Carbon sequestration from forestry and agriculture

Rob Stavins writes about curbing potential climate change by sequestering carbon rather than, or in addition to, reducing emissions from fossil fuel consumption. Stavins focuses mainly on preserving and increasing forest coverage. There are two good reasons for this focus: (1) deforestation is responsible for about 20% of CO2 emissions worldwide and (2) preventing deforestation and planting new forests appear to be low-cost ways of reducing total emissions.

Within the Waxman-Markey bill, CO2 emissions can be offset from agriculture and forestry activities. I'm not convinced much sequestration gains are to be had from agriculture. But farmer interests smell an opportunity, and with 80 years of rent-seeking under their collective belts, they are quite good at capitalizing on them. Under the bill (at least some versions of it) USDA will run the offset program, not EPA. That's probably essential given political constraints.

Some environmentalists smell a rat in the offset provision. They seem to see offsets as a loophole to avoid actual emissions reductions. There may be some truth to this.

My view is a little different (see earlier post). The problem is that by restricting emissions from carbon-based fuels and ultimately increasing the price of energy, there will be increased demand for other resources, including those from agriculture and forestry. Instead of using oil and gas people will use wood and ethanol. If carbon emissions from wood and ethanol are not counted they will be under-priced in a cap-and-trade world. Besides wood and ethanol, there are surely a zillion other indirect market implications we are unlikely to imagine.

So, in the end, we must at least try to count all the carbon. Otherwise we'll be squeezing a balloon--reducing emissions in one part of the global economy just to have them pop out somewhere else. It's not much different from having cap-and-trade in the U.S. and then buying Chinese goods produced using their uncapped carbon emissions. Eventually, we'll need to get China, India, and the rest of the developing world on board. Everyone knows this. But not everyone seems to recognize that we need to count all the carbon.

An offset policy doesn't capture these indirect effects. Even a painfully complicated offset policy that attempts to trace market impacts far and wide to make sure they are "additive." Even if there are no offsets, energy price changes will shift demand for all kinds of resources, from firewood to ethanol, all which affect the carbon balance.

I don't think many are yet willing to seriously consider the difficulty of this problem. It almost surely won't get into the first bill. But sooner or later we'll see fewer emission reductions than we expected. Maybe then we'll start counting all the carbon. Hopefully it won't be too late.

Reliable and transparent measurement of carbon emissions and sequestrations from forestry and agriculture will be key. While current [proposed] offset policies may do little in the way of actually influencing the carbon balance, they will spur research and debate about measurement issues. That's a good first step.

We've hit bottom in the housing market

In case you haven't noticed the efficient markets hypothesis has been proven false.

That means, at least occasionally, there are $100 bills lying all over the place to be picked up by those savvy enough to notice.

If you've read Robert Shiller's books and papers, studied the data, you would recognize that RIGHT NOW is one of those times: We've hit bottom in the housing market. Yes, housing prices are predictable. The price to rent ratio isn't bad. Not bad at all. And it's much better given today's remarkably low interest rates.

If you are a first-time buyer now is a ridiculously good time to buy because the government will give you $8000 on top of the already good deal that is the current housing market.

It's a little harder if you're an investor because interest rates are not as advertised: few banks are lending to investors and the terms are pretty ugly. Expect a higher interest rates and 3 to 4 points origination fees, even if you're buying an under-priced foreclosure, putting 25% down and have 800+ credit scores.

If you're paying with cash you can find properties with a 10 to 1 price to rent ratio. Easy. At least in markets I know well. That means a conservative estimate right now is that these properties will earn a 10% real return over the long run. That's insanely high given long-run inflation indexed bonds pay 1-2%. This is a risk premium to put all risk premiums to shame.

So if you have cash and a little patience, go buy a house. Ten years from now you'll be very happy you did.

But before you do as I suggest, be sure to read my disclaimer.

What is a farm?

Sounds like an obvious, even stupid question, no?

Awhile back I complained about reports in the New York Times and many other places that drank the spiked koolaid put out by the USDA that claimed the number of farms was growing. (See here and here.)

The problem is, the increase in the number of farms was in all likelihood a statistical allusion stemming from a quirky (and wholly misleading) definition of a farm. You see, most farms that USDA calls farms you and I probably wouldn't call a farm. To the USDA a farm is any place that could have produced $1000 of agricultural output. Horses, Christmas trees, and maple syrup all count. Inflation, high commodity prices in 2007, plus the fact that the USDA has been searching harder and harder for those illusive small farms over the last ten years or so, added up to more micro $1000 farms.

This goofy definition does strange things to both farm numbers and average farm size, to the point where average farm size is an utterly meaningless statistic.

Why do we have such a silly definition of a farm?

Well, some funding from USDA to the states is tied to the number of farms in the state. So yes, it matters a lot to some people what that definition is. And if USDA were acknowledge how few farms were really out there it might be harder for the agency to justify its existence.

Anyway. This was one of my rare posts that was picked up other more prominent bloggers out there, including a link from Mark Thoma, and nice mentions by Grist and Ezra Klein.

Not long after USDA-ERS came out with a nice little report lead-authored by an old friend and colleague Erik O'Donoghue that makes all of this very clear. I had lunch with Erik today and he tells me this little report is getting a lot of attention. That's very nice to hear!

Now will they change the definition of a farm? Well, I'm not holding my breath until they do.

Note to self: A good justification for assigning tough homework (also very funny)

Via Mark Thoma, we have Richard Green posting an email from one of his students:

The rigors of the USC Masters in Real Estate Development Program

A student of ours emails:

I just wanted you to know that this assignment got me out of a traffic ticket this morning.

La Cienega was shutdown to due an accident and I was trapped. So, I made a u-turn which included driving over a curbed median. A motorcycle cop pulled me over and gave me a lecture about how this isn't Texas (I have texas plates) and "cowboy driving" is not acceptable....whatever that means. So I told him that I had to get to campus for the mid- term and I had a limited amount of time to complete the homework assignment. I pulled out assignment #3 to make my story credible and he took it with him when he went back to his motorcycle.

When he came back he told me that it seemed like the assignment was going to be enough punishment and he let me go.

Conservation programs drive crop production

I noted this stylized fact in an earlier post, but I think it is important enough to emphasize again: Over the last 100 years most variation in crop production comes from agricultural policy. But it's a lot different from what gets reported in the popular press. Or even the journals. It's primarily conservation policies that pay farmers not to plant. Effects of production subsidies are (probably) quite modest and mainly have indirect effects that are hard to figure out.

Here are two pictures. The first shows harvest cropland, failed cropland (with the infamous dust bowl years on 1934-1936 being the only clear discernible events), and acres in set-aside and conservation programs. Since 1986, the set-aside and conservation acres are comprised entirely of land in the Conservation Reserve Program. It's also interesting to note that while production has increase steadily with yields, there is no discernible trend in crop acreage: it's been about 300-350 million acres for a hundred years. That's about the size of nine or ten average-sized states (the area of North Carolina is 34.5 million acres).

So what drives variations in conservation acreage? That would be prices. Acres in conservation increase when prices fall, and vice versa. Which brings me to the second graph: it shows conservation acreage plotted with an index of key commodity prices (corn, soybeans and wheat, which comprise most U.S. cropland), adjusted for inflation and lagged one year. I lagged the price index one year because it takes a year for policy to respond to prices.

It could be that harvested cropland would have responded to price fluctuations even without changes in conservation policy. But I think that's a tough argument to make.

Anyhow, I wish both popular and scholarly reporting on agricultural policy and commodity prices would keep in mind the central importance of conservation policy.

Commodity Prices: Supply, Demand and Speculation

For awhile, commodity prices starting to climb again, which some, like me, took as a sign that the economy would soon start growing again. I heard a rumor that editor of the Journal of Environmental Economics and Management predicted oil will hit $100/bbl by the end of the year. But now commodity prices are falling off again.

I think Paul Krugman's tidbit on all this is right on the money: it's been speculation about "green shoots" that now are not materializing as expected. Unlike the much larger boom in commodity prices that culminated in last summer's record peak, the recent more modest rise appears to be due to speculation. This is indicated by the rise in inventories that accompanied the boom. The market was anticipating world demand to rise as the recession bottomed out and growth resumed. So, instead of selling commodities at low prices, commodities were stored, in speculation of higher future prices. But future demand growth is proving more elusive than thought, so prices are falling off again, a lot like long-term interest rates.

Looking more broadly at the pattern commodity prices, something quite astonishing has happened over the last few years. Price fluctuations have become much more a demand-related phenomenon than a supply-related phenomenon.

For energy price fluctuations used to come mainly from oil embargoes, wars, and worry about impending wars or other events creating supply interruptions. Occasionally there was worry about OPEC commitments having real teeth. Thus, there were supply actual shocks or speculation about possible supply shocks that sent prices soaring, with prices falling once the actual or feared shock abated.

For agricultural commodities prices trended down due to remarkable yield growth. Price fluctuations came mainly from surprises in the weather. Prices and inventories would occasionally build up because markets anticipated some kind of supply disruption.

But today it's all about demand. Demand for all kinds of commodities from oil to food grains came from tremendous growth in China and India. Supply growth couldn't keep up. Agricultural commodities got an additional demand boost from ethanol, which also linked agricultural prices more closely to energy prices. Then, when the global economy tanked, so did commodity prices. And today speculation, instead of being about possible supply disruptions, is all about when demand growth will resume.

Killian has a nice technical academic paper on all of this, focusing on oil prices, recently published in the flagship economics journal (AER). Here's an unguarded version. It's also pretty obvious if you just stare at the data long enough. The story looks very similar for agricultural commodities.