Analysis |  Do carbon markets help slow climate change?  Maybe.

Analysis | Do carbon markets help slow climate change? Maybe.


As countries gather in Sharm el-Sheikh next week for the COP27 climate conference, there has been growing concern about the slow progress on the pledges of the 2015 Paris Agreement. National emissions pledges to date, experts warn, will not be able to limit global warming to 1.5 degrees Celsius (2.7F) – and governments are not even fully implementing those pledges.

Despite the disappointing incrementalism of the, one part of the global climate regime continues to gain momentum: carbon markets. Article 6 of the Agreement created two new market-based mechanisms to help countries meet their national commitments. The first, a global emissions offset mechanism, allows countries and private entities to pay carbon offsets elsewhere and count them towards their own emissions reductions.

The second mechanism, known as internationally traded mitigation outcomes (ITMOs), allows countries to trade reductions bilaterally. Carbon markets may seem like an elegant solution, but they are extremely difficult to implement well and have a very mixed record of actually reducing emissions.

Carbon trading is complex in practice

The economic logic of carbon markets is simple: trading allows reductions to occur where they are cheapest, thereby maximizing efficiency. In practice, however, the challenges are many.

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The offset mechanism will be administered by the United Nations Framework Convention on Climate Change (UNFCCC), through an expert oversight body that is in the process of creating its governance structures. Like its predecessor, the Clean Development Mechanism, the new offset mechanism will outsource the certification of offset projects to third parties.

The bilateral trade mechanism is much more of a work in progress. The rules of the Paris Agreement provide guidance, but not enforcement, on how countries should carry out these collaborative efforts. Currently, a number of countries are piloting projects under bilateral agreements.

Double counting was a big sticking point in negotiating the Article 6 rules. In theory, nations will use “matching adjustments” to ensure that only one nation can claim the cuts against their pledge from Paris. Yet questions remain about how to implement corresponding adjustments over time – and when they will be applied, given that countries’ pledges have different timeframes and end dates.

A second unknown is how the voluntary carbon market could appear on these new markets, in particular the offset market. Created mainly by NGOs, this market, distinct from the “compliance” markets created by the government, allows companies to buy offsets to reduce their emissions.

Many companies have now pledged to reach net zero, reducing their emissions and balancing any residue through carbon removals or offsets. This has created a growing demand for offsets in the voluntary market, the value of which has quadrupled in 2021. But there are serious concerns about the quality of these offsets – do they represent genuine reductions or smart accounting?

The voluntary market has been incorporated into public regulations in a limited way – although it is not yet clear what role it might have under Article 6. The Surveillance Body has not decided which compensation methodologies will be used, but the preliminary wording leaves the door open to designing the voluntary market.

A handful of governments allow companies to use private offsets to meet regulatory requirements. More recently, countries decided that certain voluntary market offsets could be used to meet the Aviation Emissions Agreement target of making the aviation industry carbon neutral from 2027. Due to these new claims for offsets, the global voluntary market is now valued at around $2 billion.

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Problems with carbon markets are not new

Governments, non-governmental organizations and businesses now have around a quarter century of experience in carbon trading, but several problems persist. To date, the picture is very mixed, showing the limited capacity of these markets to produce significant reductions.

First, the quantification of offset reductions has been problematic from the outset. Carbon offsets require estimating the absence of emissions based on a hypothetical counterfactual. Offset projects ask: how much CO2 (or other greenhouse gas) would have been emitted without this project? While there are methodologies that standardize these estimation exercises, critics repeatedly point out that voluntary offset and compliance markets fail to produce emission reductions that are genuinely “additional” – that is. that is, reductions that would not have occurred in the absence of the project. Studies suggest that the reductions produced by the clean development mechanism, the predecessor and model of the new offset mechanism, are greatly overestimated. Even Pope Francis has expressed concern, noting that carbon markets “may lead to a new form of speculation that would not help reduce emissions of polluting gases around the world.”

Second, so far, emissions trading has had limited effects on reductions. The innovation of Article 6 is that countries can decide how to create the “quotas” that they negotiate. Yet emissions trading is hardly a driver of decarbonization. Existing efforts to pay developing countries to keep forests standing have been criticized for overstating reductions, for example. And even in the developed world, reductions tend to come from incremental measures like switching fuels or improving efficiency rather than weaning off fossil fuels. Recent US moves to invest in green industrial policy through the Cut Inflation Act may serve as a model for other countries, but many international organizations beyond the UNFCCC continue to advocate for carbon pricing as a key solution to climate change.

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Third, the voluntary clearing market is under-regulated. It predated the Clean Development Mechanism by about a decade and has been plagued by ongoing concerns about shoddy offsets that fail to deliver further reductions due to measurement, permanence or leakage issues. Nature-based offsets, such as forests or grasslands, can be destroyed by fire or drought, instantly erasing any reduction. Or, an offset project may simply move emitting activities elsewhere beyond the project boundaries (the leakage problem). Although there have been multiple efforts to improve the quality of offsets, these have come from the voluntary market itself. Given the incentives of private standard setters to drive demand and maintain market share, there are legitimate concerns about the feasibility of self-regulation.

Despite these hard truths, Article 6 ensures that carbon markets are likely to continue to grow, especially with the voluntary market available as a ready-made backstop – or potential addition – to current multilateral mechanisms. So even if COP27 produces more “blah blah blah,” as climate activist Greta Thunberg dismissively put it, carbon markets are about to grow. Unfortunately, they have not yet delivered the rapid reductions in emissions required by the global climate crisis.

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Jessica F.Green (@greenprofgreen) is a full professor in the Department of Political Science and the School of Environment at the University of Toronto.

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