Two different market-based approaches exist to set a price on carbon and push companies to decarbonize.
Companies considered high-polluting, fall under the Regulated Carbon Market and are subjected to a CO₂ emissions quota. All companies can also voluntarily contribute to projects avoiding or capturing carbon emissions to account for their own footprint.
For more information on Carbon Removal Methods, download the guide. Both markets were designed to set a price on carbon, but they function differently. The object of this article is to compare their main characteristics.
The structure of the Regulated Carbon Market is based on a ‘cap and trade’ system. A number of quotas is allocated to the regulated companies and can be exchanged between the market players. The total number of quotas allocated represents the market cap. The list of companies is defined by the European Union. One quota is equivalent to one tonne of CO₂ and regulated companies can sell or buy quotas between them to comply with their limit.
It is a regulated market: the quota price depends on offer and demand. Government-supervised registries and non-compliance penalties have been implemented to ensure compliance and transparency. For instance, in the case of the European Union Emission Trade Scheme (EU ETS), the common European Registry has been implemented and a penalty of €100/t has been set. Storage of quotas is also authorized, but only under governmental monitoring.
In contrast, the Voluntary Carbon Market operates on a more flexible basis. This is an over-the-counter market where companies and individuals can buy carbon credits issued by certified projects, often as part of voluntary initiatives. The price of credits in this market is more variable and depends on many factors, such as the location of the project, the environmental and social co-benefits it generates (such as biodiversity or community development), and the certification standard (e.g. Gold Standard or VCS). These features make the Voluntary Marketplace an attractive mechanism for organizations seeking to go beyond their regulatory obligations.
The lack of transparency in some Voluntary Carbon Market transactions may undermine the credibility of carbon credits, but efforts are underway to improve traceability and ensure that each credit corresponds to a genuine reduction or sequestration of emissions. These initiatives are aimed at boosting confidence in the market and attracting more companies and individuals keen to make a voluntary contribution to the fight against global warming. At ClimateSeed, we are committed to transparency and the strict selection of quality projects.
For a deep-dive on this topic, be sure to watch our webinar: From Carbon Offsetting to Climate Contribution.
First, the cap-and-trade system pushes companies to decarbonize as it sets a limit on the polluting capacity of regulated companies. Second, since 2012 the number of freely allocated quotas has been progressively reduced. Some industries operating within the Regulated Carbon Market need to buy quotas to pollute: it is the polluter pay-principle.
To buy these quotas, auctioning rules have been implemented. By 2034, all quotas in the market will be auctioned meaning that for every tonne of carbon emitted within the EU from regulated companies, a carbon price will apply.
The carbon reduction projects on the Voluntary Carbon Market avoid or capture CO2 emissions. They are classified under several project typologies, such as forestry & land use, renewable energy, household community devices and water management, agriculture and waste management.
International standards (Gold Standard, VCS, etc.) set guidelines and methodologies to certify projects, which are assessed by independent third parties. Organizations thus choose projects most aligned with their environmental and social goals.
The Regulated Carbon Market is a powerful climate policy tool. All participants are obligated to comply with its rules. As soon as the price of carbon is high enough, as it is the case now, companies are pushed to find faster ways to decarbonize. Decarbonization becomes a cost-saving measure.
The two main limits of this market today are the carbon allowances surplus and the leakage risks.
Whereas the Regulated Carbon Market does not facilitate the financing of climate friendly projects, the Voluntary Carbon Market does. Besides the carbon avoidance or capture, the projects also generate other positive environmental and social impacts linked to the United Nations Sustainable Development Goals, such as gender equality, life-on-land protection, or education.
The Voluntary Carbon Market valuation reached $2Bn in December 2021 as an increasing number of companies commit to net-zero targets and aim to meet the Paris Agreement’s goals.
However, lack of transparency and poor communication could hinder the development of this market.
At ClimateSeed, we support our customers in measuring and reducing their carbon footprint. We also maintain strong relationships with project developers implementing recognized projects on the Voluntary Carbon Market, to offer our customers a portfolio of high-quality projects, enabling them to decarbonize outside their own value chain.