CARBON CREDITS: A GLOBAL BUSINESS
Quick to sense the underlying profits, the private sector is wholesale jumping on to the Green Gravy Wagon.
By Suchitra
21/10/24
The carbon market is a term that dominates the green space. In simple terms, carbon markets are trading systems that deal with' carbon credits' instead of commodities or services. Companies and individuals can purchase carbon credits from entities that remove or reduce greenhouse gas emissions. In monetary terms, one ton of carbon dioxide or another greenhouse gas reduction equals one carbon credit that trades on the Carbon Market. As noted by the United Nations, carbon is now traded similarly to other commodities.
Governments or international bodies regulate some carbon markets and require participation from certain industries, while others operate on a voluntary basis.
So why are private companies getting drawn towards this trade? Trading carbon credits can help companies meet ambitious greenhouse gas reduction targets. Many companies have committed to reducing emissions, yet most find they cannot fully eliminate them, especially those aiming for net-zero, where removals must offset emissions. For these companies, carbon credits are essential.
The Taskforce on Scaling Voluntary Carbon Markets (TSVCM), supported by the Institute of International Finance (IIF) and McKinsey, estimates that demand for carbon credits could grow 15-fold by 2030 and 100-fold by 2050, with a market value exceeding $50 billion by 2030.
Voluntary carbon markets also direct private financing to climate-action projects with additional benefits such as biodiversity conservation, pollution reduction, public health improvements, and job creation. These markets are crucial for funding innovations in climate technologies and mobilizing capital for emissions-reduction projects, particularly in the Global South.
Why & How They Operate
The importance of carbon markets has been underscored by global efforts to mitigate climate change by preventing the global temperature from rising by more than 2°C.
Meeting these goals requires significant investment, with developing nations alone needing up to USD 6 trillion by 2030 to fund their climate action plans. The Intergovernmental Panel on Climate Change(IPCC) has reported a critical financial gap, with current climate-related financial flows being three to six times lower than what is required by 2030. To bridge this gap, many countries are turning to carbon markets as a solution for financing climate action and driving necessary systemic changes.The Paris Agreement, particularly through Article 6, encourages using carbon market mechanisms to meet climate goals. Consequently, global interest in carbon markets has surged, with 83 per cent of Nationally Determined Contributions (NDCs) indicating the intention to utilize such markets to reduce emissions.
Carbon markets are a central feature of cap-and-trade programs designed to reduce greenhouse gas emissions. In a cap-and-trade system, governments or groups of governments set a cap on emissions and allocate emissions limits to participants, such as countries or companies. Entities not using their entire allotment of carbon credits can sell them to those expecting to exceed their limits. Carbon credits represent permits that allow the purchaser to emit a specified amount of carbon dioxide or other greenhouse gases.
Organizations can create carbon credits or offsets by either reducing or removing carbon dioxide. Reduction initiatives include efforts like installing solar panels or developing wind farms, while removal projects involve capturing and storing carbon dioxide through methods such as reforestation or carbon capture technology.In addition to governments and large industries, other businesses, organizations, and even individuals participate in carbon trading. They may wish to offset their carbon footprints, fulfil corporate environmental promises, or speculate on carbon credit.
Carbon markets are categorized into two primary types: compliance and voluntary. Compliance Marketsare established by governments or multi-government bodies that regulate the supply and trading of credits.In voluntary markets, carbon credits are traded voluntarily. The supply of credits largely comes from private entities that develop carbon projects or governments that create programs certified by carbon standards to generate emission reductions or removals.
As of recent years, approximately 30 compliance markets existed worldwide, alongside numerous voluntary markets. Compliance markets are significantly larger, with a valuation of $850 billion in 2021, compared to $1–2 billion for voluntary markets.
Carbon markets place a price on greenhouse gas emissions, providing financial rewards for nations and businesses that reduce their emissions while creating disincentives for those that exceed their limits. These markets help mobilize resources for transitioning to a low-carbon economy, smoothing the pathway for companies and countries as they work toward emissions reduction goals.
Global Carbon Markets
The European Union's Emissions Trading System (EU ETS), launched in 2005, is one of the world's largest and longest-running carbon markets. It includes all EU nations, as well as Iceland, Liechtenstein, and Norway, regulating emissions from over 10,000 facilities in the energy, manufacturing, and transportation sectors.
China's national Emissions Trading System (ETS), introduced in 2021, is now the world's largest in terms of covered emissions. However, it currently focuses only on the power sector, with plans to expand to other industries.
Major exchanges in the voluntary market include Xpansiv CBL in the U.S. and ACX in Singapore. The United Nations also operates a Carbon Offset Platform for voluntary participation, allowing organizations and individuals to purchase credits to offset their emissions.
The Clean Development Mechanism (CDM), established under the Kyoto Protocol, is another prominent compliance market. It allows developed nations to meet emission reduction targets by investing in emission-reduction projects in developing countries.
While carbon pricing adoption has been limited globally, signs of progress are emerging, especially in middle-income countries like Brazil, India, and Turkey. Currently, 75 carbon pricing schemes operate worldwide, covering approximately 24 per cent of global emissions, with projections suggesting coverage could rise to 30 per cent through new taxes and emissions trading systems (ETSs).
Carbon Credits
With limited government mandates for greenhouse gas (GHG) reduction, an increasing number of companies are adopting "net zero" targets. Over one-third of the world’s 2,000 largest publicly traded companies have committed to these goals, aiming to cut emissions through operational changes, product reformulations, renewable energy use, and carbon offset purchases.
Carbon credits allow companies to compensate for their emissions by financing projects that reduce or remove GHGs, but questions about the credibility and quality of these credits persist. As more companies adopt net-zero pledges, rising from 500 in 2019 to over 1,000 in 2020, they must reduce emissions as much as possible while transparently reporting their progress.However, some companies face prohibitively high costs in reducing emissions with current technologies, and in certain industries, emissions cannot be fully eliminated. For instance, cement production involves calcination, a chemical process responsible for significant emissions. To compensate for these limitations, "negative emissions" through removing greenhouse gases are necessary, often achieved via carbon credits.
Carbon credits, representing avoided or removed emissions, have been increasingly used to offset unavoidable emissions. McKinsey estimates that in 2020, carbon credits offset 95 million tons of carbon dioxide equivalent (MtCO2e), more than double the volume in 2017. As global decarbonization efforts intensify, demand for voluntary carbon credits is projected to grow, potentially reaching 1.5 to 2.0 gigatons of CO2 by 2030 and up to 13 gigatons by 2050. This could drive a market size between $5 billion and $50 billion by 2030.
Despite the potential supply of carbon credits, challenges remain in mobilizing projects at scale. A large share of potential credits, particularly from nature-based solutions, is concentrated in a few countries. Finishing such projects is difficult due to long delays between initial investments and credit sales. As a result, the practical supply of credits may be limited to 1 to 5 gigatons per year by 2030.
Additional challenges include limited verification processes, pricing uncertainty, and low market liquidity. High-quality credits are scarce due to inconsistent accounting standards, and project developers often struggle with long verification lead times and unpredictable demand.
Standardized principles for defining and verifying carbon credits are essential to scale the voluntary carbon market effectively. Uniform carbon credit attributes would simplify transactions, improve liquidity, and support the development of reference contracts that could enhance price transparency. Moreover, creating robust trading and post-trade infrastructures, such as clearinghouses and meta-registries, would facilitate larger-scale trading and ensure market integrity.
Ensuring the market's transparency and integrity requires clear anti-fraud measures, streamlined digital verification processes, and governance oversight. Demand signals from buyers would also encourage suppliers to increase project development, supporting the necessary supply to meet global emissions-reduction goals.
However, the carbon credit market remains too small and underdeveloped to impact emissions reductions significantly. Some critics, including high-profile voices, argue that companies overly reliant on carbon offsets may face accusations of "greenwashing" — presenting environmental claims that do not align with real-world impacts.
Quality assurance is critical when selecting carbon credits. Factors such as additionality (whether the project would have happened without the credit), accurate quantification of carbon reductions, leakage (the risk that emissions reductions are displaced elsewhere), and permanence (the durability of the emissions reductions) are key considerations. Companies must also evaluate the vintage (the year credits were issued) and potential co-benefits, such as biodiversity enhancement or job creation.
The carbon credit landscape is highly fragmented, with multiple standards, registries, verifiers, brokers, and rating agencies. Leading companies and frameworks, such as the Voluntary Carbon Markets Integrity Initiative and the Oxford Net-Zero Aligned Offsetting Principles, offer guidance for engaging responsibly in this market.
Brazil’s Promise
Brazil could become to carbon removal what Saudi Arabia has been to carbon production, despite the current challenges facing the voluntary carbon market. In 2023, the volume of credits traded in this market was less than half of 2022’s, with its value falling from $1.9 billion to $723 million, partly due to scandals involving fraudulent claims of forest protection.
However, optimism remains high in Brazil. Companies like re.green are focusing on large-scale reforestation, with projects planting trees on degraded land. For instance, Microsoft has committed to buying 3 million tonnes of carbon credits from re.green over 15 years, while Google is expected to follow suit.
Reforestation is particularly attractive in Brazil, where degraded land and a tropical climate favour fast tree growth. McKinsey estimates that by 2030, with carbon credits priced at $30 per tonne, reforestation could be more profitable than cattle ranching on half of Brazil’s pastureland. Restored forests in Brazil could account for 15 per cent of the global carbon removal potential from reforestation.
Brazil is also exploring regulatory measures, such as leasing 2.5 million hectares of public land for reforestation and establishing an emissions trading system. Meanwhile, advancements in rating agencies and satellite technology are improving transparency and reliability in the market. However, challenges remain, including land ownership disputes and the need for better tools to measure carbon sequestration.
If global carbon market rules are finalized under the Paris Agreement, allowing countries to trade credits and avoid double-counting, Brazil’s reforestation efforts could greatly benefit both the planet and the economy.
Africa’s Next Big Export?
The African Carbon Markets Initiative (ACMI), a UN-backed group, estimates that Africa taps into just 2 per cent of its carbon-credit potential and aims to generate $100 billion in annual carbon credit sales by 2050. Even a fraction of this would greatly benefit a continent where foreign direct investment has never surpassed $80 billion annually. Kenyan President William Ruto has described carbon credits as an "unparalleled economic gold mine" and envisions them as a major export for the country. However, like many natural resources in Africa, the path forward is fraught with risks.
Africa has participated marginally in carbon markets, contributing 3 per cent of credits under the UN’s Clean Development Mechanism (CDM) and about 10 per cent in voluntary markets. Carbon markets have already boosted projects such as clean cooking-fuel startups, and ACMI seeks to grow Africa’s voluntary market. For example, the UAE pledged $450 million in credits at the Africa Climate Summit, and the Johannesburg Stock Exchange launched its own voluntary marketplace.
A larger opportunity lies in Article 6 of the Paris Agreement, which allows countries to trade carbon credits to meet their emission targets. Some African countries, like Kenya, Ghana, and Senegal, have already made strides in this area by selling credits to countries such as Switzerland. However, challenges remain, including avoiding double counting of credits and scepticism about the effectiveness of carbon-saving projects, especially those linked to forest conservation.
India's Carbon Market
As India strives to become the third-largest economy by 2030, decoupling this progress from harmful carbon emissions is essential. Although India is the world's third-largest emitter of greenhouse gases (GHG), its per capita emissions (1.8 tonnes of CO2) remain lower than the global average of 4.4 tonnes of CO2. Acknowledging its moral responsibility towards a greener planet, India's Prime Minister has taken the Panchamrit Pledge, with ambitious climate targets for 2030 and a commitment to achieving carbon neutrality by 2070. As highlighted during COP 27, India balances its developmental needs with reduced carbon emissions through the principles of Common but Differentiated Responsibilities and Respective Capabilities (CBDR-RC). Initiatives like Mission LiFE and the Green Credit Program are promoting sustainable lifestyles.
India's establishment of a Carbon Credits Trading Scheme (CCTS), building on the Electricity Conservation Act of 2001 and the Environment (Protection) Act of 1986, marks a strategic shift toward leveraging climate finance and low-cost technologies for a just economic transition. The CCTS, part of the Indian Carbon Market (ICM), aims to reduce GHG emissions by allowing obligated entities to trade carbon credit certificates based on their performance against emission intensity targets. Currently, India operates two market-based emission reduction schemes: the Perform, Achieve and Trade (PAT) program and the Renewable Energy Certificates (REC) system. Through the CCTS, an additional avenue for trading carbon credits is being created, complementing the voluntary market, where India ranks as the second-largest source of carbon offsets globally.
India's strategic focus on 13 sectors, including green hydrogen, sustainable aviation fuel, and offshore wind, aims to attract investments and technology beyond traditional solar projects. To ensure the system's integrity, the National Steering Committee for Indian Carbon Market (NSCICM) and the Bureau of Energy Efficiency (BEE) will set baseline and monitoring standards for activities under the CCTS.
Assessment
The current climate-related financial flows are three to six times below the levels needed by 2030.
T
h
e carbon markets can cover this gap to finance
climate
action and facilitat
e
essential systemic transformations.
The current carbon market is fragmented and lacks transparency. Some credits represent questionable emissions reductions, and limited pricing data creates uncertainty for both buyers and suppliers. Market participants, standard-setting bodies, financial institutions, and infrastructure providers must address these challenges to ensure the market's growth and effectiveness
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There must be transparency in the institutional and financial infrastructure for carbon market transactions. And there must be adequate social and environmental safeguards to mitigate against any adverse project impacts – and to promote positive ones. More importantly,
h
uman rights must also be respected, including those of Indigenous peoples and local communities.
Tags
# Green Economy, #Carbon Market, #Carbon Credits, # Brazil, # India, #Indian Carbon Market. # Africa
