Do Carbon Markets Work?
Much has been made of the agreements reached at COP26 for the development of Carbon Markets. This has been hailed as a cause of optimism in the future.
The agreement reached in Glasgow was made by 200 countries which have committed to implementing Article 6 of the 2015 Paris Agreement. This Article allows countries to partially meet their climate change targets by buying offset credits from other countries which have exceeded theirs. This recognised that massive investment is required to achieve the targets, and that the capital markets will only invest for a suitable return.
But the first question to ask is, are we robbing Peter to pay Paul? If you are going to wreck my garden so I can no longer grow any fruit or vegetables, but pay my neighbour to clear and clean his or her garden, how does this help me?
The origins of this concept are the Kyoto Protocol signed in 1997, which recognised that global warming is a global problem. Whilst at the time, the largest polluter in the world was the US, it was evident to all concerned that the damage done by the US was not confined to the US. The concept of carbon trading was an answer to the problem of international accountability. Hence the idea was born that countries could trade carbon credits in an attempt to involve them all in the fight, incentivising those with greater potential to correct the problem, like the US, to take greater action in achieving it.
Kyoto fell at the first hurdle. Bill Clinton and then George Bush were reticent about the agreement, and then withdrew from the treaty just before its ratification, shortly after the election of George Bush Junior, thus hampering the entire concept by withdrawing its main target. It limped through the Noughties as a concept, with a variety of different mechanisms proposed, none gaining universal acceptance.
But surely the concept is misplaced. It assumes that “Global” means everywhere. It does not. Global warming is different depending on which part of the world you inhabit. The increase in temperatures is far higher already at the Poles than anywhere else in the world. It is far lower at the Equator. The impact of the warming is greater and lesser in the same way. Ironically, among the countries already worst hit by climate change, and expected to be one of the worst affected by it, is the US. Floods, tornadoes, wildfires, excessive cold, excessive heat – you name it, the US is already suffering from it.
So let me rephrase the question: if the US is going to continue to wreck its own ecosystem and its capacity to support its population, but pay for the regeneration of ecosystems in Africa and Asia, how does this help the Americans struggling to maintain their lives in the US? By the time the benefits to the wider global system of the support provided to Africa and Asia can be felt in the US, it will be too late for all the Americans living there now.
The second big question about Carbon Markets is this: are they real? Of course, there is a short answer to that question. They do exist, there are several around the world, they are trading. The largest is the EU Emissions Trading Scheme. Following the UK’s exit from the EU, it has set up its own version of the same thing. Wood Mackenzie estimates that the global carbon market is worth $1 billion annually, as at November 2021. This gives it real substance, perhaps.
Or does it? The figure quoted by Wood Mackenzie means that $1 billion is currently paid annually for carbon credits by organisations in countries exceeding their agreed emission quotas. It is paid in return for the carbon credits offered by others, with projects which are removing carbon from the atmosphere. The context for these payments gives us a different perspective on the question of their economic significance. The Energy sector is measured in multiples of trillions, not single billions. $1 billion is a drop in the ocean. But this really is the nub of the problem.
The energy industry makes up 25% of global GDP, and without energy there is virtually no economic activity. Weaning the world off carbon energy is an enormous task that has to involve everyone on the planet because we all consume energy, something that was clearly acknowledged by COP26. Carbon is the thread that runs throughout the energy industry so it is the only credible lever to pull to achieve global alignment during the energy transition, hence the value of a carbon credit mechanism. Getting the pricing right will be crucial to attract the vast amount of capital required to solve the climate crisis. We can try to control carbon prices but ultimately they are driven by supply and demand which are notoriously difficult to control, particularly on a global scale where politics and other macro factors are at work.
As a mechanism, carbon trading would seem to make sense. But once again, does it? It is a different version of the Polluter Pays principle. But note the difference. The Polluter Pays principle is that the polluter pays for the pollution he or she causes. The purpose of the payment is to clear up their own pollution. You wreck my garden, you pay to clear it up. The result? My garden is damaged, and then repaired. The principle behind carbon markets is based on what are commonly called Offsets. The polluter pays in proportion to the pollution he or she causes by paying for someone else to reduce pollution elsewhere. It is a crucial and obvious difference.
In reality, is carbon trading likely to make any difference at all? It does, but the reality is that, although a net reduction in emissions is achieved when the polluter pays, he or she continues to pollute. Who does this help? Mainly the people who earn money from the companies that are doing the polluting. Meanwhile, the rest of the world continues to use their products and suffer the consequences.
The third big question about Carbon Markets is even simpler: is there any evidence that they work? We have no comparisons in their support. But we do have direct experience. 25 years of direct experience. Our experience is that they are difficult to apply so it has been hard to reach any international agreement and impossible to achieve binding commitments, and that they are of necessity clumsy and controversial. COP26 reached more widespread agreement on the way forward than has been reached at any previous COP since the Kyoto Protocol was established. Agreement is one thing, but as we have seen at previous COPs, implementation is, disappointingly, quite another.
On the other hand, during these 25 years, the problem they are designed to address – global warming – has not improved, it has not even stabilised, it has got worse. Not just slightly worse, much worse. In fact, the last 25 years have been the worst 25 years in the history of precisely the problem that Carbon Markets were intended to solve. Based on this evidence, why would anyone hope that Carbon Markets might be of any significance in solving the problem over the next 25 years?
One final and intensely frustrating note worth mentioning in closing. Carbon Trading has always been cited as an economic alternative to Carbon Taxes. In fact, they are not alternatives, and many nation states have used both in some measure. Carbon Taxes are much closer to the Polluter Pays principle, levied at source, and used by the relevant Government in the same region from which the pollution originates. At the time of writing, the UK Government is considering the removal of the environmental charge on domestic energy bills in the UK because of the soaring wholesale price of gas, and the consequences faced by UK householders in similarly soaring energy bills.
In other words, in response to a crisis in the supply of a substance which has been one of the major causes of the global problem we are all facing, the UK government seeks ways to make the supply and use of the substance easier and cheaper. This is a different principle altogether; the polluter need not pay if payment is uncomfortable or difficult. But it also forces us to confront the ultimate truth in this debate. The polluter is ourselves, sitting in our heated homes with the lights burning and our cars waiting for us in the morning.