Last updated: 08/2024
What’s the purpose of the carbon markets?
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, the cost to society is 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 greenhouse gases (GHG), governments around the world have favoured market mechanisms.
In 1997, one outcome of the Kyoto Protocol negotiations was to establish just such: a set of flexible market mechanisms (the “Carbon Markets”) that would allow companies or countries the ability to trade GHG emissions permits and drive emissions reductions at the same time.
The trading system under a global marketplace was designed to operate in two ways;
A managed ‘cap-and-trade’ scheme
If you started at the beginning of our Knowledge Base, you have already learnt about this mechanism through the UK’s Emissions Trading Scheme (UK ETS).
These schemes help to lower global emissions by limiting and reducing a country’s or company’s permit to pollute (“allowances”) over time. Cap and trade systems 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.
An 'offsetting' mechanism
The second trading system was the ‘carbon offsetting mechanism’.
A country or company could compensate for its residual or unavoidable emissions by purchasing a carbon credit (1 carbon credit = 1 tonne of CO2e) from a project reducing carbon emissions elsewhere in the world (“offsetting”).
The idea was that this mechanism would allow carbon finance to flow from the developed nations (historically, the big emitters who had set climate targets) to projects in developing nations. Alongside reducing GHG emissions, such projects often host other social and environmental co-benefits for the surrounding area and communities.
In both systems, the idea was that over time it should become cheaper to abate emissions in-house rather than purchase carbon credits or allowances - creating a financial incentive to curb GHG emissions whilst increasing action to mitigate the global impacts of climate change.
What changed for the voluntary carbon market under the Paris Agreement?
Firstly, the Paris Agreement recognised the need for truly global action – meaning all (or almost all) countries adopted their own climate targets, not just the richer, developed nations as was the case with the Kyoto Protocol. This also meant that emissions reduction (offset) projects could be set up in all countries – not just the developing countries.
Secondly, as the voluntary carbon market (VCM) evolved, the need for regulation to ensure integrity, transparency and quality of projects was recognised under Article 6.
With both in mind, negotiators on Article 6 had their work cut out for them. They needed to set out the rules and governance structures to overcome key challenges, including carbon offset accounting (for example: where to count the carbon offset if the business that buys it is in a different country than where the project is hosted) and claims, to support developing a strong, standardised and commoditised market.
Such rules were and still very much are fundamental to building trust and confidence with buyers, and by extension creating the climate action needed to keep us in line with our 1.5c ambitions.
Voluntary carbon market rules and governance structures
There are nine rules to govern and implement international carbon market mechanisms under Article 6. These have been in active debate since 2015 and a consensus was only reached in Glasgow at COP26 (2021).
The most up-to-date documents and decisions by the UNFCCC can be found here.
In essence, Article 6 exists to promote voluntary, international cooperation to tackle climate change, raise climate ambition and make it more affordable, unlock financial support for developing countries and help them build resilience to the inevitable impacts of climate change.
The Voluntary Carbon Markets Integrity Initiative and the Integrity Council for the Voluntary Carbon Market developed from/align with the Paris Agreement, and set clear standards for carbon buyers and sellers, helping to provide a high-integrity voluntary carbon market.
How is price determined in the voluntary carbon market?
Unlike the compliance market, price in the voluntary carbon market is not managed. Numerous influences determine how much a carbon credit will sell for. These include but are not limited to:
Shadowing of the compliance markets
Project type
Project location (land and establishment costs)
Standards under which the projects are certified
Integrity and quality of claims (project level ratings)
Monitoring, reporting and verification (MRV) practices
Project co-benefits (e.g. biodiversity uplift, health and wellbeing, flood mitigation, etc.)
Supply and demand
When there is a high demand for carbon credits, perhaps because of growing climate awareness or pressure to set net-zero targets, or there is a limited number of credits on the market, the price will rise.
If the market takes a hit, perhaps because of diminishing trust in the integrity of projects, or there are more credits in the market than buyers, the price will drop.
This demonstrates the importance of maintaining a healthy market, with high-integrity credits on offer and buyers who are keen to support the mechanism. When the price of a carbon credit is too low:
It doesn’t reflect the societal and environmental cost of carbon in our atmosphere
It disincentivises new development of carbon projects – and new climate innovations
It disincentivises in-house abatement (because it’s cheaper to offset than invest in decarbonisation)
Carbon Markets 2.0 (and other emerging nature markets)
Since the Paris Agreement in 2015, the voluntary carbon market (as well as best-available science and global climate literacy) has evolved again and is still evolving. Standards like the Science-Based Targets Initiative (SBTi) have emerged to set out limits and guidance for the use of offsetting in science-based goals (impactful in line with the 1.5c limit).
Organsations are encouraged to follow a mitigation hierarchy of ‘Avoid, Reduce, Offset’ so that elimination at the source is prioritised. The current guidance says that high-quality carbon credits can be bought to offset unavoidable or hard-to-abate emissions or as part of ‘Beyond Value Chain Mitigation’, which is essentially investing because it’s a good/smart thing to do. Particularly if your organisation relies on the natural world to operate, which arguably all do. No carbon can be claimed towards organisational emissions as part of this strategy.
There has been a notable shift in corporate attitudes towards carbon offsetting too. Organisations are now seeking ways to address climate, communities, and ecosystems together. While the carbon market is still an effective way to do this (for example, a woodland might deliver biodiversity uplift, public access to green space, and flood mitigation) other nature markets and standards are also emerging to meet and regulate this demand. For example, the biodiversity market.
As a result, the carbon market is having to adapt – now more than ever there is huge pressure to deliver credits that are high quality, traceable, and delivering more than just carbon sequestration or avoidance. While upholding integrity is vital for the trustworthiness and impact of these projects and the wider market, there is a balance to be struck. Practicality is also crucial for their viability and potential for expansion.
What is Forest Carbon’s role in all of this?
Forest Carbon is primarily focused on driving action for UK woodland creation and peatland restoration projects, as well as selling carbon credits from verified international projects. We use international credits when an organisation wants to meet near-term climate targets that cannot be met by UK credits. Read more on our ‘Buying carbon: how it works’ page.
Our core purpose is to maximise investment and optimise its impact, so that land managers across the country can harness the power of natural processes to help restore our environment and put our society on a path to genuine sustainability.
How can I act?
Depending on whether you’re an individual, a young business, or an established business, there are several ways you can reduce your impact on the planet.
Established businesses should measure and report on their scope 1, 2, and 3 emissions and establish a science-aligned reduction strategy. Unavoidable or residual emissions should be offset through high-integrity projects that are mitigating emissions elsewhere. Go above and beyond with Beyond Value Chain Mitigation (BVCM). Forest Carbon is a reputable supplier but do your research.
New/small businesses should focus on improving climate literacy internally, and embed policies that prioritise and support the well-being of people and the planet. Investing in the UK’s voluntary carbon market is one such action. Visit the Carbon Club to take action now. If you will grow into a business that’s likely to have a large footprint (e.g. FMCG, agriculture, construction, travel, etc.) you should prepare to tackle your emissions like an established business.
See the Climate Change Committee’s recommendations for individuals.
Next up, learn more about Forest Carbon’s woodlands and peatlands.
