The need for addressing the climate crisis through the transition to decarbonised economies is gaining precedence throughout the world. Several countries have set ‘carbon neutral’, ‘net zero’, or ‘net negative’ targets and the number of private enterprises doing the same is also on the rise. The timeline and scope (types of gases) covered varies by country; for example Sweden has committed to greenhouse gas neutrality by 2045, while China is focusing on becoming primarily carbon dioxide neutral by 2060. The consensus by scientists, however, is that in order to meet the Paris Agreement goal of limiting global warming to 2˚C or lower, the global community needs to increase climate ambition reach net zero emissions by no later than 2050. Carbon neutral or net zero implies that any emission of the type(s) of greenhouse gas covered by the policy is matched or netted off by an appropriate mix of direct emissions reductions, emissions avoidance, and emissions removal and sequestration.
To place a price signal on polluting sectors and to incentivise the adoption of low-carbon technology, a growing number of countries at all levels of economic development are either implementing or considering carbon pricing mechanisms as part of their climate policy. Additionally, countries or regional jurisdictions that have already implemented carbon pricing mechanisms are strengthening or complementing those systems. Germany, for instance, is a part of the European Union Emission Trading System (EU ETS) but it is also working on creating a domestic emission trading system for the transportation and building sectors.
A discussion on carbon pricing driven largely by the Energy Chamber has emerged as part of Trinidad and Tobago’s climate policy landscape. Nevertheless, the terms carbon pricing, carbon markets, and carbon trading are sometimes used interchangeably without distinction for the types of pricing mechanisms and markets that exist.
There are two types of carbon markets. The first is a compliance or mandatory market and the second is the voluntary market. A compliance market is typically government mandated and covers certain scopes and sectors of the economy. Within a compliance system, two kinds of market instruments can deliver an explicit price on carbon: emissions trading and carbon taxes. These market instruments are quite similar as they seek to internalise the costs carbon emissions impose on society. By complying with this mandated price on emissions, be it through trading or a tax, the implementing jurisdiction (government, state, region) anticipates producers, consumers, and investors will change their behaviours to reduce emissions in a way that provides flexibility on who takes action, what action they take, and when they take that action.
The key distinction is that with a carbon tax the implementing jurisdiction sets the price and allows the market to determine the quantity of emissions. On the other hand, with emissions trading, the jurisdiction sets the quantity of emissions and allows the market to determine the price. It is possible to create a hybrid system that combines elements of an emissions trading system and carbon tax.
Carbon trading through an emissions trading system (ETS) works to limit total emissions while enabling emissions reductions to be realised at the lowest possible cost. The most wellknown ETS is perhaps the EU ETS.
Under an ETS, the implementing jurisdiction imposes a limit (cap) on the total emissions in one or more sectors of the economy, and issues tradable allowances not exceeding the level of the cap. Each allowance typically corresponds to one tonne of emissions. The regulated participants in an ETS are typically required to surrender one allowance for every tonne of emissions for which they are accountable. Participants that hold allowances can sell, or bank them for future use; entities that require additional allowances may buy them on the market. They may also be able to use eligible emissions units from other sources, such as domestic or international offsets mechanisms (the voluntary market) or other ETSs. The voluntary carbon market is built upon carbon crediting – issuing tradable units to actors that are implementing approved emission reduction activities. These emission reductions represent avoided or sequestered emissions that are additional to businessas- usual operations; meaning that emissions are lower as a result of these activities than they would be in a scenario without the incentives from the crediting programme. Credits are voluntarily generated and exist outside of the scope of compliance markets. A key differentiation is that a credit is backed by one tonne of emissions that has been avoided or sequestered, whereas an allowance in an ETS is simply a “permission to emit” one tonne of carbon dioxide equivalent.
The voluntary market is the mechanism to trade carbon credits. These credits can be sold to ‘offset’ individual or organisational emissions on a completely voluntary basis. For example, an individual may choose to offset their emissions associated with air travel. An organisation may decide to set emission reduction targets as part of its corporate social responsibility or voluntary climate goals. In addition, credits generated in the voluntary market can be used by countries to help them meet Nationally Determined Contributions (NDC).
Getting value out of the voluntary carbon market is nuanced. End-users of carbon credits pursue projects with attributes beyond emissions reductions. The highest value carbon credits are typically from projects that also generate various co-benefits ranging from increased biodiversity, job creation, support for local communities, and health benefits from avoided pollution. Additionally, the voluntary carbon market can generate flows of private capital to developing countries as activities and projects in these countries can provide a cost-effective source of these carbon emission reductions. A subsequent article will focus on the opportunities for emission reduction projects in Trinidad and Tobago.