Carbon markets 101: a beginner's comprehensive guide

Carbon Allowances vs Carbon Offsets

Under the European Union Emissions Trading System (EU ETS) businesses which produce significant carbon emissions such as power stations, manufacturing and industrial plants must pay for the carbon emissions they produce. This is achieved by buying carbon allowances - 1 allowance means the owner can emit 1 tonne of CO2. Companies face a fine if they generate more than their ‘allowance’.

Under the 'cap and trade' model which defines the market, all businesses covered by the scheme are given a total amount of allowances - which they must trade these among themselves in order to define a value for their carbon emissions. Companies actively reducing carbon emissions through general business operations can then sell excess allowances to businesses producing over their allowance, allowing the purchasing business to benefit from the original business ‘offsetting’ that carbon. This is called a carbon offset.

This means that producers of carbon emissions then have to make a choice as to whether they buy enough allowances to cover the carbon produced by their operations, or reduce the amount of carbon they emit if they cannot buy enough allowances.

Compliance Carbon Markets vs Voluntary Carbon Markets 

Carbon markets tend to be broadly separated into two distinguishable groups: compliance markets and voluntary markets and dependant on the amount of emissions created, can offer differing levels of flexibility to achieve set sustainability goals.

Compliance markets 

Set by governments, compliance markets are designed to make sure carbon reduction targets are achieved in line with evolving carbon market regulations by employing the carbon allowance model (see Carbon allowances vs carbon offsets section above), which essentially means a business will pay for carbon emissions. These mandatory guidelines apply to all governments and companies that reach certain emission thresholds and compliance is a legal requirement. 

Compliance markets tend to:

• Apply only to energy-heavy businesses that hit significant emissions thresholds such as aviation and power stations

• Companies choose whether to reduce carbon emissions or buy carbon allowances to compensate

• Often include regulated carbon allowance schemes 

Voluntary markets

Alternatively, in the case of voluntary markets, participation in a voluntary market – or offsetting – is optional. Voluntary markets operate outside of government influence, meaning that companies and organisations can decide their own carbon reduction targets and the extent to which they achieve them. 

Voluntary markets tend to:

• Be attractive to businesses that want to achieve emissions reductions over government-mandated levels 

• Offer flexible reduction targets for businesses not liable to operate in compliance markets 

• Sometimes be used to demonstrate a company’s dedication to sustainability targets 

Carbon Market Regulations

Carbon market regulations must keep pace as organisations and businesses seek to take greater control of their carbon emissions to hit both government-mandated and organisation-led net zero goals.

Double-counting of carbon allowances or offsets, potential human rights abuses, and greenwashing – which falsely identifies an organisation as sustainable without genuine credentials – are all serious concerns, which is why carbon market regulation is key. 

Often, the trader of carbon offset operates within an industry that deliberately removes or reduces greenhouse gases – for example, an electric car manufacturer. To ensure that units of carbon sold aren’t counted twice towards carbon reduction, the organisations selling declare the units sold as avoided, sequestered or reduced. 

Key carbon market regulations include: 

• The correct recording of carbon offset units that have been declared avoided, sequestered or reduced

• Safeguarding communities that might be vulnerable to human rights violations as a result of carbon markets - e.g indigenous people living in rainforest environments 

• Transparent transactional and financial infrastructure for carbon offset markets 

• Clear validation of green credentials and processes for businesses and organisations 

• Actual, accurate and transparent nationally determined contributions (NDCs) 

• Permanence of carbon offset units are designed to ensure that the effects of the carbon reduction from a project should be long-lasting – for at least 100 years

Getting Started with Carbon Trading

Compliance vs voluntary carbon market 

Determine where you are on your carbon reduction journey and whether you need to operate within government-mandated carbon market or a voluntary carbon market. 

Carbon reduction penalties 

Find out how close you are to attaining carbon reduction targets within government-mandated timelines and whether you would receive penalties in your current state if you make no carbon reduction efforts before those deadlines. 

Reducing carbon vs carbon offset trading 

Measure how much carbon you need to offset. Which is more financially viable – investing in measures to reduce your own carbon emissions or investing in carbon offsetting from another organisation looking to sequester?

Using a carbon calculator 

Implement a carbon calculator to determine how much carbon your business creates. If you’re over-achieving carbon reduction targets, decide how much you can afford to avoid, sequester or reduce without affecting your own carbon reduction targets. 

Deciding who to trade with 

Whether you’re buying or selling carbon offset units, make sure you’re trading with an organisation that won’t harm your reputation or industry position. Identify which partners align with your business’ values and goals and seek to trade only with those organisations.