Impact of Cap and Trade Legislation on U.S. Agriculture

AgMRC Renewable Energy Newsletter
September 2009

Don Hofstrand  Don Hofstrand
  Agricultural Marketing Resource Center

In this article I will outline some of the potential impacts on the agriculture sector of a cap and trade system similar to the one being presented in the American Clean Energy and Security Act (HR 2454).  This legislation recently passed the U.S. House of Representatives and is currently being considered by the Senate.  USDA has released a preliminary analysis of the effect of the legislation on U.S. agriculture. (1) Below is a summary of the agricultural impacts presented in the report.  Then I will present some issues not covered by the report and end with a brief discussion of the choices facing U.S. agriculture.

A cap and trade system provides an upper limit or cap on greenhouse gas (GHG) emissions (carbon dioxide, methane, nitrous oxide, etc.). Certain users of fossil fuels will be required to reduce their GHG emissions to meet the cap.  Emitters can meet the cap requirements by either reducing their own emissions or paying someone else to reduce their emissions.  This is where the “trade” comes in – money in exchange for emissions reduction.  The emitters will probably choose the lowest cost alternative for meeting their reductions under the cap by investing in methods to reduce their own emissions or pay someone else to reduce their emissions.

Production agriculture is not included in the current legislation as one of the industries that is required to “cap” their GHG emissions. However, they can provide emission reduction offsets to companies in industries that are required to cap their emissions.  This has the potential to provide an additional income stream for agriculture.

Although agriculture is not required to cap its emissions, it is impacted by the industries that are required to cap their emissions.  Many of these companies are in the energy industry and must pass the additional costs on to their customers in the form of higher prices.  Because production agriculture is heavily dependent on energy, higher energy prices will impact agriculture’s cost of production.
Estimated impact on energy prices

The U.S. Environmental Protection Agency’s estimated impact of this legislation on future energy price increases to the year 2050 is shown in Figure 1.  For example, electricity prices are expected to increase by 14 percent by the year 2025, with natural gas and petroleum increasing by 8.6 and 4.7 percent respectively. 

Impact on Production Agriculture

USDA in its preliminary analysis projected the impact these energy price increases will have on agriculture’s cost of production.  The direct impact arises from increases in the price of energy that is used directly in the production process.  Examples include the price of diesel fuel, gasoline, electricity, LP gas, etc.  The direct impact on crop production varies according to the region of the country.  For example, the direct impact will be greater where substantial amounts of energy are used for irrigation.

The indirect impact of higher energy prices on agriculture comes in the form of energy used in the manufacture of production inputs.  Although there are many indirect impacts on production inputs, the largest is the manufacture of nitrogen fertilizer from natural gas.  Indirect impacts are larger than direct impacts and are estimated to account for about 70% of the total impact.

The total impact (direct and indirect) of higher energy prices on the cost of production is shown in Figure 2.  The inflation adjusted impact on the cost of production is project for three future time periods.

In the near term, nitrogen fertilizer is essentially exempted from these prices increases by being an “energy-intensive trade exposed entity” (EITE).  However, the EITE is phased out in the medium and long term.

The cost increase is greatest for corn because it is a high energy consumption crop.  Wheat is lower and soybeans are even lower.  For example, corn production costs are expected to increase $1.19 per acre in the near-term (next decade) and $25.19 in the long term (mid-century).  However, this assumes no change in crop production practices.  Over the next forty years, improved production practices for crop production may reduce energy consumption substantially.
Estimated impact of input prices changes on variable costs of crop production

The direct impact on livestock production is estimated to be very small.  However, the indirect impact from higher feed prices is more significant because feed costs make up a large portion of livestock production costs.  The increased cost of feed is due to the crop increases shown in Figure 2. 
Estimated impacts of input prices changes on net farm income

The overall impact on net farm income is expected to be relatively small as shown in Figure 3.  Net farm income is expected to be down about 1 percent in the next decade, decreasing by about 7 percent by mid-century.

This analysis does not include the potential impacts of the increased demand for biomass due to the Renewable Electricity Standard provisions of HR 2454.  It also does not include any possible increase in biofuels demand due to higher energy prices.

Changes in Energy Intensity

While the information above provides a good “first look” at the impact of the legislation on production agriculture, there are other perspectives that need to be discussed.  One of these is the long-term downward trend in energy usage per unit of output in the agriculture sector as shown below. 

Enerfy intensity in U.S. Agriculture

Energy intensity reflects the total amount of energy used in the production of output.  Since 1973, farm output has grown by 63 percent while energy consumption has declined 26 percent. (2)  The decline in energy intensity is the result of improved machinery and equipment, enhanced energy efficiency, changes in tillage practices, improvements in genetic ability of crops to utilize fertilizer, increased livestock feeding efficiency, and changes in the commodities produced.  This trend is expected to continue, especially if driven by higher energy prices.  These increases in efficiency will soften or offset the economic impact of higher energy prices.  The most significant impact will occur in the medium-term and long-term time frames.

Greenhouse Gas Emission Offsets

As we indicated above, cap and trade legislation allows for the emission reductions produced by one business to be sold to another business to provide offsets for their emissions.  Agriculture has the potential to play a significant role in the generation of these offsets.

Production agriculture is a significant emitter of greenhouse gases accounting for about 8 percent of U.S. emissions, as shown in the recent AgMRC article “Climate Change – Agriculture’s Impact on Greenhouse Gas Emissions."

By reducing its greenhouse gas emissions, agriculture has the potential to provide emissions offsets to companies in other industries and thereby generate a revenue stream for farmers.  Some potential sources for offsets are discussed below.

Carbon Sequestration in Agricultural Soils -- Agricultural soils have great capacity to store or “sequester” carbon.  Productive soils are the critical resource behind U.S. agriculture’s enormous production complex.  Many of these soils are black because they contain generous amounts of “organic matter” that accumulated over centuries when native grasses grew and decomposed.  Similarly, productive brown colored soils developed in the eastern Corn Belt from decaying forest vegetation. 

Organic matter in soils provides a great storehouse of carbon, just as forests provide a major carbon storehouse.  When soils are tilled, organic carbon is released into the atmosphere where it combines with oxygen to form carbon dioxide (CO2).  Crop production practices involving no tillage (no-till) stops the release of carbon and can actually increase soil carbon.  As discussed in the AgMRC article “Energy Agriculture -- Carbon Farming,” no-till farming can provide a carbon offset revenue stream for farmers.

Charcoal provides another method for sequestering carbon in the soil.  Originally created by Indians of the Amazon basin, charcoal has the potential to increase the productivity of agricultural soils while also sequestering large amounts of atmospheric carbon.  The tropical soils of the Amazon are highly oxidized and infertile.  However, they are interspersed with well-defined areas of highly productive soils that were created by local Indian tribes.  These soils contain large amounts of charcoal and show remarkably enhanced fertility compared to untreated soils in the same locations. Furthermore, this carbon appears to have been sequestered in the soil for hundreds if not thousands of years.  As described in AgMRC article “Reinventing Agriculture for Environmental Enhancement,” charcoal provides a much greater potential for carbon offsets than no-till farming.  Switching from conventional tillage to no-till sequesters about 310 tons of carbon dioxide per year.  Charcoal produced by a closed-loop farming operation where corn stover is used as the charcoal feedstock will effectively sequester 1,800 tons of carbon dioxide per year. This closed loop system is currently being investigated by researchers at Iowa State University. (3)  We will further explore the opportunities for charcoal in future newsletter articles.

Carbon Capture and Sequestration -- A major research focus is the development of technology to capture CO2 emissions from a production facility and store them (often underground) so they will not escape into the atmosphere.  Called “carbon capture and sequestration” (CCS), this technology is often discussed in combination with the GHG emissions from burning coal.

This technology could also be applied to corn ethanol production.  An ethanol plant produces three outputs in about equal proportions by weight -- ethanol, dried distillers grains with solubles and carbon dioxide.  Capturing and sequestering this carbon is a potential income stream for an ethanol business.  However, different than a coal burning plant where the objective is to minimize the increase in atmospheric CO2, sequestering CO2 from an ethanol plant can actually reduce atmospheric carbon.  This is because most of the CO2 emissions from ethanol production are part of the natural carbon cycle.  These emissions come from carbon stored in the corn feedstock that subsequently came from CO2 in the atmosphere.  The atmospheric carbon became part of the corn plant through photosynthesis.

Nitrogen Fertilizers -- The basic ingredient of the array of nitrogen fertilizers used in production agriculture is ammonia (NH3).  Most ammonia is made from natural gas which provides the hydrogen atoms.  Although natural gas does not produce the level of GHG emissions of coal and gasoline, it is still a significant emitter.  So, nitrogen fertilizer is a major component of the GHG emissions from crop production. 

Using a different feedstock to produce ammonia holds the opportunity to greatly reduce the carbon footprint of nitrogen fertilizer, in addition to weaning us from foreign sources of ammonia.  As discussed in the AgMRC article “Using the Wind to Fertilize Corn,” wind power can be used to make renewable ammonia.  In addition, a variety of other renewable hydrogen feedstocks are being investigated to make ammonia.

The development of technologies to reduce the nitrous oxide emissions caused by the soil microbial action during nitrification and de-nitrification of soil nitrogen has the potential to greatly reduce GHG emissions.  Nitrous oxide is a very potent GHG.  One ton of N2O is the equivalent to about 300 tons of CO2.  As shown in AgMRC article “ Greenhouse Gas Emissions of Corn Ethanol Production,” nitrous oxide accounts for half of the emissions from corn production.

Other Potential Offsets -- Methane (CH4) is a greenhouse gas with twenty times the potency of carbon dioxide (CO2).  When manure is handled as a solid or deposited naturally on grassland, it decomposes aerobically (with oxygen) and creates few methane emissions.  However, manure stored as a liquid or slurry in lagoons, ponds, tanks or pits, decomposes anaerobically and creates methane emissions.  Methane emissions can be reduced through the application of technologies (e.g. anaerobic digesters) designed to capture the methane and use it as an energy source.

Our Path to the Future

While not perfect, the proposed legislation working its way through the U.S. Congress is a serious effort to combat climate change.  For U.S. agriculture, it appears that cap and trade legislation would seem to have a relatively small negative impact.  On the upside, it could potentially provide a significant additional income stream for agriculture.  Although much of this potential is based on technologies that are not yet fully developed, there is little doubt that agriculture (especially our soils) has the capacity to substantially reduce and/or sequester greenhouse gas emissions.

Implementing major new changes like cap-and-trade legislation introduces uncertainty.  However, there is substantial uncertainty and downside risk from continuing on our present path.  As discussed in AgMRC articles “Climate Change -- Impact on Midwest Agriculture

Climate Change -- Impact on Global Agriculture,” climate change has the potential to significantly impact the world’s agricultural production capacity.  Not developing greenhouse gas reduction technologies today will lead to the need for developing technologies to help us adapt to climate change in the future.  This will be a much greater technological challenge.


1 EPA Analysis of the American Clean Energy and Security Act of 2009H.R. 2454 in the 111th Congress. U.S. Environmental Protection Agency Office of Atmospheric Programs. June 23, 2009. 

2 Perspectives on Food and Farm Policy: Rural Development and EnergyAmber Waves. Special Issue, May 2007.

3 Robert Brown. “Reinventing Agriculture for Environmental Enhancement.” Ag Marketing Resource Center Renewable Energy Newsletter. June 2009.