Carbon Trading: the limits of free-market logic

20 September 2007

Putting a price on carbon and making the polluter pay makes sense, doesn't it? Kevin Smith shows how carbon trading has merely created big profits for transnational companies and had no impact on climate change.

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If, as their proponents claim, carbon markets are wonderful tools for bringing about emissions reductions and provide economic support for clean technologies in the global south, then we should ask one question: why have they been met with a mounting chorus of criticism from civil-society organisations, social movements and journalists around the world?

Plans are being made, through processes like the G8+5 Climate Dialogue for countries like China (ie countries currently without commitments under the Kyoto Protocol) to adopt carbon trading as part of their climate policy, and there needs to be an assessment of whether such schemes really work in reducing atmospheric carbon – or if they are simply a means for polluting industries to profitably avoid the issue of making emissions cuts.

Cap and trade

The free-market logic behind the scheme looks simple on paper. Countries taking part in “cap and trade” schemes like the European Union Emissions Trading Scheme (EU-ETS) have a limit set on the amount of carbon they can emit in a given time period (the “cap”). This allotted amount of carbon is carved up and allocated between different industrial locations in the country. If, for example, a cement factory goes over its allocated portion of carbon emissions, it has to purchase spare emissions from another market participant, for example, a power station that has emitted less than its allocation, and can therefore sell profitably sell them on (the “trade”).
The problem lies in the fact that carbon trading is designed with the express purpose of providing an opportunity for rich countries to delay making costly, structural changes towards low-carbon technologies. This isn’t a malfunction of the market or an unexpected by-product: this is what the market was designed to do.

The economist John Kay wrote in the Financial Times: “when a market is created through political action rather than emerging spontaneously from the needs of buyers and sellers, business will seek to influence market design for commercial advantage.” In terms of climate change and carbon trading, the “commercial advantage” (at least in the short term) lies in avoiding the costly structural changes, and industry has influenced every stage of the design and implementation of the carbon market to this end.

Businesses and industries in the global north have avoided making these infrastructural changes by ensuring that the price of carbon permits is kept absurdly low. It is much cheaper for industry to purchase cheap carbon credits to make up any emissions short-falls than to implement the technologies that would actually bring about real emissions reductions at source.

The low price of carbon permits was ensured in the first round of the EU-ETS by governments handing many more emissions permits to industry than was necessary; the majority of industrial locations had more emissions permits than they needed. When news of this massive over-allocation was revealed, it caused the price of carbon to drop dramatically. Economists estimate that carbon permits should be priced at around 30 to 50 euros per tonne in order to create sufficient incentives for low-carbon technologies. Towards the end of the first round of the EU-ETS the price of permits was regularly dipping below one euro per tonne.

Market enthusiasts argue that the “cap” will be tightened in the second round, causing the price of carbon to rise. But in order to prevent this happening, business has lobbied for a means of importing more cheap credits into the system, generated in countries like China, through the Clean Development Mechanism.

Clean development?

Instead of trading with other market participants in Europe, another option for our cement factory would be to purchase “carbon credits” that have been generated outside of the trading scheme, through a project in a developing country that supposedly reduces or avoids emissions.

An example would be a hydro-electric power station in China that has sold its supposed emissions reductions to companies from rich countries as part of the Clean Development Mechanism (CDM). China has been the world leader in this market, generating some 60% of all CDM credits in 2006.

The CDM has had some bad publicity in the last six months. An article in The Guardian newspaper in June 2007, said: “[the CDM] has been contaminated by gross incompetence, rule-breaking and possible fraud by companies in the developing world, according to UN paperwork, an unpublished expert report and alarming feedback from projects on the ground.”

Despite the regulatory framework that surrounds the CDM, there is both the incentive and the opportunity for project developers to distort key information, so as to make a project appear more effective and generate more credits – or gloss over any local resistance to the project.

For example, the principle of “additionality” is a pre-requisite for a project to qualify for CDM status: it has to be proved that the project would not have taken place without the funding provided through the CDM; any climate benefits should be additional as a result of the funding. Otherwise, unscrupulous operators could simply claim carbon funding for projects that would have taken place anyway, meaning industries in rich countries could justify further pollution on the false premise of being responsible for emissions reductions elsewhere.

However, many CDM projects under consideration in China involve generating hydro-electricity: there are 248 currently in the pipeline. There are strong grounds to be extremely sceptical over whether these are genuinely additional, given that such projects are very common in China, and have been actively promoted by the government. The question arises over whether they would have been happening had it not been for CDM funding. In 2005, the International Rivers Network submitted a comment to the CDM panel in reference to the Xiaogushan Large Hydroelectric Project in northwest China’s Gansu province, which pointed out that the application for CDM funding was submitted two years after the construction of the dam had begun, and that “project documentation from the Asian Development Bank clearly states that Xiaogushan was the least–cost generation option for Gansu and that revenue from CDM credits was irrelevant to the decision to go ahead with the project.”

It is not well documented whether there is local support for the various hydro-electric projects in China that are being promoted through the CDM, which as a pre-requisite should bring developmental benefits to local communities. Many of the corporate benefactors of CDM money in other countries are the target of sustained local resistance from communities who have to endure the often life-threatening impacts of intensive, industrial pollution.

In 2005, about 10,000 people from social movements, community groups and civil society organisations mobilised in Chhattisgarh, India, to protest the environmental public hearing held for the expansion of Jindal Steel and Power Limited (JSPL) sponge iron plants in the district.

The production of sponge iron (an impure form of the metal) is notoriously dirty, and companies involved have been accused of land-grabbing, as well as causing intensive air, soil and water pollution. JSPL runs the largest sponge-iron plant in the world, which is spread over 320 hectares on what used to be the thriving, agricultural village of Patrapali. This plant alone has four separate CDM projects, generating millions of tonnes of supposed carbon reductions that could be imported into the EU-ETS. The inhabitants of three surrounding villages that would be engulfed are resisting a proposed 20 billion rupee (around US$412 million) expansion. In this case, the CDM is not only providing financial assistance to JSPL in making the expansion, but also providing them with “green” credibility by putting them at the forefront of the emerging carbon market.

The head of China’s environmental agency, Zhou Shengxian recently attributed the rise in social unrest across the country to pollution scandals and the degradation of the environment. An article in the Guardian newspaper said that his comments “underscore the frustration of state mandarins at local government officials who ignore environmental standards in order to attract investment, jobs and bribes.” Given such circumstances, it is highly possible that the CDM will provide financial support to the sort of environmentally irresponsible power and chemical plants that are increasingly becoming the target of community protest in China.

Pollution and power

The largest share of CDM credits worldwide (30%) has been generated by the destruction of HFC-23. This potent greenhouse gas is created by the manufacture of refrigerant gases. A study in the February 2007 article of Nature showed that the value of these credits at current carbon prices was 4.7 billion euros. Not only was this twice the value of the refrigerant gases themselves, but it was also estimated that the cost of implementing the necessary technology to capture and destroy the HFC-23 was less than 100 million euros: something in the region of 4.6 billion euros was being generated in profit for the owners of the plants and the project brokers. In an article in the Sunday Times, it was reported that two Chinese companies were set to make around US$1 billion in 2007 alone as a result of CDM money given for the destruction of HFC-23.

This enormous sum of money generated by these Kyoto-style trading schemes has not gone to the companies and communities who are taking action on clean energy and energy-reduction projects, but rather to big, industrial polluters who are then at liberty to reinvest the profits into the expansion of their operations. Ashish Bharat Ram, the managing director of an Indian company that reported a profit of 87 million euros from the destruction of HFC-23 in 2006 and 2007, told the Economic Times that: “Strong income from carbon trading strengthened us financially, and now we are expanding into areas related to our core strength of chemical and technical textiles business.”

The structure of the CDM is such that it is usually an option reserved for large companies who can provide the capital needed not only to implement the project, but also to go through the long process of accreditation and certification, with all the attendant expenses of carbon consultants, third-party verifiers, ongoing project monitoring and so forth. Larry Lohmann argues in his book “Carbon Trading – A Critical Conversation on Climate Change, Privatisation and Power” that this “reinforces a system in which, ironically, the main entities recognized as being capable of making ‘emissions reductions’ are the corporations most committed to a fossil-fuel burning future… while indigenous communities, environmental movements and ordinary people acting more constructively to tackle climate change are tacitly excluded, their creativity unrecognized, and their claims suppressed.”

It seems that the only people who are benefiting from the carbon market and CDM projects are the polluting corporations that are involved in both Europe and the global South, as well as the new class of handsomely-salaried carbon technocrats and brokers, which has sprung up to service the needs of the market. There is an urgent need to recognise that the market’s fixation on short-term profit maximisation is not an appropriate instrument to induce the large-scale and costly infrastructural changes that need to take place in all countries in the transition to low-carbon economies.

About the authors

Kevin Smith

Kevin Smith has been working with the environmental justice project at TNI since 2005, although he was more informally involved since it started out as Carbon Trade Watch in 2002. He has a degree in Human Sciences. He used to be the editor of the Green Pepper magazine and in 2003 he helped to establish Escanda, a residential project in Northern Spain that combines sustainable living with political engagement at local and international levels. He currently lives in London works part time at Platform. He has been active in climate justice issues since the COP 6 in Den Haag in 2000 and participates in the international Durban Network for Climate Justice.

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