by The threat of climate change has never been more pressing and countries around the world are scrambling to reduce their carbon emissions in an effort to limit global warming. One of the tools that has emerged to help nations cut emissions is the development of carbon credit markets. A carbon credit represents one ton of carbon dioxide or its equivalent in another greenhouse gas that is not emitted into the atmosphere because of a climate-related project. These credits can then be traded in emerging compliance carbon markets or voluntary carbon markets.
The Kyoto Protocol and the Rise of Emissions Trading
The Kyoto Protocol, adopted in 1997, was a major driver in establishing the first international system for trading carbon credits. By setting binding emission reduction targets, the Kyoto Protocol established commitments by industrialized countries and the European Union to cut their overall emissions of carbon dioxide and five other greenhouse gases by at least 5% between 2008-2012 compared to 1990 levels.
One of the flexibility mechanisms created under the Kyoto Protocol was emissions trading. This allowed countries that have emission units to spare – emissions permitted them but not ‘used’ – to sell this excess capacity to countries that need to make up a shortfall in their national emissions targets. This created what became known as the carbon market and allowed trading of carbon credits between nations.
The emergence of the European Union Emissions Trading System (EU ETS) in 2005 became the largest compliance carbon market in the world up to that point. Covering over 11,000 power stations and industrial plants in 31 countries, the EU ETS has driven hundreds of millions of euros of investment in low-carbon projects globally through trading of EU Allowances and Certified Emission Reductions credits. Over time, carbon credit prices in the EU ETS have fluctuated significantly based on the supply and demand balance. The price volatility highlights the challenges in properly aligning carbon market design with environmental and economic goals.
Voluntary Carbon Offset Markets Fill Important Role
Alongside compliance Global Carbon Credit voluntary carbon offset emerged organically to allow individuals and companies to voluntarily offset their emissions. While smaller in size and scope than the EU ETS, voluntary carbon offset markets play an important role in supporting climate projects in developing countries that need financing but are not covered by compliance trading systems.
One example is projects that reduce emissions from deforestation and forest degradation, known as REDD+. As tropical forests continue to disappear at an alarming rate, largely due to agricultural expansion, REDD+ projects generate carbon credits by protecting and expanding forest areas. The sale of voluntary carbon credits provides a revenue stream that helps rural communities transition to more sustainable land use and livelihood practices that conserve forests over the long term.
Voluntary markets also support renewable energy projects like wind, solar, biomass and hydropower that displace carbon-intensive coal and diesel generation. The sale of carbon offsets helps develop bankable project models that can be scaled up over time. Energy access projects distributing efficient cookstoves and lighting as alternatives to charcoal and kerosene have also generated significant volume of voluntary carbon credits.
Harmonization and Standardization Needed to Drive Larger
While voluntary carbon markets have catalyzed important climate solutions, challenges exist around additionality, permanence and issues of double-counting that reduce the credibility and environmental integrity of credits in some cases. Harmonization of methodologies, verification processes and registries is needed to professionalize the voluntary carbon market and standardize the quality and transparency of credits.
The promotion of larger-scale programs and standardized crediting frameworks could help voluntary transactions converge under a unified global market. As more countries and subnational jurisdictions develop compliance trading systems under the Paris Agreement, linkages between compliance and voluntary carbon trading could emerge. This would help scale up emission reduction activities – both within and beyond countries’ national pledges – required achieve global climate targets.
New carbon pricing initiatives like the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) also represent promising developments that will expand global demand for carbon credits. As the world transitions to a low-carbon economy supported by climate policy frameworks like carbon pricing, the role of carbon markets will only increase. With greater standardization and oversight, consistent carbon crediting policies can further unlock the potential of trading mechanisms to efficiently finance emission cuts at the scale urgently needed through public-private partnerships.
While carbon markets are still a work in progress with room for improvement, they stand as promising policy instruments to cost-effectively shift investments towards low-carbon alternatives. By establishing a monetary value for avoided emissions, carbon credits can help scale up green technology deployment and sustainable land use practices aligned with the Paris Agreement’s climate goals. With continued effort to strengthen their integrity and expand trading linkages, carbon markets hold significant long-term promise to drive meaningful climate action through innovative market tools.
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1. Source: Coherent Market Insights, Public sources, Desk research
2. We have leveraged AI tools to mine information and compile it
