Economics 134 Past Paper Notes PDF

Economics 134 L12. Environmental offsets Will Rafey UCLA November 13, 2024 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 1 / 29 Environmental offsets Definition and rationale Monitoring quality Adve...

Economics 134 L12. Environmental offsets Will Rafey UCLA November 13, 2024 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 1 / 29 Environmental offsets Definition and rationale Monitoring quality Adverse selection California forest offsets California carbon market Empirical strategy Results Will Rafey (UCLA) Econ 134 L12 November 13, 2024 1 / 29  Environmental offsets Environmental offsets Definition and rationale Monitoring quality Adverse selection California forest offsets California carbon market Empirical strategy Results Will Rafey (UCLA) Econ 134 L12 November 13, 2024 1 / 29  Environmental offsets Definition and rationale Environmental offsets Sometimes, activities can be undertaken to offset environmental destruction. We call these activities “environmental offsets.” Useful to distinguish between two kinds of environmental offsets: voluntary — e.g., buying “carbon offsets” to offset the emissions from flying mandated — e.g., offsetting activities mandated by an environmental impact assessment during a land use permitting processes Will Rafey (UCLA) Econ 134 L12 November 13, 2024 2 / 29  Environmental offsets Definition and rationale Will Rafey (UCLA) Econ 134 L12 November 13, 2024 3 / 29  Environmental offsets Definition and rationale Should we encourage environmental offsets? For us, two key economic questions: 1 how costly are offsets relative to “direct” environmental protection (or allowing the environmental destruction to proceed)? 2 are offsets “good substitutes” for direct environmental protection? The first question is the same we asked about environmental markets if some people or firms can supply environmental protection at lower cost, then it is efficient to incentivize them to do so! The second is a new concern key problem: the quality of offsets is often difficult to verify and monitor the certification system for offsets becomes crucially important Will Rafey (UCLA) Econ 134 L12 November 13, 2024 4 / 29  Environmental offsets Definition and rationale 1. How costly are offsets? Usually much less costly. Will Rafey (UCLA) Econ 134 L12 November 13, 2024 5 / 29  Environmental offsets Definition and rationale McKinsey’s marginal abatement cost curve Will Rafey (UCLA) Econ 134 L12 November 13, 2024 6 / 29  Environmental offsets Definition and rationale McKinsey’s marginal abatement cost curve Will Rafey (UCLA) Econ 134 L12 November 13, 2024 6 / 29  Environmental offsets Definition and rationale 2. Monitoring offsets Are offsets “good substitutes” for direct environmental protection? Depends on 1 what type of environmental benefit the offset creates 2 the counterfactual: what would have happened if the offset were not bought 1. Benefit. Need to monitor future outcomes—e.g., if the offset is a forest to reduce carbon emissions, then it matters whether the forest is cut down in five years or if the forest is (eternally) sustained with new trees as old trees die displacement—saving a forest might induce greater deforestation elsewhere 2. Ideal counterfactual: offset project would not have taken place difficult to assess often assumes a “baseline scenario” that is untestable Will Rafey (UCLA) Econ 134 L12 November 13, 2024 7 / 29  Environmental offsets Monitoring quality Monitoring quality Example. Suppose that the marginal social cost of one ton of carbon is $10/ton we can capture one ton of carbon by planting trees, for costs that range between $5–$20/ton Solution: We should plant all trees that cost $10/ton or less. we can implement this with a subsidy of $10/ton for tree carbon capture all trees that cost no more than $10/ton to plant will be planted the more expensive trees will not be planted! this is just the Pigouvian tax, which happens to take on a negative value Will Rafey (UCLA) Econ 134 L12 November 13, 2024 8 / 29  Environmental offsets Monitoring quality Monitoring quality, cont’d Example, cont’d. Continue to suppose that the marginal social cost of one ton of carbon is $10/ton Now also suppose that each tree will successfully grow with probability p = 0.9 and fail otherwise Solution: We should plant all trees that cost $9/ton or less. Why? Because we should subsidize them for their expected externality: 0.1 · 0 + 0.9 · $10/ton = $9/ton Will Rafey (UCLA) Econ 134 L12 November 13, 2024 9 / 29  Environmental offsets Monitoring quality Discussion when offsets have uncertain quality, we should take this into account in the design of our economic policies here, need to adjust the Pigouvian tax (subsidy) to account for the probability that the offset does not always work perfectly an assumption in the above example: the unknown quality of the offset project did not depend on its cost we will now see what happens when this is not the case ,→ Will Rafey (UCLA) Econ 134 L12 November 13, 2024 10 / 29  Environmental offsets Adverse selection Monitoring quality, cont’d’d Example, cont’d. Now suppose that the marginal social cost of one ton of carbon is $10/ton all trees cost less than $10/ton, but every third tree costs $0 to plant (and was going to be planted regardless!) Solution: we do not want to subsidize the trees that would be planted no matter what why? they trap carbon, but the marginal social value of subsidizing these trees is zero because the subsidy does not affect whether the tree is planted if we can observe which trees are inevitable, then we subsidize the rest if we cannot observe this, it becomes more complicated if we subsidize with the “average” marginal social value, 32 · 10, then some trees that cost more than $6.67/ton will not be planted... this is not efficient Will Rafey (UCLA) Econ 134 L12 November 13, 2024 11 / 29  Environmental offsets Adverse selection Monitoring quality with adverse selection Another example. Suppose that each potential offset project i has environmental quality (positive environmental externality) worth vi vi is distributed uniformly on [0, 1]. Then the average quality, E[vi ], is 1/2. ,→ while some projects are worth more than 1/2, without additional information, society on average obtains only 1/2 for a project drawn at random from [0, 1]. Finally, suppose that the cost of undertaking a project is ci , and that it correlates with quality so that 2 ci = vi. 3 That is, higher-quality projects cost more. Will Rafey (UCLA) Econ 134 L12 November 13, 2024 12 / 29  Environmental offsets Adverse selection Monitoring quality with adverse selection Suppose we use the policy from before, where we reward each project with a subsidy s equal to its expected value, s = E[vi ] = 1/2. What happens? each offset project i with ci ≤ s will be undertaken offset projects with ci > s will not be undertaken. Will Rafey (UCLA) Econ 134 L12 November 13, 2024 13 / 29  Environmental offsets Adverse selection Adverse selection, cont’d Consider the set of offset projects that are undertaken (ci ≤ s). Since ci = 23 vi , we know that ci ≤ s is the same as 2 vi ≤ s. 3 When s = 1/2, we obtain 23 vi ≤ 12 , or 3 vi ≤. 4 This is the selection problem: the offsets undertaken are only those with vi ≤ 34 , as opposed to all vi ∈ [0, 1]. In particular, since vi ∼ Unif(0, 1), the average value of subsidized offsets is only   3 3 E vi vi ≤ = , 4 8 which is less than 1/2! Will Rafey (UCLA) Econ 134 L12 November 13, 2024 14 / 29  Environmental offsets Adverse selection Discussion when the uncertain environmental benefit correlates with the project’s cost, then how we incentivize offsets can affect their average environmental benefit here, when higher-quality projects are also more expensive, we get what is known as adverse selection lower-cost projects select into the offset regime because lower-cost projects have lower quality, this lowers the average quality need to condition on how the policy itself will affect the expected value of the offsets Will Rafey (UCLA) Econ 134 L12 November 13, 2024 15 / 29  Environmental offsets Adverse selection Brief detour involving a philosopher So far, two arguments “against” using offsets 1 may not actually deliver true quality 2 policies may lead to adverse selection Sometimes also argued that offsets can undercut other pro-environmental actions... Will Rafey (UCLA) Econ 134 L12 November 13, 2024 16 / 29  Environmental offsets Adverse selection Brief detour involving a philosopher Michael Sandel (1997), Harvard philosophy professor: Despite the efficiency of international emissions trading, such a system is objectionable for [several] reasons. [... ] [T]urning pollution into a commodity to be bought and sold removes the moral stigma that is properly associated with it. [... ] A[nother] objection to emission trading among countries is that it may undermine the sense of shared responsibility that increased global coop- eration requires. Will Rafey (UCLA) Econ 134 L12 November 13, 2024 17 / 29  California forest offsets Environmental offsets Definition and rationale Monitoring quality Adverse selection California forest offsets California carbon market Empirical strategy Results Will Rafey (UCLA) Econ 134 L12 November 13, 2024 17 / 29  California forest offsets California carbon market California’s carbon cap-and-trade (AB 32) California has a cap-and-trade that covers 75% of the state’s carbon emissions offsets can be used by polluting firms to comply with their legal obligations Prospective offset projects follow detailed rules from the California Air Resources Board (CARB) projects submit an application to CARB CARB evaluates applications, decides how many offsets to award, if any projects then can sell credits to firms By September 2020, 193 million offsets (each 1 tCO2 ), valued at $2.6 billion at market prices ($13.67/credit). More than 80% are for “improved forest management.” ,→ Will Rafey (UCLA) Econ 134 L12 November 13, 2024 18 / 29  California forest offsets California carbon market Forest offsets Source. Badgley et al. 2022, Figure 1 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 19 / 29  California forest offsets California carbon market How California approves offsets Offset credits are rewarded for improved forest management that increases carbon above modeled baseline scenarios give credits to landowners who claim that, without the credit, they would cut down the forests according to a baseline scenario landowners can only claim scenarios above the regional average prediction for the next 100 years Then, they obtain credits equal to the difference between initial carbon stock (observed) the long-run counterfactual stock (baseline) Will Rafey (UCLA) Econ 134 L12 November 13, 2024 20 / 29  California forest offsets California carbon market Carbon offsets for forest management Solid green line is the counterfactual “baseline” — when the landowner claims the forest will be cut down without offset payments implies a long-run baseline average (grey dashed line) if this is above the regional average (black line), proposal is approved Will Rafey (UCLA) Econ 134 L12 November 13, 2024 21 / 29  California forest offsets California carbon market Assigning offset credits to projects Source. Badgley et al. 2022, Figure 4 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 22 / 29  California forest offsets California carbon market Virtually all projects max out on credits Source. Badgley et al. 2022, Figure 3 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 23 / 29  California forest offsets California carbon market “Over-crediting” if the baseline is overly pessimistic Source. Badgley et al. 2022, Figure 4 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 23 / 29  California forest offsets California carbon market “Under-crediting” if the baseline is overly optimistic Source. Badgley et al. 2022, Figure 4 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 23 / 29  California forest offsets Empirical strategy Recalculating the baselines Recent work evaluating the 100-year predictions: Badgley et al. (2022) “Systematic over-crediting in California’s forest carbon offsets program,” Global Change Biology, 28:1433–1445. Research design: replicate California’s method for predicting 100-year classifications based on geographic regions (R 2 = 0.97) develop an alternative, more “ecologically robust” definition controlling for different species of trees e.g., Douglas Fir and tanoak (more carbon-dense, 122.5, 192.5 tCO2 /acre) versus ponderosa pine (60.4 tCO2 /acre) use classification algorithm to predict forest types to recalculate more appropriate baseline Will Rafey (UCLA) Econ 134 L12 November 13, 2024 24 / 29  California forest offsets Empirical strategy Adverse selection Example: Southern Cascades Ecosystem M261B, carbon-dense: 150.5 tCO2 /acre Ecosystem M261A, M261D, less dense: 120.6, 100.6 tCO2 /acre Average for all is 121.8 tCO2 /acre. −19% less than the M261B average! Will Rafey (UCLA) Econ 134 L12 November 13, 2024 25 / 29  California forest offsets Empirical strategy Adverse selection Mixed conifer assessment area in the Southern Cascades (Badgley et al. 2022, Figure 6). Will Rafey (UCLA) Econ 134 L12 November 13, 2024 26 / 29  California forest offsets Results Estimated crediting error by project Source. Badgley et al. 2022, Figure 5 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 27 / 29  California forest offsets Results Estimated crediting error by project Source. Badgley et al. 2022, Figure 5 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 27 / 29  California forest offsets Results Estimated crediting error by project Source. Badgley et al. 2022, Figure 5 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 27 / 29  California forest offsets Results Estimated crediting error by project Source. Badgley et al. 2022, Figure 5 Will Rafey (UCLA) Econ 134 L12 November 13, 2024 27 / 29  California forest offsets Results Discussion Badgley et al. (2022) find evidence of substantial over-crediting: Calculate over-crediting due to inflated baseline of 30.0 million tCO2 (90% CI: 20.5–38.6 million tCO2 ). 29.4% of credits analyzed (90% CI: 20.1%–37.8%) at market prices ($13.67/offset), these excess credits are worth $410 million (90% CI: $280–$528 million) Will Rafey (UCLA) Econ 134 L12 November 13, 2024 28 / 29  California forest offsets Results Next time We have a midterm, in-class: cumulative but emphasis on Lectures 6–11 and material from Problem Set 2 open-note; this includes electronic devices Potentially interesting economics discussion on public radio about post-2024 climate policy: https://www.kqed.org/forum/2010101907787/ what-the-trump-administration-could-mean-for-our-climate Will Rafey (UCLA) Econ 134 L12 November 13, 2024 29 / 29