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Carbon Market FAQs

The basics of carbon offsetting

When companies or individuals go about their daily lives and conduct business they use energy. When this energy is derived from fossil fuels such as oil, coal and gas, it releases carbon and other greenhouse gases (GHGs) into the atmosphere. This is one of the key contributors to climate change.

Carbon offsetting is the process by which businesses and households can compensate for the release of these GHG emissions by funding certified GHG emission reduction projects that either destroy GHG emissions, prevent their release elsewhere or sequestrate the carbon dioxide.

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What is a carbon credit or offset?

A carbon credit, or carbon offset, is a financial unit of measurement that represents the removal of one tonne of carbon dioxide equivalent (tCO2e) from the atmosphere.

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Where do carbon credits come from?

Carbon credits come from GHG emission reduction projects that deliver measurable reductions in emissions by either:

  • Replacing the use of dirty fossil fuels with renewable energy;
  • Reducing the use of fossil fuels through energy efficiency; or
  • Capturing and storing already released carbon in trees and other plants.

For example, a wind farm project supplies power stations with renewable energy replacing the need for energy produced from fossil fuels such as coal. Energy efficiency projects reduce the direct release of GHGs into the atmosphere, e.g. a domestic project in Kenya that The Gold Standard is in the process of accrediting, distributes an engineering system for low-income families that treats contaminated water, reducing the direct release of GHGs into the atmosphere by avoiding the need to burn firewood to boil water. It is estimated that this project will generate more than 2-million emission reduction credits per year, the equivalent of taking nearly 350,000 cars off the road for one year.

Capturing and storing already released carbon in trees and other plants is known as carbon sequestration and requires the protection of existing forests or the planting of additional trees and plants.

The atmosphere has no national boarders and does not care where GHGs are emitted or prevented. The most important factor in terms of fighting climate change is reducing the total amount of emissions worldwide.

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Why carbon markets?

Climate change caused by greenhouse gas (GHG) emissions is a serious global problem. National and international attempts to mitigate the growth in atmospheric concentrations of GHGs have resulted in the formation of a carbon market. Currently the carbon market is comprised of a compliance market, made up of emitters who are obligated to reduce their emissions and a voluntary market, in which organisations voluntarily reduce their carbon emissions. Most economists argue that an efficient, international carbon market will reduce GHG emissions at the lowest cost, allowing polluters that are unable to abate their own emissions cheaply to invest in projects globally that can.

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The compliance carbon market

In 1992 the United Nations Framework Convention on Climate Change (UNFCCC) was created to raise awareness and build knowledge to help mitigate climate change. In 1997, more than 170 countries adopted the Kyoto Protocol to the Convention. This set legally binding targets for 37 industrialised countries to limit or reduce overall GHG emissions by at least 5% below 1990 levels during the period 2008-2012.

To achieve the targets set within this protocol, three flexible financial mechanisms were created:

  1. Emissions Trading – the international transfer of emission allocations between industrialised (Annex 1) countries. E.g. a country that stays within its target can sell the surplus allowances to another country that has exceeded its limit.
  2. The Clean Development Mechanism (CDM) – creates carbon credits called Certified Emission Reductions (CERs) through emission reduction projects in developing countries, regulated by the United Nations. Emitters who have exceeded their emission allocations can purchase these CERs to make up the difference.
  3. Joint Implementation – any Annex I country can invest in emission reduction projects in any other Annex I country as an alternative to reducing emissions domestically.

The rational behind such schemes is that climate change is a global problem and that the location of GHG emission reductions is irrelevant in scientific terms.  This means that a tonne of carbon dioxide reduced in a cook stove project in Kenya has the same environmental value as a tonne of carbon dioxide reduced through a wind project in China or a clean energy project in the United States. The difference in these projects is the cost of implementation.

The emission reductions generated by these flexible mechanisms are collectively referred to as ‘carbon credits’. A carbon credit is a financial instrument that represents a reduction or the avoidance of one tonne of carbon dioxide equivalent (tCO2e) from the atmosphere.

These three mechanisms, along with the European Union Emissions Trading Scheme (EU ETS) put in place by the EU in order to meet its Kyoto target, make up the largest environmental market in the world for the trading of carbon credits.

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The voluntary carbon market

In a voluntary carbon market, an entity (company, individual, or other “emitter”) volunteers to offset its emissions by purchasing carbon credits that reduce the amount of carbon in the atmosphere. It is driven by a company’s desire to demonstrate leadership and/or ‘do the right thing’ and has been around in different forms for many years. The wish to make voluntary commitments to reduce their impact on the environment pre-dates the Kyoto Protocol.

Reasons to engage in the voluntary carbon market could include:

1. To save money/reduce operating costs

2. Corporate Social Responsibility (CSR)

3. Leading by example

4. Demand from stakeholders

5. Pre-compliance

6. Green marketing / boosting green and socially responsible credentials

7. Mitigating reputational and commercial risk

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What are the main differences between a compliance carbon market and a voluntary carbon market?

Carbon markets can be either voluntary or mandatory. The main difference between the two is that the voluntary market is unregulated.  Even so, there are recognised international standards, such as The Gold Standard, that monitor and verify the quality and validity of the carbon credits that are traded.

Those involved in both markets also tend to have different profiles. Compliance schemes are currently aimed at the most “energy intensive” emitters (at a company level). These include power generators, oil refineries, iron and steel production and processing companies, those who produce commodities such as cement, glass and ceramics and the paper and pulp industry.

The voluntary market serves the purpose of businesses (typically blue-chip corporations), government departments, NGOs and single individuals wanting to manage their carbon footprint.

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How does an emissions trading scheme work?

Emissions trading, also known as ‘Cap and Trade’, is a market-based approach to address climate change.

The ‘Cap’

The basic principle involves setting a limit on the total quantity of GHG emissions allowed to be released over a given period of time (the “cap”). Each participant in the scheme receives an individual cap or allowance. Emission permits or allowances are issued to help cover these caps.

And the ‘Trade’

The trading part establishes a market for these permits by allowing organisations to buy and sell depending on whether they have a shortfall or surplus in allowances. (E.g. a participant who emits less then their allowance can sell the unused balance to another participant who has exceeded their allowance). Emissions trading encourages companies to continually reduce emissions – the more permits they don’t use, the more money they can make from selling that excess.

Offsetting

Most emissions trading schemes also allow participants to purchase carbon credits from GHG emission reduction projects in developing countries. One credit equals one tonne of emissions saved. As long as these credits are certified to the correct level then they can count towards the emitter’s target back home. However, to ensure that emitters are making a significant contribution to controlling their own emissions, and are not just buying their way out of their obligations, offset usage in trading schemes is usually limited to a proportion of the overall emissions target.

An emissions trading scheme, when functioning well, results in overall emissions remaining within the cap, while individual participants have the flexibility of a market-based mechanism within which to operate.

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What does “additionality” mean and why is it important?

Additionality is a defining concept of carbon-offset projects. To qualify as a genuine carbon offset, the reductions achieved by a project need to be ‘additional’ to what would have happened if the project had not been carried out (e.g. continued as business-as-usual). For instance, if a project is viable in its own right, say through the sale of electricity, or because of government funding, regulation or other policies, then it cannot be used as an offset project as it would have been undertaken regardless of investment secured through carbon markets.

The concept of additionality is important as only carbon credits from projects that are “additional to” the business-as-usual scenario represent a net environmental benefit. Without the “additionality” requirement, there is no guarantee that the emissions reduction activities will lead to a reduction of greenhouse gases into the atmosphere.  Therefore, in simple terms, if carbon credits are awarded to activities that would have happened anyway, emissions are allowed to rise without a corresponding cut elsewhere, therefore making the process meaningless.

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How can we know if an emission reduction is real?

Genuine carbon standards have been set up to provide assurances to buyers that the emissions reductions generated by a particular project are indeed real, quantifiable and additional.

Credible standards provide high quality, independently verified assessments of the emission reductions produced by a project.  The Gold Standard goes one step further and ensures that all its projects meet robust and stringent methodology requirements for sustainable development in the local area.

To ensure the purchase of high quality carbon offsets, it is imperative that companies pursue offsets that have been subjected to rigorous third party monitoring, reporting and verification procedures. It is also useful to source carbon credits from a reputable offset supplier who can offer transparency in terms of the projects, pricing and retirement of the carbon credits.

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How does carbon offsetting provide a solution to climate change?

Carbon offsetting on its own will not provide a solution to climate change, it will need a multi-layered approach with different schemes working in conjunction. However, that said, carbon offsetting does have a large role to play in the overall approach to carbon management. Reducing emissions internally takes time and money; carbon offsetting is a quick and cost effective way to balance a carbon footprint whilst waiting for the fruition of internal abatement measures.

At the same time, the emission reduction projects paid for by offsets introduce clean technology and investment into developing countries, helping communities to improve their economy and industry but not at the cost of the environment. Carbon offsetting projects help to successfully establish a path to a low carbon economy.

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Why should a business consider carbon offsetting?

Carbon offsetting provides the opportunity to offset unavoidable emissions, reducing a company’s impact on the environment. It offers companies’ access to compelling social-economic community marketing opportunities whilst helping to finance projects that would not otherwise be viable. The atmosphere does not care where GHGs are emitted or where they are prevented. All that matters in the fight against climate change is reducing the total amount of emissions.

In addition to showing leadership and environmental stewardship there are many reasons to reduce emissions and support carbon offsetting, including:

  • Mitigate against the risk of impending regulations
  • Create significant savings from reduced energy bills and increased operational efficiencies
  • Demand from stakeholders, improving brand perception, especially in the eyes of environmentally conscious consumers
  • To meet with Corporate Social Responsibility (CSR) obligations
  • Leading by example, power to evoke a real change in consumer purchasing behaviour
  • Reputational and commercial risk of not being seen as environmentally conscious
  • The rising threat of extreme weather warnings, rising sea levels and natural disasters
  • Security risks from lack of energy, water and food supply
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Are carbon credits just ‘permissions to pollute’?

No. Even with the clean technology we continue to develop, our society as a whole is going to carry on polluting the atmosphere. It is not possible to not pollute, but one thing we can do is regulate it whilst we move to low carbon economies.

Under Emissions Trading Schemes there is a maximum amount of CO2 that countries, or companies, are allowed to release into the air every year.  Countries and organisations can buy or sell carbon credits, that is, the allowance to put more carbon into the air, from other countries and organisations. Where one might lose a carbon credit, the other is gaining it.

In fact, having carbon credits is believed to help reduce pollution as it encourages companies to continually reduce emissions. Buying obligatory carbon credits is an additional cost to a company, it therefore motivates companies and countries to look for ways to internally reduce the amount of CO2 they emit. Likewise, there is an incentive to pollute less than the allocation as selling the surplus carbon credits is also lucrative.

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Are some offsets or carbon credits better than others?

Arguably, as long as the credit is trustworthy and robust, a ton of CO2 removed from the atmosphere is a ton of CO2 removed from the atmosphere, it doesn’t matter where or what type of technology was used. However, different types of carbon credits suit different buyers depending on their needs and obligations. For example, compliance buyers may prefer cheaper offsets to meet their obligations in the most economical manner whereas buyers building a comprehensive CSR strategy may prefer more ‘charismatic’ projects that meet both their environmental and the social-economical commitments. So there isn’t one carbon credit better than another, but there are carbon credits more suited to a business need than others.

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Should I buy carbon credits for investment purposes?

The Gold Standard Foundation is aware that there have been complaints to the Financial Services Authority (FSA) in the United Kingdom about carbon credit trading schemes. While none of the complaints to the FSA were related to The Gold Standard, some financial institutions, hedge funds and corporations do invest, buy, sell and trade in carbon credits, including Gold Standard-certified carbon credits.

The carbon markets have witnessed significant growth over the last few years, but they are not risk-free. Investing in carbon credits is more complex than a traditional investment, making the opportunity more difficult for individual investors to evaluate. If you need to sell your carbon credits at any given time, you should be aware that your ability to do so will be contingent on the state of the secondary trading market, which is affected by various global political and economic factors that are beyond The Gold Standard Foundation’s control. The Gold Standard Foundation recommends that purchasers of its credits retire them in order to reduce their carbon footprint.

The Gold Standard Foundation will be a part of any industry initiative on best practice and strongly recommends that consumers seek independent financial advice before investing in the carbon markets. Individual investors are also urged to review the additional resources listed below and check the registration of any person or company offering an investment opportunity in the carbon markets.

QUESTIONS TO ASK BEFORE INVESTING

  • How do I know whether carbon credits are an appropriate investment for me given my overall investment objectives?
  • What are the fees and other costs? You should pay particular attention to the fees and hidden costs of any product you invest in.  Ask your investment professional to explain all of the fees and costs associated with the investment.
  • How long will my money be tied up? While it is easy to turn many investments into cash, liquid markets for some types of carbon credits might not exist.  Research the type of credit you are buying before you purchase.
  • What risks are associated with the underlying project(s) and certification standards?


ADDITIONAL RESOURCES

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