Last month, the Washington Post released the findings of their six-month investigation into rainforest carbon offset projects located in the Brazilian Amazon. The Post concluded that more than half of these projects showed signs of fraud. This mirrors similar investigations, which determined that the majority of rainforest offset credits issued by the largest certifier of credits may be worthless. A 2023 study calculated that as few as 12% of all existing carbon offsets create a real reduction in greenhouse gas emissions, while the rest provide no benefit to the environment.
These disturbing reports show that, as countries and companies rush to honor their pledges to become net carbon neutral, they risk buying false and fraudulent carbon offsets that are essentially worthless. Morgan Stanley has predicted that the voluntary carbon offset market, which totaled around $2 billion in 2020, will grow to around $250 billion by 2050, putting billions of dollars at risk while failing to protect the environment.
Due to the novelty of carbon offset projects, their complexity, and the lack of regulation, whistleblowers will play a critical role in uncovering fraud committed in connection with the offering of these projects.
What Is the Voluntary Carbon Market?
There are two types of markets that trade carbon credits: compliance (also referred to as “regulatory” or “mandatory”) and voluntary.
Compliance Carbon Markets
Compliance carbon markets are those markets where participation in the market by certain carbon emitters is mandated by regulation.
An example of a compliance market is the European Union Emissions Trading System (ETS), the world’s oldest carbon credit market. The EU ETS regulates around 10,000 industrial plants and power stations and approximately 390 aircraft operators. The ETS is a “cap and trade” model, which limits a company’s annual greenhouse gas emissions and allows companies to trade their emission rights through carbon credits, also known in this context as emission allowances.
Each emission allowance permits a company to emit one metric ton of carbon dioxide or equivalent greenhouse gas. Companies must either buy these allowances at auction or, in some cases, receive free allocations from the government. If a company emits more than its limit, it must purchase additional allowances from the market or face heavy fines.
The United States does not regulate greenhouse gas emissions at the federal level, so there is no national compliance carbon market, but some individual states and regions have created their own cap-and-trade programs, such as the California Air Resources Board Cap-and-Trade Program .
Voluntary Carbon Markets
A voluntary market, by contrast, is exactly what it sounds like: market participants are not compelled to limit emissions but choose to buy and sell carbon credits to reduce their carbon footprint. The carbon credits traded in a voluntary carbon market are carbon offsets, a type of carbon credit that allows businesses and individuals to compensate for their own emissions by investing in a project that reduces emissions elsewhere. An airline, for example, can invest in reforestation projects to offset the greenhouse gas emissions created by its flights.
Voluntary carbon markets are unregulated, and the price and quality of carbon offsets vary widely among projects. This has led to widespread fraud and a public clamoring for governments or third-party organizations to impose strict standards on the voluntary carbon market. The European Union ETS does not allow companies to use international carbon offset credits because of their questionable quality.
What Are Carbon Credits?
The term “carbon credit” is often used interchangeably to refer to both an emission allowance (or carbon allowance) used in compliance markets and a carbon offset, used primarily in voluntary markets. In both cases, one carbon credit generally corresponds to one metric ton of carbon dioxide or other greenhouse gas.
What Are the Different Kinds of Carbon Offsets?
There are generally three kinds of carbon offset credits: reduction, removal, and avoidance.
Carbon reduction
Carbon reduction projects use new technology or new practices to decrease the amount of greenhouse gas emissions compared to prior uses. An example of a popular carbon reduction project is the distribution of low emission cookstoves in developing regions where millions of families cook with wood fires, kerosene, or other smoky fuels.
Carbon removal
Carbon removal projects extract carbon dioxide from the atmosphere and lock it away in a harmless form. Removal projects can be nature-based, such as tree planting and reforestation, or technology-based, such as direct air capture and storage.
Carbon avoidance
Carbon avoidance projects prevent carbon emissions from happening. One of the most prevalent examples is avoiding deforestation. Wildfires and logging account for the release of more than 8 billion tons of carbon dioxide every year, or up to 19% of the world’s greenhouse gases. In a process similar to a conservation easement, landowners can earn carbon offset credits by pledging to protect their forests.
Many Carbon Offset Projects Overestimate Their Benefits
Most carbon offset projects suffer from the same flaw: their environmental benefits are perilously difficult to quantify. This leads to the overestimation of carbon credits in the voluntary carbon market. It can also lead to outright fraud.
For low-emission stove projects, for example, one must consider the efficiency of the different types of stoves used in the projects and whether their use is actually adopted by the recipients. One study found that these projects overestimate their carbon credits by a factor of 10.
It is even harder to quantify the benefits of carbon avoidance projects, which must estimate the amount of greenhouse gases that would have been released, absent the project. These calculations are often based on speculation. Some experts are calling avoided deforestation carbon offsets “a scam” that produces “phantom credits.” In a recent study, researchers examined dozens of avoided deforestation projects and determined that only 6% of the offset credits generated by these projects represented a real reduction in emissions.
Fraud is rampant among these projects. Given the lack of regulation and the lack of transparency in how benefits are determined, criminals can easily create and sell illusory carbon credits. The recent Washington Post article explained just one method, in which the majority of Brazilian avoided deforestation projects included protected public lands where logging is already prohibited.
The Federal Government Position on Voluntary Carbon Markets
This past spring, the White House issued a joint statement of Policy and New Principles for Responsible Participation in Voluntary Carbon Markets that attempts to address these deficiencies in the voluntary carbon markets. The statement is the U.S. government’s pledge to advance the responsible development of voluntary carbon markets with “clear incentives and guardrails in place to ensure that this market drives ambitious and credible climate action and generates economic opportunity.”
CFTC is Looking for Carbon Market Whistleblowers
The CFTC has recognized the harm that is being caused by fraudulent carbon offsets and has claimed anti-fraud and anti-manipulation authority in carbon credit markets, including carbon offsets. The agency’s Whistleblower Office issued an alert last year informing the public on how to identify and report potential Commodity Exchange Act (CEA) misconduct connected to fraud or manipulation in the carbon markets.
The Commission is soliciting whistleblowers to come forward with information about fraud or manipulative trading of carbon credits and other environmental commodities as well as related derivatives.
The CFTC is asking potential whistleblowers to be on the lookout for:
- Manipulative and wash trading or other violations of the CEA in carbon market futures contracts;
- Fraud in the underlying spot markets related to ghost/illusory credits listed on carbon market registries;
- Double counting or other fraud related to carbon credits;
- Fraudulent statements relating to material terms of the carbon credit, including, but not limited to: quality, quantity, additionality, project type, methodology substantiating the emissions claim, environmental benefits, the permanence or duration, or the buffer pool; and
- Manipulation of tokenized carbon markets.
The CFTC’s Whistleblower Program offers whistleblowers between 10% to 30% of the amount of monetary sanctions collected when the total monetary sanctions exceed $1 million. Whistleblowers can anonymously report fraud through an attorney and are protected by the CFTC’s policy against retaliation.
The whistleblower alert is a rare move by the CFTC to specifically call on whistleblowers to report fraud or manipulation in a particular sector—environmentally related products.
The CFTC’s whistleblower program has been a huge success. Since issuing its first award in 2014, the CFTC has awarded approximately $370 million to whistleblowers and enforcement actions associated with those awards have resulted in monetary relief totaling more than $3.2 billion.
Report Carbon Market Fraud
If you know of carbon market fraud and would like to talk to an experienced whistleblower attorney, contact Phillips & Cohen for a confidential review of the matter.
Phillips & Cohen’s partners include the former Director of the CFTC’s Whistleblower Office, Christopher Ehrman, first Chief of the SEC Office of the Whistleblower, Sean X. McKessy, and the attorney with the most whistleblower awards under the Dodd-Frank Act, Erika Kelton.
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