Forest Owner Opportunities in California’s Cap and Trade Program

In 2006, California passed Assembly Bill (AB) 32, the Global Warming Solutions Act, directing the California Air Resources Board (ARB) to develop a program to reduce greenhouse gas emissions to 1990 levels by the year 2020 in California.  ARB developed its Cap and Trade Program, and 2013 saw the start of mandatory compliance obligations.  In general, the program sets emission caps which reduce over time and which trigger emission compliance obligations.  To comply with the program, covered entities such as electric utilities or fuel refineries must acquire either emission allowances (“Allowances”), issued by the ARB, or carbon emission offset credits (“Carbon Offsets Credits” or “COC”) from COC project owners/developers (collectively, “Compliance Instruments”) and then surrender these Compliance Instruments to the ARB for their covered emissions.

The Carbon Offset Credit component of the program creates opportunities for forest owners in the lower 48 states to participate and receive revenue for being a COC provider.  As part of the Compliance Offset Program, the ARB has adopted four Compliance Offset Protocols under which projects can be developed, implemented and verified for issuance and sale of Carbon Offset Credits:  Ozone Depleting Substances Projects Protocol, Livestock Projects Protocol, Urban Forest Projects Protocol, and US Forest Projects Protocol (the “Forest Protocol”).

The COC creation market has the potential to be significant.  Unlike voluntary carbon credit markets, California Carbon Offset Credit prices are responsive to regulatory floors and requirements—namely, the ARB sets a price floor for the Allowance auctions which helps to support COC prices.  COC prices are discounted to the Allowance price because Carbon Offset Credits may comprise only 8 percent of a covered entity’s compliance obligation.   For example, the 2014 floor price for an Allowance is set at $11.34, and the 2014 Allowance budget is 159.7 million Allowances—meaning there is an opportunity in 2014 to market approximately 13 million offset credits at prices that could range from $8-10 per offset (or higher if the allowances trade higher than the floor price).  This annual market opportunity grows in later years due to additional covered entities entering the regulatory program (for example, the Allowance budget jumps to 394 million Allowances in 2015).  Further, there is flexibility in the market as Carbon Offset Credits may be banked for future year compliance obligations.

Eligibility of forest lands for the Forest Protocol depends on the project type.  The Forest Protocol identifies three different project types: 1) Reforestation; 2) Improved Forest Management; and 3) Avoided Conversion.

  • Avoided Conversion projects may only occur on privately owned (including tribal) land, unless the land is transferred to public ownership as part of the project.  Lands are only eligible if it can be demonstrated that there is a significant threat of conversion of project land to non-forest land use.
  • Reforestation projects are limited to lands that have had less than 10 percent tree canopy cover for a minimum of 10 years or have been subject to a Significant Disturbance removing at least 20 percent of the land’s above ground live biomass in trees.  The projects may occur on private land, tribal land or on state or municipal public land.
  • Similarly, Improved Forest Management projects may occur on private, tribal or state/municipal lands.  These projects involve management activities that maintain or increase carbon stocks on forested land relative to baseline levels of carbon stocks.  To be eligible, these lands must contain more than 10 percent tree canopy cover.

Notably, federal lands, except for tribal lands, are not eligible for any of the projects.  The exclusion of federal lands creates a significant opportunity for private and tribal forest owners to participate in the carbon market and create additional asset value.  The Carbon Offset Credits create opportunity for an annual revenue stream. And, importantly, some of the Forest Protocol projects are not incompatible with ongoing timber management objectives, but may, in fact, help generate revenues that can assist in overall forest health and timber management objectives such as through thinning projects and/or biomass removal.  The Carbon Offset Credit revenues could also be rolled into other management objectives, for example, forest land acquisition.  However, there is a cost to entry and ongoing management costs for reporting and verification which should be factored into any project projection.

Any forest owner interested in the program should contact a reputable professional to assist them in a feasibility review of the Forest Protocol and the forest owner’s lands, forest composition and management practices and objectives.  This would evaluate potential size of project, credit generation and revenue and cost projections.  For example, under the Improved Forest Management protocol, project sizes under 5,000 acres may not make financial sense standing alone, but could perhaps be aggregated with other land holdings.  In addition, invalidation and other legal risks should be evaluated.

In summary, the California Cap and Trade Program is large enough and valuable enough to entice interest in forest carbon offset project development on private and tribal lands.  These offset projects can create additional value for forest owners, but only if they are consistent with existing overall management objectives. While the market is regulated, it is also still emerging.  Accordingly, it is important to evaluate the risks as well as the opportunities before committing to a project.