Smoking chimneys

The great carbon credit swindle

With much of the funding for renewable energy projects based on carbon trading, it is vital that practices operate successfully. But, as E&T discovers, all may not be well with the scheme.

We can all look back on 2008 as the annus horribilis of financial markets. There is, though, one exception: carbon. The continued spectacular growth of the carbon markets shows no sign of holding back. From €22bn in 2006, to €40bn in 2007 and to an estimated €100bn in 2008. By some estimates, that figure could rise to €550bn by 2012 and, with the inclusion of the US, €3tr in 2020.

At the same time, you cannot help but notice that man-made carbon emissions are still going up; in the 1990s by 0.8 per cent per year, rising to 3.1 per cent from 2000 to 2006. In other words, a nearly 40 per cent increase from 6.2bn tonnes in 1990 to 8.5bn tonnes in 2007.

Meanwhile, disconcertingly for some doomsayers, in the last year, the climate has refused to respond in kind to an increase of CO2 in the atmosphere - as record early and deep snowfalls in Europe's and North America's ski resorts would attest. Temperatures do appear to have actually dropped and are even forecast by some climate scientists not to increase at all until 2018 .

So, for everyone not on the inside of the carbon markets, the tough questions to ask are: is it a waste of their money or, much worse, are they actually being swindled?

Governments waste money all the time on well-meaning projects that go awry. But, more worryingly, in the trade of carbon there does appear to be growing evidence of fraud on a large scale. So where is it happening?

At the heart of the controversy of carbon trading lies the principle of additionality. Carbon reduction projects are only meant to receive carbon credits (i.e. finance) if it can be established beyond doubt that the project did not have the financial wherewithal to succeed without them. This is actually very hard to do because both sides have a vested interest in saying yes. For example, a vendor of carbon credits has a vested interest in getting rid of them without too much oversight and a project developer is very tempted to portray his need for carbon credits to reduce the cost of his investment. But if projects are not genuinely additional, then the carbon offsets that companies and well-meaning types have purchased are all for nothing.

Deceit and lies

A quite staggering figure of the scale of deceit over additionality is that almost three-quarters of projects in receipt of carbon finance were already complete at the time of approval.

Moreover, according to David Victor, a carbon trading analyst at Stanford University, two-thirds of the supposed "emission reduction" credits from the CDM (Clean Development Mechanism) are not making real reductions in CO2 emissions at all.

Perhaps this would be much less of a problem if we could have confidence in the auditing of the scheme. But, since December 2008, the United Nations (UN) suspended the world's largest auditor of clean energy projects. That auditor is Norway's DNV (Det Norske Veritas, which translates as 'The Norwegian Truth'), which, to date, has validated the carbon credit suitability of around 50 per cent of worldwide projects.

UN inspectors found "non-conformities" during a visit to DNV's headquarters, principally concerning the fact that DNV had failed to properly vet projects for approval. This included DNV's practice for internal audits and various documentation shortcomings. At the time of going to press, DNV is still suspended, pending a second inspection by the UN in January 2009.

HSBC, the one bank that seems to have come out of the credit crunch relatively unscathed, had such low confidence in the credibility of the carbon offsetting market, it decided to ignore the market altogether and fund its own carbon reduction projects. This matters a lot to the bank because in 2005 it decided to go carbon-neutral. It's highly likely that other firms may take this path too.

So much, then, for the problems of additionality and auditing. Some of greatest fraud has emerged with a hyper potent greenhouse gas called trifluoromethane or HFC-23. This gas is a waste product from the manufacture of HFC-22, a refrigerant gas, and each molecule of HFC-23 causes 11,700 times more global warming than CO2. So making sure it is not released into the atmosphere ought to be a good idea.

Money money money

The irony is that Chinese and some Indian chemical firms realised there was huge money to be made by proposing to manufacture HFC-23, unless they received carbon credits to invest in scrubbing technology to prevent its release into the atmosphere. Of course, the cost of this equipment is very low compared to the profit that can be made by receiving carbon credits for HFC-23 removal. It has been estimated that around 60 per cent of all reductions achieved from Kyoto's CDM are from HFC removal. Climate Change Capital, a London-based firm is thought to have received £375m worth of credits from Chinese HFC projects.

Even blue chip chemical firms like DuPont appear to have got in on the HFC act. DuPont allegedly asked its customers to pay $4 per tonne to eliminate carbon dioxide from its HFC-23 producing plant in Kentucky.

It is also bizarre how nuclear power is excluded from applying for credits while even new coal plants that may have some biomass co-firing, or IGCC technology, may actually receive CDM approval. Lobbying in Brussles has clearly distorted the effectiveness of the carbon markets and it is not obvious that this will change any time soon.

But it would be quite wrong to assume that all the fraud, or at least inconsistencies, are on the side of the private sector. For carbon trading to work, governments have to set a declining annual quantity of permits to emit a metric tonne of carbon dioxide. Over time, this would push up the price of carbon and increase investment in low carbon technologies.

Yet, since the very beginning, EU governments have weakened the effectiveness of the scheme by allocating more permits than there were carbon emissions.

In 2005, the EU Emissions Trading Scheme allocated 4 per cent more permits than there were carbon emissions which, naturally, sent the price of carbon into freefall.

With targets, EU governments and nationals have a history of cheating. This has happened for a long time with the Common Agricultural Policy and the Commons Fisheries Policy, so why should emissions trading be any different?

Unfortunately, as long as there is a government-controlled cap on supply of CO2 credits, which errs on the side of supplying too many, it will be very difficult for carbon trading to deliver on its promise.

Carbon trading will continue to grow, not least due to the much wider inclusion of the US under President Obama.

Yet the problems of additionality, auditing, distortionary lobbying and government controlled caps are not going away. Fraud in the carbon markets will continue to be a regrettable feature for the foreseeable future.


Dan Lewis is research director of the Economic Research Council [new window], Britain's oldest economic think-tank, and contributes to the media as a journalist and broadcaster.

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