Amid increasing pressure on countries and institutions to take responsibility for their emissions, the carbon credit market has gained momentum. What is the carbon credit market?
A carbon credit is a unit equivalent to avoiding or removing one ton of carbon dioxide from the atmosphere. Carbon credits are issued through climate action projects that capture carbon dioxide, such as tree planting, stopping deforestation, or replacing open-air fires with efficient cooking stoves. The number of carbon credit units produced by a single climate action project depends on the tons of carbon dioxide that are avoided, to ensure the desired impacts of the project.
What You Need to Know about Carbon Credits
Carbon credits are adopted according to internationally recognized standards, providing rigorous methodologies for calculating impacts within a coordinated audit framework and regularly monitored climate action projects. These standards ensure the proper implementation of climate action projects, ensuring that projects cannot be developed without carbon credit revenues and that they create permanent and measurable climate benefits.
Once carbon credit units are issued, a unique definition is assigned to each credit unit and recorded in publicly available registries to ensure that a credit unit cannot be calculated and sold more than once during climate change mitigation.
Carbon credits are also a documentation tool for companies to reduce global emissions today, as companies strive to reduce their carbon footprint.
The Journey of Carbon Markets
In 1977, the Clean Air Act was issued in the United States, one of the first mechanisms to offset emissions from industrial and commercial activities worldwide. This law allowed companies wishing to increase their emissions to do so by paying another company that reduces its emissions of the same pollutant by a greater amount.
The law was a financial incentive for companies to reduce their emissions to some extent. Then, in 1990, amendments were made to the same law, allowing companies to expand their purchase and sale of carbon credits, aiming to invest in emission reduction projects. Subsequently, the Clean Development Mechanism (CDM) was established as part of the Kyoto Protocol, adopted during the 1997 climate summit, which required industrialized countries in its first phase to reduce emissions.
This mechanism expanded the concept of carbon emissions trading globally, focusing on the main greenhouse gases causing climate change. This mechanism enabled advanced countries to sponsor emission reduction projects in developing countries, as the cost of greenhouse gas emission reduction activities is usually much lower in developing countries.
A Future Investment Tool
The carbon credit allows companies to issue a certain amount of greenhouse gases. Each credit unit equals one ton of carbon dioxide or its equivalent of other greenhouse gases. Companies receive a specific number of credit units, and if they manage to reduce greenhouse gas emissions, they will have surplus credits, which they can then sell to other companies and make money. Purchasing companies often cannot reduce emissions, which encouraged the creation of a market for trading carbon credit bonds between companies.
The UAE Takes a Step Ahead
In November 2022, the UAE investment company "Mubadala" announced its acquisition of a strategic stake in the AirCarbon Exchange (ACX). The ACX is the world's leading platform in the voluntary carbon market sector, headquartered at Hub71, the global technology ecosystem in Abu Dhabi.
This deal supports the launch of the first fully regulated exchange for carbon trading, and the establishment of a carbon trading clearinghouse in the global Abu Dhabi market. About a year later, the Dubai Financial Market announced the launch of a pilot platform for trading carbon credits during the 28th Conference of the Parties to the United Nations Framework Convention on Climate Change (COP28).
This step solidifies the leading position of the financial market at the forefront of climate action as a regulatory platform to facilitate capital aggregation for projects, trade carbon credits, and secure asset management to support the UAE government's goal of achieving carbon neutrality by 2050.
How Are Carbon Credits Sold?
In a broader view, carbon markets are exchanges where companies or countries buy and sell shares (credits or allowances) of carbon dioxide emissions that cause global warming. The party wishing to meet its emission reduction commitments pays another party that has already reduced its emissions, and the evaluation of this process is based on evaluation programs that include assessment criteria, with various factors affecting the pricing of carbon credits traded in the markets.
Trading carbon credits is based on incentive principles aimed at reducing or removing carbon emissions from the atmosphere and is part of national and international efforts to curb climate change.
Carbon credits and allowances consist of a variety of projects that reduce greenhouse gas emissions, identified within programs as a means for countries to meet their emission reduction commitments under the Paris Agreement goals agreed upon during the 2015 climate summit.
Demand for Carbon Credits
According to the International Energy Forum, enhancing voluntary carbon markets requires addressing challenges such as low liquidity, limited financing availability, and data scarcity. Building market trust is vital to achieving these goals, so global efforts must be combined to increase transparency and ensure stability.
Carbon credits must be provided while developing more green projects, especially since most potential carbon credit supplies related to forest preservation or tree planting are concentrated in a small number of countries. If these obstacles are addressed, demand for carbon credits could increase by 15 times by 2030, and up to 100 times by the mid-century. Research firm Wood Mackenzie estimates that demand for carbon credits ranges from 8 to 12 gigatons of carbon dioxide annually.
Carbon credits can be used to promote clean energy technologies in the developing world, as the United States launched an initiative during COP27 in Egypt in 2022 to enable companies to obtain credits to finance green projects in developing countries.
Emerging market governments have recently focused on carbon credits, as Saudi Arabia held its first auction in October 2022 to sell 1.4 million tons of carbon credits.
COP28 Maximizes Carbon Credits
At COP28, the World Bank announced ambitious plans to grow global carbon markets with a high degree of safety and integrity. Fifteen countries are expected to generate income from selling carbon credits resulting from forest conservation. These countries are expected to achieve more than 24 credits and around 126 million credits by 2028, which could generate $2.5 billion under suitable market conditions, with a significant portion of this amount benefiting local communities and countries.
Thriving carbon markets can do so for the benefit of other countries in the long run. These fifteen countries are Chile, Costa Rica, Côte d'Ivoire, the Democratic Republic of the Congo, the Dominican Republic, Fiji, Ghana, Guatemala, Indonesia, Lao People's Democratic Republic, Madagascar, Mozambique, Nepal, the Republic of the Congo, and Vietnam.
The World Bank launched the Forest Carbon Partnership Facility, which has supported pilot programs since 2018 to establish effective systems for carbon credit initiatives. By supporting five countries in 2024, the World Bank will work with governments and local communities to access carbon markets. By 2028, all fifteen participating countries in the Forest Carbon Partnership Facility are expected to be in a position to interact and engage with carbon markets.
