‘Perverse’ Carbon Payments Send Flood of Money to China

To offset their own carbon emissions, European companies have been overpaying China to incinerate a powerful greenhouse gas known as hfc 23. And in a bizarre twist, those payments have spurred the manufacture of a harmful refrigerant that is being smuggled into the U.S. and used illegally.

European legislators in Brussels have discovered that the strategy they devised to combat climate change is helping subsidize the economy of their, and America’s, major global competitor — China. European companies have been overpaying Chinese companies more than 70 times the cost to eliminate a potent greenhouse gas — triflouromethane, or hfc 23, a byproduct of manufacturing a refrigerant that has been banned in developed countries and is being phased out in developing ones.

In order to offset their own greenhouse gases, companies and utilities in Europe that are subject to the emission limits of the Kyoto Protocol have been paying vastly inflated prices to Chinese companies to destroy hfc 23, and in the process have been providing the Chinese government with hundreds of millions of dollars in tax revenue to compete against Europe’s own “green” industries. European concern about this practice was a major source of contention during last week’s climate negotiations in Cancun, as the UN attempted to defend the integrity of the multi-billion dollar global carbon offset market.

Two European Parliament members have alleged a ‘gross misuse of European consumers’ money.’

And in an odd twist, the incentives offered through the UN’s Clean Development Mechanism (CDM) also appear to be stimulating production of an ozone-depleting refrigerant gas that has been landing in the U.S. black market. Investigations by the U.S. Environmental Protection Agency (EPA)and U.S. Customs and Border Protection have led to the conviction of several smugglers who have illegally imported the ozone-depleting refrigerant, hcfc 22, into the U.S. for sale to trucking companies, supermarkets, automotive supply shops, and other large-scale users of refrigerant gases. The illegal refrigerant is significantly cheaper than non-ozone-depleting refrigerants permitted in the U.S., a price discrepancy triggered partially by the large overpayments to Chinese firms that have led to an ample supply of hcfc 22 on the international black market.

That black market completes a global circuit unique to the era of climate change: From China’s industrial zones, the credits for the greenhouse gases — bought and sold as commodities on the global carbon markets — flow to European companies that need them to continue polluting at home, while the underlying ozone-depleting gas responsible for creating those credits flows to American companies seeking discounted refrigerants.

“It’s perverse,” says Gerben-Jan Gerbrandy, a Dutch member of the European Parliament. “You have companies which make a lot of money by making more of this gas, and then getting paid to destroy it.”

Two European nonprofits, the Germany-based CDM Watch and the London-based Environmental Investigation Agency, kicked off the controversy when they asserted last summer that European companies were paying dramatically inflated prices for the emissions credits. Companies purchase the credits for about $15 a ton, while the actual cost for incinerating the gas in China or India is around 20 cents a ton. More than a billion dollars, the nonprofit groups concluded, have thus far been spent on the credits. Two members of the European Parliament have demanded an inquiry by the European Commission into the “gross misuse of European consumers’ money” in the UN-administered offset system.

“European consumers are paying a billion euros to buy something worth less than 100 million euros,” says Theodoros Skylakakis, a Greek member of the European Parliament, who, along with Gerbrandy, demanded that the commission begin tightening the rules governing the hfc 23 offsets in the European Trading System. “Some people are getting extremely rich because of a loophole in our Clean Development Mechanism,” says Gerbrandy.

Hfc 23 is, per pound, 11,000 times more potent than CO2 as a contributor to global warming.

Hfc 23 is, per pound, 11,000 times more potent than CO2 as a contributor to global warming. The European Union has adopted a carbon emissions trading scheme, and more than half of the 474 million tons of emission credits now utilized to offset companies’ emissions are involved in paying firms in China and elsewhere to destroy hfc 23. Major utilities in Germany, the UK, the Netherlands, Italy, and Japan rely heavily on these emissions offsets, as do a number of U.S. companies operating in Europe, including Chevron and Conoco Philips. Major U.S. financial houses, such as Goldman Sachs, Citibank, and JP Morgan Chase have significant holdings in the credits linked to the gas.

The greenhouse gas is a byproduct of the manufacture of the refrigerant gas. And the offset credits paid to Chinese and Indian companies to eliminate the former, according to CDM Watch, have actually stimulated increased production of the latter — the ozone-depleting refrigerant hcfc 22, which is itself a potent greenhouse gas. CDM Watch has compiled records showing that companies in China and India have significantly increased production of hcfc 22 in order to receive funds to incinerate the byproduct gas, hfc 23. Some basic math suggests why: According to the Environmental Investigations Agency, the price for a ton of hcfc 22 fluctuates from $1,000 to $2,000, while that same ton can generate about $5,000 to $6,000 in hfc 23 Clean Development Mechanism credits.

The United Nations Environment Programme reports that from 2004 to 2009, production of the ozone-depleting hcfc 22 refrigerant gas grew from 15 million to 28 million tons, paralleling the evolution of the offset program intended to eliminate its byproduct, hfc 23. But Hcfc 22 itself is actually the replacement gas for the ozone-destroying chlorofluorocarbons that have largely been eliminated under the 1989 Montreal Protocol, a treaty signed by 196 countries to reduce depletion of atmospheric ozone. Hcfc 22 is already illegal in Europe, and is sold in the U.S. only in small quantities strictly licensed by the EPA. Developing countries have until 2030 to phase out hcfc 22 completely.

Some of the rapidly increasing production of hcfc 22 is being used in developing countries, where a growing middle class can afford for the first time to purchase products using refrigerants, such as air conditioners. But the illegal refrigerant is increasingly showing up in the U.S. black market.

The European offset payments are setting the Kyoto and Montreal Protocols on a collision course.

Over the past year, in an effort dubbed Operation Catch-22, federal investigations have led to several convictions of people smuggling hcfc 22 into the U.S. In one instance, Alex Garrido, president of an import-export firm called Kroy Corporation, was arrested after an Operation Catch-22 team caught him on surveillance tape receiving, storing, and preparing to sell illegal shipments of hcfc 22 from China. Garrido pled guilty and was sentenced in February to two-and-a-half years in prison. In another instance, the St. Louis-based Marcone Company, a wholesale supplier for hardware stores and large construction projects, was accused of violating the Clean Air Act for attempting to sell more than 220,000 pounds of the illegal refrigerant.

Thomas Land, who works in the EPA’s Office of International Negotiations — and who is involved in coordinating diplomatic and enforcement efforts for the Montreal Protocol — says that the UN-administered subsidies to eliminate hfc 23 have led to an oversupply of hcfc 22. And the increasing supply has led to a decreasing price. “Because production is subsidized, the prices are artificially low,” Land says.

This has made the illicit gas far more financially attractive to large-scale users of refrigerants in the United States than the more expensive, non-ozone-depleting refrigerants. In this way, the European offset payments are setting the Kyoto and Montreal Protocols — the two seminal environmental treaties of our time — on a collision course.

China, the world’s largest emitter of greenhouse gases, is at the center of the brewing controversy. China is host to two-thirds of the 474 million tons of emission reductions that the UN says have resulted from the sale of offsets, according to a team of researchers at Dartmouth College’s Climate Justice Research Project, who have been studying the global offset markets. Overall, 60 cents of every dollar spent on the global carbon markets goes to China; and 50 of that 60 cents goes to eliminating hfc’s. Of the 19 refrigerant factories receiving credits through the Clean Development Mechanism, 11 are in China, which accounts for 80 percent of the hfc credits. (Another five hfc projects are in India, and one each is in South Korea, Mexico, and Argentina.) European companies and countries have channeled more than a billion dollars into Chinese projects aimed at eliminating hfc’s.

In response to the huge windfall of profits under the scheme, the Chinese government has imposed a 65-percent tax on all corporate profits from emissions reductions schemes. Over the last five years, the tax revenues have amounted to at least $650 million. The money is channeled into an arm of the Chinese Ministry of Finance called the CDM Fund.

Though the funds are generated via the Clean Development Mechanism, the government has no obligation to report how they are being used. As of October, according to the fund’s website, it appears that none of the money had yet been spent. When, and if, those hundreds of millions of dollars are spent, a significant portion is earmarked for the further development of China’s renewable energy industries, including wind and solar power — technologies in which China is already beginning to dominate world markets.

“We are providing unacceptable subsidies to Chinese industries that are already close to dominating the global market in renewable energy technologies,” says the European Parliament’s Gerbrandy. In other words, to Europe’s — and America’s — competitors.

The controversy over hfc’s came to a head at the climate negotiations in Cancun last week.

In the last week of November, CDM Watch and the Environmental Investigations Agency presented their critique to the executive board of the UN’s Framework Convention on Climate Change. The central question, according to Eva Filzmoser, program director of CDM Watch, is whether the hfc credits, vital to the functioning of the cap-and-trade system borne of the Kyoto Protocol, actually deliver the emission reductions being paid for. “The gap between the price for the credits and the actual costs for incinerating the gas,” she says, “means we have a huge amount of money not being spent on actually reducing emissions.”

The claim puts the UN in a quandary. It has no power to rescind past credits, even those whose integrity is called seriously into question. Reassessing the validity of credits that account for at least half of the capital now churning into the offsets could set off a chain reaction, challenging the structure and integrity of the global carbon markets. The International Emissions Trading Agency, representing the world’s carbon traders, has expressed opposition to the changes, stating that the decision be based on “sound environmental and economic analyses of the consequences.”

On Nov. 25, the European Commission proposed that the European Trading System (ETS) no longer accept hfc credits starting in 2013. That proposal awaits approval by the European Parliament and the EU’s Council of Ministers. If approved, it would put the UN in another quandary: How to assess the real value of the bulk of certified emission reductions already on the market, and how to move forward when the ETS — the world’s biggest market by far for emission credits — will be refusing to accept them in three years? UN officials declared that they would study the matter, while also issuing another 20 million tons worth of credits for an hfc project, to be used by a consortium of European utilities.

The controversy over hfc’s came to a head at the climate negotiations in Cancun last week. Last Tuesday, Chen Huan, deputy director of China’s CDM Fund, the recipient of the hfc tax revenues, denounced the attempts to reduce the use of hfc credits as “irresponsible,” and attacked the calculations on which they are based as “implausible” and lacking in documentation. He threatened that Chinese industries would vent hfc gases without government controls if the subsidy program was discontinued, telling Point Carbon News — a market monitoring and news service — that efforts to stop the credits are “not acceptable for China because it deviates from the principle of common but differentiated responsibilities.”

The Environmental Investigations Agency and CDM Watch responded by accusing the Chinese of holding the climate “hostage” and saying that the funds already generated through the hfc tax revenues “would be enough to fund the actual cost of HFC-23 destruction in China for at least 50 years, well beyond the date when HCFCs will be phased out by the Montreal Protocol.”

Meanwhile, money continues to pour into the Chinese CDM Fund, and Operation Catch-22 enforcement agents continue to lay traps for the new generation of ozone gas smugglers.