Carbon credits: History of Emissions Trading and Market Overview

A brief description of Emissions Trading

The ultimate goal of carbon credits is to reduce greenhouse gas (GHG) emissions into the atmosphere.

Emissions trading (also known as carbon trading) is known as an approach in the market to limit pollution through the process of providing economic incentives to reduce corporate emissions. Carbon trading allows businesses or individuals to take environmental protection measures at any location in the most cost effective manner. By applying this trading method, the firms are able to combine ecologic effectiveness with economic efficiency.

When a business discharges into the environment more than what is allowed in their license, these polluters will need to increase the amount of emissions allowed by purchasing licenses from the people who sell them. This exchange creates the term Emissions trading. The buyers have to pay for the right to increase the amount of pollutants while the sellers are receiving a fair reward for lowering emissions by selling pollutant permits. The regulator will not be concerned who owns the unused allowances, as long as the total emissions are reduced.

Under an ETS, companies or groups are given emission permits, which are known as carbon credits, that enable them to discharge a particular quantity of a specific pollutant during a certain time period. In fact, businesses or organizations that need to own carbon credits to cover the emissions their business has on the environment. The ultimate goal of carbon credits is to reduce greenhouse gas (GHG) emissions into the atmosphere. To successfully achieve long-term objectives of emissions reductions, allowable emissions need to be set lower than the previous year and reduced each year thereafter.

The trading of a finite number of permits leads to the establishment of a market price for emissions, allowing polluters to determine the most cost-effective way to achieve the needed reduction. Emissions trading has been used successfully to reduce acid rain emissions, and it is now being utilized in various initiatives across the world to manage greenhouse gas emissions.

History of Emissions Trading

In response to increasing assertions that global warming is occurring as a result of man-made emissions and uncertainty over its potential consequences, the international community began the long process of developing effective international and domestic measures to deal with GHG emissions (carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulphur hexafluoride). In 1992, that process began and the UN Framework Convention on Climate Change (UNFCCC) was signed in Rio de Janeiro by 160 nations. UNFCCC is just a framework, as its name implies; the essential details were left to the UNFCCC’s Conference of Parties (CoP).

In 1992, that process began and the UN Framework Convention on Climate Change (UNFCCC) was signed in Rio de Janeiro by 160 nations.

The evolution of emissions trading may be split into four phases throughout the course of its history:

1. Gestation: Independent of the former, fiddling with “flexible regulation” at the US Environmental Protection Agency (by Coase, Crocker, Dales, Montgomery, and others).
2. Proof of Principle: In 1977, the Clean Air Act included the “offset-mechanism” as part of the Clean Air Act, which allowed for the trade of emission certificates. When a business pays another company to decrease the same pollutant, it may be eligible for an allowance under the Act for a higher quantity of emissions.
3. Prototype: As part of the US Acid Rain Program under Title IV of the 1990 Clean Air Act, the first “cap-and-trade” system was launched, which was formally proclaimed as a paradigm change which is developed by “Project 88,” a network-building initiative in the US to generate both together environmental and industrial interests.
4. Regime formation: branching out from the US clean air legislation to global climate policy, and then to the EU, with the anticipation of a developing carbon market worldwide and the formation of the “carbon industry”.

On December 11, 1997, one important economic reality recognised by many countries — the Kyoto Protocol. It took effect on February 16, 2005, after a lengthy ratification procedure. The Kyoto Protocol now has 192 signatories. Generally, the Kyoto Protocol puts the United Nations Framework Convention on Climate Change into action by committing developed and developing nations to limit and reduce GHG emissions in line with agreed individual targets. The Convention merely requires such nations to adopt policies and measures on mitigation and to report periodically.

The Kyoto Protocol contained provisions that are allowed for the development of flexible market mechanisms through emission permit trading. Countries must fulfill their objectives largely through national means under the Protocol. The Protocol, on the other hand, provides them with three market-based tools to help them accomplish their goals:

• Clean Development Mechanism (CDM): allows countries with an emission reduction target under the Kyoto Protocol (Annex I Parties) to implement GHG reduction or removal projects in non-Annex I Parties to generate certified emission reductions (CERs).
• Joint Implementation (JI): allows parties in Annex I to carry out projects in the territory of other counties within the annex in order to create emission reduction units (ERUs)
• International Emission Trading (IET): allows Annex I Parties that have emission units to spare to sell this excess capacity to countries that are over their targets, which are assigned amount units (AAUs). Therefore, they create new commodities in emission reductions.

Besides, the Paris Agreement was generated in 2015 among 196 Parties at COP 21. This is a legal binding international treaty on climate change. Its goal is to keep the global temperature rise this century below 2 degrees Celsius above pre-industrial levels and to pursue efforts to limit the temperature increase even further to 1.5 degrees Celsius.

In October 2016, the Carbon offsetting and reduction scheme for international aviation (CORSIA) was developed by the International Civil Aviation Organization (ICAO). It is a resolution to achieve the goals of reducing GHG emissions for international aviation, including measures such as the development of technologies and new standards for aircraft; improved air traffic control and ground operations for fuel economy; use of biofuel; and implementation of emissions trading and offset mechanisms.

Market overview

Carbon markets include mandatory (compliance) schemes and voluntary programs. While compliance markets are generated and regulated by mandatory international, regional, and subnational carbon reduction schemes, Voluntary markets exist outside of compliance markets and allow businesses and individuals to buy carbon offsets on a purely voluntary basis, with no intention of use for compliance.

Voluntary, non-regulated companies may acquire compliance offset market credits in some cases. However, voluntary offset market credits are not authorized to meet compliance market demand unless they are specifically admitted into the compliance regime. Voluntary offset purchasers are motivated by several factors such as corporate social responsibility, ethics, and reputational or supply chain risk. Pre-compliance purchasers buy offsets speculatively before the launch of the compliance carbon market, intending to get a cheaper price than what the identical offset would later fetch in the compliance program.

The carbon market allows organisations, firms and individuals to voluntarily offset their emissions in the course of their operations through trading carbon credits. These can be credits created either under Clean Development Mechanism (CDM) or under other standards operating in the voluntary market. This voluntary market operates not because of government obligations but as a matter of own (corporate) social responsibility (CSR) and/or as a response to market pressure and public opinion.

Voluntary markets coexist with compliance offset markets, which are driven by legislated limitations on GHG emissions and operate on a far larger scale. Compliance carbon markets are marketplaces where regulated companies can buy and sell emissions permits (allowances) or offsets to fulfill predefined regulatory objectives.

Compliance markets went through four main phases:

• European Carbon Markets: regulated by the European Union, it is the oldest and largest Emission Traded System (ETS) operating worldwide. The system covers around 45% of EU’s carbon emissions
• California Cap-and-Trade Program: This Program was generated ideally in 2012 and began its compliance obligation in January 2013. It is linked with Ontario and Québec’s systems. The California program covers sources responsible for approx. 80% of the state’s GHG emissions
• USA — Regional Greenhouse Gas Initiative: RGGI is known as the first mandatory GHG ETS in the US. They cover emissions from the power industry and ten states from the East coast
• New Zealand Emissions Trading Scheme: Launched in 2008, originally designed to cover the whole economy, it has broad sectoral coverage, including forestry

According to several reports, the valuation of the global carbon market has increased by 20% in 2020, reaching a total value of nearly €230bn and is the fourth consecutive year of record growth, in which:

• European Emissions Trading System (EU ETS): Most of the 20% growth has come from the European Emissions Trading System (EU ETS), which accounted for almost 90% of global value with a record-high global trading volume of 10.3 Gt.
• North American: Western Climate Initiative and Regional Greenhouse Gas Initiative show the same trend as Europe, which has increased by 16% in terms of overall market value from 2019, to Eur22 billion and Eur1.7 billion.
• New Zealand’s Market: Market value increased to €516 million on higher average allowance prices, nearly 20% higher than in 2019.
• South Korea’s Market: At ~€829 million, a 10% increase from 2019
• China’s Market: The eight Chinese regional pilot systems has resulted in an aggregate market of €257 million, slightly higher compared to 2019

In recent years, climate change has received more and more attention, and with the Paris agreement, many countries intend to contribute to the carbon market. As a carbon market is instrumental in achieving more ambitious climate goals, it will further increase global carbon trade in the future. In addition, governments around the world are increasingly relying on voluntary carbon market mechanisms — notably standards and registries — to inform the creation or function of compliance tools.

About Oxychain: Oxychain is an on-chain solution to create interoperability between the carbon markets and the digital world with software infrastructure for on-chain compensation. Oxy Labs, the company behind it, aims to bring transformative solutions to the conventional Carbon Markets with a focus on capillarity, accessibility, and interoperability.

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