CARBON MONEY

If you have wondered, as I have, how carbon trading works, how money is made from global warming, the UN’s role in the process, and what they were talking about in Copenhagen, the following article is an excellent primer. It recently appeared on pajamasmedia.com.
CLIMATEGATE: HOW TO FOLLOW THE MONEY

December 23, 2009 - by Charlie Martin

There’s big money in climate.

That became strikingly obvious in Copenhagen. The conference itself cost in the neighborhood of $30 million, but that was only the visible tip of the melting iceberg. Add to that the celebrities, the demonstrators, the congressional delegations, and the corporate displays, and you can bet something closer to $60 million was really spent on the conference — along with, of course, a carbon footprint the size of Morocco’s. The one significant outcome of the Copenhagen conference was an agreement to continue the international market in carbon offset trading that would otherwise have expired in 2012 and to prevent a crash in the carbon credits market.

It appears that most of the participants saw the money spent as an investment.

To see why, we need to look at the way Kyoto has turned into cash for many of the biggest names in the climate change world, and to do that we need to understand how the whole carbon trading scheme works.

Simple Carbon Trading

Start with the simple proposition that you want, for whatever reason, to reduce the amount of greenhouse gases (GHGs) being emitted by human activities worldwide. The reasons, of course, are all based on the idea that humans emitting GHGs are causing unexpected and unacceptable changes in the climate. Whether that’s true or not is a topic for other articles; for now, just take it as given.

There are actually a number of GHGs that could be an issue, but the largest share of human-produced GHGs is in carbon dioxide (CO2). So for simplicity, the Kyoto Protocol normalizes everything in terms of CO2 alone, using a number called the global warming potential (GWP). By definition, the global warming potential of CO2 is 1; the highest GWP is for sulfur hexaflouride, a gas used mainly in electrical equipment. Sulfur hexaflouride has a GWP of 23,900, so for Kyoto Protocol purposes, releasing 1 ton of sulfur hexaflouride is considered to be 23,900 tons of CO2.

Now, if there were a king of the world, that dread sovereign might just say: “Hey! Stop emitting GHGs!” And that would be that. In the real world, if you want to reduce GHGs, you have to come up with some kind of scheme to get people to do it (more or less) voluntarily. Governments do this, normally, with taxes. The simplest scheme is just to tax anyone who emits GHGs, charging them enough to pay for the bad effects. Reduce the amount you emit and your taxes go down.

Of course with a government program, and particularly with the UN, nothing is that simple.
Developing countries, particularly India and China, have rapidly growing economies and populations that really enjoy that their standards of living are rising toward first-world levels. These countries, as they improve their standards of living, are necessarily going to release more CO2. In the simple model, they would be expected to pay for those emissions.

Carbon Trading after Kyoto

India and China, with rapidly growing economies and populations that are really enjoying progress towards a first-world standard of living, didn’t like this scheme at all. To them, the simple carbon tax is just a massive tax, reducing their GDP and impeding their progress. Add to this the historical resentment of colonialism, and the simple carbon tax was a non-starter.

The Kyoto plan was intended to solve this — at the cost of more complexity — by using a carbon trading scheme. For example, imagine China is going to build a new power plant that would have emitted 1,000 tons of CO2 a year. If China instead builds that plant with new technology that reduces the emissions to 500 tons a year, they get 500 tons of carbon credits in the form of a certificate of emission reduction (CER). The theory is that they can then sell those CERs to other places as “credit” in place of CO2 emission reductions, something we’ll discuss below.

The devil is in the details, of course. If you can get a 500 ton CER for building the power plant better, shouldn’t you get 1,000 tons of credit for not building the power plant at all?

That could be a pretty sweet deal — you can not-build a lot of power plants in a year. If there’s a market for these CERs, that’s a license to print money. So there’s immediately a problem — you must somehow establish that you only provide CERs for projects that would otherwise have been built anyway.

The Kyoto Protocol establishes a mechanism to certify these emission reductions called the Clean Development Mechanism (CDM), which establishes a bureaucratic process under the supervision of the UN to do this certification. The purpose of the CDM is to keep the process honest. Only certify emission reductions for projects that would have been built anyway and that would have had a greater carbon footprint if they had been built the way they would have been built.

Got that? You have a CER, with real cash value, as long as a UN organization will certify what you might have done, and the way you might have done it, if you had done it, and done it that way.

Now, let’s leave the third world and go to the developed world, the first world, or what the Kyoto Protocol calls the Annex I countries. In fact, let’s go to the the U.S., where there is a power plant that already emits 1,000 tons of CO2 a year. They can offset that emission by buying the CER from China — but why would they bother?

Of course, some people would buy CERs out of commitment or guilt — say Hollywood folks who want to continue to use their private jets — but the market in guilt is actually pretty limited.
For this scheme to work, there has to be some reason why the power plant would be forced to reduce their carbon emissions. That’s where the Kyoto Protocol come in. Part of the protocol is an agreement by each of the Annex I countries that they will reduce their carbon emissions by some amount, but that reduction can either be in actual reductions or by buying CERs.

Put together, these two parts — an enforced reduction or “cap” on carbon emission and a way to trade CERs — are the key components of a “cap and trade” scheme, which is the basis of the Kyoto Protocol.

Carbon Markets

There’s one more missing component here. There has to be a way for people with CERs to find people who want to buy CERs — in other words, there has to be a market. This market operates, just like the New York Stock Exchange, the Chicago Board of Trade, or the rug merchant in a bazaar in Istanbul, as a profit-making entity. Every time Wayne in Chicago buys a CER from Wang in Shanghai, the guy facilitating the market — call him “Al” — takes a little off the top in the transaction.

Now we’ve got a picture of the whole transaction:

1. Wayne in Chicago needs to reduce his CO2 emissions by 500 tons, so he contacts Al.

2. Wang in Shanghai has a 500 ton CER.

3. Wayne and Wang agree, through Al, that the 500 ton CER is worth $1000.

4. So Al takes the CER from Wang, paying him $980 (subtracting a $20 commission from the $1,000 trade price) and gives it to Wayne in exchange for $1,020 (because Al is charging Wayne a commission too.)

Now, on paper at least, Wayne is only producing (net) 500 tons of carbon emissions.

Perverse Incentives

“On paper” is the key here. In reality, Wayne alone used to be emitting 1,000 tons of carbon. Now, Wayne and Wang together are emitting 1,500 tons in total. Wayne is out $1,020 for the CER, Wang is $980 richer, and Al has made $40.

On paper, it’s a reduction of 500 tons of CO2 emissions, but it’s only a real reduction if Wang really would otherwise have built a power plant to emit 1,000 tons. But because Wang knows he can make money on the CERs, that is going to factor into his decision to build a power plant at all — all the incentives in Wang’s case are to build more power plants and emit more CO2, as long as he can convince someone (in this case a UN organization) that he “really would have built the power plants anyway.”

Of course, Wayne could have kept his $1,020 if it weren’t for the government forcing him to reduce his “carbon footprint.” So this is effectively a tax. The effect is that Wayne is paying $1,020 in taxes, of which $40 goes to Al and $980 goes to Wang in China, and there is a net reduction in carbon output only if the CERs really represent carbon that “would have been emitted anyway.”

And this all managed by the paragon of incorruptible altruism, the United Nations.

Follow the Money

The frightening thing, at least for Al and Wang, is that this was all set to go away. The Kyoto Protocol expires in 2012, and without an agreement to extend it, new Chinese power plants would have to be built without cash coming from the developed world and carbon trading markets would have nothing to trade.

The amount of money involved isn’t trivial. According to Richard North at the Daily Mail, the carbon trading market last year was worth about £129 million (or about $205 million U.S.) and was heading toward trillions of dollars by 2020. So it’s probably not a coincidence that, for all the discord in Copenhagen, the one thing to which all the parties did agree was to extend the Kyoto cap and trade system. The market in carbon offsets or CER would continue.

Who benefits from this?

An interesting question. Of course, it’s well known that Al Gore is heavily involved in the carbon offset market and in other environmental ventures. There is speculation that Gore could be the world’s first green billionaire.

Another beneficiary is the UN itself. All of these international processes happen under the supervision and control of the UN and UN-chartered nongovernmental organizations.

The most interesting connection that’s come out in recent days is Dr. Rajendra Kumar Pachauri — the chairman of the IPCC. Pachauri, an engineer and economist by training, joined the Tata Energy Research Institute (TERI) in April of 1981 as managing director and continues to be employed there to this day. TERI was renamed in 2003. According to the Science and Public Policy Institute, at the time of the name change TERI communications director Annapurna Vancheswaran said:

"We have not severed our past relationship with the Tatas. It [the name-change from Tata Energy Research Institute to The Energy Research Institute] is only for convenience.
Pachauri, and TERI, maintains close ties with the Tata Group."

Pachauri, it turns out, has a number of interesting connections. Beside the connection to Tata — TERI insists it has terminated the official connection — Dr. Pachauri is a director or advisor to many other organizations involved in the “climate industry.” The Telegraph puts it like this:

"What has also almost entirely escaped attention, however, is how Dr. Pachauri has established an astonishing worldwide portfolio of business interests with bodies which have been investing billions of dollars in organizations dependent on the IPCC’s policy recommendations."

These outfits include banks, oil and energy companies, and investment funds heavily involved in “carbon trading” and “sustainable technologies,” which together make up the fastest-growing commodity market in the world, estimated soon to be worth trillions of dollars a year.

Today, in addition to his role as chairman of the IPCC, Dr. Pachauri occupies more than a score of such posts, acting as director or adviser to many of the bodies which play a leading role in what has become known as the international “climate industry.”

Roger Pielke Jr. looked at the conflict of interest policies at the UN and concluded that Dr. Pachauri’s business connections appear to conflict with the normal UN policies, but that it’s not clear that the IPCC is covered:

Based on the WMO and UN discussions of conflicts of interest, it seems clear that Dr. Pachauri has, at the very least, several associations that raise the appearance of a conflict of interest in such a way that does not preserve and enhance “public confidence in their own integrity and that of their organization.” Since we do not have details on Dr. Pachauri’s activities or compensation from these various organizations and businesses, it is impossible to tell what, if any, conflicts actually may exist.

It is perfectly reasonable to expect high-ranking IPCC officials to follow the WMO and UN guidelines for conflict of interest and disclosure. Apparently, they presently do not follow these or any other such practices. If the IPCC does not have any policies governing these issues, it certainly needs to develop them, lest they give the impression that climate scientists play by different rules than everyone else.

Lord Monckton, in an open letter to Dr. Pachauri and the IPCC, made another point. In one specific instance, Tata industries owns Corvus Steel, which owns a steel mill in the UK. Monckton wrote:

"The Tata group is now owner of Corus Steel, which, not long ago, closed down the steelworks in Redcar, UK, putting 1,700 workers out of their jobs. Corus stands to make billions by cashing in on now-surplus EU “carbon credits” given to the steelworks. It stands to make a great deal more, via the Clean Development Mechanism that is one spin-off from the IPCC process, by transferring steel production from the Redcar works to India."

Tata stands to gain from the Clean Development Mechanism by receiving credits for notional carbon “savings” obtained by investing in a new steel plant in the Indian province of Orissa, which will initially produce 3 million tons of hot rolled steel — exactly the capacity of the now-closed Redcar plant.

From the discussion above, it’s clear what happens here. When they close the still mill in Redcar, that is a lot of carbon emissions they no longer make; that’s a large CER. At the same time, they open a new steel mill in Orissa that produces exactly as much steel. If they can convince some UN functionary that this new mill “would have” been built anyway, and “would have” produced much more carbon emissions had they hypothetically built it in that alternate world, they can realize more CERs that can be exchanged for real cash in the carbon markets. At least, they can if they can convince the UN. Remember that you need a UN certification of what you might have otherwise done, and how you would have done it, if you had done it and done it that way.

And Dr. Pachauri, with his extensive ties to Tata and his leadership position in the IPCC, seems likely to have substantial influence in the UN.

Who Benefits?

At the conclusion of the Copenhagen talks, what was the actual result? The Obama administration hoped for an agreement with developing countries, particularly India and China, that would include binding targets for GHG reductions and verification procedures to ensure that carbon credits represented “real” reductions.

What they got was a non-binding agreement that basically has no effect except that the existing Kyoto agreement for cap and trade continues. This seems unlikely to limit carbon emissions much — after all, the theoretically binding agreements of Kyoto weren’t particularly successful. (In fact, the U.S. has been closer to meeting its announced goals than the EU, even though the U.S. didn’t ratify the treaty.)

What’s interesting is that carbon offset prices collapsed along with the collapse of the Copenhagen talks. It’s pretty straightforward to understand what this market is saying. Up to the last gasp in Copenhagen, the betting had been that there would be even more restrictive limits on carbon in the developed countries and so greater demand for offsets. The markets didn’t get those and so “decided” offsets were worth less. On the other hand, with no agreement at all, the value of a carbon offset would be near zero, and China, India, and people who invested in the carbon markets would be seriously hurt.

This eleventh-hour non-binding agreement, made by just a few participants, seems to have primarily had the effect of preserving the carbon market’s existence.

Which means that the existing carbon trading scheme continues. China, India, Tata Group, Rajendra Pachauri, and “Al” are still in business.

Charlie Martin is a Colorado computer scientist and freelance writer. He holds an MS in Computer Science from Duke University, where he spent six years with the National Biomedical Simulation Resource, Duke University Medical Center. Find him at http://chasrmartin.com, and on his blog at http://explorations.chasrmartin.com/.