Carbon Economy 101

Sabrina Salov, Market research analyst at We Grow Green Tech

What is the Carbon Economy

The Carbon Economy generally refers to production and consumption patterns of carbon across corporations, countries, and regions. In the last decade, developments initiated in international agreements such as the Paris and Kyoto Accords have created opportunities for companies and organizations to reduce their carbon emissions and exchange credits for doing so.

A carbon credit is typically a certificate or permit, often referred to as a carbon allowance, which represents a right to emit one tonne of carbon dioxide or greenhouse gas equivalent within a given time frame.[1] Depending on the country, industry, and crediting mechanism, credits can either bought by participants at a fixed price and by voluntary auction or distributed free of charge based on forecast carbon emissions. Carbon Credits may also be issued from several different mechanisms that are addressed below.

In many exchange platforms and crediting mechanisms, players must meet a target reduction amount in order to earn carbon credits. In many trading operations, if a player emits less than the target then it can sell its excess credits to those who do not meet theirs accordingly. Such carbon credit trading between countries and corporations are done so on exchange platforms and are regulated.

Because there is no central authority that measures carbon credits, credit units do not have the same value. Notably, voluntary units tend to be less valuable than units sold through regulated systems.[2] This is ultimately due to the trivial nature of supply and demand in a voluntary exchange market.

Carbon Pricing

Carbon pricing reflects the initiatives that put an explicit price on greenhouse gas (GHG) emissions expressed in a monetary unit per ton of carbon dioxide equivalent (tCO2e). This Includes carbon taxes, ETSs, carbon crediting mechanisms, and results-based climate finance (RBCF).[3]

o Carbon taxes — taxies, levies, and excise duties that explicitly state a price on carbon.

o ETSs — also known as Emissions Trading Systems, creates a supply and demand relationship for carbon credits or emissions allowances and establishes a market price for greenhouse gas emissions. By using Cap-and-trade or baseline-and-credit systems, ETSs ensure that the required emission reductions will take place to keep players within their pre-allocated carbon budget.[4]

• Cap and trade — total cap is set on the number of emissions for a certain section of the economy. Emissions units are either auctioned off or allocated according to set criteria. Regulated emitters must surrender an emissions unit per ton of emissions, but have the option to reduce their own emissions or trading allowances
• Baseline-and-credit — baselines are set for regulated emitters. Players with emissions above their designated baseline need to surrender credits for emission above their baseline. Players that have reduce their emissions below their baseline receive credits for these emissions reductions, which they can sell to other emitters.

o Carbon crediting mechanisms — initiatives that issue tradable emission units to actors that voluntarily implement emission reduction activities that are additional to business-as-usual operations. This is different than ETSs where actors have mandatory obligations. Crediting units can be linked to carbon taxes or ETSs if policymakers choose to give regulated emitters an alternative means of compliance.

o RBCF — form of climate finance where funds are disbursed by the provider of climate finance to the recipient upon achievement of a pre-agreed set of climate results (ex: voluntary purchase of carbon credits for non-compliance purposes). Private organizations can purchase emission reductions to compensate for their own emissions, also known as carbon offsetting.

o International carbon pricing — practice within organizations of assigning a monetary value to GHG emissions in their policy analyses and decision making.

Internal carbon pricing

Internal Carbon Pricing has been adopted by many companies that are working to reduce and manage GHG emissions, and actively inform the decisions going into their projects.

Why do companies use internal carbon pricing?

• Stimulate clean technology and innovation, driving low-carbon investments and pathways to economic growth
• Internally address the GHG emissions that haven’t received a carbon price from government regulation
• Help manage abatement costs for reaching emission reduction targets
• Help shift the burden for damage directly back to those who are responsible for it and can reduce it

Carbon Crediting [3]

Carbon Crediting — what is it?

Carbon Crediting — the process of issuing tradable units to actors that are implementing approved reduction activities

• Represent avoided or sequestered emissions that are additional to busines-as-usual operations. Emissions are lower as a result of these activities than they would be in a counterfactual scenario without the incentives from the crediting program.
• Generated voluntarily and exist outside of the scope of other carbon pricing initiatives where covered entities have a compliance obligation, making them different from allowances under cap-and-trade or performance credits under baseline-and-credit ETS systems.
• Separate from project-based mechanisms, crediting can also be scaled up to include policy-wide crediting mechanisms.

Carbon Credits — How to use them

Offsets — emission reductions achieved by one entity can be used to compensate for (i.e. offset) emissions from another entity

o You can offset emissions for compliance obligations for a carbon tax or ETS or contribute to a voluntary market where carbon credits are used to offset individual and organizational emissions on a voluntary basis

o Credits can also be used as a means of quantifying and rewarding emission reductions from projects receiving carbon finance

• There are several different ways to use carbon credits

1. Can be established internally as part of a player’s obligations under a carbon tax or ETS
2. In addition to offering regulated companies some flexibility for compliance, offering financial incentives (i.e. monetizable carbon credits) sectors not covered under a mandatory pricing initiative could be enticed to reduce their emissions and encourage low-carbon innovation. As long as the reductions generated from crediting activities are real, crediting can also speed up climate action by enabling reductions to happen faster. Abatement strategies would need to go beyond offsetting. Entities will need other measures to drive down emissions in their own operations
3. Can be purchased voluntarily by companies to reach corporate social responsibility or voluntary climate goals
4. Countries can trade credits as mitigation outcomes to achieve their NDC targets

Sector Map of Crediting activities

In order to compare and consolidate data in a consistent manner, the sectoral scope activities and their emission mitigation activities are mapped as follows:

Three Types of Crediting Mechanisms

• International Crediting Mechanisms — governed by international climate treaties and are usually administered by international institutions (ex; Clean Development Mechanism and Joint Implementation).
• Independent Crediting Mechanisms — mechanisms not governed by any national regulation or international treaties. They’re administered by private and independent third-party organizations, which often are governmental organizations (ex; Gold Standard and Verified Carbon Standard).
• Regional, National, and Subnational Crediting Mechanisms — governed by their respective jurisdictional legislature and are usually administered by regional, national, or subnational governments (ex; Australia Emissions Reduction Fund and the U.S. State of California’s Compliance Offset Program).

International Crediting Mechanisms

The two International Crediting Mechanisms, the Clean Development Mechanism (CMD) and Joint Implementation (JI), are established under the Kyoto Protocol and their futures under the Paris Agreement are uncertain. However, the structures of these mechanisms will most likely serve as a template and considerable influence for the future of Article 6 standards under the Paris Agreement.

I. Clean Development Mechanism (CDM)

• Allowed emissions reductions from registered activities in “non-Annex I” countries to be transferred to “Annex I” countries, who could use these credits for compliance with their emissions commitments under the Kyoto Protocol
• Over 250 methodologies on how to credit activities across a wide range of project types, with over 75% of the credits issued have come from the industrial gas and renewable energy sectors
• Influence has been in decline as global attention has shifted away from Kyoto protocol

II. Joint Implementation (JI)

• Works similarly to CDM, with the exception that it involved cooperation between two countries with emission target obligations
• Nuance within the JI mechanism concerning cancelations and obligations required for Allocated Allowance Units (AAUs) have resulted in no activities since 2016, with no new projects registered or new ERUs issued

III. Article 6.2

• Allows countries to sell any extra emission reductions they have achieved compared to the target (self-defined, nationally determined contributions). These are called Internationally Transferred Mitigation Outcomes (ITMOs).
• Countries are allowed to enter into bilateral agreements and self-define how “environmental integrity” is ensured. No specific body controls the market and quality of the emission reductions transferred would not necessarily be measurable
• Risks- if national emission reduction targets are too weak, which is the case for several countries not requiring them to take any climate action, then transferred credits will have no value for the climate

IV. Article 6.3

• Project developers will reduce emissions through specific actions in a country and sell them to another country/ company/ person
• Requires more “governance” — more control from a body tasked with establishing detailed rules and verifying that projects and credits are in compliance

Independent Crediting Mechanisms

Independent crediting mechanisms generate credits that are generally used for voluntary offsetting purposes and make up the majority of the voluntary carbon offset credit market. Some independent carbon credits are also used for compliance purposes in standard carbon pricing operations, which complicates the boundaries between voluntary and compliance carbon markets. As the carbon economy expands and climate action becomes more salient and necessary in business practices, the number of independent crediting mechanisms has increased. However, there are 4 mechanisms that currently dominate the independent crediting territory:

I. American Carbon Registry (ACR)

• Crediting for emission reductions for both voluntary and compliance markets for projects based primarily in the U.S.
• First independent voluntary offset program in the world with the fourth-largest independent crediting mechanisms by total issued credit volume to date with most of its credits from forestry and carbon capture and storage activities.
• Currently serves as an Offset Project Registry (OPR) for the California Compliance Offset Program

II. Climate Action Reserve

• Originally began as the California Climate Action Registry and was created by the state of California in 2001 to promote and protect local businesses as they prioritized reducing their GHG emissions
• Climate Reserve Tonnes (CRTs) are primarily used for voluntary offsetting purposes with 97% of activities involving reducing emissions from landfills, reduce ozone-depleting substances, and forestry
• Similar to ACR, also credits voluntary offsetting activities and serves as an OPR for CA

III. Gold Standard

• Established by the World Wildlife Fund and international NGOs as a crediting mechanism for both voluntary offsetting and additional certification on the social impacts of CERs It is based out of Switzerland but geographically covers the entire globe.
• Focus on generating co-benefits, such as employment and health improvements for local communities alongside emission reductions from its projects
• Strict requirements to demonstrate appropriate safeguards to ensure co-benefits
• Verified Emissions Reductions (VERs) are primarily used for voluntary offset purposes, although many have been used for compliance purposes under the Colombia carbon tax
• Active in aligning its activity with the Paris agreement and the UN Sustainable Development Goals (SDGs) through a best practice standard called the “Gold Standard for the Global Goals” (2017).
• Second-largest independent crediting mechanism by crediting project activity and credit volume with a significant promotion of activities form renewable energy and cookstove fuel switch projects. Additionally, it is the only one of the four largest crediting mechanisms to be based outside of the U.S.

IV. Verified Carbon Standard (VCS)

• Founded by carbon market actors including The Climate Group, International Emissions Trading Association, the World Business Council for Sustainable Development, and the World Economic Forum to certify and credit voluntary emission reduction projects
• Verified Carbon Units (VCUs) are primarily used for voluntary offsetting but additionally support over 17 million VCUs from VCS projects used for compliance under the Colombia carbon tax
• Active in aligning its crediting activities with the Paris Agreement and the UN SDGs. Launched the Sustainable Development Verified Impact Standard (SD VISta) in 2019, which is a framework for assessing and reporting on sustainable development benefits of project-based activities
• The largest independent GHG crediting mechanism and the largest issuer of REDD+ and forestry credits overall, and also serves as an OPR for the state of California.

Conclusion

Carbon pricing strategies are often understood as the most efficient means to reducing carbon emissions, as it allows entities responsible for polluting carbon and other GHG emissions with cost-effective solutions and mitigation techniques. However, increasing knowledge and available information on carbon accounting and emission reduction operations, the market for carbon credits and future for a low-carbon economy still faces many challenges.

The evolution of carbon accounting will provide an opportunity for leading entities and institutions to address modern expectations, issues, and goals for the carbon market. Moreover, carbon accounting relies on full disclosure of GHG emissions, verification and reporting performed by a trusted entity, and establishment of baseline reduction standards and responsibilities. [5] The absence of strong, reliable measuring standards, domestically and internationally, creates obvious loopholes and implications for under or over counting emission reduction initiatives. Required levels of universal coordination, structure, and addressing local-level needs complicate the growing market system. Thus, carbon accounting operations and trading practices rely on a series of assumptions (e.g., economic rationality, perfect information, credibility, and broad coverage) that may cloud harmful developments and create instability.[6]

Additionally, carbon pricing typically captures the market and environmental costs of emissions, but often fails to protect local stakeholders and deliver sustainable development in the process. This is substantially due to perverse incentives for private entities or those interested in voluntary crediting mechanisms, as it is cheaper to pollute and buy credits than it is to transform the waste production practices. Thus, in practice, carbon pricing promote the optimization of business-as-usual models but fail to drive fundamental systemic change.

Finally, although carbon neutrality may be awarded case-by-case and carbon pricing could help reduce individual emission production, carbon offsets are only a small step to mitigating our climate crisis. Carbon offsetting can only do so much for reducing emission rates, as production and consumption levels of non-renewable energy continues to grow. [7] This is not the first time that we should conclude there is a need for radical, lifestyle change amongst all individuals, private entities, and government institutions.

Bibliography

1. How Carbon Credits Work | Nativeenergy.” Native Energy, 9 Jan. 2018, https://native.eco/2018/01/how-carbon-credits-work/.

2. “What Are the Carbon Credits? | How Do Carbon Credits Work?” Submer, 19 Aug. 2019, https://submer.com/blog/what-are-carbon-credits/.

3. World Bank, editor. The World Bank Group a to z 2016. World Bank Group, 2016.

4. “Pricing Carbon.” World Bank, https://www.worldbank.org/en/programs/pricing-carbon. Accessed 2 Nov. 2020

5. lopotan, Igor, et al., editors. Economic and Social Development (Book of Abstracts), 53rd International Scientific Conference on Economic and Social Development. 2020, http://www.esd-conference.com

6. Rosenbloom, Daniel, et al. “Opinion: Why Carbon Pricing Is Not Sufficient to Mitigate Climate Change — and How ‘Sustainability Transition Policy’ Can Help.” Proceedings of the National Academy of Sciences, vol. 117, no. 16, Apr. 2020, pp. 8664–68

7. Environment, U. N. “Carbon Offsets Are Not Our Get-out-of-Jail Free Card.” UN Environment, 10 June 2019, http://www.unenvironment.org/news-and-stories/story/carbon-offsets-are-not-our-get-out-jail-free-card

[1] How Carbon Credits Work | Nativeenergy.” Native Energy, 9 Jan. 2018, https://native.eco/2018/01/how-carbon-credits-work/.

[2] “What Are the Carbon Credits? | How Do Carbon Credits Work?” Submer, 19 Aug. 2019, https://submer.com/blog/what-are-carbon-credits/.

[3] World Bank, editor. The World Bank Group a to z 2016. World Bank Group, 2016.

[4] “Pricing Carbon.” World Bank, https://www.worldbank.org/en/programs/pricing-carbon. Accessed 2 Nov. 2020

[5] lopotan, Igor, et al., editors. Economic and Social Development (Book of Abstracts), 53rd International Scientific Conference on Economic and Social Development. 2020, http://www.esd-conference.com

[6] Rosenbloom, Daniel, et al. “Opinion: Why Carbon Pricing Is Not Sufficient to Mitigate Climate Change — and How ‘Sustainability Transition Policy’ Can Help.” Proceedings of the National Academy of Sciences, vol. 117, no. 16, Apr. 2020, pp. 8664–68

[7] Environment, U. N. “Carbon Offsets Are Not Our Get-out-of-Jail Free Card.” UN Environment, 10 June 2019, http://www.unenvironment.org/news-and-stories/story/carbon-offsets-are-not-our-get-out-jail-free-card