Which agency should regulate carbon credits in the US?

Introduction

Project-based carbon credits are intended to harness private investment to mitigate climate change. A carbon credit is a transferable unit that generally represents one metric ton of carbon dioxide or carbon dioxide equivalent.¹ In the voluntary carbon market, companies and other entities buy carbon credits from project developers or intermediaries to counteract their own greenhouse gas (GHG) emissions. There is no legal requirement to participate. In a compliance carbon market, a government sets a total emissions limit and requires covered entities to obtain, either directly from the government or by trading with each other, permits (called “allowances”) for each ton of pollution they emit. These programs are often called cap-and-trade, or emissions trading, systems. Some compliance markets let covered entities use a limited number of project-based carbon credits for compliance purposes.²

Despite their promise to mitigate GHG emissions and their increasing adoption, project-based carbon credits and the markets where they trade face significant challenges. A substantial majority of carbon credits (potentially over 80%, according to a handful of recent peer-reviewed studies) suffer from integrity problems—meaning that they often do not represent the claimed level of emissions reductions or removals (or that they cause negative externalities).³ Misaligned incentives and market failures in markets for carbon credits likely contribute to these integrity problems. On the supply side, misaligned incentives among project developers, crediting programs, and validation and verification bodies may subtly encourage inflation of projects’ emissions reductions or removals and over-issuance of carbon credits.⁴ In addition, information asymmetries make it challenging for buyers to distinguish between high-integrity and low-integrity credits.⁵

These problems have harmed the credibility of project-based carbon credits as a tool for mitigating climate change. And while private standard-setters like the Integrity Council for the Voluntary Carbon Market have made incremental improvements, they have not yet resolved these issues. Meanwhile, some advocates have begun to explore other frameworks for carbon crediting that would depart more drastically from the current system.

Project-based carbon credits remain largely unregulated in the United States (and throughout the world). Federal regulation could address these problems, restoring the credibility of carbon credits as tools for mitigating climate change and increasing private spending to further this goal.

This policy brief examines which federal agency or agencies would be competent to regulate project-based carbon credits in the United States. The policy brief first examines the suitability of several U.S. federal agencies that advocates and stakeholders have suggested might regulate project-based carbon credits: the Environmental Protection Agency, the Department of Energy, the Department of Agriculture, the Commodity Futures Trading Commission, the Securities and Exchange Commission, and the Federal Trade Commission. (See the summary table below.) It then provides background about how some U.S. states and foreign governments have regulated project-based carbon credits or, relatedly, compliance carbon markets. It concludes that both the Environmental Protection Agency and the Department of Energy are competent to regulate project-based carbon credits, because both agencies have relevant missions, experience, and technical expertise. As between these two agencies, the choice may depend on political considerations; no federal agency currently has authority to directly address the integrity problems that affect project-based carbon credits, and changing this would require an act of Congress.

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