AD//HOC
Understanding the Externalities of Carbon Credit Markets, Pt. 1
A topic I want to address is the concept of carbon credit markets and how they can be used to both generate capital and create a market-based ameliorative solution for commercial environmental damage. This system is hinged on the carbon credit itself-- a permit that allows the holder (usually a corporation or bank) to emit carbon dioxide or other greenhouse gases; typically equating to one ton of carbon dioxide per credit. These credits can be exchanged between entities, with sellers generating capital off of excess credits (by reducing emissions) and buyers in effect “paying” for their excess pollution.
This market-based solution can be backed with strong data science capability in order to help assess capital gains from land holdings, as well as predictive analytics about the future of the carbon credit market overall. A LeSalle University study found that indeed that a carbon rate can adequately be created and predicted using machine learning models. And, CO2 emissions can also be predicted using public open data sources that provide economic, population and surface temperature features. This gives a huge advantage to carbon credits over other incentive-based methods, since it can be leveraged with available information to determine future pricing and values (much like CME or the stock market). With this, carbon credits can offer environmental benefit even after it initially hits the market. McKinsey, the consulting firm that’s known generally for being pretty heinous in its dealings, outlines the roles that these credits play in both the short and long term to cut pollution:
In the short term, voluntary carbon credits from projects focus on emissions avoidance/reduction can help accelerate the transition to a decarbonized global economy, for example by driving investment into renewable energy, energy efficiency, and natural capital. Avoiding emissions is typically the most cost-efficient way to address atmospheric greenhouse gas concentrations.
In the medium to long term, voluntary carbon credits could play an important role in scaling up carbon dioxide removals (or negative emissions) needed to neutralize residual emissions that cannot be further reduced. At least 5 gigatons of negative emissions will be needed annually to reach net-zero emissions by 2050. These could be realized through a combination of natural climate solutions such as reforestation (for example, sequestering carbon in trees) and nascent technology-based carbon capture, use, and storage solutions. Voluntary carbon credits can help finance the scale-up of these solutions.
Carbon credits serve the dual-role of both incentivizing companies to be ahead of the curve with pollution output (requiring them to purchase less or no credits, and giving them the ability to sell their excess), and making polluters pay per each ton of carbon they emit beyond their given allotment (having to purchase the credits at market value). The “polluter-pay” principle is foundational to environmental economics, as Mizan Khan highlights in his paper Polluter-Pays-Principle: The Cardinal Instrument for Addressing Climate Change — “polluter-pays-principle (PPP) as an economic, ethical and legal instrument and argues that it has the potential of effecting global responsibility for adaptation and mitigation and for generating reliable funding for the purpose. However, the contradiction is that while it rests on neoliberal market principles, the UN Framework Convention on Climate Change did not include the PPP as its provision though the principle of ‘common but differentiated responsibility based on respective capabilities’…currently there is an emerging consensus that a carbon tax should be applied globally to address the intractable problem of climate change. Since the problem relates to a global commons, the issue is how to apply the PPP globally yet equitably.”
It’s obvious in the latter part of that quote that there is still some dissonance around the mechanism and equitability of carbon credits as they’re applied both domestically and abroad. To note— this is not a perfect solution to the growing problem of environmental damage. Yale’s Environmental360 newsletter notes that “critics warn of a growing market in outdated credits that offer no carbon benefit for the planet, since the carbon-saving projects they were once intended to fund have long been in operation without the benefit of sales of credits… There are increasing calls from industry and the finance sector to reform markets in carbon credits to improve their performance in delivering actual carbon reductions.” I think it’s important to support the carbon credit-based solution as it’s the best we have at the moment, but we cannot be complacent in looking for new, data-driven solutions as the future moves closer. To underscore it’s existence as a market mechanism more than a pollution mitigator, it seems important to highlight both Enron and Goldman Sachs as the architects of “cap-and-trade” (cap pollution, trade credits). The architects of this system have come out and stated that carbon credits cannot be used as an end-all be-all for pollution control, and had mixed results replicating similar market mechanisms with things like fertilizer and erosion run-off. And all of these are issues with the understanding that the market is operating perfectly, with all parties having the same level of information (we know this to be untrue in the vast majority market mechanisms— do a little research on “cap-and-giveaway” to induce a stress headache, as we’ll touch on that another time).
With all this in mind, there are many questions that can be raised— How can existing data sources (i.e. public data) be leveraged to get more information on carbon credits in the hands of every day investors? What other market-based solutions can be utilized to limit pollution? What data would be needed to accomplish this?What are the ramifications if the carbon credit market is used like the stock market? What does historical data say what happens when a market mechanism fails, and how might this affect the environment?