EU OFFICIALS VIEW OFFSETS AS POSSIBLE OBSTACLE TO

UNCLAS SECTION 01 OF 03 BRUSSELS 000708

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EIND ENRG EUN EWWT KGHG SENV TPHY TRGY
TSPL
SUBJECT: EU OFFICIALS VIEW OFFSETS AS POSSIBLE OBSTACLE TO
LINKING CARBON MARKETS

REF: BRUSSELS 259


1. (SBU) Summary: EU Commission officials, EU Parliament
officials, NGOs, and industry are looking to the United
States for development of a comprehensive cap and trade
program that can benefit from the EU's experience with its
own Emissions Trading Scheme (ETS). The use of carbon
offsets in the system is of particular interest, because
several European officials believe a transatlantic divergence
on how offsets are applied could be the largest obstacle to
linking systems in the future. Knowing that the United
States will likely lead on the issue of climate change in
talks leading up to Copenhagen in December, the EU is glad to
share its experiences with offsets and the lessons it learned
with ETS. Several key themes emerged in conversations:

-- most European officials anticipate some form of
transatlantic carbon market in the future, and some in DG
Environment consider this step to be more important possibly
even than an agreement in Copenhagen;

-- the U.S. focus on the use of domestic agriculture and
forestry offsets could prove to be a contentious issue when
engaging with the EU and ETS; and

-- any offset program must be tapered and balanced; that
is, the total number of offsets permitted must not represent
too large a portion of the emissions cap, and this proportion
should decrease over time. End Summary.

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Linking the U.S. and EU Carbon Markets
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2. (SBU) Damien Meadows, Deputy Head of Unit in DG
Environment and one of the architects of the EU's Emissions
Trading Scheme (ETS) Revision Directive, says that the
European Union's main climate goal, possibly more important
than an agreement in Copenhagen, is the creation of a global
carbon market, beginning with an OECD-wide market and
eventually expanding to include major emerging economies (see
reftel). Recognizing this will take some time, Meadows
thinks that the first step in the process should be to link
ETS with a U.S. system expecting Japan and others to follow
our lead. A key aspect of linking cap and trade systems is
establishing consistency in the application of carbon
offsets-emissions credits received normally through financial
support of projects to reduce emissions, either domestically
or in third countries.


3. (SBU) Meadows recommends a working group between
implementing experts in DG Environment and the U.S.
Environmental Protection Agency (EPA) to coordinate work on
clean development mechanisms (CDMs) and sector-based
crediting approaches to minimize future divergence. Tomas
Wyns, policy officer for the Climate Action Network, agrees
that linking the two systems will be an important issue, but
thinks that offsets present a challenge. Unlike the EU,
which is pressing for a transatlantic market as soon as
possible, Wyns does not think that linking needs to be
rushed; it is more important and less expensive if the market
works correctly.


4. (SBU) To link the U.S. and EU systems, Meadows believes
that it will be necessary for U.S. and EU regulators to
accept offsets permitted under the other's schemes.
According to Meadows, the United States' focus on the use of
domestic offsets should be modified to be more open to
projects in developing countries while the EU should be more
critical of the projects it accepts. Meadows recommends a
flexible system that will allow for adjustments as the U.S.
government discovers what works and what does not. Henrik
Hasselknippe, global carbon market analyst for Point Carbon,
noted that if there is heavy reliance on forestry or
agricultural offsets in the U.S. system, neither of which the
EU has accepted, the divergence will be difficult to overcome.

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Domestic vs. International Offsets
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5. (SBU) A key point highlighted by most officials is the
difference in importance given to domestic offsets in U.S.
draft legislation and the EU scheme. Meadows explained that
unlike U.S. companies, European firms generally have not
expressed interest in domestic offsets. Also, the EU has
preferred to avoid uncertainty related to measuring domestic
agricultural offsets, finding it cheaper to fund CDM projects

BRUSSELS 00000708 002 OF 003


in developing countries. Europeans have observed that U.S.
farmers believe that agricultural offsets will benefit them,
but Meadows cautions the United States to consider what might
happen if the system turns around, and agriculture becomes a
source rather than a sink, for example during a drought.
Under this scenario, he questioned if farmers would then be
required to pay into the system. The EU does not consider
agricultural offsets to be cost-effective, given the
technical and administrative burden required to make precise
emissions measurements on small farms. However, Meadows
recognizes that the United States has more industrial,
large-scale farms where measurement is much easier and where
accounting for methane emissions is currently under way.
Despite this difference, Meadows suggests that the United
States use policies already in place, such as linking current
farming subsidies to better practices, instead of offering
offsets.

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Forestry Offsets
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6. (SBU) There is no clear consensus in Europe as to how to
address forestry. The EU has encountered a great deal of
pressure to allow forestry credits to be used as offsets,
which it has thus far resisted. Meadows points out the total
number of available forestry credits dwarfs the ETS emissions
cap, and because prices for forestry projects are cheap,
which can lead to windfalls and speculation, both of which
distort the market. Kavita Ahluwalia, Parliamentary
Assistant to Member of European Parliament (MEP) Avril Doyle
(Ire, EPP-ED),mentioned that MEP Doyle generally is opposed
to forestry offsets. However, since deforestation is a big
problem, she believes that perhaps a small number of credits
in the U.S. system would not be an issue. By contrast,
Tomas Wyns argued that the best method is to use a
market-linked approach and invest auction money in
reforestation, instead of providing credits.

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What Europeans Want in a U.S. Cap and Trade System
-------------- --------------


7. (SBU) The EU will be looking to the United States for
leadership on the climate issue. Although Meadows finds much
in the current proposal by Congressmen Waxman and Markey
laudable, he is concerned about the large number of offsets
available, and thinks it would be better if the United States
reduces the amount over time. Despite that criticism,
Meadows said the Commission is taking some cues from the
draft bill, explaining that as the EU moves toward ETS' Phase
III beginning in 2013, it is considering discounting CDM
projects on a 5:4 ratio, as proposed in the draft. Meadows
also said that the EU might rule out what it considers to be
"inappropriate" projects; for example, if China does not
ratify a global climate agreement, it will not be granted any
more CDM projects.


8. (SBU) In crafting a U.S. cap and trade system, Vicky
Pollard of DG Environment warns that the United States cannot
just use sticks to press companies into compliance. CDM
projects will be seen as carrots and welcomed by businesses
struggling to upgrade their equipment. However, Pollard
cautioned that the United States and the EU must be careful
in developing their respective CDM programs to be sure that
developing countries do not take advantage of loopholes. For
example, Pollard explained that Nigeria has slowed its
domestic CO2 emissions legislation so it will be chosen for
more CDM projects. She believes that such unintended
consequences will be more likely if the United States does
not craft legislation carefully.


9. (SBU) Several European officials argue that a successful
offset program should be graduated and balanced, with more
offset credits allowed at the beginning, slowly lowering the
total amount allowed. Hasselknippe cautions against allowing
too many credits at the beginning and cited the example where
the EU has allowed too many offsets, driving down the carbon
price. Though the draft Waxman-Markey bill limits the value
of offsets by offering only an 80% credit for offsets
purchased, Hasselknippe believes it would be easier to impose
limits on the total number of allowed offsets and let the
market set a price. He also believes that the Waxman-Markey
proposal is too generous on offsets and those numbers will be
impossible to find in the United States.


10. (SBU) Wyns stated that the United States must find a
balance between what is feasible and what is necessary.

BRUSSELS 00000708 003 OF 003


"Offsets can play a valuable role" in striking this balance,
by allowing for flexibility to achieve the cap target.
Although there are lessons to learn from the EU experience,
Wyns says the "best way to learn is by starting a system"
because the economic and environmental realities in the
United States are inherently different from those in Europe
and will naturally achieve different results.

MURRAY
.