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A Tale of Two Carbon Markets: The Origins

Originally published on

In the search for a way to profitably reduce greenhouse gas emissions, no approach is as widely embraced -- or as controversial -- as carbon markets. Embraced by countries and companies alike, carbon markets are a way for high-emitting companies (and potentially nations) to “offset” their emissions by purchasing credits for carbon allowances from low-emitting companies (or countries) or from projects that are reducing or removing emissions altogether from the atmosphere.

Some of these offset projects can range from wind and solar energy projects in emerging markets that reduce emissions, to ecosystem conservation and restoration projects (often called natural climate solutions, or NCS), and to the en vogue carbon removal technologies that sequester carbon deep underground in geologic reservoirs (often called technology based solutions, or TBS).

There are two types of carbon markets, voluntary and compliance markets, and both are incredibly powerful tools to drive climate mitigation efforts: they can align incentives with minimal intervention and direct action toward adoption of mission critical climate solutions to reduce or remove emissions. In just the past year, phenomenal developments in the carbon markets space have demanded the world’s attention and frenzied interest.

In order to know where these markets are headed in the future, it’s helpful to understand how they got started in the first place. And that story begins with a brilliant scientist by the name of Freeman Dyson, who proposed one of the most popular and controversial climate solutions to date: planting trees at massive scale to suck carbon out of the atmosphere.

Dyson also happened to be a card-carrying member of The Global Warming Policy Foundation, an anti-climate policy lobbyist group. In fact, Dyson even argued that increased carbon dioxide in the atmosphere was a good thing for the world. Dyson once stated, “The fact is, carbon dioxide will increase. We will continue to burn oil and coal, and probably it does us good. The Earth will get greener as a result…carbon dioxide is so beneficial…it would be crazy to reduce it”.

This is all much to the chagrin of actual climate scientists who all but unanimously disagreed. Despite this, Dyson’s thinking shifted people toward looking at nature-based carbon removal solutions as a potential way to address climate change, particularly as alarm over global warming started to take a larger stage in public discourse.

In 1989, in the midst of one of the worst droughts in the U.S. that pushed global warming to the front pages for the first time, Applied Energy Services Corporation (AES) contracted World Resources Institute (WRI) to look at opportunities to offset the CO2 emissions from their coal-based power plant in Connecticut. They saw forestry projects as a cost effective way to offset their emissions, and ultimately, be seen as “good corporate citizens''. WRI helped AES source an agroforestry project in Guatemala, where they would plant 51 million trees over the course of 10 years with an expected 16 million tons of carbon sequestered (studies in later years would show that this project only sequestered 10 million tons at best).

AES did this twice more: they invested in another project in Paraguay to offset a 180MW coal-based power plant in Hawaii and offset another plant in Oklahoma by protecting Amazon rainforests through helping indigenous communities gain legal title to 1.5 million hectares of their traditional territories. The price per ton of carbon for these projects came out to $0.13/ton and $0.20/ton, respectively.

It was a dirt cheap way for AES to save face and improve its public perception in light of growing alarm around climate change. There was no third party standards to follow, no peer-evaluation and AES didn’t even intend on using the offsets officially––they really only wanted to be able to show that they cared. AES always looked at these projects as a way to improve their public image, but the idea of offsetting started to attract attention from corporations as well as those concerned about climate change alike.

The Clean Air Act: A Spark of Genius that Inspired the Compliance Markets

While the Clean Air Act, first legislated in 1963 and amended in 1970 under Richard Nixon to combat horrifying levels of air pollution in the United States, has always been a cornerstone mechanism to deliver US environmental policy such as vehicle emissions and air quality standards, it was the 1990 Clean Air Act Amendment that created the blueprint for modern day compliance carbon markets.

For several decades prior, acid rain caused by sulfur dioxide and nitrogen oxide emissions were acidifying lakes and rivers, resulting in biodiversity loss, and damaging vegetation from lowered soil pH levels and increasing aluminum concentrations in forest soils and agricultural lands.

As the problems with acid rain worsened, over 70 bills were proposed in congress and nothing could move past the gridlock. The Environmental Defense Fund began to think creatively about market-based solutions and looked to an economist named John Dales at The University of Toronto who had been studying the use of tradeable permits and allowances to account for environmental costs with minimal governmental intervention. Many environmentalists were outraged by the idea of proposing a market-based policy intervention over a “command and control” approach to policy making, but the EDF stuck to their policy––it was good for the environment and firmly rooted in fundamental market economics that could make a huge difference if it actually worked. 

At the time, the Bush Administration was enticed by the market-driven policy and was keen to see it enacted to follow through on George H.W. Bush’s commitment to be “the environmental president”. The EDF worked closely with the administration through tough negotiations as they developed this marketplace approach to reducing sulfur and nitrogen emissions, despite ideological differences. When the White House attempted to change the bill’s language of a hard cap to a limit on the rate of change of these emissions, a change that was more palatable to corporations yet would all but destroy the efficacy of the proposed intervention, the EDF and EPA pushed to ensure that the hard cap was in the policy or else there would be no deal.

President Bush eventually accepted the language and overruled his advisors that were proposing the alternative. With that, the Clean Air Act of 1990 created the first emissions trading system at the time––and it was incredibly effective. While it took two years for a company to finally bite, the Tennessee Valley Authority became the first electricity provider to purchase an offset at $250/ton.  When the cap finally went into effect in 1995, emissions fell by 3 million tons that year. Well ahead of schedule.

Over the next 20 years, the cap-and-trade system has allowed companies to figure out the more affordable ways to reduce their emissions and as a result, the policy has cut acid rain in half, generated approximately $122 billion per year in additional benefits from healthier communities and environments, and has spared polluting utilities nearly eight times the costs that would have been incurred over an alternative command-and-control policy. 

The emissions trading policy was powerfully effective and while the policy was originally proposed to manage pollutants contributing to acid rain, it became clear that this same economic model could be used for carbon emissions. Over time, emissions trading went from “being a pariah among policy makers…to being…everybody’s favorite way to deal with pollution problems,” according to MIT researchers in Markets for Clean Air: The U.S. Acid Rain Program. And thus, the compliance markets began to emerge.

Why this matters

A couple of clear patterns emerge that are still shaping the evolution of carbon markets today: 

1. Emissions Trading Schemes are highly effective forms of policy, but they have to have the buy-in and the political will to be able to deliver impact, especially at a federal scale. Rooting itself in fundamental market-based economic principles makes it not only palatable across the aisle to those who are supposedly keen to reduce government oversight, but it also makes it a powerful mechanism to drive down emissions by aligning incentives and incorporating environmental externalities that would otherwise not be reflected in the market. Unfortunately, it is hard to see such bipartisan efforts take place at a federal scale in the United States today; this leaves the question as to whether states will take up the mantel and join California and the Northeast in participating. 

2. Voluntary Carbon Markets have to establish trust and integrity alongside scale in order for them to be considered a viable climate solution. The price per ton for these offsets were alarmingly low, there was no validation of these projects, and the standards were not set for these initial projects. Fortunately, as we will see in the next post of this series, thanks to organizations like Verra, The Gold Standard, The American Carbon Registry and even newer organizations like the Integrity Council for the Voluntary Carbon Markets, the ecosystem is demanding and delivering higher-quality carbon offsets than before. Much more has to be done on this, but the market is trending in the right direction from its origin at least.

3. Public perception matters–– because civic engagement matters. If policy makers and corporations hadn’t been pushed by their constituents and their customers to do something about the climate issues that concerned them, nothing would have gotten done. More and more companies have committed to climate targets than ever before, and it is absolutely critical that the public does not lose focus on making sure that these commitments turn into real action; carbon markets are simply another powerful tool in our toolkit to help us get the job done.

We will keep seeing these trends emerge over time and as we explore the next phase of the evolution of carbon markets: the experimentation phase––up next.



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