Making Climate Policy Work by Danny Cullenward

Author:Danny Cullenward [Cullenward, Danny]
Language: eng
Format: epub
Publisher: Wiley
Published: 2020-10-05T22:00:00+00:00

Why knife-edge incentives encourage low quality

Beyond the structural imbalance between pro-quality and pro-quantity constituencies, the economics of additionality leads to a pernicious problem we call knife-edge incentives. In order to deliver cost containment, regulated industries and policymakers seek high volumes of offsets at the lowest cost. Ironically, the economics of this goal dramatically increases the risks that offset projects will be awarded credits even when the projects don’t achieve all (or any) of the additional emission reductions claimed.

In order to meet the additionality standard, an offset project must claim that its emission-reducing activity is economically infeasible in isolation – otherwise, the project could be financed on its own without an offset credit. But a low-cost offset project is also claiming to be just barely infeasible: that is, the project almost makes sense on its own, but purportedly doesn’t unless climate regulators award it an offset credit. Infeasibility is a binary condition, but the real-world circumstances that define what is feasible rarely sit neatly inside or outside the feasibility box. Small changes in commodity prices, technology, and market conditions could easily swing a project into economic feasibility in the absence of offset credit incentives – many of those changes are hard for regulators to observe. Similarly, if project proponents put their thumb on the scale – even just a little – they may be able to show how a project that would be pursued on its own merits looks to be just barely infeasible in the context of an offset additionality claim. A project claiming low costs stands on a knife’s edge: a small change in project costs in one direction makes it truly additional, and a small change in the other direction makes it totally non-additional. Under these technical conditions, a completely one-side political economy takes effect with predictable results.

An extreme example shows how knife-edge incentives penalize activities that would be truly additional. Consider direct air capture (DAC) technologies that remove low-concentration CO2 out of the ambient air for geologic sequestration or industrial application. These technologies could conceivably play an important role in cleaning up excess pollution, especially as society gets much more concerned about rapid warming. But they are prohibitively expensive today. Some three startup companies are developing pilot projects with costs estimated at up to $600/tCO2 or more: that is, one to two orders of magnitude more expensive than explicit carbon prices observed in the real world.8 Unlike a low-cost offset project, one can be extremely confident that a DAC project will deliver truly additional credits – there is no knife-edge concern because the economics of DAC are so unattractive with today’s emission credit prices. In contrast, incumbents seeking to maximize offset credits will avoid things that are hard and costly and seek, instead, projects as close to the knife’s edge as possible.

Offsets consistently end up with low quality in the real world because the forces that prefer quantity dominate those that prefer quality and because low-price offsets that satisfy emitters’ demand for quantity are the most likely to be non-additional in the first place.

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