Defining a Regulatory Framework for Energy Efficiency Offsets

Problems in counting energy efficiency measures as offsets

Greenhouse gas emissions reductions attributable to conservation measures which increase

energy efficiency have sometimes been used as offsets for GHG emissions from electric power
generators. But these offsets have not been tradable. That is because emissions traders do not
recognize reductions in “indirect emissions”, i.e., reductions in the demand for electricity.

The only reductions with respect to electricity that are now tradable come from reductions in
direct emissions associated with the supply of electricity by power generators. They come from
net reductions of direct emissions from measures such as (1) fuel switching and improved
efficiency of fuel use occurring at existing power plants; and (2) generation from new sources
such as wind and solar, which are credited with displacing electric power generation from
competing power plants, thereby reducing those plants’ direct emissions.

Emissions brokers have been unwilling to trade in offsets which are based on reductions of
demand because such “offsets” are considered to be double counting. This evaluation is
grounded in the assumption that any mandatory regulatory program will set emissions caps at
electric power plants in absolute tons, based on their historic emissions levels. Compliance with
such a cap can be achieved by reducing a plant’s output of electricity, and, proportionately, its
fuel use and emissions. Under this kind of cap, energy efficiency measures that reduce customer
demand for electricity should not be credited as offsets. If they were, they would be counted
twice:

(1) the decrease in demand for electricity would reduce its production, helping electricity
generators meet their emissions allowances, and
(2) the offset could be purchased by an electricity generator to augment its emissions
allowance.

Another problem in crediting emissions reductions due to increased efficiency in energy use is
that appropriate baselines would have to be established. This may be a burdensome task given
the wide range of uses of electricity. Establishing emissions rate baselines is also necessary in
order to quantify direct emissions reductions from increased energy efficiency for uses of energy
other than electricity, such as for transportation and space heating.

Need for a regulatory framework in which energy efficiency measures could be credited as
offsets

We should not exclude from recognition as offsets one of the most productive approaches for
reducing the GHG intensity of economic activity. Energy efficiency initiatives by consumers are
needed to reduce the adverse impact of GHG emissions reductions on income growth.
Acceptance of indirect emissions reductions for inclusion in the emissions trading market is an
appropriate way to value and provide incentives to fund such initiatives.

Bernard Tuchman
The following regulatory approach would allow validation of offsets for reduced direct and
indirect emissions from sources other than major emitters, based on improved energy efficiency:

1. Mandatory caps on the total supply of carbon, in tons, from upstream sources (fossil
fuel suppliers). Allowances could be traded between fossil fuel suppliers.

2. Mandatory caps on emissions rates for major emissions sources (electric generators
and other point sources). The total allowance, expressed in tons, for any covered
facility, is determined by its output (for electricity, in megawatt hours) multiplied by
an allowed emissions rate (for electricity, in tons per megawatt hour). If emissions for
a facility covered by a mandatory cap are less than its allowance, the difference, in
tons, could be banked for later use, or traded to other facilities whose emissions
exceed their allowances. A facility could also meet its allowance through the
purchase of emissions offsets from outside the covered sector.

Basing mandatory limits for power plants on emissions rates rather than absolute
tons allows for the recognition of offsets due to reductions in demand for
electricity stemming from measures which increase efficiency in the use of
electricity. That is because there is no double counting of these reductions.
Reductions in electricity output induced by lower demand do not help a generator
meet its allowed emissions rate per megawatt hour.

Both the upstream absolute carbon cap on fuel suppliers, and emissions rate standards for major
emitters, should tighten over time to achieve GHG emissions reduction goals. In the case of the
upstream absolute tonnage cap, steady incremental reductions in the carbon supply would allow
the economy to adjust to GHG emissions reductions gradually, through increased efficiency in
electricity generation, improved production processes, and reduced GHG intensity of final uses.

A rate-based emissions standard would allow firms to grow in output without violating their
emissions obligations. Thus, it may appear that a rate-based performance standard is looser than
an emissions cap that is stated in terms of a fixed number of tons. But the actual impact of each
approach depends on the level of stringency of the standard, and how it changes over time.

Control of emissions from major emissions sources is insufficient to assure that an overall
reduction in GHG emissions will be achieved for a region or nation. To ensure that overall
emissions stay within pre-determined bounds requires either an upstream cap, or regulation over
all direct sources of emissions.

Even with upstream carbon caps, there is strong reason to establish mandatory caps on emissions
rates from major emissions sources, with emissions trading. This regulatory structure provides
explicit incentives to focus entrepreneurial attention on opportunities to profit from rapidly
reaching greater energy efficiency in both regulated and non-regulated sectors, thereby
minimizing the cost of achieving GHG goals over time.

Energy efficiency baselines should be set for downstream outputs and final consumer uses so that
measures which help move the economy towards higher energy efficiency are creditable. This
recognition would serve to support a widening market share for the most energy-efficient
technologies and practices available. Without support, these leading-edge technologies and
organizational methods would be adopted more slowly, or remain as “niche” products at the
fringe of commercial profitability. A larger and more secure market should induce investment to
improve product design, develop expert capacities, and achieve economies of scale in production
and distribution. This should reduce costs and encourage deepening market penetration. The goal
is for innovative approaches embodied in credited measures to become economically self-
sustaining. When a product or practice is well established in the conventional market, then

Bernard Tuchman
subsidies are no longer needed. At that time the performance standard (the baseline from which
credits are measured) should be tightened to provide a renewed incentive for the introduction of
the next generation of efficiency improvements. Thus, this approach meets the standard for
additionality of emissions reductions, achieving reductions which would not occur under a
business-as-usual scenario.

Role of Local Initiatives in Defining a Framework

for Trading Offsets from Energy Efficiency Measures

It is important to define conditions in which energy efficiency measures could be appropriately

credited as offsets. In the absence of action on the national level, both in the U.S. and Canada,
the role of designing the architecture of GHG emissions control policy has devolved upon the
states and provinces. This should be viewed as opportunities to focus on providing incentives for
measures that reduce energy use per unit of output or unit of service performed in both the
regulated and non-regulated sectors.

While local initiatives cannot create fully developed regulatory structures within their limited
domains, they can recognize, in their emissions trading programs, offsets from energy efficiency
measures which reduce the demand for electricity. These productive measures are compatible
with certain regulatory structures. Identifying the national regulatory framework in which such
offsets are appropriately credited should change the presumptions of emissions traders. If there is
at least a chance that these offsets will be valid under a future regulatory scheme, then emissions
traders should be willing to market them, even if the value of these offsets is discounted to reflect
uncertainty.

Bernard Tuchman