5 november 2009

[As the possibility of a favorable outcome for next month's climate negotiations in Copenhagen becomes ever more remote, NGO critique of the market mechanisms favored in most of the discussions by negotiating partners is sharpening. A considerable part of the climate movement that had earlier reluctantly supported emissions trading as the only realistic course has begun arguing against it. For an extensive analysis of the failure of carbon trading, see Dangerous Obsession, a book-sized pdf just posted by Friends of the Earth ]

Unveiling Carbon Trading

by Oscar Reyes and Tamra Gilbertson, Transnational Institute, October 5, 2009

The headlines tell the story. “Billions wasted on UN climate programme.” “Truth about Kyoto: huge profits, little carbon saved.” “UN effort to curtail emissions in turmoil.” “The Carbon Folly: Policymakers’ Favourite Global Warming Fix Isn't Working.” “European Union’s efforts to tackle climate change a failure.” “The great carbon credit con: Why are we paying the Third World to poison its environment?”

Behind these headlines lies a tale of the growing failure of the main tool governments, financial institutions and corporations have adopted to address climate change. This is carbon trading – a multi-billion dollar scheme whose basic premise is that polluters can pay someone else to clean up their mess so that they don’t have to.

Cap and trade

Carbon trading is a complex system which sets itself a simple goal: to make it cheaper for companies and governments to meet emissions reduction targets. It takes two main forms: “cap and trade” and “offsetting.”

Under “cap and trade” schemes, governments or intergovernmental bodies like the European Commission hand out licenses to pollute (or “carbon permits”) to major industries. Instead of cleaning up its act, one polluter can then trade these permits with another who might make “equivalent” changes more cheaply. This is the approach underlying the European Union Emissions Trading Scheme (EU ETS), the world’s largest carbon market, which was worth US$63 billion in 2008 and continues to expand rapidly.

The theory is that the availability of carbon permits will gradually be reduced, ensuring scarcity so that the market retains its value while at the same time forcing a reduction in the overall level of pollution. The cap part is supposed to do the work, environmentally speaking, setting a legal limit on levels of permissible pollution within a given time period. Each cap reduction is, in effect, a new regulatory measure introduced by governments and/or international bodies to restrict pollution further.

The “trading” (or “market-based”) component of such a scheme does not actually reduce any emissions. It simply gives companies greater room to manoeuvre in addressing the emissions problem, for which reason carbon trading proposals are sometimes also referred to as “flexible mechanisms”. Installations exceeding their reduction commitments can sell their surpluses to those who have failed to clean up their act adequately. Companies that want to keep on polluting save money, while in theory companies that are able to reduce beyond legal requirements will seize the chance to make money from selling their spare credits. But this flexibility comes at a cost – what is cheap in the short-term is not the same as what is effective in the long-term or environmentally and socially just.

In practice, the scheme has failed to incentivise emissions reductions. In the first phase of the EU ETS, which ran from 2005 to 2007, the ‘cap’ on emissions was set higher than the level of existing pollution as a result of industry lobbying. Prices collapsed, and no pollution was reduced.

In the second phase of the scheme, which began in 2008, prices rose to around €30 per ‘ton of CO2 equivalent’ emissions, but have since crashed to around one-third of that level. The explanation is relatively simple. Allocations were made on the assumption that European economies would keep growing, but the economic crisis has reduced output and power consumption, leaving companies with a surplus of permits. Since these were mainly given out for free, the net effect is directly opposite to the scheme’s intention: polluting industries were offered a lifeline by cashing in their unwanted permits, while the ‘price signal’ that is meant to change their polluting ways is rendered largely meaningless. This problem was compounded by the inclusion of a significant number of “carbon offsets” within the EU ETS.

Carbon offsets

Carbon offsetting is a second type of carbon trading. Instead of cutting emissions at source, companies, and sometimes international financial institutions, governments and individuals, finance “emissions-saving projects” outside the capped area. The UN-administered Clean Development Mechanism (CDM) is the largest such scheme, with almost 1,800 registered projects as of September 2009, and over 2,600 further projects awaiting approval. Based on current prices, the credits produced by approved schemes could generate over $55 billion by 2012.

Although offsets are often presented as emissions reductions, they do not reduce emissions. Even in theory, they at most merely move reductions to where it is cheapest to make them, which normally means a shift from Northern to Southern countries. Pollution continues at one location on the assumption that an equivalent emissions saving will happen elsewhere. The projects that count as “emissions savings” range from building hydro-electric dams to capturing methane from industrial livestock facilities.

The carbon “savings” are calculated according to how much less greenhouse gas is presumed to be entering the atmosphere than would have been the case in the absence of the project. But even the World Bank officials, accounting firms, financial analysts, brokers, and carbon consultants involved in devising these projects often admit privately that no ways exist to demonstrate that it is carbon finance that makes the project possible. Researcher Dan Welch sums up the difficulty: “Offsets are an imaginary commodity created by deducting what you hope happens from what you guess would have happened.” Since carbon offsets replace a requirement to verify emissions reductions in one location with a set of stories about what would have happened in an imagined future elsewhere, the net result tends to be an increase in greenhouse gas emissions.

As of September 2009, three-quarters of the offset credits issued were manufactured by large firms making minor technical adjustments at a few industrial installations to eliminate HFCs (refrigerant gases) and N2O (a by-product of synthetic fibre production). As Michael Wara of Stanford University puts it, “the CDM market is not a subsidy implemented by means of a market mechanism by which CO2 reductions that would have taken place in the developed world take place in the developing world. Rather, most CDM funds are paying for the substitution of CO2 reductions in the developed world for emissions reductions in the developing world of industrial gases and methane.”

Proponents of the CDM suggest that a new balance of future projects will gradually move closer to incentivising cleaner energy and more sustainable development. Yet the evidence does not support this conclusion. The next largest project type, in terms of the number of carbon credits it generates, is hydroelectric power – yet the local environmental and social impacts of such projects are frequently severe, while methane emissions from dams (a potent source of greenhouse gases) make the climate benefits of such projects highly questionable. A similar assessment could be made of biomass power projects, which tend simply to count the methane (CH4) emissions that are avoided because it is burned rather than allowed to biodegrade – without considering the huge emissions caused by cutting down forests or draining carbon-rich peatlands to set up the plantations that provide the biomass feedstock.

A plethora of fossil fuel projects are also supported by the CDM. To apply for the scheme, a project simply needs to prove that it is cleaner than the norm for existing power production in the region or country where it is located. As new plants are generally more efficient than old, this is rarely a difficult task. A recent study of new gas-fired power stations in China, for example, found that all twenty-four new Combined Cycle Gas Turbine plants under construction between 2005 and 2010 had applied for CDM subsidies. A second example involves new “supercritical” coal-fired power plants, which have been eligible for CDM credits since autumn 2007 – despite the fact that coal is amongst the most CO2 intensive sources of power. This sets up a perversely circular structure where, instead of envisaging a rapid transition to clean energy, the CDM is subsidising the lock-in of fossil fuel dependence through providing incentives for new coal-fired power stations in the South, rather than renewable energy infrastructure based on local needs. With the credits that these new plants will generate, the CDM is at the same time encouraging a continued reliance on coal-fired power stations in the North as well.

The use of “development” and “poverty” rhetoric to describe offsets masks their fundamental injustice: offsets hand a new revenue stream to some of the most highly polluting industries in the South, while simultaneously offering companies and governments in the North a means to delay changing their own industrial practices and energy usage. Carbon offset projects have also resulted in land grabs and the repression of local communities.

Ways forward

The failings of carbon trading are not simply problems in how its rules were designed, or or teething problems in its implementation, but are fundamental to the whole scheme itself. Markets are by essence growth-oriented, so look for new sources of accumulation. In carbon markets, this is achieved by increasing their geographical scope and the number of industrial sectors and gases they cover. Yet this contradicts the essence of tackling climate change which is about reducing use of fossil fuels and consumption.

Introducing carbon as a commodity has resulted in new opportunities for profit and speculation. The carbon market is already developing the way of the financial market with the use of complex financial instruments (futures trading and derivatives) to hedge risk and increase speculative profit. This runs the risk of creating a “carbon bubble.” This is not a surprise, as it was created by many of the same people at the Chicago Climate Exchange who created the derivatives markets that led to the recent financial crash.

Ultimately, the whole approach distracts from effective solutions – trapping us within a framework that sees the climate problem in primarily financial terms, restricting our horizons to ‘emissions reductions’ while sidestepping the key questions of how and when these are made. As Larry Lohmann of the Corner House research and advocacy group explains, carbon trading ‘disembeds the climate problem from the challenge of initiating a new historical pathway to overcome current dependence on fossil fuels, which are by far the major contributor to human-caused climate change’.

If a cleaner future is the goal, then the process should start elsewhere. At a global level, clean infrastructure investment tends to require upfront public funding – which should come largely from industrialised countries, since they predominantly caused the problem. Such funding is no guarantee of success, however, unless a decentralised structure is adopted which allows for meaningful citizens´ participation and sensitivity to local contexts – allowing for the adaptation and improvement of locally-adapted industrial and agricultural techniques, and engaging in a bottom-up assessment of real energy needs.

This requires an urgent break from the carbon market model. Instead of stimulating new commodity markets, the targets and obligations placed on industrialised countries should be met domestically. A plethora of existing regulations, performance standards and incentives exist to help guide this path – ranging from “feed in tariffs” for renewables, to emissions output limits on power producers and heavy industry. But these, in turn, will not be enough unless we return the focus to how current industrial and agricultural models have caused climate change. Instead of adapting the climate debate to existing economic models, we need to look at climate change of a symptom of their failure and explore genuinely sustainable ways to move beyond them.

This article is based on the forthcoming publication: Carbon Trading: how it works and why it fails (Dag Hammerskjold Foundation)

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