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Voluntary Carbon Market: principles and examples

In this article we’ll explore what voluntary carbon markets actually are, how they operate, and the benefits and challenges of their current structure.
Business
2023-01-13T00:00:00.000Z
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Increasing numbers of individuals, companies and governments are waking up to climate change and pledging to reduce their own carbon footprint. However, many find that they can’t fully eliminate their emissions. Voluntary carbon markets allow carbon emitters to offset their unavoidable emissions by purchasing carbon credits. In recent years there’s been a big surge in demand from those looking to take part in voluntary carbon markets, but how exactly do they work? 

👉In this article we’ll explore what voluntary carbon markets actually are, how they operate, and the benefits and challenges of their current structure.

👀 What exactly is a voluntary carbon market?

Voluntary carbon markets are markets where carbon credits are purchased on a voluntary basis, rather than because an organisation (this might be a company, individual, NGO or a government) needs to comply with mandatory legal emission reduction obligations. They allow carbon emitters to offset their unavoidable emissions via the purchase of carbon credits.

 ❓What is a carbon credit? A carbon credit is a permit that allows a country or organisation to produce a certain amount of carbon emissions that can be traded if the full allowance is not used. Each credit corresponds to one metric ton of reduced, avoided or removed CO2 (or equivalent greenhouse gas emissions) and can be used by an organisation to compensate for their unavoidable carbon emissions. When a credit is purchased by an organisation and used for this purpose, it becomes an offset and is moved to a register for retired credits, meaning that it is no longer tradeable. 

The money that goes into the purchase of these carbon credits is then funnelled into climate-action projects that might otherwise not get off the ground. In addition to carbon offsetting, the projects may also benefit things such as biodiversity protection, pollution prevention, public-health improvements, employment creation, or the development of green technology. 

Organisations can participate in a voluntary carbon market either individually or as part of an industry-wide scheme. 

wind turbines in countryside

What’s the difference between voluntary and compliance carbon markets?

Compliance carbon markets, also known as the regulatory carbon market, are carbon markets that are regulated by national, regional or international carbon reduction regimes. Examples include the EU Emissions Trading Scheme and the UK ETS. 

These markets operate a cap-and-trade system where organisations are given a certain amount of ‘allowances’ (think of this as a permit that allows them to emit greenhouse gases). The cap represents a finite supply of allowance - ie. new ones can’t be created. However, organisations can sell and buy credits. This incentivises organisations to cut down on their emissions because if they don't, they risk having to purchase surplus carbon credits. 

Voluntary carbon markets on the other hand, are completely discretionary. Organisations participate in it because they want to, not because they have to. Many companies participate in it for example because they want to contribute to the climate change fight, or perhaps more cynically, because they think it's a good PR move. 

Unlike the compliance carbon market, the voluntary carbon market uses a project-based system in which there is no finite supply of allowances. More carbon credits can be created through the development of additional projects that help to avoid, reduce, or remove carbon emissions.

How are voluntary carbon market credits priced?

The pricing of carbon credits under a voluntary carbon market is a bit more complex than that of the compliance carbon market credits. This is because the types of projects funded by the credits vary hugely. Generally speaking the following factors are considered when determining the price of a credit: 

  • Project size - large scale projects that produce a high volume of carbon credits tend to have lower prices. Smaller projects, generally speaking, are more expensive to set up and run, and so they may produce fewer carbon credits. 
  • Project location - if a project is in a very rural, hard to reach location, or in an area of crisis the project may create more expensive credits. 
  • Standard - the project quality may influence the credit price. 
  • Co-benefits - benefits that go beyond the removal or reduction of emissions will also be considered.

How do companies trade the credits under the voluntary carbon market?

As it stands there’s no centralised voluntary carbon market and so project developers can sell their credits directly to buyers, through a broker, or via a retail trader. While most carbon credit transactions take place directly there are some exchanges that are starting to emerge, these aim to simplify and speed up the rate of carbon credit trading. 

trader sitting in front of screen with investment data

How are voluntary carbon markets regulated?

To ensure that the credits meet a minimum standard, they must first be verified by an independent third party. This third party will consider the following factors when awarding a standards certification: 

  • Calculation of the level of CO2 removed or reduced and the resulting credits - depending on the type of project involved there will be different methodologies or requirements that are used to make this calculation. 
  • The emission reduction must result in a permanent reduction in emissions and must not be at risk of reversal. 
  • The project must not be legally required, financially attractive or commonplace without the carbon credit investment. 
  • There is no release of unintended emissions resulting from the project. 
  • The credit can only be claimed once and proof of credit retirement is provided upon maturation of the project.

How do voluntary carbon markets help reduce CO2 emissions? 

So how exactly do projects under the voluntary carbon market contribute to the fight against global warming? 

The whole point of the voluntary carbon market is to provide an investment mechanism for the offsetting of unavoidable carbon emissions. Carbon credits fund carbon offsetting projects (though there may very well be other benefits to the project too).These projects will fall under either carbon avoidance and reduction, or carbon removal or sequestration. Let’s explore what these terms mean in a bit more detail below: 

  • Avoidance of nature loss - this is where the loss of nature such as forests and peatland is avoided/prevented. These types of areas absorb huge amounts of carbon and are what is known as carbon sinks (ie. an area that absorbs more carbon from the atmosphere than it releases). 
  • Additional emissions avoidance or reduction - this is where emissions are avoided or reduced from current sources that don’t otherwise have any financial incentive or regulatory requirement to reduce their emissions. 
  • Nature based sequestration - this is where activities result in the capture of carbon, for example reforestation, the restoration of mangroves, seagrass and peatlands.
  • Removal of carbon from the atmosphere via technological solutions - this is where technology is used to remove CO2 from the atmosphere and store it via secure methods. 
two boys planting trees

What types of projects do voluntary carbon markets fund?

Voluntary carbon markets support a wide variety of environmental projects. However, the aim is always to reduce or remove greenhouse gas emissions or carbon dioxide from the air. These projects can be anything from small local initiatives to large-scale industrial projects. 

Common examples of projects are reforestation projects, wetland management programs, carbon capture and storage, the development of renewable energy and green technology, regenerative agriculture programs… the list goes on. 

More often than not these projects also drive additional benefits - something that’s known as ‘co-benefits’. Co-benefits of the different projects can vary hugely and include things like improving water quality, presenting deforestation, creating local jobs and businesses. Project developers may design the project in such a way that the co-benefits align with the United Nations Sustainable Development Goals (SDGs), which can in turn increase the overall value of a credit. 

❗️ No matter what type of project is created, they all have one requirement: this is that the project, removal, or reduction of emissions would not have otherwise occurred.

woman clearing dead vegetation from field

Benefits of the voluntary carbon market

Voluntary carbon offset markets are often promoted as one of the best solutions to dealing with unavoidable carbon emissions. But what exactly are the benefits? 

  • Innovation - compliance carbon markets (ie. those that are required by law) are often strictly regulated and subject to stringent bureaucratic constraints. Whereas voluntary carbon markets have a lot more freedom in this regard, this means that project developers have the freedom to be more innovative. For example they may be able to implement a project that would be considered too small or not viable for the compliance carbon market. This can result in innovations that may help to lower the cost of emerging green technologies. 
  • Complementary  - voluntary carbon markets don’t detract or take away from the compliance carbon markets, they complement them by providing an opportunity for projects that wouldn’t be feasible under the compliance carbon market. It also allows organisations to go further than what they’re legally required to. 
  • Expansive - not everyone is subject to the compliance carbon market requirements and so the voluntary carbon market allows organisations (and individuals) to gain experience with carbon markets and their inventories, reductions, storage etc. 

Challenges faced by the voluntary carbon market

Despite the clear benefits that the voluntary carbon market brings it’s not without problems and its critics argue that it is fragmented and complex and that credits do not always accurately represent emissions reductions. Limited pricing data also makes it very different for carbon credit buyers to know if they’re paying a fair price. Let’s take a look at these concerns in a bit more detail below: 

  • Buyers can’t always be sure that the project is of a high quality and free from reputational risks. The complexity of the system means there are varying methodologies, verifiers, and standards that allow poor-quality projects to reach the market. 
  • The market is complex to understand for new buyers. Purchasing and understanding carbon credits requires technical and market knowledge. 
  • Concerns over greenwashing. A company may use the voluntary carbon market in an effort to look ‘green’ while failing to take any real climate action. In this situation, instead of actively trying to reduce carbon emissions, a company takes the easy way out by simply ‘offsetting’ emissions. 
  • Lack of information on who owns what. Yes, credits used for offsetting are recorded in a registry, however there’s a lack of information on the owner, the beneficiary and the details of the project. Hundreds of millions of active credits on the market are unaccounted for which makes it very easy for companies to make unverifiable claims. 

💪 So how can we strengthen the voluntary carbon market?

The voluntary carbon market has the potential to help us transition to a decarbonised global economy through the redirection of investment into renewable energy and energy efficiency. Not only this, but it can also help us to scale-up the removal of carbon dioxide emissions in an effort to offset unavoidable emissions and reach net zero. However, if it’s going to realise its full potential the voluntary carbon market is going to have to address the challenges it faces. 

So, what is needed to overcome these challenges? 

  • Strengthened quality assurance - in order to address the limited transparency on project methodologies and project progress, strengthening of impact and quality assurance is required to address stakeholder scepticism.
  •  Alignment on the credible use of carbon credits - there needs to be greater consensus amongst stakeholders as to the value of carbon credits. They’re a powerful tool in the fight against climate change but they shouldn’t be the whole story. Organisations still need to take every effort to reduce their own carbon footprint. 
  • New market infrastructure - the current fragmented structure means that there’s little transparency when it comes to market data. In order to bring credibility and to scale the voluntary carbon market, new infrastructure that standardises and provides transparency is needed. 

Voluntary carbon markets could play a crucial role in the transition to net zero by supporting decarbonisation that goes beyond simply reducing individual emissions. But to realise this potential, significant effort is needed to iron out challenges and scale up the market. 

What about Greenly? 

At Greenly we can help you to assess your company’s carbon footprint, and then give you the tools you need to cut down on emissions. Why not request a free demo with one of our experts - no obligation or commitment required. 

If reading this article has inspired you to consider your company’s own carbon footprint, Greenly can help. Learn more about Greenly’s carbon management platform here.

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