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lead.jpg (22302 bytes)    Volume 3 
   Number 4
   26 October 1998 

EARLY ACTION CREDITING: A DOMESTIC IMPERATIVE FOR KYOTO COMPLIANCE

Michael S. Burnett, Trexler and Associates, Inc.
Mr. Chuck McDermott, The Citizens Companies


The Early Action Context

Under the Kyoto Protocol, industrialized countries have committed to significant reductions in their combined national emissions of a basket of six greenhouse gases (GHGs). Overall, these "Annex B" Parties agreed to reduce their emissions by 5.3 percent from 1990 levels by the first "budget period," which runs from 2008-2012. The United States committed to a seven percent reduction. Both figures are somewhat misleading. The implied reduction for the United States from "business-as-usual" emissions projections by the 2008-2012 budget period is actually more than 30 percent; for Annex B countries as a whole, the reduction from business-as-usual projections is around 25 percent.

Many participants to the Kyoto process view the commitments made in the Protocol as being too timid. Yet these targets and timetables actually suggest a significant change of course in countries’ energy economies over a relatively short timeframe – approximately a decade. Even with several flexibility mechanisms built into the Protocol, major changes in energy supply and utilization patterns will almost certainly need to occur in most Annex B countries to achieve compliance with the Protocol’s terms.

Even assuming that the process started in Kyoto moves forward with all due speed and the Protocol or a successor instrument is ratified and enters into force in the foreseeable future, it will take at least several years to establish the national policy frameworks needed to implement the required emissions reductions. Many proposed policy measures, such as carbon taxes and GHG trading, face daunting political and technical hurdles.

Viewed from this perspective, the 2008-2012 budget period is much nearer than it might at first appear. National GHG emissions cannot be turned on a dime. If emissions continue on their business-as-usual course over the next few years – which is completely allowable under the terms of the Protocol – achieving the required reductions by the budget period will become increasingly difficult, if not impossible, for the United States and many other Annex B countries. If the reduction commitments built into the Kyoto Protocol are to be achieved without massive and probably politically unacceptable economic dislocation late in the next decade, industrialized countries will need to move toward an emissions "glide path" that puts national emissions within striking distance of any emissions target that ultimately enters into force.

Realizing how far countries such as the United States have to go to meet the Kyoto Protocol’s commitments, participants to climate change policy development are increasingly focusing attention on the concept of "early action crediting." Going a step beyond simply asking companies to begin voluntary emissions reduction efforts, early action crediting tells companies that they will receive credit for certain reduction measures taken before introduction of mandatory emissions reduction mandates. These early action credits could be used in any future trading or regulatory system aimed at complying with GHG emissions reduction mandates.

The concept of early action crediting is being pursued at several levels. Canada, for example, is pursuing a major policy roundtable on early action crediting, and in mid-October Senators Chaffee, Mack, and Lieberman introduced proposed early action crediting legislation in the U.S. Senate. In the private sector, many corporations actively support early action crediting. They do not want across-the-board emissions reduction mandates later on to effectively penalize them for measures they take over the next several years, and they want as large a time window as possible for planning out how they will achieve what may be significant reduction mandates passed down from the national to the corporate level. Many environmental groups also support early action crediting, recognizing that progress needs to be made toward a glide path consistent with U.S. obligations under the Protocol.

The fact that key U.S. business and environmental interests are arguing similar points with respect to early action crediting is politically significant. In the polarized climate within which the climate change debate is occurring in the United States, the imperative of early action crediting may be an issue on which competing forcing interests can agree, at least partially breaking the current policy stalemate.

Early Action and the Kyoto Protocol

With the exception of the Clean Development Mechanism (CDM) under Article 12, the Kyoto Protocol does not provide international recognition for so-called early actions. It simply requires that countries achieve a given level of emissions reductions by the first budget period. Whether the Protocol should be changed to expand the scope of countries’ ability to apply early action against their first budget period commitments will certainly come up at the fourth Conference of the Parties (COP-4) to the U.N. Framework Convention on Climate Change, which meets in November 1998 in Buenos Aires, Argentina. Some countries argue that the same kind of banking accorded CDM efforts should be made available to efforts taken through the joint implementation mechanism of Article 6, or even to strictly domestic measures within Annex B countries.

The absence of early action crediting for most measures under the Kyoto Protocol has implications for the pursuit of early action crediting at the domestic level. If most emissions reduction measures taken between now and the first budget period do not qualify for early action banking against countries’ international obligations under the Protocol, each ton of domestic credit awarded for an emissions reduction achieved prior to the budget period will require that actual emissions during the budget period be reduced by one ton beyond the country’s reduction commitment already built into the Protocol. At some level of domestic early action crediting, this situation could increase the future burden on non-participants to an early action crediting system to such a degree as to become politically impossible. The target could collapse.

The practicalities of early action crediting participation and the magnitude of that participation, however, are such that it is unlikely that national budgets would be significantly distorted. Many participants in early action programs would not use their participation to achieve huge emissions reductions, but rather to gain experience with procedures and technologies. National early action crediting programs can also include caps on the number of credits available and targeting the activities to be credited.

Moreover, reductions through the Kyoto Protocol’s CDM have an advantage as compared to reductions through an operational joint implementation program under Article 6. The differences between Articles 6 and 12 with respect to credit banking prior to 2008 will be most apparent in Eastern Europe and the former Soviet Union. These countries formerly saw themselves as having a comparative advantage under the flexibility mechanisms, and this issue will clearly engender discussion at COP-4.

The arguments surrounding early action banking and crediting at the international level and the implications of banking for the environmental integrity of the Kyoto Protocol targets are complex. Early action crediting issues at the international level can be quite different than those involved in early action crediting at the domestic level. Domestic crediting is the primary topic of this review article.

Domestic Early Action Crediting: The Policy Logic

Annex B governments recognize that achieving the reductions mandated by the Kyoto Protocol will become increasingly politically and economically costly to achieve as business-as-usual emissions continue to rise. While governments signed the Kyoto Protocol and will be bound by the Protocol should it enter into force, governments have little direct influence over a country’s GHG emissions. Government commitments ultimately need to result in a translation of national emissions reduction mandates into on-the-ground emissions reductions by the emitting entities. There are several reasons why a government should be willing to promote early action crediting, notwithstanding the current zero-sum nature of such crediting for purposes of complying with the first budget period:

Early action programs promote business and policy learning. Policymakers can gain valuable experience with different mitigation policy approaches, which they can use when formulating long-term policy, while businesses can gain experience with mitigation technologies.

Voluntary early reduction programs promote creativity in finding effective ways to reduce emissions. Early action programs will be better able to promote identification of the full range of reduction options, potentially saving significant amounts of money over a more conventional regulatory or tax-based approach.

Early reduction programs provide national policymakers with empirical information regarding the cost of achieving a national emissions reduction target. While some observers argue that significant emissions reductions are available at low cost or even a profit, others argue that it will be difficult and expensive. Each side points to its own modeling efforts but to little empirical experience. Properly structured early reduction programs could yield valuable information about the magnitude of different emissions reduction options, their cost, and how to bring them about.

The lack of an early action crediting program results in a tremendous disincentive against companies taking voluntary actions. In the past, companies that have taken voluntary environmental measures before implementation of new environmental mandates have often, in effect, been penalized for their efforts. In the U.S. sulfur dioxide arena, for example, many people perceive that "early actors" have been penalized by the form of subsequent emissions reduction mandates. The prospect of this scenario happening in the context of climate change mitigation may stop even progressive companies from taking aggressive actions to reduce GHG emissions in the near-term future.

Domestic Early Action Credits: The Business Logic

The logic that makes early action a desirable policy on a macroeconomic basis also applies at the microeconomic and corporate level. Business interests increasingly recognize that the climate change issue is not likely to disappear any time soon and that formal emissions reduction mandates are more a matter of "when" than of "if." Waiting until the last minute to begin changing behaviors or technologies in order to meet emissions reduction mandates is not a wise business strategy when compared to achieving emission reductions along a more gradual glide path.

There is do doubt that companies are willing to do more in the climate change arena if they receive some form of credit and know they will not effectively be penalized later for acting early. A 1997 survey of electricity producers by Trexler and Associates, Inc. for the World Bank provided significant insight into companies’ views on expanding their early action activities. Companies said they would be willing to do much more to reduce emissions, but that their pursuit of emissions reductions cannot be purely altruistic or motivated by public relations. They need a business reward, which is what emissions reduction credits provide. It is now abundantly clear that an early action crediting system that is to have any hope of generating emissions reductions that are significant in terms of obligations under the Kyoto Protocol will have to move beyond current voluntary emissions reduction programs.

Structuring Domestic Early Action Credits: A Discussion of the Issues

Early action crediting is intuitively simple and attractive. All early action proposals, in principle, reward emitters for reducing emissions prior to mandated deadlines. The details of an operational system undoubtedly will entail a more complicated set of regulations and verification requirements, but the overall goal remains early achievement of environmental goals.

In practice, designing an early action crediting system raises potentially difficult issues. Although challenging, there is no reason to believe that these issues cannot be satisfactorily addressed. How these issues are addressed, however, will significantly affect overall outcomes, including the magnitude of reductions accomplished, advancement of national compliance objectives, types of early actions undertaken, the amount learned, and costs of the system.

Several issues receiving current attention are briefly introduced below, although a thorough review of issues and alternate approaches is beyond the scope of this paper.

Determination of appropriate credit vehicles: A variety of mechanisms are potentially available for promoting early action credits. These include state and federal legislation, additions to the tax code, or other means. Approaches not requiring legislative approval, however, may have limited ability to provide companies with sufficiently reliable crediting guarantees.

Determination of creditable mitigation activities: Observers differ on whether it is appropriate to limit the types of activities that could be credited under an early action crediting system. Policymakers could direct mitigation efforts by how they treat direct emissions reductions associated with a company’s own operations vs. carbon offset projects, for example. Specific technologies could be favored, or any legitimate reduction could receive the same credit.

Determination of the "but for" baseline: For the same reasons that baselines are a challenge for project-based mitigation under Articles 6 and 12, one of the most difficult issues associated with early action crediting is determining the baseline against which emission reduction measures will be measured and credit awarded. Several alternate approaches have been proposed or could be envisioned:

Credit could be given for any emissions reductions below a company’s current emissions level. This approach is arbitrary and is unlikely to target "true" reductions from a business-as-usual case particularly effectively.

Credit could be given for any absolute emissions reductions below a company’s projected "but for" emissions trajectory or for a reduction in a proxy such as CO2/kWh or CO2/$ of output. In both cases, "but for" trajectories need to be created.

Credit could be given only for absolute emissions reductions below a company’s 1990 emissions level, or even only for reductions going beyond a set reduction level from 1990 emissions. This approach is obviously restrictive; companies that have grown since 1990 would have to make large reductions before starting to accrue any early action credits.

Minimizing "anyway" tons: The approach taken to the baseline issue will have major implications for the proportion of credited reductions that are "true" reductions from business-as-usual and for the magnitude of early actions undertaken. A program awarding a significant proportion of credits to declining industries and non-competitive facilities would do little to move the economy onto the glide path.

Balancing interests of participants and non-participants in the crediting system: Some observers have raised concerns that benefits accruing to participants in an early action crediting system may come at a cost to non-participants. This is primarily due to the "zero-sum game" nature of domestic early action crediting. The magnitude of the zero-sum problem would vary with the types of early actions being credited:

Early emissions reductions that leverage even greater reductions later (e.g., technology demonstration or commercialization efforts) may have a minimal or no zero-sum impact. They might even have a significantly beneficial impact on emissions in the first budget period.

Early emissions reductions for which banking is allowed will create no zero-sum problem. Banking will be allowed, for example, for projects pursued under the CDM.

Emissions reductions that result from measures that continue into the budget period will at least reduce emissions in the future, somewhat lessening the zero-sum problem.

Emissions reductions undertaken now that have no impact on emissions in the budget period would be expected to create the most potentially significant zero-sum problem. This might be particularly true for reductions that would have been available for pursuit in the first budget period.

The zero-sum game nature of early action credits may or may not be a significant issue for decisionmakers. Its importance will depend largely on the objectives ranked as most important in establishing an early action crediting system.

Limiting the magnitude of early reduction credits made available: Many observers are proposing that the number of early action credits be limited specifically because of the potentially negative implications of the zero-sum nature of early action crediting. One proposal, for example, is to limit total available early action credits under a future U.S. crediting system to five percent of the total tons allowed the United States during the first budget period.

Addressing the issues introduced above will be challenging, but should not prove overwhelming. The potential benefits associated with early action crediting systems, based on the perspectives of a wide variety of interest groups, appear sufficiently compelling to warrant taking on this task.

U.S. Early Action Crediting Activity

At least three organizations have proposed designs for early action crediting programs in the United States:

The CEO Coalition to Advance Sustainable Technology has proposed a performance- based approach under which participating companies would receive early action credits for reductions beyond an assumed business-as-usual improvement rate.

The Center for Clean Air Policy has proposed a tons-based approach by which companies would receive credits for reducing emissions below a line connecting their 1990 emissions to a level seven percent lower in 2008, in effect giving credits only for companies going beyond reductions required by the Kyoto Protocol.

The Environmental Defense Fund has also proposed a tons-based approach under which a company would earn early action credits for keeping its cumulative emissions below a target figure.

As of the end of October 1998, immediately prior to COP-4, early action crediting proposals in the United States continue to evolve. As Senator Lieberman stated in introducing early action legislation in mid-October, "[t]his is a win-win proposal for industry and the environment. Companies that move forward with emission reductions will be rewarded and, at the same time, the risks of global warming will be minimized." It appears that early action will receive increased attention in the next session of Congress; industry and other groups are now joining together to push the idea.

Conclusions

Early action crediting, at least domestically, is vital to achieving the Kyoto Protocol’s emissions reductions objectives. It will take years to gain the necessary consensus for the Protocol to come into force, and years to design domestic implementation frameworks. The Protocol itself creates a barrier to early action by countries and companies by not crediting early actions against national obligations in the first commitment period.

This barrier may or may not be good for the environment. But even with this barrier, early action crediting at the national level makes policy and business sense. More countries and companies now see that early action toward an emissions "glide path" that can lead to Kyoto compliance is preferable to the disruption that will likely occur if we wait for ratification of the Protocol before initiating domestic measures. The absence of national-level early action crediting systems constitutes a significant impediment to such voluntary activities. There is a perverse risk that companies that move forward with mitigation now will be penalized, as has happened in the past. Beyond removing this risk, establishing an early action crediting system promotes business and policy learning, provides a testing ground for a range of technology and policy options, develops real-world mitigation cost data, and encourages companies to get onto their own glide path.

Trexler and Associates, Inc.