Carbon markets

101

What are carbon markets?

Photo by Tyler Casey on Unsplash

Carbon markets are trading systems in which carbon credits are sold and bought. Companies or individuals can use carbon markets to compensate for their greenhouse gas emissions by purchasing carbon credits from entities that remove or reduce greenhouse gas emissions.

One tradable carbon credit equals one tonne of carbon dioxide or the equivalent amount of a different greenhouse gas reduced, sequestered or avoided. When a credit is used to reduce, sequester, or avoid emissions, it becomes an offset and is no longer tradable.

So basically, what the carbon markets do is turn CO2 emissions into a commodity by giving it a price.

There are broadly two types of carbon markets: voluntary and compliance.

Voluntary carbon markets refer to the issuance, buying and selling of carbon credits, on a voluntary basis. The current supply of voluntary carbon credits comes mostly from private entities that develop carbon projects, or governments that develop programs certified by carbon standards that generate emission reductions and/or removals. Demand comes from private individuals that want to compensate for their carbon footprints, corporations with corporate sustainability targets, and other actors aiming to trade credits at a higher price to make a profit.

Compliance markets are created as a result of any national, regional and/or international policy or regulatory requirement. One type of compliance market that many people will have heard of are emissions trading systems (ETS). Operating on a “cap-and-trade” principle, regulated businesses – or countries, as in the case of the European Union’s ETS – are issued emission/pollution permits or allowances by governments (which add up to a total maximum, or capped, amount). Polluters that exceed their permitted emissions must buy permits from others with permits available for sale.

Current supply is still concentrated on crediting from renewable energy activities, improving energy efficiency, carbon and methane capture and sequestration but nature-based sources such as land use and reforestation are becoming increasingly important.

Why do we hear so much about carbon markets?

At a time when most governments around the world are still investigating how they will achieve their climate goals and what policy mechanisms they will leverage, there is a growing interest in carbon markets. Indeed, the Paris Agreement enables the use of market mechanisms such as emission trading systems, carbon taxes or international carbon trading through Article 6 and 83 percent of Nationally Determined Contributions or NDCs state the intent to make use of international market mechanisms to reduce greenhouse gas emissions.

Photo by František G. on Unsplash

While there are many opportunities – not least the fact that a share of the proceeds can support the most vulnerable countries to adapt to climate change, there are also serious concerns including issues related to double-counting of GHG emission reductions, human rights abuses, greenwashing and controversies about over-crediting from some projects. 

For carbon markets to be successful, these issues must be addressed. Emission reductions and removals must be real and aligned with the country’s NDC. There must be transparency in the institutional and financial infrastructure for carbon market transactions. And there must be adequate social and environmental safeguards to mitigate against any adverse project impacts and to promote positive ones. In particular, human rights must be respected, including those of indigenous peoples’ and local communities.

Last but not least, national and supranational guidance and regulation to promote market-wide standards will be essential to bolster integrity in the space and make day-to-day practices more robust and resilient.

No magic silver bullet

There are many theoretical possible uses of carbon removal units : complying with reduction obligations, meeting removal obligations, reducing / complying with tax obligations, offsetting of emissions at voluntary markets,…

Yet reductions and removals remain two inherently different things. Indeed, carbon removals cannot compensate delayed emission reductions. In addition, as climate change accelerates and ecosystem storage capacity declines, permanence becomes more and more challenging. Finally, they can be subject to verification, enforcement and ultimately accountability issues.

Should carbon removal become a compliance unit in the EU ETS or other similar systems, a robust definition will be necessary to guarantee that removals are only eligible if they remove atmospheric carbon and store it for the duration of CO2 atmospheric lifetime. 

In addition, the use should be limited to cases that do not divert the efforts from reducing emissions. Examples of such uses include complying with carbon removal obligations, voluntary uses for purposes other than offsetting (e.g. contribution claims) and disbursing subsidies and other incentives.

In a nutschell, permanent removals are an interesting lever that complement rather than offset emissions reductions. As such, it makes sense to keep a clear separation between the targets and the means for emissions reductions versus removals.