History of carbon markets

History of carbon markets

The world needs a flourishing carbon market to fight climate change. Climate change is a market failure; humans have failed to accurately “price” the destruction that climate change is already causing and will cause in the future.

Even if viewed purely through an economic lens, the price of incremental CO2 emissions should be significant.

However, carbon markets haven’t historically and don’t currently do a good job of translating invested capital to impact. In this whitepaper section, we’ll first examine the history of carbon markets and understand the basics. Then, we’ll explore the challenges that diminish current carbon markets’ impact. From there, we’ll establish Nori’s perspective on carbon markets and how that informs Nori’s design choices and practices.

Carbon credit basics

Projects or companies supply carbon credits based on work that prevents or removes existing atmospheric emissions. A carbon credit generally represents the avoidance or removal of one tonne of CO2 equivalent emissions ("CO2e"):

• Avoidances and reductions prevent future emissions

• Carbon removals remove past emissions from the atmosphere

Carbon credit suppliers range from renewable energy projects that help avoid future emissions to reforestation projects that plant trees that perform photosynthesis and engineered solutions that remove CO2 from the atmosphere. Only about 5% of all carbon credits in the voluntary carbon offset market are carbon removals.

A brief history of carbon credits

In 1989, Applied Energy Services pioneered the first carbon offsetting project. The company sought to 'offset' the future emissions of a new coal-fired power plant by financing an agriforest in Guatemala.

The history of this project is illustrative of the types of challenges that persist in carbon markets. An analysis of this first carbon offsetting project 15 years after the project's inception found that the agriforest didn't remove nearly as much CO2 as Applied Energy Services predicted it would. And the benefit the project provided paled compared to the emissions from the coal-fired power plant it intended to offset.

Today, carbon credits and offsets constitute a $250B+ market. The vast majority of trading activity occurs in compliance markets, many of which are cap-and-trade markets.

Compliance markets exist because of international protocols and treaties, which, starting with the Kyoto Protocol in 1997, set annual limits on allowable greenhouse gas ('GHG') emissions for countries and other major emitters (e.g., large corporations). When entities exceed their allowed annual limits, they buy and (ideally) retire carbon certifications. These certificates are generated based on rules set by the governing bodies of the compliance markets. They can stem from market participants who are below their cap and have cap space to sell to other market participants or from other projects that offset emissions to produce additional credits.

The European Union's Emissions Trading System (EU ETS) is the largest compliance market globally. It commands a 90%+ share of the market. It's worth noting that under these systems, annual limits are set by governmental entities. While they often seek advice from climate scientists and other stakeholders, selecting the right caps and allowances to drive impact is a challenging, often political exercise.

In contrast to the compliance market, the 'voluntary' carbon market ('VCM') is one in which market participants aren't participating for compliance reasons. For instance, when Fortune 500 companies announce net-zero targets, their proposals hinge partly on buying carbon offsets to meet their goals. There is no legislation compelling them to set these targets.

While smaller than the compliance market, the voluntary market has seen significant growth. In 2021, the voluntary carbon market crossed $1B for the first time, a fivefold increase from 2016—estimates for the future size of the VCM range from $50B to $100B.

In addition to compliance and voluntary markets, there are also industry-specific markets. CORSIA, the Carbon Offsetting and Reduction Scheme for International Aviation, is one example. International states and countries voluntarily opt into CORSIA, making it more like a voluntary market with a governing body that provides guidance and oversight.

Nori's focus

Nori focuses on scaling the voluntary carbon market, especially on the supply side. Supply is the critical problem to solve in carbon markets, not demand.

As this market grows, it’s also crucial that it serves the needs of all stakeholders, delivers measurable impact towards reversing climate change, and utilizes efficient infrastructure, standards, and protocols that help drive this maximum impact. The following sections will explore challenges in carbon markets in greater detail, especially those most relevant to design choices in Nori’s marketplace.

At the same time, considering how complex VCMs are, this shouldn’t be considered an exhaustive list of worthwhile problems that need solving or would benefit from greater alignment.