Saturday, February 6, 2010

The Failure of Zero Sum Carbon Credit Markets

In light of the recent scandals of scammers ripping off companies for millions of dollars worth of carbon credits, I thought it would be good timing to drag up this notion from a paper I wrote while in college.

Carbon Credit Markets don't actually do anything.  Before you grab your pitchfork, hear me out.  Businesses and governments rave about CCMs and the great good they are doing.  They talk about how much they have accomplished with these markets, and how much they have reduced carbon emissions.  However, a common sense analysis shows that the markets don't do anything at all, and in some ways could actually be slowing things down.

First of all, the Carbon Credit Market does not exist naturally.  A CCM only exists when there is a mandatory government regulation on emissions.  The government says that all companies have to reduce carbon emissions by x% by this date.  So, it is the regulation that results in the carbon gas reductions, not the market.  Then what does the market do?  Well some companies aren't going to make the required reduction by that deadline, and others will surpass it.  The CCM allows manufacturers who cannot meet the mandated reductions to purchase offsets against their failures to avoid paying fines.  And who do they purchase these credits from?  From people who exceed the required reductions.

This market may create an incentive for innovators to exceed the reductions, but guarantees that these innovations will not have a net positive effect at the same time, because exceeding the reductions is only incentivized to the extent that the overall mandated reduction is not met.  In other words: good companies only do better than expected to the extent that bad companies don't play along.  Therefore it is a zero sum market with no tangible positive result.

One of the reasons that this whole scam is so well loved by businesses, by the way, is that the value of  a carbon credit must be lower than the cost of paying the equivalent in fines.  Otherwise the company would just pay the fine instead.  This has two results: the financial penalty for companies that don't meet the reductions is softened (which is bad), and that financial penalty is sent to the shareholders of the good companies instead of a dedicated government fund (which is bad if you are a socialist and good if you are a conservative capitalist).

Personally, I think that the companies that don't meet required reductions should just be fined, and the fines should be earmarked for specific green projects.  You could still encourage exceeding mandated reductions with tax incentives.  But ultimately, it just rubs me the wrong way when people claim that the Carbon Credit Markets are doing so much good in the fight against global warming, when it is the mandated reduction that is doing all the heavy lifting.  The CCM is just a PR trick, because our culture prefers the word 'market' to the word 'mandate.'

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