Businesses are increasingly using carbon trading as a strategy to reduce their carbon emissions. Compliance markets and voluntary carbon markets are the two primary types of carbon trading. Although they both aim to reduce carbon emissions in the long run, there are important differences between them.
A regulated carbon trading market, the EU Emissions Trading System (EU ETS) accounts for over 40% of the EU's greenhouse gas emissions. The EU ETS establishes an overall cap on emissions before distributing to market participants credits, which reflect the right to emit one tonne of carbon dioxide equivalent. According to each participant's specific emissions, these allowances can be bought and sold. Participants who emit less than their allocation can sell their extra allowances to participants who emit more than their allocation.
The main distinction between the compliance and voluntary carbon markets is that the former are regulated by law, whereas the latter are determined by consumer preferences. In a compliance market, businesses have to abide by legal standards and buy certificates to cover their emissions. There may be financial penalties for noncompliance. Voluntary carbon markets, on the other hand, run independently of all regulations. Businesses have the option to buy carbon credits, which show a decrease in greenhouse gas emissions through projects like reforestation or renewable energy. Carbon credits can be bought on a voluntary basis and are often used to balance off emissions that cannot be prevented.
The cost of carbon credits is another important distinction between the compliance and voluntary carbon markets. Compared to voluntary markets, compliance markets often have higher prices per tonne of carbon dioxide equivalent. This is because there is a larger demand for permits in compliance markets because there is a fixed supply that is subject to regulations. In contrast, the supply of carbon credits is more flexible in voluntary markets, and market forces decide the prices.
Despite their differences, compliance and voluntary carbon markets both contribute significantly to the solution of the climate change problem. A legal framework for lowering greenhouse gas emissions is provided through compliance markets like the EU ETS, which also encourages businesses to invest in low-carbon technologies. Contrarily, voluntary markets enable businesses to assume accountability for their carbon emissions and make investments in carbon-beneficial projects.
The voluntary carbon market is fast growing, and many businesses have ambitious goals to become carbon neutral, even though the EU ETS compliance market is the largest carbon trading system in the world. In order to reduce greenhouse gas emissions and address the global challenge of climate change, both markets have a role to play.