Trade Carbon Credits Are Generated
A worldwide market in carbon credits has been growing, driven by the desire to limit global warming. The carbon markets have become a focal point of this year’s United Nations Climate Change Conference, known as COP26. However, many people do not know what carbon credits are or how they work. The carbon credit system is a key piece of the 1997 Kyoto Protocol International Treaty and the Paris Agreement of 2016.
A company that emits greenhouse gases gets a number of credits, or emissions permits, to pollute. It can sell any unused credits to another company that wants to reduce its own emissions. The resulting “cap and trade” system creates a monetary incentive for companies to reduce their greenhouse gas emissions. And it incentivizes those that cannot easily reduce their emissions to compensate for their residual pollution by purchasing and retiring carbon credits.
Developing a robust trade carbon credits market requires a massive reduction in greenhouse gas emissions across the globe. Many countries, businesses and individuals are making a strong effort to reduce their own emissions. But they will need to supplement those efforts with carbon credits to achieve the reductions needed to meet the goals set in the Paris Agreement.
How Trade Carbon Credits Are Generated
To be viable, the voluntary carbon market needs a mechanism to deliver credible and verifiable carbon credits to buyers. This would help transmit a clear signal of demand that will encourage buyers to increase their purchases and suppliers to scale up their projects. A robust, efficient voluntary carbon market will also make it easier to verify that credits represent genuine emission reductions.
For example, suppose a timber landowner agrees to refrain from aggressively cutting trees on a track of land in perpetuity. The landowner can then sell offset credits to a cement manufacturer that has to meet regulatory requirements. This is a win for both the timber landowner and the cement manufacturer. But the timber landowner probably needs specialized advice on navigating complex regulations and finding carbon credit buyers, as well as assistance in planning the project to maximize its offset opportunities.
In addition, it takes time to register and verify a new carbon project and bring it to market. This could delay the flow of credit to buyers, which can erode their willingness to purchase. And a slow flow of carbon credits can drive up prices.
Finally, the voluntary carbon market relies on a wide variety of verification standards and methodologies. This makes it difficult to compare and contrast different projects. To reduce the risk of fraud and misreporting, the voluntary carbon market needs a standard, digital process to verify projects at regular intervals, rather than just at their completion. This would lower issuance costs, shorten payment terms, speed credit issuance and cash flow for project developers and allow for easy tracking of credits from origin to buyer.
A more streamlined verification process would also improve the integrity of the carbon credit market and boost its credibility in the eyes of buyers and investors. In a similar way that a physician might not be certified to practice without graduating from medical school, a trusted third party would need to be qualified to verify the carbon-reduction claims of a carbon project.