Leakage from Carbon Offsets

As I've described in some of my earlier posts [1, 2, 3], there is a big problem with CO2 cap-and-trade policy that counts carbon from fossil fuels but does not count carbon from forestry and agriculture. The problem is fossil fuels will be replaced by other energy sources, like biofuels, that can affect the carbon balance in powerful and sometimes indirect ways. For example, biofuel consumption will be derived from land. This ultimately puts pressure on prices of agricultural commodities. Higher commodity prices leads to more crop production and higher crop production ultimately comes from deforestation.

It's hard to tell how large this problem may be. But the fact that 20 percent of carbon emissions come from deforestation suggests it could matter a lot.

Right now alternative sources of carbon sequestrations and emissions are being targeted by carbon offsets. If you feel guilty about burning fossil fuels you can go to places like TerraPass.com or www.Carbonfund.org to buy offsets for your emissions. Carbon offsets are also playing a big role in the Waxan-Markey bill. But leakage, the problem I described yesterday that did not make it into an otherwise wonderful NY Times article, makes these offsets smaller than you probably think.

So how much do offsets actually influence the carbon balance?

Here's a rough calculation based on some of my current research with Wolfram Schlenker. (This is a bit wonkish.)

Our research finds that worldwide demand for the world's four most important crops, wheat, rice, corn and soybeans, is highly inelastic. Our estimated demand elasticity is -0.05. This means prices need to double to get the world to reduce consumption by 5 percent. Our estimated supply elasticity is about 0.1. This means the farmers of the world will produce about 10 percent more if prices double. We find that basically all the supply response comes from expansion of crop area as opposed to greater production per acre.

A big assumption I'm going to make is that cropland expansion ultimately comes from deforestation. It may be that some new cropland comes from range or pasture and then the lost pastureland and rangeland is replace by deforestation. There's nothing about our study that makes these particular links explicit, but at present I don't believe it's far from the truth. I'm making lots of other small implicit assumptions but it's too much to get into in a blog post.

The figure below shows how to connect demand and supply to the amount of "leakage" in carbon offset policies. Leakage increases as the size of the supply elasticity increases relative to the size of the demand elasticity. With a supply elasticity about twice as large as demand, the amount of leakage is about two-thirds. That is, for every 3 acres of forestland preserved (prevented from switching to crops), 2 acres are deforested somewhere else. That's about what's drawn in the figure (but in reality both curves are steeper and the price increase is much greater).
So you need to buy about three times as much offsets as you think you do to be truly carbon neutral.

Yes, I'm making tons of assumptions and extrapolating big time. But based on what I know now I think this estimate is a reasonable one.

The carbon offset organizations say they account for leakage. I'm more than a little skeptical. The problem is the that leakage can occur on the other side of the planet from where the offsets happen. And if one carbon offset company doesn't account for leakage (a very hard thing to do) then its carbon offsets will be cheaper, which kind of mucks up incentives for the other companies to account for leakage.

Update: Here is a link to a rough draft of our research that estimates the elasticities. The paper does not look at leakage but I think the next draft will. I rounded the numbers a bit for simplicity.

Note also that there are some kinds of carbon offsets that probably wouldn't have much of a leakage problem. Like paying farmers to control methane emissions from livestock (yeah, it's what you think it is). But I think offset potential for everything besides [preventing] deforestation is small potatoes.