The Capitalist’s Approach to a Greener World: Carbon Credits
While the topics of decarbonization, emission reduction, and sustainable business operations have circulated for decades in reflection of an increasingly hotter planet, the root causes of sluggishness in meaningful action toward these initiatives lie in commercial feasibility. Transforming fundamentally pollution-generating core business processes for vast numbers of polluting entities is expensive, complex, and often unrealistic, especially considering the tight turnaround windows often associated with decelerating climate change. Consequently, the societal approach to economic decarbonization has instead formed around the widely-known concept of ‘net-zero’ or offsetting pollution, which quickly birthed the commodity markets of carbon credits and a market-based incentivization structure for green businesses. Exploring carbon credits uncovers its potential to become a commercially feasible, much-needed catalyst toward economic decarbonization, but also reveals the current system’s complementary flaws and exploits that leave serious room for amelioration.
A Penny Saved is a Penny Earned
Carbon credits as commodities are byproducts of the ‘cap and trade’ system. The program’s premise entails a government setting a ‘cap’, or an upper limit, of pollution in a given industry. This ‘right to pollute’ gradually decreases every year, and exceeding the limit would incur fines and regulatory sanctions. To stay under the imposed limit, polluters must either leverage innovation to reduce emissions across their value chains or buy ‘allowances’. These allowances, known as carbon credits, are purchased from other businesses to reduce or remove pollution, legally allowing additional pollution within a purchased amount. This is where the term ‘net zero’ comes into play, as environmental damage is, in a sense, compensated for by others not polluting as much or making efforts to reverse it. Conventionally, one carbon credit equals one metric tonne of pollution, often carbon dioxide. As businesses that often have allowances left over are those leveraging innovations in sustainability, such as clean technology, economic incentivization drives entities to pollute less for additional revenue on top of cost avoidance. For instance, Tesla’s top line has often benefited from leftover credits as an EV enterprise; it made a staggering $1.78 billion USD in 2022 from carbon credit sales revenue.
The global premiere of a large-scale ‘cap-and-trade’ program began with the American government in the 1980s. As coal-fueled power plants fulfilled the demand for household electricity, the released toxic byproducts – sulphur dioxide clouds – returned as acid rain, damaging eastern Canadian and American wildlife, people, and landscapes. Through years of discussions and various trials of environmental taxes, the marketplace-based idea of emissions trading was born through the 1990 Clean Air Act Amendments. When it took effect in 1995, acid rain emissions were reduced by three million tons in the same year, which underpinned the gradual policy establishment of ‘cap and trade’ as a popular means for autonomous emission reduction from polluters without significant government costs. By 2007, it saw a 43% drop from 1990 emissions levels, despite the 26% increase in electricity from coal-fueled power plants. Following this American example, the UN’s Kyoto Protocol in 1997 saw world leaders agreeing on the adoption of carbon credits in an attempt to reduce greenhouse gases, especially carbon dioxide, from the atmosphere with economic feasibility in consideration. Signed into international law in 2005, this mandate gave industrialized countries – 37 nations and the EU, with voluntary participation from others – maximum emission levels with the same foundation of gradually lowering the cap over time. Once the first commitment period ended, 196 parties signed the Paris Agreement at the end of 2015, which superseded the Kyoto Protocol and recalibrated global targets but kept the carbon trading mechanisms in place.
Money Trees
A corresponding global carbon market quickly emerged as more carbon credits began trading across industry verticals. On both national and international scales, two types of such markets exist: compliance and voluntary. Compliance markets form to meet regulatory requirements from any national, regional and global climate policies. In contrast, voluntary markets exist for entities looking for a profit in sales of such credits or derivative financial products based upon the market system. Voluntary markets are often driven by governments or private entities pushing projects involving emissions reductions or removal, which supplies the demand from corporate or individual entities wanting to offset their carbon footprints or other players in the market. These mechanics have shaped the aggregate global market to a $909 billion USD valuation in 2022, alongside projections of around 21% CAGR (compounded annual growth rate) within the next five years to reach approximately $3 trillion USD in 2028.
An example of a respected, active carbon trading market is the European Union’s Emissions Trading System (ETS). Inaugurated in 2005 as the world’s first international emissions trading system, it is now the largest, comprising 87% of the global market valuation. Its market mechanism replicated from the ‘cap and trade’ approach applied across pollutant-heavy verticals – namely energy, heavy industry (oil, steel, cement, paper, glass, etc.), logistics, and civil aviation – has driven emissions reduction by around 35 percent between 2005 and 2021 in the EU. The ETS went through several iterations to become the world’s cornerstone marketplace for carbon trading, most notably when it introduced a unique mechanism called the Market Stability Reserve (MSR) a decade after crashes in carbon allowance prices during the 2008 global financial crisis where commercial pollution became more affordable. The MSR gave the EU more control over the market supply, which kept the price of polluting high and drove companies towards ‘greener’ processes.
On the domestic front, efforts made meaningful traction in 2022; in fact, Canada’s first federal carbon credit market was launched in the year, although British Columbia, Quebec, and Alberta had smaller regional compliance credit systems.
Wanting Greener Pastures
While the market-based carbon credits have shown meaningful results and data points to indicate their efficacy in significant commercial steps towards decarbonization, the discussions about the foundational ethics are still ongoing. In particular, critics argue that the system is built on greed, where corporate entities will pollute and optimize for the least costly means to do so without inherent change of their value chain models – as long as the price of carbon is higher than the cost of credits.
Another notable concern revolves around the validity or authenticity of many carbon credits and their issuing agencies. As a recent example, a 2022 investigation into Verra, one of the world’s leading carbon standard issuing organizations, suggested that more than 90% of their rainforest offset credits are not representative of genuine carbon reductions. Journalists reported that only a few of Verra’s rainforest projects had evidence to support deforestation reduction. At the same time, analysts from a University of Cambridge study controversially claimed that Verra overstated threats for about 400% on average for its ‘REDD+’ forest projects.
A critical flaw in the system often discussed is carbon leakage, which describes the practice where a company decides to relocate their production or elements of its value chain to countries with lenient climate policies – often in developing nations – away from their home countries, effectively appearing to make commitments in the home front while polluting equal or more significant amounts than the before. Such offshoring of pollution means aggregate environmental damage is untouched, but rather hidden away in a mere redistribution scheme that removes it from domestic carbon tracking.
Insert Credit Here?
The bottom line may precede the planet and the people in the modern capitalistic system that optimizes operations towards fiscal profit. Without transparency into entities’ intentions in climate-related commitments or correct forecasts into the business landscapes, it is impossible to determine the trajectory of modern sustainability efforts and their outcomes in the battle against climate change, even after world leaders have set tangible targets for 2030 or 2050. Work undoubtedly remains for completion in polishing and refining the architecture of the carbon credit system worldwide. Still, it has nonetheless proven effective in incentivizing polluting players to enter new trajectories. Perfecting the system could be the only option remaining, as time continues to tick in this game.