Problems with carbon markets

Meaghan Beattie and tasty food

A recent article in Scientific American makes a lot of good points about carbon markets and emission trading. Perhaps most important among them is the recognition that the simple existence of a market cannot ensure good environmental outcomes: there must be strong and appropriately designed institutions backing it up. Otherwise, well-connected firms will be able to wriggle through loopholes, fraud will occur at an unacceptable level, and cheating will be endemic.

The article points out some of the big failures in carbon markets so far. Within the European Union Emission Trading Scheme, far too many permits to emit were distributed for free. As a result, their price collapsed in April 2006. Even worse, coal companies in Germany and elsewhere were given free permits to pollute, able to sell some of those permits for cash, and willing to charge their customers for carbon costs that never existed. Also problematic has been the prominence of HFC-23 (trifluoromethane) projects within the Clean Development Mechanism of the Kyoto Protocol. Getting rid of HFC-23 entirely should have only cost about $136 million. It has an absurdly high global warming potential (12,000 times worse than CO2), and is easy to destroy and replace with less problematic chemicals. So far, firms have been able to earn $12.7 billion for partial elimination. The authors of the article suggest that simply paying for the $136 million worth of equipment would be far more sensible than allowing firms to exploit the price difference between the value of emission reduction credits and the cost of eliminating HFC-23.

Other problems with markets include the difficulty of working out what emissions would have been in the absence of some change (the approach used for many carbon offsetting systems) and the way markets can encourage incremental approaches to emission reduction rather than the fundamental overhaul of industrial sectors and energy infrastructures.

None of this is to say that markets are not important. Indeed, carbon pricing is an essential component in the fight against climate change. What it shows is that participants in markets cannot be implicitly trusted, and neither can the governments operating them. There must be mechanisms for oversight and enforcing compliance and a constant awareness about possibilities for cheating or gaming the system. Insofar as it has helped people to develop a better sense of these things, the Emission Trading System of the EU has been a valuable front-runner.

Author: Milan

In the spring of 2005, I graduated from the University of British Columbia with a degree in International Relations and a general focus in the area of environmental politics. In the fall of 2005, I began reading for an M.Phil in IR at Wadham College, Oxford. Outside school, I am very interested in photography, writing, and the outdoors. I am writing this blog to keep in touch with friends and family around the world, provide a more personal view of graduate student life in Oxford, and pass on some lessons I've learned here.

32 thoughts on “Problems with carbon markets”

  1. Shouldn’t the cheapness of getting rid of HFC-23 reduce the price of CDM credits to the marginal abatement cost of HFC-23? You would then expect all HFC-23 production to be eliminated, at that price, before the price of CDM credits shifted up to the marginal abatement cost for the next cheapest option.

  2. Green protectionism

    Nov 15th 2007
    From The Economist print edition
    A dangerous flaw in a bill to control carbon emissions

    FOR those (such as this newspaper) who argue that the only way to avert dangerous climate change is to set a price on CO2 emissions, what’s going on in America’s Congress is excellent news. A bill to set such a price has achieved a remarkable degree of cross-party support (see article). Federal emissions controls in America are essential to tackling climate change globally. So it is especially unfortunate that the bill includes a provision that would turn the fight against climate change into a tool for protectionists.

  3. Cap-and-trade in the north-east
    Embracing Reggie

    Nov 15th 2007
    From The Economist print edition
    A scheme that tries to avoid Europe’s mistakes

    “COULD America’s first experiment with a cap-and-trade scheme for greenhouse gases go awry? That is the fear of some observers of the Regional Greenhouse Gas Initiative (RGGI), an agreement among ten north-eastern states to cut emissions from power plants by 10% between 2009 and 2018.

    The states in question formed RGGI (pronounced “Reggie”) out of despair at the federal government’s failure to tackle emissions growth. Some states in the West and the Midwest are working on similar schemes. But RGGI will be the first to start up: emissions will be capped from January 1st 2009.”

  4. “RGGI’s designers hope to avoid some of the flaws that have dogged the Emissions Trading Scheme (ETS), the European Union’s ongoing experiment with cap-and-trade. European governments handed out emissions permits to existing power plants and factories free of charge; that turned out to be a windfall for big polluters, who were able to sell on unneeded permits for huge profits. Moreover, it gradually became clear that governments had handed out too many permits, causing their price to fall to almost nothing in the first phase of the scheme, which ends this year. If permits are so cheap, why cut emissions?”

  5. HFC-23 is a by-product of the production of HCFC-22: a refrigerant.

    The concern is that creating a market for HFC-23 destruction encourages HCFC-22 production.

    HFC-23 is destroyed by incineration.

  6. Eliminating HFC-23 projects from the Clean Development Mechanism could significantly increase the cost of Certified Emission Reductions.

    At present, HFC-23 projects produce about 41 Mt of certified CO2 reductions. By 2012, they are expected to be 502 Mt.

  7. Indian chemical company SRF is also receiving substantial numbers of CDM carbon credits for eliminating an obscure industrial waste product known as HFC23, a highly potent greenhouse gas.

    HFC23 is a by-product of manufacturing refrigerant gases used to cool fridges and air conditioners.

    It is nearly 12,000 times as toxic as carbon dioxide in its climate impact if it enters the atmosphere.

    But getting rid of HFC23 is quite easy and relatively cheap.

    The solution is to burn it off in an incinerator.

    SRF has installed an incinerator for burning off HFC23 at its plant in Rajasthan.

    The project has been registered with the CDM and is receiving up to 3.8 million carbon credits a year.

    These are currently worth $50m to $60m a year.

    SRF is likely to receive the credits for a period of about 10 years, so it is in line for a total windfall in the region of more than $500m, a gigantic sum for a smallish chemical plant located in rural India.

  8. Is Obama Administration Failing an Early Climate Test?

    By Emily Gertz

    At an interagency meeting, this still-unnamed economist argued that HFCs would be needed to trade against other greenhouse gases in a US carbon market — and thus that the US should support controlling them under the Kyoto climate change agreement and its successor treaty.

    “In other words,” writes SolveClimate’s David Sassoon,

    “a utility company or cement manufacturer on the hook to reduce CO2 emissions under a federal climate law could opt to find sources of HFCs and have them destroyed instead. Since HFCs are as much as 11,990 times more potent than CO2, small amounts could substitute for large amounts of CO2 emissions and offer a cheaper alternative to emissions reductions, lubricating the economy to a more gradual embrace of a price on carbon. It also means CO2 emissions would ratchet down more slowly.

    The difference of opinion within the administration on one of its signature issues was an unexpected development.”

  9. G.J.M. Velders, D.W. Fahey, J.S. Daniel, M. McFarland, and S.O. Andersen. 2009. The large contribution of projected HFC emissions to future climate forcing. PNAS, doi: 10.1073

    The projections are based on new baseline scenarios out to 2050. The new global HFC emission projections are significantly higher than previous estimates especially after 2025 in developing countries. By 2050, the emissions are equivalent to 9-19% (CO2 eq. basis) of the projected global CO2 emissions in a business-as-usual (BAU scenario and contribute a radiative forcing in the range of 0.25-0.40W/M2, which is about a factor of 3 larger than previous estimates. By 2050, the HFC radiative forcing fraction is projected to be 7-12% of that for CO2.

  10. “There are also concerns about market-based schemes. Even though markets could provide much-needed finance for REDD schemes, many people are uncomfortable that they could also yield big profits for investors and landowners. In China, a market-based scheme to encourage companies to phase out a powerful greenhouse gas, HFC-23, produced such enormous windfall profits for some companies that the government felt it necessary to impose a 65% tax, with the proceeds invested in green development projects.

  11. How carbon markets work in the Regional Greenhouse Gas Initiative

    I draw three major lessons from the report.

    1. Keep trading transparent. Ownership of RGGI permits are registered in a public tracking system. Futures and options are exchange-traded on the Chicago Climate Futures Exchange and the Green Exchange. Smart, because:

    Public exchanges are attractive to firms that need a simple way to trade standard products. Moreover, public exchanges effectively eliminate the risk of default by counter-parties, since the exchange constantly monitors the account holdings of each participant to ensure that they have posted sufficient financial security to meet their obligations.

    RGGI does allow over-the-counter (OTC) trades (trades between two private parties) for futures, options, and other derivative products. While OTC markets do provide some benefits for certain firms, they are murkier than public exchanges. And even the public exchanges may not require all the details that are important to understanding a transaction. (Potomac identified one instance in which a small quantity of allowances was traded at a price that seems too high—and though there are a number of perfectly reasonable explanations for the trade, the exchanges did not require sufficient information from the trading parties to allow the market monitor to draw conclusions.)

    2. Keep a level playing field. RGGI publicly announces the “clearing price” of its auction at a pre-specified time so that all participants have access to the same information and the same time. Similarly, the U.S. Commodity Futures Trading Commission publishes a weekly report documenting the positions, both long and short, of firms trading futures and options on the commodity exchanges. Once again, market participants operate with shared information, which curbs manipulation.

    3. Keep an eye on the ball. Frequent analytical reports, like this one from Potomac, are key to ensuring that the carbon markets are well-functioning and fair. Good market monitoring can enable government regulators and administrators to act in a timely fashion if something goes awry. And they can fine-tune their policies and procedures based on good information.

  12. “Andreas Stohl of the Norwegian Institute for Air Research and his colleagues have been looking at weather patterns to discover where some of these gases are emitted. The level of a gas seen at a particular monitoring station depends on where it came from and which way the wind was blowing, so if you have a number of stations and some data on how their readings change with wind directions, you can have a good guess at the source.

    Among Dr Stohl’s conclusions is the positive one that China now seems to be emitting less HFC-23, a powerful greenhouse gas produced by the refrigeration industry, than it did in 2005. This suggests that the large amounts of money invested through carbon markets in reducing such emissions may be having an effect. More detailed studies might show precisely which industrial regions the gases are coming from, and thus reveal what is going on with specific HFC-23-mitigation projects. “

  13. “THE point of carbon markets is to put an efficient price on the right to emit carbon dioxide. Recent events in Hungary show how tricky it is to achieve that goal. At issue is the sale by Hungary’s Ministry of Environment and Water of 800,000 certified emission-reduction credits (CERs). CERs are generated by the Kyoto protocol’s “Clean Development Mechanism”, whereby reductions in greenhouse gases in developing countries can produce a carbon credit for use in industrialised markets. The problem with the sale was that Hungarian firms had already used the CERs to offset their own emissions.

    Used credits are worthless on European carbon exchanges. The European Union argues that one credit must equal one tonne of carbon dioxide for its Emissions Trading Scheme, the largest emissions market, to be effective. Since the whole point of the credits is to cut carbon, double-counting them makes a mockery of the system. “

  14. “WHY”, asked a Chinese negotiator, “is this working-group facing so much difficulty in showing a minimal semblance of being alive?” It was a fair question at the end of two weeks of climate discussions in Bonn. The talks led to some progress in some areas, but bogged down in almost all others. There is a moment in such negotiations when you come up against a nagging problem: many countries that are committed to act on climate change will seek to avoid really doing so for at least as long as other parties are under no such commitment—if not longer.

    Other questions are even less tractable. Whose money, and how much, might flow through the new conduits for finance, which have yet to be established? What sort of commitments, if any, will the various less developed countries make in return for some of that money? The LCA’s sister negotiations, the Kyoto protocol (KP) track, show how much more vexed things get when commitments actually look as if they might cost money. Two technical problems bedevil the KP track. One is “land use, land-use change and forestry”, known to its friends as LULUCF. It could become a loophole for wriggling out of emission cuts—if, among other things, the baselines for forests are set too low, or if the rules allow the growth of a forest to be counted as a credit while its later felling does not constitute a debit.

    The other problem is “hot air”, meaning the emission credits that have accrued to countries, such as Russia, that have seen their emissions fall below the Kyoto baseline year of 1990 simply because of economic contraction. Like a lax attitude to LULUCF, hot-air credits could allow developed countries that have pledged “emissions cuts” under the Copenhagen accord to meet those commitments without actually cutting emissions by much. According to analysis by the Dutch environmental-assessment agency, pledges which under one set of hot air and LULUCF rules would require a 12% cut on 1990 levels, would demand only a 4% reduction under a different set of rules. These are the sort of things that matter at negotiations—and on which they founder.

  15. “Environmental NGO, CDM-Watch, proposed last month an amendment to the methodology which CDM HFC-23 projects conform. CDM-Watch alleged that some operators of HFC-23 projects could be “gaming” the system in order to gain more CERs (which on the secondary traded market are currently worth approximately €12).

    The group questions the adequacy of the ratio of HCFC-22 to HFC-23 that is used by projects to calculate their emission reductions. Currently, the rules set the maximum ratio at 3%, so 0.03 tonnes of HFC-23 to 1 tonne of HCFC-22. But the proposal sees this reduced to a minimum of 0.2%

    The CDM’s Methodology Panel, the body charged with overseeing the methodologies of the CDM, chose to ask the higher-profile CDM Executive Board (EB) to decide on the issue. There remains a good chance that the EB fails to reach a verdict and instead passes the issue up to the UNFCCC because of how politically charged this topic has become.

    Indeed, CDM-Watch appears more than aware of the politically sensitivity that surrounds the HFC-23 controversy. CDM-Watch warned that EB members from China, India, Netherlands, UK, Japan and Norway should abstain from voting on the proposed methodology revision due to conflicts of interest. These countries either host the projects or have vested interest in the CER generation.

    In any case, the proposal has caused a stir in the CDM and participants are looking for certainty. The EU and the US have both made suggestions that offsets generated by the destruction of HFC-23 may be banned from their respective carbon reduction plans after 2012 (if one is ever enacted in the US). So investors in HFC-23 reduction projects are right to be concerned.

    If restrictions are approved, it is still unclear when they will take place. Current project contractual agreements indicate that the EB may have to wait until a project requests an extension to their crediting period (usually seven years, with the possibility of two extensions) before amending the methodology. In fact, a request to extend the crediting of a certain HFC-23 in South Korea was postponed last month by the EB until a later date, certainly until something more concrete has been decided.”

  16. Pingback: Climate and HFC-23
  17. Clean-energy credits tarnished

    WikiLeaks reveals that most Indian claims are ineligible.

    As the world gears up for the next round of United Nations climate-change negotiations in Durban, South Africa, in November, evidence has emerged that a cornerstone of the existing global climate agreement, the international greenhouse-gas emissions-trading system, is seriously flawed.

    Critics have long questioned the usefulness of the Clean Development Mechanism (CDM), which was established under the Kyoto Protocol. It allows rich countries to offset some of their carbon emissions by investing in climate-friendly projects, such as hydroelectric power and wind farms, in developing countries. Verified projects earn certified emission reductions (CERs) — carbon credits that can be bought and sold, and count towards meeting rich nations’ carbon-reduction targets.

  18. Policy Brief: A New Look at Loopholes

    To date, 42 developed countries (Annex 1) have submitted pledges. Fulfilment of the developed country pledges is projected to reduce emissions by up to 4 billion tons (Gt) CO2e in 2020 from “business as usual” (UNEP 2010). This is about one third of the estimated 12 GtCO2e of emissions reductions that would be needed to remain on a path consistent with keeping warming below 2°C (UNEP 2011). Unfortunately, weaknesses in international emissions accounting could substantially weaken these already insufficient pledges, negating much if not all of their intended emissions benefits. In this paper, we address the following five “loopholes” in the existing negotiation framework, examine their impact, and list possible policy solutions to close them:

    * Hot Air – surplus allowances (AAUs) from the first commitment period.
    * LULUCF weak accounting rules
    * CDM credits that do not represent real emissions reductions.
    * Double counting of emissions reductions
    * Emissions from International aviation and shipping

  19. Carbon prices
    Breathing difficulties
    A market in need of a miracle

    THE European Union’s Emissions Trading System (ETS), the world’s biggest carbon market, has two main aims. One is to restrict the carbon-dioxide emissions of the 11,000 companies trading on it to an agreed cap. The other is to give these firms an incentive to invest in clean technology. On the first count, thanks to the economic malaise, the ETS is a success: its participants’ emissions are well below the current cap. On the second, for the same reason, it is failing wretchedly. Oversupplied with permits, the market has tanked. Having reached nearly €30 ($47) a tonne in 2008, the carbon price is now persistently under €10: much too low to prod firms to make their investment plans greener.

    The situation is about to get worse. The EU is in the process of selling an additional 300m permits to raise cash for green energy projects, adding to oversupply. It is also about to introduce a new regulation on energy efficiency, which will further reduce emissions and which was not factored into the current cap. Matthew Gray of Jefferies, an investment bank, reckons that by 2020 the ETS will have an accumulated surplus of 845m permits, against a planned cap that year of 1.8 billion permits.

    Investors in green technology are pleading for intervention to prop up the carbon price. Various ways have been suggested, from setting a carbon floor-price to tightening the cap. In December, when the carbon price fell well under €7, a committee of the European Parliament recommended three possible strategies: withhold—or “set aside”—an undetermined tranche of permits from the market; withhold 1.4 billion permits; or tighten the cap. On February 28th a higher-powered committee approved the first strategy. It will now be voted on by the parliament; if passed, the details will be negotiated with member states.

  20. IT HAD been a nervous few days. So the California Air Resources Board (CARB), which is running the state’s new cap-and-trade scheme for greenhouse-gas emissions, can be forgiven for celebrating its first big test in eccentric fashion. Barely an hour after details of the first auction of emissions permits were revealed, staff filled a conference room in their downtown Sacramento office to inflate a large blue radio-controlled fishlike balloon bearing the words “Success Shark”.

    CARB says it has learned from the failings of the EU’s effort, such as an oversupply of permits and fraud in offset projects. This has not insulated it from critics who say it has no right to raise revenues from a scheme that would work just as well if all the allowances were given away. (10% of the 2013 batch will be auctioned; more in later years.)

  21. Carbon markets
    Extremely Troubled Scheme
    Crunch time for the world’s most important carbon market

    ON FEBRUARY 19th Europe’s emissions-trading system (ETS) faces a potentially fatal vote. It could not only determine whether the world’s biggest carbon-trading market survives but delay the emergence of a worldwide market, damage Europe’s environmental policies across the board and affect the prospects for a future treaty to limit greenhouse-gas emissions. Quite a lot for a decision which—as is the way of things European—sounds numbingly technical.

    The vote is due to take place in the environment committee of the European Parliament. If the committee approves the proposal before it (and the parliament in full session as well as a majority of national governments agree with the decision), this would give the European Commission, the European Union’s executive arm, the power to rearrange the ETS’s schedule of auctions. Its plan is to delay the sale of about 900m tonnes of carbon allowances from around 2013-16 to 2019-20.

    The low prices reflect a chronic oversupply of carbon allowances, which the commission puts at 1.5 billion-2 billion tonnes, roughly a year’s emissions. When the ETS was designed in the mid-2000s, growth was strong and demand for carbon allowances was expected to be high. Their number was therefore fixed (at 16 billion tonnes for 2013-20). But demand has crashed. Other temporary factors are also driving prices down: more frequent auctions mean that allowances which once sat unused for months now come onto the market immediately; a special reserve for new entrants has boosted supply; and hedging by power stations has dried up.

  22. The price of carbon emissions fell to a record low after the European Parliament rejected a plan to tackle the massive oversupply of carbon credits being sold on the EU’s Emissions Trading System. The EU wanted to take about 900m tonnes of carbon allowances off the market and reintroduce them in six years when, it was hoped, demand would be stronger. The plan was voted down after some members of the parliament expressed fear it would increase energy costs for consumers. Prices have fallen from €20 ($30) a tonne in 2011 to under €3. See article

  23. Under the old system, electricity prices spiked during peak hours (the middle of the day and early evening), falling at night as demand ebbed. Companies made all their money during peak periods. But the middle of the day is when solar generation is strongest. Thanks to grid priority, solar grabs a big chunk of that peak demand and has competed away the price spike. In Germany in 2008, according to the Fraunhofer Institute for Solar Energy Systems, peak-hour prices were €14 per MWh above baseload prices. In the first six months of 2013, the premium was €3. So not only have average electricity prices fallen by half since 2008, but the peak premium has also fallen by almost four-fifths. No wonder utilities are in such a mess.

  24. “The other influence was the shale-gas bonanza in America. This displaced to Europe coal that had previously been burned in America, pushing European coal prices down relative to gas prices. At the same time, carbon prices crashed because there were too many permits to emit carbon in Europe’s emissions-trading system and the recession cut demand for them. This has reduced the penalties for burning coal, kept profit margins at coal-fired power plants healthy and slashed them for gas-fired plants. Gérard Mestrallet, chief executive of GDF Suez, the world’s largest electricity producer, says 30GW of gas-fired capacity has been mothballed in Europe since the peak, including brand-new plants. The increase in coal-burning pushed German carbon emissions up in 2012-13, the opposite of what was supposed to happen.”

  25. Europe has always played an outsized role in the climate-change debate. It was a Swedish scientist who, in 1896, first posited a link between surface temperatures and the concentration of carbon dioxide in the atmosphere. A century later the European Union’s environment ministers (who at the time numbered among their members one Angela Merkel) adopted the aim of keeping global warming to below 2°C. For years the European Union has set policies to curb emissions and discourage energy use (see chart). Germany is switching to renewables in a massive “energy transition”. The Paris agreement, which saw more than 190 countries pledge to keep global warming to “well below” that threshold, was a triumph of Gallic diplomacy.

    At least, so goes the boosterish story Europeans tell themselves. In fact, the EU’s stated goal of a 40% cut in greenhouse-gas emissions by 2030, as measured against levels in 1990, is inadequate if it is to do its share in keeping global warming below 2°C. Its policies for electricity generation have misfired, too. True, subsidies have boosted wind and solar power, and by around 2030 these will become the EU’s largest source of power generation, according to the International Energy Agency. But that has had two perverse consequences. The first is lower wholesale electricity prices, meaning squeezed revenues and lower investment. The second is rising imports of fossil fuels to keep the lights on when the sun is hidden and the winds are still. Together, these have meant a heavy reliance on plants burning cheap-but-dirty fuels such as brown coal. Europe’s shift away from nuclear power, which generates no carbon dioxide, has made reducing emissions harder—especially in Germany, which decided in a panic to close all 17 of its nuclear plants after the Fukushima meltdown in Japan.

    The EU Emissions Trading Scheme has also fallen short. After the financial crisis of 2007-08, there was a glut of carbon permits. Prices have dropped by four-fifths since then, to around €5 ($5.67) per tonne. To help the planet much, they would have to be €40 or so.

  26. This year two climate-related shake-ups are going ahead that in the past would have outraged Europe’s big emitters—utilities, steel producers, paper and chemical firms. First is a reform to the European Union’s Emissions Trading System (ETS), a cap-and-trade system once ridiculed for the low price of its carbon allowances. The second is the phasing out of coal owing to a growing conviction in north-western Europe—including Britain, Belgium and France—that it should become history. Within a few weeks, a commission in Germany is expected to announce plans for a gradual phase-out of coal. Both measures are likely to raise power prices in Europe because, absent a meaningful carbon price, coal has been dirt cheap. Yet industrial firms, massive energy consumers, seem to be viewing the changes with resignation, not revolt.

    Start with the ETS. It works by setting a steadily falling cap on emissions and providing tradable allowances up to that limit. But it has been plagued by a huge surplus of permits, exacerbated by the 2008-09 financial crisis, making prices so low as to be meaningless. Reforms introduced this month (that remove almost a quarter of the oversupply each year until 2024) made carbon one of Europe’s hottest markets in 2018. The price of permits tripled from €8 ($9.60) per tonne to €25, as hedge funds piled in.

    Carbon prices could go up as dramatically as when the Arab embargo drove up the price of oil in 1973, reckons Per Lekander of Lansdowne Partners, an asset manager in London. That may be wishful thinking (carbon prices have tumbled this year), but even if prices stay where they are, the impact on heavy emitters will be severe. These firms say that compensation schemes are insufficient. Still they insist the ETS is the most market-friendly way of curbing emissions, and is better than ad hoc regulation.

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