In environmental offset schemes, there is often a time lag between when the environmental damage is done and when the offset project delivers its full benefits. How should this be accounted for in the design of the scheme?

There are various potential causes for such a time lag.

1. Typically, it takes some time before the offset project commences. Some vegetation is cleared for a development or infrastructure project, and some time later, the offset project gets underway. I’ve observed some particularly long time lags (e.g., five to 10 years) in schemes where the developer contributes money into a fund in lieu of undertaking or finding an offset project themselves.
2. Once an offset project is in place, it often takes time for the desired biological/ecological changes to occur. The length of the time lag depends on the local climate, the types of vegetation involved, the specific biological/ecological changes, and so on. If, for example, the aim is to replace nesting hollows in mature trees, that might take 100 years or more. If the aim is just to grow new vegetation, it probably takes at least a decade.
3. Some offsets are based on reducing future environmental damage. From the program’s point of view, these are somewhat risky because you may not be confident that the damage would actually occur, but that’s a separate issue. If this type of offset is accepted by a program, then there is a potential time lag if the future environmental damage is not going to occur immediately. If the best bet is that some vegetation would have been cleared in five years time, that means there is a five-year delay in the offset project generating any benefits. In most cases, the delay can only be estimated on a best-bet basis, but that is better than ignoring it.

The different delays may need to be added up, particularly delay types 1 (delay in project commencement) and type 2 (delay in ecological changes).

Having estimated the total delay relevant to a project, how should the offset scheme make allowance for that? My advice is to reduce the benefits that are estimated to be delivered by the offset project. This means that, to fully offset the negative impacts of development, a bigger or more valuable offset project is required . The longer the time lag, the greater the reduction in benefit, and the larger or better the offset project needs to be.

The way to quantify the required reduction in benefits is through compound discounting. I’ve written about discounting in the context of costs and monetised benefits in various other posts (e.g., see PD362, PD242, PD224, PD33, PD34). It’s a logical way of accounting for the fact that a future benefit involves an opportunity cost in the shorter term. In the case of monetised benefits, the short-term opportunity cost is the loss of revenue that occurs because the money invested in the project or policy is not available to put into some other project, or maybe into a bank account. If the rate of return on the best alternative investment is, say, 5% then future benefits and costs are divided by 1.05 for each year into the future that they occur. If a benefit is expected to occur 10 years in the future, it is divided by 1.05¹⁰ = 1.63. If the predicted benefit is $1,000, it gets reduced to $1,000/1.63 = $614 in an economic analysis. There are a lot of potential nuances to this, but that’s the essential idea.

In the case of an offset project, where we are estimating the benefits in ecological terms but probably not monetising them, the relevant short-term cost is different. In the national offset scheme in Australia, which is for threatened species and threatened ecological communities, future benefits of an offset project are discounted using the annual probability of extinction of the threatened species or ecological community. For example, for an endangered species, they use a discount rate of 1.2% (Miller et al. 2015). If a project would generate 5 points of benefit for an endangered species in 15 years’ time, that gets reduced to 5/1.01215 = 4.18 points.

In my view, if the objective of the program is to avoid extinction, this is a reasonable approach. The rationale is that, if the species were to go extinct during the time lag, the benefits of the offset would be lost.

I’d view that approach as a minimum requirement for evaluating offsets that address impacts of development on threatened species or communities.

For other types of environmental impacts, the rationale for discounting would be that the community prefers environmental benefits to occur sooner rather than later, because the community is missing out on ecosystem services in the meantime. It’s less obvious what that discount rate should be, but I’d suggest something like 5%, reflecting research about people’s time preferences for other types of benefits. The two types of discounting could be combined, if relevant.

If discounting is not applied to the benefits of offsets to allow for time lags, it means that the offset scheme is not delivering sufficient benefits to fully offset the impacts.

Further reading

Miller, K.L., Trezise, J.A., Kraus, S., Dripps, K., Evans, M.C., Gibbons, P., Possingham, H.P. and Maron, M. (2015). The development of the Australian environmental offsets policy: from theory to practice, Environmental Conservation 42(4): 306–314.