Carbon markets and ESG investing have been in the news for some time now, and global interest in them has only been rising. Over 130 countries have carbon reduction targets of some kind, with new border taxes, reporting schemes and compliance markets being announced regularly.
As carbon markets are new ground for many of us, and even the organisations currently engaging with them often don’t have their usual trading and risk systems in place to manage them, below we have summarised the key information everybody should know when considering whether carbon market activity is right for them.
We break down the key areas and provide a short summary for each to give you a one-stop resource for everything related to carbon markets. We have also included links to relevant Gen10 articles that explore each section in detail if you’d like to know more.
Compliance markets are growing rapidly. In 2023, 23% of global greenhouse gas emissions were covered by a carbon tax or emissions trading scheme, compared to 7% a decade earlier. Revenues from these taxes and emissions trading schemes also reached a record high, of $95 billion, in 2023. As these compliance markets grow, they are beginning to include some areas of carbon emissions that were previously only served by voluntary markets, but this is not to say that voluntary markets will be phased out any time soon.
Analysts expect market growth in the coming decades, and the optionality when purchasing voluntary carbon credits, as well as the broader mandate of these markets, means that organisations trading in compliance markets may still supplement this activity with purchasing voluntary credits as well.
Factors driving carbon markets
A range of stakeholders are pushing commodities players to act to reduce their carbon footprint and engage in carbon markets. On top of carbon legislation, 80% of investors consider ESG policies when making investment decisions, customers are cleaning up their supply chains, and trade finance providers are increasingly offering preferential rates for lower-carbon or more sustainable cargoes. Carbon markets have evolved to help organisations lower their net carbon footprint. They allow organisations that are not able to fully reduce their carbon dioxide emissions to buy carbon credits that offset the remaining emissions. Each credit is the equivalent of one tonne of carbon dioxide where the emissions have either been removed from the atmosphere (such as by planting a forest) or were prevented, for example by donating renewable power generators or efficient cookstoves to remote villages. There are also financial incentives to engage in carbon markets. Most compliance carbon markets have a goal of making lower-carbon production a financially viable, or even a cheaper option for industry. And voluntary markets allow producers to offer the lower net carbon products that consumers increasingly demand. These factors combined mean that all commodity producers, traders and buyers need to be prepared to operate in carbon markets.Types of carbon markets
There are many different carbon markets in existence, and the number is constantly changing as new schemes develop. As carbon markets are still in their early stages, future market consolidation is likely, but this is currently slow to materialise. The two main types of carbon markets are compliance and voluntary markets, although these can be broken down further. For example, compliance markets can operate as cap-and-trade schemes, or emissions trading schemes (ETSs), where companies trade permits to pollute and scarcity sets market prices. Or they can be baseline-and-credit mechanisms where organisations operating below a given carbon threshold can sell credits equivalent to the difference.
Compliance markets |
Voluntary markets |
| Mandated by a government or other body. | Established at the organisational level based on their own agenda. |
| Usually overseen by regulators, with clear rules and structures. | There may be some oversight in the form of disclosures or over advertising claims but often less regulated than mandatory offsetting. |
| Credits are generally standardised within a particular scheme. | Each project can be considered on a unique basis, with organisations able to demonstrate improvements against multiple UN Sustainable Development Goals, depending on the projects they choose to fund. |
| In the early stages but moving towards transparency and co-operation between schemes. | Generally more fragmented and less transparent. |
Realising the full value of voluntary carbon credits
Compliance markets are standardised, with every credit worth the same one tonne of CO2, which can be an advantage in situations where efficiency and faster deal-making is important. But in voluntary markets, the unique attributes of every carbon project can be captured and factored into pricing. Some factors affecting the price in these voluntary markets are due to the cost of the project, such as its size and location; remote projects may require a larger investment in logistics as an example. But there are other credit attributes that can help sellers command a better price because they are worth more to buyers. These attributes include:- UN Sustainable Development Goals – projects can deliver other benefits alongside carbon reduction, this could include providing high-quality jobs, clean water, or sustainable infrastructure, all of which could command a higher price.
- Project methodology – projects that remove carbon dioxide are generally seen as more beneficial than those that avoid emissions. Other projects may also realise a price premium for improving health outcomes in deprived communities, such as cookstoves that reduce woodburning.
- Additional services – projects may provide photographs, updates or marketing materials that some organisations find valuable.
- Vintage – the year the credit is issued. Buyers are often wary of purchasing older carbon credits, which can push prices down.
Transparency will be critical in carbon markets
Because carbon markets are still in their early stages of growth and lack integration, their complexity means that transparency can be a real challenge. There are thousands of projects generating carbon credits, hundreds of participants in carbon markets and many different registries tracking credit production, and credit retirement when they are used to offset a real-world tonne of CO2. Carbon markets and registries are working to share data and integrate better, but this will take some time and businesses remain exposed in the meantime. For example, one of the major risks of multiple registries is the risk of double-counting, where a single tonne of carbon dioxide from a project is listed and sold on multiple registries. Being able to trace each credit across any counterparties back to its source reduces this risk, as does having effective KYC policies and processes. Low-quality carbon credits also create reputational risks for end buyers and brokers, as an end buyer purchasing a low-quality credit may not actually be offsetting their complete carbon footprint and risks accusations of greenwashing. Purchasing low-quality credits can even cause net harm as it means money is being diverted away from projects that would have had an environmental impact. Brokers, too, could be affected if they are not performing due diligence on the projects behind the credits they collate, and not providing transparency to end users, as they could face legal as well as reputational risks.
The goal of transparency is tracing real-world emissions to the corresponding offsetting project