Challenges to carbon markets’ efficacy towards net-zero
Photo by Chris LeBoutillier on Unsplash
I recently came across multiple peers who had asked about the general mechanics, landscape, and effectiveness of carbon markets in curbing greenhouse gas emissions. Carbon trading is not a novel idea, and markets for this activity already exist around the world. However, the concept is challenging to understand even for climate professionals. This is due to the complex interplays between policies and regulations; climate research and modeling; business and technology developments; and many more (too many to be listed here) that inform carbon trading activities. The breadth and depth of the subject is extensive, requiring vast amounts of time and effort to research and learn.
So I thought… why not write about it?
Here are the 3 (of many) factors that challenge the carbon markets’ efficacy towards net-zero:
Setting carbon price at the optimal level is challenging.
Basic principles of economics are at play in all market-driven solutions. Therefore, the goal is to have a nice balance between demand and supply for carbon emissions credit. In order to have an effective and efficacious carbon market that reduces greenhouse gas emissions, its price needs to be high enough to encourage voluntary reductions among participants, but not so high that the economy is harmed. However, the difficulty of setting a “balanced” carbon price is that no one knows what that price is. To determine such a price, models are used to project estimated carbon emissions in the coming years, but herein lies the second challenge…
Data used to build the model and project estimated carbon emissions are often inaccurate, imprecise, inconsistent, and unreliable.
The output can only be as good as its input. Currently, creating, validating, maintaining, and gathering accurate, precise, consistent, and reliable data is incredibly difficult. This is because of the shear amount of relevant data sets that exist. Furthermore, the varieties of procedures employed to handle the data sets; organizations and personnel involved to curate data sets; as well as the limitations and shortfalls in measurements and methodologies involved to create the original data are are not standardized nor regulated, which leads to additional challenges.
In this vein, there are increasing numbers of useful and relevant datasets being voluntarily made public by organizations around the world. This includes those provided according to the Environmental, Social, and Governance (ESG) frameworks and other Corporate Social Responsibility (CSR) initiatives. However, ESG and CSR disclosures are not regulated nor standardized. Therefore, there is no validation of provided data nor enforcement mechanisms to ensure that they are valid and consistent. Europe has been making headway on this front in Q1/2022, but its likes in the United States or elsewhere has yet to surface (at least as far as I am aware). (Update 04/2022: SEC just proposed a requirement for publicly-traded companies to disclose climate-related risks, pending public comments, amendments, and formal adoption). Furthermore, the inaccurate, imprecise, inconsistent, and unreliable data sets lead to another and third challenge where…
Assumptions made in the models—which are informed by faulty and/or inconsistent data and used in models to yield carbon emissions projections—often lead to erroneous results.
Without accurate, precise, consistent, and reliable data, it is difficult to empirically verify fundamental truths. With so many complex relationships and questionable validity of data sets used in the models, calculations do not return repeatable results. Even if it did, no one would be sure that “it is the one”. In California during the past decade or so, projected carbon emissions levels were often overestimated, and therefore, actual emissions were well below expected levels. Likewise, because carbon emissions ceiling was set so high, there were little to no reason for anyone to care about carbon emissions. In other words, the price to over-emit carbon was too low—zero—so no one had to shell out cash to offset their emissions.
Just to be clear, I believe in market-driven solutions for carbon emissions reduction. They have their place. In fact, I think market-driven solutions are great, because they can be self-regulating to balance the supply with demand, vice versa. However, market-driven solutions cannot be the “be-all, end-all” because of the possibilities to malfunction without effective design and appropriate oversight. There is simply too much risk for abuse and manipulation by the powerful few, who have too much stake (i.e. control) over the market. Look no further than stock markets to better understand how carbon markets may, and will, behave with no one keeping everyone honest.
Most peoples’ reservations toward the carbon markets that exist are due to how it has underperformed so far. In California, carbon market was instituted with good intentions and sound logic. However, the challenges of projecting accurate carbon emissions levels and setting the “correct” price led to its inefficacy. To be honest, I am not sure where the carbon market is headed. Support for it is still there, but it seems to fall lower and lower on the priorities list of many organizations, policymakers, and regulatory personnel due to lackluster results. There is a larger interest in pursuing alternative approaches, such as increasing renewable portfolio standards (RPS) and other non-taxation methods, to achieve what carbon pricing (e.g. taxes, fees) did not achieve. At this point, my hope is that someone somewhere steps up to address its current issues and mitigate shortfalls. Since much of the carbon market and emissions standards fall under the policies and regulations umbrella, I believe a big push from the advocacy and lobbying space will be critical to gain any momentum in any direction.
At the end of the day, carbon market is one of many tools that we have, and the urgency of the climate crisis convinces me that we need to use it.