Jakub Fegyveres
Carbon markets are, currently, a highly topical issue in contemporary environmental policy. Included as one of the three mechanisms for cross-border "voluntary cooperation" within the framework of the Paris Climate Agreement, they are currently one of the main drivers of emissions reduction, as well as providing a source of climate financing. Currently, there are 33 non-voluntary carbon markets in operation around the world, though this number looks set to grow. Presenting their 2023 Nationally Determined Contributions (NDCs) 143 of 154 Parties to the United Nations Framework Convention on Climate Change (UNFCCC) stated "that they plan to or will possibly use carbon credits [...] as a means to finance climate action and achieve national targets." In addition, at this year’s at Cop29, new rules for carbon markets were set out after previous deadlock on the issue, signalling a new intent and hope in this important sphere of climate policy. Therefore, it is appropriate to consider the shape carbon markets should take, and the ways in which they may be utilised to their fullest extent.
Before doing that, however, some background is required. Put simply, carbon markets are a mechanism which enables the assigning of a price to a volume of the greenhouse gas (GHG), making possible its subsequent trading. This occurs either in the form of allowances or credits, traded on so-called “compliance” and “voluntary” carbon markets, respectively. Compliance markets, typically set up by states or regions, are entered by companies through legal obligation. They operate on a cap-and-trade system, meaning a total permissible volume of emitted carbon dioxide is decided upon. A set number of allowances, which allow their buyer to emit a certain volume of carbon dioxide (typically 1 tonne per allowance), is sold to the highest bidder through an auction process, unless freely given away, as is the case for some chosen industries. In contrast, as their name indicates, voluntary markets are not participated in under the threat of sanction, and they act as the venue for the sale of carbon credits, rather than allowances. This means that companies seeking to offset their emissions, or even become net-positive can, in theory, buy the requisite number of credits to justify these claims.
It is worth underlining the importance of these markets’ potential success, as substantial and continuous emissions reductions are necessary in order to meet the 1.5°C target set in Paris in 2015, which would contribute towards avoiding the worst effects of warming. Further, the currently dire state of financing adaptability initiatives, especially in the Global South, also underscores the importance of the usage of carbon markets, especially the voluntary variant. As things stand, with the recently agreed $300bn New Collective Quantified Goal (NCQG) failing to meet expectations and requirements, this issue has gained renewed pertinence.
There are two principal ways in which carbon markets should be improved to achieve these targets. The first applies to compliance markets, such as the European Union’s (EU), Japan’s or China’s Emissions Trading System (ETS), which operate on a cap-and-trade basis. The size and reach of this “cap” are often rightly called into question, given the markets’ substantial potential to act as an even larger force promoting emissions reduction. For instance, despite being the world’s largest carbon market, China’s ETS only covers around 40% of the country’s CO2 emissions. It is worth mentioning, however, that markets such as the EU’s ETS do provide for a 62% emissions reduction by 2030, and virtually all markets are set up with a continually decreasing cap.
Secondly, with a view to increasing their value, the cause of bolstering the markets’ credibility, a lack of which experts view as the cause of the two most recent carbon market crashes, should be given the utmost attention. This issue has gained increasing prominence, as research has necessitated questions of whether the agreements that underpin voluntary markets, designed to affect the removal of a given volume of carbon dioxide, are actually being honoured. In light of the recent discovery that 90% of carbon offsets issued by the biggest certifier are “worthless”, it is no surprise that voluntary markets have suffered from a lack of credibility, which has a real impact on their usage and, ultimately, the state of the climate. Similarly, a 2024 study in Nature found that, of the projects it investigated, only 16% of the credits issued actually resulted in the promised offsets. Naturally, this justifiable lack of trust has stunted the growth of voluntary markets, worth less than $1bn as of 2023, and a 20% dip in the price per credit year on year. In practice, increasing trust in compliance markets could happen through a third-party review, or the widespread implementation of pre-determined standards and reporting procedures. There is evidence in the form of steps in the right direction in this area, namely in the form of the “Core Carbon Principles”, released recently by the Voluntary Carbon Market Integrity Council. If implemented properly, these standards could chart the course for considerable voluntary market growth, helping direct much-needed capital and investment towards adaptation efforts in the Global South.
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