As reported earlier, Exxon pledged to reach net-zero carbon emissions from its global operations by 2050.

In a statement, Exxon’s Chairman and CEO, Darren Woods, “We are developing comprehensive roadmaps to reduce greenhouse gas emissions from our operated assets around the world.”

Woods went on to say, “Where we are not the operator, we are working with our partners to achieve similar emission-reduction results.”

Exxon’s plans to reduce carbon emissions.

In addition to net-zero global operations by 2050, Exxon has promised:

$15 billion towards reducing GHG emissions over the next six years.
Better processes to reduce methane gas leakage.
To reach net-zero within the U.S. Permian Basin shale field by 2030

Exxon also bid highest to obtain offshore properties to use for carbon sequestration.

Critics feel Exxon is not doing enough.

Exxon’s goal involves scope 1 and scope 2 targets. This includes oil, gas, and chemical production. So, these cuts do not apply to consumer emissions, which are scope 3.

Critics feel this puts Exxon behind competitors who are scope 3 focused.

Josh Eisenfield, corporate accountability communications manager with Earthworks, said that by not including scope 3 emissions, Exxon would be “pushing the blame off of themselves and onto consumers.”

Scope 3 emissions matter.

In 2020, 650 million tons of GHG emissions were from Exxon’s oil sales.

This would not be addressed under Exxon’s net-zero pledge. 

However, Exxon is investing in carbon capture and storage, and the creation of hydrogen and biofuels. By doing so, Woods believes these fuels will be more accessible to consumers.

The need for action.

The fossil fuel industry accounts for over 36 billion tons of GHG emissions each year. Without more action, this number will rise.

In addition to new technologies, oil companies are using carbon credits to reduce their footprint. Some are even selling oil and gas as a bundle with offsets to create carbon-neutral oil as a short-term solution.

After Exxon’s announcement, its shares went up by 1.7 percent.

The post Exxon Commits to Net-zero Emissions by 2050 appeared first on Carbon Credits.

The article below was written by Lawson Steele – Joint Head of Carbon & Utilities Research at Berenberg Bank.

He has been in the carbon game since 2004 and it was published on his LinkedIn page on January 20, 2022.

Overview

I thought it high time to write an in-depth article on my favourite subject – EU ETS carbon, don’t you know.

Carbon has been a 10-bagger since I went on the bull path in January 2018.So it seemed poignant to ask two questions:

Does that mean it’s run is at an end?

Has the buy case ended or crumbled?

I’ve done a lot of work to retest the carbon buy thesis I’ve held for four years. The answer to both questions is an unequivocal NO.

The fundamentals still stack up and there is much more to come. So, if you have time, and the inclination, grab a coffee, sink into a comfy chair and here goes…

A more bullish view on the EU ETS carbon price

I have increased my average carbon price by 46% over 2022-30. I now forecast a peak of €150/t (previous €110/t) in Q123, closing this year at €130/t (€110/t).

Even without the Fit for 55 package, I expect the EU ETS carbon price to breach the €100/t barrier in the coming months (from the current €80/t).

In fact, I think it is highly likely that the price will go well north of my average €118/t 2022 target (the grey area and pointy arrow in the chart below).

The EU ETS carbon price could double, triple or quadruple (EUR/t):

And a much higher carbon price makes sense. Since the EU ETS scheme began in 2015, Industry has done virtually nothing to reduce its emissions.

If the EU’s goal is to reach the 55% emission reduction by 2030, which it clearly is, then the carbon price has to be sufficiently high to trigger that behavioural change.

Carbon at €80/t simply does not do that. And that is why all the EU’s reforms (MSR and Fit for 55 Green Deal) of the ETS are designed to do just that.

So let’s take a look at the fundamentals.

Revisiting my carbon bull case: stick

I stick with my bullish stance as I revisit and retest the fundamental buy case for carbon. Yes, carbon has been a 10-bagger since I turned bullish in January 2018 at €8/t. But that in itself does not necessarily stop it being, for example, a 20-bagger.

I revisit my view and conclude that it still holds true: carbon allowances are becoming increasingly scarce. Companies under the scheme will have to pay up for the right to pollute.

Which is precisely what the EU ETS is designed to do: send a price signal to force companies to reduce their emissions, ie to save the planet and protect the scarcest resource – my, and your, atmosphere.

Three reasons for entities to buy EU ETS carbon allowances

Any company or investor will have different priorities, but, for non-compliance entities, there are three main reasons to own EU ETS carbon allowances. Compliance entities have these three reasons plus, of course, having to buy allowances to comply/offset their emissions. These are:

to potentially earn a significant return: double, triple or quadruple the current price;
to contribute to a greener planet, forcing companies to reduce their carbon emissions; and/or
to protect the company against higher costs/inflation triggered by a higher carbon price.

If companies are short allowances, it is going to hurt

Sooner or later there will be a carbon cost associated with every transaction on the planet. Today, only 25% of the world’s daily 135mt of CO2 emissions is under a carbon scheme. And one scheme dominates: the EU’s Emission Trading Scheme (ETS).

As a corporate, if you do not own carbon allowances, whether for EU ETS compliance or for net zero targets, you are short. Doing nothing to cover your carbon emissions (whether direct or indirect) is effectively running a short.

A higher carbon price is going to come back and bite you. The same applies to individuals who will ultimately pay the lion’s share of the costs of carbon reduction.

COP26 was a failure to the planet

Non-specific coal reduction targets (eg “phase down” rather than “phase out”), agreeing to meet again next year to pledge further cuts (which was ostensibly the goal of COP26).

China pledging to reduce emissions from 2030 (but no discussion of the increase prior to that) and become net zero by 2060 (really?), and India targeting reaching net zero only by 2070 (oh come on, be serious) all means that the onus on saving the climate falls upon regulated emission trading schemes worldwide, of which the EU ETS dwarfs all others combined.

Consumers and corporates will have to do their bit. Politicians have thus far done very little to organise emission reduction strategies. Fortunately, EU politicians are, by and large, becoming ever greener.

There is a massive green push at the EU

The EU has shown that it is serious about reaching its 2030 emission reduction targets. Political momentum is to cut more emissions – and earlier than planned. Hence the EU Commission’s Fit for 55 package currently being debated in the EU.

It is all about tighter targets, not the status quo (let alone an easing). And the Commission is trying to speed up implementation.

Some resistance is to be expected

Of course, there has been (since the scheme began in 2005, and Kyoto 1997), and is always going to be, opposition to a higher carbon price. This has been a perennial debate since inception with Poland being one of the most vociferous (despite getting the lion’s share of carbon revenues, €8bn+ at current prices – year in, year out; see chart at end of article for full country breakdown.

To avoid legal paralysis, on 1 November 2014 the EU changed the original voting mechanism for legislation (ie not just for the EU ETS) so as to be able to sideline unreasonable opposition.

Article 16 of the Treaty of the EU stipulates that the conditions for a qualified majority are:

a majority of countries: 55% (comprising at least 15 of them), or 72% if acting on a proposal from neither the Commission nor from the High Representative; and
a majority of the population: 65%.

Poland makes yet more noise, but the argument is flawed

On 9 December 2021, the Polish Parliament passed (54%) a resolution to put forward a motion at the next EU Council meeting to suspend the EU ETS. The EU ETS is the “cornerstone policy” of the EU in its fight against climate change. I do not believe the Polish views will derail this train.

The Polish PM, among others, cites the carbon price as being the reason for high energy prices, blaming speculators in the process. I disagree.

Contrary to most other European countries, Polish electricity generation prices are much more dependent on hard coal prices than gas (70% of generation is hard coal/lignite). Hard coal prices increased from USD70/t (one-year forward API2) in Q121 to a peak of USD190/t in October 2021 and now trade at USD110/t, still way above Q121.

Because Poland is so dependent on coal, the carbon impact is, quite rightly, more severe: coal-fired electricity produces twice as much carbon as gas-fired electricity. So, Polish electricity prices have indeed suffered from a higher carbon price but also because the price of coal has risen remarkably – the impact split is about 50:50.

But let us not forget: the whole purpose of a higher carbon price is to trigger switching from more carbon-intensive processes (eg coal) to less carbon-intensive processes (eg gas and renewables).

And Polish (and other Eastern European) utilities have had free carbon allowances during 2013-20 which were not available to Western European utilities, ie they were treated leniently to help them move away from coal. In practice, little happened for many years (renewables is now c18% of generation).

When I look at German power prices, my analysis shows that carbon accounts for just 12% of the four-fold increase in German generation power price over the last 12 months. Gas, up eight-fold, is the culprit, accounting for 80%.

Gas prices account for 80% of the fourfold increase in generation costs – carbon just 12%:

In my view, the carbon price rally has been primarily driven by fundamentals, not speculation.

Significant legislative changes have markedly improved fundamentals.
The EU now has legally binding 2030 and 2050 climate targets. This is a firm commitment to reduce emission volumes. The EU’s prime weapon is the EU ETS. Despite being its “cornerstone policy”, it only covers 41% of emissions.
The Market Stability Reserve (MSR) mechanism came into effect on 1 January 2019. This results in enormous cuts in annual supply (auctions). It was brought into being specifically to push the carbon price up to a meaningful level, ie a level which would result not just in coal-to-gas switch for the power sector but also a reduction in industrial carbon emissions.

While the former has been successful (bar for short-term gas availability), the latter has not. In other words, the carbon price has been high enough to trigger coal-to-gas switching but not high enough to make it financially attractive for industry to reduce emissions.

Compliance is mandatory; non-compliance is penalised: On 30 April 2022, compliance entities under the EU ETS will have to deliver allowances to match their audited 2021 emissions. Failure to do so results in a €111/t penalty and still having to deliver those allowances in April 2023, on top of the allowances due for the emissions in the calendar year 2022. In 2023, the penalties will get worse: a 25% shortage of allowances in 2021 followed by an even larger 35% shortage in 2022, ie a cumulative 60%.

There is room for speculators

The EU’s European Securities and Markets Authority (ESMA) has, in its preliminary report, exonerated financial speculators as the “culprits” of the carbon price rally. Bravo ESMA: correct.

The full report is due in the coming months, but I would expect little change: the carbon price, in my view, has gone up due to fundamentals (implemented by the EU), not to “rampant speculation”, ie market tightening has been the principle driver of higher carbon prices – by the EU’s market design (the MSR).

The EU ETS carbon price could triple or quadruple

Even without the Fit for 55 package, I expect the EU ETS carbon price to breach the EUR100/t barrier in the coming months (from the current EUR80/t). In fact, I think it highly likely that the price will go well north of my average EUR118/t 2022 target.

Simply put, there is no clearing price for carbon: demand and supply do not meet. That, together with the draconian penalty, is enough to theoretically push carbon to infinity. Carbon is mispriced: there is just not enough analysis out there in this embryonic market.

That is beginning to change and, with it, a there is dawning realisation of the multi-year deficit this market is up against. With it, we might actually get a carbon price that forces industry to do what it should have done over the last 15 years: reduce emissions.

The key price driver is the multi-year trading deficit

There is a lot of noise currently in the carbon market, most of which is largely just that and detracts from market fundamentals. The crux is that the market is short supply. That is by far the overriding driver.

I forecast a 25% shortfall in supply versus emissions/demand in 2021, followed by 35% this year, 28% in 2023 and 23% in 2024 – which means that, cumulatively, there is a 111% deficit by 2024.

The multi-year trading deficit:

Demand: relatively stable

Demand/emissions picked up in 2021, boosted by increased emissions of c40mt from the coal to gas retrenchment (higher gas prices) and an estimated growth in industrial production/emissions of 3.9%.

For 2022. I expect demand/emissions to fall from 741m to 728m: higher industrial output (I conservatively assume 2.0% versus economists’ consensus of  c3.0%) will be more than offset by power abatement from renewables.

In 2023 I expect a reversal of the gas to coal move in Q421/Q122 as well as the French nuclear shutdowns. Power abatement will be offset by growth in industrial emissions as well as a recovery in aviation. In other words, I expect demand to be relatively stable from 2023 onwards for a few years.

Note that I conservatively estimate 1.0% pa growth in industrial output from 2024-30; this is considerably below the 1.8% pa historical average.

Supply: significant curtailment makes this the key driver of the carbon price

But the carbon price development is a supply story: Supply dropped by one-third, 294m, in 2021 to 574m versus demand of 741m. I expect it to fall by a further 14%, 82m, to 493m this year, well below demand of 728m. Demand and supply do not reach equilibrium until 2028.

The deficits are primarily driven by cuts in supply/auction of allowances (m):

It is the orange line in the chart above that matters the most: the cumulative supply deficit just gets worse and worse. Consider what that means: a 100% cumulative supply deficit in 2024, ie all demand cannot find a single allowance to buy to comply – that happens in just three years’ time. And it goes on south to 139% by 2030.

Supply cuts are mechanical, driven by the MSR

The Market Stability Reserve (MSR) is a mechanism that, under certain technical conditions, withdraws supply from the market (by reducing pre-scheduled auction volume).

This alone will take 300m-350m allowances out of the market over the next four years – every year. Contrast this with my forecast trading deficit of over 200m pa. The deficit is unequivocally driven by supply reductions.

The MSR mechanism is formulaic. If the total float of allowances in the system (called TNAC, the total number of allowances in circulation) exceeds 833m, then the pre-scheduled auctions are reduced by 24% x TNAC.

At the end of 2020, TNAC was 1,579m. So, the MSR reduction would be 378m (in practice it is based on a two-year weighted average, so it was 323m in 2021). This year it gets bigger at 366m, ie 50% of demand.

The MSR drives down supply by an average 36% every year over the next five years (m allowances):

The MSR is a counterbalance mechanism to any recession

The MSR is also interesting because it is a counterbalance. The float of allowances (TNAC) rose in 2020 as supply (daily auctions and free allowances) did not change but emissions fell as industrial output reigned in, swelling the float of allowances – which increases subsequent years’ MSR reductions.

In other words, an economic recession might have an impact in that year but gets ironed out in subsequent years, so it is a kind of self-balancing recession-proof mechanism.

And if there are insufficient allowances in the system, deemed as less than 400m (TNAC), then 100m will be put back into the system: this happens in 2027, 2029 and 2030 on my estimates.

The MSR is a recession-proof mechanism (m allowances):

There is insufficient liquidity in the system

I estimate that there are not sufficient existing allowances to cover the deficit. Yes, there were 1,579m permits floating around the system (the TNAC) at the beginning of 2021.

But these are already part of, or being mopped up for, hedging by utilities, industry (and, to come, maritime), aviation and investors. This liquidity constraint, coupled with the annual supply-demand imbalance and stiff penalties, explains why I am so bullish on the carbon price.

There are now no spare permits in the system (m); pre-demand snowball effect:

Further tightening of supply is likely

The Fit for 55 package, currently being discussed by the EU’s Council and Parliament, is all about further tightening of the system. This shows the EU’s commitment to achieve emission reductions and save the planet.

The EU wants a 55% reduction of 1990 emission levels by 2030, up from the 40% prior target. Interesting, more onus has been put on the EU ETS system, which covers only 41% of EU emissions, to achieve a 61% reduction (thereby putting less onus on industries outside the system, predominantly agriculture, buildings and transport).

The Fit for 55 package has created a lot of noise. I assume it is enacted in 2024. It could happen earlier, which would worsen my 2023 28% deficit forecast to 36%. Consequently, the next three years’ deficits are almost exclusively driven by the MSR. Fit for 55, while interesting and laudable, is a driver of the carbon price in the longer term, not the short or medium term.

There are not sufficient allowances to enable compliance

There are not sufficient allowances to enable companies – and this is absolutely key. It means that there are not sufficient allowances to be bought by emitters to deliver to their governments to match their emissions every 30 April.

A brutal penalty price for non-compliance

The penalty price for non-compliance is brutal: not only do companies have to pay a penalty of €111/t (€100/t in 2013, revised by annual CPI) per allowance not delivered, but that non-delivered allowance has to be (bought and) delivered the following year.

Which means that in 2022, not only is there a 34% deficit, but compliance entities are also trying to buy the 25% not delivered for 2021 emissions. Thus the (cumulative) deficit is really 59% (which gets progressively worse as time goes on).

Unchecked, the carbon price goes to infinity

If there are not enough allowances to go around, which there are not, then that, together with the non-compliance penalty, unchecked, drives the carbon price to infinity. And this is a crucial point.

In the first instance, emitters are prepared to pay up to €111/t to avoid the penalty price. But once the allowances get to €111/t, emitters will still not have bought the allowances they require (there was, after all, a 25% deficit for the last calendar year, 2021).

They will then, if not beforehand, realise that the opportunity cost is indeed the €111/t penalty but also the price of the allowance which has to be bought for delivery the following year. So the opportunity cost is actually €222/t (since the allowances would then be trading at €111/t).

Hence the price of allowances goes to €222/t (there is not enough supply to meet demand). But then 22% of emitters will have not bought the allowances they need so their opportunity cost is now the €111/t penalty plus the cost of the allowances, now trading at €222/t – ie, €333/t. And so on to infinity. What will stop it going to infinity will be demand elasticity but, before that, I assume, it will take a political reaction.

There could be a political reaction, but it will take time

If the carbon price goes sufficiently high, the ensuing political reaction will likely be slow to occur. I assume the carbon price goes to €130/t by year-end before going to €150/t for Q123 and Q223.

Thereafter, I assume a retrenchment to an average of €114/t in 2024, due to political reaction, before climbing north again toward €150/t by 2030. In reality, the reaction could take much longer and, more likely, the carbon price will blow through those levels.

I predict a political reaction kicking off at the price which creates the intensity of the (ongoing since Kyoto 1997) political debate. Simply for argument’s sake, let’s call that price €150/t. The price needs to be there for at least one quarter for the market to realise it is not a one-off aberration.

Then the EU Commission must realise it has to come up with a proposal, write it and table it. By way of example, it took nine months for the Fit for 55 Green Deal package proposal to be put together. Then it goes to EU Council, requiring c70% approval by the 27 members.

Then it goes over to the EU Parliament for 50% approval by its 27 members. If Parliament wants its stamp of approval, it goes back and forth, a maximum of three times. Then Council, Parliament and the Commission reach a trilogue agreement. Then they find a spare plenary session where it can be voted through. Then enacted. Then rolled out.

The whole process will take time; it will probably take three years for the Fit for 55 Green Deal to be fully enacted. It took four years for the MSR approval.

And it should take time: the EU has the principle of legitimate expectation enshrined in law which means, in plain speak, that if it shifts, in this case, the carbon goal posts, it can be sued (you have a legitimate expectation that you can trade on an enacted law and that it won’t change, at least not abruptly).

The EU desires neither of these outcomes and has shown, over time, that everything is done deliberately; the MSR (four years in the making) and Green Deal (likely three years) being proof. The EU wants the market to set the price: a fast move would kill the carbon market and, I think, they know that (nor do they have the desire to do so).

But EU ETS carbon price has to be well into triple figures to have an impact

Since demand and supply do not intersect and, unchecked, carbon goes to infinity, economics 101 does not work. I look at the potential carbon price in two ways:

Politics: The head of EU Climate, Frans Timmermans, has publicly stated that the carbon price needs to be well north of €50/t. In Germany, the industrial heartland of Europe, the new government has stated that it wants a carbon floor of €60/t (should the price fall below that it would buy allowances). EU Greens target €150/t, as does the Bank of England. Norway is calling for a price of €200/t.
Corporates: One of the most efficient chemical companies in Europe, BASF, has implied that a carbon price south of €140/t will not incentivise carbon reduction (so it presumably needs the price to be north of €140/t and sustainably so). Added to this, a leading cement player, HeidelbergCement, put that number at €120/t. A leading insurance company, Swiss Re, uses a carbon price of €200/t. And shipping companies are talking of needing the carbon price as high as €150/t.

The demand snowball effect: many will try to buy more allowances

I have not factored in the snowball effect into my model. However, it is a distinct possibility. The snowball effect happens as follows.

Industrial companies wake up and smell the (carbon) coffee: the cost of carbon becomes significant (lower free allocations from 2021, 80% instead of 90% plus a higher carbon price). The best strategy is to hedge themselves against higher carbon prices and carbon allowance scarcity. So, industrials will (try to) buy more carbon allowances.
Power companies will face increased demand from consumers for longer-dated electricity contracts. They will be happy to oblige. Having fixed the power price, they will want to fix their fuel costs and their carbon cost. So, power companies (try to) buy more carbon allowances.
Aviation, once traffic volumes recover, will also come to the realisation that they need to protect themselves. So, airlines will (try to) buy more carbon allowances.
Maritime joins the EU ETS system in 2024. Shippers are already working out that they need to protect themselves. So, shipping companies (try to) buy carbon allowances.
Financial investors, seeing that market participants are waking up to the supply deficits will also position themselves accordingly. So, financial investors will (try to) buy more carbon allowances.
Retail will eventually come into the market. Although difficult at the moment for retail investors to buy carbon allowances, I believe it is only a matter of time before they can sit around the dinner table and brag about the allowances they have bought to reduce their carbon footprint and make the world a better place. So, retail will (try to) buy more carbon allowances.
Net zero compliance should also trigger more allowance buying. Carbon allowances are far better at doing what they say on the tin than many voluntary carbon offset projects. Corporates are waking up to this alternate EU ETS asset class which will help them achieve their net zero targets. The same applies to financial investors – and, for that matter, utilities. So, more companies will (try to) buy more carbon allowances.

Do not forget, EU ETS’s €50bn+ revenues are a godsend

Not much is said by the EU and member countries about the revenues that the EU ETS system generates, but annual auctions of c600m allowances generate, at today’s price of €80/t, €50bn of pseudo tax revenues.

To give this number context, it is larger than the UK’s €40bn Brexit bill. But it recurs annually: it is an annuity. And if I am right in my forecasts, it could triple or quadruple.

These revenues are all distributed to every one of the EU’s 27-member finance ministries, with the sole stipulation that at least 50% should be invested in climate-related projects (a fairly weak requirement, in my view).

That is a considerable amount of money, more so in these tight fiscal times. It also affords, should the countries choose, significant funds to help industries modernise and/or innovate (on top of which there are two specific funds set up just for this).

Germany, for example, is partly funding the removal of the EEG surcharge from energy bills through the state budget, supported, of course, by higher carbon auction revenues.

So, when a country says it is against a high carbon price, the finance ministry will likely not agree – Poland included, which has the largest share, 17%, i.e., more than €8bn at current prices – year in, year out (well, increasing if my forecasts are right).

This is a superb, vast and timely stealth tax – at least from the point of view of the beneficiary countries and EU.

EU ETS revenue share by country (top 8):

Finally, the EU should be brave and not afraid of high carbon prices: they are needed to achieve their 2030 goal. I won’t pontificate – lord knows you’ve done well to read this far – probably the only reader.

Right, if you got this far, your coffee must now be drained and brain overflowing – time to rebalance the two. Till the next time.  Be safe, be healthy, be fun. Do good.

PS: these are all my views and I could be completely wrong so don’t rely on them

Original article appeared on LinkedIn HERE

The post Left Unchecked – The Carbon Price Goes to Infinity appeared first on Carbon Credits.

OPIS, an IHS Markit company (NYSE: INFO), has expanded its Global Carbon Offsets Report.

It now includes a Carbon Neutral Fuels Index (OPIS CNFI) and a Core Carbon Credits (OPIS CCP) assessment.

In a statement, Fred Rozell, President of OPIS said that “Price clarity is imperative for negotiating a fair and competitive premium to existing commodities benchmarks for the cost of offsetting emissions.”

OPIS believes these tools can help the energy industry become carbon neutral.

What does it mean when a company is carbon neutral?

You may have heard the terms carbon neutrality and net-zero emissions used interchangeably, but they do not mean the same thing.

Net-zero is when a company stops its GHG emissions. This means they are not putting any more GHG into the atmosphere.

A company is carbon neutral when it offsets its GHG emissions. So, the company still emits GHG but it invests in environmental projects to help ‘offset’ those emissions.

Net-Zero =”Zero” Carbon. Carbon Neutral = “Neutral” Carbon. 

To be carbon neutral, companies purchase carbon credits through the carbon market. For every carbon credit purchased, a metric ton of carbon is offset.

1 Carbon Credit = 1 Metric Ton of Carbon.

Many industries do not have the technology to eliminate or reduce their GHG emissions. The tech is either too expensive, not ready for use, or non-existent.

This is why carbon markets are so important.

Carbon offsets help to fill that gap. This way, companies can do something good for the environment while they work on net-zero solutions.

How can these tools increase carbon neutrality?

OPIS CNFI will list offset prices for 18 standard liquids, gaseous fuels, and eight IMO shipping fuels. OPIS CCP will have CORSIA-eligible credits, REDD+ credits, and other agriculture, forestry, and land use (AFLOU) credits.

The OPIS Global Carbon Offsets Report was launched in December 2020.

The report is the most extensive in the world. Assessments are published each day – reflecting confirmed bids, offers, and trades.

The post OPIS Expands Global Carbon Offsets Report to Increase Carbon Neutrality appeared first on Carbon Credits.

Carbon Markets 101

A carbon market allows investors and corporations to trade both carbon credits and carbon offsets simultaneously. This mitigates the environmental crisis, while also creating new market opportunities.

New challenges nearly always produce new markets, and the ongoing climate crisis and rising global emissions are no exception.

The renewed interest in carbon markets is relatively new. International carbon trading markets have been around since the 1997 Kyoto Protocols, but the emergence of new regional markets have prompted a surge of investment.

The advent of new mandatory emissions trading programs and growing consumer pressure have driven companies to turn to the voluntary market for carbon offsets. Changing public attitudes on climate change and carbon emissions have added a public policy incentive. Despite an ever-shifting background of state, federal, and international regulations, there’s more need than ever for companies and investors to understand carbon credits.

This guide will introduce you to carbon credits and outline the current state of the market. It will also explain how credits and offsets work in currently existing frameworks and highlight the potential for growth.

1. Carbon Credits, Offsets and Markets – An Introduction

The Kyoto Protocol of 1997 and the Paris Agreement of 2015 were international accords that laid out international CO2 emissions goals. With the latter ratified by all but six countries, they have given rise to national emissions targets and the regulations to back them.

With these new regulations in force, the pressure on businesses to find ways to reduce their carbon footprint is growing. Most of today’s interim solutions involve the use of the carbon markets.

What the carbon markets do is turn CO2 emissions into a commodity by giving it a price.

These emissions fall into one of two categories: Carbon credits or carbon offsets, and they can both be bought and sold on a carbon market. It’s a simple idea that provides a market-based solution to a thorny problem.

2. What are carbon credits and carbon offsets?

The terms are frequently used interchangeably, but carbon credits and carbon offsets operate on different mechanisms.

Carbon credits, also known as carbon allowances, work like permission slips for emissions. When a company buys a carbon credit, usually from the government, they gain permission to generate one ton of CO2 emissions. With carbon credits, carbon revenue flows vertically from companies to regulators, though companies who end up with excess credits can sell them to other companies.

Offsets flow horizontally, trading carbon revenue between companies. When one company removes a unit of carbon from the atmosphere as part of their normal business activity, they can generate a carbon offset. Other companies can then purchase that carbon offset to reduce their own carbon footprint.

Note that the two terms are sometimes used interchangeably, and carbon offsets are often referred to as “offset credits”. Still, this distinction between regulatory compliance credits and voluntary offsets should be kept in mind.

3. How are carbon credits and offsets created?

Credits and offsets form two slightly different markets, although the basic unit traded is the same – the equivalent of one ton of carbon emissions, also known as CO2e.

It’s worth noting that a ton of CO2 does refer to a literal measurement of weight. Just how much CO2 is in a ton?

The average American generates 16 tons of CO2e a year through driving, shopping, using electricity and gas at home, and generally going through the motions of everyday life.

To further put that emission in perspective, you would generate one ton of CO2e by driving your average 22 mpg car from New York to Las Vegas.

Carbon credits are issued by national or international governmental organizations. We’ve already mentioned the Kyoto and Paris agreements which created the first international carbon markets.

In the U.S., California operates its own carbon market and issues credits to residents for gas and electricity consumption.

The number of credits issued each year is typically based on emissions targets. Credits are frequently issued under what’s known as a “cap-and-trade” program. Regulators set a limit on carbon emissions – the cap. That cap slowly decreases over time, making it harder and harder for businesses to stay within that cap.

Around the world, cap-and-trade programs exist in some form in Canada, the EU, the UK, China, New Zealand, Japan, and South Korea, with many more countries and states considering implementation.

Companies are thus incentivized to reduce the emissions their business operations produce to stay under their caps.

In essence, a cap-and-trade program lessens the burden for companies trying to meet emissions targets in the short term, and adds market incentives to reduce carbon emissions faster.

Carbon offsets work slightly differently…

Organizations with operations that reduce the amount of carbon already in the atmosphere, say by planting more trees or investing in renewable energy, have the ability to issue carbon offsets. The purchase of these offsets is voluntary, which is why carbon offsets form what’s known as the “Voluntary Carbon Market”. However, by buying these carbon offsets, companies can measurably decrease the amount of CO2e they emit even further.

4. What is the carbon marketplace?

When it comes to the sale of carbon credits within the carbon marketplace, there are two significant, separate markets to choose from.

One is a regulated market, set by “cap-and-trade” regulations at the regional and state levels.
The other is a voluntary market where businesses and individuals buy credits (of their own accord) to offset their carbon emissions.

Think of it this way: the regulatory market is mandated, while the voluntary market is optional.

When it comes to the regulatory market, each company operating under a cap-and-trade program is issued a certain number of carbon credits each year. Some of these companies produce less emissions than the number of credits they’re allotted, giving them a surplus of carbon credits.

On the flip side, some companies (particularly those with older and less efficient operations) produce more emissions than the number of credits they receive each year can cover. These businesses are looking to purchase carbon credits to offset their emissions because they must.

Most major companies are doing their part and will or have announced a blueprint to minimize their carbon footprint. However, the amount of carbon credits allocated to them each year (which is based on each business’s size and the efficiency of their operations relative to industry benchmarks)., may not be enough to cover their needs.

Regardless of technological advances, some companies are years away from reducing their emissions substantially. Yet, they still have to keep providing goods and services in order to generate the cash they need to improve the carbon footprint of their operations.

As such, they need to find a way to offset the amount of carbon they’re already emitting.

Here’s an example:

Let’s say two companies, Company 1 and Company 2, are only allowed to emit 300 tons of carbon.

However, Company 1 is on track to emit 400 tons of carbon this year, while Company 2 will only be emitting 200 tons.

To avoid a penalty comprised of fines and extra taxes, Company 1 can make up for emitting 100 extra tons of CO2e by purchasing credits from Company 2, who has extra emissions room to spare due to producing 100 tons less carbon this year than they were allowed to.

The Difference between the Voluntary and Compliance Markets

The voluntary market works a bit differently. Companies in this marketplace have the opportunity to work with businesses and individuals who are environmentally conscious and are choosing to offset their carbon emissions because they want to. There is nothing mandated here.

It might be an environmentally conscious company that wants to demonstrate that they’re doing their part to protect the environment. Or it can be an environmentally conscious person who wants to offset the amount of carbon they’re putting into the air when they travel.

For example: in 2021, the oil giant Shell announced the company aims to offset 120 million tonnes of emissions by 2030

Regardless of their reasoning, companies are looking for ways to participate – and the voluntary carbon market is a way for them to do just that.

Both the regulatory and voluntary marketplaces complement one another in the professional (and the personal) world. They also make the pool of buyers more accessible to farmers, ranchers, and landowners – those whose operations can often generate carbon offsets for sale.

5. Overall size of carbon offset markets

The voluntary carbon market is difficult to measure. The cost of carbon credits varies, particularly for carbon offsets, since the value is linked closely to the perceived quality of the issuing company. Third-party validators add a level of control to the process, guaranteeing that each carbon offset actually results from real-world emissions reductions, but even so there’s often disparities between different types of carbon offsets.

While the voluntary carbon market was estimated to be worth about $400 million last year, forecasts place the value of the sector between $10-25 billion by 2030, depending on how aggressively countries around the world pursue their climate change targets.

Despite the difficulties, analysts agree that participation in the voluntary carbon market is growing rapidly. Even at the rate of growth depicted above, the voluntary carbon market would still fall significantly short of the amount of investment required for the world to fully meet the targets set out by the Paris Agreement.

6. How to produce carbon credits

Many different types of businesses can create and sell carbon credits by reducing, capturing, and storing emissions through different processes.

Some of the most popular types of carbon offsetting projects include:

Renewable energy projects,
Improving energy efficiency,
Carbon and methane capture and sequestration
Land use and reforestation.

Renewable energy projects have already existed long before carbon credit markets came into vogue. Many countries in the world are blessed with a natural wealth of renewable energy resources. Countries such as Brazil or Canada that have many lakes and rivers, or nations like Denmark and Germany with lots of windy regions. For countries like these, renewable energy was already an attractive and low-cost source of power generation, and they now provide the added benefit of carbon offset creation.

Energy efficiency improvements complement renewable energy projects by reducing the energy demands of current buildings and infrastructure. Even simple everyday changes like swapping your household lights from incandescent bulbs to LED ones can benefit the environment by reducing power consumption. On a larger scale, this can involve things like renovating buildings or optimizing industrial processes to make them more efficient, or distributing more efficient appliances to the needy.

Carbon and methane capture involves implementing practices that remove CO2 and methane (which is over 20 times more harmful to the environment than CO2) from the atmosphere.

Methane is simpler to deal with, as it can simply be burned off to create CO2. While this sounds counterproductive at first, since methane is over 20 times more harmful to the atmosphere than CO2, converting one molecule of methane to one molecule of CO2 through combustion still reduces net emissions by more than 95%.

For carbon, capture often happens directly at the source, such as from chemical plants or power plants. While the injection of this captured carbon underground has been used for various purposes like enhanced oil recovery for decades already, the idea of storing this carbon long-term, treating it much like nuclear waste, is a newer concept.

Land use and reforestation projects use Mother Nature’s carbon sinks, the trees and soil, to absorb carbon from the atmosphere. This includes protecting and restoring old forests, creating new forests, and soil management.

Plants convert CO2 from the atmosphere into organic matter through photosynthesis, which eventually ends up in the ground as dead plant matter. Once absorbed, the CO2 enriched soil helps restore the soil’s natural qualities – enhancing crop production while reducing pollution.

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