Introduction and summary
In recent years, many businesses in the United States have made public commitments to reduce their carbon footprints or even achieve net-zero carbon emissions. In response to growing public and shareholder demands to address climate change, these businesses, including many large corporations, have increasingly purchased products called “voluntary carbon offsets.”
Carbon offsets are defined as “tradable ‘rights’ or certificates linked to activities that lower the amount of carbon dioxide (CO2) in the atmosphere.”1 Essentially, the purchaser of an offset can claim a credit for an effort that either removes carbon from the atmosphere or prevents new emissions. Since many businesses with net-zero pledges still rely on carbon-intensive activities, directly reducing their own emissions may be difficult or expensive to achieve. But offsets allow these businesses to say that they have helped fund projects that reduce carbon in the atmosphere, in effect “canceling out” the carbon they emit from their own business activities.
With demand for offsets growing quickly, the market has boomed in recent years, increasing to $1 billion last year; it is projected to continue expanding exponentially as major corporations seek to fulfill net-zero pledges.2 Offsets, essentially, have become big business.3 Large corporations—such as Disney, Microsoft, and Nike—are now allocating significant resources toward purchasing offsets,4 and an entire industry of project developers, auditors, standard-setters, brokers, and exchanges has sprouted up to sustain the market. Meanwhile, recently-agreed-to international carbon reduction compliance schemes, such as the airline industry’s Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) mechanism5 and the Paris Agreement’s Article 6,6 will undoubtedly contribute to even greater demand for offsets.
But carbon offsets and their markets face an existential problem: There is no reasonable guarantee that they actually work. A substantial body of scientific research and investigative reporting has revealed that, for a variety of reasons, many offsets simply do not achieve the results they claim. As the market for offsets grows, this raises two significant concerns:
- These instruments may serve as a convenient way for businesses to claim that they are climate friendly while avoiding taking steps toward tangibly reducing their own carbon footprints.
- Persistent problems with quality assurance place offsets markets at particular risk of fraud and manipulation.
These problems have led numerous critics to characterize offsets as “a spectacular failure,” “riddled with fraud,” “rely[ing] on debunked assumptions,” and “suffer[ing] from intractable conceptual issues.”7
Fraud is a unique challenge for offsets given their distinctive attributes. For tangible commodities such as oil or wheat, verifying delivery of the promised good is not too difficult. But in most cases, the owner of an offset credit cannot realistically verify on their own that the promised reduction in emissions is occurring. Instead, the purchaser must rely on certain assurances made by the seller or an auditor—for example, that the underlying environmental project would not have occurred absent the potential to sell offsets or that a given forest storing carbon will not be cut or burned down. These types of assumptions and assurances make the market for offsets particularly susceptible to fraud and manipulation.
Given these problems, many, if not most, carbon offsets are highly flawed and problematic instruments. This is especially the case for the nature-based offsets that compromise a significant share of the market. To put it plainly, if a carbon offset cannot reasonably guarantee that it is worth 1 metric ton of carbon not in the atmosphere, then its use to meet environmental goals or promises should be strongly discouraged. What’s more, today, most offsets come from emission reductions.8 However, to align with the Paris Agreement’s net-zero goals, emissions reduction is not enough. Purchasers of offsets need to look to permanent carbon removal, which extracts carbon directly from the atmosphere.9
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To this end, action by government regulators may be necessary. In a major step forward, the Commodity Futures Trading Commission (CFTC) has expressed interest in whether it should start playing a role in overseeing the voluntary carbon market. In June 2022, the agency convened a roundtable of market participants and experts to discuss the market and the CFTC’s potential role in it,10 and it has also issued a request for information about how it may engage in new rulemaking, guidance, or other actions.11 With the recent advent of derivatives products such as futures contracts based on offsets, the CFTC will likely have an important role in both regulating the derivatives as well as monitoring the underlying offsets markets.12
This report examines the current state of the voluntary carbon market, evaluating offsets’ purported benefits as well as their flaws. It highlights the already well-documented and numerous problems in assuring the quality of offsets, such as how some avoided-emissions projects may result in new emissions happening elsewhere, or how some projects would likely occur even if they had not received funding from the purchaser of the offset. Given these problems, the report argues that current standards are insufficient to prevent fraud in offsets markets and that government action is necessary to disincentivize the proliferation of low-quality nature-based offsets and a risky derivatives market based on them. It concludes with an analysis of the CFTC’s legal authority and provides recommendations for how the agency can act to improve standards and curb fraud and manipulation in the market.
Without regulatory oversight, there is no guarantee that offsets can truly offset purchasers’ emissions, and although the market for carbon offsets is growing as companies strive to reduce their greenhouse gas emissions, an unregulated offsets market may be worse for climate change than no offsets at all. The CFTC cannot address all regulatory concerns, but efforts that it makes could be a decent start.
The basics of carbon offsets
Carbon offsets are, in theory, fungible—or interchangeable—assets that can be bought and sold at a market-determined price. Currently, the market for carbon offsets (sometimes referred to as the voluntary carbon market) is largely unregulated in the United States, with offsets issued by nongovernmental entities.
Offsets vs. allowances
Offsets represent activities that have either directly removed carbon from the atmosphere or prevented new emissions. This is to be distinguished from carbon allowances, which are credits that give the holder the right to emit a certain amount of a greenhouse gas. Allowances are issued under mandatory emissions reductions systems such as cap-and-trade programs and are thus regulated directly by governments whose jurisdictions have such programs in effect. While a patchwork of state and regional market-based greenhouse gas reduction programs do exist in the United States, the country currently does not have a national mandatory emissions reduction scheme for carbon dioxide. Thus, offsets are generally used to fulfill voluntary pledges made by businesses to achieve emission reduction goals.13
Globally, the four most commonly used standards are the Verified Carbon Standard, administered by the organization Verra; the American Carbon Registry; the Climate Action Reserve; and Gold Standard. These account for almost all the world’s voluntary carbon market offsets.14 Each of these entities has its own particular methodologies and protocols, as well as its own registry to track credits from the projects verified under its protocols. Since there is no overarching national regulatory framework governing carbon offsets in the United States, these entities play a central role in governing the voluntary market.
The carbon offsets market has existential problems that heighten the risk of fraud and manipulation
Proponents of carbon offsets argue that they provide a pragmatic and efficient way to match businesses’ need to meet emissions reduction goals with environmental projects’ need for funding—and, in doing so, can contribute to a reduction in global atmospheric carbon. Advocates typically argue that offsets provide a market-oriented, cost-effective way to meet net-zero goals,15 that offsets markets provide a source of capital to spur the development of green projects,16 and that the commodification of credits facilitates offsetting by making it easier for businesses to purchase credits in the primary or secondary markets.
But several challenges call into question the integrity of the credits and their markets—and by extension, the validity of the claims made by businesses who use offsets to meet their net-zero targets. These problems—including evidence that many carbon offsets do not actually represent permanently removed carbon or avoided emissions—have persisted in offsets markets despite widespread knowledge of their existence and purported efforts by market participants to fix them. If these existential problems are not addressed, many carbon offsets will continue to be flawed, ineffective means of achieving emissions reduction goals and highly susceptible to misleading claims and outright fraud—in short, products whose existence may be negatively contributing to climate change.
Offsets frequently do not deliver their intended carbon reductions
It is prohibitively expensive or impossible to guarantee that most carbon offsets represent 1 metric ton of carbon removed from the atmosphere or in avoided emissions. In voluntary carbon markets, nongovernmental organizations issue credits and rely on audits and pledges from a variety of private actors and market makers, and there are no unbiased governmental entities that monitor all steps of the process and ensure that offsets are meeting the claims made. A growing body of academic research is demonstrating that the numbers simply do not add up,17 and investigative reporting has uncovered glaring instances in which forests underlying carbon offsets have been substantially logged or burned—or, conversely, were never at risk of being deforested.18 Quality assurance is a major challenge, and several key factors call into question the integrity of offsets.
Offsets may not deliver permanence
The first problem with quality assurance is permanence. For many nature-based offsets involving carbon sequestration, permanence is very difficult to achieve. The project must be ongoing in perpetuity for the credit’s claim of representing carbon removal to remain valid. This is especially the case for forest-based offset projects, which typically involve either planting new trees or preventing deforestation. If a forest is burned down in a fire, the carbon it stored is released back into the atmosphere.19
Guaranteeing that a forest will remain intact forever—or for any length of time—is nearly impossible. Fires,20 changes in land ownership, political turmoil, and so many other factors can lead to forests being damaged unexpectedly.21 Yet many businesses that use forest-based offsets purchase 40-year contracts—promises that the forests will be protected for 40 years, then could be harvested. This has led one scientific researcher to write that “the timelines over which carbon removal needs to occur are fundamentally inconsistent with the planning horizons of private companies today.”22 Since carbon dioxide stays in the atmosphere for about 100 years, a forest must stay intact for at least that amount of time for the offset to be valid.23 A major investigation by ProPublica in 2019, however, found several instances of projects in Brazil and Cambodia that had experienced significant deforestation despite being used for avoided-deforestation offsets. In one example, an area used for credits that had started out as 90 percent forested had gone to 0 percent in less than a decade.24
Offsets may have leakage
The execution of a project that prevents new emissions does not necessarily lead to a net reduction in atmospheric carbon, because offsets projects cannot always eliminate the market demand that still exists for resources such as trees or fossil fuel energy. The protection of one forest from deforestation may simply lead to another forest being cut down, resulting in no net reduction in carbon dioxide. This phenomenon is known as leakage.
Leakage is a particularly acute problem for forest-based offsets because protecting a forest from being cut down does not eliminate the market demand that still exists for the lumber. According to research cited by the Intergovernmental Panel on Climate Change (IPCC)—the primary body coordinating the global response to climate change—the leakage rate from reduced timber harvesting in the United States could be up to 92 percent. This means that up to 92 percent of any reduction project would be replaced by timber harvesting elsewhere.25 One study estimated that 84 percent of reduced timber harvesting in the western United States in the 1980s and 1990s was replaced by harvesting elsewhere in North America.26 Notably, a recent study into forest-based offsets issued for use in California’s statewide cap-and-trade system—which allows companies to use a limited number of offsets to supplement their emissions reductions requirements—found that 82 percent of the projects examined likely do not represent true emissions reductions due to lenient leakage protocols. According to the study, “The total quantity of emissions allowed because of this over-crediting equals approximately 80 million tons of CO 2, which is one third of the total expected effect of California’s cap-and-trade program during 2021 to 2030.”27
Researchers have also found evidence of leakage in other offsets projects such as cookstove replacement and nitrous oxide abatement. In fact, one study estimated that about 20 percent of credits for nitrous oxide abatement via adipic acid production issued under the Clean Development Mechanism (CDM)—the U.N. offset scheme used for compliance with the Kyoto Protocol—did not represent real emissions reductions due to leakage.28
Offsets may not be additional
The problem of additionality is perhaps the most difficult and pervasive problem to overcome in offsets markets. Additionality refers to the fact that a project must have occurred only because of the funding that was received from the sale of the offset credit. In other words, the funding for the offset must have had a causal effect: If the project would have occurred anyway without the funding or if some other source of funding likely would have been found, then the credit cannot be said to be additional. This problem is significant because it can lead to over-crediting; that is, allowing purchasers to claim credits for projects that the funding did not actually bring about allows them to claim credit for something that did not actually lead to a reduction in emissions.
A simple but common example of this can be found in avoided-deforestation projects.29 Such projects involve paying the owner of a plot of trees to not cut down those trees. In order for that offset to actually represent prevented deforestation, however, one must assume that the landowner was capable of cutting down those trees and was planning to do so. This, and many other scenarios, requires engaging in difficult counterfactuals that ultimately rely on the assurance of the project developer or difficult fact-finding by an auditor that the creation and purchase of the offsets were the actual cause of a decision not to deforest; would investments in renewable energy projects or efficiency upgrades have been made absent offsets? If the landowner was not otherwise planning to cut down those trees, then the carbon offsets are not valid. Similarly, carbon offsets can create perverse incentive for entities to claim that they were planning to engage in more carbon-producing activities than they were in order to use that claim to sell more offsets—a practice known as inflating baselines. Even those who do not falsely inflate their baseline activities may still inadvertently make inaccurate promises or projections, which would affect the integrity of the offset.
Many offsets appear, on their face, to have questionable claims of additionality, but proving counterfactuals is very difficult, particularly when it comes to someone’s intentions. Just as evaluating a forest owner’s claim about how many trees they were going to cut down is challenging, so is evaluating whether funding to support a new renewable energy project was really necessary, since the price of developing such projects has fallen in recent years.30
Academic research has demonstrated that nonadditionality is a widespread problem in carbon offset markets: According to one report, “The problem of additionality is an inherent weakness in offset projects.”31 Studies of the two offsets programs used under the Kyoto Protocol both found problems with additionality: One study estimated that at least half of approved offsets under the CDM went “to projects that would very likely have been built anyway.”32 A second study estimated that 85 percent of CDM-issued projects it examined had a low likelihood of being additional,33 while a third study estimated that roughly three-quarters of offsets issued under the Joint Implementation program were unlikely to be additional, which “may have enabled global GHG [greenhouse gas] emissions to be about 600 million tonnes of carbon dioxide equivalent higher than they would have been if countries had met their emissions domestically.”34
Despite purported efforts by standard-setters to improve on this area, additionality remains a major challenge that may never be totally overcome. Research has shown that additionality poses problems in cookstove projects,35 renewable energy projects,36 and forest-based projects.37 Forest-based projects, as indicated by the examples presented in the Introduction, present acute additionality concerns because of the difficulty of definitively proving baselines—for example, how many trees would a forest owner have not cut down anyway if she had not received funding from the offset? In many cases, it may be nearly impossible to know for certain.
Offsets may be issued under flawed protocols
A key reason why permanence, leakage, and additionality are significant problems in the voluntary carbon market is that the protocols used to verify offsets’ quality are not sufficiently rigorous. In the United States, each of the four main standard-setters—Verra’s Verified Carbon Standard, the American Carbon Registry, the Climate Action Reserve, and Gold Standard—has its own procedures and protocols used to verify offsets, and these entities are not subject to government oversight or regulation. The result is that the standard-setters can assert that their protocols have rigorous procedures, businesses can buy offsets they issue—without any due diligence from either the businesses or a government regulator—and there is no way of guaranteeing that the standards are actually producing offsets that remove carbon from the atmosphere or prevent new emissions.
There is growing evidence that the protocols issued by the main U.S. standard-setters have a poor track record in terms of the quality of offsets. The ProPublica investigation, for example, examined several sites in Cambodia that received offsets issued under Verra’s standards for avoided deforestation and found that only 46 percent of the land was still actually forested.38 Recently, in fact, the CEO of Verra, the largest standard-setter, acknowledged that a large number of renewable energy offsets listed on Verra’s registry are likely nonadditional,39 raising major questions about how effectively the standard-setters are managing the quality of their inventories.40
Researchers have pointed out that current methodologies behind offset protocols are flawed despite purported improvements, to the point that there is widespread over-crediting in the market. This has even been the case in California’s compliance system, where researchers have found that significant over-crediting has resulted from standards not being stringent enough. For example, California’s definition of “permanence” at 100 years is insufficient to actually guarantee permanent sequestration of carbon in forests.41 In one study, researchers examined 12 forest-based projects certified under Verra’s Verified Carbon Standard and found that “the crediting baselines assume consistently higher deforestation than counterfactual forest loss in synthetic control sites.” In other words, the methodologies used overstated the actual impacts of the projects on climate change mitigation.42 These results suggest that existing protocols are not stringent enough to produce credits that genuinely offset carbon emissions.
Low-quality offsets may be worse for the climate than no offsets at all
The quality problems inherent in carbon offsets raise significant questions about the extent to which these instruments are causing more harm than good to the environment. Proponents of offsets, even in admitting that they can be imperfect, will often claim that a benefit to the climate still results from the process of businesses providing a source of capital to environmental projects that need funds, even if such projects do not fully meet the promises they make.43
But given the significant problem of systemic over-crediting described above, the benefit of even flawed offsets may be outweighed by the harm. Importantly, many businesses use offsets to avoid reducing their own emissions after they have made public climate commitments such as achieving net-zero emissions. But if the offsets they use do not guarantee emissions reductions, then these businesses are in effect adding new emissions on net. As the retail price of carbon offsets remains relatively low—typically ranging in price from $5 to $20 per metric ton44—some observers have characterized offsets as essentially being a “licence to pollute.”45 In some cases, offsets also offer a convenient way for businesses to benefit from the positive public relations that can result from making bold climate commitments without having to make significant changes to their practices. This has led to a serious concern that businesses may be using offsets as a means of “greenwashing”—that is, misleading the public as to how environmentally friendly their businesses are and undermining the public’s perception of the need for mandatory actions that would actually reduce emissions.46
In short, if a business buys offsets that are not truly permanent or additional, and maintains the status quo of its own emissions, then it has not reduced its net emissions. Worse yet, if businesses use carbon offsets to help meet emission reduction standards in compliance programs—for example, California’s statewide cap-and-trade system—then the use of low-quality offsets may be causing more carbon emissions to occur than otherwise would be.47 At best, offsets are only a short-term fix to the problem of climate change and do not displace the need for businesses to reduce their own carbon emissions.
Current standards are insufficient to minimize the risk of fraud in the offsets market
Due to the problems with offsets’ quality and market fragmentation described above, the offsets market has a significant risk of fraud. Because offsets have inherent challenges such as permanence, additionality, and the market being divided by registries that operate under different standards, an asymmetry of information exists between project developers and individuals and businesses seeking to buy offsets. For example, a buyer may have difficulty verifying whether an offset is truly additional if additionality is ultimately determined by the intent of the project developer. Without government oversight, it is very difficult for buyers to have any certainty that the offsets they are purchasing are worth 1 metric ton of carbon removed from the atmosphere.
Fraud is a significant risk in carbon markets
Governments, nongovernmental organizations, and researchers have long expressed concern about fraud in carbon markets.48 The Federal Trade Commission first warned of the potential for fraud in carbon offsets markets more than a decade ago,49 and more recently, a report by the government of Norway found that there is a “high” risk of fraud in its International Climate and Forest Initiative.50 Academic researchers and journalists have warned about several vulnerabilities to fraud in carbon markets—even in compliance markets that are subject to government oversight.51 A January 2021 letter to the Taskforce on Scaling Voluntary Carbon Markets signed by 47 academics and researchers characterized the market as “riddled with fraud.”52
Notably, a 2013 report by the international law enforcement agency Interpol listed several factors that make carbon markets “particularly vulnerable to fraud and other illegal activities”:53
- Fraudulent manipulation of measurements to claim more carbon credits from a project than were actually obtained
- Sale of carbon credits that either do not exist or belong to someone else
- False or misleading claims with respect to the environmental or financial benefits of carbon market investments
- Exploitation of weak regulations in the carbon market to commit financial crimes, such as money laundering, securities fraud, or tax fraud
Examples abound of cases involving the distribution of offsets that appear to meet these conditions. In one case, a New Hampshire timber company was paid millions of dollars to not cut down trees from a forest where, because of the ruggedness of the terrain, it would have been extremely difficult and therefore economically prohibitive for the company to have cut down those trees anyway.54 In another case, a conservation nonprofit that maintained a forest claimed that it was in a position to cut down significantly more trees than it plausibly ever would—yet was still paid to not cut down those trees.55 In 2018, a report by The San Diego Union-Tribune found “numerous instances where companies and nonprofits selling offsets didn’t shrink their carbon footprint” as a result of funding from California’s carbon offset program.56 And the 2019 ProPublica investigation into forest projects in Brazil and Cambodia uncovered clear examples of forest-based projects blatantly failing to adhere to the promises they made. Meanwhile, in Australia, which uses offsets for its compliance emissions reduction program, academics have characterized its carbon offset program as a “fraud” and a “sham” due to significant problems with quality.57
Higher standards and government oversight could reduce the risk of fraud
Problems such as these will likely continue to persist so long as there are no stringent standards across the voluntary carbon marketplace, as there are no strong incentives in place for market participants to ensure quality: A business that purchases credits simply to be able to claim that it has reduced its net emissions does not necessarily care if the underlying credit really avoids all the problems described in the previous section of this report. Meanwhile, the existence of multiple registries could lead to perverse incentives in that a developer with a low-quality project could essentially “shop” for a standard that will register its product even if others will not. Meanwhile, with no regulations in place and high information asymmetry, businesses that have made climate commitments may be unwilling to conduct due diligence and will simply try to find the cheapest, lowest-quality offsets available to purchase.58 As long as there is no enforcement of standards, businesses can still use purchased offsets to tell the public they have met their commitments.
For these reasons, the federal government—not just industry participants—would play a welcome role in improving standards. Standards that would benefit the marketplace and reduce the risk of fraud include:
- Establishing a standard for high-quality carbon offsets, defining them as representing a verifiable and unique claim to carbon that is permanently removed from the atmosphere and that would not have been removed absent the intention to create and sell an offset
- Developing a standard for the definition of “permanence”—namely, that only projects that physically remove carbon dioxide from the atmosphere and store them indefinitely (without risk of a forest fire or clear-cutting) can be considered genuine removals
- Improving transparency in the market by creating a uniform public disclosure regime by which issuers of offsets must abide—which would give buyers more information about the underlying projects so they can make better decisions when they purchase credits
- Developing a standard for accounting methods
- Setting higher requirements for capitalization of buffer pools to insure against unforeseen disturbances, such as natural disasters, to the permanence of offsets projects59
It is important to note that meeting higher standards may be impossible for many, if not most, offsets on the market today. However, if that is the case, then arguably these offsets—particularly nature-based offsets such as forest projects—should not exist at all.
The fragmented structure of the market and the poor track record of standard-setters in terms of approving low-quality offsets60 necessitates government action and oversight to ensure uniform standards that apply consistently to all market participants. Particularly, with the high risk of fraud in the market, the government has a strong interest in protecting individuals and businesses who buy offsets without full knowledge of what they are purchasing and whether the credits genuinely represent the emissions reductions they claim.
The CFTC can play a significant role in addressing problems with the structure of the voluntary carbon market
Fortunately, there is one federal agency that may conduct at least limited oversight of offsets markets: the Commodity Futures Trading Commission.
The CFTC is responsible for ensuring the efficiency and stability of large sections of the nation’s derivatives markets. Derivatives are contracts between two parties in which “prices are determined by, or ‘derived’ from, the value of some underlying asset, rate, index, or event,”61 and include financial instruments such as futures, in which two parties agree to buy and sell assets for a specific price at a particular time in the future. Derivatives contracts can be compared with spot contracts, in which two parties agree to buy and sell assets for immediate delivery.
The CFTC has full regulatory authority over the markets for derivatives, but because the price discovery function of derivatives is inhibited if the markets for commodities—“goods sold in the market with a quality and value uniform throughout the world”62—are manipulated, the CFTC also maintains limited authority to address fraud and market manipulation in commodity spot markets. Specifically, the Commodity Exchange Act (CEA), which gives authority to the CFTC, makes it unlawful “to cheat or defraud or attempt to cheat or defraud” other commodity market participants;63 unlawful “to manipulate or attempt to manipulate the price” of commodities;64 and a felony “to manipulate or attempt to manipulate the price of any commodity” through “false or misleading or knowingly inaccurate reports.”65 Importantly, the CFTC can promulgate regulations detailing which activities may be considered fraud or market manipulation,66 and its authority over commodities extends beyond physical commodities—such as corn and wheat—to virtual commodities, including bitcoin,67 and intangible financial indexes such as the London Interbank Offered Rate (LIBOR).68
Because carbon offsets are being treated as commodities—registries issue standardized and interchangeable offsets—the CFTC’s authority applies to these markets. Accordingly, the CFTC should consider undertaking the following actions.
Ensure standards result in promised greenhouse gas reductions
As explained above, in order to be effective means of reducing carbon emissions, commoditized carbon offsets must represent a verifiable and unique claim to carbon that is permanently removed from the atmosphere and that would not have been removed absent the intention to create and sell an offset. This statement adheres to the principle that a carbon offset must be verifiable, unique, permanent, and additional.
However, some carbon offset standards appear to permit projects that fail to meet one or more of these requirements, and as a result, credits may not actually deliver their claimed emissions reductions. The CFTC should consider evaluating private sector standards to determine whether the standards, if followed, will truly result in verifiable, unique, additional, and permanent emissions reductions.
The CFTC could write guidance that specifically establishes how to measure quality as well as what activities may constitute fraud or manipulation. For example, such guidance could establish a clear definition of what constitutes actual permanence—particularly for forest-based offsets, which are inherently at risk of logging or fires—and could establish strict procedures for determining additionality, perhaps with a rebuttable presumption that certain kinds of avoided-emissions projects are not additional. Also, guidance could outline the CFTC’s opinion on what constitutes a high-quality offset and whether certain types of offsets should be eligible to be used for derivatives contracts. The Center for American Progress believes that guidance establishing that nature-based offsets are unlikely to deliver on their promises and that businesses should avoid purchasing them would send a much-needed message to the market.
Given the well-documented problems with offsets not meeting the promises made by issuers that have been laid out in academic research and media reports, CFTC guidance on marketing claims and fraud would be especially useful. In its “Green Guides” for environmental marketing claims, the Federal Trade Commission writes that:
It is deceptive to misrepresent, directly or by implication, that a carbon offset represents emission reductions that have already occurred or will occur in the immediate future. … It is deceptive to claim, directly or by implication, that a carbon offset represents an emission reduction if the reduction, or the activity that caused the reduction, was required by law.69
The CFTC could expand on this guidance to explicitly define what factors would cause an offset to be fraudulent—for example, if a developer clearly did not need the funding from the sale of the credit to complete the project or sells multiple credits to different buyers based on the same project.
Alternatively, the CFTC could model guidance on the U.S. Department of Agriculture’s food-quality labels, which it uses for a variety of commodities such as beef and corn.70 For example, offset projects that involve carbon dioxide scrubbing or permanent removal and storage could receive a high-quality label, while avoided deforestation projects with significant risks of leakage, nonpermanence, or questionable additionality could receive a low-quality label. In doing this, the CFTC could establish that only the offset projects that receive a high-quality label are eligible for inclusion in derivatives contracts or could establish a rebuttable presumption that offsets with low-quality labels are susceptible to fraud and manipulation.
Guidance would be greatly beneficial to market participants by sending a clear signal discouraging the sale of offsets that cannot deliver on what they promise.
Refuse to endorse specific standards
Although the CFTC could play a beneficial role in establishing higher standards, given the current problems with existing protocols used in the voluntary carbon market, the CFTC should be careful to avoid endorsing—or giving the impression of endorsing—an existing standard that sounds good on paper but still fails to produce verifiable, permanent, and additional offsets. If the CFTC determines that it is impractical or too difficult to develop its own definition of a high-quality offset, then it could alternatively use guidance to clearly establish what current standards or protocols created by private entities are not suitable for offsets that are not subject to fraud or manipulation. In doing so, the CFTC could use the growing body of academic research and investigative reporting on over-crediting of offsets based on insufficiently rigorous protocols.
Exercise authority over registries in their role as delivery points for offset contracts
The four main offset standards used in the U.S. voluntary carbon market—Verra’s Verified Carbon Standard, the American Carbon Registry, the Climate Action Reserve, and Gold Standard—play an outsize role in the marketplace. These entities not only set the scientific standards used to verify an offset project, but they also list credits on their registries and track their ownership throughout their life cycles. For this reason, the entities play a critical role in carbon-offset futures markets, since they essentially serve the function of “delivery points” at which the ownership of credits is exchanged when a futures contract is settled. As such, these entities could be subject to direct oversight by the CFTC.71 Particularly, the CFTC can require that these entities engage in practices to “prevent manipulation, price distortion, and disruptions of the delivery or cash-settlement process through market surveillance, compliance, and enforcement practices and procedures.”72
Based on the significant flaws in quality described above, the offsets market would benefit from government oversight of the registries and basic standards put in place to prevent risks to investors. As noted in a report by the International Swaps and Derivatives Association:
It is important to ensure registries have consistent and transparent rules on how [carbon offsets] are verified, counted and transferred. Failure to correctly track and safeguard carbon credits, or a gap in standards in the creation of a carbon credit itself, could lead to fraudulent practices, such as greenwashing and double counting. As with other rules for delivery points, consistent and transparent requirements for carbon registries help guarantee the legitimacy of transactions and ensure they are entered for legitimate purposes. Likewise, clear rules and widely agreed standards … will make compliance easier for market participants and may reduce the need for enforcement actions.73
CFTC oversight of these currently unregulated registries would be a critical step forward in upholding the integrity of offset-based derivatives. Without effective oversight of the entities that keep track of the derivatives’ underlying offsets, investors cannot be certain that the derivatives actually represent what they claim—that is, the future delivery of offsets that represent avoided or removed carbon emissions. This is especially important in light of the admission by Verra’s CEO, mentioned above, that an unknown number of offsets may not be additional.74 CFTC supervision over registries may be necessary to make sure that listed offsets meet the requirements set by a given standard’s protocols. For example, the value of the Chicago Mercantile Exchange’s Global Emissions Offset (GEO) futures contract is based on CORSIA-eligible credits; specifically, offsets within the American Carbon Registry, Climate Action Reserve, and Verified Carbon Standard registries.75 CFTC oversight over these registries may therefore be necessary to make sure that the futures contracts are not being manipulated and that the underlying offsets reflect the promise that the futures contracts are delivering offsets that meet CORSIA eligibility standards, which include additionality, permanence, and nonleakage.76
Bring enforcement actions against individual projects for fraud and market manipulation
As mentioned above, the CEA grants the CFTC jurisdiction over commodity spot markets to address fraud and market manipulation.77 This extends to intangible commodities. For example, courts have ruled in favor of the CFTC having jurisdiction over bitcoin as a commodity.78 The CFTC’s interest in policing spot markets extends logically from its direct authority over commodity derivatives: If the underlying commodities are fraudulent or have been manipulated, that directly affects the integrity of derivatives contracts based on those commodities.79
With carbon offset derivatives now being traded on the market, the CFTC should use its authority under the CEA to engage in enforcement actions cracking down on fraud and manipulation in the voluntary carbon market.80 The CFTC often engages in anti-fraud enforcement actions against entities selling precious metals that do not deliver on the quality promised to buyers,81 and it can use that same authority to police carbon offsets that clearly do not deliver on their promised emissions reductions. According to a 2011 report issued by a federal interagency working group on carbon markets:
Because the CFTC has broad enforcement authority to pursue manipulation of a commodity’s price in interstate commerce, the agency would have the authority to bring actions against individuals or entities believed to be involved in the price manipulation of allowance and carbon offsets.82
In order to do so, the CFTC could apply its rule on “Prohibition on the Employment, or Attempted Employment, of Manipulative and Deceptive Devices and Prohibition on Price Manipulation” to deceptive reporting on offsets credits.83 This rule extends the definition of unlawful manipulation to include:
Deliver[ing] or caus[ing] to be delivered, or attempt[ing] to deliver or cause to be delivered, for transmission through the mails or interstate commerce, by any means of communication whatsoever, a false or misleading or inaccurate report concerning crop or market information or conditions that affect or tend to affect the price of any commodity in interstate commerce, knowing, or acting in reckless disregard of the fact that such report is false, misleading or inaccurate.84
Arguably, the sale of offsets based on projects by issuers who know that those projects are not truly permanent or additional falls under this definition.
Alternatively, the CFTC could promulgate a new rule defining what constitutes fraud and manipulation in the sale and trading of carbon offsets. Such a rule could, for example, establish a rebuttable presumption that offsets that are most susceptible to problems with permanence, leakage, and additionality—such as avoided-deforestation projects—are fraudulent because they cannot reliably guarantee they are reducing the emissions promised.85
In order to be able to investigate offsets projects and issuers to bring enforcement cases, the CFTC should hire climate and climate finance experts who can objectively evaluate whether projects are really meeting goals promised in offsets contracts and whether the protocols used by standard-setters are systematically leading to more offsets credits being issued and sold to customers than actually represent any genuine carbon removal or avoided emissions. The agency should investigate the extent to which standard-setters are systematically allowing offsets onto their registries that do not represent genuine carbon removals. The CFTC could then engage in enforcement actions to crack down on cases in which lax standards have led to the crediting of offsets that are likely fraudulent. Doing so would send a signal to the rest of the market that issuing offsets that do not stand up to the highest possible standards of verifiability, permanence, and additionality could lead to legal liability for registries. If the CFTC does not put some pressure on registries to make sure that the offsets they list actually represent genuine carbon removal, registries may have no incentive to eliminate illegitimate offsets from sale.
Additionally, the CFTC should consider investigating and bringing enforcement actions against projects that blatantly fail to deliver on promises. While it is likely impossible to do so across the entire market, the CFTC could start with cases that have already been publicly highlighted through investigative reporting.86 Cases in which forest owners sell avoided-deforestation credits based on trees that they were unlikely to cut down anyway may be of particular interest. If a forest owner cannot provide evidence that the sale of an offset actually caused them not to cut down certain trees they otherwise would have, then the offset is not valid. An offset is not legitimate if it is not additional, and an avoided-deforestation project is not truly additional unless it has a definitive, causal effect in preventing trees from being cut down. Given the ubiquity of forest-based offsets on the market—and it is likely many of these offsets are included in CFTC-approved futures contracts—the CFTC should at least investigate how pervasive nonadditionality of forest-based projects is and whether the problem constitutes fraud and manipulation that would give rise to enforcement actions.
The CFTC enforcing against the most blatant cases of fraudulent sales of offsets would not solve the entire problem, but it could provide a disincentive for developers to create new projects that are not genuinely additional or permanent. Even setting a precedent with a small number of cases that over-crediting of offsets constitutes fraud or manipulation could have a significant impact on the market as a whole.
Investigate the role of businesses acting as brokers in the marketplace
One intriguing layer of complexity in the market is the existence of for-profit companies that act as brokers. Many of these companies act as intermediaries in the spot market, listing environmental projects on their websites, and offer individuals and businesses the ability to purchase offsets based on the carbon removal or avoided emissions from those projects.87 When a customer makes a purchase, the broker buys the offset on the customer’s behalf and then immediately retires the credit on the registry on which it exists.88 The broker then sends the customer some form of certificate signifying that it has offset a certain quantity of carbon emissions.89
These companies provide a service that may make the process of purchasing offsets easier for individuals or businesses, but their existence raises certain concerns. First, since these companies purchase offsets on someone else’s behalf, the registry might list the broker as the purchaser and retiree of the credit—not the clients who originally paid for them. This means that investors seeking to evaluate the legitimacy of a businesses’ net-zero claims based on purchases of offsets would not be able to independently verify that the business purchased those offsets.90 Second, many of these companies sell credits to their customers at a significant mark-up, meaning that a large amount of the money that businesses are supposedly spending on offsets is padding the profits of these companies instead of going directly to project developers.91
Finally—and importantly—without sufficient government oversight of these brokers, there may be no way to guarantee that a broker is not engaging in double-counting or selling illegitimate offsets to buyers. For example, recent investigative reporting into a for-profit company that trades offsets in New Zealand found that the company did not actually require project developers to do anything differently based on the sale of credits and could not guarantee that the project developers used the money from the credits to offset carbon. When asked by a reporter to explain the decision not to obligate landowners to take action, the company’s founder responded that “it is an extremely nuanced topic” and declined to discuss further.92
The risks associated with these businesses may fall within the CFTC’s enforcement authority over commodity cash markets. If a broker, for example, purchases and retires a credit from a project developer but then sells the rights to that offset to more than one individual or business—or, if a broker accepts payments from customers seeking offsets but does not actually purchase credits, while telling customers that they have—those would appear to be fraudulent activities involving commodities, and the CFTC would have the authority to bring an enforcement action against that broker. Likewise, given the significant variation and constant fluctuations in prices across the marketplace, unscrupulous brokers could be engaging in activities to manipulate prices—by, for example, buying cheap offsets and then making false or misleading statements that drive up their price. These activities also may fall within the CFTC’s enforcement authority.
Allow certification only of derivatives products based on high-quality offsets
When it comes to jurisdiction over carbon offset derivatives, the CFTC has broad regulatory authority. The purpose of the CFTC’s authority over derivatives markets is to ensure that markets operate fairly and efficiently, with adequate price discovery, transparency, and participation.93 In many cases, the CFTC delegates some authority to exchanges to self-regulate, so long as such entities—known as designated contract markets (DCMs)—follow rules set by the CEA and CFTC regulations.94
Importantly, in addition to periodically monitoring DCMs for compliance with agency rules, the CFTC has statutory authority to set listing standards for exchanges.95 Listing standards are policies set by exchanges that determine whether a product is eligible to be traded on their platforms. The CFTC has authority to approve or disapprove of listing standards of registered exchanges, and it could use this authority to require that DCMs have listing standards that prohibit the listing of derivatives whose underlying offsets are susceptible to manipulation and require any derivatives to only include high-quality offsets—potentially excluding offsets such as forest-based projects that are most susceptible to permanence and additionality problems.
The CFTC allows DCMs to self-certify that new derivatives products comply with CFTC and exchange rules without a formal review process by the agency’s staff, and the CFTC has recently allowed self-certification for new offset-based futures contracts.96 However, one of the CFTC’s “core principles” with which derivatives products must comply to be certified states explicitly that, “The board of trade shall list on the contract market only contracts that are not readily susceptible to manipulation,”97 and CFTC regulations require that any derivative “meets the risk management needs of prospective users and promotes price discovery of the underlying commodity.”98 Given the inherent risk of fraud and manipulation in the vast majority of offsets today and the fact that physical delivery of some derivatives contracts may not result in receipt of usable offsets, the CFTC should not allow self-certification of offset derivatives and instead engage in a thorough and formal review process for any new proposed contract. In doing so, the CFTC could set a rebuttable presumption that new contracts are susceptible to manipulation, requiring a higher burden for the issuer to demonstrate that the underlying offsets are reliable.
Additionally, the CFTC should consider examining the self-certification of the GEO and N-GEO futures contracts by CME Group last year. In particular, the CFTC should investigate whether these contracts effectively met the core principle for avoiding products that are susceptible to manipulation. Notably, the self-certification document for these contracts merely states that:
The Contract is not readily subject to manipulation due to the deep liquidity and robustness in the underlying cash market, which provides diverse participation and sufficient spot transactions to support the final settlement index.99
Given all the problems with the underlying cash market described above, this statement may be worthy of closer investigation by the CFTC.
For example, when it comes to the GEO contract, which is based on CORSIA-eligible offsets, the CFTC may have a particular interest in reviewing whether the futures contract is subject to manipulation, especially in light of a report last year by the European Commission, which found that CORSIA has “major flaws in the scheme,” with “questionable quality of offsets” and “all having issues with double counting.”100 These findings should raise concerns that a futures contract based on CORSIA-eligible offsets may be subject to manipulation or may not meet risk management needs. For example, an end user of the GEO contract may receive delivery of an offset that does not permit them to truly offset their emissions. If the CFTC finds that CME did not sufficiently prove that the GEO or N-GEO contracts are not susceptible to manipulation or do not meet the needs of end users, then it should consider taking the further step of de-listing those contracts and preventing them from being traded. CME did not respond to requests for comment about whether these contracts were subject to manipulation.
As described above, price discovery is very difficult in the voluntary carbon market. Without price discovery, the value of derivatives as a tool for hedging is significantly diminished if not impossible, meaning that offset-based derivatives are mostly likely going to be used mostly for pure speculation.101 For this reason, it is unclear what beneficial purpose these products would serve in the market or for the environment, and the CFTC should carefully examine these factors when evaluating new proposals. Also, given the significant concerns with the quality of the underlying assets, the CFTC has a compelling interest in closely monitoring offset-based derivatives, particularly in the still-early stages of the market. One of the main causes of the 2008 global financial crisis was the proliferation of derivatives based on risky assets,102 and the CFTC must ensure that similar irresponsible market activity does not occur again in the realm of carbon offsets.
Conclusion
The rapid growth of the market for voluntary carbon offsets, paired with proliferation in the use of offsets by businesses to achieve net-zero commitments, poses an important public policy problem. Businesses are increasingly purchasing offsets to justify continued carbon emissions, but the significant quality problems throughout the market cast doubt on whether these instruments are really doing what they claim—and worse, they may be leading to more emissions than otherwise would be occurring. Offsets, particularly nature-based offsets, are so flawed that unless substantial improvements in quality assurance are made, their use by businesses to meet environmental goals should be strongly discouraged. Given that offsets are widely traded as commodities, that demand for offset-based derivatives products is growing, and that fraud may be a widespread problem throughout the marketplace, the Commodity Futures Trading Commission has a clear role to play in addressing the problem of low quality and policing for illegal activities.
Acknowledgments
The authors thank Danny Cullenward, Barbara Haya, and Lilith Fellowes-Granda for their helpful conversations and comments.