Carbon offset is an innovative mechanism where an individual or company that is unable to reduce their own emissions is allowed to invest in emissions-reduction projects located in a developing nation. This would theoretically lead to lower emissions or at least neutral emissions as a whole.

The Kyoto Protocol included, as part of its emissions-reductions processes, the Clean Development Mechanism (CDM) which would allow developed countries to gain emissions-reduction credits by investing in emissions reduction projects in developing countries. The Kyoto Protocol and thus the CDM is still in effect, but developing countries had firm objections to the CDM. The fear was that developed countries would avoid reducing their own emissions by investing in developing countries and that they would not invest in ‘value-addition’ projects, instead writing off their already existing investments as being emissions reducing investments.

Source: Fern.org

Theoretical linkages to carbon offsets

Carbon offsetting as an economic theory seems to be well-defined under Coase’s theorem, which can be summed up as ‘if trade in an externality (in this case, the externality is emissions) is possible and there are sufficiently low transaction costs, bargaining will lead to a Pareto efficient outcome regardless of the initial allocation of property.’ Pareto efficient outcomes are solutions where any change in allocation of the goods in question will lead to making one or more participant worse off.  

However, carbon space does not have well-defined property rights. In fact, carbon space as a whole can be said to be one of the most controversial matters currently under discussion, as developed countries are unwilling to accept that emissions from the industrial era onwards should be taken as part of their share and developing countries feel that their own development space should be respected as developed countries as a whole already have better quality-of-life.

The most common argument in favor of offsetting is the ‘comparative advantage’ theory. It states that given free reign, industries and countries which can afford to do so will reduce emissions at minimal cost whereas industries and countries which cannot reduce emissions will have to pay a price for it. From a certain point of view this seems reasonable and even fair; after all, it is reasonable to assume that emissions from (say) the toy industry would be easier to reduce than the power provision sector. However, in practice (cite) we can see that carbon markets do not reward innovation and afford the world the best combination of practices.

Corporates which can afford to pay are chose the payment route rather than investing in innovative technological solutions like cleaner technologies, development process and so on. Over the long-term, innovation will be necessary and those who don’t innovate will fail but corporates, like politics, rewards immediate returns over long-term strategic planning. This can be seen in the longstanding efforts of oil and gas mammoths to propagandize against climate change, even though quite clearly in the end they would have to fall in line and this may cause them greater expense than if they had started the shift early and smartly diversified their investments.

Arguing against carbon offsetting

In practice, carbon offset has failed in its basic tenet, which is to reduce emissions. This is partly because the carbon offset market worldwide is ill-regulated or not regulated at all in most countries. When paying, clients do not have the choice to choose what projects their money goes to, or even what type of projects - afforestation and renewable energy projects being the two broad types of projects popular for carbon offsetting.

However, research has found that 85% of the offset projects used by the EU under the UN’s CDM failed to reduce emissions and these are better-regulated than most of the crowd. It is likely that the way carbon offset projects would have to be structured in order to be effective is simply not possible in a profit-making institution. According to the report on the CDM, most of the projects carried out made false assumptions of alternative scenarios or the projects were likely to have happened anyway in which case the actual benefits of the money paid in is overestimated.

The theoretical structure of carbon offset is simple: to ‘cancel out’ a certain amount of emissions, carbon offset businesses will quote a price. This money is then injected into projects which will reduce emissions (such as afforestation projects which absorb a certain amount of carbon dioxide) or prevent emissions (such as renewable energy projects replacing conventional energy).

These kind of projects are not quick or cheap, they have to be planned for months and implementation takes years. So by the time most investors want to put their money to use, these projects are already in place, and there is no value-addition or actual emission reduction from their money. As such the whole exercise ends up merely being a feel-good factor for the person paying. Moreover, if the trees never grow to maturity then they might end up not actually absorbing carbon dioxide, and other such common issues may mean that the projects themselves are not actually of much use.

Another issue is that most of these projects focus on developing countries in order to reduce costs of the project. This is an insufficient investment, when (apart from India and China) the developed world still has the greatest share of emissions.

Source: World Resource Institute

This brings us to the next big point, which is that corporates in particular, (and who can forget the fact that only a hundred companies have been responsible for about 70% of greenhouse gas emissions) will concentrate on the profit-motive unless forced to take emissions into account. Carbon offset, in this case, has a negative effect on innovation which would reduce greenhouse gas emissions because as long as corporates judge that paying up is easier, they will not look at the long-term and will not invest in reducing emissions.

Alternatives to carbon offset

Currently, other market-based emissions-reductions are Renewable Energy Certificates and carbon allowances, which tend to be better regulated, at least in developed country markets. The trouble is that the mechanisms are still similar. Carbon allowances work by allocating carbon credits and then having (a strict upper cap, so that overall the carbon emissions are limited to a tolerable level. Renewable energy certificates are there to certify that a particular entity/individual have invested in clean energy.

If individuals can pay, they won’t have to make the real effort needed to change the structure of the economy.

The only true way to reduce emissions is to have firm worldwide commitment to it that will ensure that all governments are equally strict on emissions. Otherwise, like tax havens, pollution havens may very well become an issue.

While market-based emissions reduction processes may very well be necessary at some point in the future, unfortunately regulations at this point are simply not strict enough to make any existing mechanisms worth the price. Instead, the most important priority right now is to place constant pressure on governments and on the global negotiations to make greenhouse gas emissions a priority and to take immediate, strict action in order to reap the benefits of a cleaner way of life.

(This article has been written by Mohini Ganguly who is working as a Research Associate in CUTS International, under Centre for International Trade, Economics & Environment. She holds a Masters in Climate Change and Sustainability Studies from Tata Institute of Social Sciences (TISS), Mumbai)