[UPDATE] Congressman Rick Boucher (D-VA) helpfully sets the stage for this post (emphasis added):

I’ve been working extensively to fashion a controlled program that Congress can adopt which will preserve coal jobs, create the opportunity for increasing coal production and keep electricity rates in regions like Southwest Virginia affordable. The compromise that I have reached with Chairman Waxman achieves those goals.

First we provide emission allowances under a cap and trade program to electric utilities for free,” Boucher said. “That provision will keep electricity rates affordable in regions where most of the electricity is coal fired, and Southwest Virginia is certainly such a region. Secondly, we provide two billion tons of offset each year during the life of the program. Those offsets would enable electric utilities like AEP (American Electric Power) to invest in forestry, agriculture and projects like tropical rain forest preservation in order to meet their CO2 reduction requirements under legislation. Therefore, they can comply with the law while continuing to burn coal.

[END UPDATE]

The Waxman Markey Bill is a massively complex, sprawling, and confusing piece of legislation (here in PDF). Reading through it I observed the large role of offsets in the legislation and decided to quantify that role.

Waxman-Markey (WM) focuses on a basket of greenhouse gases expressed in terms of greenhouse gas equivalencies. This makes it a bit difficult to compare apples to apples with EPA projections, so to simplify I am going to start by looking only at carbon dioxide in the analysis below. As I’ll show, introducing the other gases reenforces my conclusions.

Over the past 10 years carbon dioxide emissions represented about 83 percent of total greenhouse gas emissions (with the other 17 percent contribute from the otehr greenhouse gases) and this number has varied by less than a percent annually (source). So to calculate future allowed carbon dioxide emissions I multiplied the WM allowances by 0.83 (found on pp. 407-408 of the bill). This results in a total cumulative allowance for carbon dioxide emissions of 72.9 gigatonnes of carbon dioxide (GtCO2) to 2030.

I then took the most recent analysis from EPA for its projection of carbon dioxide emissions under business as usual (source) and adjusted these under the stair-step increase in “covered entities” under W-M from 66.2% in 2012, to 75.7% in 2014, to 84.5% in 2016 and thereafter (this stair-stepping reflects the phase in of parts of the economy covered under the bill). I then added up the cumulative total emissions to 2030 (as far out as EIA projects) resulting in 92.6 GtCO2 by 2030.

So far this looks like a projected decrease in carbon dioxide emissions of 19.7 GtCO2 or 22% from the cumulative business as usual total (i.e., 92.6 minus 72.9). But then the fun and games begins.

WM appears to grant covered entities the ability to offset up to a total of 2 GtCO2e (the “e” is for equivalent, recognizing the other gases) each year. If these offsets are fully used, these would allow another 38 gtCO2e of emissions to 2030. In practice this would mean that the 19.7 GtCO2 in emissions reductions (representing the difference between business as usual and the allocations under WM) could be avoided by using about half the available offsets under the bill.

Now you might saw, what about the other gases in the basket? These actually make the use of offsets to carbon dioxide even more appealing, because the “carbon dioxide equivalencies” are much greater per ton than for carbon dioxide. For instance the table on pp. 391 to 392 shows that other gases have weights of up to 22,800 times that of carbon dioxide. This means that reducing 1 ton of sulfur hexaflouride, for instance, would be equivalent to reducing the emissions of 22,800 tons of carbon dioxide. So there will be an added incentive to offset carbon dioxide emission using gases other than carbon dioxide as the basis for offsetting.

WM include a provision that the president can add (or subtract) from the total number of offsets available, so the 2 GtCO2e per year can easily be adjusted. (Can you imagine the implications in a future presidential election?) There is also a strange provision that allows for (what I’ve termed) “grandfathered offsets” created since 2001 to have standing under the program, meaning I suppose, that offsets already created can be used in future implementation of the program. There are many dozens or more other exceptions, rules, qualifications, and contingencies that I have not explored.

The bottom line is that under WM, it seems quite possible that business as usual carbon dioxide emissions can continue simply through reliance on about one half of the available offsets. To the extent that these can be conjured up, they will work to depress the price of the allowances issued under the program, keeping down the carbon price. More generally, WM sets up a massive accounting game that should be appealing to carbon traders and those providing offsetting services, as well as many others involved in the carbon industry. It is no wonder that many enviornmental groups are opposed to WM.

Writing last week on the similarities between scandal engulfing the UK Parliament and the failure of bank regulation, John Kay describes a general lesson that might equally be applied here:

The Australian economist, Joshua Gans, recently described a problem central to the current financial turmoil. How could he persuade his young son not to wet his pants?

Believing in the power of incentives, Mr Gans offered a reward if his son could keep his pants dry for seven nights. The boy simply removed his pants. The prohibition was on wetting pants, not on wetting the bed. Young Gans was learning a skill that would equip him well to be a British MP, or a senior executive in a global bank.

Many MPs need second homes to perform their duties. Such rules were not intended to allow less honourable members to build a property portfolio by charging the taxpayer to refurbish a succession of second homes. These members argued that what they did was consistent with the rules.

The Basel banking principles attached varying capital requirements to different types of assets. But it was easy to rearrange how assets were categorised, even as the underlying risks remained the same.

The Gans household elaborated the rules to close the loophole, only to discover that their child was able to construct yet more ingenious methods of circumvention. . .

Regulation by rules invites compliance with the rules rather than the objective of the rules, and the more extensive the rules the easier it is to lose sight of the objective. Many MPs plainly believed that since there were rules on what they could claim, any claim within these rules was legitimate. The Basel directives can be seen, in retrospect, probably to have done more harm than good. Banks took the view that capital sufficient to comply with the regulations was sufficient for their business needs. Surplus capital was for wimps.

Much of what the financial services industry today describes as compliance is no more than the system of internal control that any well-run institution would itself impose. But when control becomes compliance, business necessity becomes bureaucratic obligation. Everyone in the organisation can make common cause in minimising its practical effect.

Simpler rules may be less harmful than complex rules, but they can only work when the simplifications correctly exemplify underlying values.

It is bizarre, even farcical, that the U.S. Congress says that it is committed to reducing greenhouse gas emissions, but at the same time it is spending a huge effort and political capital creating a Byzantine system of rules that will allow, even encourage, exactly the opposite to happen.