A Big Loophole in Cap and Trade

Nearly 3,000 miles from the U.S. Capitol, where lawmakers are debating landmark climate legislation, a crucial aspect of the national campaign to limit greenhouse gas emissions is taking shape at the headquarters of Sierra Pacific Industries.

Situated on the banks of the Sacramento River, Sierra Pacific is California's largest nongovernment landowner and timber harvester. The privately held company, which has estimated annual revenues of $1 billion, says it will manage trees on 60,000 acres of its land in a way that will soak up more carbon dioxide and slow global warming. In exchange, it could receive about $10 million over five years via the sale of "carbon offsets"—financial instruments that would play a vital role in the proposed "cap-and-trade" system at the core of pending climate legislation.

The buyers of Sierra Pacific's offsets—manufacturers, power companies, and other sources of greenhouse gases—would be allowed to continue some of their emissions on the theory that the pollution will be balanced out by the preservation of Sierra Pacific's CO2-consuming trees. This is one way cap and trade is supposed to encourage environmentalism without unduly inhibiting industry. The term refers to the strategy of setting an overall limit on emissions and allowing companies to use market trading to meet the cap.

"The carbon model fits very well with intensive forest management," says Mark Emmerson, Sierra Pacific's CFO, during an interview in a company conference room adorned with blond Douglas fir paneling. "Every year, we end up with more trees in the ground than we began with."

QUESTIONABLE VALUEBut there's a hitch: Long before considering the offset plan, Sierra Pacific had already agreed to grow more trees. In other words, the offsets may not result in any new conservation. The forestry giant could reap a windfall while industry continues to pollute.

Sierra Pacific's plans illustrate a potential weakness in the cap-and-trade approach, one that has already cropped up in Europe, where the strategy has been used for several years: If offsets are not policed stringently, they will do little to curb global warming.

In June the House of Representatives narrowly approved a bill that aims to cut heat-trapping emissions 17% by 2020 from 2005 levels. Several Senate committees are working on similar legislation; all of the versions encourage use of offsets from such U.S.-based projects as those that replant forests or capture methane from dairy farms. If a final bill emerges, President Barack Obama is expected to sign it.

Purchasing offsets that represent someone else's commitment to reduce emissions is generally much less expensive than renovating a factory to make it green-friendly. But there is a drastic shortage of projects in the U.S. that would generate offsets. And regulators may feel pressure to weaken rules to allow more offsets into the system.

California, a trailblazer on climate rules, enacted its own global warming law in 2006. It seeks to reduce greenhouse gas emissions to 1990 levels by 2020. How California fares could foreshadow the fate of any national cap-and-trade system.

LESS THAN ADVERTISEDAfter deliberating for two years, the state adopted the latest rules for forest offsets in September. "Our purpose is to make sure there is environmental integrity," Gary Gero, president of Climate Action Reserve, a Los Angeles nonprofit charged with creating the rules, told a luncheon of state legislative staff members in Sacramento in October. "If someone says they've reduced 1 ton of greenhouse gas emissions, there [should be] legitimacy to that claim."

The program has already sparked the sale of offsets in anticipation of its 2012 start. "The protocols work with our business," says Neal Ewald, vice-president and general manager for California operations at timber company Green Diamond Resource. Sierra Pacific issued a press release in September about its 60,000-acre project, constituting 3% of the company's landholdings. The endeavor would absorb an additional 1.5 million tons of carbon dioxide over the next five years—"in excess of what would have otherwise occurred," the company claimed. In a separate statement, California Governor Arnold Schwarzenegger said the effort would be equivalent to removing 300,000 cars from the road for a year.

A close look at Sierra Pacific's plans reveals that the company may create less additional environmental benefit than advertised. Under long-standing California conservation rules—which predate requirements related to global warming—the company filed a plan in 1999 committing to how it would conduct logging over the next 100 years. Sierra Pacific estimated that the volume of trees on its land, measured in conifer timber feet, would nearly triple, from 17.8 billion in 1999 to 50 billion in 2079.

In carbon-project documents released in early November, Sierra Pacific is proposing to seek credit—and get paid—for some of the same increased volume of trees it had promised in 1999.

Sierra Pacific executives object to the question of whether their offset sales will result in additional environmental protection. "We don't have to do what we said we were going to do [in the 1999 state forestry filing] until we sign the carbon agreement," says Edward C. Murphy, a Sierra Pacific forest manager. "Because we were smart enough to figure out how to increase carbon [reduction] before it became a rule, we shouldn't get credit for it? ... It's a nonsensical question."

Other offset project developers concede that the approach is a work in progress. Chris Kelly, California program director of the Conservation Fund, a nonprofit in Arlington, Va., has established two large forestry projects in California's system and has nearly sold out the offsets through 2015, raising an expected $17 million from a range of companies. But Kelly's group had purchased the land in 2004 and 2006 with state-subsidized loans—and with the agreement that it would not intensively harvest the land. Having agreed to preserve the trees several years ago, the fund will be paid for making the same guarantee again.

"We're working with the protocol that the state gave us and followed it to the letter," Kelly says. He argues that it's important to get some kind of climate regulation in place, even if flaws have to be ironed out later: "What California is trying to do is get something out there that we can all work with."

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