Sean recently wrote a provocative post on why "additionality" -- one of the bedrock principles of carbon markets as presently designed -- is an expensive waste of time. This is a rich topic, and my perspective as a carbon offset retailer differs from his as an energy producer. It's worth spending a few posts exploring why.
When we ask whether a greenhouse-gas reduction is "additional," we're asking if it would have happened in the absence of whatever incentive we've applied. According to the logic of additionality, if the reduction would have happened anyway, then we've wasted our money. Additionality is a fairly horrible piece of jargon, and I've only ever heard it used in the context of carbon policy. But in understanding why the concept matters, it's useful to step back and consider how it applies in other contexts.
In fact, the question of additionality arises every time we try to use an incentive to achieve a certain outcome. Say you own a grocery market, and you run a coupon in the Sunday circular to entice shoppers to your store. Lots of people redeem the coupon in the following week. Was the promotion a success? Well, it depends. Presumably some of the people who redeemed the coupon would have shopped at your store anyway. You wasted your money on those folks. But some of the people who redeemed the coupon are new customers, "additional" to your normal store traffic.
To know whether your promotion was effective, you'd have to measure these two groups to see whether the new shoppers compensate for the free riders. Needless to say, such measurements are difficult and expensive in real life, so most retailers don't bother. They use some rules of thumb to limit their risk and assume that coupons are on balance a boost to business.
Similar logic applies to just about any arena in which economic incentives are applied. The California Clean Car Discount Act aimed to stimulate the purchase of fuel-efficient cars by refunding money to people who buy hybrids. Of course, people were already buying plenty of hybrids in the absence of this incentive, so some significant portion of the refunds would necessarily be "nonadditional," wasted on people who would have bought hybrids anyway.
Which isn't to say such refunds are a bad idea, any more than grocery store coupons are a bad idea. Some degree of nonadditionality is inherent in any incentive system. That's the rub. The degree and costs of nonadditionality matter a lot in designing an incentive program, a point to which I'll return in a future post.
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Comments
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Russ Posted 2:47 am
30 Mar 2008
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bigTom Posted 5:16 am
30 Mar 2008
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Adam Stein Posted 6:16 am
30 Mar 2008
BigTom -- not really. If a project makes financial sense on it's own, its probably not ever going to be eligible for offset revenue. And if it doesn't make sense on its own, there's no perverse incentive. Further, you can generally claim offset revenue in the future if you can credibly demonstrate that anticipation of such revenue played a part in the decision to go ahead with the project. So there really isn't that much of a timing issue. Finally, real world experience suggests that this scenario just isn't all that common or plausible. There was no mad stampede to cut CO2 emissions prior to the creation of a carbon market, and it's really hard to see that providing an additional financial incentive is going to do anything other than accelerate such projects.
www.terrapass.com/blog
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Biodiversivist Posted 6:25 am
30 Mar 2008
without a precise definition of what is a "bad idea."
It all comes down to cost per unit of mass. So, start by picking a cutoff. If the price per ton falls on the "bad idea" side, you have a bad idea.
I have seen no data that would suggest to me the hybrid rebate was a good idea or not. It certainly got some people to buy a Prius sooner than they might have, but at a time when the price of the Prius was inflated. Had they waited, they could have gotten one for the same net amount when the prices came down. It also gave ammunition to hybrid hatas, who spread internet rumors, which probably hurt sales as well.
Ah, crap, now I have to build another spreadsheet.
http://home.comcast.net/~russ676/photo/priuscarbon3.gif
Just whipped this out without a thorough check or peer review, so if anybody spots a discrepancy let me know. I'll fix it and repost.
In the end, it all comes down to biodiversity. Poison Darts--Protecting the biodiversity of our world
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Adam Stein Posted 7:06 am
30 Mar 2008
www.terrapass.com/blog
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Sean Casten Posted 10:58 am
30 Mar 2008
If so, are there exceptions if you can present proof that your board has previously rejected this investment in spite of it's economics? Does it suffice to present examples of similarly attractive returns that your board has previously rejected? How about if your company is nearing bankruptcy - can you then present your Chapter 11 filing as proof that there is no way your company will fund a project right now, regardless of it's return? (And do you then provide a discount on the chance that your investment is going to be nothing more than a pile of metal should you go through Chapter 7?)
The issue, as I see it is that if the answer to any of the above questions is "well, it depends", then additionality falls into the classic philosopher king problem (e.g., that the ideal form of government is a benevolent despot.) Such a model doesn't exist, and so it simply adds friction to the carbon transaction, driving $ away from carbon reducing projects.
I'm eager to read your follow up posts. But I remain fairly well convinced that any effective carbon policy must price all tons of GHG emissions equivalently (whether they are increases or decreases). Unless you can convince me that additionality doesn't distort the pricing such that some tons are worth more than others, I'm skeptical.
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Jason D Scorse Posted 1:44 pm
30 Mar 2008
This means that most of these middle income to wealthy people simply got subsidized
This means that it probably cost the government at minimum 10-20k to bring 1 new hybrid on the road
The marginal benefit of that is very low- probably an extra 10mpg since the alternatives have good gas mileage
This is a terribly inefficient and regressive way to decrease gasoline use
J.S.
I teach environmental economics and blog at http://www.voicesofreason.info.
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human power Posted 2:40 pm
30 Mar 2008
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spaceshaper Posted 10:04 pm
30 Mar 2008
It should go without saying that public policy formulations designed to achieve actual reductions in greenhouse gas emissions need to be subject to measurable and definitive scientific parameters. Additionality has already failed the tests of scientific definitiveness and measurability in the offset business, where the rule seems to be that it's additional if I say it is. IMHO.
The true meaning of life is to plant trees, under whose shade you do not expect to sit.
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Adam Stein Posted 10:56 pm
30 Mar 2008
Sean -- the answer to your hypotheticals really aren't "it depends". There are different ways to measure additionality, with the stringency being determined by the standard being applied. Some standards -- such as the ones for RECs -- rely on simple qualification criteria that apply to broad classes of projects. Others look at project-specific details that include financial metrics such as IRR. In no case that I can think of would developer-specific issues (such as the company's financial health) play a part in an additionality test.
www.terrapass.com/blog
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Sean Casten Posted 11:09 pm
30 Mar 2008
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spaceshaper Posted 11:31 pm
30 Mar 2008
That said, BioD's table prompts some interesting thoughts. He shows variations in only two columns: two versions of the cash incentive and several versions of the % incentivized. The latter, which leads to huge variations in outcome, is pure guesswork of course - this is not a criticism of the methodology, just an observation.
Similar outcome variations would be observed by changing the number in the first column - miles driven per year. It assumes that Prius drivers have the same average mileage as all drivers. Suppose this is not the case - I have seen unreferenced claims of 6,700 miles/year as a Prius average, if this is true I'd guess it's an indicator of the kind of owner the car attracts. This would almost double the public cost per ton of public good in carbon reduction. On the other hand, a Prius driven 100,000 miles per year would improve the cost/benefit at a given level of subsidy and incentive performance eight-fold.
In other words, IF subsidy is the way you want to go, taxi operators and similar irreducible heavy users would clearly make a far effective target than general users.
The true meaning of life is to plant trees, under whose shade you do not expect to sit.
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spaceshaper Posted 11:37 pm
30 Mar 2008
It's just the additionality that's nothing but a wet finger in the breeze.
The true meaning of life is to plant trees, under whose shade you do not expect to sit.
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Adam Stein Posted 1:24 am
31 Mar 2008
(Note that there actually is a huge price spread in the carbon market, but this is the result of fragmentation, nothing inherent in the concept of additionality. One would expect that fragmentation to decrease as the market matures.)
spaceshaper -- again, this just ain't so. There's an increasingly intricate policy apparatus set up around gauging additionality. It's not perfect, but it's certainly not arbitrary.
www.terrapass.com/blog
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Sean Casten Posted 2:01 am
31 Mar 2008
Here is the issue:
Project 1 passes an additionality test, and therefore gets compensated for it's associated GHG reductions. Let's say for the sake of argument in current voluntary markets that's worth $5/ton.
Project 2 doesn't pass the additionality test, and therefore doesn't get compensated for it's associated GHG reductions. Ergo, the carbon reduction it produces is worth $0/ton.
Thus, the additionality test has, by design, created a $5/ton spread in GHG pricing, skewing the capital allocation decision. As an investor, rather than evaluating both projects ont their merits with a known value for GHG reductions adding to those merits, I only get compensated for the GHG reductions in one of the two. Which, proportionally, means that I have a slightly greater incentive to invest in the suboptimal project, creating both economic and environmental loss.
Another thought experiment to clarify. At current prices for solar photovoltaics, they don't justify the investment if the only value they can earn credit for is displaced retail power. So we work hard to help PV panels capture other value streams, from net metering to tax incentives to capital buydowns. And even with all those, I think we would probably both agree that a guy who wants to put PV on his roof can probably always pass an additionality test. Which raises the following question: What is the price for PV at which it is no longer "additional"? $1/watt? $0.50/watt? I don't know the answer, but any additionality-authorizer must implicitly be able to calculate this number as the point at which a PV investment is no longer additional. And if I know that number and I am a PV developer, I have an incentive to get my prices down to just north of that $/watt value so that I stay additional.
I grant you that this is an ounce too precise - but it is precisely the degree of false precision imposed by additionality tests, and why I asked what the specific criteria are.
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Adam Stein Posted 4:14 am
31 Mar 2008
Some specific responses:
This whole issue sort of goes away when a carbon cap is in place. Assuming the cap encompasses all electricity generation, then low-carbon sources of energy will automatically be privileged in the marketplace by carbon pricing. Moreover, if we want to specifically goose renewables over and above the pricing advantage conferred by a cap, the appropriate way to do so is through an allowance set-aside. The allocation formula for set-asides is an esoteric policy arena, but I suspect it's one that you will be getting to know in the near future. Specifically, I'm guessing you'll be most interested in an output-based allocation mechanism. Such a system would apportion allowance revenue based purely on output -- additionality tests wouldn't enter the picture at all.
You raise a good point about the perverse incentives of specific IRR cutoffs for renewables. Again, though, I think this goes away under a cap. The allowance market will be so much larger than the offset market that there will be quite strong incentives to reduce the cost of renewables.
www.terrapass.com/blog
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Biodiversivist Posted 4:48 am
31 Mar 2008
In the end, it all comes down to biodiversity. Poison Darts--Protecting the biodiversity of our world
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Sean Casten Posted 5:33 am
31 Mar 2008
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KenG Posted 6:22 am
31 Mar 2008
I bought a hybrid car even though (becuase of AMT) I got no tax advantage. I did it because I needed a new car and I thought the technology was cool. It's additional but it's not because of the incentive.
I'm delaying installing a geothermal heating system. Partly because I won't qualify for the incentives, partly because I think installation costs are coming down with experience, and partly because I don't think my gas furnace is worn out quite yet. When I have to replace the furnace, I'm 100% sure I'm going geothermal. Will that be additional, even if I get the incentives?
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spaceshaper Posted 8:17 am
31 Mar 2008
The true meaning of life is to plant trees, under whose shade you do not expect to sit.
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Adam Stein Posted 8:53 am
31 Mar 2008
www.terrapass.com/blog
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spaceshaper Posted 9:12 am
31 Mar 2008
You point out many of the problems yourself. "Increasingly intricate" sounds like a bureaucrat's wet dream, a nightmare for those actually trying to achieve positive climate effects.
And how about this from your OP:
Needless to say, such measurements are difficult and expensive in real life, so most retailers don't bother. They use some rules of thumb to limit their risk and assume that coupons are on balance a boost to business.
Looks like the old wet finger to me.
The true meaning of life is to plant trees, under whose shade you do not expect to sit.
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