The role of carbon markets in preventing dangerous climate change - Environmental Audit Committee Contents

Memorandum submitted by FERN


    — The ETS has hampered the transition to low-carbon economies because resources have flown into setting up an immense carbon trading apparatus, not research & development into transitioning UK energy and transport infrastructure to be fit for the low-carbon realities of the future.

    — The EU ETS overestimates the potential of pricing as a means to achieving structural changes in the energy and transport infrastructure. While a carbon tax will certainly not be sufficient in and by itself to trigger a just and swift transition to low-carbon economies, its advantages over carbon trading as a means of putting a price on carbon are many, as Dr. James Hanssen pointed out in his recent testimony to the US House Committee on Ways and Means: "Cap & Trade' increases costs to the public as does `Tax & Dividend', but without the dividend. Thus it should be termed `Tax & Trade'." He further states that "[e]xcept for its stealth approach to taxing the public, and its attraction to special interests, `Cap & Trade' seems to have little merit."1

    — Carbon offsets do not contribute to preventing dangerous climate change because carbon offsets do not reduce emissions. At best, they stabilise emission levels: A reduction in one place justifies an extra emission in another place. This best-case scenario appears to be rare in reality and it is not possible to verify whether or not the claimed reduction has been over and above any that would have occurred anyways. As a result, any trading scheme involving carbon offsets may increase rather than reduce ghg emissions because it will allow extra emissions without the certainty of corresponding extra reductions elsewhere.

    — Offset standards have not been able to address this fundamental shortcoming: it is impossible to verify whether credits sold by any one project are based on genuine, additional emission reductions that would otherwise not have occurred. At least 1/3 and possibly up to 2/3 of registered CDM projects are business-as-usual projects that do not deliver additional emission reductions.2 Due to lack of transparency, it is not possible to even assess with any certainty the level of non-additional credits of offset projects in the voluntary offset market.

    — A November 2008 US Government Accountability Office report states that its "Key lessons from the CDM include: (1) the resources necessary to obtain project approval may reduce the cost-effectiveness and quality of projects; (2) the need to ensure the credibility of emission reductions presents a significant regulatory challenge; and (3) due to the tradeoffs with offsets, the use of such programs may be, at best, a temporary solution."3 In addition, offsets do not contribute to changing the energy infrastructure either in the offset producer or the offset buyer country and the UK government must phase-out its use of offsets as soon as possible.

    — Trading in credits from offset schemes presents a high risk of creating a lemons market because it is impossible to assess the true value of the credit being sold, because "[o]ffsets are an imaginary commodity created by deducting what you hope happens from what you guess would have happened."4

    — If the objective of the government's climate policy were to trigger a swift, just and effective transition to a low-carbon economy in order to prevent dangerous climate change, carbon trading ought not be the central pillar. In our view it should not even be part of the mix of policy instruments because it (a) has neither triggered the kind of technological shift needed to move our fossil fuel dependent economies onto a low-carbon pathway; (b) turned the polluter-pays-principle into a polluter-is-being paid principle by providing billion-euro windfall profits to some of the largest ghg emitters (c) incorporates the trading of offset credits whose generation is based on story-telling and hence ultimately not verifiable. As Dr. James Hanssen stated at a recent US House Committee hearing: "[t]he worst thing about cap-and-trade, from a climate standpoint, is that it will surely be inadequate to achieve the sharp reduction of emissions that is needed. Thus cap-and-trade would practically guarantee disastrous climate change for our children and grandchildren."5

    — FERN believes that a crucial first step in implementing an effective UK climate policy will be for the UK government to end the use of carbon offsets. It will further be crucial to identify a broad range of effective approaches that will provide a realistic possibility of transitioning the country's fossil fuel dependent energy infrastructure and transport systems towards low-carbon dependence. Given the immensity of the task, as well as the urgency to provide the right incentives before long-term energy infrastructure decisions are taken, a thorough assessment of available policy instruments that may include but is not limited to market-based instruments such as taxation, and financial incentives for innovation will enable the government to replace the ineffective and costly carbon trading infrastructure and begin focusing on policy measures that hold a chance of playing a positive role in preventing dangerous climate change—carbon trading does not.


  1.  FERN is an environmental and social justice advocacy non-profit organisation founded in 1995, which works to promote environmental and social justice.

  2.  FERN has pursued research into climate change policy, emissions trading, and carbon trading, in particular carbon offsets, since 2000. Initially focusing on the analysis of carbon trading as a potential new financing instrument for the expansion of monoculture tree plantations, FERN has critically analysed the climate justice implications of implementing carbon trading schemes. FERN has documented the reality of carbon offset projects and engaged in strengthening global networks advocating for climate justice and a swift transition to low-carbon economies.6 Working closely with organisations in India, Brasil, Congo Basin countries, Uganda, Indonesia, the US and Canada, FERN has analysed the role carbon offsets play in the European Emissions Trading Scheme and in voluntary offset markets.

  3.  FERN's submissions to the Environmental Audit Committee inquiries into the International Challenge of Climate Change, the role of the voluntary carbon offset market and, recently, on "forests: the future role of carbon markets in their protection and the timber trade" have argued that (1) carbon markets, in particular where they include the use of carbon offsets, delay or even prevent rather than accelerate a just transition to low-carbon technologies; (2) carbon offsets have not contributed significantly to sustainable development but on the contrary, in many cases have had serious negative social and environmental impacts; (3) reliance on carbon offsets as a way to finance reducing deforestation initiatives in the context of an international climate regime will threaten to ignore forest peoples' rights and fail both, to reduce emissions and address the drivers of forest loss; (4) any use of carbon offsets is incompatible with the government's pledge to prevent dangerous climate change.


  4.  A growing body of academic research shows that emissions trading tends to discourage, not encourage, innovation by lowering the cost of compliance through conventional measures such as regulation or taxation. Driesen for example documents how even innovation that costs a lot now can prove economically and environmentally superior over the long run, because innovation can make costs of new technologies fall over time. His research further shows how some innovations provide very wide ranging environmental and social benefits and can alter pathways while emissions trading encourages selection of technologies and measures with the cheapest short-term cost, not the cheapest long-term cost or the greatest long-term value.7 With regards to triggering a transition towards low-carbon economies such long-term values may far outweigh the short-term cost savings. In their working paper `The Missing Instrument: Dirty Input Limits'8, Driesen and Sinden also evaluate the use of Dirty Input Limits (DILs), ie quantitative limits on the inputs that cause pollution as a climate change protection instrument. They state that "DILs provide an alternative to cumbersome output-based emissions trading and performance standards. DILs have played a role in some of the world's most prominent environmental success stories."

  5.  Oxford University economics professor Dieter Holm further points out that "[t]he price of carbon has had virtually no effect on the market so far and virtually no effect on climate change,"; he adds that "[t]he trouble is that there are a lot of people out there making a lot of money out of carbon trading and who want to perfect the market rather than press for the changes that are actually needed." Driesen and Holm's s analysis is echoed by Jim Watson of Sussex University Energy Group: "Governments are relying way too much on the price of carbon to deliver everything." Watson further points out that "The oil price shocks of the 1970s didn't wean us off oil, so why should we believe that a high carbon price will wean us off carbon."9

  6.  Given the relatively short time span left to initiate a just transition to low-carbon economies if dangerous climate change is to be prevented with at least some likelihood, a thorough assessment, identification and implementation of the most effective policy instruments for triggering the kind of energy and transport infrastructure change required to climate-prove our economies is urgently required. The mounting evidence that carbon trading will not be able to provide the right incentives for these types of innovation or a switch to low-carbon energy pathways adds further urgency to a thorough independent assessment of the role carbon trading is playing in preventing or exacerbating climate change before carbon trading is expanded and developed into a global policy instrument.


Cap-and Trade component

  7.  Windfall profits, negligible reductions, no change in energy pathway, three price crashes and a continuing oversupply of permits summarise the experience of the first and beginning of the second phase of the EU Emissions Trading Scheme.10 In 2008 the WWF stated in a report on the EU ETS second phase that the organisation is "concerned that the ETS is financially rewarding some of the worst carbon polluters in the EU." And further that "Power companies in five EU member states could realise windfall profits over the next four years of up to €71 billion as a result of the handing out of emissions allowances for free."11 A recent FERN Briefing12 shows that the option to "bank" unused credits and allowances for use beyond 2012 combined with the ETS's carbon offset loophole allowing significant influx of carbon offset credits and the economic downturn reductions by 2020 reduction obligations within the EU may be as low as 3.9% compared to 1990 emissions.

  8.  The economic crisis and recession have exacerbated the ineffectiveness of the EU ETS and it is likely that neither phase II nor Phase III will deliver any significant domestic emission reductions other than those related to the economic downturn. Economists and carbon analysts have long been pointing out the failings of the scheme: In 2007, IPA Consultants pointed out that "By 2015, the UK's electricity system will look remarkably similar regardless of assumptions on how the EU ETS plays out." Citigroup's Peter Atherton stated in January 2007 that the "ETS has done nothing to curb emissions ... is a highly regressive tax falling mostly on poor people ... Enhances the market power of generators. Have policy goals been achieved? Prices up, emissions up, profits up... so, not really." Philip Luyten, environment manager at Total Petrochemicals states that "The EU ETS has given no extra incentives for greenhouse gas reductions or changes to the fuel mix,".13 Emissions in the EU have increased by 5 percent since the start of the ETS. This will mean that until 2020, the EU and the UK government's key climate policy instrument will not deliver any meaningful reductions in the highest emitting industry sectors, the sectors where investments into a swift transition are most needed yet will be least likely due to the availability of cheaper carbon trading options.

  9.  Over-allocation is a problem not limited to the EU ETS: According to research published by carbon market analysts Point Carbon, the emissions of carbon dioxide covered by the Regional Greenhouse Gas Initiative (RGGI) in the Eastern US dropped by over 20 million short tons between 2005 and 2006, leaving the scheme over-allocated by 24 million short tons or 13% of the cap in 2009.14


  10.  The widely announced "tightening of the cap" in the 2nd phase of the ETS has been accompanied by the less-publicised "widening of the hole": Companies will be able to use significantly more carbon offset credits during phases II and III of the ETS. FERN's calculations15 and an analysis by the Öko-Institute16 in Germany suggest that 60-90% of reduction obligations can be achieved by purchasing carbon offset credits and thus virtually no domestic reductions will be required from the majority of companies covered by the ETS.

  11.  Up to 50% of the offset projects currently registered by the Kyoto Protocol's CDM are believed to be business-as-usual projects which do not deliver additional emission reductions. Given that every offset project selling credits based on reductions that would have happened anyways (ie are not additional) justifies an extra emission under the ETS that is not covered by an equivalent extra reduction from the offset, the offset hole in the ETS will lead to higher, not lower global emissions. Michaelowa and Michaelowa argue that carbon offsets "in developing countries provide politicians in industrialized countries with a welcome strategy to divert the attention of their constituencies from the lack of success in reducing greenhouse gas emissions domestically."17

  12.  Neither offset standards nor an elaborate bureaucracy of the UNFCCC's Clean Development Mechanism have been able to prevent bogus offset credits from entering the carbon market en masse. This is not surprising given the inherent flaw of carbon offsets: They generate credits based on a counterfactual story of how high emissions "would have been" in the absence of the offset project. It is impossible to verify the validity of such a story of "what would have happened if" and thus, it is impossible to determine with certainty whether an offset credit is based on a genuine additional emission reduction or not: "Offsets are an imaginary commodity created by deducting what you hope happens from what you guess would have happened"18

  13.  In addition to this fundamental and insolvable shortcoming of carbon offsets, the structure of the carbon market has also created incentives that favour offset projects which deliver large quantities of cheap credits rather than projects which arise from the needs and priorities of local communities or that disburse appropriate renewable energy. This is reflected in the experience of a long-term renewable energy and community activist and specialist in Africa, "When the company for which I worked for 10 years got into carbon trading, I became increasingly distraught. It was no longer about "sustainable development", it was about tonnes of CO2 on make-believe spread sheets".19

  14.  Under the CDM the largest number of carbon credits has been generated by projects claiming to reduce the potent greenhouse gas HFC-23,9 rather than CO2. It has been estimated that the value of credits given to HFC-23 projects at average 2007 carbon prices is €4.7 billion. However, an estimate of the cost of technology needed to capture and destroy the same amount of HFC-23 is €100 million. Around €4.6 billion has been generated in profit by HFC-23 generating plants, which could then further expand their operations with the reinvestment of this profit. Indian chemical company, SRF, made €87 million from the sale of carbon credits in 2006-07. Ashish Bharat Ram, managing director of SRF, noted 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."20

  15.  FERN and partner organisations in the Durban Group for Climate Justice have documented extensively the serious negative social and environmental impacts of a wide range of carbon offset projects in both the CDM and voluntary offset market.21 These include gas capture for electricity generation in pig iron sector, HFC projects, biomass projects, avoided deforestation projects, tree planting projects, small hydro projects, wind energy projects, all in India; tree plantation and energy efficiency projects in the charcoal industry, hydro projects and biomass projects in Brasil, landfill methane capture in South Africa, tree planting in Uganda and Ecuador.

  16.  Initial research by FERN into forest conservation projects suggests that the same negative impacts and a return to the "guards and guns" approach to forest conservation can be expected at least in some areas if forests are included in international carbon offset schemes.

5 March 2009

REFERENCES1  Statement of Dr James Hansen, Adjunct Professor, The Earth Institute at Columbia University, New York, New York Testimony Before the House Committee on Ways and Means February 25, 2009.

2  Schneider, Lambert: Is the CDM fulfilling its environmental and sustainable development objectives? An evaluation of the CDM and options for improvement. Berlin, Germany 2007 and Wara, Michael and Victor, David: A realistic Policy on International Carbon Offsets. Stanford, California 2008.


4  Welch, Dan: "A Buyer's Guide to Offsets". Ethical Consumer 106, May/June 2007

5  Statement of Dr James Hansen, Adjunct Professor, The Earth Institute at Columbia University, New York, New York Testimony Before the House Committee on Ways and Means February 25, 2009.

6  For a list of reports and documentation of the impacts of carbon offset projects on local communities and the environment, see

7  Driesen, David M: Does Emissions Trading Encourage Innovation?. Environmental Law Reporter, Vol 32, January 2003. or DOI: 10.2139/ssrn.336661; Driesen, David M: "Sustainable Development and Market Liberalism's Shotgun Wedding: Emissions Trading under the Kyoto Protocol", Indiana Law Journal 83, 1: 21-69; 2008.


9  ANALYSIS-Carbon price is poor weapon against climate change. 24/ 09/ 2007 8:29am EDT

Jeremy Lovell

10  See for example US Government Accountability Office: Lessons Learned from the Euopean Union Emissions Trading Scheme and the Kyoto protocol's Clean development Mechanism. GAO-09-151 November 2008.


12  Reducing emissions or playing with numbers? What the EU Climate Action and Renewable Energy Package commit the EU-27 to in terms of reduced emissions. FERN Forest Watch Special Briefing March 2009.

13  EUETS will not drive abatement in phase 2. ENDS Report February 2007.

14 Emissions Trading in the US: Is RGGI Over-Allocated? Washington D.C. Aug 17 2007.

15  Reducing emissions or playing with numbers? What the EU Climate Action and Renewable Energy Package commit the EU-27 to in terms of reduced emissions. FERN Forest Watch Special Briefing March 2009.

16  Schneider, Lambert: Is the CDM fulfilling its environmental and sustainable development objectives? An evaluation of the CDM and options for improvement. Berlin, Germany 2007 and Wara, Michael and Victor, David: A realistic Policy on International Carbon Offsets. Stanford, California 2008.

17  Michaelowa, Axel/Michaelowa, Katharina: "Does Climate Policy Promote Development?", Climatic Change 84: 1-4; 2007.

18  Dan Welch, Ethical Corporation.

19  Anon (2007b): Personal communication.

20  Cited in Lohmann, Larry: Climate Crisis: Social Science Crisis In: Der Klimawandel: Sozialwissenschaftliche Perspektiven, VS-Verlag, forthcoming.

21  See, and for links to reports and video documentation on the impacts of carbon offset projects

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