A New Player in Carbon Trading: Governments

There is a new source of controversy around carbon offsets the role of governments. Nation-states are getting more involved in voluntary carbon markets (VCMs), and that is not necessarily a bad thing. Indeed, it was only a matter of time before governments began to participate, and, if done right, such government involvement can help address some of the issues surrounding VCMs. These markets could reach between US$100 billion and US$500 billion or more, depending what activities are allowed to generate carbon credits.

A necessary condition for markets to function properly is establishing who has the right to trade. For voluntary carbon markets, this is still under debate. Recently, countries like Papua New Guinea and Honduras declared bans or moratoria on trading carbon for private interests. In another example of government involvement, Zimbabwe – the twelfth largest source of carbon offsets – announced earlier this year it would take half of all revenue created by offset projects.

Behind this trend of increasing state involvement is Article 6 of the Paris Agreement, partially agreed upon during the climate conference held in Scotland in 2021. The “Glasgow Rulebook” sheds some long-awaited light on how nations can participate in carbon trading, but as a report from The Nature Conservancy explains, there is still work to be done. Namely, guidelines need to be put in place to understand how a credit traded in the voluntary market—for example for the purposes of meeting a corporation’s climate pledge—could be accounted for in national climate commitments, or NDCs.

Countries have not fully agreed on the rules, but, since Glasgow, they have reacted swiftly to the prospects Article 6 entails, including in the Americas. This region is the world’s second largest provider of carbon credits and is home of some of the largest carbon reserves, such as the Amazon rainforest. In Brazil, the government of President Lula da Silva has backed a draft law that would introduce a cap-and-trade system which would regulate heavy industry and keep a rein on the many carbon trading activities in the country. To mention one example, the state of Tocantins has reached an agreement to sell carbon credits to Swiss oil-trading company Mercuria. The law is under discussion but has already drawn criticism as the Senate exempted the largest source of emissions: the agricultural sector. In another example, Japan is setting the groundwork to trade carbon credits to meet its own climate targets, and has signed preliminary agreements with 27 countries, including Costa Rica, Chile and Mexico.

There are three main underlying motives behind public involvement. First, some states wish to pause carbon projects until proper safeguards are in place so that integrity, equity, and land rights can be considered properly. Second, countries want to make sure they can comply with their climate obligations before selling their carbon sinks to foreign parties. Third, governments want to rightfully participate in the financial benefits of carbon trading operations. These points are illustrated in Honduras’ 2022 press release about a carbon trading moratorium, or in the indigenous protection language that has been included in Brazil’s proposed cap-and-trade system.

Governmental participation was bound to happen and can help address some of the major issues with carbon markets. These include questions about their true capacity to capture CO2 and concerns about land-owner protections, the accumulation of which led the CEO of Verra – a leading credit certifier – to their resignation. Governments are well-positioned to address these integrity concerns, prompting a public discussion about climate change mitigation. For example, in the US, a report by the Bipartisan Policy Center and the company Carbon Direct outlines how federal government involvement can help ensure high-quality carbon credits. According to the report, most stakeholders agree that at least some level of government involvement would contribute to the market’s integrity.

Furthermore, the involvement of governments is an unavoidable step to clarify how carbon markets interact with countries’ climate change plans or Nationally Determined Contributions (NDCs). Until now, three carbon trading systems have been running in parallel: voluntary carbon markets, compliance carbon markets (like the EU’s and California’s Emission Trading Scheme), and trading that happens under the Paris Agreement’s framework. Given their legislative power and role in international negotiations, government participation must ensure these systems interrelate properly.

It is important to recognize that inadequate policies can also be detrimental to climate change mitigation prospects and that climate change won’t wait until we figure them out. For example, the Zimbabwean Government’s decision to take half of the carbon offset’s revenue was an unexpected policy choice, added regulatory uncertainty, and left project developers and investors reevaluating future projects.

Behind the complex conversations on carbon offsets is the possibility that carbon markets are not the ultimate goal but are a means to an end. Ultimately, their objective is to mobilize financial resources towards activities that remove, reduce, or avoid greenhouse gas emissions from the atmosphere.

Recognizing this, innovative approaches that could prove less fraught have come forward. For example, the Emission Liability Management, in which emissions are properly accounted for and addressed as liabilities, solves the drawbacks of the current three-scope system and forces corporations and countries to internalize the cost of their GHG pollution. The Paris Agreement recognizes the need for new approaches and includes language for “non-market” activities in it, which could include capacity building or financial transfers that do not involve carbon trading. Quickly testing and scaling these new financial tools will be crucial. As Elinor Ostrom, a pioneer of environmental governance, clearly stated: while important, neither states nor markets alone can address complex environmental governance issues.

Voluntary carbon markets have proliferated, fueled by their promise to mobilize resources to address climate change quickly and at scale. However, just like any other market, the time has come for public institutions to set the rules surrounding them. COP28 may provide much needed clarity around how to do this. The window for climate action keeps shrinking and we cannot wait much longer.

Daniel Gajardo is an interdisciplinary environmentalist originally from Santiago, Chile, and the co-founder of Reciprocal, the first environmental venture studio in Latin America in the Caribbean. The research for this piece was done while he was a Sustainable Finance Fellow and a Knight-Hennessy Scholar at Stanford University, where he pursued a dual Master’s in Environment and International Policy. Daniel writes about current environment and climate change issues, with perspectives from the Global South, and has been published by Mongabay, the World Resources Institute and Chinese Dialogue.