How can carbon-offsets work?

What do Norway and the New Jersey Nets have in common? They are among the myriad entities declaring that they are or will be carbon neutral. That's is great but it reminds of one thing that has been bothering me for a while now. In a lot of these cases, they rely on "carbon offsets". And to me, well I have an issue with carbon-offsets -- they can't work. Here's a rant expanded from an email exchange I had back in November 2007.

First of it's not that I'm not green -- far from it, I even joined Greenpeace way back! Second, it's not that I don't believe in markets -- far from it! So now let's back up for a second and consider the common "green market mechanisms". As far as I know (which is not much but hey, who else is around?), there are four types of incentive-based mechanisms being suggested in the world with the goal of reducing the amount of carbon in the atmosphere due to human activity. Do they work? And what's wrong with carbon-offsets in particular?

My favorite is the carbon removal X-prize. A prize is a very efficient way of funding R&D. Basically you put up a $25M prize, and it might lead to 10 teams spending $24,999,999 each in parallel, and then one or more of them would actually solve it, while creating many useful partial solutions and spin-offs along the way! So from society's point of view, you get up to $249,999,999 worth of R&D using just $25M to stimulate it. But it's a long shot approach, excellent return, but high risk. Clearly, the world needs incremental approaches as well to balance our species-survival portfolio.

The popular incremental approach is cap & trade. That seems to work.. Sounds like the incentives are right on. Those who can figure out ways to reduce emissions get rewarded, and those who can't, pay for it. Both sides work incrementally thus, without any huge disruptions to society, we get gradual improvements. The only problem is that the cap levels are kind of arbitrary and could be changed by fickle and/or corrupt politics which might distort the incentives. Still given some consistency across time and space, the incentives should work as expected because both the reward and the penalty happen at more or less the same time.

If you really think about it, carbon tax is a simpler better version. It has the advantages of cap and trade with fewer costs, and it can work more widely since it wouldn't only apply to specific industries. The only downside is that its' tough to get people to support anything with the word "tax" in it. (So the difference in cost between "carbon tax" and "cap & trade" is simply the cost of weak leadership in democracy.

But really maybe there's a magic solution? One with no new taxes! Yay! No caps or limits! Yay! A win-win solution! Maybe... carbon offsets. Are they too good to be true? Yes. Here's the problem as I see it: If I want to build a carbon-belching factory or travel on a carbon-spewing jet plane, and then offset it by paying someone to plant a forest of trees, what will prevent the trees from being cut down in the future? When that tree will be cut down or die -- after 5 years or 20 years or 500 -- really changes the value of the offset and whether it truly cancels out my plane trip or my factory.

And here securing the tree is not just another implementation detail. It's a central, fundamental flaw of the market. Because the incentives are not there. If I'm the polluter and you're the off-setter, once I pay for the right to pollute, I will happily pollute and I don't care anymore about whether you truly keep the tree alive, I've already gotten the credit for it. You the seller can take my money and still cut the tree. This is not like normal uncertainty/risk about the value of a product or service. In a normal market, the buyer wants to get the stuff they bought, which is what keeps the seller from cheating. But in the carbon offset, the buyer has no incentive to care once they got the credit, and the seller, once they are paid for planting, has a huge incentive to just chop the tree and use the wood.

Of course people cheat in all markets. But enforcement, regulations etc. can only work if the vast majority of buyers and sellers have the basic incentives to make it work, and the law only has to deal with a small minority of cheaters. For example in stock markets or commodity markets, the buyers and sellers police each other because if one cheats the other loses. In the carbon-offset market, they can both cheat and not tell anyone. SO enforcement is going to be prohibitively expensive. Basically you have to set up a well-meaning intermediary like a fund that receives the money from the offset buyers and pays out the planters over the lifetime of the tree... That's a huge problem.

My guess is the offset market is of purely psychological value... It's very much like Catholic "indulgences" that you could buy from the church to cancel out your sins in exchange for some money. Clearly a very profitable scheme. If you're the church, it's just free money. It's better than free money: they give you money and they thank you and you increase your power over them! Which begs the question... Who is the church of carbon-offsets?