Do you ever ask yourself why we still have a climate problem? If you believe the announcements and advertising messages from many companies, then it should actually be solved in the very near future. From the car manufacturer to the chemical industry to the sporting goods manufacturer: everyone is climate neutral or will be in the near future. There must be something in these promises, because no company today can afford to tell gross untruths. Greenpeace is watching you! So how do they do it?
There are often so-called compensation transactions behind this, in which alleged CO2 savings are sold worldwide. This has created a huge market. Companies appear on it as providers who organize projects, primarily in developing countries, that are intended to reduce carbon dioxide emissions. These savings are documented in the form of certificates and sold to other companies, which can then claim that they have not carried out the CO2 avoidance themselves, but have financed it. This is worth it because it is much cheaper in developing countries than in industrialized countries where production and consumption are already very energy efficient.
The danger of compensation
The problem, however, is that these voluntary compensation transactions only really lead to CO2 savings if it is ensured that the certified reduction was actually achieved and that it was additional. The example of Cooking stoves that are distributed in poorer African countries as a climate protection measure, clearly shows that doubts are warranted. It is highly likely that some of the compensation promised by the certificates will not actually take place. Is that bad? It depends on.
If one takes the position that any CO2 reduction that takes place in developing countries is to be welcomed, then one could overlook the cheating that occurs. A ban on such transactions would in any case be counterproductive because the voluntary contributions of European companies would lead to significantly less CO2 avoidance if they had to take place domestically. They would probably then be eliminated altogether.
However, voluntary compensation transactions are problematic because there is a risk that criticism of them will become a criticism of the mandatory emissions trading is connected. This threatens because many critics of compensation transactions do not understand – or do not want to understand – the fundamental difference between the two “CO2 markets”. This could culminate in the demand that emissions avoidance must generally take place at home because they cannot be controlled abroad. However, that would be a climate policy catastrophe.
What is effective climate protection?
If humanity wants to be successful in the fight for the climate, then it must focus on cost-effective climate protection – and this includes being able to exploit the cost differences between countries to reduce costs. A primarily national climate protection policy, like the one Germany is currently pursuing, is doomed to failure. In order to provide constructive criticism of CO2 compensation transactions, you have to go further and take a closer look.
In principle, the idea of implementing CO2 avoidance in countries outside of Europe because the avoidance costs are lower there makes perfect sense. A cost-effective climate policy requires that avoidance always occur where the marginal abatement costs are lowest. The reason is simple. Only cost-efficient behavior ensures that we get the greatest climate protection effect for the resources we use. If the companies that conclude compensation deals used the money invested at home, the result would only be a fraction of the CO2 reduction that can be achieved in developing countries.
It is a relatively obvious idea that when looking for the most cost-effective way to avoid greenhouse gases, one should look beyond national borders and beyond one’s own continent. After all, the climate doesn’t care where on earth carbon dioxide is saved. So it is not surprising that this form of climate policy was already adopted in the first well-known climate agreement – the Kyoto Protocol.
Exchange with developing countries
Two instruments were created for this purpose: the Clean Development Mechanism (CDM) and the Joint Implementation (JI). The latter stipulated that a state that had committed itself to the goals of the protocol could implement or finance a CO2 reduction measure in another such state and in return take over the corresponding emission rights. The CDM stipulated that a Kyoto Protocol state could carry out a measure in a developing country and then credit itself with corresponding emission rights.
Quantitatively, the CDM was far more important than the JI. According to the Federal Environment Agency, 2.141 billion tons of carbon dioxide equivalents had been verified worldwide by the beginning of 2022. However, the boom for this instrument was very short. In 2013 the instrument was more or less over. What happened?
A measure in a developing country could only lead to a crediting of emission rights if the CO2 avoidance actually took place and if it was additional, i.e. would not have taken place without the European partner. It cannot be determined with certainty whether these conditions are met. Because you need a reference scenario from which you can derive what would have happened without European intervention. This can lead to errors in two directions. Either too many measures are licensed because the reference scenario assumes too much CO2 emissions, or too few CDM measures are approved because the opposite is the case.
A private business
In the early 2010s, there were many critics of emissions trading who claimed that the CDM had made emissions trading unusable and should therefore be abolished. Politicians have reacted to this. Although emissions trading was not abolished, CDM was actually abolished. First a quota was introduced, then the entire instrument was shut down. There is no functioning successor instrument.
Instead, compensation transactions are now booming, where monitoring and certification are a purely private matter. Everyone involved has a great interest in ensuring that the highest possible CO2 savings are certified. This increases the risk of abuse.
These private and voluntary compensation transactions have nothing to do with European emissions trading, the EU Emissions Trading System (ETS), even though both are often mentioned in the same breath. Because there are still many misunderstandings about this, we will briefly explain how this system works.
The crucial difference
The European Union determines which emitters fall into the emissions trading system – for example the power plants of electricity producers – and determines the Europe-wide maximum amount of CO2 that may still be emitted within this sector. Emission allowances are issued for this amount and an issuer may only emit if it holds the relevant allowances. With this first step of the ETS, the amount of CO2 is controlled and systematically reduced, because fewer tons of carbon dioxide can be emitted each year.
In order to achieve the climate target, you only need this quantity limit; a market is not necessary. This only comes into play at the second stage of the ETS, where the aim is to decide where to make the CO2 savings needed to stay below the maximum amount. Issuers with low abatement costs act as suppliers in this market and those with high costs act as buyers. As a result, avoidance is carried out where it costs the least.
The voluntary CO2 market and the compensation certificates traded there are something different. Only those emission allowances that have been issued by the EU and that are monitored by the responsible emissions trading body are traded in the ETS. A compensation certificate, on the other hand, is a piece of paper on which a company assures that it has carried out CO2 avoidance in a developing country on behalf of the buyer. This is not emissions trading as used in the ETS.
Certificate trading is a success, compensation is not
This presupposes that a maximum amount is set that cannot be exceeded. This means that every issuer that uses some of the budget set by it has to bear the costs that arise elsewhere in order to save its emissions. He bears these costs by buying the emission rights from another emitter, who then has to avoid the corresponding amount of CO2.
The experience of the past 17 years has shown that the ETS works excellently. It is the world‘s most successful climate protection instrument. We must strengthen and expand emissions trading – that is the right lesson from all the experience we have. In concrete terms, this means that we have to integrate further sectors – especially transport and the heating market – and that we have to integrate other countries, especially developing countries.
This is possible if we combine it with a smart development policy. Within emissions trading, the problem that could not be solved with either the CDM or the compensation transactions disappears: a check of “additionality” is not necessary when the maximum quantity is specified.
A notice: The article was published on May 30, 2023 Cicero.
Blog post on the “C02 compensation” series
Lukas Rühli (2023): Indulgence trading or an efficient means of climate protection?
Otto-von-Guericke University Magdeburg