What is the carbon market and how does it work?

O carbon market has become an unavoidable “theme”. Concerns around the fulfillment of the Paris Agreement, whose main objective is to reduce the temperature increase to 1.5º degrees, leads to the search for new solutions to reduce emissions of CO2 and other polluting gasess. After all, these are the main trigger of climate change. Thus, there is an increasing consensus on the need to reduce emissions of these polluting gases in order to decarbonize the economy and achieve the objective of the Paris Agreement. To this end, there are several ideas and solutions, and among them we find the carbon market.Also read: Environmental sustainability: 10 explanations for the urgency of change

What is the carbon market?

The carbon market is the most popular name for the market for the transaction of emission permits for polluting gases. In fact, there is a market where you can buy permits to pollute and make money selling those permits. They exist various carbon markets in different parts of the world: Canada, Europe, Brazil. The largest market is in Europe and is called CELE – European Emissions Trading.These markets appeared after the creation of the United Nations Framework Convention on Climate Change. UNFCCC), during the ECO-92 conference. But it was only in 1997, with the Kyoto Protocol, that more concrete objectives were established for this market. It is thus a solution inspired by the financial markets to be able to overcome a negative externality: the air pollution. In this market, what is transacted is a very particular “commodity”: greenhouse gases. Although not just CO2, these gases are called carbon..

What are carbon credits?

Before understanding how the purchase and sale of carbon credits works, it is necessary to understand what the carbon credits. These are true carbon financial assets that are bought and sold like a commodity. Each country and company (obliged to comply with CO2 emission limits) can not pollute its quota and keep a carbon credit that they can sell on the carbon market. Common examples are companies that sell carbon credits to factories that run on wind, solar or hydroelectric power, as they are carbon-free. The CCarbon revenue is thus an “authorization” for a company or a country to emit greenhouse gases up to a certain limit. Those who pollute and emit more have to buy credits. Those who emit less can sell their extra allowances. Each credit corresponds to one ton of CO2.

How it works?

The basic philosophy behind the carbon emissions market, which underlies the Emissions Trading System, is a Cap and Trade system. This system has a limit (cap), that is, a maximum ceiling to be able to emit gases pollutants and, at the same time, allows pollute more than this limit, acquiring emission licenses (trade). This principle is valid for the regulated market for carbon credit transactions, that is, for the Emissions Trading System, which is mandatory for certain sectors. For example, polluting sectors such as the chemical, automotive, oil and aeronautical industries.Each issuer covered by the emissions trading system must have a emission right equivalent to each ton of CO2e it emits. These emission rights can also be freely traded. This allows system participants to buy additional emission rights or, if they succeed in reducing their own emissions, sell excess emission rights.Alongside this regulated and mandatory market, there is another market, the voluntary. Although it is based on the same principle, it works completely voluntarily and allows its opening to other agents.

Types of carbon market

O regulated market it is maintained by governments willing to adjust carbon trading in some way. In this market, companies must agree to take steps to emit less. The most important regulated market is the European one, which is maintained by the European Union. O voluntary market it is formed by companies committed on their own to offset emissions by buying credits from those who are able to prove that they are taking carbon out of the atmosphere, with forestry activities or replacing dirty energy, such as coal, with clean sources, such as solar plants. In this modality, carbon credits are traded based on the law of supply and demand. In fact, this voluntary market allows companies, NGOs, institutions and even citizens to take responsibility for offsetting their own emissions, buy carbon credits from third-party projects that result in the effective reduction of emissions or carbon capture. of carbon, one project has to prove that it has an additional effect. That is, the project must be able to demonstrate that it causes an impact that would not exist in the absence of the incentive given by the carbon credit. Read also: Sustainable investment: investing and helping the planet

Clean Development Mechanism

O Clean Development Mechanism is a way to participate in the carbon market. This mechanism aims to avoided emissions can offset those realized and makes it more flexible to be able to meet emission reduction targets. For example, by producing energy from renewable sources, energy production from other sources that release polluting gases is avoided. Therefore, this mechanism contemplates the possibility of through projects, such as the creation of new forms of renewable energy and reforestation actions, if they can sell the carbon credits that these environmentally friendly actions will generate. But for a project to be validated, it must go through a careful evaluation that guarantees the feasibility of the execution and if the goals are measurable, identifiable and expandable andwhat would happen if the project did not exist. Therefore, it is fundamentall ensure the correct accounting of carbon emissions through transparent and clear metrics. Also read: Learn to calculate your environmental footprint

Advantages of the carbon credits market

Although the carbon markets are still not working perfectly and need to be fine-tuneds, especially with regard to metrics to assess emissions, as well as the accounting and allocation of permits, bring important advantages, namely:Foster the adoption of good environmental practices since the existence of a market with these characteristics gives a signal, a financial incentive for governments, companies and consumers to opt for more environmentally friendly investments and practices.Addressing climate change and fostering the Green Economy: a market that allows the transaction of carbon credits is a tool that allows acting in the short term and in the long term, making it possible to adopt measures in different time horizons that face global warming and climate change. In this way, the reduction of emissions will happen where the associated cost is lower, facilitating an efficient decarbonization of the economy.Diffusion and production of green technologies: the realization of clean projects and investments to reduce emissions requires more environmentally friendly technology such as green hydrogen and expertise in this area, which can make it possible to create more jobs in this area and a truly environmentally sustainable economy .Possibility of generate additional revenue and enhance natural capital.

And the downsides?

Although the creation of a market to tackle air pollution is positive, there are some disadvantages, namely: richer countries may give in to the “temptation” of not reducing their emissions as they can buy carbon credits. They can even pollute more at the expense of reducing emissions from other countries. To do so, simply buy credits to offset additional emissions. poorer countries can be harmed by not having a way to reduce their emissions and, as a result, damage their economies. Therefore, it is necessary that they be helped with investment to develop cleaner production solutions. As it is a potentially advantageous market, some countries may create fake carbon credits. Therefore, it is essential to establish harmonized and transparent evaluation measures and accounting procedures.

Trading carbon emissions in Europe

O European Emissions Trading (CELE) is managed by the European Union and is the largest in the world. It is also Europe’s main mechanism for dealing with climate change. The ETS was created by Directive 2003/87/EC (later amended by Directive (EU) 2018/40). In Portugal, it was transposed by Decree-Law nº 233/2004. The CELE establishes limits of andmissions for specific sectors such as mineral oil refining, metallurgy, clinker, lime and glass production, ceramics, pulp, chemicals and aviation. Thus, a company in these sectors that reduces its emissions can use excess licenses to cover your future needs or sell them for use by other companies or organizations. The ETS also provides for the possibility for its participants to use credits associated with emission reduction projects around the world. However, this resource is limited as the primary objective is to reduce greenhouse emissions and lead those industries to change their operating procedures and technology to achieve this objective.global emission limit has been reduced over time. By 2030, the global cap on emissions will be subject to a linear reduction factor of 2.2% on the total amount of available emission allowances. An emission permit allows the emission of one ton of CO2 equivalent during a certain period, and the Obtaining emission allowances is normally done by auction, as in the financial markets.