Major Global Carbon Markets and Exchanges
Carbon markets are designed to create economic incentives to reduce greenhouse gas emissions, which are the primary cause of climate change. These markets provide a mechanism for companies and governments to trade carbon credits, which represent the right to emit a certain amount of greenhouse gases. There are currently two types of global carbon markets: quota-based and project-based.
Quota-based Market The quota-based market operates on a cap-and-trade system, where a governing authority sets a cap on greenhouse gas emissions for a defined period. The two types of caps are absolute caps and intensity-based caps. An absolute cap is a fixed quantity of allowed emissions, while an intensity-based cap is a cap on a pre-specified rate of emissions relative to inputs or outputs at the level of jurisdiction.
After the cap is set, carbon emission allowances are allocated to covered entities either through free allocation or an auction in the primary market. In the secondary market, companies can buy and sell allowances to meet their compliance requirements. The trading units of carbon allowances are usually equivalent to one tonne of carbon dioxide (CO2e).
Project-based Market The project-based market adopts the principle of baseline-and-credit, also known as an offsetting mechanism. Under this mechanism, there is no explicit cap on emissions for a jurisdiction or company. A company can aim to reduce their GHG emissions to a certain level below the level in a baseline scenario, which is formulated by third-party verifiers and may take into account the sector the company operates in and the technology constraints it faces.
Carbon offsets can be generated from either the avoidance/reduction of emissions or removal/sequestration through either direct actions (such as forestation projects) and/or emerging technologies (such as carbon capture). To verify the effectiveness of a carbon offset project, the project plan or description is validated by an independent auditor and the implementation is verified by another independent auditor, who will send its report to a standard-setting body (e.g. Verra and Gold Standard) if the criteria are met.
Carbon Markets Classification From a regulatory perspective, carbon markets can be classified into two types: mandatory carbon markets and voluntary carbon markets (VCMs).
Mandatory carbon markets are a kind of quota-based carbon market with legally binding emission reduction requirements from entities covered by the ETS. Covered entities can trade carbon emission allowances (or carbon offsets accepted in some markets) to meet their emission reduction requirements. Mandatory carbon markets are fragmented across jurisdictions. Currently, carbon allowances are restricted for use only within their own jurisdiction and are generally not fungible across mandatory markets.
Voluntary carbon markets (VCMs) are typically established by certain international organizations, countries, or private companies to enable voluntary offsetting of carbon emissions. Carbon offsets purchased in the voluntary market are often used to offset emissions that cannot be reduced, and to achieve net-zero emissions. The trading unit of carbon offsets is usually one tonne of CO2e.
Major Carbon Markets and Exchanges The following are some of the major global carbon markets and exchanges:
- European Union Emission Trading Scheme (EU ETS) The EU ETS is currently the largest carbon market in the world. It was launched in 2005 and covers more than 11,000 installations in the power and industrial sectors in 31 European countries. The EU ETS is a mandatory carbon market and operates on a quota-based system.
- California Cap-and-Trade Program The California Cap-and-Trade Program is the second-largest carbon market in the world. It was launched in 2013 and covers the power and industrial sectors in California. The program operates on a quota-based system and is linked with the Quebec Cap-and-Trade Program.
- Regional Greenhouse Gas Initiative (RGGI) The RGGI is a mandatory carbon market