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Quality Enhancement in Voluntary Carbon Market

Bachelorarbeit 2008 122 Seiten

BWL - Beschaffung, Produktion, Logistik


Table of Contents


Executive Summary

Table of Figures

Table of Boxes

Abbreviations and Acronyms


1 An Overview of Existing Carbon Markets
1.1 Regulated Markets
1.1.1 The Kyoto Protocol
1.1.2 European Emissions Trading Scheme
1.1.3 Other Planned Trading Schemes under the Kyoto Protocol
1.1.4 Australia, finally committing to Kyoto
1.1.5 North American Initiatives
1.2 Unregulated Carbon Markets
1.2.1 Chicago Climate Exchange and Australia Climate Exchange
1.2.2 Functioning of Voluntary Carbon Markets
1.2.3 Market Volume and Prices
1.2.4 Market Dispersion
1.2.5 Project Types and Locations
1.3 Innovation or Security – Choice of Voluntary or Compliance Market

2 Along the Supply Chain of Carbon Offsetting – Market Players 26
2.1 Project Developers
2.2 Verification Organisations
2.2.1 Verification and Labelling
2.2.2 Verifying the Verifiers – Greenpeace and Co.
2.3 Offset Suppliers
2.3.1 Non Profit Sellers – Changing the World for a Better
2.3.2 Brokers and Consultants – Drivers for Innovation
2.3.3 Investment Banks, Funds and Speculators – Important Investors
2.3.4 Wholesalers and Retailers – Profit Seeking Middlemen
2.3.5 Companies – Jumping on the Carbon Neutral Train
2.4 Purchasers of Carbon Offsets
2.4.1 Individuals – Underrepresented Target Group
2.4.2 Business – Most Attractive Large-Scale Purchasers
2.4.3 Events – Accounting for Carbon Footprints
2.4.4 Public Institutions and Governments – Combining Efforts towards a Low-Carbon Society
2.4.5 NGO’s – Sceptic Customers

3 Instruments for Quality Enhancement 52
3.1 Criticism and Problems of the Voluntary Market
3.2 Standards and Labels
3.3 Registries
3.4 Carbon Exchanges
3.5 Governmental Action
3.5.1 Sensitisation of the public
3.5.2 Regulatory framework
3.5.3 Initiator for Action
3.6 Guides and Codes
3.7 Credit Ratings
3.8 Managerial Approaches towards Quality
3.8.1 Benchmarking
3.8.2 Strategic Alliances
3.8.3 Environmental Risk Management
3.8.4 Green Teams

4 Evaluation of Quality Instruments and Perspectives 76
4.1 Evaluation of Quality Instruments
4.2 Review on Experts’ Opinions towards the Future of Voluntary Offsetting
4.2.1 Investors See Necessity to Overcome Structural Barricades
4.2.2 Consultants Predict Continued Growth
4.2.3 Conservationists Call for Faster and Deeper Change
4.2.4 Offset Suppliers Lack Overarching Market Information
4.3 Scenario 1: An Overregulated Voluntary Market
4.4 Scenario 2: A Supply Driven Market
4.5 Scenario 3: A Demand Driven Market
4.6 Scenario 4: Aligning Supply and Demand





Firstly, I would like to dedicate thanks to my professors Thomas Rasmussen and Krzysztof Zięba for accompanying the writing of this paper. Additionally, I sincerely thank Sylvain for continuously supporting and inspiring this work. Of course, all those who supported my humours and provided assistance in any other form also shall be thanked here, as my family and husband in particular.

Executive Summary

Market Overview

On carbon markets one unit traded refers to one ton of carbon dioxide or equivalents[1]. This merchandise, named offset or carbon credit, generally is produced by an emission reduction project through removal, avoidance or reduction of atmospheric carbon dioxide or equivalents. Differentiation is made between regulated carbon markets which are designed to achieve compulsory emission reductions and voluntary markets where actors trade regardless of imposed commitments.

Since the beginning of the century, different regulated carbon markets evolved or are evolving in developed countries. Due to increased public attention, financial attractiveness and the need for action to mitigate global warming, these markets have large growth potential. Nevertheless, a lack of commitment and instruments to face climate change in developing countries can be observed. Though, several studies and ongoing discussions[2] revealed that sustainability and development are not mutually exclusive. Therefore, one may expect nations like China and India to change from pure project host countries to active carbon markets.

Besides compliance markets, a niche for voluntary carbon trading developed, mainly in North America, Europe and Australia. As differences in project types, market players and locations illustrate, voluntary offsetting offers an alternative for compliance regimes (e.g. for least developed countries, individuals or small projects). Major advantages of the former are:

- Higher flexibility through lack of large and inert institutions
- Greater innovation potential due to its unregulated nature
- Experimentation and gaining expertise for compliance markets

Nevertheless, uncertainty and lack of credibility impede development in non-compliance regimes. For attaining substantial growth in the following years, the introduction of clear and feasible quality measures is crucial condition, since clarity and transparency will enhance customer confidence and demand. Therefore, this thesis will examine needs and interests of market participants in order to establish or evaluate (existing) quality measures for voluntary carbon trading.

The Supply Chain

Due to a complex distribution structure, certain actors may inert several functions in the carbon supply chain. Therefore, motivations can overlap among different groups; see Figure 4 for a simplified model of the supply chain in voluntary carbon markets.

Being the value creating element, project developers or producers of carbon credits are driven by the profit motive (mainly carbon consultancies) or explore new project finance strategies (NGO’s or other non-profit organisations). Also conservation concerns and attractive innovation possibilities incite participation in carbon trading. Therefore, project developers will increase quality in carbon markets by providing cost-efficient emission reductions, value added projects as well as high quality expertise in order to increase their competitiveness. For avoiding project failure and the resulting non delivery of credits, this group will strive to develop efficient risk management techniques.

Verifiers of carbon offsets primarily seek to establish their label, guarantee minimum standards and profit from a dynamic market. Monitoring groups on the other hand ensure consumer protection by independently supervising the market and publishing the results.

Referring to middlemen, primary motivation for participation is the generation of benefits or exploiting attractive investment opportunities, as well as sensitisation of the public. Concerning quality, pure offset providers will seek to achieve economies of scale by improving product life cycles, organisation patterns and risk management tools. Also the development of improved distribution structures will advance the voluntary offset market. Especially non-profit entities will enhance value added projects for differentiation reasons.

Important qualities for offset purchasers are the environmental integrity of offsets, or if projects are truly reducing emissions (‘additionality’) and value added attributes, amongst others for communication purposes. Individuals rather seek for low cost options to mitigate their carbon footprint, whereas businesses will rather aim to exploit the image value by purchasing ‘high quality’ and generally more expensive carbon credits. Governments on the other hand, use voluntary offsetting to provide a good example and for sensitising consumers on climate change issues.

Criticism and Quality Enhancing Instruments

Major weakness of the voluntary carbon market is its missing uniformity which increases insecurity for the consumer. In the past, a lack of standardised verification and the complete absence of registries prepared the ground for abuse and fraud. Also, different methods for the estimation of actual emission reductions add to uncertainty. Moreover, consumers are alienated by unclear risk distribution and the lack of transparency. Although, since 2007 market conditions were improving, a long path remains until poor quality products are the exception on international carbon markets.

In order to attract a growing number of market players, especially individuals, these mentioned obstacles have to be overcome. Challenge herby is to achieve improvement by simultaneously maintaining core advantages of the market: flexibility and innovation potential.

2007 was marked by the introduction of potentially market shaping standards, growing use of third party verification and the beginning institution of registry systems. Thus, offset providers increasingly account for customers’ demand for quality. Standardisation and labelling will facilitate comparison of different carbon products, whereas third party verification and registries can limit fraud and abuse. Under these conditions, the institution of exchanges for voluntary carbon offsets is most probable. So far, mainly compliance credits can be traded on exchanges. However, this infrastructure could further enhance transparency of the unregulated carbon market.

In June 2008, another quality instrument emerged. Risk ratings of carbon offset projects will provide investors with the possibility to establish efficient hedging strategies. Additionally, project managers will be motivated to reduce project risks for attracting funds.

Being very recent structures, these mentioned instruments cannot be evaluated in a qualified manner yet. Nevertheless, one may predict the continuous improvement of market infrastructure in order to attract purchasers and therewith enable substantial growth.

Governments and international institutions can prevent fraud and abuse in the voluntary carbon market by means of regulation and supervising institutions. They also play a role as initiator of programmes and networks. Additionally, communication policies will increase transparency and clarity for consumers. However, for not sacrificing market qualities, measures should be developed together with the offsetting industry.

Different guides and codes concerning voluntary offsetting overflow the market and increase consumers’ insecurity. Therefore, only such recommendations underlying stringent criteria and avoiding conflicts of interest potentially increase clarity and quality.

Offset providers may improve performance and their products by means of managerial quality approaches. Benchmarking and risk management for instance can be applied to prevent project underperformance or failure and therewith reduce the risk of non-delivery. Strategic alliances and green teams enhance innovation potential through knowledge transfer. Thus, competitive advantages can be created by entities using mentioned strategies.


Altogether, the voluntary carbon market is maturing, due to the institution of market infrastructure and quality measures throughout 2007 and 2008. Therewith it opens for mainstream participants. In other words, enhanced information and standardisation enable the entrance of inexperienced buyers and sellers and lay ground for market expansion.

Experts on carbon markets confirm this observation. They expect this quality development to continue, but also perceive the necessity for greater commitment, in order to meaningfully advance towards the objective of a low-carbon society.

Although there are initiatives underway to regulate parts of the voluntary offset market, for instance concerning advertising, the introduction of obstructive regulation seems unlikely to date. Most probable intervention of governments will be in form of promoting the participation in compliance markets. A supply driven market would be characterised by the prevalence of technological solutions in order to produce a large quantity of offsets at lowest cost. In a purely unregulated demand driven market, on the other hand, value added projects and branding would dominate. But price erosion and fraud potential would constrain the establishment of this market. Conversely, growth of the last years, enhanced market quality and the increasing maturation indicate for a wealthy development of voluntary carbon offsetting.

Considering recent trends as the “flight to quality” (Carpoor and Ambrosi 2008, p.23), increasing entrance of financial actors, standardisation of products, differentiation of actors and the aligning interests of providers and purchasers, one can assume the emergence of following more or less interrelated segments:

- A technology market for commercial actors seeking to achieve a large quantity of emissions reductions in the most efficient manner. This section is important for the advancement towards a low-carbon society as it incites (technological) progress;
- A ‘gourmet carbon market’ would satisfy purchasers as individuals or businesses, seeking for value added projects to exploit image and marketing potentials. This market segment combines emission reductions with development benefits.
- A carbon finance market for professional investors looking for sustainable investment and hedging solutions. This immaterialised market ensures liquidity and activates opportunities for growth.

Concerning mentioned tendencies, a continuation of market shaping and further quality enhancement seems most probable. This would facilitate ongoing growth, as experts and market players predict for coming decades.

Nonetheless, carbon markets should not be understood as the ultimate solution for climate change. In order to meaningfully reduce carbon dioxide in the atmosphere and prevent global warming, a paradigm shift has to take place. The market for voluntary offsetting, therefore, can only be a modest contribution to the necessary change towards a low-carbon society

Table of Figures

Figure 1: Functioning of allowance-based transactions

Figure 2: Functioning of project-based transactions

Figure 3: Levels and organisms in Kyoto emissions trading

Figure 4: Supply chain in voluntary offset markets

Figure 5: Interaction between compliance and voluntary carbon markets

Figure 6: Development of project-based transactions from 1998 – 2006

Figure 7: Location of offset buyers

Figure 8: Geographic dispersion of offset providers

Figure 9: Comparison of project types in Kyoto and non-compliance markets

Figure 10: Geographic dispersion of voluntary and Kyoto projects

Figure 11: Carbon offset suppliers by primary and secondary business activity

Figure 12: Processes for internal and external verification

Figure 13: Development of offset suppliers by category until 2007

Figure 14: Logo of the Carbon Trust

Figure 15: Evolution of carbon procurement vehicles from 1999 (compliance and voluntary)

Figure 16: Distribution of motives by type of carbon fund

Figure 17: Distribution of demand for voluntary carbon offsets

Figure 18: Purchasers’ motivations for buying carbon offsets

Figure 19: Purchase criteria for offset buyers

Figure 20: Quality criteria concerning carbon offsets as perceived by market players

Figure 21: Differentiated definition of quality for carbon offsets

Figure 22: Standards used 2007 in the voluntary carbon market

Figure 23: Market share of registries by transaction volume

Figure 24: Growth of voluntary carbon offsetting as predicted by market actors

Figure 25: Three sections of a future voluntary carbon market - prediction

Table of Boxes

Box 1: Mismanagement, project failure and ways out

Box 2: Two best practice examples of non-profit retailers

Box 3: Good and bad practices of for-profit suppliers

Box 4: Greenwashing and how to recognise it

Box 5: Case study UK - Paving the way towards a low-carbon society

Box 6: Indulgence Discussion

Box 7: Case study DEFRA Code

Box 8: How developing countries can benefit from offsetting

Abbreviations and Acronyms

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Climate change represents an ongoing threat, not only since it attracted growing media attention in recent years. Therefore, scientists urge to reduce the concentration of carbon dioxide in the atmosphere in order to prevent most disastrous consequences.

One method, chosen by the international community to achieve this reduction and therewith mitigate global warming, is via the establishment of so called carbon markets. Most famous example is probably the European Emissions Trade System (EU ETS), where pollution allowances can be exchanged among actors. The reduction then is achieved by the setting of a ceiling or cap by authorities. Besides, there are also voluntary carbon markets where actors aim at reducing emissions with self-imposed targets.

Objective of this paper will be to elucidate this unregulated market for carbon commodities and understand its functioning. Since voluntary carbon trading was largely criticised for a lack of quality and transparency, methods to overcome such weaknesses shall be presented and evaluated as well.

Beginning with an overview of different systems of carbon trading, the reader will subsequently learn about existing and emerging carbon markets, their characteristics and performance. Notably compliance and non-mandatory schemes will be distinguished. Juxtaposition will allow for evaluating strengths and weaknesses of both systems.

For gaining an understanding of the supply chain in the voluntary carbon market and comprehend underlying motivations, a presentation of market players will follow in the second chapter.

Based on market actors’ motives, a model for ‘high quality’ carbon commodities will be established in the third part, whereby criticism is also taken into account. An examination of instruments to enhance quality and to overcome shortcomings of non-mandatory markets will be examined in the following.

The fourth chapter will provide an evaluation of and an outlook on the beforehand discussed quality mechanisms. Additionally, different scenarios will be developed in order to predict the future of voluntary carbon trading.

1 An Overview of Existing Carbon Markets

Enlightening the jungle of different carbon markets will be the challenge of this chapter. Other emissions trading schemes exist as for instance the sulphur dioxide market in the US, however, they will not be considered within this work. Object of study will be markets where units traded refer to tonnes of carbon dioxide equivalent emissions (tCO2e)[3].

Besides the classification in compliance and voluntary markets which will be specified below, two characteristics are differentiated:

- Allowance-based transactions designate exchanges of carbon units that were “created and allocated (or auctioned) by regulators under cap-and-trade regimes” (Capoor and Ambrosi, 2007, p.8). This approach ensures simultaneously the realisation of emissions reduction through a defined ceiling and flexibility. Market actors are free to chose the method of reduction, weather decreasing own pollution or purchasing credits, to comply with objectives. Thus, emissions reductions are realised in the most economic manner.

Abbildung in dieser Leseprobe nicht enthalten

Figure 1: Functioning of allowance-based transactions

Source: Author

- Credits from project-based transactions have to be created through verifiable and additional greenhouse gas reductions (Capoor and Ambrosi, 2007, p.8). More precisely, the project may generate carbon credits solely if mitigation of pollution would not have happened otherwise.

Abbildung in dieser Leseprobe nicht enthalten

Figure 2: Functioning of project-based transactions

Source: World Bank 2006

Most criticism concerning carbon trading refers to project-based transactions, because of the questionable real quantity of carbon mitigation and implied risk. Furthermore, in voluntary markets the verification process is not obligatory, which causes insecurity and fraud potential as well.

Therefore, the thesis aims at increasing clarity in this market segment and evaluates techniques to ensure quality for project-based credits in the voluntary offset market.

In the following carbon offset or solely offset will be referred to as “the process of reducing and/or counterbalancing greenhouse gas (GHG) emissions by purchasing credits from others through emissions reductions projects” (IGD, 2007). This reduction may be realised by sequestration, compensation or another form of decreasing atmospheric carbon, see Project Types and Locations of voluntary markets for more precise information.

The principle of carbon offset is based on the knowledge that for the global warming effect it is indifferent where cutbacks in emissions are made, results are equal. Mostly, credits are purchased to compensate ones’ own emissions production, for instance for a long-distance flight or an event. In other words, total emissions stay at the same level. A more detailed discussion about this issue can be found in section 3.1, Box 6: Indulgence Discussion. But firstly an overview of this complex market will be given.

1.1 Regulated Markets

So called compliance markets are characterised by conformity with either an international, national or regional commitment (Gardette and Locatelli, 2007, p.10). In other words, all markets that underlie any binding framework (policy or jurisdiction) are considered regulated, mandatory or compliance markets. Subsequently, presently existing compliance carbon markets will be presented.

1.1.1 The Kyoto Protocol

As most comprehensive international agreement, the United Nations Framework Convention on Climate Change (UNFCCC) paved the way for creating a collective action plan against the consequences of global warming. As a result, in 1997 on the eponymous conference in Kyoto, Japan, nations agreed on mechanisms and measurable emissions reduction targets. At present, 180 countries have accepted or ratified the treaty with the United States as single Annex I country having signed, but not ratified the Protocol yet.[4]

Within the Protocol which entered into force on February 16th 2005, parties engaged to reduce greenhouse gas (GHG) emissions by at least 5% compared to 1990 levels. According to the Treaty, this reduction shall be realised “primarily through national measures”. Though, parties may achieve their targets also via the following mechanisms:

- As one offset instrument, the Protocol established the Clean Development Mechanism (CDM) in Article 12. The concept is that Annex I parties may acquire credits from emissions reduction projects in non-Annex I countries, in order to attain their reduction objectives. These credits, named certified emissions reductions (CER), are accredited by the CDM Executive Board.

- Similar to the above mentioned model functions the Joint Implementation (JI) mechanism agreed in Article 6. This represents also a project-based approach, but emissions reductions units (ERUs), the “currency” of this instrument, are created and exchanged among Annex I nations.

- Emissions’ trading [5] (Article 17) is an allowance-based system and frequently confused with offsets, although they are not equal. Emissions allowances are distributed by assigned bodies for exchange among Annex I parties and not, as for offset credits, created through the prevention of emissions. Thus, reduction objectives are attained by distribution of fewer permits than required.

illustration not visible in this excerpt

Figure 3: Levels and organisms in Kyoto emissions trading

Source: UNFCCC 2008, adapted

As illustrated above, in the Kyoto Protocol emissions trading model project-based (CER, ERU and RMU[6] ) and assigned units, called assigned amount units (AAU), can be exchanged. In other words it is the market place for different “currencies” meaning different emissions reductions credits. Marketplaces for exchange are different registry systems that have to be established by each Annex I party, underlying Kyoto control mechanisms.

Within the first two years of official Kyoto trading, primary project-based transactions (CDM and JI) increased by 219% and valued €5.8 billion in 2007 (Carpoor and Ambrosi 2007, p.3 and 2008, p.1). For comparison: Voluntary project-based trading was projected at €86 million in the same year (Hamilton 2008, p.6).

The Kyoto project-based mechanisms as one example for regulated markets will serve as reference for comparison and enhance understanding of the carbon offset market.

1.1.2 European Emissions Trading Scheme

With a trading volume of about €37 billion in 2007 (Capoor and Ambrosi 2008, p.1), the European Emissions Trading Scheme (EU ETS) is the largest carbon emissions marketplace worldwide comprising 27 nations.

Additionally to its member states, the European Union ratified the Kyoto Protocol and defined its individual reduction targets which are even more ambitious (8%) as Kyoto requirements (>5%). At present, the system encompasses polluting industries only. Nevertheless, inclusion of other sectors as aviation and businesses is foreseen.

Commencing in 2005, EU ETS suffered a severe downturn during its first commitment period. Due to an over allocation of trading permits, prices plummeted to under €1 at the beginning of 2007 and never rebound (European Energy Exchange, 2008). After this learning phase, allocation and trading conditions will be more stringent for following commitment phases according to Carpoor and Ambrosi (2007, p. 15). The doubling of EU ETS value from 2006 to 2007 proves the specialists’ right and illustrates increased market stability. Additional expertise was acquired by the superseding of the UK emissions trading scheme which was in place from 2002 to the beginning of 2007 (DEFRA 2008).

Presently, efforts are undertaken to associate EU ETS and the Kyoto market, so that especially project-based credits are fungible in both the European and the Kyoto scheme. According to an EU official, accomplishment of the linking (stipulated in the so called Linking Directive, Directive 2004/101/EC, compare EUROPA 2006) is envisaged until end 2008 (Reuters 1).

With this connection EU ETS will transform from a purely cap and trade model into a combined system with allowance-based and project-based trading as stipulated and practiced in the Kyoto approach.

1.1.3 Other Planned Trading Schemes under the Kyoto Protocol


According to the Japanese minister on environment, Ichiro Kamochita, the fifth larges carbon emitting country aims at introducing a “real”[7] allowance-based trading system for the post Kyoto commitment period. Since the Protocol expires after 2012, Japan advances the view that industry based emissions reduction objectives represent the most effective way to face climate change challenge after expiration (Reuters 4); an opinion widely criticised by developing countries which consider this approach as unfair due to their large energy industry (Casey 2008).

Operating solely a voluntary system to achieve Kyoto objectives at present, the government acknowledged the necessity of compulsory emissions cuts by this statement.

So far, polluting industries may participate in the Japanese Voluntary Emissions Trading Scheme (JVETS). Launched in 2005, the system entered into second phase with 59 participating facilities and/or companies one year later (Dr. Ninomiya, 2006, p.2). Tradable units are Japanese emission allowances (JPAs) and CERs from the Kyoto market.


Canadian government still lacks behind in initiating emissions reduction measures in compliance with its Kyoto commitment. Nevertheless, preparations for introducing policy instruments to reduce carbon emissions are underway since 2005 (IETA, 2008).

In June 2006, a joint venture was instituted between Montreal Exchange and Chicago Climate Exchange (CCX)[8] to launch a carbon dioxide trading system. After several delays due to lack of government approval, launch was planned for March 30th 2008 (Reuters 5). However, success of this market is questionable since Quebec, Manitoba and British Columbia already joined US emissions reduction initiatives and most exchange members are experienced EU ETS participants, referring to an insider. In two months solely three contracts were completed according to Reuters’ information, which seems to confirm doubts on the exchange’s advancement (Reuters 20).


Against an environmental tax, the New Zealand government decided to stepwise introduce an emissions trading scheme until 2013 (Ministry for the Environment, Wellington, New Zealand, 2007, p.4). The allowance-based system commenced in January 2008 with the forestry sector. Energy, industrial process emissions, agriculture, waste and all other emissions are to be integrated until finalisation. Besides New Zealand Units (NZUs), credits from other international trading schemes are accepted to increase liquidity. Project-based options will probably complete the scheme in the future, according to the Ministry for the Environment (2007, p.6).

1.1.4 Australia, finally committing to Kyoto

Due to government change, Australia finally committed to ratification of the Kyoto Protocol in December 2007 and initiated action for the establishment of a nationwide trading mechanism to comply with Kyoto reduction objectives. Introduction of the scheme shall take place until 2010 (Reuters 3), because…[9]

Australia wants to become “part of the global solution on climate change, not just part of the global problem"

Australia’s’ Prime Minister Kevin Rudd [10]

Besides these recent efforts to install a national emissions trading scheme, Australia operates the second largest emissions trading market at present. The New South Wales Greenhouse Gas Abatement Scheme valued approximately €164.5 million in 2007 (Capoor and Ambrosi 2008, p.1).

Commencing on January 1st 2003, the mechanism represents a regional initiative only, requiring from electricity producers and retailers to decrease their GHG emissions, based on their market share. Since 2005, the Australian Capital Territory[11] is comprised in the system as well. Mitigation of emissions shall be realised by means of abatement projects generating credits and being verified by the Independent Pricing and Regulatory Tribunal of New South Wales (NSW). Thus, Australia is practicing project-based emissions trading and encourages its participants to reduce atmospheric GHG at its source.

Trading units are NSW Greenhouse Abatement Certificates (NGACs) or Renewable Energy Certificates (RECs). Other “currencies” are not eligible. Nevertheless, according to Carpoor and Ambrosi (2007, p.18), demand in the voluntary market for NGACs arises.

1.1.5 North American Initiatives

Contrary to politics’ reluctance for Kyoto ratification so far, several US states developed their individual program to conquer climate change issues. Besides trading schemes for other pollutants, following carbon markets are evolving:

- Initiated by the State New York the Regional Greenhouse Gas Initiative (RGGI) aims at reducing carbon emissions from power plants and counts ten member states already (stand March 2008). Launch of the proposed allowance-based trading system is foreseen in 2009. Participants committed to reduce overall carbon emissions by 10% until 2018 compared to levels of the first year. Offsets will also be allowed in order to achieve reduction objectives (RGGI, 2007).
- Combining efforts of Canada, the United States and Mexico, the Western Climate Initiative, or former Western Regional Climate Action Initiative (WRCAI), involves commitments of nine states. Since efforts to design an integrated, market-based emissions reduction model commenced in February 2008, concrete proposals for instruments are still under discussion. Most probably a combined scheme with offset and allowance approach will be created. However, members already agreed on 15% reduction targets compared to 2005 emissions levels (Western Climate Initiative, 2008).
- In November 2007, six US states and one Canadian province signed the Midwestern Regional Greenhouse Gas Accord which aims to create a cap and trade scheme for reducing emissions (MGA, 2007).

For independently gathering emissions data in North America, 53 US states and Canadian provinces established “The Climate Registry” (stand as of March 31st 2008). This non-profit organisation is designed to monitor GHG emissions of members. Objective is to create an overarching supervisory body for voluntary and mandatory emissions reduction regimes in North America (The Climate Registry, 2008).

Since beginning of the century, different regulated carbon markets evolved or are in preparation in developed countries. Due to increased public attention, financial attractiveness and the need for action, these markets have large growth potential.

Nevertheless, a lack of commitment and instruments to face climate change in developing countries can be observed. Presently, discussions and several studies[12] revealed that sustainability and development are not mutually exclusive. Therefore, one may expect nations like China and India to shift from project host countries to active carbon markets.

1.2 Unregulated Carbon Markets

Contrary to compliance markets, voluntary offsetting does not underlie any formal commitment (Gardette and Locatelli, 2007, p.10). Nevertheless, schemes exist within this market where members may define individual and legally-binding emissions reduction objectives, as for instance under the Chicago Climate Exchange. After short presentation for the sake of completeness, those mechanisms will not be considered further in this thesis, since purpose is to enlighten non-binding markets.

1.2.1 Chicago Climate Exchange and Australia Climate Exchange

Launched in 2003, the Chicago Climate Exchange (CCX) was the first globally operating, comprehensive and voluntary emissions trading scheme. This system offers entities and individuals the possibility to contribute to the mitigation of global warming effects.[13]

Since CCX functions as registry, trading of both allowance and project units is possible, comparable to Kyoto emissions trading. Different to the latter, CCX trading involves a category for banks and speculators which do not engage in emissions reduction. Their role is to ensure market functioning by providing capital.

In July 2007, the Australia Climate Exchange (ACX) started operating. Growing demand for voluntary offsets on the continent triggered its creation. Compliance as well as voluntary carbon credits can be transacted (Capoor and Ambrosi 2008, p.17).

1.2.2 Functioning of Voluntary Carbon Markets

Participants in non-compliance markets are individuals, businesses, communes or other organisms. Motivation to purchase these project credits originates from various reasons, as there are meeting self-imposed reduction targets, mitigating the own carbon footprint or social responsibility (EAC, 2007, p. 8).

Basically, there are two methods of offsetting for the consumer:

- Direct purchase of offsets to reduce or compensate emissions. Corporations like HSBC for instance neutralise part of or their entire emissions production with offsets.

- Payment of an additional “environment fee” on products or services. When booking a flight for example the passenger may chose to pay more in order to compensate emissions produced by the travel. Offsets are purchased by the company collecting the funds then.

Offsets are created according to the principle of project-based transactions. This means customers acquire units of CO2e that are eliminated elsewhere. Important particularity: Independent verification is not obligatory in voluntary markets. So, customers may purchase emissions reductions (ER) only or verified emissions reductions (VERs). Another trading unit mainly purchased in the US refers to renewable energy projects and is called REC (renewable energy credit; compare Bayon, 2007a, p.29). Such commodities will not be part of following analysis, since they do not refer to carbon equivalents.

Additionally, carbon credits from the voluntary market “are not tradable among schemes” (EAC, 2007, p.8). In other words, offsets purchased from one supplier may not be resold to an actor in another system, so far. However, with the establishment of registries and subsequently their linkage this exchange of offsets among schemes might be feasible in the future.

The picture below illustrates the value chain in voluntary carbon markets, with examples of market players for each category:

illustration not visible in this excerpt

Figure 4: Supply chain in voluntary offset markets

Source: Bellassen and Leguet 2007, adapted

Another speciality of this market is that some organisations vend compliance credits such as CERs, NGACs, EUAs or RMUs (Bayon 2007a, p.25) on a voluntary basis. Reason may be increased accountability and consumer’s trust, due to more stringent control measures.

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Figure 5: Interaction between compliance and voluntary carbon markets (not to scale)

Source: Author

1.2.3 Market Volume and Prices

In 2007, Ecosystem Marketplace found that voluntary carbon markets valued around 42.1 MtCO2e (Hamilton 2008, p.5), a 194% increase compared to the year before.

In money terms voluntary carbon transactions (also referred to as over the counter trading) amounted to €86 million according to the experts. Despite its 13-fold smaller volume, the market for voluntary emissions credits is expected to reach the size of 2006 primary CER trading by 2010 according to the Climate Group (compare EAC, 2007, p.15).

Harris advances the view that “introduction of credible project and retailer standards … [in voluntary carbon trading] has the potential to greatly influence the market by enhancing credibility and driving demand.” (Harris 2007, Abstract) Also IDEAcarbon experts estimate that future growth will depend to a large extend on the introduction of credibility and quality measures in the following years (2007, p.2).

Abbildung in dieser Leseprobe nicht enthalten

Figure 6: Development of project-based transactions from 1998 – 2006

Source: Capoor and Ambrosi 2007

Looking at the development of project-based transactions, one recognizes that a voluntary market already existed when signing the Kyoto Protocol. First traceable offset action in history is the financing of a carbon sequestration project in Guatemala by the American energy producer AES Group in 1989 (Belassen and Leguet 2007, p.6).

From 2001, when structures for Kyoto mechanisms were in place[14], CDM and JI trading challenged the leadership of voluntary market players. Soon regulated trading overtakes voluntary offsetting, probably because of higher certainty and control measures. Another boost can be observed after official entering into force of the Protocol.

Concerning prices, a very high volatility can be observed in voluntary schemes where prices ranged from $1.80 to one very high example of $300 per tCO2e in 2007 (Hamilton 2008, p.38). Partly, this is due to the fragmented structure and high competitiveness of the market. Moreover, implied risk and uncertainties, as for instance non-delivery for future emissions reductions, may also influence on price formation.

On average carbon credits in the over-the-counter market valued $6.10 per ton of carbon equivalent (equals approximately €4). This was an increase by 50% compared to the year before, according to data from Ecosystem Marketplace (Hamilton 2008, p.8).

1.2.4 Market Dispersion

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Figure 7: Location of offset buyers

Source: Hamilton 2008

From the consumer’s perspective, corporations from the UK dominate voluntary carbon markets in Europe, according to Gilles Corre, director of the environmental markets department at Evolution Markets[15] in London (FT 2007). Another large proportion of offset purchasers is located in North America (37%), whereas developing countries do not even participate 1% to offset demand (Hamilton 2008, p.66).

As Capoor and Ambrosi state (2007, p.37), the voluntary market is “highly fragmented”. Therefore, and because of an explosion of online providers, difficulties arise to locate sellers for carbon offsets. Nevertheless, within the frame of “Mission Climat”, Bellassen and Leguet (2007, p.16) analysed 84 offset providers and observed the following allocation:

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Figure 8: Geographic dispersion of offset providers[16]

Source: Bellassen and Leguet 2007

As anticipated, majority of offset providers is located in northern nations with high demand in carbon credits. Europe represents the largest portion, but North American corporations are not much inferior in number.

Solely one corporation is located in a developing country, namely “The Green Initiative” from Brazil (Bellassen and Leguet, 2007, p. 30). As know-how, transparency and clarity will ensure market stability, one may expect the number of southern service providers to increase. Since especially Latin America and Africa have large potential to produce offsets, one may foresee an expansion into producers markets as well.

From the producer’s side, African countries still are to exploit their potential, according to the Carbon Markets Association (2007, p.2). See the next section for more information on project locations.

1.2.5 Project Types and Locations

For offsetting emissions, a reduction elsewhere is required. There are different methods for realising this decrease in atmospheric carbon or equivalents. Options are:

- Removal of emissions, for instance by means of sequestration or carbon sinks
- Avoidance of emissions production, e.g. through withdrawal of pollution allowances, development of energy efficient technologies or replacement of polluting equipment/ activities

Comparing the allocation of project types from voluntary markets and Kyoto mechanisms in the following graph, two major differences become obvious. Forestry projects are an important source of emissions reductions in voluntary schemes, whereas Kyoto participants favoured industrial gas projects. Besides this differentiation, both markets increasingly converge, compared to the years before where differences were more evident.

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Figure 9: Comparison of project types in Kyoto[17] and non-compliance markets

Source: Hamilton 2008

The large extend of land use, land use change and forestry (LULUCF) offsets may be explained by severe restrictions in Kyoto mechanisms. However, scientists such as Johannes Ebeling from EcoSecurities[18] hope for greater acceptance of forestry schemes in a post Kyoto agreement (Reuters 6). Since deforestation accounts for 25% of global emissions, its avoidance is a cost effective and efficient measure to respond to global warming (Howden, 2007), which may explain its success in non-compliance schemes. Nevertheless, popularity of such projects decreased, also in voluntary markets, “due to concerns about permanence” (Bayon 2007a, p. 28).

According to Ecosystem Marketplace, 36% of over the counter (OTC) trading originated from CDM, CCX or other credits (Bayon 2007a, p.25).

Whereas Asia dominates in compliance and non-compliance markets, a great disparity can be observed when looking at distribution patterns of remaining project locations, as becomes obvious from the figure below. Other developing countries generate the second largest quantity of carbon credits under Kyoto trading, due to the large amount of CDM transactions (93% of ‘Kyoto projects’).

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Figure 10: Geographic dispersion of voluntary and Kyoto projects

Sources: Hamilton 2008 and Capoor and Ambrosi 2008

North America represents the second largest project location in voluntary schemes. This is owed to the absence of an overarching compliance market in the US and Canada and growing demand for domestic projects (Capoor and Ambros 2008, p.42). Altogether, one recognizes a predominance of developed countries as project location in voluntary schemes. Southern nations still have to exploit their potential on carbon credits in both schemes. While African projects will most probably generate certificates under voluntary schemes, because of very stringent measures under Kyoto and a costly approval process; Asian or Latin American project developers on the other hand might exploit both market options.

Besides compliance markets, a niche for voluntary carbon trading developed, mainly in North America and Europe. As differences in project types, market players and locations illustrate, voluntary offsetting offers an alternative for Kyoto regimes (e.g. for least developed countries, individuals or small projects).

Nevertheless, for attaining substantial growth in the following years, the introduction of clear and feasible quality measures in voluntary markets is crucial condition, because clarity and transparency will enhance customer confidence and demand.

1.3 Innovation or Security – Choice of Voluntary or Compliance Market

For completing the picture of carbon markets, a comparison will be made between voluntary and Kyoto project-based trading. More precisely, primary trading of carbon credits from the Clean Development Mechanism (CERs) will be juxtaposed to voluntary carbon offsetting. Main focus hereby will be laid on differences between both markets, only a short collection of similarities can be found at the end of the chapter.

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As formerly mentioned, major distinction of both markets is their contrasting motivation. Whereas voluntary offsetting does not underlie any formal commitment, CER trading originates from the necessity of meeting compulsory emissions reduction targets. Any other intention shall not be excluded by this statement. For more information on different stimuli of market players read the section below.

Another differentiation is the non exchangeable nature of voluntary credits, in contrast to CER which can be purchased and sold in various schemes. Furthermore, the voluntary market is divided into numerous segments, as for instance providers specialised in passenger air transport or event offsetting. For ensuring accurate accounting of credits, one registry was designed in order to follow CER transactions. In voluntary systems, this measurement is still largely missing, although organisms increasingly use registries as well.

Additionally, the verification system in both markets differs. Pollution credits from the clean development mechanism are exclusively certified by the UNFCCC communications hub. Voluntary offsets on the other hand, firstly do not need to be certified at all and secondly, may be approved by different organisms, either private regulatory bodies for labelling or another verifier (Bellassen and Leguet, 2007, p.12 ff).

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Looking at the value chain, one recognises different structures as well (see Figure 3 and Figure 4). Compared to primary CER trading, non-compliance operations are rather complex with many market players involved.

On the other hand, the former is more restrictive concerning participants. Even if the Kyoto Protocol was designed to realise reduction in CO2 output on a broad level, some potential purchasers are excluded. This is largely due to bureaucracy, high transaction costs and participation requirements. Especially those actors are attracted by voluntary carbon markets, which guarantee higher flexibility.

Concerning geographic distribution, one observes the highest demand in both markets from purchasers located in the United Kingdom. But also Western European and North American participants offset their emissions voluntarily.

According to predictions from Capoor and Ambrosi (2007, pp.22), Canada has large potential for CER trading, especially in regard of possible environmental regulation to come. Contrary to Japanese entities whose CDM transactions decreased significantly from 2005 to 2006 and the experts expect only feeble demand from the fifth largest polluter in the following years.

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[1] See glossary for more information on carbon equivalents.

[2] Most recent studies from OECD “Environmental Outlook to 2030” and EcoSecurities “Generating carbon finance through avoided deforestation and its potential to create climatic, conservation and human development benefits”, discussions on commitments of developing countries on Bangkok climate talks in April 2008, etc. discuss the compatibility of emission reduction and development.

[3] Greenhouse gases, recognised by the Kyoto Protocol are carbon dioxide as major emission caused by human activity, methane, nitrous oxide, hydro fluorocarbons, perfluorocarbons and sulphur hexafluoride. These gases are classified depending on their global warming potential (GWP), whereas CO2 serves as basis with 1 GWP. This methodology simplifies emissions trading under various schemes; because units traded or offset refer to the same “product”, namely CO2 equivalents, compare UNFCCC 2008. For instance, if the GWP of a gas is twelve times higher than the effect of CO2, one ton of this gas would equal 12 tCO2e.

[4] Following information compare UNFCCC, 2008

[5] Since emissions trading does not equal carbon offsets, some markets in this section are presented solely to complete the overview of carbon markets. Subsequent considerations will be based on CDM, JI and project-based offset markets only.

* Allowance issuing bodies in Annex I nations distribute AAUs to polluters in the respective country.

[6] Credits issued for biodiversity projects are called RMU, those projects concern land use, land use change and forestry (LULUCF) and are subject to severe regulations due to controversially discussed emissions reductions in the long term, especially for forestry. For more information see section 3.1 about Criticism and Problems of the Voluntary Market.

[7] Dr. Yasushi Ninomiya from the Japanese Ministry of the Environment described the JVETS as “first experiment” in order to develop a binding or as he wrote “real” emissions trading scheme for Japan, compare: Dr. Yasushi Ninomiya (2006), p.8.

[8] Attention: CCX is a voluntary system and does not underlie any Kyoto or other commitment except freely given.

[9] Following information, if not otherwise stated, compare GGAS, 2008.

[10] This statement refers to Australia being second largest per capita polluter in the developed world, compare Reuters 2.

[11] The Australian Capital Territory is situated in NSW and comprises the territory of Canberra.

[12] Most recent studies from OECD “Environmental Outlook to 2030” and EcoSecurities “Generating carbon finance through avoided deforestation and its potential to create climatic, conservation and human development benefits”, discussions on commitments of developing countries on Bangkok climate talks in April 2008, etc. discuss the compatibility of emission reduction and development.

[13] Following information, compare CCX 2007, if not stated otherwise.

[14] CDM Executive Board commenced working in 2001, compare UNFCCC 2007.

[15] Evolution Markets is a New York based investment broker, specialised in sustainable finance products, compare Evolution Markets 2007.

[16] The collection of offsetting companies is focussed on English and French speaking countries, therefore it may not reflect entire market reality. Nevertheless, the chart gives an idea of the distribution of offsetting providers in 2007.

[17] Figures refer to primary CDM and JI transactions.

[18] EcoSecurities is a Dublin based leading seller of GHG reduction credits, both in compliance and voluntary markets. Its services include expertise in project development as well as financial know-how, compare EcoSecurities 2008.

[19] Compare Bayon, 2007, p.26

[20] Refers to volume of projects, micro = <5,000 tCO2e reductions per year, small = 5,000 to <20,000 tCO2e/yr, medium = 20,000 to < 50,000 tCO2e/yr, large = > 50,000 tCO2e/yr; compare Harris, 2007, p.16


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Fachhochschule Stralsund – Wirtschaft, Baltic Management Studies
voluntary carbon market offset kyoto protocol emmissions trading quality



Titel: Quality Enhancement in Voluntary Carbon Market