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The limits of free-market logic

Kevin Smith

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Carbon trading, its backers claim, brings emissions reductions and supports sustainable development in the global south. But, argues Kevin Smith, it may do neither, and is harming efforts to create a low-carbon economy.
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If, as their proponents claim, carbon markets are wonderful tools for bringing about emissions reductions and provide economic support for clean technologies in the global south, then we should ask one question: why have they been met with a mounting chorus of criticism from civil-society organisations, social movements and journalists around the world?

Plans are being made, through processes like the G8+5 Climate Dialogue for countries like China (ie countries currently without commitments under the Kyoto Protocol) to adopt carbon trading as part of their climate policy, and there needs to be an assessment of whether such schemes really work in reducing atmospheric carbon – or if they are simply a means for polluting industries to profitably avoid the issue of making emissions cuts.

Cap and trade

The free-market logic behind the scheme looks simple on paper. Countries taking part in “cap and trade” schemes like the European Union Emissions Trading Scheme (EU-ETS) have a limit set on the amount of carbon they can emit in a given time period (the “cap”). This allotted amount of carbon is carved up and allocated between different industrial locations in the country. If, for example, a cement factory goes over its allocated portion of carbon emissions, it has to purchase spare emissions from another market participant, for example, a power station that has emitted less than its allocation, and can therefore sell profitably sell them on (the “trade”).

The problem lies in the fact that carbon trading is designed with the express purpose of providing an opportunity for rich countries to delay making costly, structural changes towards low-carbon technologies. This isn’t a malfunction of the market or an unexpected by-product: this is what the market was designed to do. The economist John Kay wrote in the Financial Times: “when a market is created through political action rather than emerging spontaneously from the needs of buyers and sellers, business will seek to influence market design for commercial advantage.” In terms of climate change and carbon trading, the “commercial advantage” (at least in the short term) lies in avoiding the costly structural changes, and industry has influenced every stage of the design and implementation of the carbon market to this end.

Businesses and industries in the global north have avoided making these infrastructural changes by ensuring that the price of carbon permits is kept absurdly low. It is much cheaper for industry to purchase cheap carbon credits to make up any emissions short-falls than to implement the technologies that would actually bring about real emissions reductions at source.

The low price of carbon permits was ensured in the first round of the EU-ETS by governments handing many more emissions permits to industry than was necessary; the majority of industrial locations had more emissions permits than they needed. When news of this massive over-allocation was revealed, it caused the price of carbon to drop dramatically. Economists estimate that carbon permits should be priced at around 30 to 50 euros per tonne in order to create sufficient incentives for low-carbon technologies. Towards the end of the first round of the EU-ETS the price of permits was regularly dipping below one euro per tonne.

Market enthusiasts argue that the “cap” will be tightened in the second round, causing the price of carbon to rise. But in order to prevent this happening, business has lobbied for a means of importing more cheap credits into the system, generated in countries like China, through the Clean Development Mechanism.

Clean development?

Instead of trading with other market participants in Europe, another option for our cement factory would be to purchase “carbon credits” that have been generated outside of the trading scheme, through a project in a developing country that supposedly reduces or avoids emissions. An example would be a hydro-electric power station in China that has sold its supposed emissions reductions to companies from rich countries as part of the Clean Development Mechanism (CDM). China has been the world leader in this market, generating some 60% of all CDM credits in 2006.

The CDM has had some bad publicity in the last six months. An article in The Guardian newspaper in June 2007, said: “[the CDM] has been contaminated by gross incompetence, rule-breaking and possible fraud by companies in the developing world, according to UN paperwork, an unpublished expert report and alarming feedback from projects on the ground.”

Despite the regulatory framework that surrounds the CDM, there is both the incentive and the opportunity for project developers to distort key information, so as to make a project appear more effective and generate more credits – or gloss over any local resistance to the project.

For example, the principle of “additionality” is a pre-requisite for a project to qualify for CDM status: it has to be proved that the project would not have taken place without the funding provided through the CDM; any climate benefits should be additional as a result of the funding. Otherwise, unscrupulous operators could simply claim carbon funding for projects that would have taken place anyway, meaning industries in rich countries could justify further pollution on the false premise of being responsible for emissions reductions elsewhere.

However, many CDM projects under consideration in China involve generating hydro-electricity: there are 248 currently in the pipeline. There are strong grounds to be extremely sceptical  over whether these are genuinely additional, given that such projects are very common in China, and have been actively promoted by the government. The question arises over whether they would have been happening had it not been for CDM funding. In 2005, the International Rivers Network submitted a comment to the CDM panel in reference to the Xiaogushan Large Hydroelectric Project in northwest China’s Gansu province, which pointed out that the application for CDM funding was submitted two years after the construction of the dam had begun, and that “project documentation from the Asian Development Bank clearly states that Xiaogushan was the least–cost generation option for Gansu and that revenue from CDM credits was irrelevant to the decision to go ahead with the project.”

It is not well documented whether there is local support for the various hydro-electric projects in China that are being promoted through the CDM, which as a pre-requisite should bring developmental benefits to local communities. Many of the corporate benefactors of CDM money in other countries are the target of sustained local resistance from communities who have to endure the often life-threatening impacts of intensive, industrial pollution.

In 2005, about 10,000 people from social movements, community groups and civil society organisations mobilised in Chhattisgarh, India, to protest the environmental public hearing held for the expansion of Jindal Steel and Power Limited (JSPL) sponge iron plants in the district. The production of sponge iron (an impure form of the metal) is notoriously dirty, and companies involved have been accused of land-grabbing, as well as causing intensive air, soil and water pollution. JSPL runs the largest sponge-iron plant in the world, which is spread over 320 hectares on what used to be the thriving, agricultural village of Patrapali. This plant alone has four separate CDM projects, generating millions of tonnes of supposed carbon reductions that could be imported into the EU-ETS. The inhabitants of three surrounding villages that would be engulfed are resisting a proposed 20 billion rupee (around US$412 million) expansion. In this case, the CDM is not only providing financial assistance to JSPL in making the expansion, but also providing them with “green” credibility by putting them at the forefront of the emerging carbon market.

The head of China’s environmental agency, Zhou Shengxian recently attributed the rise in social unrest across the country to pollution scandals and the degradation of the environment. An article in the Guardian newspaper said that his comments “underscore the frustration of state mandarins at local government officials who ignore environmental standards in order to attract investment, jobs and bribes.” Given such circumstances, it is highly possible that the CDM will provide financial support to the sort of environmentally irresponsible power and chemical plants that are increasingly becoming the target of community protest in China.

Pollution and power

The largest share of CDM credits worldwide (30%) has been generated by the destruction of HFC-23. This potent greenhouse gas is created by the manufacture of refrigerant gases. A study in the February 2007 article of Nature showed that the value of these credits at current carbon prices was 4.7 billion euros. Not only was this twice the value of the refrigerant gases themselves, but it was also estimated that the cost of implementing the necessary technology to capture and destroy the HFC-23 was less than 100 million euros: something in the region of 4.6 billion euros was being generated in profit for the owners of the plants and the project brokers. In an article in the Sunday Times, it was reported that two Chinese companies were set to make around US$1 billion in 2007 alone as a result of CDM money given for the destruction of HFC-23.

This enormous sum of money generated by these Kyoto-style trading schemes has not gone to the companies and communities who are taking action on clean energy and energy-reduction projects, but rather to big, industrial polluters who are then at liberty to reinvest the profits into the expansion of their operations. Ashish Bharat Ram, the managing director of an Indian company that reported a profit of 87 million euros from the destruction of HFC-23 in 2006 and 2007, told the Economic Times that: “Strong income from carbon trading strengthened us financially, and now we are expanding into areas related to our core strength of chemical and technical textiles business.”

The structure of the CDM is such that it is usually an option reserved for large companies who can provide the capital needed not only to implement the project, but also to go through the long process of accreditation and certification, with all the attendant expenses of carbon consultants, third-party verifiers, ongoing project monitoring and so forth. Larry Lohmann argues in his book “Carbon Trading – A Critical Conversation on Climate Change, Privatisation and Power” that this “reinforces a system in which, ironically, the main entities recognized as being capable of making ‘emissions reductions’ are the corporations most committed to a fossil-fuel burning future… while indigenous communities, environmental movements and ordinary people acting more constructively to tackle climate change are tacitly excluded, their creativity unrecognized, and their claims suppressed.”

It seems that the only people who are benefiting from the carbon market and CDM projects are the polluting corporations that are involved in both Europe and the global South, as well as the new class of handsomely-salaried carbon technocrats and brokers, which has sprung up to service the needs of the market. There is an urgent need to recognise that the market’s fixation on short-term profit maximisation is not an appropriate instrument to induce the large-scale and costly infrastructural changes that need to take place in all countries in the transition to low-carbon economies.

Kevin Smith is a London-based researcher with Carbon Trade Watch, which is a project of the Transnational Institute. He is the author of the report “The Carbon Neutral Myth – Offset Indulgences for your Climate Sins” and the co-author of “Hoodwinked in the Hothouse – the G8, Climate Change and Free Market Environmentalism”.

Homepage photo by Phil Thirkell

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Informative article

This piece has increased my knowledge of this subject. Hopefully, all people involved in this area will also come to read this article.


清洁发展机制 (CDM)的初衷是双重:1。为发达国家减排达标降低成本;2。促进技术转让到发展中国家,帮助其可持续发展。

CDM尽管包括提高能源效率和可再生能源项目,但这类对可持续发展真正有利的项目,按照CDM的规则证明其“附加性”时,由于技术原因而比大工业气体和甲烷项目困难;另一方面获得的利益也不如甲烷和工业气体(如HFC)多,因为这后两类温室气体的威力分别是二氧化碳的21 倍-上万倍,就是说减少1吨这两类气体,可卖信用额(即挣的钱)是减少1吨二氧化碳(通过节能和可再生能源)的20-上万倍!如果没有其他约束单靠市场机制的话,CDM投资当然都涌向大工业和甲烷,而没有能促进穷国的可持续发展。


CDM, the typical example

The initial two motives of CDM are: 1. To lower the cost of emission reduction in developed country; 2. To encourage the exchange of technology to help the sustainable development in developing country. CDM includes improving energy efficiency and developing renewable energy program. But when comparing with Methane and other gas for industry, those programs need more complicated technology and make less profit. The reason is that the profit made from reducing 1 ton of Methane or other industrial gas is 20 times as much as carbon dioxide. So the market mechanism cannot stop the main investment of CDM flowing into this field instead of promoting the sustainable development in developing country. It is clear that environment and sustainable development problems cannot be solved only by the restriction of market mechanism. But recently lots of countries show interest in it, the main reason could be the huge profit.


1. 通过削减化学气体(N20,HFC-23...)的排放量来减少污染,这是该项目的主要目标,从反方面又可以说是CDM如何运作的典型案例。另外,这也意味着还没有现行的国家级政策法规来阻止温室气体的排放。所以对碳排放实行收税是促进排污削减的唯一法门。2.从长远来看,CDM将主要着力于可再生能源及能源利用效率项目。化学气体项目基本已经完结。3. CDM是资本如何运作的好案例,也是目前为止抑制全球变暖最行之有效的办法。

Emission trading is the most effective way so far

1. Projects that aim to cut emissions by reducing chemical gas emissions, like N2O, HFC-23, are the main targets of the intiative. On the contrary, it is a typical example to show how CDM works. Because there are no national regulations or laws on greenhouse gas reductions, to place a tax on carbon emissions is the only incentive for its reduction.

2. In the long term, CDM projects will mainly involve in renewable energy and energy efficiency areas. Chemical gas projects are almost done already.

3. CDM is a good example of how capital works out. So far CDM is the only effective way against global warming.

清洁发展机制 (CDM)国内如何动作

清洁发展机制(CDM)在中国听说有一些时间了,浙江省有成功案例,我想了解目前国内哪家公司在动作这项目,浙江现在企业发展很快,也存在这个问题,我在浙江大学从事信息咨询工作,如果相关企业与我联系,可以帮助推广。古方山人:[email protected]

How does CDM work in China?

We've heard of CDM for a while in China. There are some successful examples in Zhejiang Province. I wonder which companies are currently employing CDM in China. Companies in Zhejiang are developing very fast. They are somehow related to this issue. I'm working as an information consultant in Zhejiang University. If any relevant company would like me to help, feel free to contact me. Gu Fang Shan Ren: [email protected]


诚如2号评论所言,运作甲烷和HFCs更有利可图,其中HFCs更是一时间成了香饽饽,不过根据国家发展和改革委员会国家气候变化对策协调小组办公室发布的CDN项目信息统计,最后一个在发改委注册的HFC项目在所有1550多个项目中排第72位,意即大概3年前HFC项目就已开发完毕了。甲烷回收利用项目倒是时有耳闻,但目前大部分CDM项目为小水电、风电、生物质发电和其他一些能效提高项目,其基准线情景(Baseline Scenario)大多为电网供电,对应的GHG(Green House Gas)就是燃煤产生的CO2了。


——Adam Cheung

It can solve environment problems to a certain degree

Like Comment Number 2 said, it is more profitable to operate Methane and HFC programs. HFCs was once very popular.

However according to the statistics of CDM programs released by the Office of National Coordination Committee on Climate Change of National Development and Reform Commission (NDRC), the last HFCs registered with NDRC ranks 72 among all the total of 1550. i.e. all HFCs had been developed three years ago. Projects on methane recovery and use, however, are heard from time to time. Most of the current CDM programs are small hydro power, wind power, biomass energy and other efficiency-improving programs, whose Baseline Scenaior is mainly to supply power to the power grids with the corresponding Green House Gas (GHG) of CO2 from coal combustion.

In summary, the market mechanism ensures the survival of the whole profession of CDM. As long as it is profitable, people will do it no matter how big or small the emissions reduction will be. As long as there is emissions reduction, there will be environmental benefits. Of course, because of the inherent tendency towards self-destruction of market,it is necessary to introduce supervision and guiding mechanism. But so far, there have not been any major problems. ---Adam Cheung

Translated by Yan LIU


2005年2月16日正式生效的《京都议定书》诞生了全球碳排放交易市场。应对全球气候变化领域签署的这一国际条约成为推动以市场手段控制温室气体排放的国际法保证。《议定书》的“清洁发展机制”(CDM)更促使我国在2012年以前可以通过“经核实核证的减排量”(CERs) 的交易,促得工业化国家向我国投资减排项目而实现其部分减排义务,进而使我国相关项目下企业获得数量可观的融资机会。
与此同时,始自2007年的金融危机已经冲击了全球的金融业务,碳金融也不例外,EUA及CER的二级市场价格跌至历史低点,CER一级市场价格也继续面临压力。加之碳信用额本身的限制、CER需求疲软、已签约的未来违约风险以及经济衰退等问题,都使得我国这样一个所谓“先进发展中国家” 面临政策的调整和应对可能风险的机制。
作者是华东政法大学国际法学博士研究生李威,联系邮箱为[email protected]

Carbon credits, carbon trading, carbon finance

The 'Kyoto Protocol' which officially came into effect on 16 February 2005 has established a global market for trading carbon emissions. This international treaty aimed at addressing global climate change has become a guarantee under international law which promotes using markets to control greenhouse gas emissions. The Protocol's "Clean Development Mechanism" (CDM) has compelled China to pass the trading of " Certified Emissions Reductions" (CERs) before 2012; urged industrialised countries to invest in emission reduction programs in China, to help fulfil China's part of the obligation to reduce emissions and then to ensure that companies in the relevant programs receive a considerable amount of financing opportunities. However, the system for the post-Kyoto generation is full of variables and future statutes under international law will not be able to ensure that China will always be in the non-Annex 1 country camp nor that China will definitely not participate in the reducing emissions privilege. In addition, because EU companies are the largest buyers of carbon credits, in future climate change agreements, the EU council will have the final say on how the market operates. Developed countries, led by the EU, already rigidly control established primary and secondary markets; everywhere within the relevant international regulations, it is clear that a strategic chess game is being played in the interests of the powerful countries. At the same time, starting from when the 2007 financial crisis hit the global financial services, carbon trading being no exception, and prices in the EUA and CER secondary markets fell to an all-time low, prices in the CER primary market continued to face pressure. Together with problems such as, the limitations of carbon credits themselves, sluggish demand in the CER, the risk of existing agreements being broken off and economic slowdown, caused China, a so-called "advanced developing country" to face policy adjustments and possibly risky mechanisms. Because of this, the development of China's carbon finance must be placed against macroscopic background of the development of international law, in accordance with the regulations of international environmental law and international financial law, integrating it fully with the reality of China's development. The international political power of major developing countries must be exploited to the full when participating in the games surrounding regulation, as regulation advances the development of existing carbon finance markets, maps out the possible variables facing the post-Kyoto generation and will provide a scientific basis for decision making regarding China's participation in international carbon finance. Written by Li Wei, PhD research student in International Law at East China University for Political Science and Law, email: [email protected]
(Translated by Jodie Gardiner)



We need to fast-track the development of carbon finance

Carbon finance is the result of economic measures enshrined in international law, designed to encourage the effective reduction of carbon emissions. It forms part of a cutting edge development model within the realm of environmental finance. The kind of carbon trading that has emerged both within and beyond the international legal framework following the establishing and development of carbon markets and carbon credit needs the support and guarantees provided by carbon finance. For it's part, carbon finance needs to be granted an equal and more efficient status within international law. Because of this, the concept of carbon finance itself needs further clarification, while both its current status and the issues it may encounter in the future demand closer analysis and evaluation. In this way, we will be better able to promote the scientific development of carbon finance within the stipulations of international law.

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