Global carbon market hits $800 billion despite dwindling trade volumes

A few days ago, we reported that green and socially responsible investments, aka ESG (Environmental, Social, and Governance) investing, have slowed down dramatically amid multi-year highs in oil and gas prices. ESG assets in the United States have fallen by 50% compared to 2020 levels, a worrying trend considering the alarming climate reports that have been coming in. Back in March, the Intergovernmental Panel on Climate Change (IPCC) published a report that claimed that global financial flows into climate solutions are 3-6x lower than the levels required for the world to meet its climate goals by 2030.

But a fresh climate report suggests that it’s not all doom and gloom. Bloomberg New Energy Finance (BNEF) has reported that the total value of major compliance carbon markets is expected to exceed $800 billion in the current year, good for a 5% Y/Y increase despite falling trade volumes amid Russia’s War in Ukraine. The growth reflects an increase in allowance prices from reforms looking to leverage carbon markets, which have been tempered by concerns related to energy affordability and security.
But, what are carbon markets and how do they work?

Carbon markets are trading systems in which carbon credits are sold and bought. Companies or individuals can use carbon markets to compensate for their greenhouse gas emissions by purchasing carbon credits from entities that remove or reduce greenhouse gas emissions.

There are broadly two types of carbon markets: compliance and voluntary. Compliance markets are created as a result of any national, regional and/or international policy or regulatory requirement. Voluntary carbon markets refer to trading carbon credits on a voluntary basis. One type of compliance market are emissions trading systems (ETS) that operate on a “cap-and-trade” principle, regulated businesses – or countries, in the case of the EU’s ETS – are issued emission/pollution permits, or allowances by governments (which add up to a total maximum, or capped, amount). Polluters that exceed their permitted emissions are required to buy permits from others with permits available for sale (i.e., trade). The European Union launched the world’s first international ETS in 2005. Since then, many more national and subnational ETS have been coined and are operational or under development.

In 2021, China launched the world’s largest ETS in terms of emissions regulated, estimated to cover around one-seventh of global carbon emissions from the burning of fossil-fuels. A new report says that China’s ETS has largely been meeting its goals despite the fledgling market facing many challenges.

The EU remains the world’s largest carbon market in terms of both traded volume and value. However, its dominance is slipping with the bloc claiming 75% of global carbon market futures and auctioned volumes, or around 8 billion allowances, in the current year, down from almost 90% in 2017. The UK carbon market is also lagging. Back in August, Citi warned that UK’s carbon permit prices could fall by almost 50% thanks to the UK government’s “lack of political ambition” to reform the country’s emissions trading system. According to Citi, the credits could fall to £22 ($28) a metric ton, the auction reserve price for Britain’s carbon market. The cost of the credits has already plunged 42% in the current year to £40.50, almost half the level of similar contracts in the European Union market.

The cost of UK pollution rights slumped to a two-year low after the government unveiled its plans for reforming the country’s emissions market. The fresh proposals tighten the cap on the rights through 2030 by about 30% but also come with the release of about 54 million allowances from 2024 to 2027 to ease the pace of the supply cut, effectively making it cheaper for the industry to emit CO2. Prime Minister Rishi Sunak has committed to granting hundreds of new oil and gas production licenses in the North Sea amid growing concerns among his Conservative Party that green policies will hurt household finances.

Source: BNEF

Carbon offsets might not work

Though widely used by developed economies, the efficacy of carbon offsets as a means to control climate change is increasingly being brought into question.

Scientists, activists, and concerned citizens have highlighted how companies are now using carbon offsets as a free pass for climate inaction. The types of carbon offset projects that are implemented are diverse, ranging from forestry sequestration projects to energy efficiency and renewable energy projects. The world needs to lower annual emissions by 29-32 gigatonnes of equivalent carbon dioxide (CO2e) by 2030 to have a fighting chance to stay below 1.5°C. That’s ~5x the current commitments by companies, organizations, and governments. We need to lower our GHG emissions by 45% over the next decade if we are to avert catastrophic planetary changes.

The sad truth is that trees planted today simply can’t grow fast enough to come anywhere near achieving this goal, and the majority of carbon offset projects will never be able to curb emissions growth if coal power plants and gasoline vehicles continue being so dominant.

UNEP has warned that the biggest risk posed by carbon credits is that they tend to encourage complacency. According to UN Environment climate specialist Niklas Hagelberg:

“UN Environment supports carbon offsets as a temporary measure leading up to 2030, and a tool for speeding up climate action. However, it is not a silver bullet, and the danger is that it can lead to complacency. The October 2018 report by the Inter-governmental Panel on Climate Change made it clear that if we are to have any hope of curbing global warming we need to transition away from carbon for good: by traveling electric, embracing renewable energy, eating less meat and wasting less food.”

Renewable Energy Credits, or RECs, have been suggested as a better alternative to carbon offsets. Whereas a carbon offset represents an action that effectively sequesters carbon, RECs are like a property deed representing a part of a renewable energy source, such as a solar or wind farm.

By buying RECs and pairing it with electricity from the grid, companies and organizations directly support the development of renewable energy infrastructure. RECs provide access to alternative energy sources to areas that do not have the capacity to produce their own renewable energy.

Alex Kimani


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