Carbon markets are an important part of the corporate sustainability toolkit, but they can be challenging to navigate. If you're new to the topic or need a refresh, this comprehensive guide will help you better understand compliance and voluntary carbon markets, and determine their role in meeting your climate goals.
As the race to net zero intensifies entire nations, businesses and individuals are making bold commitments to help fight climate change.
While the transition to renewable energy and other emissions reduction initiatives must be the priority – it is estimated that more than one third of the climate mitigation efforts will come from investment in nature-based solutions.
We have a global 'net' zero target knowing that eliminating all emissions is not possible in the foreseeable future. Therefore, we must mobilise investment to help us protect, restore, and better manage natural elements such as forests, soils, and wetlands; and in technologies that will help us avoid and remove emissions.
Carbon markets are a critical tool in helping us do this. They help facilitate international co-operation, support corporate net zero ambitions, and enable individual contributions.
And you don’t need a finance degree to understand them, we’re all carbon market participants after all.
For those new to this space or those seeking a refresh, this comprehensive guide will help you:
Carbon markets are systems where people – usually organisations – can buy and sell carbon credits. A carbon credit is a certificate that represents one tonne of carbon dioxide equivalent.
Today when discussing carbon markets, we do so in two main categories: compliance carbon markets and the voluntary carbon market.
These systems are created based on national, regional and/or international policies or regulations.
In compliance-based carbon markets, governments or regulatory bodies set limits on the total amount of greenhouse gas (GHG) emissions that certain industries or businesses can emit. These schemes are usually called emission trading schemes (ETSs).
Emissions trading schemes typically fall into two main categories: cap-and-trade schemes and baseline-and-credit schemes.
As more and more organisations and individuals want to help repair the climate, they’re looking to offset emissions they can’t reduce, or to invest in nature because it is the right thing to do – and not because they are legally required to do so.
This is driving the ongoing growth in the international voluntary carbon market.
The voluntary carbon market is a system, and its associated schemes or standards, that enables the buying and selling of carbon credits on a voluntary basis. Carbon credits are created by carbon projects which are initiatives designed to avoid emissions or to remove carbon from the atmosphere.
To help manage the growing number of carbon projects, and the carbon credits they produce, a number of voluntary certification and accreditation bodies have been created.
These include standards and registries that govern the issuance of carbon credits units by certified projects, such as the Verified Carbon Standard, the Gold Standard and the Clean Development Mechanism.
These standards can also apply to be endorsed by the International Carbon Reduction and Offset Alliance (ICROA) as a signal of good governance, open access and robust validation and verification of carbon projects.
It is difficult to precisely calculate the size of the market, however most analysts agree that it will only grow in size and importance. By one estimate the voluntary carbon market reached approximately US$2billion in 2021, four times its 2020 value. It is expected to reach US$10 - $40 billion by 2030.
As such, regulatory bodies and verification agencies are accelerating their efforts to continuously improve the integrity and liquidity of the market. A recent example of this is the Integrity Council for the Voluntary Carbon Market’s (ICVCM) release of a global benchmark for carbon credit quality (called the Core Carbon Principles).
These critically important frameworks are welcomed by both buy and sell side market participants, and they will continue to grow and evolve in line with the market.
While compliance carbon credit units are controlled by government policy (i.e. it determines emissions caps or baselines set, and how compliance credits are created), there is a growing number of carbon credits created and traded on the voluntary carbon market.
Let’s take a look at the different types of carbon projects and credits in the voluntary carbon market, and how they are created.
Carbon credits in the voluntary carbon market are broadly classified as carbon avoidance credits and carbon removal credits, delivered through either nature-based projects or technology-based projects. Please see the table below.
Nature-based carbon removal projects often attract a price premium because they are often viewed as higher impact, both in terms of greenhouse emissions and other forms of nature repair, such as biodiversity. We discuss this in more detail further in the guide.
Carbon projects and the carbon credits they produce are created by carbon project developers.
In nature-based projects, project developers can be the landowners, but most often they are organisations that coordinate the project on behalf of landowners and/or local communities.
In technology-based projects they are usually organisations that invest in building the infrastructure or technology that will deliver the carbon avoidance or removal, or that partner with local communities.
Project developers structure the project, determine the best standard for accreditation, and coordinate the process of accreditation and creation of carbon credits.
While each project is different in terms of impact, budget and crediting period, the lifecycle of a carbon unit on the voluntary carbon market usually looks like this:
*Please note that the steps below - particularly steps 1 and 2 - have been simplified to provide a high-level introduction only.
Selecting the right carbon projects is a critical process for corporate sustainability teams. The team needs to ensure that the investment is having a positive impact, that it's meeting the expectations of customers, investors and other stakeholders, and that it's done in a way that maintains trust and credibility.
The stakes are high at a time of growing urgency for meaningful climate action, and when public awareness and scrutiny of carbon projects is at an all-time high. Here are some key things to consider.
It is important that the carbon procurement process is aligned to the objectives of your overall net zero strategy and the values of your organisation.
If you're not sure where to start, or need assistance in a process that's already underway, a consultant that understands the corporate decarbonisation journey and carbon markets can help you:
Part of the initial strategy process is the selection of the right voluntary certification or accreditation framework to help guide your climate journey. Organisations such as the Voluntary Carbon Market Initiative (VCMI) and Climate Active provide frameworks that guide corporate use of carbon credits to make credible claims. The Science Based Target initiative's (SBTi) corporate standard, while under review, does not currently endorse carbon credits as a tool to meet corporate targets. It does however recognise the importance of beyond-value-chain mitigation which includes making voluntary investments towards climate positive projects.
Corporate focus on project quality sends powerful demand signals to the market. As such, transparency into carbon project specifications is also evolving quickly, helping to make the selection process a little easier.
When carbon credits are created, project developers are obliged to provide details about the plan and output of these projects, as well as monitoring reports that compare actual impacts against predicted impacts.
Carbon project developers will also typically publish the following data about each project. These can be used as markers of quality that, together, help guide the due diligence process.
As discussed earlier, carbon markets exist in both compliance and voluntary schemes. Compliance carbon markets are created and regulated by mandatory carbon reduction regimes in certain countries, whereas the voluntary carbon market enables companies to purchase carbon credits on a voluntary basis.
In certain cases, non-regulated entities may buy compliance market credits to meet their voluntary sustainability goals. An example of this is the Australian Carbon Credit Unit (ACCU) which can be traded both on the compliance and voluntary carbon market.
There are tools available today that let you find and filter on the project detail to help make project selection easier. It makes sense if these tools are integrated into a broader climate management system so you can manage your net zero program in one place.
The purchase of carbon credits for both compliance and voluntary purposes usually takes place in the primary or secondary market.
Put simply, the primary market or direct investment refers to the purchase of credits directly from the project that creates them.
The secondary market, on the other hand, refers to the trade of credits between buyers and sellers after their initial sale in the primary market. These may be excess units that an organisation holds, or units that were originally purchased as an investment vehicle.
Let’s take a look a closer look at the main ways to purchase carbon credits:
The science could not be clearer. Our planet needs us to take bold and decisive action and the urgency is building.
This must start with deep and meaningful emissions reductions, but the time is here to leverage all tools at our disposal. This includes investment in our natural assets and in technology-based solutions that help us remove and avoid emissions.
Carbon markets can help us do this. They enable international collaboration, support corporate net zero commitments, and help funds flow to communities that are among the most affected by climate change.
As we move forward in the fight against climate change, carbon markets will continue to evolve and adapt to the changing landscape, driving further innovation and collaboration among businesses, governments, and individuals.
By understanding the nuances of carbon markets and their essential role in achieving our climate goals, we can all contribute to building a more sustainable and resilient future.
Are you read to take the next step on your net zero journey?
CORE Markets is an end-to-end markets, technology and climate solutions partner for business.
We offer corporate net zero services, project optimisation services, and corporate and institutional brokerage services, all backed by a powerful software-as-a-service platform.
We help corporate sustainability teams, carbon & clean energy project developers, and wholesale & industrial clients, take decisive action to net zero. Get in touch with our team to see how we can help.
Understanding compliance and voluntary carbon markets: A guide for sustainability leaders
