Officials behind the United Nation’s carbon credit program should be wondering what kind of monster they have created. After numerous examples of fraud and a rising chorus of fears that the carbon credit market will attract organized crime, the UN is facing new allegations that carbon markets create a perverse incentive for polluters to increase their production of an environmentally-toxic substance.

The latest allegation comes after a watchdog group, CDM Watch, issued a formal request to the UN’s climate change secretariat, saying the current carbon credit system allows companies, mostly based in India and China, to “game” the system.

According to CDM Watch, 19 firms have been producing excess greenhouse gas pollution for the sole purpose of destroying it—and, in the process, receiving valuable carbon offset credits from the UN called Certified Emission Reductions (CERs) for doing so. These companies sell their "emission reductions" to European CO2 emitters who are exceeding their legally-binding limits. In the process, the predominantly Indian and Chinese firms earn CERs worth millions of dollars.

CDM Watch contends that companies manufacturing the refrigerant gas HCFC-22 and its unwanted chemical byproduct, a potent greenhouse gas called HFC-23, have discovered a new profit center—CERs. Rather than venting the HFC-23, as they would normally have done, they can burn it for US$0.20 per ton of CO2, and earn CERs at the rate of $8 per metric ton of CO2 for doing so. In the end, they earn more from "abating" HFC-23 than from producing the primary product HCFC-22.

CDM Watch and Lambert Schneider, a German CDM expert who helped design the system at its conception, smelled a rat when they noticed that HCFC-22 production was rising steadily—despite the fact that, historically, it experienced more volatility in supply and demand.

"What I found most astonishing," Mr Schneider told the New York Times, "is that many of the plants produced exactly the amount where they are eligible to get credits for.”

He says data shows most of the firms now design their businesses around earning these carbon credits. HCFC-22 production has at least doubled since the CDM program began, and the output of heat-trapping HFC-23 has spiked as well. HCFC-22 is also a greenhouse gas and ozone-depleting substance.

This has sparked outrage among climate change advocacy organizations such as CDM Watch and Noe 21, which research carbon offsetting projects in industry.  "Sometimes they produce gas just to burn it and get some CDM money, and it's not at all an honest way of behaving," said Chaim Nissim, an engineer with the Geneva-based Noe21.
 
"It's fake," Nissim said.
 
"It's a real attack against the CDM," said Eva Filzmoser, head of the Bonn, Germany-based group CDM Watch. "There's a lot of money that's in there, and of course who wants to forget about it if you can have it?"
 
How many CERs have been generated from this manufactured pollution is unclear, but CDM Watch estimates as much as half of the 246 million CERs issued to HCFC-22 producers to date—earning around $2-billion for 19 firms and accounting for around half of all CERs generated—could have been given as a result of this perverse incentive. Those firms, though mostly in India and China, are also located in South Korea, Argentina, and Mexico.

Warning signs that not all was right in carbon markets first appeared in 2007. But the CDM Executive Board, a governing body within the UN in charge of overseeing the CDM rules and procedures, tightened the rules only in a minor way and the firms in question continued to take advantage of the UN-created carbon market for the next three years.
 
In its submission to the CDM Executive Board, CDM Watch has proposed to undo the perverse incentive by capping the number of CERs that can be issued for the destruction of HFC-23, reducing the number of CERs by 90 percent.
 
Patricia Adams of the Canadian-based environmental organization, Probe International, a carbon market critic and an economist by training, says that the firms have done nothing wrong. They just followed the ill-conceived market rules set up by the United Nations. Blame lies squarely with the UN, she says, for having created a perverse incentive which firms were only rational to exploit.
 
"The CDM market violates the most elementary economic rules by paying the polluter," Ms. Adams argues. "If HFC-23 is indeed a pollutant, make the polluters pay for the right to emit it. Then they will smartly find a way to abate."
 
The UN eschewed this real market mechanism, apparently, because the emerging economy countries like China and India didn't want to penalize their industries. Instead, it rewarded them, the UN way.

Further Reading:

• From the Daily Mail: "In the fields around this giant chemicals factory in Gujarat, the barren soil smells of paint stripper and the water from the well makes you gag. So why has it been given tens of millions of pounds of taxpayer-funded UN ‘green reward points’, which are traded hungrily on the financial markets at huge profit?" Read the full story.
• Scamming the carbon markets in ten easy steps
• Carbon credit fraud makes its way to Liberia
• It's official: global warming solutions will destroy the environment
• Power taken from the people: UN carbon scheme threatens to ‘recentralize’ forest governance, spelling doom for forest ecologies
• The Offsetters’ Paradox: Wind mills in China highlight incurable problem with international carbon credits
• Carbon may turn subprime
• Carbon offset companies: the new snake oil salesmen?
• Coming soon to a carbon market near you: regulation and corruption
• Gasping for air: Carbon markets stumble, again
• The great carbon con
• Carbon markets deflating in the wake of Copenhagen
• The state of affairs for carbon
• Breathe of fresh air: banks pull out of carbon market
• The next big scam: carbon dioxide
• Russian Roulette: Russia’s surplus of carbon credits too big of a gamble for some
• Group tracks carbon credit trading and issues warning
• Carbon credit scams add to the growing list of alleged fraud cases
• At what cost are carbon credits funding hydro projects in the developing world
• How Kyoto credit scams work
• Carbon Boondoggles