Chapter 2 Role Of Governments In The VCM Carbon

IntroductionChapter 1About the VCMChapter 2Role of Governments in the VCMChapter 3VCM and the Paris AgreementChapter 4GHG Accounting in the VCMChapter 5About Carbon CreditsChapter 6High-Quality Carbon CreditsChapter 7Carbon StandardsChapter 8Carbon Credit GenerationChapter 9Carbon Credit UsesChapter 10Carbon and Community RightsChapter 11Benefit SharingChapter 12Nature-based SolutionsChapter 13REDD in the VCMChapter 14REDD NestingTheVoluntaryCarbonMarketExplainedChapter 5

VCM Primer vcmprimer.orgChapter 5: What is a carbon credit?A carbon credit is a tradable unit thatrepresents one ton of greenhouse gas(GHG) emission reductions or removals.Carbon credits in the voluntary carbonmarket (VCM) are generated by theactivities of projects and programs thatare certified by carbon standards. Thecredits are purchased by companies,individuals, and other entities to offsetGHG emissions or otherwise contributeto emissions abatement. The prices ofcarbon credits are determined by thetypes and quality of VCM activities andthe demand for credits from thoseactivities.What does a voluntary carbonmarket carbon credit represent?A carbon credit is a tradable emissionsunit. Each carbon credit that isgenerated in the VCM represents oneton of GHG emissions that was notemitted to or removed from theatmosphere compared to baselineemissions. To enable standardizedaccounting, GHG emission reductionsand removals are measured in carbondioxide equivalent (CO2e) units, oftenexpressed in tons (t) or Metric tons (Mt)of CO2e emissions reductions andremovals and abbreviated as tCO2e orMtCO2e.Carbon credits that are traded in theVCM are certified and issued by carbonstandards according to the rules andrequirements set by carbon standardorganizations and GHG creditingprograms. Certified GHG emissionreductions and removals are convertedinto carbon credits when they are issuedin the GHG registry of the certifyingcarbon standard. Registries allow thetransfer of credits between accountsand the tracking of issuances andtransfers.Carbon credits are distinct from theallowances that are traded incap-and-trade systems. Allowancesare tradable permits that authorize theholder to emit a certain quantity ofGHGs in the future, while carbon creditsrepresent emissions that weresequestered or avoided in the past.Through carbon credits, the VCMprovides incentives to private andpublic actors to contribute to climateaction. Sellers generate voluntarycarbon credits to finance activities thatreduce the release of new GHGemissions to the atmosphere or removeemissions already in the atmosphere.Buyers use VCM carbon credits todirectly offset their GHG emissionsagainst a voluntary or complianceemission reduction target, or tocontribute to broader corporate orpublic climate goals to reduce GHGemissions overall by buying creditswithout offsetting.How is the market for carboncredits structured?In economic terms, carbon credits aretradable commodities. Carbon creditsare generated, sold, transferred, andpurchased by private and publicactors that fill different roles in thecarbon market. The supply anddemand structure of the market isdepicted in figure 5.1.Carbon credit supply: Project andprogram managers design andimplement mitigation activities that1

VCM Primer vcmprimer.orgare registered under GHG creditingstandards and generate carbon credits.Activity managers may be for-profit ornon-for-profit private projectdevelopers, local private or communitylandowners, or municipalities, publicagencies and—particularly in the case ofpublic sector jurisdictional programs—subnational or national governments.To create a VCM activity, developersdesign a project or program, consultwith government entities and localcommunities, comply with carbonstandard requirements to receivecertification, establish monitoringsystems, and sell credits to buyers or tointermediaries. Activity developers mayrecruit investors to provide upfrontfinancing, partner with localcommunities or civil societyorganizations, or engage otherparticipants. Government may mobilizeadvance finance for VCM activities frombudgetary resources or fromdonor-sponsored programs.Carbon credit demand: The final usersof most VCM carbon credits are privatecompanies that voluntarily engage inclimate mitigation to offset their GHGemissions or to achieve broadercorporate climate goals. Governments,non-governmental organizations(NGOs), and individuals also buy VCMcarbon credits to offset emissions fromflights, events or the production ofgoods and services. Activities,products, or services that offset GHGemissions are often marketed ascarbon neutral.’Investors and intermediaries operateon both the supply and demand sidesby investing in projects and bypurchasing carbon credits. Marketintermediaries generally are for-profitcompanies that act as traders or fundmanagers that manage carbon creditportfolios. They ensure the availabilityof risk capital and help market stability.Investors are private companies,foundations or individuals who workFigure 5.1 The market for carbon creditsSupplyDemandregisterLocal & national governmentsissueImplementProject or program managersInvestorsCarbon standardsCorporatescreditsCarbon pateIPLCsbenefitGovernments & NGOsfinance2

VCM Primer vcmprimer.orgwith intermediaries or projectdevelopers to finance carbon creditprojects or programs, often in exchangefor a guaranteed quantity of or price forcredits generated by the projects orprograms.Regulators: The direct regulators of theVCM are private carbon standardorganizations, which are, in most cases,international NGOs. The standardorganizations set requirements of GHGcrediting programs that projects andprograms must fulfill to generatetradable carbon credits. Governmentsmay regulate the VCM, by formulatingsocial or environmental projectstandards (safeguards), definingcarbon rights and benefit sharingrequirements, or linking the VCM toParis Agreement commitments,compliance carbon markets or othercarbon pricing schemes.Indigenous Peoples and localcommunities (IPLCs): IPLCs may holdland, forest, or carbon rights, or havecustomary or traditional access to landwhere emission reduction activitiestake place. As land managers, IPLCs areon the supply side of the VCM. Theymay engage directly in projectdevelopment or participate throughbenefit sharing agreements.How are carbon credit pricesdetermined?The price for a carbon credit is anessential piece of information for boththe supply and demand side of themarket. On the demand side, it allowsend buyers to evaluate the costs ofmeeting corporate climate targetsand to determine what role the VCMcan play in achieving those targets. Onthe supply side, clear price signals areimportant for project developers todecide whether it is worth developingVCM projects or programs and howmuch carbon finance can contribute todevelopment and implementation costs.At present, the prices in the VCM are nottransparent. There is no commonmechanism to set prices and enhancemarket transparency. Carbon credits ofdifferent origin and quality havedifferent prices. In the current VCM(November 2021), the price per carboncredit can vary from a few cents perMtCO2e to USD 20 per MtCO2e. As themarket gains volume and becomesmore liquid, more standardized pricesetting methods are likely to emerge.Exchanges, credit ratings, and priceindices are expected to lead to moretransparent carbon pricing. In addition,initiatives such as the Taskforce forScaling Voluntary Carbon Markets arelooking to increase harmonization,efficiency, and transparency of the VCM.Carbon prices in the VCM are influencedby vintage, quality, certifications,negotiating power, and risk.Newer credits are valued more highlythan older credits. The year in which acarbon credit was issued is its vintage.Buyers may prefer credits with newervintages because they are issuedaccording to the more recently updatedmethodologies and standardrequirements and may be available insectors—like nature-based solutions —that previously were not credited in theVCM. It is also easier to determine thatnewer credits are financiallyadditional, as credits from oldervintages may represent GHG emissionreductions or removals from activitiesthat no longer need finance incentivesfrom the VCM.3

VCM Primer vcmprimer.orgHigh-quality credits are more costly.Often, projects or programs thatgenerate high-quality credits haverelatively higher costs for designing andimplementing activities, monitoring,and verifying impacts, and buildingrelationships with local stakeholders.High-quality credits represent real,measurable, and additional GHGemission reductions or removals.Verifying these impacts necessitatesincreased monitoring reliability, whichcomes with increased costs. Highquality credits also often yieldsustainable development, biodiversityconservation, and other social orecological benefits in addition to GHGreductions or removals, which requiresignificant upfront investment. Whilebuyers wish to support high-qualityprojects, they do not alwaysdemonstrate a willingness to pay pricesthat reflect the true financial needs ofthese projects. Increased investment inhigh-quality projects can be encouragedby clear and transparent benefitsharing requirements in thejurisdictions where projects take place,the use of carbon standards that certifysustainable development goalcontributions, and monitoring andquantification of sustainabledevelopment benefits to demonstratethat high prices are fair.Additional certifications can drivehigher prices. Projects that haveachieved additional certifications ofbroader sustainability benefits demandhigher prices. For example, the Climate,Community, and Biodiversity Standardconfirms environmental and socialbenefits of forest carbon projects. UnderVerra’s Sustainable DevelopmentVerified Impact Standard (SD VISta) orthe Gold Standard for the Global Goals(GS4GG), project developers can certifycontributions to SustainableDevelopment Goals (SDGs). Certifiedsustainable development contributionsgive buyers the assurance that suchbenefits are real and likely to generatepositive environmental and socialimpacts in addition to GHG emissionreductions and removals. GS4GG andSDVISta certify positive environmentalor social attributes for VCM projects, or—for project developers that wish to goa step further—independently tradablesustainable development assets, whichcan be priced independently of carboncredits of the underlying project.Prices are determined by powerasymmetries and the ability of partiesto negotiate. If certain buyers or groupsof buyers dominate shares of the VCM,they are often able to determine theprice. This is particularly true forjurisdictional programs for ReducedEmissions from Deforestation andDegradation Plus (REDD ), where afew coordinated multilateral andbilateral buyers dominated transactionsin the past. Results-based paymentprograms, such as the Forest CarbonPartnership Facility (FCPF) or the REDDEarly Movers (REM) Programme, orbilateral buyers, such as Norway'sInternational Climate and ForestsInitiative (NICFI), set reference prices.Recently, the Lowering Emissions byAccelerating Forest finance (LEAF)Coalition, a private-public consortium,decided to set a new, higher referenceprice. The prices set by these programlevel initiatives influence project-levelcarbon prices in comparable projectclasses.The distribution of risk is reflected incarbon prices. Carbon prices depend onthe allocation of project development,investment, and performance risk. Ingeneral, the lower the perceived risks,and the more robust the measures putin place to mitigate risks and ensure4