As the scientific evidence of global climate change continues to accumulate (IPCC, 2007) and the predicted impacts of a warming planet become more widely known, national policies and international agreements designed to mitigate global warming have sought to strike a balance between environmental sustainability and economic achievement. Agriculture is at the center of this balancing act. On the one hand agriculture will need to adapt to a changing climate by developing new crop varieties and management practices, and on the other hand it has the opportunity to help mitigate future climate change by reducing the greenhouse gas emissions (GHGs) it generates. To learn more about the effects of climate change on Indiana agriculture, please refer to the article by Shively, et al. in the August 2008 edition of the PAER. The principal GHGs emitted from agricultural activities are carbon dioxide (CO2), nitrous oxide (N2O) and methane (CH4). Agriculture accounts for 6% of all anthropogenic U.S. GHG emissions, including 32% of all methane and 80% of all nitrous oxide emissions (EPA 2009b). Methane is 25 times more potent and nitrous oxide is 300 times more potent than CO2 at trapping heat in the earth’s atmosphere.

 

Under the 1997 Kyoto Accord, a global framework for reducing GHG emissions to pre-1990 levels established binding emissions reduction targets and timetables for industrialized countries and included flexibility provisions intended to reduce the overall cost of emissions reductions. Countries could design their own domestic policies to meet Their emissions targets and Kyoto’s fl exibility provisions allowed for cooperation between industrialized and developing countries to achieve Emissions reductions.

Despite the fact that not all countries ratified the 1997 agreement, many countries and states have enacted policies individually or in cooperation to reduce GHG emissions through an emissions trading framework. The largest GHG market in the world is the European Union-Emissions Trading Scheme, which began trading in 2005. The fi rst such initiative in the U.S. is the Regional Greenhouse Gas Initiative (www.rggi.org) involving ten Northeastern and Mid-Atlantic states. A group of western states and Canadian provinces are organizing a similar regional exchange under the Western Climate Initiative (www.westernclimateinitiative.org), and several Midwestern states (Indiana is an observer that has not committed to capping state emissions) is called the Midwestern Greenhouse Gas Reduction Accord (www. midwesternaccord.org). In addition to binding regulatory approaches taken by state and national governments there has also been a similar voluntary private market initiative called the Chicago Climate Exchange (www.chicagoclimatex.com).

 

Cap and Trade

Economists have taken a strong interest in helping governments to evaluate different policy instruments that can be used to achieve emissions reductions. On the basis of the success of the United States’ sulfur dioxide (SO2) emissions trading program and a large body of research, policy designs that establish enforceable property rights to verifi able quantities of emissions have been pursued most frequently and are the focus of the majority of ongoing national and international policy debates dealing with climate change. This type of policy design is commonly referred to as a “cap and trade” program, because the government establishes a “cap” on total emissions, allocates permits that constitute individual property rights to emit an allowable quantity of a pollutant, and allows fi rms to trade these emissions “allowances.” An allowance entitles its owner to one metric ton (tonne) of carbon dioxide equivalent (tCO2e) emissions. The total emissions cap is expressed in terms of millions of tCO2e (MtCO2e) and the sum of all individual allowances equals the emissions cap or target.

Because different fi rms operating in many sectors of the economy use very different technologies, they have different GHG abatement costs and there are potentially significant gains from trade if regulated fi rms are allowed to exchange emissions allowances in a market. By allowing firms to trade allowances, firms with the lowest abatement costs can abate more pollution than required by the cap and sell excess allowances to firms with higher abatement costs. This allows society to achieve the desired environmental objective at a lower total cost than if all fi rms were only allowed to generate emissions equal to the amount of allowances they hold and no trade of allowances were allowed. All else equal, a more stringent emissions cap will place greater pressure on all fi rms operating under the cap and is expected to result in greater demand in the market for allowances; this will have the effect of driving up the market price of allowances and thus fi rm compliance costs. Many factors in cap and trade program design can influence the overall cost to society, but that is not the focus of this article. To learn more about how cap and trade works, please refer to the short online “Primer” by Purdue professors Raymond and Shively (2007).

Including mechanisms that give firms time to develop and transition to less carbon-intensive technologies and energy sources reduces the overall cost of achieving emissions reductions while increasing the political feasibility of a cap and trade policy. There are several commonly proposed mechanisms to achieve this, but the one most relevant for Indiana agriculture is allowing regulated firms to pay for GHG emissions reductions by unregulated sources that have the effect of offsetting emissions released by regulated fi rms. This mechanism is called an emissions offset and is the focus of this article. Agriculture is eligible to supply emissions offsets under proposed cap and trade legislation in the US because agriculture will not be subject to the emissions cap under currently proposed legislation being debated in Congress. Unlike power plants and other large stationary sources of emissions, farms will not be involved in buying and selling emissions permits because agriculture will not be directly regulated. Farmers, like all American households, will bear a share of the cost capping CO2 emissions through expected increases in the cost of goods and services that generate GHG emissions.

Agriculture and forestry are two of the most commonly considered sources of offsets in an emissions trading market because these economic sectors have the potential to adjust management practices in ways that reduce emissions of CO2, CH4 and N2O(IPCC 2007; EPA 2005). The remainder of this article discusses potential sources of GHG emissions offsets that represent opportunities for agriculture under policies to address climate change and the challenges that must be addressed in order for agricultural offsets to provide income to farm households.

 

Agricultural Offsets 

Agricultural management practices can be altered or changed in many ways to reduce emissions from existing practices, to enhance the removal of CO2 from the atmosphere (called carbon sequestration), or displace emissions from fossil fuels by using dedicated energy crops or residues as sources of energy (IPCC 2007). Displaced fossil fuel emissions from bio-energy crops represent an important opportunity for agriculture going forward and remain a fertile topic for research as the US continues to rely on a renewable fuel standard as an important component of energy and climate change policies. Fossil fuel emissions displaced have not been treated as a source of offsets under cap and trade policies to date, but do provide an important income opportunity that should counteract the expected increase in agricultural input costs discussed below.

The most widely discussed source of agricultural offsets come from sequestration of atmospheric carbon in agricultural soils. Soil management practices that increase sequestration include conservation tillage (e.g. mulch till, strip till and no till) and crop residue management Lal, et al. 1998). Vegetative carbon storage can be enhanced through use of cover crops, perennial grass plantings and grazing management (Follett, et al. 2000). Reduced or more precise application of nitrogen fertilizer or livestock manure can reduce N2O emissions if greater nitrogen use effi ciency can be achieved. Methane emissions from livestock can be reduced by improving feeding and manure management practices (e.g. by covering lagoons or capturing methane through use of anaerobic digesters). Increased feeding efficiency can be achieved through the use of dietary additives that suppress methanogenesis or improved forages, and opportunities for manure management, treatment and storage that reduce methane emissions both represent mitigation options in livestock management. While existing agricultural practices already play a role in mitigating the global warming effect of some fossil fuel emissions that result from fertilizer production and fuel use, there is considerable potential to expand and improve upon existing practices. This potential for wider use of mitigating practices is what creates the opportunity for farmers to sell emissions offsets in a market for CO2 equivalent emissions.

In moving from the science of carbon sequestration and methane capture to thinking about the adoption of new cropping or manure management systems, it is necessary to take into account whether there are adequate incentives for farmers to adopt these practices. Policy makers can only realistically expect farmers to adopt these practices if the costs of implementation are covered by the benefi ts farmers receive.

The economic analysis done by the US EPA (2005) to assess the domestic carbon sequestration potential of forestry and agriculture found that for market prices over US$30/ tCO2e, the economic incentives are such that crop and pasture lands are expected to be converted to forests because the sequestration potential of forest exceeds soil carbon sequestration and high prices cover the cost of land use conversion. Over the higher range of prices considered, agricultural soil carbon has lower relative economic potential than afforestation. While it is true that farmers can plant trees on marginal lands, this illustrates one reason why agriculture should not be analyzed in isolation of other sectors that can supply offsets. It is also important to consider both domestic and international sources of offsets because the demand side of the emissions market will be seeking to minimize its cost of compliance and it stands to reason that if another country can supply the offsets needed for compliance at a lower cost than American farmers, the lowest cost source of abatement will be exhausted before fi rms consider paying for higher cost alternatives.

 

 

Domestic Policy Situation

In June 2009 the House of Representatives narrowly passed the American Clean Energy and Security Act (ACES or Waxman-Markey bill after its sponsors) of 2009 (H.R. 2454) that would create a cap and trade system and reduce domestic CO2 emissions 83% by 2050. The different Titles and Subtitles contained in its 1400 pages cover renewable energy, energy effi ciency, greenhouse gas emissions, “transitioning to a clean energy economy,” and the supply of emissions offsets from agriculture and forestry. As the Senate continues to take up this issue, it does so knowing that the EPA administrator signed an “endangerment fi nding” in December 2009 stating that “the current and projected concentrations of the six key well-mixed greenhouse gases…in the atmosphere threaten the public health and welfare of current and future generations.” The EPA was forced to determine if GHGs should be regulated under the Clean Air Act by a 2007 Supreme Court ruling. The administration and members of Congress would prefer to address GHG emissions through legislation, but regulation may follow if ACES or something similar is not passed in the near-term.

 

Opportunities and Challenges

The main economic motivation for including offsets as part of a cap and trade policy is to reduce the overall cost of achieving the emissions target or cap. Economic analysis of cap and trade legislation is perhaps the best place to look to see the estimated effect of including offsets on the cost of allowances, and thus the overall cost of achieving a GHG emissions target. Recent analysis of ACES by the U.S. Congressional Budget Offi ce found that the inclusion of both domestic and international offsets has “a signifi can’t effect on allowance prices” and decreases the market price 69% in 2012 to US$35 compared to when offsets are not a compliance option under the legislation (CBO 2009, p.16). The US EPA’s economic analysis of the same legislation similarly found that “offsets have a strong impact on cost containment” and that “without international offsets, the allowance price would increase 96%” to US$25-34 in 2015 (EPA 2009a, p.3). Both analyses of the most recent federal cap and tradelegislation in the U.S. illustrate how incorporating offsets into a cap and trade program may significantly influence the cost to society of climate change mitigation.

The USDA estimates that gross annual revenue from carbon offset trading could total $2.1 billion within a few years after Waxman-Markey becomes law. By 2042, when the proposed emissions cap becomes more stringent, annual gross revenue from offsets could reach $28.4 billion (USDA 2009). It is not possible to determine from these early analyses what share of Indiana agricultural land is predicted to be converted to conservation tillage or planted in trees. The most recent IN State Department of Agriculture statistics indicate that 68% (3.03M acres) of all soybean acres and 26% (1.59M acres) of all corn acres in Indiana were planted in some form of conservation tillage in 2007.

Because of agriculture’s strong reliance on fossil fuels, it stands to reason that the cost of farm inputs is expected to increase under the cap and trade legislation before Congress. The USDA’s preliminary analysis of the legislation estimates that per acre variable cost of production for corn and wheat will increase 4.5% and for soybeans 2.2% by 2027 due input price increases. The biggest impact comes from increased fertilizer prices after 2025. The estimated effect of these changes in costs translates into a 3.5% drop in net farm income in 2027 (USDA 2009). It is important to note that these estimates only include the effect of increased input costs on 200 production costs, and do not take into account the increased demand for bio-energy crops to adapt to higher energy prices and future changes in the renewable fuel standard, technological and management changes to adapt to higher input costs, or the effect of emissions offsets on commodity prices. All of these factors excluded from the USDA’s preliminary analysis are expected to offset the cost of implementing the proposed ACES legislation. Current estimates of the increase in net farm income from biofuels crop revenue under the most recent renewable fuel standard suggest that the increase in revenue will more than offset the increased costs from CO2 limits.

In order for farmers to be able to be paid for offsetting GHG emissions an offset registry has to be created to verify emissions reductions, ensure reductions are over-and-above what would occur under “business as usual” in the absence of the legislation, and ensure that management practice changes that create offsets are permanent. The USDA is charged with establishing and maintaining the offset registry under the ACES legislation.

 

Conclusion

 

Agricultural offsets are often viewed as a tool to bridge the gap between the present and the time when new technologies and fuel sources can be developed that achieve emissions reductions that are not subject to the same challenges. By lowering the cost of reducing emissions in the near term, offsets can help reduce the overall cost to society of transitioning away from fossil fuels, increasing energy efficiency, and developing new technologies. The precise long-term implications of climate change for agriculture remain uncertain and the challenge of operationalizing a national offset registry is a significant undertaking, but agriculture certainly wants to be at the table when a major policy is enacted.

 

References

Congressional Budget Office, Cost Estimate. 2009. “H.R. 2454 American Clean Energy and Security Act of 2009,” http://www.cbo. gov/ftpdocs/102xx/doc10262/hr2454.pdf.

Environmental Protection Agency. 2005.“Greenhouse Gas Mitigation Potential in U.S. Forestry and Agriculture,” EPA 430-R-05-006.

Environmental Protection Agency, Offi ce of Atmospheric Programs. 2009b. “Preliminary Analysis of the Waxman-Markey Discussion Draft: The American Clean Energy and Security Act of 2009 in the 111th Congress,” http://www.epa.gov/climatechange/ economics/pdfs/WM-Analysis.pdf.

Environmental Protection Agency. 2009c. “Greenhouse Gas Mitigation Potential in U.S. Forestry and Agriculture,” EPA 430-R-05-006.

Folett, R.F., J.M.Kimble, and R. Lal. 2000. The Potential of U.S. Grazing Lands to Sequester Carbon and Mitigate the Greenhouse Effect. CRC, 1st Edition.

Intergovernmental Panel on Climate Change. 2007. Fourth Assessment Report, Working Group III Report, “Mitigation of Climate Change”.

Lal, R., J.M. Kimble, R.E. Follett and C.V. Cole. 1998. The Potential of U.S. Cropland to Sequester Carbon and Mitigate the Greenhouse Effect. CRC, 1st Edition.

Raymond, L. and G. Shively. 2007. A Primer on Market-Based Approaches to CO2 Emissions Reductions. Policy Brief 2007-01. West Lafayette, IN: Purdue Climate Change Research Center. https://www.purdue.edu/ climate/Cap%20and%20Trade%20Policy %20Brief.pdf

Shively, Gerald E., Otto Doering, Noah Diffenbaugh, Laura Bowling, Christian Krupke, Bryan Pijanowski, Jeff Holland, and John Dunning. 2008. Forecasting the Likely Impacts of Climate Change on Indiana Agriculture. Purdue Agricultural Economics Report, August.

USDA, Offi ce of the Chief Economist. “A Preliminary Analysis of the Effects of HR 2454 on U.S. Agriculture,” Washington, DC: 2009.