What is a Carbon Credit Market?
By: Lena Dente and Michael Rauter
In our latest articles we discussed the role of climate finance in achieving the goals of the Paris Agreement. To be clear, a significant increase of investments is needed to substantially reduce greenhouse gas emissions needed keep the 1.5°C target within reach.
The voluntary carbon market is a controversially discussed but potentially important contributor to the climate finance needs of various entities, seeking ways to reduce their emissions. Using carbon credits to offset emissions has sparked a heated debate amongst many stakeholders, many of whom lament the lack of transparency, quality, standards, and equitability of the carbon credit markets. Given that many organisations and stakeholders seek to incorporate carbon credits into their emissions reductions planning, we have decided to look at the topic more closely.
What are Carbon Credits?
Carbon Credits is a term to describe certificates that can be bought on the voluntary carbon market to compensate for own emissions. The idea is fairly simple: financially support projects, which develop and implement actions that actually reduce greenhouse gas emissions through their actions. These can include for example replacing diesel-powered irrigation pumps with solar-powered pumps, replanting mangroves in coastal environments, sequestering carbon in avoided deforestation or planting new trees. One Carbon Credit represents one tonne of CO2 that has been reduced, sequestered, or avoided.
The Greenhouse Gas Protocol and the International Carbon Reduction and Offset Alliance have defined the 4 key criteria projects must fulfil in order to be recognised as a carbon offset project and to be included in the certified registries:
Additionality – this means a Carbon Credit can only be claimed if the reduction of emissions would not have happened, if the project had not been enacted. This factor also means that project implementation relies on the funding provided by the Carbon Credits. If a project were possible without the carbon credit income, it cannot be a carbon offset project.
Exclusion of double counting – carbon credits cannot be counted as a voluntary market reduction and a compliance market reduction. More on markets below.
Permanence – the emissions saved must be permanent. There is not currently a clear and agreed to definition of what “permanent” means. Should we measure in decades, centuries, or millennia?
Regular independent audits – through various stages of development, implementation and measurement/assessment, independent and neutral audits must be completed.
What is the difference between the voluntary and the compliance markets?
Carbon credits are created not only to reduce emissions, but to create revenue. The compliance markets were created in response to the need for legally binding emission targets, which were agreed on in the Kyoto Protocol and the Paris Agreement. The international-, national- and regional governmentally regulated systems usually operate as cap-and-trade markets. A finite amount (cap) of so-called allowances is created to limit the emissions of specific industry sectors or countries. The obligated participants of the compliance markets can only emit as much CO2 as represented by the allowances in their possession. The allowances can be traded on the compliance markets, which aims to motivate the participants to reduce their emissions.
The voluntary carbon market is project based, which means that there is no limited amount of Carbon Credits. New ones can be created with the initialisation of new projects. In addition to the project owners and Carbon Credit buyers, more actors are involved in the market. These include institutions that ensure carbon credit standards and third-party auditors, who act as inspectors of the projects. Once a Carbon Credit is created with approval of the third-party auditor, it is electronically registered. A Carbon Credit that has been sold on the market to a buyer is then retired in the registry.
According to a recent article in Foreign Affairs, the voluntary carbon market has grown exponentially since its creation – increasing in value by 600 percent from 2018 to 2021 alone. It is now worth $2 billion. In 2022, over half of all offsets were sold on the voluntary market. [1]
Market-based solutions can be particularly useful, where is the problem?
A problem lies in the interdependence of the two markets and the blurred boundaries between them.
The reduced emissions of specific projects may not only be claimed by the project owner and subsequently by the buyer of the Carbon Credits, but by countries related to their targets under the Paris agreement. This potential for double claiming may even lead to an increase in global emissions.[2] Critics also argue that Carbon Credits from the voluntary market do not motivate or incentivize the reduction of own emissions, rather are used by companies to avoid formal regulations of their activities. Recent media reports, in the German-language weekly die ZEIT-online and the British Guardian have shown that the methodologies of the world’s leading carbon credit certifier were flawed. [3] [4]
An additional critical point is that the Carbon Credits are based on emissions reductions based on baseline predictions that vary widely and wildly. If you plant acre of forest saplings today, you cannot accurately predict how much CO2 will be sequestered over a 50-year time period. Next year, there could be a devastating wildfire that wipes out the entire project. Or, a drought could stunt the growth and viability of the saplings. There is a high degree of uncertainty that impacts the robustness of the claims that can be made regarding the potential reductions.
Why is the voluntary carbon market still important?
A challenge faced by the global community addressing climate change, is finding adequate funding. The annual funding shortfall for adaptation alone now range from $194 billion to $366 billion. [5] Voluntary carbon markets provide a flexible financing model that can mobilise capital for climate change related projects quickly.
Examples exist where the voluntary carbon market has led to effective CO2 reduction and improved sustainable working methods. The main challenges of the voluntary carbon markets are the insufficient transparency, lack of standardisation and partially poor quality of the Carbon Credits. Addressing these points as well as the question of assessments and accountability, will be crucially important to creating a robust Carbon Credit market system that works for all stakeholders – including the planet.
** Michael Rauter is currently volunteering for the World Future Council, supporting with research in the thematic area of energy and just development. In his everyday life, Michael works as a fuel cell engineer on low carbon aviation for Airbus.
Sources
[1] Foreign Affairs Magazine – The False Promise of Carbon Offsets, Jessica F. Green, 20 November 2023.
[2] German Environment Agency – Future role for voluntary carbon markets in the Paris era
[3] Zeit Online – Phantom Offsets and Carbon Deceit, Tin Fischer and Hannah Knuth, 19 January 2023.
[4] The Guardian – Revealed: more than 90% of rainforest carbon offsets by biggest certifier are worthless, analysis shows, Patrick Greenfield, 18 January 2023.
[5] Reuters – Climate adaptation funding gap 50% higher than estimated, UN says, David Standway, 2 November 2023.
