Carbon Credits: A History and Potential Future
Evan Spinner
In the last several years, as carbon capture technology has developed, various nations and global companies have come to see it as a solution to the climate crisis. Carbon credits have existed as a tool to address climate change for much longer than their recent spotlight in the environmental zeitgeist might suggest. There are two main ways of administering carbon credits: through carbon credit markets, and through domestic tax systems. Each carries its own benefits and risks. These will be examined, and this blog post will recommend increased regulatory due diligence and consideration of the use of blockchain technology to improve each system.
The Kyoto Protocol, the precursor to the Paris Climate Accord, was enacted in 1997.[1] It established an emissions trading scheme, which allowed participating countries to trade credits on a carbon market to comply with their emissions targets.[2] Alternatively, countries could decide not to participate in the markets and instead pay for carbon reduction projects in developing countries, which would result in them receiving emission reduction credits.[3]
This is similar to today’s prototypical system of carbon credits. A company, country, or other party pays money into a fund or project approved by the organization issuing credits, and receives a determined amount of credits. The organizations which issue credits are referred to as carbon credit verifiers, brokers, and marketplaces, and include organizations such as SCS Global Services, Cloverly, and Lune.[4] While decades have passed since the Kyoto Protocol, and the Paris Agreement has become the operative international climate agreement, the system of carbon credits remains largely similar to how it was in 1997. It just receives more attention.
However, this structure is far from the only system for administering carbon credits in order to tackle the effects of the climate crisis. The United States has used a tax credit since 2008 to incentivize the development of carbon capture and sequestration (CCS) technology.[5] The credit system was amended in 2009 and overhauled in 2018. These amendments increased the credit’s value and removed the cap on the amount of captured greenhouse gasses eligible for the credit in order to promote the adoption of CCS technology.[6] This tax credit is calculated according to the total metric tons of carbon dioxide either captured and disposed of or captured and used in some other capacity (such as fracking).[7]
The traditional carbon credit system and the tax credit system, while different frameworks, have many of the same benefits and many of the same risks. Both raise concerns as to the authenticity of the actual work that must be done to secure a credit. For example, for carbon credits bought and traded in markets, there is concern that the underlying source of the credits may be fraudulent or otherwise ineffective at creating any real impact in terms of lowering the levels of carbon dioxide in the atmosphere.[8] For tax credits earned through the capture and sequestration of carbon dioxide, there are concerns that data manipulation and other fraud may occur to gain the benefit of the credits.[9]
Lessons from the fraud accompanying the rollout of the EPA’s Renewable Fuel Standards and the renewable identification numbers, which involved document and record forgery, offer opportunities to avoid the same mistakes in the carbon credit administration system. A potential novel solution to fraud can be found in the blockchain with its inherent authentication features.
When the EPA created their renewable fuel standards in 2007, they included provisions for unique identifiers known as renewable identification numbers (RINs).[10] The RINs were created by creating or importing eligible biodiesel.[11]The RINs would attach to the biodiesel whose importation or creation generated them.[12]Certain methods were enacted whereby the RINs could be separated from their associated biodiesel and traded and sold through a website designed by the EPA for participants to meet their responsibilities under relevant legislation.[13] However, this system was quickly abused, with individuals registering fictitious companies, using companies with dormant industrial equipment, or manipulating the travel of biodiesel to make it appear as though they were producing more than they actually were.[14] This resulted in millions of dollars of fraud.[15] Through adopting improved due diligence prior to the granting of applications for companies looking to be certified as producers of biodiesel, the EPA was able to combat the occurrence of fraud and ensure the program met its stated goals.[16]
The global carbon market, while similar to the RIN system, presents unique issues due to its greater size and complexity. The carbon credit system has resulted in rampant allegations of greenwashing, or the practice of overselling a project or product’s environmental benefits, as well as fraudulent accounting to make a climate offset project appear more worthwhile for investment.[17] Further, there are allegations of what is referred to as double counting.[18] Double counting occurs when one party purchases a credit connected to an offset project, claims the carbon reduction benefit it carries, then sells the credit to another party. The buyer of the credit then claims the same carbon reduction benefit, despite not contributing to the offset project themselves.[19] This is just one example of the issues faced by the implementers of these policies in an effort to ensure transparency and efficacy of the systems.
In the case of RIN fraud, the EPA found that simple investigative work minimized the threat of fraudulent applications.[20] This measure is simple to implement and straightforward in its operation. The technically complex issues inherent in the carbon credit markets are less straightforward. A novel approach to deal with the technologically complex issues posed by the carbon credit administration system is the use of the blockchain. The blockchain is typically associated with cryptocurrency such as Bitcoin. It consists of a series of blocks and chains which track the movement of ownership of an item among individuals.[21] However, the blockchain has more purposes outside of cryptocurrency, and is useful in authenticating documents and transactions. Each transaction has a unique blockchain, and each block on the chain appears with a unique code of the information contained in the block. If any information is altered by one user, all other users can see this and will be alerted as to the occurrence of the fraud.[22]
Applied to carbon credit markets for carbon offset projects, the blockchain would allow prospective buyers to see the ownership history of a particular credit, enabling them to measure the impact their purchase would have. This avoids double-counting with a past owner’s use of the carbon credit. Additionally, the blockchain would help prevent fraudulent accounting practices, since the blockchain could not be altered without alerting the public.[23] The use of the blockchain could also assist the government in identifying if the information being provided in support of a party’s request for tax credits is legitimate.
The two possible solutions for the problems facing carbon credit markets — ensuring due diligence or implementing the blockchain — span a spectrum of complexity. While regulatory due diligence seems simple, it is effective. At the same time, when determining which solutions are the most promising, it is important to also consider factors which make their adoption difficult. Although the blockchain represents a useful mechanism to remedy problems facing the existing carbon credit administrative system, the level of technological complexity necessary to comprehend and utilize it presents barriers for governments and private parties. Greater education as to the benefits and use of the blockchain in areas other than cryptocurrency are necessary prior to securing its adoption in administering the carbon credit market.
[1] Anna Maiuri & Mark Bennet, Carbon Credit Trading in Michigan: Out of Chaos Comes Opportunity, Mich. Bar J. Env’t L. 43, 44 (2009).
[2] Id.
[3] Id.
[4] Varsha Ramesh Walsh & Michael W. Toffell, What Every Leader Needs to Know About Carbon Credits, Harv. Bus. Rev. (Dec. 15, 2023), https://hbr.org/2023/12/what-every-leader-needs-to-know-about-carbon-credits.
[5] Michael L. Platner, 45Q Carbon Sequestration Tax Credit Summary, 67 Ann. Inst. on Min. l. 347, at 347 (2020).
[6] Id. at 349-350.
[7] Id. at 348.
[8] Gary E. Marchant et. al., Bringing Technological Transparency to Tenebrous Markets: The Case for Using Blockchain to Validate Carbon Credit Trading Markets, 62 Nat. Res. J. 159, 167 (2022).
[9] Wayne D. Hettenbach & Lauren D. Steele, The Past May Be Prologue: Energy Credit Fraud and Its Lessons for Carbon Credit Systems, 69 Dep’t Just. J. Fed. L. & Prac. 79, 84 (2021).
[10] Id. at 81.
[11] Id.
[12] Id.
[13] Id.
[14] Id. at 87.
[15] See id. at n.25-27.
[16] Id. at 96-97.
[17] Marchant, supra note 8, at 167.
[18] Id.
[19] Id.
[20] Hettenbach and Steele, supra note 9, at 87.
[21] Id.
[22] See id. (describing the features of blockchain).
[23] Id. at 174.