Cop26: What are carbon markets and how will they work?

New carbon trading markets could unlock major funding options for countries to meet climate goals, but activists are wary

Carbon trading markets were formally adopted by countries at the Cop26 climate summit in Glasgow (Getty Images)

The Cop26 summit in Glasgow ended with a deal to set rules for international carbon markets, paving the way for countries to buy and sell carbon credits from one another and potentially unlocking significant funding for efforts to combat climate change.

The markets could open up possibilities for funding climate initiatives for countries that succeed in reducing emissions, and can give an option to others to buy and use international carbon credits to meet their climate goals.

The framework was agreed upon in the Glasgow climate pact adopted by 197 countries on Saturday.

The prospect of carbon trading was already part of the 2015 Paris agreement under Article 6.

However, an absence of clear regulations and some contentious issues kept it from becoming an international trade framework in previous sessions.

While the Glasgow summit managed to overcome some major sticking points in the negotiations of carbon credit trading, its efficiency in reducing the world’s overall emissions has divided experts.

But the agreement at least means that trading will begin in a more structured manner.

Here’s a look at what these markets will look like and what this means for the world.

1. How will carbon markets work?

   While carbon markets already exist in several countries at a national level, and some bilateral deals have also been signed to transfer credits, the new framework has established an international standard for the trade.

   The deal signed in Glasgow details how carbon credits will be calculated, how they will be transferred, and how the system will contribute to reducing global greenhouse gas emissions.

   A carbon credit simply refers to a certificate representing the right to emit one tonne of carbon dioxide or the equivalent amount of any other greenhouse gas.

   When a country reduces more carbon emissions than stated in its climate action goals, it can obtain carbon credits for the units of those additional curbs. These credits can then be sold to another country that is willing to buy them in order to be able to emit more greenhouse gases and maintain its climate action goals.

   In other words, carbon credits become a commodity to be traded in international markets, opening up the possibility of monetising high performance in climate mitigation action, while also giving an option to countries to buy more carbon space without adding on extra emissions.

   Aside from countries, corporates can also trade in carbon credits in order to meet the legal framework. Some companies have already begun such trading. The cost of paying for emission credits becomes an internal cost of doing business and are visible on a balance sheet.

   In recent years, the carbon credit trade has seen a surge. Data from the State of the Voluntary Carbon Markets 2021 showed that as of 31 August 2021, voluntary carbon markets had already posted £556m in sales for 239.3 million credits.

   According to a McKinsey report, the total value of global carbon markets grew by more than 20 percent in 2020 — the fourth consecutive year of record growth.

   This is promising for the international trade of carbon credits under a unified structure.

   However, the process isn’t flawless, and that is why it has taken so long to create a framework.

   There have been concerns about how monetising the reduction of emissions will affect the planet.

2. What were the points of contention?

   In the past, countries have failed to agree upon frameworks relating to taxation on deals and avoiding double counting. While the Glasgow accord managed to strike a compromise, the efficiency of certain aspects remains to be seen.

   Taxation has been a major point of contention in carbon credit trading, the proceeds from which were supposed to fund climate adaptation in poorer and vulnerable nations. Rich countries disagreed with the taxes proposed.

   The Glasgow deal has made bilateral trading of carbon credits non-taxable, and levies a 5 per cent tax on the issuing of credits to be collected for the adaptation fund. These credits will be open to the public and private sectors for trading.

   It also aims to remove 2 per cent of the credits from the system so that greenhouse gas reductions in one place are not cancelled out by continued pollution elsewhere. However, activists have said that this isn’t sufficient.

   The deal also solved a dispute between countries over a cut-off date for credits issued, stating that those issued before 2013 will not be carried forward. Several concerns have been raised over the millions of credits issued during the 1997 climate Kyoto protocol, which critics say do not represent real emission curbs.

   But the quality of credits issued after 2013 also remains in question.

   “Sadly, the zombie credits have been given renewed life and could continue to be used for the next decade, cleansing climate targets on paper but spoiling the atmosphere in reality,” said Gilles Dufrasne, policy officer at Carbon Market Watch.

   Another contentious matter in the negotiations was the fear of credits being counted twice. If a credit for a single tonne of CO2 reduced can be counted towards multiple climate commitments, it creates more problems than solutions.

   Under the framework agreed upon in Glasgow, the selling country will add an emission reduction credit to its tally and the buyer country will deduct one. However, there is no formal system in place to account for this.

3. How effective can carbon markets be in reducing emissions of harmful gases?

   While economic analysis supports credit markets as a cost-effective way of reducing emissions, some climate activists disagree.

   Protesters in the past have disrupted Cop conferences to highlight the risks of a market system that will allow greenhouse gas emissions, when in reality, they need to stop entirely to reduce warming.

   Carbon offsetting — compensating for carbon dioxide emissions — has been questioned by experts and activists alike who say these policies can be a mere distraction from demands of real change to save the planet.

   Nations most vulnerable to the effects of climate change have also raised concerns that offsetting simply allows business as usual.

   “On Article 6, we will need to remain vigilant against greenwashing,” the Marshall Islands’ climate envoy Tina Stege said in a statement.

   Jonathan Crook, a policy officer at Carbon Market Watch, said that international carbon markets will largely be used to shift pollution from one place to another.

   “That governments would still want to rely on this faulty logic shows that our leaders have not grasped the urgency to act,” Mr Crook added.

   Amnesty International said in a statement that it was deeply alarmed that human rights - particularly those of Indigenous peoples, local communities, women and workers - were “in danger of becoming a casualty of Cop26 negotiations”.

   The adovacy group said that states were looking to put in place “harmful mechanisms for the expansion of carbon markets without strong safeguards to ensure real emission reductions and robust human rights guarantees to protect people who will be most affected by these measures”.

   However, the prospect of trading and monetising carbon credits can be beneficial for developing countries that have been putting in money to enhance their green infrastructure while international negotiations do very little to ensure climate finance.

   Brazil’s environment ministry hailed the setting up of international trade regulations as a “Brazilian victory in Glasgow!”. The country has vast forest reserves and is “preparing to be a great exporter of carbon credits”.

   “It should spur investment and the development of projects that could deliver significant emissions reductions,” Brazil’s chief negotiator Leonardo Cleaver de Athayde told Reuters.

   Similarly, experts also see great prospects for India.

   “Now that Cop26 has finalised the rules of carbon trading, India will be able to sell more than a million carbon credits from previous years, and can also create a domestic market for carbon trading,” said Ulka Kelkar, climate programme director of WRI India.