The Carbon Cure — Carbon Market Mechanisms Explained
The following is an excerpt from a new CleanTechnica report, The Carbon Cure: Effective Actions to Combat Climate Change through Carbon Markets. For more on the types of carbon markets across the world and their role in stabilizing our climate, buy the full report or become a CleanTechnica Member, Supporter, Technician, or Ambassador by the end of Monday, September 27, and we’ll send it to you.
Carbon Market Mechanisms Explained
We can all agree that something needs to change to mitigate the Earth’s exacerbated greenhouse effect. The actions of individuals and companies are shaped by external policy and market forces. Governments are responsible for setting rules that help inform and determine individual and company behavior, hopefully with a view to staying under the 1.5 or 2-degree threshold.
Collectively, we need to a) reduce our carbon emissions drastically through policy and action, b) create ways to penalize carbon emissions, and c) create mechanisms to offset carbon emissions. Enter carbon market mechanisms. The good news is that these already exist globally in various forms and policies. Carbon market mechanisms aim to reduce greenhouse gas emissions cost-effectively by setting limits on emissions for industries and enabling the trading of emission units, which are instruments representing emission reductions. There are several mechanisms used currently to that end:
Here are the basic carbon market concepts which will be covered in this report:
4.1. Carbon Offsets
This system creates a financial incentive to transfer or redistribute their pollution and to curb emissions. This can be done through carbon offsets or by purchasing carbon credits.
A carbon offset is a certificate representing the reduction of one metric ton (2,205 lb) of carbon dioxide emissions and provides a way to compensate for emissions by funding equivalent carbon dioxide savings elsewhere. The reason why this mechanism is so valuable to large emitters like coal plants is that it is much more challenging for them to reduce their emissions internally and would take a more significant investment to do so rather than invest in technology, development, jobs, etc. in other places that result in reduced emissions. In other words, carbon offsets enable capital to be invested in reducing emissions in the most efficient manner possible. The vast majority of carbon offsets are made through forest conservation and reforestation. Other applications to offset carbon emissions include investing in renewable energy, energy efficiency, and some newer and more innovative applications include soil carbon and methane reduction from farm and agricultural practices.
For instance, a dairy farm installs an anaerobic digester¹ to capture and destroy methane that would otherwise be released into the atmosphere when animal manure decomposes. Every ton of emissions reduced results in the creation of carbon offsets. Since anaerobic digesters are expensive to install and maintain, the dairy farm sells the emissions reductions from their project in the form of carbon offsets to finance the construction and operation of the digester. Carbon offsets are therefore an available tool for individuals and organizations that wish to mitigate the impact of their own carbon footprints.
Carbon offsets are verified against certain standards:
– Climate Action Reserve (CAR)
– American Carbon Registry (ACR)
– Gold Standard
– Verified Carbon Standard (VCR)
4.2. Carbon Credits
In the simplest terms, a carbon credit is an instrument that represents ownership of one metric tonne of carbon dioxide equivalent that can be traded, sold, purchased, retired, etc. A carbon credit is typically generated from third-party certified projects which produce carbon offsets, which are then turned into credits. Since carbon dioxide is a global impact gas, both offsets and credits essentially have the same reduction in carbon dioxide emissions and the same benefit to the planet in terms of climate change. In other words, carbon emissions create smog, acid rain, and other detrimental effects which are not only affected in the area of emissions, but globally; and thus, the location of carbon emissions are not as important as the overall reduction in carbon emissions.
4.3. Cap-and-Trade
Cap-and-trade is a market-based approach to reduce carbon emissions by providing economic incentives to polluters. A government regulatory system determines the number of permits that allow a discharge of a specific quantity of emissions over a set time period. The number of permits is capped based on reduction targets. These permits can be purchased or traded enabling exchange between organizations. The number of available permits decreases over time, putting pressure on the participating companies to invest in cleaner production options and reduce their greenhouse gas (GHG) outputs. In the long run, this fuels innovation and drives down the price of new technologies. Here is a helpful video by Canada’s Ecofiscal Commission to explain further: Carbon pricing: how does a cap-and-trade system work?
If a company is regulated under a cap-and-trade system, they likely have an allowance of credits they can use toward their cap, or upper limit of emissions. If they use fewer emissions (credits) than they are allocated, they can trade, sell, or hold the credit. If they sell a credit, this is taken out of their emissions allowance. Likewise, if they use more carbon than they have allocated, they must purchase a credit to be in compliance. This tradable credit results in emissions reduction from activities like reduced air travel, energy use reduction, or changing a business practice, to name a few.
4.4. Carbon Tax
Under a carbon tax, the government sets a price that emitters must pay for each ton of GHGs they emit. Businesses and consumers will take steps, such as switching fuels or adopting new technologies, to reduce their emissions to avoid paying the tax. Some jurisdictions combine carbon tax with carbon offsets.
4.5. Comparing Carbon Tax to Cap-and-Trade
These two systems are quite similar but have some differentiating qualities. Both put a price on carbon, create market-based incentives for emissions reductions and innovation, can generate revenue that can be recycled back to the economy, and both are more cost-effective than inflexible regulations.
Where they differ is that a carbon tax guarantees a certain carbon price, whereas a cap-and-trade system guarantees a certain amount of emissions reduction. The core advantage of a carbon tax is its simplicity. The core advantage of a cap-and-trade system is that it is easier to harmonize with other cap-and-trade systems.
¹ Anaerobic digestion is a process through which microorganisms, or bacteria, break down organic matter in the absence of oxygen. The process is used to manage waste or to produce fuel (source: EPA)
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