What do we mean by "voluntary" vs. "compliance" carbon markets? I recently listened to Jo Paisley and Michael Azlen discuss carbon markets in a GARP podcast, and it crystalized something I've been cogitating on for a while.
We hear all the time about voluntary markets vs. compliance markets, but how are we distinguishing between the two? One market is usually defined as "offsets," and the other as "cap and trade." Voluntary carbon markets are often characterized as risky, the second as solid. But are these characterizations helpful, in particular as we look forward?
A few thoughts:
- 1Offsets can be part of compliance markets, as they are in California, and as they were under the Clean Development Mechanism (CDM). And even though they were regulated, studies concluded that a majority of offsets were low quality (generally on additionality grounds). So "regulating offsets" is no panacea.
- 2Cap and trade markets can also be risky. The EU Emissions Trading Scheme (EUETS) was substantially over-allocated at the beginning which lead to very low prices. It took years to correct the problem. Another pandemic, or an economic recession for any reason, could create the same problem of too many allowances in cap and trade programs around the world, leading to a dramatic fall in prices. There's risk there.
- 3Then there is the Article 6 carbon market, which is gearing up big time. Is that a voluntary market or a compliance market? I think most people assume the latter; but I would suggest it has much more in common with offset markets than it does with cap and trade allowance trading. After all, there is no cap! And it's easy to see how the Article 6 market could end up being evaluated in ways similar to the CDM. Most of the operative incentives are actually the same.
I'm not trying to come up with new carbon market typology, but I do think the idea of "voluntary vs. compliance" is often over-simplified from a risk perspective -- as is how we're thinking about Article 6.