Optimal monitoring and offset prices in voluntary emissions markets

Carbon offset markets are modeled as an uninformed regulator who wishes to use a voluntary price instrument to reduce harmful emissions under varying degrees of private information. Regulators offer agricultural producers payments to reduce their emissions for some price per ton relative to the social price of carbon. Abstracting from distributional concerns or costly transfers, we derive optimal contracts for offsets contracts, minimizing welfare losses from adverse selection. The model shows how the level of monitoring and the prices offered should vary depending on the regulator's information. Although existing and proposed policies discount the price that offset producers receive relative to the social cost of carbon to account for the adverse selection, our model argues that optimal offset prices may be above the social cost of carbon for sufficiently high levels of monitoring. Our model also identifies and quantifies the types of firms that produce additional offsets for a given contract, offering guidance on how regulators might better target offset contracts.