Carbon Market

Carbon Offsets—how do they work? You’ve adjusted your lifestyle—started bicycling more, switched out all of your old florescent lights for CFLs or LEDs —but just can’t drop those long flights to Hawaii for a weekend getaway. Or perhaps your company is struggling to meet their carbon reduction sustainability goals. With no more options available and still looking for ways to reduce your carbon footprint, you’re in need of help. This is where carbon offsets come in to play. Traditional carbon offsets have a bad rap and for good reason- they typically lack verification, transparency, and impact. Not a good recipe for success. A recent emergence of regulatory cap and trade frameworks, however, has significantly improved the potential for a successful carbon market. Today, many of the voluntary carbon offset programs are linking with the regulatory frameworks to create a verifiable, transparent, and impactful purchase.

Carbon Market Terminology

A carbon credit is equivalent to one metric ton of carbon dioxide (CO2). Carbon credits or permits are required when organizations are faced with regulatory emission caps. Credits can either be (1) an allowance, or (2) an assigned amount unit provided at the time of establishment of the carbon regulatory framework. Carbon credits must prove “additionality,” which means the projects must prove that they will be “additional to” the business as usual scenario of the organization completing the project.

Carbon exchanges provide a platform to buy and sell carbon credits. Buyers are primarily 1) companies required to meet emission caps, 2) companies seeking to buy low in anticipation of future emission caps (Pre-Compliance), 3) individuals seeking to offset their emissions, as well as 4) enterprising entities seeking to make money off betting on prices of future carbon credits. There are dozens of exchanges, with each year bringing new dominant marketplaces depending on the prevailing political and financial winds.

In order to realize greenhouse gas emission  (GHG) reductions, carbon credits must be retired, and listed on a registry to ensure the credit is no longer available for use. As opposed to a carbon credit, which allows an organization a certain amount of emissions, an individual or organization will pay another organization to implement an emissions reduction project to offset their emissions. These carbon offsets are the more notorious of the two, as they are frequently less actualized.

Carbon Market Overview

1. Compliance

• When faced with GHG mandates, whether a global target such as the Koyoto Protocol  or a regional mandate such as RGGI (Regional Greenhouse Gas Initiative) in the northeast U.S., qualifying entities are required to reduce their emissions below a certain threshold or buy permits allotting them higher emission levels. Each protocol or cap and trade initiative sets standards to establish allowable carbon permits for participating entities. These standards drive the type of permits available in the compliance market.

2. Voluntary

• More applicable to you, the individual, is the voluntary market. Individuals and companies who would like to take responsibility for their carbon emissions as well as entities purchasing “pre-compliance” credits (anticipating a future regulation) voluntarily buy carbon offsets from various organizations throughout the world. Voluntary carbon credits can either be bought through a formal exchange (think stock market) or from an “over-the-counter” exchange in which buyers and sellers directly engage with one another. Voluntary transactions represented less than 0.1% of the share of the global carbon markets in 2010¹.

Characteristics of Carbon Credits

1. Vintage: year carbon reduction takes place.
2. Source: type of project or technology used to offset carbon emissions.
3. Certification regime: There are dozens of standards in both the Compliance and Voluntary Markets. Each year seemingly brings a new standard as the old one bites the dust.
   • Compliance Market: The Kyoto protocol established the Clean Development Mechanism (CDM), which has a board that approves projects by issuing Certified Emission Reductions (CERs). By the end of the year, California’s Cap and Trade legislation will be operating, and it has its own set of standards (it won’t accept CERs). Today, the compliance market is largely driven by the European Union’s Emissions Trading Scheme, which occupies 97% of the carbon market after factoring in secondary transactions (ex. World Bank).
   • Voluntary Market: In 2010, the Voluntary Carbon Standard (issues Verified Carbon Units, VCUs) remained atop the list as the highest market share on the voluntary market. The Climate, Community and Biodiversity Standard (CCB) emerged as a increasingly popular standard, although its credits must be linked with VCUs for verification. Notably, the Chicago Climate Exchange collapsed in 2010, as it closed its doors stating it was satisfied with having paved the way for other carbon exchanges.

This chart highlights the various standards by market share in the Voluntary Market.²

Types of Emissions Reductions Projects

The U.S. Compliance Market is in its infancy, with only the Regional Greenhouse Gas Initiative (RGGI) currently in operation. California’s cap and trade system is set to begin in 2013, with the Western Climate Initiative aiming to build off of that. RGGI is largely driven by capping emissions from power generation facilities, but allows up to 3.3% of a power generator’s emissions to come from one of five qualified offset projects:³

1. Methane capture or destruction from landfills.
2. Reduction of sulfur hexafluoride from electricity transmission and distribution equipment.
3. Carbon sequestration  via afforestation (planting trees).
4. Non-electric end-use energy efficiency  in buildings.
5. Methane reduction from agricultural manure management.

These offset projects must occur in a participating RGGI state, and be verified by a RGGI approved independent verifier.

California is following a similar pattern with its cap and trade system, allowing power generators to purchase offsets to accrue carbon credits. The California Air Resources Board approved 4 U.S. project types:⁴

• Urban forestry
• Forestry
• Livestock methane
• ODS (Ozone Depleting Substances)

Two types are also expected in the future:

• REDD supply from Acre, Brazil, and Chiapas, Mexico
• U.S. based agricultural sequestration (cropland management and nutrient management).

This is a great opportunity to note the importance of retiring a carbon credit. When a power generator purchases a carbon credit, it does not actually reduce emissions. In order to get credit for the reduction and the ensuing increase in their emission cap, the carbon credit must be retired, and taken off the market.

Although the Voluntary Market is much smaller than the Compliance Market, it makes up for that in flexibility of projects. The most common types of voluntary, Over The Counter transactions are listed in the chart below.

However, it is also increasingly possible for entities to purchase carbon credits from the Compliance Market, and then retire them. Carbon Lighthouse, a Palo Alto, CA based start-up, is pioneering these efforts.⁵ They buy a carbon permit from a cap and trade market, such as RGGI, and then sell portions of that permit to individuals and companies who are interested in offsetting their behavior. Because these permits are needed by the power plants to emit a certain number of tons of carbon, buying these permits literally prevents that carbon from being able to enter the atmosphere.

Where do we stand globally?

The Kyoto Protocol  spearheaded the global carbon market by establishing a regulatory need for carbon tracking. To do this, it established the Clean Development Mechanism (CDM), which validates and measures projects to ensure they produce authentic benefits and are actual projects that otherwise wouldn’t have occurred. CDM approves of Certified Emissions Reductions for organizations to meet their emissions quota if they can’t do so on their own.

Because the United States did not ratify the Kyoto Protocol, it does not take part in this carbon market as a nation. Additionally, efforts to create a national cap and trade system faltered in the political turmoil in 2009 in the U.S. This explains why Europe is the primary driver of global carbon markets. However, sub-national efforts are emerging, as seen with RGGI and California’s efforts. RGGI is just now starting to tighten the clamps on emission permits to a point where emitters will actually need them, thus causing some states to rethink their decision to partake in the initiative.

Globally, the dead end of the Copenhagen talks really stymied any hope of a global, unified carbon market. However, consensus around REDD (Reducing Emissions from Deforestation  and Forest Degradation), is driving money and the carbon markets towards efforts to ensure the health of our forests, a key factor in carbon sequestration.

So you want to partake in the market? Now what?

Well, first, it’s important to understand the incredible turmoil surrounding the carbon markets today. Before you jump in headfirst, you should first look to your day to day life to see how you can reduce carbon emissions personally. Instead of paying some third party broker to reduce emissions halfway across the world, why not invest it in a local community solar project? Check out this site if you are interested: here .

If you are still looking to invest in carbon offset projects, then make sure the projects are linked to verifiable emission reductions from a Compliance Market, or a reputable Voluntary standard. There are great new organizations out there, such as Carbon Lighthouse, that can buy carbon credits in bulk and sell you a portion of one for you to retire in your name. Another great organization to check out is the Bonneville Environmental Foundation if you are interested in purchasing carbon offsets.⁶ Good luck reducing your footprint, however you plan on doing it!