Optimal Discounting of Forest Offsets in the Carbon Market

Abstract

Unilateral actions to reduce CO₂ emissions can be costly and may lead to carbon leakage through relocation of emission-intensive and trade-exposed industries (EITE). This article examines the welfare effects of introducing an emission offset mechanism for the EITE sector, where EITE producers may have to acquire more than one offset credit to balance one emission allowance. The analytical results suggest that it is globally welfare improving for a region to introduce such an offset mechanism, with an optimal conversion rate below 1. Moreover, numerical simulations in the context of the European Union emission trading system and the Reducing Emissions from Deforestation and Forest Degradation) credits support the analytical findings.