Carbon trading no cure-all

Of all the systems pitched as environmental panaceas, few seem seem to be as mired in controversy and confusion as carbon trading.

At its core, carbon trading is an attempt to use market economics to reduce the world's output of carbon dioxide, one of the leading greenhouse gases that has been linked in scientific research to climate change.

Carbon trading, also known as carbon offsetting or a cap-and-trade system, allows companies and governments that produce a lot of carbon dioxide to mitigate the noxious impact of their activities by paying other companies and governments to reduce theirs by a corresponding amount.

It sounds great in theory, but detractors say it's riddled with inconsistencies in practice.

"My main issue is the lack of accountability," University of Guelph environmental economics professor Ross McKitrick says. "The problem with the whole offset system is that it's very hard to maintain."

'There's huge potential for fraud.' —Probe International's Patricia Adams

If you break the rules on a stock exchange, a regulatory body such as the Securities and Exchange Commission or the Ontario Securities Commission can enforce the rules and dole out punishments. But with a nebulous carbon market that transcends international borders and has no centralized exchange, the issue is a bit murkier.

McKitrick gives the hypothetical example of a Central American company that earns money by planting forests on behalf of carbon polluters. "Are they just chopping down the trees and two years from now, taking a picture of an empty field and selling the same service again?" he wonders.

Indeed, as watchdog group Probe International's executive director Patricia Adams says, as it stands now there's very little to stop the group from selling the same offset to multiple buyers, or buyers from reselling spent credits.

"There's no product," she says. "All the buyer and the seller want is the permit, so there's no inherent value in the thing being traded beyond public relations."

"There's huge potential for fraud."

The environmental group Sierra Club "cautiously supports" carbon trading systems, executive director John Bennett says, as long as the credit is for real energy reductions based on real energy projects.

"When trading emissions, you should have permanent emissions.… We want someone in a factory to reduce emissions — that's good credit. But for a corporation to go to Guatemala and buy a forest and get that to count as a credit? We don't support [that]," says Bennett.

Enforcement an issue

Experts agree that compliance has to be in the hands of a dedicated third party. In the current hodge-podge system, the credit buyer has no incentive to ensure the carbon promises are met because they've already paid for the value the credit represents, and the seller won't want to have anyone poking around their operations. But finding an appropriate regulator with authority across continents can be tricky.

"You need an army of regulators; you just can't do it," Adams says. "You need some sort of gatekeeper and right now nobody has the time and energy to take that on."

That's part of the reason why thus far, carbon trading systems have taken a regional approach. Europe leads the way, having set up the Emission Trading System, known as the ETS, on Jan. 1, 2005. When the ETS first came online, governments were asked to create carbon caps on industries in their area.

The governments then issue permits to firms and industries allowing them to produce set amounts of carbon dioxide. Companies falling below their targets earn credits, while those exceeding their targets must purchase credits to make up the shortfall. Any whose emissions exceed their credits are fined.

Local governments are responsible for enforcement, which has led to some problems.

Hundreds of billions of dollars worth of carbon credits have traded on the ETS since it was founded. But because governments are often reluctant to be harsh on companies for fear they will leave, taking their economic benefits to another region, there is doubt about how much good the system has done. It's too easy to bend the rules.

McKitrick related the tale of a British automaker that recently shut its domestic plant and moved production to China. In one fell swoop, the automaker got the benefit of a lower-cost production centre in China and valuable credits for reducing its carbon footprint in Europe.

"Companies that are smarter than others can get ahead," said Rodney White, University of Toronto professor and co-author of the book Carbon Finance: The Financial Implications of Climate Change.

Some companies will go as far as using fraud to get ahead. In December, Interpol announced it had uncovered a sophisticated carbon trading fraud ring that had made off with more than $7 billion over the preceding 18 months.

The scam was essentially an old-fashioned tax-evasion scheme, made possible by the nebulous nature of international carbon markets.

The fraudsters set up numerous trading accounts on the ETS, then bought credits tax-free on exchanges in countries outside Europe. Those credits were transferred into the European accounts and the fraudsters collected tax on the transactions, but the monies were never paid to any European tax agencies.

The bogus trading accounts were then shut down before tax authorities could collect.

With competing carbon trading systems and no centralized authority tasked with policing, similar abuses could still happen. A recent report by auditor firm Deloitte warned that fraud, bribery and money laundering could be the norm in the $132 billion international carbon market.

"Emissions trading schemes may well attract highly organized fraudsters," Deloitte's forensic financial crime partner Chris Noble says. "The warning signs are already apparent."

Canadian systems

In 2007, Alberta became home to North America's first rudimentary carbon trading market when that province set up the Alberta Offset System.

Much like the European model, the Alberta Offset System has no hectic, gleaming trading floor on which to buy and sell credits. Indeed, the only people who know about the system are polluters, firms that have reduced their carbon footprint and received credits for doing so, and brokers who act as intermediaries between the two parties.

After the province assesses how much carbon a polluting company is allowed to emit, the company can either pay $15 for every tonne of excess carbon it produces to a government-run green technology fund, or purchase credits from companies who are under their target.

When the Alberta system was launched, the going rate for carbon credits was $6 to $8 a tonne. It's up to about $13 now.

Some of the clear winners in the system are farmers, many of whom have reaped six-figure windfalls for using Earth-positive farming techniques to help capture more carbon.

National system

But beyond a token transfer of funds from polluters to non-polluters, there's some doubt as to what the program has accomplished — the province is emitting more greenhouses gases today than at any point in its history.

Still, the system is held up as a model for a national regime that Ottawa was originally supposed to implement in January 2010. As that deadline for the so-called cap-and-trade system has come and gone, it's unclear what comes next.

In a speech in January 2009, Environment Minister Jim Prentice outlined the Harper government's preference for following the U.S. lead. Canada supports a "common cap-and-trade system" and a "shared target" for cleaner electricity, he said at the time.

As recently as last month, Prentice was touting a continent-wide, enforceable carbon trading system to ensure compliance to the government's ambitious new fuel efficiency standards.

In reality, the North American system is still largely piecemeal. The largest player is the Chicago Climate Exchange , known as the CCE, a purely voluntary system that offers companies and governments the option to buy carbon credits from outside bodies to offset their carbon-producing activities.

CCE credits are more symbolic than substantive, McKitrick said, and typically part of a larger, environmentally positive public relations campaign. It's on the CCE that things like credits for air travel, which can then be sold to flyers for a nominal fee, are often traded.

Carbon tax preferred

Indeed, economists and environmentalists find rare common ground in their preference for a hard carbon tax over carbon trading.

"Applying cap and trade to CO2 is the wrong way," McKitrick said, "because it creates a market that didn't exist and gives the entire supply to the private sector."

"Big energy firms lobby for this because it effectively creates a cartel for them," he said.

Indeed, experts say a carbon tax where governments simply tax carbon emissions beyond a certain level would be preferable because it would be a natural way for governments to control the cost of doing business, like any other tax or fee.

Under cap-and-trade systems, carbon has become the new kid on the block of commodities, except that companies aren't paying for the commodity itself so much as the right to produce it. "In carbon trading," Adams says, "neither party cares about the product so it’s a market that cannot be regulated — self- or otherwise."

Ultimately, carbon trading markets depend on the enforcement of a willing government, Bennett says.

"The market system doesn't work unless there is a value on carbon, a cost to emitting it," says Bennett.

"You're going to have to buy your way out one way or another. If you're not buying credit, then you're investing in things that reduce your emissions. No company is going to buy credit if it's cheaper to reduce emissions," he said.