Has Cop27 resurrected global carbon trading?

Promising equity and efficiency in the fight against climate change, yet long scuppered by low prices, patchy coverage, tepid demand and opaque reporting, carbon trading has been a source of enduring frustration for environmental policymakers.

Despite these difficulties, however, voluntary carbon markets are in the middle of a resurgence as a way to facilitate climate action, in large part due to weakening political will and global appetite for the kind of transformative change that underscored enthusiasm for the Paris Climate Agreement in 2015. 

A deepening sense of despair, coupled with the increased assertiveness of less-developed countries of their rights to industrialise and exploit their natural resource base given extremely low historical emissions, has led to climate crisis fatigue and growing talk of “pragmatism”.

This has resurrected a package of market-based, financialised solutions such as carbon trading and climate reporting, to spur climate action. This shift in tone is especially evident in a recent series of announcements at Cop27, particularly the new rainforest alliance incorporating carbon trading offsets against environmental protection with the Democratic Republic of Congo (DRC) as a core founding partner, and the new voluntary carbon market (VCM) initiative for Africa.

Both these developments mean carbon trading may soon be big business on the continent, and promise millions of new green jobs and billions in revenue. But is it really possible given the fragmentation and inefficiencies plaguing even the largest carbon markets globally, and the financial sector market expertise needed for it to take off in Africa?

Carbon trading: an elegant economic solution?

Carbon trading is best understood as a system in which companies or governments can buy and sell permits to emit greenhouse gases, with prices normally denominated per tonne of CO2. The goal of this system is to create a market in which companies have an incentive to reduce their emissions as the costs of permits rise.

The idea has a pedigree going back to Nobel Prize-winning economist Ronald Coase, whose 1960 essay “The Problem of Social Cost” proposed a revolutionary new method of dealing with environmental problems.

When economic activity causes unwanted environmental impacts such as pollution, waste or habitat destruction, Coase argued, the best approach is not to regulate, ban or even tax the activity, but instead to marketise it by allocating property rights to participants in markets. By making people and firms bargain over, then find a consensus price for the “right” to harm the environment, he suggested, it becomes possible to achieve an optimal level of damage that balances society’s conflicting desires to both protect and use resources.

Faced with climate change, the appeal of a global market and global consensus prices for the right to emit carbon is clear. If accurately measured, and fairly priced, such a scheme could allow carbon-intensive industries such as power generation, transport and manufacturing to purchase carbon “credits” – generated via offsetting activity such as tree planting and energy efficiency improvements – that cover the climate impact of their activities.

This would buy them time to decarbonise, and give them an incentive to do so, while elegantly maintaining the balance between carbon-negative and carbon-positive actions, thereby minimising the economic disruption of reducing emissions.

For less-developed countries, too, the model has important benefits. As the source of most of the world’s “sinks” – the forests, wetlands, peatlands and reefs that draw down and sequester carbon from the atmosphere – these countries are in prime position to generate masses of saleable carbon credits for economic income, the returns on which could top up and smooth out the sluggish and uneven cash flows of climate finance currently on offer from more-developed countries and non-governmental agencies.

Carbon markets: big idea, practical problems

It is not hard to see why influential voices from Brussels to Benin have been excited about pricing and trading carbon. Pascal Lamy, former director-general of the World Trade Organisation and current board member at the Mo Ibrahim Foundation, called it the “panacea” in the fight against climate change in an interview with African Business on the eve of Cop27. Yet practice has often fallen short of the theory.

For a start, global carbon markets are comparatively fragmented: the current system is made up of over 40 disconnected regional and national regimes, which vary greatly by size, nature and coverage. This has led to a variety of accounting and pricing treatments, making these markets particularly inefficient and volatile, with wild intraday fluctuations. Their opacity has also, perhaps most worryingly, laid the groundwork for fraud.

A good place to demonstrate this contention is by looking at the largest scheme in the world by market value, the European Union Emissions Trading Scheme (EU ETS).

Red flags for EU’s carbon scheme

Launched in 2005, it limits emissions from some 10,000 installations across the EU countries plus Iceland, Liechtenstein and Norway, covering around 45% of the EU’s total greenhouse gas emissions.

Though estimates of the EU ETS vary wildly depending on the calculations used, its size and value make it a good test case for the real-world implications of carbon trading for emissions reductions.

Despite the depth and pedigree of the EU ETS, its long-term indicators do not make a clear-cut case for the efficacy of carbon trading in the service of climate action, nor do they necessarily provide lessons on how an African VCM could be more efficiently and transparently structured.

A World Wide Fund for Nature (WWF) report released in November 2022 pointed out a number of red flags for the EU ETS. The WWF report asserts that member states earned €88.5bn from selling emission allowances over 2013-21. Of this, just 71.9% went into spending on climate action, with the rest being assimilated into general government revenue.

Moreover, the WWF claims, at least €12.4bn of the spending attributed to climate action was likely spent on things that were unhelpful – or even counterproductive – in terms of climate. These were things like: compensating firms for the carbon price itself; gas and coal power infrastructure; fossil fuel-based heating systems; diesel transport; or carbon-intensive forms of bioenergy. Because of this, they conclude, “even the figure of 71.9% [of climate spending] is questionable, or at least difficult to justify with any confidence”.

As the WWF sees it, there is a need for more rigorous reporting. The Fund asserts that lax rules on national reporting under the ETS make it impossible to verify that the scheme is spurring genuine climate action. Moreover, it suggests, conflicting incentives mean the scheme is being systematically undermined by its own members. In an effort to minimise transition costs, for example, over €98.5bn of credits – more than the entire revenue generated by the scheme – have been given away for free.

While the ETS may cover almost half of EU emissions, the practical implication of such carve-outs is that less than half of these emissions are actually priced. As a result, the actual carbon price being paid by firms under the scheme is just €6.58 per tonne – far short of the $40-$200 per tonne estimated by advocates to be the necessary effective price.

Which model should Africa follow?

And while the EU is the global leader in size and sophistication of its carbon market, other major economies such as China and the US are still playing catch-up. An African carbon market or other new entrants would have to figure out which model promises better outcomes, even while some of these remain very incomplete.

China’s ETS is still in its infancy, having only been established in 2021, and presently covering around 40% of national emissions. It is hoped, however, to be a key driver of the country’s ambition to peak emissions by 2030 en route to carbon neutrality by 2060, and is growing fast. Having been rolled out progressively, sector by sector, the Chinese ETS market value at 8.5bn Chinese yuan renminbi ($1.2bn), with nearly 194m tonnes of CEA (China Emission Allowance) transacted, as of 16 July 2022 according to data from Refinitiv.

The US market, meanwhile, remains fragmented, with relatively successful schemes in states like California set against a policy vacuum at the national level and outright opposition in Republican-held states.

A deeper critique

As the case of the EU ETS makes clear, poor reporting and administration have dogged even those carbon pricing initiatives that have existed for decades.

A 2021 report by McKinsey, in collaboration with the Taskforce on Scaling Voluntary Carbon Markets (TSVCM), offered six specific technocratic fixes – ranging from shared principles for defining and verifying carbon credits to the establishment of post-trade infrastructure such as clearinghouses – that could help carbon trading become more effective.

Yet beyond the realm of the technocratic lies a deeper critique; that carbon trading, by financialising and marketising the problem of climate change, perpetuates the very systems and structures that are causing it in the first place.

In a 2014 article in Carbon Management pointedly titled “Ten reasons why carbon markets will not bring about radical emissions reduction”, Rebecca Pearse and Steffen Böhm make just this argument. They review the history of the policy, pointing out the steep rises in emissions that have accompanied its development and expansion. There is nothing, after all, stopping participants simply paying to maintain or increase their emissions under a carbon trading scheme, if it makes business sense to do so.

They then unfold a series of foundational problems. First, they argue, carbon trading is unequal and regressive. In addition to the windfall gains associated with excessive compensation to firms (Tesla, for example, often makes more money selling carbon credits than it does cars), a greater proportion of the pressure of higher prices falls on low-income households, who are less easily able to adjust their carbon-intensive consumption.

Second, they claim, the policy requires the commodification and reduction of infinitely complex natural processes to measurable, comparable chunks – carbon in vs carbon out – with the inherent impossibility of this task accounting for the enormous conflict, discrepancy and indeterminacy that have characterised existing regimes.

Third, and finally, they dismiss carbon trading as more of an obstacle than a solution. The faith in pricing going back to Coase’s original formulation, which they call “utopian” – plus the reliance on technocracy, hegemonic scientific knowledge and arrays of financial brokers, speculators and intermediaries – locks in an emission-intensive status quo that augments, rather than disrupts, the power of the firms, industries, professionals and values that have driven the world to the brink of climate catastrophe.

To let these forces capture, then define, the regulatory and policy response, argue Pearse and Böhm, is not even letting the class clowns mark their own homework – it is letting them run the school.

Cop27: Could carbon trading harmonise decarbonisation and development in Africa?

Pearse and Böhm also argue that carbon trading is a particularly bad deal for less-developed countries.

Amongst other things, they suggest, it lets rich countries appear to be reducing their emissions while passing the adjustment and abatement task – with all the conflict, loss and exclusion that goes with it – over to the less-developed world where credit-generating activities are generally located. To use carbon trading as a mechanism for development, therefore, would all-but-guarantee that the journey be destructive and unjust.

Which brings us to the rainforest carbon trading alliance and the African carbon market announced at Cop27.

First, an agreement was signed on the sidelines of the conference by the Democratic Republic of Congo (DRC), Brazil and Indonesia, aimed at cooperating on rainforest preservation. The three together host 52% of the world’s tropical rainforest, with the marketisation of these resources as a source of carbon credits offering an obvious way to profit from their preservation.

Already the bloc has been nicknamed the “OPEC of rainforests”, foregrounding, in the language of the hydrocarbon age, the potential to “export” these credits to countries or firms that are otherwise unable or unwilling to decarbonise their own activities. Norway, a country that has long funded foreign conservation to offset its enormous oil and gas wealth, has already signalled its interest.

Second, there is Africa’s continental foray into international carbon markets, with Cop27 also seeing the establishment of the Africa Carbon Markets Initiative (ACMI). Claiming the potential to produce 300m carbon credits by 2030, and 1.5bn annually by 2050, while unlocking $120bn in new revenue over the same period, the ACMI, in its own words, is “a transformational economic and development opportunity for Africa”.

Already seven countries have signed up, including Kenya, Malawi, Gabon, Nigeria and Togo. Yet even with the best intentions and expertise – the ACMI steering committee boasts African and non-African heads of state, finance, conservation, reporting and development experts, and a variety of NGO heavyweights, with the 64-page accompanying report setting out the case and roadmap for the programme in painstaking detail – it is not clear that the ACMI can escape the problems bedevilling carbon markets elsewhere.

It may indeed be a transformative opportunity, but, as the international story of carbon trading makes clear, this highly complex policy and fraught implementation pathway requires deep financialisation and technical capacity. The risk of mistakes carries potential to do significant economic and environmental harm, on a continent that already bears the brunt of maldevelopment and severe climate change impacts.

Lowered ambitions at the starting block

While USAID is supporting the ACMI, John Kerry, the US climate envoy, nonetheless struck a fatalistic tone when announcing plans for his country’s own voluntary carbon trading scheme at Cop27. “I’ve been doing this since 1988”, he said, “and… I’m tired about talking about the same stuff. We have to break the mould. If we don’t come up with creative ways to mobilise money, we are going to blow through 1.5C.”

The uncomfortable reality is that carbon trading is unlikely to help meet the Paris warming target or even maintain the will to keep the target in place. Soon forced to admit carbon trading’s long, tortured policy history – the “mistakes of the past”, Kerry said, had given carbon trading a bad reputation – he nonetheless bulldozed through.

Kerry was light on details for the new, planned US scheme, an initiative whereby companies could buy carbon credits to support countries switching out of coal power. Microsoft and PepsiCo are involved in the plans, while countries and environmental groups were also supportive. Fossil fuel companies are, however, excluded.

As such, only “high-quality” credits would be allowed under the new US scheme, and strong safeguards would protect against greenwashing. At the same time, the resurgence of interest in carbon trading appears to signal a contraction of the space available for strict, ambitious, potentially punitive climate change responses; the very policies that might break Kerry’s mould.

Economically elegant, yet practically impotent, carbon trading may be back precisely because of its record of ineffectiveness. With the re-assertion of fossil fuel interests in the wake of Russia’s invasion of Ukraine, and some developing-country heads of state making the case for an all-out, carbon-intensive development agenda despite the startling escalation of climate change impacts in their regions, it may not matter that carbon trading is not the best policy for fighting climate change. It may just be the best we can have right now.

How then could a new African market for carbon guarantee fair participation for the continent in the global market without being decoupled, thereby continuing the status quo of fragmentation in an unlevel playing field? The planet only has one atmosphere – but it is one in which poorer, often African, countries are already bearing the brunt of emissions they were not responsible for to begin with.

At the very least there is a runway of case studies for African countries to learn from as they become increasingly involved in carbon trading, with a growing pool of knowledge and expertise in the region that is helping to facilitate this growth. The African market may bring some new ideas to the table.