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Making Sense of Carbon Markets

Environmental Economics

Pollution is what economists refer to as a negative externality of today’s production and supply chains. It is a cost to society not accounted for in the market price of an end product. When pollution remains unregulated and there is no cost to the polluter, that cost can be significant.

There are, however, many ways of regulating the amount of pollutants that are allowed into the atmosphere. For very harmful pollutants like lead legal limits apply, which must be adhered to. However, when it comes to regulating CO2 emissions, governments around the world have favoured market mechanisms, either putting a price on emissions through a tax, or setting up cap and trade systems.

The idea of putting a price on carbon is not a new one. As early as the 1990s carbon taxes were introduced in Finland (1990) and the Scandinavian countries (1991-1992). Carbon taxes work by setting a price on emissions, incentivising companies to reduce their footprint and to invest in low carbon technologies. In short, a carbon tax determines the price of carbon, and the market determines the quantity of emissions reductions.

The effect of the tax will of course depend on how well it’s designed, and what price it puts on emissions. A well-designed and well-implemented tax can yield significant benefits, not just in incentivising emissions reductions but in generating revenue for the government which can be redistributed to environmental causes or climate change adaptation. While a growing number of countries have some version of a carbon tax, only a few set the carbon price high enough to be impactful.

Cap and trade systems on the other hand do not put a price on emissions. Instead, they set a cap on the total emissions that are allowed in the system. Permits are issued to businesses yearly, either through auction or free allocation, each permit giving the right to emit one tonne of CO2. The number of permits issued is then reduced every year, ensuring that total emissions go down over time. Businesses can trade permits which creates a market price for carbon. In short, a cap and trade system determines the quantity of emissions that are allowed, and the market determines the price.

As with a tax, the effect of a cap and trade system depends on how well it’s designed, where the cap is set, and other outside factors. For the cap to be effective there has to be enough scarcity in the market that the emissions permits have value. If companies are simply issued permits in line with what they would otherwise have emitted, the effectiveness of the cap is limited, and the carbon price remains low.

Compliance Markets

When we talk about carbon offsetting and carbon credits, there are two largely separate markets; the compliance market and the voluntary. Purchasing permits or offsets to comply with e.g. a cap and trade system is part of the former.

When the phrase carbon price is used, it is often in relation to compliance markets, specifically to the EU Emissions Trading System (EU ETS), where the price of one permit is currently sits between €20-30. However not all offsets can be used in these markets, and where they can be used there are often limits to what portion of emissions can be offset under the cap. This is to ensure that the cap continues to create a scarcity of emission permits, and that the price of polluting remains high.

In the UK, carbon pricing exists both in the form of an Emissions Trading System, as large industrial installations, power plants, and manufacturers are currently part of the EU ETS, and as a tax. The tax was introduced in 2013 as a floor price for installations covered by the EU ETS. When the price in the ETS was too low, the tax ensured that polluters still paid a meaningful price for emitting CO2.

Voluntary Carbon Offsetting

While emissions covered by carbon taxes and cap and trade systems form an important part of tackling climate change, not all UK emissions are covered by these mandatory mechanisms. However, many companies choose to address their carbon footprint without any obligation to do so, by reducing their polluting activities and buying carbon credits in the voluntary market.

There are a whole range of options available to buyers in the voluntary market, from projects all over the world, and the price in this market can vary depending on the project type and location.

At Forest Carbon we focus on UK woodland creation and peatland restoration, generating carbon credits for the voluntary market. None of our partners are subject to mandatory obligations to offset their carbon. They are acting purely voluntarily in reducing their emissions and supporting our projects, which will draw down and store carbon for decades to come. These businesses are making sure they account for, reduce, and mitigate the emissions associated with their operations and products, while using resources to invest in natural climate solutions which will greatly benefit future generations. 

Where our
projects are

Forest Carbon leads the way in developing woodland creation and peatland restoration projects for carbon capture and ecosystem services in the UK. We have planted over 10 million new trees in 200+ new woodlands since 2006 with our partners removing over 2 million tonnes of CO2e from the atmosphere, as well as providing a host of other benefits to society, including habitat creation, biodiversity support, flood mitigation, river ecosystem improvement and public access.

Our new woodland schemes spread across Scotland, England, Wales and Ireland. They are certified by the Woodland Carbon Code – which is supported by the UK government and internationally recognised by ICROA. Planting the ‘right tree in the right place’ is required though adherence to the Forestry Commission standards.

Our peatland schemes can be found in Scotland and Wales. They are certified by the Peatland Code which is supported by the IUCN. These certification codes assure the additionality and permanence of each tonne of carbon stored.

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