Carbon Credit Buyers Beware!

Carbon trading is basically good

Carbon credits and emissions trading systems seem like a good idea in theory, right? As someone with a degree in commerce, I know that one of the basic principles of economics is that people respond to incentives. Incentives don’t always have to be monetary, but they often are in today’s society. So, if you offer to reward an industrial company for reducing hazardous emissions by giving it a “credit” that can be traded on a global market, you are likely to see results. So long as the cost of reducing pollution is less than the price of the corresponding credits in the marketplace, the company will have an incentive to reduce emissions.

Such credit trading systems have started to pop up around the world – some have even made their way to the United States (California has several). There are kinks and inefficiencies in these systems that need to be perfected (I have learned in my Environmental Law class that very often the baseline emissions caps for companies are overly generous, making initial reductions extremely easy – think “free money” – and credits can often be banked for extended periods of time – meaning a boundless number of credits could be stored and then used at one time). But, most times the basic goal of reducing overall harmful emissions proves to be effective so long as baseline emissions caps are lowered each year.

So, what’s the problem?

Unfortunately, some unscrupulous companies have found a loophole in the United Nations’ carbon credit system, one that could have potentially disastrous effects. Some background information: In order to encourage cleaner growth in developing countries, the United Nations’ Clean Development Mechanism (launched in 2005) grants carbon credits to companies in the developing world that reduce their emissions. The number of credits awarded depends upon the specific pollutant reduced, and each pollutant has been given a carbon credit exchange rate based on its warming effect and how long it stays in the atmosphere. Once the credits are granted, these companies can sell them in global marketplaces to companies in need of extra emissions capacity.

What’s the bad news? It turns out some companies have figured out a way to manipulate the system. While a company can get a single credit for reducing carbon dioxide emissions by one ton, they can get over 11,000 credits if they destroy a single ton of a harmful gas (HFC-23) that is the byproduct of producing a certain coolant (HCFC-22). The coolant is harmful, although it is quite commonly used in air conditioners. But get this: the high value assigned to destroying HFC-23 gas has actually encouraged production of the coolant just so the gas can be destroyed.

The result? Coolant is in such high supply that prices remain low and discourage development of cleaner alternatives; plants are maintaining inefficient manufacturing processes just so they can produce as much HFC-23 as possible; and some of these manufacturers actually make half of their annual profits through the sale of these credits. Within the UN’s system, HFC-23 credits to only 19 factories account for 18% of all awarded credits, more than the credits awarded to 2,372 wind power plants and 312 solar projects combined!

What was meant to encourage reduction in air pollution and to reward developing countries for clean development has turned into an exploited system that actually increases production of harmful chemicals.

What is being done to stop this misuse? Beginning next year, the European Union will no longer accept these “waste-gas credits” within its trading system, and the UN will begin to reduce the number of these credits that it awards (although this will take some time because the credits have been offered through long-term contracts). It is speculated that the EU’s ban will lower the value of the credits but that they will still be accepted in other global environmental programs, like voluntary emissions offsetting. IDEACarbon (a carbon finance advisory firm) estimates that remaining credits could still be worth $1 billion over the next eight years.
Unfortunately, many of the companies that have been profiting from this scheme (largely in India and China) threaten to simply release this highly hazardous chemical (remember it is valued at 11,000 carbon credits) into the atmosphere if they are not compensated for its destruction. Unlike most developed countries, such toxic releases are still permissible in both India and China. Legal or not, emitting such high volumes of this gas will certainly have a deleterious effect on the atmosphere.

Reflections

It’s a shame that a program with so much potential for good has been tainted by greed and manipulation. Unfortunately, I think this type of reprehensible behavior is more common than we’d like to think and can partially explain why we haven’t made more progress in reducing global emissions. In a world where money holds the promise of power and improved welfare, financial incentives rule the day. If we want a carbon credit system to be effective, we need to eliminate loopholes and impose global emissions standards. If we want to see clean technology take hold, we need to make clean technology less expensive to produce and run than fossil fuel-powered equipment (even if that means subsidizing clean technology or taxing fossil fuel usage). It will certainly be hard work, but I am optimistic that we can do it. What do you think?

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