Energy Transition: what’s wrong with voluntary carbon offset markets?

Published October 4, 2021 | 2 min read

Biraj Borkhataria, Deputy Head of European Research at RBC Capital Markets discussed the implications of the recent EU announcements related to the scope of carbon emissions trading schemes, the so-called 'Fit for 55' package, with Louis Redshaw, CEO & Founder at Redshaw Advisors.

The voluntary market has filled a void left by governments

“I’m disappointed with where we stand 24 years after the Kyoto Protocol was agreed and 16 years after the EU Carbon Emission Scheme (ETS) was started. We’ve moved forward but very slowly,” remarked Louis Redshaw. The Kyoto Protocol aimed to establish a clean development roadmap to help developing countries in particular participate in carbon markets and make it economically viable for them, he added. However, various countries did not ratify the Kyoto Protocol or did not comply with it. Many US companies, for instance, wanted to manage their own carbon footprint, leading to the birth of the voluntary carbon market, with not-for-profit companies issuing the credits. However, the market for such carbon credits is shrouded in opacity, with additional questions over the legitimacy of companies claiming carbon neutrality. “The markets are difficult to understand. They are historically oversupplied with a number of participants in the market competing to sell their offsets, but there has been dramatic growth in activity recently, with investors sweeping up pretty much all of the inventory available today.”


The speculative attraction of carbon markets

The EU ETS has indeed become a global magnet for parties looking to hedge climate change risk. “On top of the EU governments and green utilities that have benefited financially from carbon markets, we are also seeing hoarding of and speculation in carbon credits by industry, traders and other investors. Risk-friendly speculators have anticipated legislative changes, when the carbon shortage is expected to bite,” Redshaw noted. This has resulted in carbon prices in the EU ETS at more than €60. The danger is that industry offshores its carbon activities and emissions. In July 2021, the European Commission adopted a package of proposals to make the EU's climate, energy, land use, transport and taxation policies fit for reducing net greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels. However, it comes with caveats. “There are some bad design features in the 55 package that are holding back the mechanisms for fixing the problem.” To make European industry competitive with international industry, exporters into Europe should have to account for their carbon costs just as the domestic producers do, which is the purpose of the carbon border adjustment mechanism. “The adjustment mechanism is a great tool but the announcement of the details of the 55 package reveals they do not plan to implement it until 2026,” Redshaw points out.


The need for better standards

Redshaw thinks the answer lies in wider application of carbon pricing, currently high at about 60 euros, and the avoidance of creating separate trading systems for sectors currently outside of the EU ETS. “The impact of this package on the EU trading scheme is quite significant, since the 55% reduction target will fall disproportionately on the emission trading scheme.” The package could be a positive if it becomes a step towards putting a price on all carbon emissions. However, it could also end up costing Europe and the environment much more, for example if European industry (and their emissions) offshores.

Beyond the EU’s compliance market Redshaw highlighted the need for voluntary carbon market standards to be tightened, with a common understanding of regulation around what terms people can use. “The direction of travel is for an increase in the quality of carbon credits and a more reliable definition of what is acceptable to make a claim of carbon neutrality.” A lot is also expected from the COP26 meeting, with hopes of finally putting flesh on the bones of Article 6 of the Paris Accord agreed in 2015, which sets the rules for allowing the international trade of carbon credits which will help countries to meet their emissions reduction targets more cost effectively.

Climate changeClimate crisisESGEU Carbon Emission Scheme (ETS)Energy transitionKyoto ProtocolSustainability