efficiency measures, light duty vehicle standards to the Low Carbon Fuel Standard.  That means the potentially available amount of offsets at 27 million tonnes, even if not fully utilized, can fill this 18 million tonnes gap, requiring no new reductions from these sources than those already required by existing measures.

That makes the plaintiffs’ claims about offsets crucial to whether a Cap-and-Trade is anything more than a symbolic exercise in phantom accounting and will truly contribute to greenhouse gas reductions.  To be sure, merely the fact that the design allows offsets to be used up to a certain level does not mean that there will be that many offsets actually certified by the ARB.  State bureaucracy and its delays may slow the number. Potential generators may not fully take advantage of the opportunities, additional or not.  Further, the ARB may be overly optimistic about what reductions current or future requirements will achieve, therefore putting more of a burden on Cap-and-Trade [see prior blog regarding lawsuit against the Low Carbon Fuel Standard.  And if the worst occurs, the analysis shows that the entire AB 32 regime is not banking predominantly upon Cap-and-Trade.  In the end, whether the offsets are a mirage, or Cap-And-Trade in California has a design flaw, will be shown by the purchase price for offsets and allowances by 2020, if not sooner, and of course, the actual greenhouse gases that are being emitted in California.

But still, a design so dominated potentially by offsets is quite vulnerable to a design flaw.  This flaw is particularly troubling given a 2009 GAO Report criticizing the reliability of offsets, in part informed by the lessons learned from the Kyoto Protocol’s Clean Development Mechanism (CDM).  Although the GAO report was assessing the practicality of a national carbon offset program, many of its criticisms are directly relevant to the ARB’s offset program.

The GAO’s report was particularly concerned with ensuring the credibility of offsets in terms of being real, permanent, and additional.  Learning from the CDM, the report declared that it is “nearly impossible to demonstrate project additionality with certainty,” thereby almost certainly allowing nonadditional credits into the program and negating one of the main advantages of Cap-and-Trade programs over other market-based programs – greater certainty about emission levels.  Additionally, the GAO specifically cited forestry offset projects as too uncertain to call “permanent” because unexpected disturbances such as insect outbreaks and fires can unexpectedly return stored carbon to the atmosphere after offsets have already been applied to a source’s emission allowances.

In addition, the report explained that the use of carbon offsets could result in environmental and economic trade-offs.  While offsets could lower the cost of complying with emission reductions, as confirmed by the ARB when the limit on offsets was raised from 4% to 8%, this may slow investment in emission reduction technologies and decrease the motivation of market participants to reduce their emissions.  In turn, this will slow the transition to what should be the goal of a long-term greenhouse gas reduction initiative: a less carbon-intensive economy.  Importantly, if compliance obligations are primarily met with offsets, by the time sources need to actually reduce emissions because they have used up offset opportunities, emitters will not have the price signals necessary for long-term investment in technology because they had been relying on the “cheap” option for so long.

The GAO conceded that carbon offsets are, at best, a temporary solution.  Given how easy it is for the integrity of offsets to be thrown off by the uncertain future predictions, project-by-project approval and rigorous project reviews are necessary, which would in turn cause administrative and program costs to increase to an unsustainable degree.  The report acknowledged that for the CDM, carbon offsets were perhaps a good “transition tool” because they facilitated international climate change dialogue and engaged developing countries in the process.  These are not goals of AB 32, however, so even the GAO’s reach for something positive to say about offset programs cannot apply.

Nevertheless, the plaintiffs have quite a challenge to prevail in court.  California follows a Chevron like approach and defers considerably to administrative agencies when they are engaging in a quasi-legislative function.  As the California Supreme Court has stated:

“The proceedings of the Board are quasi-legislative in nature, and the courts exercise limited review out of deference to separation of powers between the Legislature and the judiciary, and to the presumed expertise of the agency within the scope of its authority. A reviewing court will determine whether the agency acted within the scope of its delegated authority, whether it employed fair procedures, and whether its action is arbitrary, capricious, or lacking in evidentiary support. [Citations omitted].  A reviewing court will not substitute its policy judgment for the agency’s in the absence of an arbitrary decision, and in the absence of statutory requirement, the agency need not  prepare findings in support of its legislative decision.”  Western Oil & Gas Assn. v. Air Resources Board, 37 Cal.3d 502, 509-510 (1984).  See Wallace Berrie & Co. v. State Bd. of Equalization, 40 Cal.3d 60 (Cal.,1985) ( “Because Berrie questions the validity of the regulation itself, the proper standard of review is whether Regulation 1670(c) is arbitrary, capricious or without rational basis.”)

Citizens Climate Lobby and Our Children’s Earth Foundation are requesting that the court repeal the compliance offset protocols in their entirety and issue a permanent injunction prohibiting CARB from using offset credits as a compliance instrument when implementing AB 32.  Plaintiffs assert that by creating an offset program that so undermines the direct requirements of AB 32, the ARB is exceeding it authority and acting in conflict with AB 32.  Therefore, Citizens Climate Lobby and Our Children’s Earth Foundation are requesting that the court repeal the compliance offset protocols in their entirety and issue a permanent injunction prohibiting CARB from using offset credits as a compliance instrument when implementing AB 32.

Asking that a Court prevent all use of offsets seems quite aggressive.  The law does not require that CARB create an offset program, but it does allow such a program as long as it meets the legislative mandates of “verifiable” and “additional.”  There is no allegation the statute itself is unconstitutional or suffers from some other flaw.  However, if the protocols allow “any” illusory offsets, these regulations would seem to be too broad given the agency’s legislative mandate.  An order rescinding the regulations would indeed put into question the validity of the ARB’s Cap-and-Trade program.

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