Discredited - The Voluntary Carbon Market in India

Thoughts on + Summary of the eponymous CSE Report.

I expect this to be the first of a series of similar posts based on several CSE Reports that I find interesting. The Centre for Science and Environment (CSE) is a Delhi-based, not-for-profit, public interest research and advocacy organization. In the process of combing the internet for topical, well-researched material, their work has come up repeatedly. Their flagship publication is the State of India’s Environment, an annual report that covers significant developments across a range of environmental frontiers in India. Although I’m starting with their topic reports, a similar post for their 2024 Report is definitely in the blog pipeline.

Here’s the link to the original report. It’s 109 pages (+ 15-page appendix) and took about 5 hours to read.

Context

The Kyoto Protocol established three market-based tools for emissions trading.

1. Emissions Trading - countries with an emissions deficit (emissions > limit) can purchase allowances from countries with an emissions surplus (emissions < limit).

2. Joint Implementation - countries can invest in emissions reduction projects in other countries subject to emissions reductions targets.

3. Clean Development Mechanism - developed countries can invest in emissions reduction projects in developing countries. Developed countries can count the associated emissions reductions toward their own emissions reduction targets.

From an economics perspective, the principle behind emissions trading is simple. Assuming that all abatement (emissions reduction) is created equal, creating a market for abatement helps entities abate at the lowest cost. If the cost of abatement is high in a high-income country, a company or government in that country can abate more cheaply by investing in projects in low- or middle-income countries. Instead of each transaction occurring at a project level, emissions reductions are split into carbon credits. In theory, each carbon credit represents a reduction of 1 Ton of Carbon Dioxide Equivalent (tCO2e), a measure of Global Warming Potential. There are two types of markets for this kind of trading.

1. Compliance Carbon Market (CCM) - participants in CCMs agree to adhere to an overall cap on emissions in a specific period. At the start of the period, participants are allocated emissions permits. The sum of the allocated permits matches the overall cap. During the period, participants with excess allowances can sell them to participants with excess emissions. These markets are often called cap-and-trade systems.

2. Voluntary Carbon Market (VCM) - buyers looking to voluntary reduce their emissions buy credits generated by emissions reductions projects.

How do VCMs work?

Buyers in VCMs comprise companies, institutions, and individuals looking to offset their emissions. They do this buy purchasing credits that, in theory, represent a reduction or removal of greenhouse gases (GHGs). These markets work on the baseline-and-crediting mechanism. An emissions reductions project establishes a baseline (emissions levels without the project) and then generates credits based on marginal reductions from that baseline. VCMs are only effective if the principle of additionality — that emissions reductions wouldn’t have happened without the project — holds.

There are a few primary groups of participants in these markets.

1. Project Developers design, implement, and manage emissions reduction projects with the goal of receiving carbon credits. They could be private (NGOs, companies, etc.) or public (governments).

2. Standards Bodies establish procedures for quantifying, verifying, and reporting emissions reductions. These bodies act as registries for the listing, verification, and retirement of carbon credits.

3. Validation and Verification Bodies (VVBs) are third-parties hired by developers to validate projects and verify their offset claims. VVBs are accredited by Standards Bodies, and their approval is necessary for offset registration.

4. Buyers drive demand in VCMs. They are typically companies, governments, or individuals looking to demonstrate their sustainability or achieve carbon neutrality.

5. Brokers link developers with buyers. They are well-informed about the projects they buy credits from, often using this information to design offset portfolios for buyers.

6. Marketplaces are platforms where credits can be listed and traded. While marketplaces have lower commission fees than brokers, buyers have less information about the projects underlying the credits.

India and VCMs

Credits linked to VCMs are significant. The sum of credits issued till date equals 10% of India’s 2020 GHG emissions. Credits linked to Indian projects comprise ~20% of all issued credits on Verra and Gold Standard, the two largest standards bodies. Most of these credits break down into two types. Renewable Energy projects comprise 90% of credits. However, these are older credits — registries no longer accept these projects since renewables became cost-competitive with fossil fuels. The lion’s share of the remainder is comprised by clean cookstove projects, a category that is growing rapidly. These projects provide efficient cookstoves to households that otherwise burn firewood in a mud chulha. Emissions are reduced by lower firewood use (less deforestation and wood-burning).

Issues with VCMs

The CSE Report then delves into five case studies — a clean cookstove project, a tree plantation, a project implementing a more sustainable technique for paddy cultivation, a biogas project, and a renewables project (Pages 52 to 84). Since they’re hard to summarize, I’d recommend reading them — they were the most illuminating part of the report. I’ll spend the rest of the article discussing issues with VCMs, drawing on examples from the case studies.

Before talking through VCM-specific issues, there are a few issues that are ubiquitous to all carbon markets.

1. Additionality - carbon markets only work if emissions reductions wouldn’t have happened without the project and associated offset revenue.

2. Baseline Estimation - baselines are, by definition, imagined. They are estimated and then compared to actual emissions to calculate reductions. In the clean cookstove case study, estimations were based on the assumption that a) households exclusively used wood stoves (many households had LPG connections) and b) households use the clean cookstoves on a daily basis (many households solely used them to boil water).

3. Permanence - emissions reductions may later be reversed. In the tree plantation case study, a forest fire eliminated a large proportion of claimed reductions.

4. Leakage - emissions reductions from the project may lead to increased emissions elsewhere.

In addition, the diffuse, opaque, and private setup of VCMs yields a completely new set of issues.

1. Intermediaries - since intermediaries each take a fee or commission, beneficiaries only receive a small fraction of offset revenue. A single clean cookstove can generate $70-280 in credits despite costing as little as $2. Often, beneficiaries still pay part of the cookstove cost.

2. Information Asymmetry - buyers, particularly in marketplaces, have very little information about projects. As a result, it is hard to compare credits.

3. Conflicts of Interest - the most glaring example of this is the relationship between developers and VVBs. Project developers hire VVBs. They can work with the same VVB repeatedly. Consequently, VVBs have a strong incentive to be negligent — their negligence will ensure the developer continues to use their services. In fact, “honest” VVBs are systematically eliminated from the market.

4. Regulation - unlike compliance carbon markets, there are no legal structures to regulate VCMs. None of the participants have to disclose information, making it prohibitively difficult for buyers (or third-parties) to verify whether their emissions were actually offset.

5. Price and Cost - often, the price of offsets doesn’t match the cost of the projects. In the biogas case study, beneficiaries got a subsidy and paid the remaining cost for the biogas plant. Although beneficiaries had to pay for the plant, buyers were able to claim the generated reductions. The offset price was lower than the cost and not shared with beneficiaries.

Going Forward

There are a few promising developments on the VCM front. Governments globally are starting to tighten regulations on VCMs. In India, both the Union Power Ministry and the Union Environment Ministry have published plans for carbon market governance. These efforts will be driven by the National Steering Committee for Indian Carbon Market.

Independent ratings agencies have also emerged. These agencies publicly assess the quality of projects and the credits they generate. They have started to garner both funding and influence.

Another interesting change is that large buyers are starting to work directly with project developers to control quality and impact. While this could be a step in the right direction, it may actually make projects more opaque.

Given the range and seriousness of issues associated with VCMs, several changes are required.

1. Transparency - without more transparency from each participant, the veracity of credits will always be questionable.

2. Revenue Sharing - project beneficiaries receive a negligible proportion of credit revenue. For projects to be impactful and sustainable, this must change.

3. Price and Cost - to enable proper revenue sharing, credit revenue must approximately match project costs. Otherwise, the revenue from carbon credits is either distributed amongst intermediaries (revenue > cost) or beneficiaries have to pay for reductions that are claimed elsewhere (revenue < cost).

4. Estimation - baseline-and-crediting estimates vary greatly, even across similar projects. Establishing more rigorous standards for estimation that are maintained through public oversight could eliminate this variation.

5. Accounting - currently, VCMs threaten to undermine India’s emissions reduction goals (if reductions are claimed by institutions in other countries) or lead to double-counting of reductions (if India and external institutions both claim reductions).

VCMs work great in theory. However, without transparency, revenue sharing, and oversight, their setup lends itself more to profiteering than abatement.