Mandatory & Voluntary Offset Markets

Carbon markets exist both under compliance schemes and as voluntary programs. Compliance markets are created and regulated by mandatory national, regional or international carbon reduction regimes.This page gives a short introduction to both markets and their programs.

Mandatory Cap-and-Trade Systems
Offset Programs within the Kyoto Protocol
Voluntary Carbon Offset Markets
Offsetting in Other System

Mandatory Cap-and-Trade Systems

Emissions Trading Under the Kyoto Protocol

The Kyoto Protocol to the United Nations Framework Convention on Climate Change (UNFCCC) established a cap-and-trade system that imposes national caps on the greenhouse gas emissions of developed countries that have ratified the Protocol (called Annex B countries ). Each participating country is assigned an emissions target and the corresponding number of allowances – called Assigned Amount Units, or AAUs. On average, this cap requires participating countries to reduce their emissions 5.2% below their 1990 baseline between 2008 and 2012. Countries must meet their targets within a designated period of time by:

reducing their own emissions; and/or
trading emissions allowances with countries that have a surplus of allowances; and/or
meeting their targets by purchasing carbon credits.

This ensures that the overall costs of reducing emissions are kept as low as possible. To further increase cost-effectiveness of emissions reductions, the Kyoto Protocol also established so-called Flexible Mechanisms: the Clean Development Mechanism (CDM) and Joint Implementation (JI).

European Union Emissions Trading Scheme

The Kyoto Protocol enables a group of several Annex I countries to join together and form a so-called ‘bubble’ that is given an overall emissions cap and is treated as a single entity for compliance purposes. The 15 original member states of the EU formed such a ‘bubble’ and created the EU Emissions Trading Scheme (EU-ETS). The EU-ETS is a company-based cap-and trade system which came into force in 2005. Under this cap-and-trade scheme, emissions are capped and allowances may be traded among countries. The EU-ETS is the largest mandatory cap-and-trade scheme to date. In 2006, it traded 1.1 billion metric tons of CO2e, valued at over €16 billion. Learn more about the EU-ETS.

There are currently several cap-and-trade compliance schemes that operate independently of the Kyoto Protocol. All of these also incorporate an offset component to their program. Three examples are:

New South Wales GHG Abatement Scheme (NSW GGAS)

The NSW GGAS in Australia aims to reduce greenhouse gas emissions from the power sector. It achieves this by using project-based activities to offset the production of greenhouse gas emissions. The program was established in 2003. Learn more about the NSW GGAS.

Regional Greenhouse Gas Initiative (RGGI)

RGGI is a multi-state regional cap-and-trade program for the power sector in the Northeast United States. The RGGI cap-and-trade program is proposed to start in 2009 and lead to a stabilization of emissions at current levels (an average of 2002-2004 levels) by 2015, followed by a 10% reduction in emissions between 2015 and 2020. Some of the program reductions will be achieved outside the electricity sector through emissions offset projects. Offsets serve as the primary cost containment mechanism in RGGI; if allowance prices rise above trigger prices, the ability for regulated sources to use offsets increases. Learn more about RGGI.

Western Climate Initiative (WCI)

The WCI is a collaboration of 5 Western US stated and British Columbia launched in early 2007. The initiative set a goal of reducing greenhouse gas emissions by 15% from 2005 levels by 2020 and requires partners to develop a market-based, multi-sector mechanism to help achieve that goal, and participate in a cross-border greenhouse gas (GHG) registry. Learn more about the WCI.

Offset Programs within the Kyoto Protocol

The Clean Development Mechanism (CDM)

The CDM allows Annex I countries to partly meet their Kyoto targets by financing carbon emission reductions projects in developing countries. Such projects are arguably more cost effective than projects implemented in richer nations because developing countries have on average lower energy efficiencies, lower labor costs, weaker regulatory requirements, and less advanced technologies. The CDM is also meant to deliver sustainable development benefits to the host country. CDM projects generate emissions credits called Certified Emissions Reductions or CERs – one CER is equal to one tonne of carbon dioxide equivalent – which are then bought and traded. Learn more about the CDM.

Joint Implementation (JI)

Joint Implementation works similarly to CDM, with the exception that the host country is not a developing nation but another Annex I country. The tradable units from JI projects are called Emissions Reductions Units (ERUs). It is not strictly a baseline-and-credit system since it also has aspects of a cap-and-trade system, and, notably, both participants have an overall reduction target. The value of both JI and CDM projects has more than doubled in recent years, reaching a
combined total of USD 5 billion (EUR 3.9 billion) in 2006 (Capoor & Ambrosi, 2007). Since JI officially starts in 2008, it is not surprising that over 90% of the credits transacted in these markets were produced by CDM projects. Learn more about JI.

The EU-ETS Linking Directive

The EU Linking Directive, which was passed in 2004, allows operators in phase 2 of the ETS to use credits from Joint Implementation (JI) and the Clean Development Mechanism (CDM) to meet their targets in place of emission cuts within the EU. Member States specify a limit up to which individual installations will be able to use external credits to comply with the ETS. These limits vary between 0% (Estonia) and 22% (Germany) of allowances. There are also restrictions on use of CERs from forestry projects and from certain types of large hydro projects. Learn more about the EU-ETS.

Voluntary Carbon Offset Markets

The voluntary carbon markets function outside of the compliance market. They enable businesses, governments, NGOs, and individuals to offset their emissions by purchasing offsets that were created either through CDM or in the voluntary market . The latter are called VERs (Verified or Voluntary Emissions Reductions). It is noteworthy that about 17% of the offsets sold in the voluntary market in 2006 were sourced from CDM projects (Hamilton, 2007). Compared to the compliance market, trading volumes in the voluntary market are much smaller because demand is created only by voluntary buyers (corporations, institutions and individuals) to buy offsets whereas in a compliance market, demand is created by a regulatory instrument. Because there is much lower demand, because quality standards are not widely established, and because they are not fungible in compliance markets, carbon offsets sold in the voluntary market tend to be cheaper than those sold in the
compliance market.

Unlike under CDM, there are no established rules and regulations for the voluntary carbon market. On the positive side, voluntary markets can serve as a testing field for new procedures, methodologies and technologies that may later be included in regulatory schemes. Voluntary markets allow for experimentation and innovation because projects can be implemented with fewer transaction costs than CDM or other compliance market projects. Voluntary markets also serve as
a niche for micro projects that are too small to warrant the administrative burden of CDM or for projects currently not covered under compliance schemes. On the negative side, the lack of quality control has led to the production of some low quality VERs, such as those generated from projects that appear likely to have happened anyway. To address these quality concerns, several voluntary offset standards have been developed. The following are described in more detail on this website:

Offsetting in Other System

Mandatory Programs

In addition to cap and trade systems, there are other mandatory systems that establish greenhouse gas (GHG) emission reductions targets for regulated entities. Unlike the cap and trade systems, these do not provide for emission allowances to be traded among regulated sources, but they do allow offsets to serve as a compliance mechanism to meet emission reduction requirements.

Below are links to more detailed descriptions of the offset features of two mandatory systems:
Alberta-based Offset Credit System
State Power Plant Rules in Oregon, Washington and Massachusetts

Voluntary Programs

Voluntary greenhouse gas (GHG) reduction programs enlist entities to voluntarily reduce emissions through internal actions or through the purchase of offsets or allowances. While neither strictly an offset program nor a cap and trade system, they do provide a framework for the development of offset markets and methodologies.

Below are links to more detailed descriptions of the offset features of two voluntary GHG reduction programs:
US Environmental Protection Agency’s (EPA) Climate Leaders Program
California Climate Registry (CCAR)