The turmoil around carbon trading

In addition to the compromise $300B funding promised to developing countries for ‘climate action’¹, COP29 set the stage for a long-awaited carbon trading agreement. Negotiators at COP29 have approved Article 6.4 of the Paris Agreement, which defines a ‘crediting mechanism’ where carbon-polluting countries can work towards their climate targets by buying credits from countries that emit less². This is, however, far from a straightforward system, with important uncertainties in its implementation, possible loopholes and overall effectiveness. 

Every carbon trading scheme aims at mitigating climate change. This is achieved through setting a total limit (or ‘baseline’) on CO2 (and other greenhouse gases) emitted by all traders during a specified time interval. The baseline is divided into permits, valued in the scheme’s unit of currency per amount of emitted CO2 (or equivalent). Those traders which emit over their assigned limit are allowed to buy permits from parties emitting below the target, thus offsetting their climate effects. Permits can be auctioned by those in the position to sell them. If a participant crosses their emission cap by the trading period’s end, they are required to serve a significant financial penalty. However, emitters may be incentivized to continue trading by ‘grandfathering’, the allocation of free permits, issued regardless of climatic impacts. Grandfathering may also be used to attract new participants, by ensuring an (initial) profitability of the scheme. 

Carbon trading is emerging as a favored policy instrument because of its multiple advantages. On the condition that no participant emits beyond its allowance, trading systems generate certain progress towards climate mitigation. It is a cost-effective instrument for governments as they must only enforce the pollution limit. Furthermore, carbon trading stimulates the adoption of new, ‘environmentally-friendly’ technologies. Nonetheless, several challenges must be addressed when implementing such a ‘cap-and-trade’ system. The baseline must be a realistic emissions target which still meaningfully contributes to mitigation. If traders buy permits from parties which do not report accurate emissions reductions, carbon markets become a remarkable means of greenwashing. To exemplify, multiple large transnational companies, including Shell, have bought permits in tropical reforestation schemes3. The current intense deforestation of the South American rainforest produces indirect CO2 emissions, as the number of trees which can take up carbon dioxide (through photosynthesis) is drastically reduced. Studies on how much carbon has been offset through reforestation showed that roughly 95% of all the sold permits did not compensate in reality for the CO2 emitted by buyers³ – turning the scheme into a false hope for the environment. Similarly, the 2022 FIFA World Cup, held in the ‘petrocracy’ of Qatar, claimed to be climate-neutral by buying carbon credits, which were ultimately found not to offset the emissions⁴. 

Carbon markets are not just doom and gloom, as demonstrated by the European Commission. EU’s take on carbon markets, the EU Emissions Trading System (ETS), is arguably the most successful (and the first large scale) initiative of its kind. Through ETS, every company from the energy, heating, manufacturing, maritime transport, and aviation sectors operating in the EU is brought under a universal greenhouse emissions cap. Emission reductions are ensured by lowering the cap on a yearly basis (although, in specific cases, grandfathering is permitted). Despite the necessity of more ambitious endeavors towards the goal of European climate neutrality by 2050 (the Green Deal), the ETS has been considered a success as it almost halved energy and industry-related CO2 emissions compared to 2005 levels⁵. By 2027, the EU aims to implement a second ETS, including building and transport-related emissions, the latter being the only sector which currently registers an increasing trend⁶. 

COP29 has paved the way for the most ambitious carbon trading scheme so far. Within this system, national actors may replace the role of companies, assigning pronounced diplomatic dimensions to carbon markets. There is hope that this global-scale project will follow the ETS model, where efficient collaboration and active monitoring make for a significant climate mitigation effort. At the same time, the distress of greenwashing does not cease to exist. It also remains to be seen how carbon trade will coexist along with contemporary shifts in globalization and the world powers’ geostrategic interests. 

References

1. COP29 UN Climate Conference Agrees to Triple Finance to Developing Countries, Protecting Lives and Livelihoods. UNFCCC https://unfccc.int/news/cop29-un-climate-conference-agrees-to-triple-finance-to-developing-countries-protecting-lives-and (2024).
2. Paris Agreement Crediting Mechanism. UNFCCC https://unfccc.int/process-and-meetings/the-paris-agreement/article-64-mechanism (2024).
3. Greenfield, P. Revealed: more than 90% of rainforest carbon offsets by biggest certifier are worthless, analysis shows. The Guardian https://www.theguardian.com/environment/2023/jan/18/revealed-forest-carbon-offsets-biggest-provider-worthless-verra-aoe (2023).
4. Too Many Carbon Offset Claims Are ‘Greenwashing’ Us into a Hotter World. Penn Center for Science, Sustainability, and the Media https://web.sas.upenn.edu/pcssm/news/too-many-carbon-offset-claims-are-greenwashing-us-into-a-hotter-world/ (2023).
5. What is the EU ETS? Climate Action https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets/what-eu-ets_en (2024).
6. Dolge, K., Barisa, A., Kirsanovs, V. & Blumberga, D. The status quo of the EU transport sector: Cross-country indicator-based comparison and policy evaluation. Applied Energy 334, 120700 (2023). https://doi.org/10.1016/j.apenergy.2023.120700