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What is Carbon Market?
Carbon market is a system where buyers and sellers come together to buy or sell carbon credits. Carbon Market is divided into two categories:
Compliance Carbon Market
Voluntary Carbon Market
Below are the key differences between these markets
| Feature | Compliance Market | Voluntary Market |
|---|---|---|
Purpose | To meet legally binding emission reduction targets | To offset carbon footprint basis internal voluntary targets |
Market Type | Highly regulated | Not regulated, market-driven |
Enforceability by | Government-mandated & legally enforced | Not Enforced, Entities buy and sell on a voluntary basis |
Buyers | Heavy emitting industries like Oil & Gas, Energy & Power, Aviation & Manufacturing, etc. | Corporates and entities with voluntary internal emission reduction targets |
Credit Pricing | Determined by regulatory bodies | Market-driven varies based on the cost of setting the project (project type), demand and supply |
Certifying Body | Certified by a designated government body of respective countries (Example: European Union has National Competent Authority in each EU country, UK Environment Agency for UK ETS) | Certified by third-party standards (e.g., Gold Standard, VERRA, Puro & VCS) |
Rationale for Growth of Compliance Carbon Markets
Compliance markets are government-mandated systems where entities must participate to meet regulatory emissions limits. These markets are primarily shaped by government policies which in turn are impacted by global climate agreements.
Government Regulations (Mandatory Compliance): Global Climate Agreements like Paris Agreement play an important role in pushing governments across the globe to set and meet compliance targets.
Governments reduce emissions through:
Cap-and-Trade Systems: A cap-and-trade system sets a limit (cap) on total emissions allowed for industries or sectors. Companies emitting less than their limit can sell excess allowances (trade) to those exceeding their cap. Examples include the EU Emissions Trading System (EU ETS) and the California Cap-and-Trade Program (USA), etc. which require companies to stay within emissions caps or purchase allowances to comply.
Carbon Taxes: Charge businesses a fee per ton of CO₂ emitted, as seen in Germany’s carbon pricing regulations in our previous insight.
Carbon Credits: Allowing businesses to offset certain portion of their compliance targets by procuring carbon credits. These credits can be procured from projects within the country and outside the country. The ones procured from outside the country are facilitated by mechanisms like Article 6 of the Paris Agreement.
Rationale for Growth of Voluntary Carbon Markets
Voluntary carbon markets function outside government mandates, enabling corporates and individuals to offset emissions beyond regulatory requirements.
🌱Corporate Pledges: A significant number of companies are committing to net-zero targets, increasing the demand for carbon credits. For instance, as of 2024, over 1,100 companies have set net-zero-aligned targets validated by the Science Based Targets Initiative (SBTi), a global organization that helps companies set science-based emissions reduction targets aligned with climate goals.
💰Investor Pressure: Investors seek to align their portfolios with environmental, social, and governance (ESG) criteria, influencing companies to adopt sustainable practices.
🛒Consumer Expectations: Consumers increasingly favour brands committed to sustainability. A 2024 PwC survey found that, despite inflation, consumers are willing to pay 9.7% more for sustainably sourced goods.
