What’s the purpose of the Carbon Markets?
Pollution is what economists refer to as a negative externality of today’s production and supply chains. It is a cost to society not accounted for in the market price of an end product. When pollution remains unregulated and there is no cost to the polluter, the cost to society in the end can be significant.
There are, however, many ways of regulating the amount of pollutants that are allowed into the atmosphere. For very harmful pollutants, like lead, legal limits apply, which must be adhered to. However, when it comes to regulating CO2 emissions, governments around the world have favoured market mechanisms, and in 1997, one outcome of the Kyoto Protocol negotiations was to establish just such a set of flexible market mechanism (the “Carbon Markets”) that would allow companies or countries the ability to trade GHG emissions permits and drive emissions reductions at the same time.
The trading system under a global marketplace was designed to operate in two ways;
- A managed ‘cap-and-trade’ scheme (eg. the European Union Emissions Trading Scheme) to help lower global emissions by limiting and reducing a country’s or company’s permit to pollute (“allowances”) over time. Cap and trade systems do not put a price on emissions. Instead, they set a cap on the total emissions that are allowed in the system. Permits are issued to businesses yearly, either through auction or free allocation, each permit giving the right to emit one tonne of CO2. The number of permits issued is then reduced every year, ensuring that total emissions go down over time. Businesses can trade permits which creates a market price for carbon. In short, a cap and trade system determines the quantity of emissions that are allowed, and the market determines the price.
- Offsetting mechanism whereby a country or company can compensate for its residual or unavoidable emissions by purchasing a carbon credit (1 carbon credit = 1 tonne of CO2e) from a project reducing carbon emissions elsewhere in the world (“offsetting”).
The idea behind all this is that, over time, it should become cheaper to abate emissions in-house rather than purchase carbon credits - creating a financial incentive to curb GHG emissions and increase action to mitigate global impacts of climate change.
Additionally, under the Kyoto Protocol this offsetting mechanism meant money through carbon finance would flow from the developed nations (historically, the big emitters who had set climate targets) to projects in developing nations. Alongside reducing GHG emissions, such projects often host other social and environmental co-benefits for the surrounding area and communities.
What’s the distinction between compliance and voluntary markets?
Simple - one is compliance, and the other is voluntary.
The early compliance markets developed under the UN, and Government mandated, were targeted towards heavy polluting industries and nations. Participation was mandated.
Over the years, non-compliant private sector contributors sought out to buy carbon credits on a voluntary basis, as a way of building upon existing CSR strategies. This established the need for a Voluntary Carbon Market (VCM) – governed and regulated by specific organisations and standards, rather than governments.
What changed for these markets under the Paris Agreement?
Firstly, the Paris Agreement recognised the need for truly global action – meaning all (or almost all) countries adopted their own climate targets – not just the richer, developed nations as was the case with the Kyoto Protocol. This also meant that emissions reduction (offset) projects could be set up in all countries – not just the poorer, developing countries.
Secondly, as the VCM evolved, it was recognised under Article 6 of the Paris Agreement the need for a more established and regulated voluntary market to ensure integrity, transparency and quality assurance for corporate buyers and projects.
With both of the above in mind, negotiators on Article 6 have been working over the past 6 years to set out the rules and governance structures to overcome some of the key challenges, including carbon offset accounting (for example: where to count the carbon offset if the business that buys it is in a different country than where the project is hosted) and claims, to support developing a strong, standardised and commoditised market.
Such rules are fundamental to build trust and confidence for buyers and needed to create the climate change action needed to keep us in line with our ambitions to keep under a 1.5c warming scenario.
How is Price determined in the VCM?
Whereas price in the compliance markets is managed, there are numerous variables determining price in the VCM. These include but not limited to; shadowing of the compliance markets; project type; project location (land and establishment costs); standards under which the projects are certified; and project co-benefits (i.e. helping improve social, community-based benefits such as health and wellbeing, gender equality etc).
More recently, another key driver of the price of carbon credits has been a significant influx of demand off the back of growing climate awareness, driving corporate carbon neutrality and net zero pledges. The demand increase of existing, issued carbon credits may lead to shortening supply, and therefore increasing prices.
The increased carbon price per unit will subsequently;
- More closely reflect the societal & environmental impact of carbon in our atmosphere
- Incentivise new development of carbon projects – and new climate innovations
- And ultimately, reach a point where it becomes cheaper to address ‘hard-to-abate’ emissions
What is Forest Carbon’s Role in all this?
Within the international Voluntary Carbon Markets, Forest Carbon is primarily focused upon driving action for UK projects – working with Nature Based Solutions such as New Woodland Creation, Peatland Restoration and newly emerging innovations.
Our core purpose is to maximise investment and optimise its impact, so that land managers across the country can harness the power of natural processes to help restore our environment and put our society on a path to genuine sustainability. To find out more about Forest Carbon.
How can I act?
Depending on whether you’re an individual, household or business, there always ways you can reduce your footprint on the planet.
For businesses this may mean taking action to mitigate the impact of your operations (Scopes 1, 2 and 3) or a specific activity/event, enhancing the environmental proposition of your products and services, or simply taking action in line with your CSR approach.
Following best practice, we recommend an approach to 1) accurately measure the carbon footprint of your operations and/or products, 2) set out and begin implementing your reduction strategy, and 3) compensate for unavoidable, residual emissions by support high quality projects mitigating emissions elsewhere with a reputable partner such as Forest Carbon.
For individuals, we recommend the using a similar approach to adjust your lifestyle and live more sustainably.