The United Nations Framework Convention on Climate Change (UNFCCC) is the Multilateral Environmental Agreement adopted at the United Nations Conference on Environment and Development, better known as the Earth Summit, in 1992. With 192 parties to the Convention, it sets the overall framework for intergovernmental efforts to tackle the problem posed by climate change.

Its principal goal is to stabilize greenhouse gas (GHG) concentrations in the atmosphere to prevent dangerous anthropogenic interference with the climate system. But the UNFCCC does not specify how this goal will be achieved. Rather, it lays out a process through which various protocols with more specific and binding commitments might be negotiated among the Parties to the Convention.

This process led to the adoption of the Kyoto Protocol during the 3rd Conference of Parties (COP) to the UNFCCC held in Japan in December 1997. The central feature of the Protocol is that it sets binding targets for 37 industrialized countries and the European community (Annex B countries) for reducing the level of GHG emissions by an average of 5% compared to 1990 levels over the five-year period 2008-2012.

A market-friendly climate protocol

The Protocol does not mandate what domestic policies can or must be implemented to achieve these reductions. But it does introduce three market-based mechanisms – Emissions Trading (ET), the Clean Development Mechanism (CDM) and Joint Implementation (JI) -- to help countries meet their emission targets, and to encourage the private sector and developing countries to contribute to emission reduction efforts.[1]

Parties with emission reduction commitments under the Kyoto Protocol (Annex B Parties) have emission targets expressed as assigned amount units (AAUs) over the 2008-2012 commitment period. Emissions trading, as set out in Article 17, allows countries that have “unutilized” AAUs - emissions permitted them but not “used” - to sell this excess capacity to countries that exceed their targets.

Joint implementation, defined in Article 6, allows an Annex B country to earn emission reduction units (ERUs) from an emission-reduction or emission removal project in another Annex B Party, each equivalent to one tonne of CO2, which can be counted towards meeting its Kyoto target.[2]

The Clean Development Mechanism allows emission-reduction (or emission removal) projects in developing countries to earn certified emission reduction (CER) credits, likewise equivalent to one tonne of CO2each. These CERs can be traded and sold, and used by Annex B countries to meet a part of their emission reduction targets under the Kyoto Protocol.[3]

These market-based mechanisms were included to accommodate the demands of the biggest GHG emitting countries led by the United States (US) which had resisted and continue to resist proposals for drastic and binding cuts to GHG emissions, pushing instead for a market-based approach such as the use of tradeable emissions permits.

In theory, by treating the right to dump CO2 in the atmosphere (expressed as CO2 emission allowances) as a scarce tradeable commodity, the carbon market creates incentives for emissions reductions because the more CO2 you emit above your allowance, the more money you would have to shell out. In this sense, it functions like a carbon tax. But unlike a carbon tax, carbon trading reduces emissions in the least cost manner because those that can easily reduce emissions most cheaply will do so the most and sell their excess allowances to those who face higher costs for emission reductions, so goes the theory.

A booming market

Even with these market-friendly mechanisms in place, the US still withdrew from the Kyoto Protocol in 2001. Nevertheless, the Protocol gave birth to the global carbon market which has since expanded exponentially in volume and value terms.

The World Bank concludes that, “Its biggest success so far has been to send market signals for the price of mitigating carbon emissions. This, in turn, has stimulated innovation and carbon abatement worldwide, as motivated individuals, communities, companies and governments have cooperated to reduce emissions.”[4]

Lowering costs for some

However the Bank’s bold claim is ultimately unverifiable. Even in principle, whatever emissions reduction that results from cap-and-trade is due to the cap imposed by regulators. The lower the cap, the bigger the reductions -- assuming they are enforced. The trade in emissions permits is merely a mechanism for allocating the costs of meeting that same regulatory measure among the different sources of emissions. Put another way, whatever emissions reduction is possible under a cap-and-trade scheme is also possible under a cap-without-trade scheme. But not all emissions reductions that can be achieved using large-scale public works projects and non-market based regulatory measures (e.g. mandatory efficiency standards or technologies) can be ensured using a cap-and-trade system which leaves the question of how to reduce emissions completely up to the discretion of polluters.

Hence critics point out that carbon trading is essentially designed first and foremost to minimize the costs faced by polluters in complying with the Kyoto Protocol rather than to effect a structural shift towards non carbon-intensive development paths at the quickest possible time to avert climate catastrophe.

Even mainstream economists who are by no means anti-market in ideology are waking up to this fact. Jeffrey Sachs, for instance, recently wrote: “Economists often talk as though putting a price on carbon emissions—through tradable permits or a carbon tax—will be enough to deliver the needed reductions in those emissions. This is not true. Europe’s carbon-trading system may or may not have modestly reduced emissions, but it has not shown much capacity to generate large-scale research nor to develop, demonstrate and deploy breakthrough technologies. At the margin, a trading system might marginally influence the choices between coal and gas plants or provoke a bit more adoption of solar and wind power, but it will not lead to the necessary fundamental overhaul of energy systems.“[5]

As Lohman points out, the underlying principle to carbon trade -- that a ton of CO2 emitted anywhere in the world has exactly the same impact on climate change and is therefore exchangeable -- is fundamentally flawed. In fact, the where and how of emissions reductions are important, not just the volumes of reduction. For instance, fossil fuel based powerplants may cost billions of dollars to set-up and can operate over 4 decades. Therefore building more of these should be avoided since they imply high levels of CO2 emissions farther into the future. Given the massive scale and extreme urgency of the need to reduce emissions, there is clearly a need to prioritize structural changes in electricity generation, transportation, industrial processes, etc. Buying cheaper emissions permits or carbon credits from offset projects allow the biggest polluters and governments to postpone such changes, making it even more difficult and expensive for society to undertake such a transition in the future.[6]

Lohman estimates that, “Given a target of 80 per cent reductions in greenhouse gas emissions by 2050, for instance, putting off action just four years doubles the yearly rate of change required, from two to four per cent. Keeping the world’s largest addicts of fossil fuels locked into coal, oil and gas for the foreseeable future – whether it is power generators or the cement, chemicals, oil and gas, pulp and paper or iron and steel industries – is exactly the opposite of the course that needs to be taken.”[7]

This is made worse by the fact that carbon trading also creates perverse incentives by allowing some of the biggest polluters to even profit from their emissions. For instance in all actually-existing cap and trade systems, “pollution rights” are granted based on historical levels of emissions. Thus the biggest polluters are awarded, free of charge, the lion’s share of the atmosphere, which they can use to generate windfall profits.

This was most famously demonstrated during the first phase of the European Union ETS, which came into effect in January 2005. At its outset, emissions allocations were granted free of charge to corporations largely based on estimates prepared by the corporations themselves. This resulted in permit allocation levels that, in some industries, exceeded their real carbon emissions by up to 50%. Thus most companies were not even compelled to make emissions cuts nor purchase pollution permits.

When this became public knowledge in May 2006, the price of carbon emission collapsed from a peak of 33 Euros to 0.20 Euros per MT CO2 – hence providing no incentive at all for reducing emissions. Meanwhile, big electricity generators were allowed to pass onto consumers the “opportunity cost” of withholding their freely-granted permits from the market. According to a report by Point Carbon commissioned by the World Wildlife Fund for Nature (WWF), by 2012 this would have delivered an additional US$112 billion in accumulated windfall profits for European power generators.[8]

Then there is the problem of measuring and monitoring actual emissions reductions at the source, given the wide range of processes and sources of various greenhouse gasses all over the world. The IPCC acknowledges the wide range of uncertainty in calculating emissions: from 10% in the case of electricity generation and some industrial processes; to 60% for coal mining and land use change; to 100% for biomass burning.[9]

The problem of measurement is further confounded by the fact that in most countries, data on industrial emissions is provided by polluting companies themselves, not by an impartial authority. The technical and institutional requirements for ensuring the veracity of claimed emissions reductions is therefore absent, especially in developing countries, or may entail far bigger costs than the alleged efficiency gains offered by a market-based emissions trading scheme.

The uncertainties involved in measurement, enforcement, policy inconsistency as well as technological change adds to the volatility of “carbon prices” and becomes the subject of financial speculation as well. Recent years have seen the rise of secondary markets and financial derivatives based on “carbon assets”. For instance, the value of secondary trading in guaranteed CERs (gCERs) from CDM projects exploded from US$ 445 million in 2006 to US$5.4 billion in 2007 with the average price also rising from US$18 per tCO2e to US$23 per t CO2e.[10] Unstable price signals therefore become an unreliable basis for planning long-term mitigation investments on the part of polluting companies – contrary to the rationale for carbon trading in the first place.

In summary, carbon trading is an unreliable and unjust mechanism for addressing the problem of climate change. It encourages delay rather than a rapid transition away from fossil-fuel based economies; it rewards the biggest polluters rather than making them carry the burden of mitigation and adaptation; and it discourages other measures for dealing with the problem.

The future at the auction block

And yet for policy makers, especially in the biggest polluting countries, carbon trading is the wave of the future. Europe is at the forefront with the EU-ETS as the centerpiece of EU climate policy. Norway, Liechtenstein and Iceland have joined the EU-ETS in Phase II. In the third phase, the scope of EU-ETS will be extended to new sectors (chemical sectors and ammonia producers), which would bring new gases (PFC and N2O) into the scheme. Aviation may join earlier toward the end of Phase II and maritime transport is also next on the list.

In June 2009, the US House of Representatives passed the American Clean Energy and Security Act (better known as the Waxman-Markey Bill) that would establish a national cap-and-trade system for curbing greenhouse gas emissions. Hailed as an “historic” piece of legislation, the bill sets a very low target for emissions cuts (17% against 2005 levels by 2020),[11] allows polluters to purchase domestic and international offsets to meet targets, and gives coal and oil industries billions of dollars in subsidies.[12] Among the bill’s supporters are big corporate polluters such as Shell Oil, BP America, and Duke Energy.

In the developing world, CDM projects generating tradable CERs continue to multiply with proposals to broaden the scope of CDM-eligible activities to include land-use, land-use change and forestry; carbon capture and storage and nuclear, as well as including sectoral crediting of emission reductions and/or crediting on the basis of nationally appropriate mitigation actions (NAMA).[13]

All this should be cause for alarm for the emerging global carbon trading system is profoundly flawed. It is essentially based on the privatization of the earth’s atmosphere and premised on the free market doctrine that the pursuit of private gain is the best way to realize socially desired outcomes. It starts with the bitter irony of freely awarding property rights over the atmosphere to the ones most responsible for its damage, then allowing them to profit from these ‘rights’ through trade and speculation. Meanwhile, the ultimate objective of arresting global warming falls victim to their singular drive for capital accumulation and profit. The system is indeed ‘cost effective’ and even profitable for some in the short term. But society pays a lot more in the long run. Indeed, the people and the planet may be forced to pay the ultimate price sooner than expected because of carbon trading.

Endnotes

1    United Nations Framework Convention on Climate Change (UNFCCC). http://unfccc.int/kyoto_protocol/items/2830.php

2    http://unfccc.int/kyoto_protocol/mechanisms/joint_implementation/items/1674.php

3    http://cdm.unfccc.int/about/index.html

4    World Bank (2008). State and Trends of the CarbonMarket 2008. World Bank. Washington D.C.

5    Sachs, Jeffrey (2008). “Keys to Climate Protection” available at http://www.sciam.com/article cfm?id=technological-keys-to-climate-protection-extended

6    Lohman, Larry (2006). Carbon Trading: A critical conversation on climate change, privatisation and power. Development Dialogue No. 48, September 2006. Dag Hammarskjöld Centre.

7    Lohman, Larry (2008). “Carbon Trading: Solution or Obstacle?” in The Impact of Climate Change on India.

8    Point Carbon (2008). EU ETS Phase II – The potential and scale of windfall profits in the power sector. A report for WWF by Point Carbon Advisory Services, March 2008

9    Intergovernmental Panel on Climate Change, Guidelines for National Greenhouse Gas Inventories. Reporting Instructions

10    World Bank 2008, op.cit.

11    This represents a measly 1-4% reduction against 1990 levels.

12    Handley, James. “Alert: Overhaul or Scrap ACESA (Waxman/Markey) Climate Bill.” From http://www.risingtidenorthamerica.org/wordpress/2009/06/26/alert-overhaul-or-scrap-acesa-waxmanmarkey-climate-bill/

13 Deborah Murphy, Aaron Cosbey and John Drexhage (2008). “Market Mechanisms for Sustainable Development in a Post-2012 Climate Regime: Implications for the Development Dividend” in A Reformed CDM – including new Mechanisms for Sustainable Development edited by Karen Holm Olsen and Jorgen Fenhann. UNEP Riso Centre.


Paul Quintos is a Policy Officer with IBON International