HOW THE CARBON CREDIT MARKETS WORK: REGULATED AND VOLUNTARY MARKETS

There are several formats and structures of carbon credit markets, which co-exist concurrently. However, they all have the same three goals: to contain the pollution of the planet with positive actions, to penalize companies and countries that pollute above the stipulated by regulation, and to allow investments by both individuals and companies in the environment.

Let's begin with regulated markets. In these markets, the government establishes the figure of a regulatory body, which has the function of ensuring compliance with annual pollution rules and limits. Each year, the regulator determines a minimum price and annual pollution limit that must be followed by all companies. Due to the 2008 global financial crisis, regulated markets crashed and deregulated.

Why did this global regulated market, the CDM (“Clean Development Mechanism”), disintegrate and why did rich countries deregulate their markets? There was a surge in prices and speculative bubble in carbon credits between 2006 and 2008, which caused the global carbon price to rise from $ 5 to $ 27, and whose movement was exacerbated in 2008 by abundant global liquidity and the expectation that Barack Obama would win the elections, sign the Kyoto Protocol and implement a cap and trade (regulated) system of carbon credits in the USA (in addition to increasing investments in renewable energy and the so-called “green economy” by trillions of dollars).

As we know, the subprime crisis came at the end of 2008, and President Obama faced strong resistance from the Republican Senate and Congress to implement the measures mentioned above. Leveraged investment positions in carbon credit have been undone, and the global price has plummeted (reaching $ 3 in 2013). The subsequent economic crisis in Europe, a continent more environmentally conscious and more advanced in environmental regulation, exacerbated the carbon credit crash and led to a global deregulation movement that lasted until 2017.

In 2017, Europe regulated itself again and today the price of carbon credit in the European ETS 25 euros (it was 10 euros last year). The regulator has already established a step ladder in which the price of European carbon credit will rise by € 5 to € 10 a year until it reaches € 65 in 2026. Why is this figure 65 euros? Because there are several studies (the main one carried out by the UNFCCC) that conclude that this is the value that would lead the world to offset/neutralize its anthropogenic emissions (those caused by humans). There are other research institutions that mention much higher values than 65 euros for the world's environmental balance. Respected institutes, such as the London School of Economics, for example, work with the hypothesis of 80 dollars in 2030 (11-20 times higher than current sales prices in Brazil) and 180 dollars in 2040.

Still on the calculation of this equilibrium price, NASA, which has been monitoring the climate in detail for more than 70 years, has studies showing that the research assumptions that established the equilibrium prices made by the UN are out of date. In other words, global warming and its consequent symptoms, such as the melting of the polar ice caps, extreme weather events, warming of ocean temperatures, among others, have been much greater than previously expected.

These recent higher-than-expected consequences (and higher impacts than previously projected) are likely to imply an increase in the equilibrium price of carbon credit in the future by climate research institutes.

In the world, several other markets outside Europe are also regulated and even follow the European Market, such as New Zealand and China (70% of global GDP is regulated today - that is, these countries establish a minimum trading price and pollution limits by country and sector). The most populous country in the world and second global GDP regulated its carbon credit market in 2020. In these markets, each credit represents a ton of carbon, equivalent to the volume of emissions that were avoided in that specific year. All carbon credits are the same in the world, regardless of how they were generated. This is an important concept as it ensures the credibility and eventual fungibility of these credits globally.

But if carbon credits are fungible and always the same, why is there such a difference in prices between the global regulated and voluntary markets? Why can't I buy the same carbon credit for $ 7 in Brazil and sell for $ 27 in Europe?

In the past (from 2005 to 2012), the regulated market was global and there was fungibility. The city of S?o Paulo held two auctions of carbon credits for the Bandeirantes landfill, at the Brazilian exchange, for 500 thousand tons at 20 dollars in 2008 and 700 thousand tons at the same price in 2012 (to put in perspective how strongly the global market crashed since then, anyone can buy as much as they like of these credits today at prices between $ 1 and $ 2). Until 2012, there were carbon credit exchanges in Chicago (CCX) and London, and global transactions followed the prices of these exchanges as a reference. The buyers of the SP city auctions were global brokers who sold these credits in Europe to companies that had to comply with pollution limits stipulated by the regulator.

Why is this no longer possible? For the reasons set out at the beginning, the global crises led to a sharp drop in the price of carbon credits globally between 2009 and 2017, and to the deregulation of global markets.

There is another reason: the regulated markets that used to be open and considered credits as fungible, are now closed and local. After the carbon market crash between 2009 and 2017, the UN and global regulators noted that, in the old system (where regulated global markets were open to credits from other regions of the world), the price did not rise to the level necessary to discourage pollution from companies. When the price would rise in the global market, supply from emerging countries like Brazil would increase, and the price would stabilize again at the level of twenty to twenty-two dollars. The current view of regulators, in this movement to return to the global regulated market that existed until 2012, is to close regulated markets to local demand and supply.

The goal is to open regulated markets to other countries and regions only when the local allowances supply has been substantially reduced (after all, permits to pollute eventually tend to zero, given that there is limited space for developed country companies to eternally reduce their pollution levels). When the price gets to be high enough to discourage pollution in their regions, that is, when it becomes close to $ 70-75 in 2026 in Europe, the regulator is likely to open the European regulated market to credits generated in other countries, especially emerging ones (which have much lower prices today). In this case, the prices of carbon credits from emerging markets like Brazil will tend to rise to reach the level of regulated markets and reach a single global price, much higher than the current one - a unique opportunity of high potential gains for those who believe in this eventual arbitrage and buy carbon credits generated in Brazil as an investment today.

How to participate and trade in the carbon credit market

In parallel with regulated markets, there has always been a voluntary, global market with an internationally recognized protocol. In the voluntary market, companies that buy carbon credits to offset their emissions do so out of their own free will, mainly due to their goal to improve their corporate image. Consumers in rich countries are already aware of climate change and want to see the companies that provide their products acting against global warming. As a result, many companies have announced actions to neutralize their carbon footprints. This year, Amazon and Microsoft announced promises to neutralize their carbon footprints by 2030 - what is called "neutral pledges". These two companies together emit 60 million tons of CO2 per year (12x the annual supply of credits currently originating in Brazil). This means, therefore, that they will buy 60 million carbon credits a year by 2030.

How can an ordinary person trade in this market? Today there are thousands of digital platforms that offer personal emissions calculators (the carbon footprint, or “carbon footprint” in English). These platforms calculate the user's personal footprint, and, at the end of the calculation, offer the service of selling and canceling the credits needed to offset the footprint (effectively creating a personal user donation system for environmental or clean energy projects, generators of credits). The user transfers money to the projects, and in return gains the satisfaction of knowing that he is contributing to the reduction of pollution on the planet.

Take, for example, flying. This is the item that generates the most pollution for an individual. Digital platforms offer users digital calculators and questionnaires that gauge how much clients have flown in a year, and sell them carbon credits to compensate their carbon footprint. As an example, in Brazil, the average emission of pollutants for each individual is around eight tons per year.

Nonetheless, current platforms (as described above) do not allow users to carry carbon credit as personal assets and to capture any price increase. For those who wish to load credits as an investment, I believe that the only option currently available on the global market is MOSS, a company I founded 2 months ago, which creates personal accounts in the global registry for the purchase of carbon credits from the Amazon:

https://moss.earth

MOSS also provides an internal, proprietary trading platform for its clients to trade their carbon credits and have liquidity in their investments.

Returning to the voluntary market, there are two types of demand: from companies and from people. And let's not be naive: companies are buying because there is an increasing demand from consumers in Europe and the United States so that they do not harm the environment. The number of environmentally conscious people, who do not consume products from companies that do not neutralize themselves, is huge and growing. As an example of this thesis, 75% of Europeans who buy airline tickets have offset their carbon footprints in the past year.

This compensation solution is digital, easy and today all European airlines have adapted their ticket sales process to offer their customers the option of personally compensating their flights. This purchase compensation practice extends to many other services and products in rich countries today: car rentals, clothes, coffee, supermarket products, etc. The mentality is definitely changing positively and we imagine that it will not be long before this practice reaches other merging markets like Brazil.

There are four types of carbon credit generation in the voluntary market

Who generates carbon credits in the voluntary market? There are four main types of credits: forestry, clean energy, landfill and biomass. Starting with forests, they are subdivided between reforestation areas and conservation areas. Second, clean energy carbon projects are simple to understand: a company builds a wind or solar farm with the capacity to replace coal or diesel power generation. The construction of clean energy parks avoids pollution by another form of dirty energy (coal-fired power plants, diesel). The third type is the landfill. Decomposing organic matter releases a lot of methane gas, and although it is much less bulky in our atmosphere, methane is much more polluting than CO2 - 20 to 30 times more. The solution to avoid landfill pollution is simple: install plants or pipes to burn this gas (flaring). Finally, the fourth type of voluntary carbon credit is biomass. In this case, the concept is aimed at small companies that have furnaces, such as small brick, tile, ceramic factories, etc. The energy used, which previously came from burning wood that was cut from local forests, is replaced by renewable fuels. Examples of these materials are sugarcane bagasse, peanut shells, fruit shells, remains of furniture, and wood shops, among several other products that are renewable. This substitution not only pollutes less but also greatly reduces the deforestation of local biomes.

Global warming is humanity's greatest challenge for the next 50 years. We are in an era when companies and people will be increasingly responsible for their carbon footprints. The carbon credit market is a viable, simple and smart solution that promotes changes on several fronts, helping with global warming, preserving forests and their biodiversity as well as local communities, and encouraging sustainable technologies in our production process. It is not a perfect system, it certainly still has flaws, but it is similar to capitalism and democracy: even if imperfect, they are the best options currently available for the organization of our society.

In the next article, we’ll cover in detail the certification process for forest carbon credits - talk to you then!