Carbon markets are trading systems in which companies or individuals can buy and sell credits that represent the reduction, sequestration or avoidance of greenhouse gases (GHG). One tradable carbon credit equals one tonne of CO2 or an equivalent GHG reduced, avoided or sequestered. These are used by companies or individuals to offset the emissions they themselves generate, thereby reducing their environmental footprint and achieving their net-zero goals.
The voluntary market makes up the bulk of the carbon credit trading sector, with buyers and sellers coming from all over the world. The global market value of this kind of carbon credit exchange stood at just under $6.7 billion as of September 2021, according to Ecosystem Marketplace, a carbon-market intelligence company.
There are also mandatory carbon markets, such as the EU Emissions Trading Scheme and post-Brexit UK national emissions trading scheme. In these, a limit on the amount of certain GHGs that an operator can emit is set and companies that exceed their allowances risk heavy fines. To stay under their cap, they can purchase carbon credits from other participants in the market, or from the government if they have unused allowances.
These credits are generally produced through projects that generate additional ‘co-benefits’ such as improving welfare for local populations, better water quality or the reduction of economic inequality. As such, they tend to trade at a premium over those from industrial projects. Certification standards play a crucial role in determining this price premium. The most widely used standard, called Verra, sets accounting methodologies specific to each project type, independent auditing and a registry system, to ensure that both the buyer and seller have confidence that the carbon credits they are purchasing are legitimate.
Despite the benefits of carbon credits, the voluntary market is a fragmented space and there are many different types of schemes that offer them. This has led to a variety of different pricing structures, with prices differing significantly across countries and sectors. It has also created uncertainty about how the credits are characterized legally and how they can be exchanged between the various schemes.
To help resolve this, the Taskforce and the UNFCCC envisage international databases or registries to track details of transactions. However, a central authority that can manage the synchronization of these registries has yet to be established. A good candidate for this role would be a trusted and respected international body, such as the Financial Stability Board or a UN agency.
While the global carbon market has a number of challenges to overcome, it is growing quickly. This is mainly due to interest in meeting corporate net-zero targets and the Paris Agreement’s aim of limiting warming to 1.5 degrees Celsius above preindustrial levels. The next major challenge will be to ensure that a common time frame, price, standard and measurement are applied across all the trading schemes around the world. Without this, the potential to reduce GHG emissions could be severely limited. For this reason, an international registry is crucial.