What Is the Carbon Credits Market and How Does It Work?
The carbon credits market is a mechanism that allows individuals, organizations, or countries to trade certifications that represent the reduction or removal of greenhouse gas emissions. The carbon credits market is also known as the carbon offset market, as it enables the offsetting of emissions that cannot be eliminated or reduced by other means.
The carbon credits market is based on the principle of “cap and trade”, which means that there is a limit or cap on the total amount of emissions that can be emitted by a group of entities, such as a country, a sector, or a company. The entities that emit less than their allocated cap can sell their surplus credits to those that emit more than their cap, creating a market incentive for emissions reduction.
There are two types of carbon credits markets: compliance and voluntary. The compliance market is regulated by international agreements or national policies that require certain entities to reduce their emissions or buy carbon credits to comply with their obligations.
The voluntary market is driven by the demand of individuals, organizations, or businesses that want to reduce their emissions or achieve carbon neutrality voluntarily, for ethical, social, or marketing reasons.
How Are Carbon Credits Generated and Verified?
Carbon credits are generated by projects that reduce or avoid carbon emissions in one place, or remove carbon from the atmosphere in another place. These projects can be either nature-based or technology-based. Nature-based projects use natural processes or ecosystems, such as forests, wetlands, or soils, to store or sequester carbon. Technology-based projects use technologies or innovations, such as renewable energy, energy efficiency, or carbon capture and storage, to reduce or eliminate carbon emissions.
Carbon credits are verified by various standards and programs that ensure that the emission reductions or removals are real, measurable, additional, and permanent. Real means that the emission reductions or removals are actually occurring and can be quantified. Measurable means that the emission reductions or removals can be monitored and reported using reliable methods and data. Additional means that the emission reductions or removals would not have happened without the project and the revenue from the carbon credits. Permanent means that the emission reductions or removals are not reversed or compromised by future events, such as fire, deforestation, or leakage.
Some of the most common and reputable standards and programs for carbon credits are:
- The Clean Development Mechanism (CDM) is a tool within the Kyoto Protocol enabling developed nations to fulfill their emission reduction commitments by investing in projects in developing countries.
- The Verified Carbon Standard (VCS) sets a voluntary benchmark for projects globally, ensuring emissions reductions are genuine, quantifiable, extra to any mandated cuts, and lasting.
- The Gold Standard is another voluntary framework, specifically targets projects in developing nations. It guarantees emissions reductions are authentic and additional, while also promoting positive social and environmental outcomes.
How Are Carbon Credits Traded and Priced?
Carbon credits are traded in different markets, depending on the type and purpose of the credits. The compliance market is divided into regional, national, or subnational schemes, such as the European Union Emissions Trading System (EU ETS), the Regional Greenhouse Gas Initiative (RGGI) in the US, or the New Zealand Emissions Trading Scheme (NZ ETS). The voluntary market is more global and diverse, and includes platforms such as the Carbon Trade Exchange, the Global Carbon Exchange, or the World Bank Carbon Partnership Facility.
The price of carbon credits is determined by the supply and demand of the market, as well as the quality and characteristics of the credits. The supply of carbon credits depends on the availability and cost of emission reduction or removal projects, as well as the regulations and policies that affect them.
The demand for carbon credits depends on the emission reduction targets and commitments of the buyers, as well as their preferences and motivations. The quality and characteristics of the credits depend on the standard and verification of the projects, as well as the type, location, and co-benefits of the projects.
The price of carbon credits varies widely across different markets and types of credits. According to the State of the Voluntary Carbon Markets 2020 report, the average price of voluntary carbon credits in 2019 was $3.5 per tonne of CO2e, ranging from $0.1 to $127.8. The average price of compliance carbon credits in 2019 was $16.9 per tonne of CO2e, ranging from $0.4 to $37.9.
Conclusion
The carbon credits market is a mechanism that allows the trading of certifications that represent the reduction or removal of greenhouse gas emissions. The carbon credits market is divided into compliance and voluntary markets, depending on the regulation and motivation of the buyers and sellers. The carbon credits are generated by projects that use nature-based or technology-based solutions to reduce or avoid carbon emissions in one place, or remove carbon from the atmosphere in another place.
The carbon credits are verified by standards and programs that ensure that the emission reductions or removals are real, measurable, additional, and permanent. The carbon credits are traded and priced in different markets and platforms, depending on the supply and demand of the market, as well as the quality and characteristics of the credits.
