A carbon market turns CO2 emissions into a commodity by giving them a price. To do this, emissions must first fall into one of two categories: carbon credits or carbon offsets, both of which can be bought and sold on a carbon market. There are two types of carbon credit markets, the regulatory or compliance, and the voluntary market.
The compliance market is used by companies that, by law, have to account for their greenhouse gas emissions. On the voluntary market, the trade of carbon credits is on a voluntary basis. The main difference between the two markets is that compliance systems are regulated by a third party following established national, regional, or provincial laws, and emission mandates to achieve emissions reduction, while the voluntary market has no official entity that verifies emissions data.
The largest compliance carbon offset program is the United Nations’ Clean Development Mechanism (CDM), a product of the Kyoto Protocol. A few others include the European Union Emissions Trading Scheme (EU-ETS), and the cap-and-trade systems from California, Canada, China, New Zealand, Japan, and South Korea.
How do they work?
Each ton of CO2 is measured in carbon credits or CERs (Certified Emission Reductions). These credits are created during the implementation phase of the project and issued once the reduction has been accounted for, whether prevented from being emitted into the atmosphere (emissions avoidance/reduction) or removed from the atmosphere as the result of the project.
Any projects that want to offer CERs in the market will need to have their emission reductions validated and registered by an executive board to ensure that real and measurable emissions reductions are achieved.
In many ways, the voluntary carbon market operates similarly to the compliance market. However, it allows private companies and individuals to purchase carbon credits on a voluntary basis. The main goal of acquiring Verified Emission Reduction (VER) credits is to neutralize carbon footprints, typically motivated by Corporate Social Responsibility (CSR) and public relations.
Companies and individuals can acquire or buy carbon credits directly from projects, companies, or carbon funds. VERs must be verified by an independent third party and must be developed and calculated according to one of the existing VER standards.
Voluntary carbon credits help finance various climate action projects that would otherwise never get started. These projects have many benefits like pollution prevention, public health improvements, and job creation. Voluntary carbon credits also support investment innovations to lower the cost of new climate technologies. The voluntary market also gives access to people like farmers, ranchers, and landowners, whose operations can often generate carbon offsets for sale.
One current problem with the voluntary market is the lack of transparency, monitoring, and projects with varying data reports. Some credits have turned out to represent emissions reductions that were questionable at best, mostly due to lack of regulation. The market makes it challenging for buyers to know whether they are paying a fair price and for sellers to manage the risks of financing and working on projects without knowing how much buyers will actually pay for carbon credits.
Carbon markets are essentially trading systems in which carbon credits are bought and sold.
Currently, one carbon credit equals one ton of carbon dioxide (or the equivalent amount of a different greenhouse gas being reduced, removed, or avoided).
The main difference between the different markets is that a VER (voluntary market), unlike CERs (mandatory market), cannot be used to achieve obligations under programs like the United Nations’ Clean Development Mechanism (CDM). However, a CER can be accepted by entities wishing to voluntarily offset their carbon footprint for things like CSR.
For carbon markets to be successful, emissions reductions must be real, verifiable, and aligned with a respective country’s standards. Data collection and technologies that provide insight into this information will allow for the shaping of modern regulations. Furthermore, transparency must exist in both institutional and financial systems for carbon market transactions and there must be sufficient social and environmental safeguards in place to mitigate any unfavorable project impacts.