The untapped potential of global carbon markets in five graphs

Rising prices and ambition are needed for these market mechanisms to play an important role in the shift towards a greener future.

More countries are recognizing the value of putting a price on carbon as a means to achieve their climate goals. About a fifth of global emissions are now covered by the so-called compliance-based carbon market, up from just 5% a decade ago.

But while support for carbon markets grows, mass adoption is still a long way off, with many of the world’s biggest emitters remaining on the sidelines. Rising prices and ambition are also needed for these market mechanisms to play an important role in the shift towards a greener future.

On the voluntary side, carbon offsets are gaining traction as corporations look for ways to neutralize their emissions, though the market remains hampered by oversupply and doubts about credibility. Still, stricter regulation could allow voluntary carbon markets to take off in the coming decades and address residual emissions that cannot be reduced by other means.

Here are five graphs from BloombergNEF on the untapped potential of global carbon markets.

1. Fulfillment markets broaden their horizons

The growing recognition of the need to put a price on pollution has seen carbon markets established in more regions and expand in terms of both the volume of emissions covered and the value traded.

There are now 30 “compliance” carbon markets operating around the world, in which entities must buy or trade allowances for the emissions they produce. Together, these markets were worth more than $850 billion in 2021 and cover about one-fifth of global greenhouse gas emissions.

The European Union was an early innovator with the debut of its Emissions Trading System in 2005, and momentum accelerated when China joined the party last year with the launch of its domestic market. But more countries will need to step up if the world wants to make a serious dent in their emissions.

“Some key jurisdictions have yet to enter the fray, such as India and the US,” says Emma Coker, European carbon team leader at BNEF. “While the US has some state-level schemes, which covered 8% of its emissions in 2021, a US national scheme remains unlikely. India has most recently discussed implementing a compliance carbon market, but in the short term has decided to focus on voluntary schemes.”

2. More ambition needed to make a real impact

In addition to the need for new markets, existing carbon pricing programs must significantly increase in size and ambition if they are to play a major role in decarbonizing the global economy.

“While some compliance carbon markets are making sweeping reforms, there is still work to be done to move them from splashing in a shallow pool to swimming in the big leagues,” says Bo Qin, principal analyst for BNEF’s carbon team.

BNEF believes that a well-functioning carbon market, dubbed the “Olympic level,” is as broad as it is deep. This means it must have ambitious emissions reduction targets and a broad scope to enable further decarbonisation. None of the world’s major carbon markets has yet reached the Olympic level.

“The EU could achieve such a feat if the reforms under its Fit for 55 package are passed without being diluted,” according to Qin. “Meanwhile, China’s likes could move forward by increasing its ambition and creating a signal of higher prices to support the reduction.”

3. Higher prices needed

While the proliferation of carbon markets is certainly good news, prices are generally too low to have a material climate impact. This is particularly true for sectors outside of power generation where switching to low-carbon alternatives remains an expensive proposition.

The World Bank estimates that a carbon price of $50-100 per ton of carbon dioxide is required by 2030 to meet the Paris Agreement’s temperature targets: limiting global warming to less than 2 degrees Celsius above pre-industrial levels.

However, only the EU, UK and New Zealand currently have prices within or above this range, and other major markets fall far short. Prices in China, the world’s largest market in terms of emissions covered, languish below $10 per ton of_CO2. Laggards will require reforms in their market designs to reach the necessary price level.

“For many, this will involve addressing the oversupply of allowances, both in terms of surplus allowances accumulated in the past (for schemes that enable this practice) and in reducing future allocations to encourage future scarcity,” Qin says.

But he also points out that the success of carbon markets is not just about reaching a certain price. “Next to price levels, the prominence of a carbon price is also key, so highly visible prices are more likely to result in behavioral change.”

4. Voluntary markets gain momentum

The other side of the carbon coin is voluntary markets, whereby entities buy offsets from projects that eliminate or avoid emissions to help neutralize their own environmental footprint.

The demand for compensation is accelerating. More than 144 million offsets were withdrawn in 2021, each corresponding to one tonne of CO2 equivalent, 50% more than the previous year.

“Despite growing corporate demand for offsets as new net-zero targets are set, the market remains oversupplied with offsets of power generation and avoided deforestation, many of which are of poor quality,” says Kyle Harrison, head of sustainability research at BNEF. “These two factors have kept prices in the market extremely low, leaving corporations with little incentive to prioritize other decarbonization strategies.”

The balance between supply and demand could change quickly, as groups like the Science Based Targets (SBTi) initiative push for the use of elimination offsets solely to achieve net-zero emissions. Meanwhile, countries such as Indonesia, Papua New Guinea and India are halting the export of carbon credits to help meet their own national climate goals.

5. Will carbon be the next big commodity market?

Despite the hype of voluntary carbon markets, they are still very small compared to compliance markets, valued at around $1 billion to $2 billion in 2021. But its potential is huge, particularly as companies will likely look to offset residual emissions in the coming decades, after exhausting all other reduction options.

In a scenario where only elimination offsets are allowed, BNEF estimates that demand for offsets could increase 40-fold between now and 2050, to 5.2 billion tonnes of_CO2 equivalent, equivalent to 10% of current global emissions. Prices could reach $120 per ton by 2050.

“Tighter regulation around supply and demand could turn the offset market of the pesky little brother of the carbon world into the next big commodity market, valued at more than half a trillion dollars,” Harrison says. “Therefore, the work of various registries, independent initiatives and technology providers will be key in the development of the market.”

There is also the potential for voluntary and compliance carbon markets to come closer, with seven major compliance carbon markets now allowing offsets to be used in some form and the COP27 summit laying the groundwork for global carbon trading to become a reality.

Source: The Energy Newspaper