The effects of climate change force many organizations from the private and public sectors, as well as individuals from the private sphere, to increasingly prioritize carbon management: the reconciliation between economic activities and their release of greenhouse gases. This Carbon Offset Carbon Trading article explains the conceptual differences between carbon offsetting and carbon trading, both of which have an important role to play in fighting climate change.
What is Carbon Offsetting?
Carbon offsetting is the practice of financing projects that reduce or sequester greenhouse gas emissions. In this way, it compensates for emissions produced elsewhere, thus neutralizing the carbon footprint of a given individual, company, or activity. Ultimately, this is achieved by sponsoring equivalent emissions reductions, ensuring a balanced environmental impact.
How Carbon Offsetting Works
- Emissions Identification: This is the most basic level. Every operation needs to calculate the total amount of greenhouse gases it is creating. You can do this on a per-activity basis, such as for travel or manufacturing, or as an at-a-glance measure of an organization’s overall carbon footprint.
- Buy into offset projects: Companies can now auction calculated emissions to offset projects. These projects, which often involve reforestation, renewable energy, and methane-capture efforts, focus on reducing or capturing emissions.
- Verification and Certification: Offset projects are verified by a credible third-party entity and certified according to strict standards (ie, the Verified Carbon Standard [VCS] or Gold Standard).
- Under implementation, projects achieve emission reductions, which are purchased as carbon credits. These credits are then used to offset the calculated emissions. Carbon offsets balance the emissions produced by an individual or organization through the emission reductions achieved by the project.
Types of Carbon Offset Projects
- Reforestation and afforestation: planting trees to remove CO2 from the atmosphere and restore degraded lands.
- RE: Renewable energySome examples of this type of investment could be solar, wind ,or hydroelectric power projects that displace fossil fuel-based energy.
- Capture of methane: collecting methane gas that would otherwise be released to the atmosphere from landfills or agricultural operations.
- Energy efficiency: using energy more efficiently when generating power, transporting goods, or heating buildings or industry.
What is Carbon Trading?
Carbon trading, also known as emissions trading, is a market-based instrument for pollution control. Specifically, it offers economic incentives for reducing emissions by creating a market for carbon allowances or credits. These allowances or credits, in turn, represent a promise to limit a specified amount of greenhouse gases in the future.
How Carbon Trading Works
Cap-And-Trade System:
Carbon trading commonly takes the form of the cap-and-trade system. In this system, a government or regulatory body sets a cap on the total emissions allowed by firms covered by the system.
Issuance of Allowances:
It is these entities who are entitled to be provided emission allowances or permits by the authorities, either freely or through auction. Each allowance represents a right to emit a certain amount of CO2 or another greenhouse gas.
Allowances Trading:
Those that have less costly emissions reductions can sell their allowances that they don’t require to those that have more expensive emissions reductions. This provides an economic incentive for all to reduce emissions.
Monitoring and reporting:
All entities must monitor and report their emissions. Geological monitoring, regular reporting, and verification enforce compliance, with penalties applied for exceeding emission limits.
Market Dynamics:
This trading market offers flexibility and cost-effectiveness, enabling businesses to buy and sell allowances allocated annually to each plant and power plant based on their original and post-reduction emission levels. If a business reduces its emissions, it has the ability to sell its allowances. In this system, supply-and-demand determines the price of the allowances.
Types of Carbon Trading Systems
- A country or regional organization could establish a cap-and-trade market, such as the European Union Emissions Trading System (EU ETS) or the California Cap-and-Trade Program.
- International Systems: International carbon trading schemes like the Clean Development Mechanism (CDM) under the Kyoto Protocol and mechanisms for international cooperation under the Paris Agreement.
Key Differences Between Carbon Offsetting and Carbon Trading
Although the two types of schemes can both be designed to help reduce greenhouse gas emissions, they work in different ways and have different purposes. Below is an outline of some key differences:
1. Purpose and Mechanism
- Carbon Offsetting: The goal is to offset emissions by funding projects that reduce or capture greenhouse gases. This approach is most often employed by individuals, organizations, or events as a means to mitigate their carbon footprint and, in doing so, contribute to overall environmental sustainability.
- Carbon Trading aims to make emissions reduction economically attractive through a market for emissions allowances. Specifically, it serves as a form of regulation in which the government or large entities impose limitations on emissions, with the intention of gradually reducing those limitations over time. Consequently, this approach incentivizes emissions reductions while encouraging continued progress toward sustainability.
2. Scope and Application
- Carbon Offsetting Voluntary application to a firm’s footprint by the emitter. It’s often done alongside other elements of a commercial sustainability strategy.
- Carbon trading typically happens within regulated sectors or entities that have emissions reduction targets set and enforced by governments or international agreements. It operates within a regulated ‘cap-and-trade’ system.
3. Market Dynamics
- Carbon Offsetting: You purchase ‘offsets’ from a specific project. These could be good projects – but they could also be bad.
- Carbon trading: trading emission allowances within a regulated market. The focus is on cost-effectiveness towards the achievement of emissions targets as a whole.
4. Verification and Certification
- Carbon offsetting, from verification to certification, represents a conditional commitment aimed at funding only real and additional emissions reductions. Specifically, this commitment is subject to verification and, therefore, seeks certification based on independently agreed standards and methodologies.
- On the other hand, carbon trading involves regulating entities that monitor and report their emissions. Compliance is ensured through regulatory oversight, with state protection in place to penalize entities that exceed emission-cutting limits.
Synergies and Challenges
(To be clear: while carbon offsetting and carbon trading are two different schemes, it’s possible that both – in conjunction with each other – could feature within a coherent climate strategy.) Example:
- Firms trading in carbon will, therefore, likely invest in carbon offset projects to achieve net-zero emissions or offset emissions that trading alone cannot easily reduce. In turn, carbon offset projects will benefit from the financing enabled by trading markets.
- Challenges: Both approaches have credibility, effectiveness, and, in some cases, market-engineering issues necessary to ensure the real and lasting climate benefits that are their intended purpose.
Future Outlook
As society and policies progress and market mechanisms evolve, the future of carbon offsetting and carbon trading will presumably continue to develop and be fine-tuned. Three key trends to watch include: 1. From offsets to carbon pricing In addition to using carbon offsets to meet corporate sustainability goals, let’s imagine pollution and carbon permits cover all emission sources on a global scale.
- Enhanced Integration: Greater integration of carbon offsetting and trading regimes with broader sustainability and climate goals, such as the United Nations’ Sustainable Development Goals (SDGs).
- Technological advances, such as the use of blockchain and artificial intelligence, significantly enhance the transparency, efficiency, and effectiveness of carbon sequestration, offsetting, and trading.
- Increased accountability can be achieved through improved verification, certification, and monitoring. This ensures that carbon offset projects and trading systems are delivering as credibly and effectively as possible.
- Further market opportunities: new types of carbon markets and offset projects coming online, which will help businesses and investors find ways to support climate action.
To develop effective strategies and policies to mitigate climate change, it is important to clearly distinguish the different meanings behind carbon offsetting and carbon trading and understand the consequences of each. Carbon offsetting creates a market towards emission compensation by paying for emission reductions elsewhere, while carbon trading sets up a carbon-reducing market by creating a financial value for emission reduction that is subject to commercial trading.
