There are two types of carbon markets:
Businesses, NGOs, and other organizations use voluntary carbon markets to offset their emissions or to support projects that reduce emissions. The choice is theirs to participate in the markets.
Governments create compliance markets to help industries meet their emissions reduction targets. They require businesses to trade carbon credits to stay within their target.
⚖️ Distinction: Compliance markets involve government-imposed limitations on emission levels, and corporations trade carbon credits to meet the limit. Voluntary carbon markets (VCM) are those in which companies or individuals choose to offset their emissions voluntarily, without being required to do so by law.
(Note that carbon credits and carbon offsets are separate but related concepts.)
The VCM has no mandatory participation. Instead, it operates on an independent desire to neutralize a carbon footprint. It allows institutions and individuals to compensate for their emissions and support projects fighting climate change.
📄 “More and more companies are pledging to help stop climate change by reducing their greenhouse-gas emissions as much as possible. Yet many businesses find they cannot fully eliminate their emissions, or even lessen them as quickly as they might like. The challenge is especially tough for organizations that aim to achieve net-zero emissions, which means removing as much greenhouse gas from the air as they put into it. For many, it will be necessary to use carbon offsets to neutralize emissions they can’t get rid of by other means. The Taskforce on Scaling Voluntary Carbon Markets (TSVCM), sponsored by the Institute of International Finance (IIF) with knowledge support from McKinsey, estimates that demand for carbon offsets could increase by a factor of 15 or more by 2030 and by a factor of up to 100 by 2050. Overall, the market for carbon offsets could be worth upward of $50 billion in 2030.”
To date, the VCM has channeled more than $5 billion into projects around the world, ranging from renewable energy and clean cookstoves to forest conservation. The incentive for participants is to create a long-term financial strategy, meet sustainability goals, and better the firm’s public reputation. These motivations provide demand for offsets, which leads to project income. In the VCM, income goes back to the developers and provides essential funding for future offset projects. The VCM creates a cycle of climate-positive action.
The government issues pollution permits, or carbon credits, to keep industries within “permissible” pollution levels. These markets are large in scale and usually have a specific purpose, such as reducing emissions within a certain timeframe or for a particular industry.
The majority of compliance carbon markets use the “cap-and-trade” system. In cap-and-trade markets, the government limits the number of emissions a company is allowed in a particular industry. For instance, the oil industry may emit more than the technology since emissions are more integral to one industry than the other.
🛩️ The European Union Emissions Trading System (EU ETS), will issue approximately 24.5 million credits to the aviation industry in 2021.
If a firm goes over the permitted cap, it’s required to buy enough carbon credits to make up for the difference. If a firm is under, it is permitted to sell the remaining & unused credits to firms over the limit. This model financially incentivizes companies to create sustainable operations by making businesses pay the price for polluting. However, this system does not directly address emissions in the way that the VCM does.
Both markets help the environment in different ways.
The compliance market follows limitations set by the government, which creates a financial incentive for companies to reduce internal emissions. Over the long term, this system pushes companies to turn their operations sustainable. However, the total emissions output relies on the opinion of governments, who have historically been inadequate at catalyzing climate action.
To stave off the climate crisis, we need solutions that can reduce emissions in the short term while creating long-term financial incentives. By driving investment into projects that produce tangible, specific emissions that have been avoided or captured, the VCM provides the immediate positive climate action that the world needs.
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