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Are carbon markets helping to slow climate change? Maybe.

Carbon trading has been around for a quarter-century. But do these mechanisms represent true reductions?

- November 2, 2022

Editors’ note: In this archival piece, Good Authority contributor Jessica F. Green explains the latest developments in carbon markets, which allow countries and companies to pay to offset their carbon emissions. This analysis was previously published in the Washington Post in November 2022, as the COP27 climate conference got underway.

As countries gather in Sharm el-Sheikh next week for the COP27 climate conference, slow progress on promises from the 2015 Paris Agreement has prompted growing alarm. The national emissions pledges to date, experts warn, won’t be able to limit global warming to 1.5 degrees Celsius (2.7F) — and governments aren’t even fully implementing those pledges.

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

The second mechanism, known as internationally traded mitigation outcomes (ITMOs), allows countries to trade reductions bilaterally. Carbon markets might appear an elegant solution, but they’re exceedingly difficult to implement well and have a very mixed record on 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, maximizing efficiency. In practice, however, there are many challenges.

The offset mechanism will be administered by the U.N. Framework Convention on Climate Change (UNFCCC), through a Supervisory Body of experts that’s currently creating its governance structures. As with its predecessor, the Clean Development Mechanism, the new offset mechanism will outsource certification of offset projects to third parties.

The bilateral trading mechanism is much more of a work in progress. The Paris Agreement rule book provides guidance, but not enforcement, about how countries should carry out these collaborative efforts. Currently, a number of countries are piloting projects through bilateral agreements.

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

A second unknown is how the voluntary carbon market might figure in these new markets, especially the offset market. Created primarily by NGOs, this market, separate from government-created “compliance” markets, allows firms to buy offsets to reduce their emissions.

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

The voluntary market has been integrated into public regulations in limited ways — though it’s yet unclear what role it might have under Article 6. The Supervisory Body hasn’t decided on which offset methodologies will be used, but preliminary language leaves the door open for drawing from the voluntary market.

A handful of governments allow companies to use private offsets to meet regulatory requirements. More recently, countries decided that some offsets from the voluntary market can be used to meet the goal of the aviation emissions agreement, which aims to make the aviation industry carbon neutral from 2027. As a result of these new demands for offsets, the global voluntary market is now valued at around $2 billion.

Problems with carbon markets aren’t new

Governments, nongovernmental organizations and companies now have about a quarter-century of experience in carbon trading — yet several problems persist. To date the record is very mixed, showing the limited ability of these markets to produce significant reductions.

First, quantifying offset reductions has been problematic from the start. 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 both the voluntary and compliance offset markets fail to produce emissions reductions that are truly “additional” — i.e., 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 for the new offset mechanism, are vastly overestimated. Even Pope Francis voiced concerns, noting that carbon markets “can lead to a new form of speculation which would not help reduce the emission of polluting gases worldwide.”

Second, thus far, emissions trading has limited effects on reductions. The innovation in Article 6 is that countries get to decide how to create the “allowances” that they trade. Yet emissions trading is hardly an engine for decarbonization. Existing efforts to pay developing nations to keep forests standing have been criticized for overestimating reductions, for example. And even in the developed world, reductions tend to come from incremental measures such as fuel switching or efficiency improvements rather than weaning off fossil fuels. The recent U.S. moves to invest in green industrial policy through the Inflation Reduction Act might serve as a model for other countries, but many international organizations beyond the UNFCCC continue to advocate for pricing carbon as a key solution to climate change.

Third, the voluntary offset market is under regulated. It preceded the Clean Development Mechanism by about a decade, and has been plagued with consistent concerns about low-quality offsets, which don’t deliver additional reductions because of problems with measurement, permanence or leakage. Nature-based offsets, such as forests or grasslands, can be destroyed through fire or drought — instantly erasing any reductions. Or, an offset project can simply shift emitting activities somewhere else, beyond the project’s boundaries (the leakage problem). While there have been multiple efforts to improve offset quality, these have come from within the voluntary market itself. Given the incentives of private standard-setters to boost demand and maintain market share, there are legitimate concerns about whether self-regulation is feasible.

Despite these hard truths, Article 6 ensures that carbon markets will probably continue to expand, particularly with the voluntary market available as a ready-made backstop — or potential addition — to the current multilateral mechanisms. Thus, even if COP27 produces more “blah blah blah,” as climate activist Greta Thunberg said dismissively, carbon markets are poised to grow. Unfortunately, they have not yet delivered the rapid emissions reductions that the global climate crisis requires.

Jessica F. Green (@greenprofgreen) is a full professor in the department of political science and School of the Environment at the University of Toronto.