Decoding Carbon Markets
What is a Carbon Market?
Carbon markets are platforms where carbon credits can be traded between buyers and sellers. These markets have become important for organizations aiming to achieve net-zero carbon emissions, enabling them to purchase credits from reduction projects. Carbon markets are broadly classified into Compliance Carbon Markets and Voluntary Carbon Markets (VCM).
Types of Carbon Markets
1. Compliance Carbon Market:
Compliance markets operate under mandatory regulations established by national, regional or international emission reduction programs. It is designed to manage emissions from industries such as power generation, oil refining, aviation, and steelmaking.
These markets set carbon prices through regulations such as carbon taxes or cap-and-trade systems that make greenhouse gas emissions more expensive.
Government or international companies allocate emission credits, and companies must stay within these limits or purchase additional credits if they exceed them.
Under the Paris Agreement, for example, more than 60 countries have adopted such an approach to meet their Nationally Determined Contributions (NDCs) in the form of emission reduction targets.
2. Voluntary Carbon Market (VCM):
Voluntary markets exist without government regulation and allow individuals and businesses to voluntarily purchase carbon credits to offset unavoidable emissions.
These markets encourage emissions reductions but focus primarily on residual emissions that cannot currently be eliminated due to technological or economic constraints.
Each Voluntary Carbon Credit (VCC) represents one tonne of CO2 (or GHG equivalent) reduced or eliminated through accepted projects.
Businesses aiming for carbon neutrality often focus on reduction projects, while those striving for net-zero emissions prioritize removal projects that physically extract carbon from the atmosphere.
Examples of carbon offset projects in VCM:
Reduction Projects: Reduce carbon emissions by converting to renewable energy or improving energy efficiency.
Removal Projects: Sequestering carbon through reforestation or advanced technologies such as direct wind capture.
Key Differences between Compliance and Voluntary Carbon Markets
Regulations and Purpose:
Compliance markets are regulated by the government, and businesses are mandated to meet regulatory requirements. Examples include emission trading schemes and carbon taxes, such as the Korea Emissions Trading Scheme.
Voluntary markets are driven by incentives, where firms and individuals choose to participate to meet sustainability goals or make green claims.
Scope and Mechanisms:
Compliance markets often include schemes such as CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation) under the Paris Agreement, where countries and industries trade for NDCs (Nationally Determined Contributions).
Voluntary markets rely on independent verification systems to ensure credibility and transparency.
The Challenges of a Voluntary Carbon Market:
Quality Concerns:
Many voluntary carbon credits (VCCs) face scrutiny for overestimating their impact on emissions reductions, undermining trust and confidence in the market.
Price Transparency:
Variability in project types and vintages makes it difficult to determine exact prices, creating challenges for buyers, sellers, and traders.
Complexity in Standards and Registries:
Too many standards, procedures, and labels complicate market navigation. Transferring credits and obtaining a retirement or certificate can also be difficult, leading to disengagement.
Carbon markets, whether compliance-based or voluntary, play a critical role in global efforts to mitigate climate change. By enabling the trading of carbon credits, they incentivize industries to reduce emissions and invest in cleaner technologies. However, improving transparency, quality standards, and pricing mechanisms remains key to ensuring their long-term success.
