Governments Act On Their Own To Support Carbon Credits
Exhibit: Indicative Allocation of Carbon Credit Retirements, 2023
Source: World Bank
Key Points: 90% of carbon offset credit demand goes toward voluntary commitments today. But credits’ use to satisfy compliance obligations should grow. Nearer term, using credits in lieu of paying carbon taxes or buying allowances should lead this growth — 35 jurisdictions allow it today and additions are in the works including the EU, India and Indonesia.
The World Bank’s annual State and Trends of Carbon Pricing report. This annual report is a solid resource for perspective on all facets of carbon pricing, including carbon related revenues (USD104 Billion in 2023, raised from carbon taxes or Emissions Trading Systems (ETS)) and the status and prospects for carbon markets.
Crediting is predominantly used to satisfy voluntary commitments today. Carbon (offset) crediting reflects the issuance of tradable securities, in which each credit reflects the avoidance or removal of one ton of carbon dioxide (or its equivalent on a global warming impact basis, CO2e). A buyer of the carbon credit “retires” the credit when the buyer “uses” the credit to report offsets to the buyers’ own CO2e emissions (the credit is retired to ensure that it is not “double counted”, i.e. that is not also used to offset a different emission ton).
Per the World Bank (WB) report, 90% of the retirements in 2023 went towards voluntary purposes, which are companies’/entities’ mitigation commitments (see Exhibit). The balance went towards compliance purposes, of which there are two broad categories:
Domestic uses for credits. Domestic obligations, imposed on companies, include carbon taxes or relate to allowances on a country’s Emissions Trading (cap-and-trade) System. Where allowed, companies can buy (and retire) carbon credits to satisfy these obligations. Domestic compliance comprised ~9% of retirements in 2023.
International uses for credits. International obligations stem from country-level or international association commitments to lower greenhouse gas emissions. Country level commitments include Nationally Determined Contributions (NDCs) while the largest international association mechanism is the International Civil Aviation Organization’s Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). In these cases a country or entity uses credits (bought from another country) to help satisfy its greenhouse gas emission reductions commitments. Once credits are bought by one country/entity, there is to be an offsetting deduction in emissions reduction that can be claimed by the “host” country (from which the credits are sourced); this offsetting deduction is referred to as a Corresponding Adjustment.
The mix should include more use of crediting for compliance purposes over time…domestic use should continue to lead compliance-based growth. Currently 35 jurisdictions (national and sub-national) allow companies to use credits to satisfy some of their compliance obligations. The most significant from a volume perspective is currently Colombia, with oil companies (e.g., Chevron) purchasing carbon offset credits in lieu of paying carbon taxes (see Exhibit). Five of the jurisdictions have been added since the start of 2023: Chile, Portugal, Saudi Arabia, Nova Scotia province, and Washington state. Further, China restarted its program following a six-year hiatus.
The WB reports that another 11 jurisdictions are developing crediting mechanisms. These include India, the EU, Indonesia, Mexico, Egypt, and Vietnam; it notes that Brazil is also moving down that path, although is at an earlier stage.
Use for cross-border (international) compliance likely only comes later. International compliance crediting is expected to be largely dependent on the countries that were party to the Paris Agreement (from COP21) agreeing on terms related to two articles: 6.2 (which addresses transferring the credit for emissions reductions from one country to another) and 6.4 (which addresses establishing a multilateral carbon credit market). Negotiations on these articles did not fare well, again, at the most recent COP as details on several items have proved intractable. Meanwhile, per the WB report CORSIA revised its allowed credits and entered a voluntary phase at the beginning of 2024. It notes demand is expected to rise significantly starting in 2028 when the program enters its obligatory phase, with the caveat that terms must be worked out for corresponding adjustments by the host countries.
5/31/2024