The carbon credit is a commodity that evolved out of the idealism of environmentalists, scientists and economists. Some governments, politicians, businesses and consumers around the world are also expressing support for such a system. What then, are these carbon credits that have entered the market? And why have they not been fully embraced around the world?

A carbon credit is created and awarded when the equivalent of one metric tonne of carbon dioxide is prevented from entering the atmosphere. Carbon credits are available for emission reductions of six different gases — carbon dioxide, methane, nitrous oxide, perfluorocarbons, hydro fluorocarbons and sulphur hexafluoride. Carbon credits are sold and purchased according to who is reducing carbon emissions and who is emitting too much carbon in the environment. The global market for carbon credits has the potential to grow to $1 trillion per year, according to some estimates.

Carbon offsetting is a process whereby carbon emission reductions in one geographic location can create a carbon credit with a monetary value to be sold to a purchaser in another geographic location. These credits, most often purchased by governments and corporations for legal or regulatory concerns, provide an economic incentive for achieving reductions in the emissions of pollutants and help to reduce their overall “carbon footprint.”

The carbon credit concept was demonstrated prominently when the Kyoto Protocol entered into force on Feb. 16, 2005. Pursuant to this protocol, each signatory country was given a greenhouse gas emission reduction target related to a base year, normally 1990. Countries that did not or could not meet these targets could purchase carbon credits to offset their internal shortfall.
Some critics suggest that the science behind global warming is both dubious and uncertain, and they doubt the sense of urgency to “act before it is too late.” What’s more relevant though, is that the integrity of the carbon credit system is in doubt. Many of the carbon credits available may be of questionable environmental value. Credits need to be verified as true and quantifiable. They will often be sold on a future project, but then how do you know that the project will ever be built? Do we know that the projects that these credits support do not have some other, unintended consequence that are bad for the environment or have other negative effects, such as displacing aboriginal populations to make room for tree plantations? There is concern that the carbon credit system is open to collusion between auditors and project developers to push through environmentally dubious projects.

The United Nations have attempted to address some of these concerns by issuing Certified Emission Reductions (CERs) and Emission Reduction Units (ERUs), which will create an organization to verify the credits. That being said, the UN is less than perfect, and remote on-site inspectors can be subject to corruption. There are some suggestions that as much as a fifth of UN carbon credits may be bogus. In contrast, The David Suzuki Foundation promotes another concept called the “gold standard for carbon offsets” as the highest standard in the world.
Let’s examine what the carbon credit is and what it is not

The carbon credit is not a natural commodity that most people, businesses or governments would normally purchase. Few people go to the grocery store to purchase a bag of carbon dioxide. Similarly, few businesses purchase carbon dioxide with the intent of reselling it at a profit. The market demand for carbon dioxide is much smaller than the supply available. According to the law of supply and demand, carbon dioxide should be virtually worthless as a commodity because there is not sufficient demand.

The carbon credit is like a virtual commodity. These credits have evolved out of the imaginary — the carbon credit does not have an underlying inherent value. Instead, the carbon credit is an intangible product because natural demand does not exist. Without forms of wireless communication, carbon credits would be very cumbersome to create, slow to trade and difficult to market. Due to these factors, the carbon trading market will always be substantially computer-based.

Demand for carbon credits are only created by governmental regulation. If the regulation ends, then the demand ends and the credits would likely become worthless.
Not all carbon credits are created equal. The least expensive credits are expected to come from projects in developing economies. One goal of the carbon credit was the intent of transferring wealth from the rich world to lift up the economies of the poor world. China and India are the two largest sellers of carbon credits and this transfer of wealth is a challenge to the carbon credit system thanks to the global recession and because countries compete against one another.
Jobs, inflation and who really pays for these carbon credits?

The driving force behind the carbon credit system is the desire for jobs, profit and influence. Administering the carbon credit system will require many government and private sector jobs and inspectors. For its part, the United Nations is embracing this opportunity to increase staff and to develop a new source of income.

If the carbon credit market has the potential to be a $1 trillion industry, then the real question might be asking who will purchase and pay for all these credits. In order to create these funds, governments, who are often running deficits, would need to free up funds by cutting programs and staff, or they would need to raise taxes to create new sources of revenue. Neither of these options would be very popular.

The solution may be to have businesses purchase these carbon credits and help fund the entire system. Governments and consumers could then also purchase credits at their discretion. This solution offers minimal cost to government and taxpayers creates jobs and does environmental good. It sounds like a win-win all the way around, but, is it?

If business must pay for carbon credits, then they will have to pass on the cost of these credits to their customers. Businesses will need to raise their prices in order to recover their increased costs. This is similar to trade unions that ask for increased wages to keep up with inflation.
Inflation means that prices in the economy are rising. An inflationary spiral can result as employees demand wage increases to catch up to the rising prices, and businesses raise prices to catch up to the rising costs that are incurred by buying carbon credits and paying higher wages.
Let’s consider the pensioner on a fixed income. Many pensions are not indexed for inflation. If inflation spirals out of control, then the pensioner’s standard of living is in jeopardy. They may need to come to their children or grandchildren, or to you to help them make ends meet.
The point is that inflation can be very dangerous for all of us, and the carbon credit has the potential to trigger inflationary pressures on the economy.

There are some natural alternatives to a carbon credit system
Some people choose to purchase carbon credits to reduce their carbon footprint. But, most of us do not purchase carbon credits. We might do our part for the environment in other ways.
Many of us try following the three Rs: reduce, reuse and recycle. In fairness, our consumption society has always been challenged to reduce and reuse, but now recycling is catching on. We can also choose products that are energy efficient and have low carbon emissions, such as hybrid cars. Instead of purchasing carbon credits, we do our part for the environment through our regular purchases.

We could also make other environmentally friendly choices. Riding a bus, cycling and walking are all good alternatives to driving a car. Since the bus is on the road anyway we will not emit any extra carbon into the atmosphere. Additionally, we need to walk to and from the bus stop, which, like cycling, is also good for our health.

The banks and carbon credits
Why then are the banks and the rest of the financial services sector lobbying and advocating in favour of carbon credits? I believe the motivation is from a financial incentive rather than from a desire to save the environment.

The financial sector is a natural partner with the carbon credit system since it offers expertise with derivative products that are needed for the carbon trading market. More importantly, the financial sector offers access to the capital needed to create the $1 trillion plus annual market that is envisioned. A partnership with the financial sector will attract the investors needed to help save the environment. The financial sector can make it happen.

It is through the financial sector that speculators will buy carbon credits, purchase any number of carbon credit financial innovations (such as futures, options and swaps), and offer the liquidity that comes with access to the world capital markets.

Companies will need to know their future cost to purchase carbon credits. Financial derivatives will allow them to buy carbon futures to lock in their cost. Financial innovation will likely see carbon credits divided into pieces so that they can then be packaged, bundled and sold in the marketplace. This is similar to a process in the United States that bundled pieces of sub-prime mortgages so that the risk could be spread and the investment could no longer be evaluated. There will be incentive for companies to put together environmentally complex and questionable carbon credit projects.

Once the carbon credit is commoditized, the pressure to certify credits will be intense. Growing demand in the marketplace will find supply whether real or not, much like the sub-prime mortgage fiasco in the United States was able to find mortgages that should have never been placed.

The carbon credit system will allow the financial sector to generate fees, commissions, bonuses and profits by taking a piece of every carbon credit sold. Some of the economic benefit of the carbon credit system will be lost to the many sources that will take a cut, and some of the carbon credit will also be lost to fraud. This leaves one to wonder how much will actually be left to benefit the environment.

There is tremendous risk for speculators because the credits can become virtually worthless. If there was no longer an environmental need for the carbon credit, or if government regulations ever ended, then demand for carbon credits could collapse. The collapse of demand would lead to a collapse of price and the entire carbon-trading market could collapse. Anyone holding credits might lose their investment. A collapse of the carbon credit market could ruin our economy and our standard of living.

So with all of these potential perils, the science better be right about the human impact upon climate change and the need and urgency to reduce carbon emissions. With all the potential problems facing the carbon credit system, the decision to move forward should not be based solely on idealism. Let’s hope that there ain’t any fool’s gold in them thar carbon credits.