Is It a Facility or an Entity and Why Does It Matter?

A facility, for the purposes of S.139, is defined as “a building, structure, or installation located on any 1 or more contiguous or adjacent properties of an entity in the United States.” As such, a facility may be a source of greenhouse gas emissions. By contrast, an entity, for the purposes of S.139, is a person, company, organization, or agency that owns or controls a source of greenhouse gas emissions, refines or imports petroleum products for transportation use, or produces or imports hydrofluorocarbons, perfluorcarbons, or sulfur hexafluoride. A single entity may own or control one or more facilities. The distinction between a facility and an entity is important to S.139 and to this analysis because greenhouse gas emissions at the entity level, not the facility level, determine who must participate in the tradable allowance system.

EIA collects energy use survey data at the sector level from energy suppliers and at the building (commercial) or facility (manufacturing, power sector) level. There is no data source that provides energy consumption (or emissions) at the entity level, complicating analysis of the proposed legislation.

Uncertainties: Offsets and Sinks in S.139

Uncertainty about the quantities and prices of offsets under S.139 could have an effect on the U.S. energy-economy over the projection period. The possible impacts of price and supply uncertainty in the allowance market are addressed by analyzing two additional sensitivity cases: one that doubles the quantity of international offsets available at each price (200 percent of S.139) and one that eliminates international offsets (0 percent of S.139).

In addition to the question of which end-use sectors would actually be covered by the S.139 emissions caps, uncertainty surrounds the issue of how many offsets will truly be available to the market and at what price (true market potential). The issue relates to the well-known problem of differentiating between technical potential, economic potential, and actual market potential for each potential source of allowances or offsets. Some of the factors contributing to the uncertainty are discussed in the following paragraphs.

International Offset Limitation: S.139 defines strict qualifying standards for the sources and countries from which U.S. entities may purchase international offsets. U.S. entities may purchase offsets from those countries that have greenhouse gas emission reduction programs with proper measurement, certification, and registry rules. While some developing countries have “signed on” to the Kyoto Protocol, few have set caps on their greenhouse gas emissions. Currently under S.139, Annex B countries represent the largest group that can be considered as possible qualifying participants. While it is possible that all Annex B countries will be participants in a greenhouse gas emission reduction program, it is also unlikely that all will participate in a greenhouse gas trading program. By one estimate,⁷⁹ only the European Union is likely to have an operational greenhouse gas emission control and trading program.

Clean Development Mechanism (CDM) Limitation: Under the bill’s provisions, bilateral CDM programs between the United States and developing countries are not allowed. Only offsets from CDM programs that are registered and certified by participants in the Annex B subgroup, if available, can be purchased by U.S. entities. The rules for such purchases have not yet been established.

Verifiability and Measurability: Before offset credits can be provided for greenhouse gas abatement, a system must be implemented that verifies the actions and the quantities abated. Many of the reductions in the agricultural sector and other noncovered sectors are small or difficult to validate. The difficulties in verification and measurement can pose a significant hurdle to participation in the abatement program.

Aggregation/Agglomeration: Small participants may be excluded from participation, even though the credits may be, in principle, economical on a per unit basis, because the transaction costs may be too high relative to the number of credits available.

Adequacy of Price Signal: Potential offsets in some markets could come from “players” whose primary interest is not sequestration. The price signal may need to be much greater than a standard “economic” price might indicate before any action to abate greenhouse gas emissions and claim or register credits is considered. For example, the control of manure-based methane from raising farm animals is of minor importance to farmers compared to their main business of raising and selling their farm animals or producing milk for sale. Behaviorally speaking, most small farmers are unlikely to pay much attention at prices developed using engineering-economic analysis.

Governance/Political Structure and Control: If the offsets are claimed from foreign investments in afforestation or other agricultural sequestration (e.g., no till farming), the longevity of such actions can be uncertain, because ownership of the lands or even the government could change, thus negating the carbon previously sequestered through such means. For example, agreements made for agricultural offsets may appear risky to a potential offset credit buyer if the buyer bears the risks of future compliance failures, because land used for afforestation/reforestation could later be converted to food production or urban growth and no longer represent an offset credit.

Treatment of “Hot Air:” The degree to which offsets from Russia and other Eastern Bloc countries whose credits result from lower economic growth might be available can significantly influence Annex B emission reduction strategies, particularly in the early compliance period. Although such credits would primarily serve to transfer wealth between nations without making real reductions in greenhouse gas emissions, they are included for the purposes of this analysis.

International MACs: The MACs provided by the Energy Modeling Forum for international non-CO2 offset curves are not estimates of observed behavior. They are scenario assumptions provided by EPA, and they are the only available source for this information. The amounts of international offsets available from sequestration are even more uncertain.⁸⁰ For example, one EMF participant proposed model results for international sequestration that would offset the entire world’s greenhouse gas emissions entirely through afforestation/reforestation four times over through the 21st century. EPA subsequently suggested that those estimates should not be used in this analysis.⁸¹ If these quantities and prices for carbon sequestration offsets were accurate, one would have to conclude that there is no global climate change problem for the 21st century.

If Annex B or Annex I restricts the United States from participating in its trading program, there could conceivably be no international offsets for U.S. entities to buy. Such a restriction currently has not been adopted by the European Union.

The principal uncertainty of this analysis is whether the quantities estimated by EPA, EMF 21, or other sources will actually be available for purchase at the prices specified. That is, “do these MACs represent competitive market prices?” Because their estimates are highly uncertain, the international offsets available to the United States have been reduced by 50 percent for the representation of the S.139 case. The use of a 50 percent reduction is equivalent to the assumption that the uncertainty in the availability of international offsets as restricted by the bill can be characterized by a uniform distribution of the quantities available at each price point and year. Recent discussions with EPA have suggested qualitatively that such reductions are reasonable. EPA used somewhat more severe reductions in its study of the Smith, Voinovich, and Brownback request in 2002.⁸² The derivation of the sinks and offsets for S.139 is described in detail in Appendix B.

Administrative Costs to the Federal Government

The administrative cost to the Federal Government of allocating allowances, monitoring the program, and enforcement could be significant, particularly when compared with the current electricity generation cap and trade program under the Clean Air Act. This is also true for the indirect costs of private industry (e.g., measurement and reporting costs and the administration costs of acquiring allowances). S.139 requires “entities owning or controlling” facilities that meet the 10,000 metric ton threshold to report their emissions and abide by the emissions limits. Because there is no existing data source that has either energy or emissions data at the entity level in the manufacturing or commercial sectors of the economy, the process of finding all the entities that are covered is likely to be costly.

Typically, carbon dioxide emissions are not actually measured but are calculated on the basis of energy consumption and process throughputs. Possibly several thousand entities will be required to report a calculation of carbon dioxide emissions, even though they are not required to report their energy consumption to any Federal agency. This requirement contrasts with the existing sulfur dioxide emissions program for utility and large industrial sources. In that program, the emissions typically are measured at the approximately 2,000 facilities covered by the program.⁸⁴ However, the sulfur dioxide emission program is far less extensive in coverage than would be the greenhouse gas emissions program proposed under S.139.

Appendix C of this report describes many of the accounting complexities associated with collecting and verifying emissions reductions under EIA’s Voluntary Emissions Reporting Program (1605b). An example of the quantity of voluntary emissions reductions and sequestration changes reported is provided. The estimates in Appendix C are an indication of the scope of reductions likely to be registered for early action credits under S.139. In addition, the accounting and program issues discussed highlight some of the challenges that would be posed under the S.139 provision for registering emissions reductions by noncovered entities for use as offsets by covered entities.

The Voluntary Emissions Reporting Program also provides an indication of the possible cost of collecting emissions information. In this program, EIA collects information from 228 respondents at a total annual operating cost, including Federal and contract personnel, of $563,000, which is equivalent to $2,469 per reporter. A recently published analysis of the number of facilities that could be affected by various emissions limits estimates that there are 11,626 facilities (7,777 industrial plants, 2,216 landfills, and 1,633 power plants) that have emissions in excess of 10,000 metric tons of carbon dioxide annually.⁸⁵ If the average administrative costs per facility under S.139 were equivalent to the average administrative cost per reporter to the Voluntary Reporting Program, then the Federal Government’s data collection cost under S.139 would be around $29 million a year. These costs, however, do not include system startup costs or enforcement costs required to ferret out entities that meet the threshold but do not report and to enforce the emissions limits for those entities that do report. Also not included in these cost estimates are the costs incurred by entities in reporting.

Notes