5 Carbon Markets Mechanisms for Greentech Companies to value their Impact

May 30, 2024

|

|

Our vision
Grégoire Guirauden

Grégoire Guirauden

Chief Operations Officer

The Main carbon markets to value Greentechs Impact

In the rapidly evolving landscape of climate change mitigation, Greentech companies are at the forefront, developing innovative solutions to reduce carbon emissions. A critical component of their success lies in effective monetization strategies for the carbon reductions they achieve. Here are five key mechanisms that Greentech companies can use to value their carbon reduction efforts - with no greenwashing whatsoever.

The European compliance carbon markets: the EU Emissions Trading System (EU ETS)

The EU Emissions Trading System (EU ETS) was officially launched in 2005 as a major component of the European Union’s policy aimed at combating climate change by reducing greenhouse gas emissions. The system was the first large-scale carbon market and remains the biggest one globally. It was designed under the Kyoto Protocol’s mechanisms, which encouraged industrialized countries to reduce their emission levels through several flexible market-based approaches.

The EU ETS specifically targets the largest polluting industries across the member states, establishing a legal framework for reducing their carbon footprint. To date, the system covers 14 of the most polluting industries in the EU, including power generation, aviation, and heavy industries like steel, cement, and paper. Each participating entity with emissions above a certain threshold is required to meet decarbonization targets every four years.

How the EU-ETS carbon market works

  1. Cap-and-Trade Principle:
    • Cap: A maximum limit is set on the total amount of certain greenhouse gases that facilities covered by the system can emit. This cap decreases over time to ensure that total emissions from these sectors drop.
    • Trade: Companies receive or purchase emission allowances, which they can trade with each other. Each allowance entitles the owner to emit one tonne of CO2 or the equivalent amount of another greenhouse gas. The ability to buy or sell allowances gives companies flexibility and provides a financial incentive to cut emissions.
  2. Coverage: The EU ETS covers more than 11,000 heavy energy-using installations (power stations and industrial plants) and airlines operating between these countries. It includes 30 countries (all EU countries plus Iceland, Liechtenstein, and Norway).
  3. Phases: The system is implemented in distinct phases to allow adjustments and improvements:
    • Phase I (2005-2007): Testing phase, mainly involving a free allocation of allowances.
    • Phase II (2008-2012): Linked with the Kyoto Protocol, this phase involved a greater reduction in caps.
    • Phase III (2013-2020): A single, EU-wide cap on emissions introduced, and a larger share of allowances auctioned rather than allocated for free.
    • Phase IV (2021-2030): Further reductions in cap and adjustments to better align with the EU’s increased climate ambitions, including a target of a 43% reduction in greenhouse gases from covered sectors by 2030 compared to 2005.
  4. Market Stability Reserve (MSR): Introduced in 2019, the MSR is designed to address the surplus of allowances in the market and improve the system's resilience by adjusting the supply of allowances to be auctioned.

Allocation of Emission Allowances

The EU allocates a certain number of free emission allowances to each participant, which corresponds to the entity’s decarbonization targets. If an entity emits more than its allowance, it must purchase additional quotas from others or face hefty fines. Conversely, if it emits less, it can sell its surplus allowances. However, the revenue from selling these allowances generally does not cover all the investments needed to achieve these reductions, meaning that industries do not profit purely from owning quotas.

Market Corrections and Carbon Border Adjustment Mechanism

Initially, the EU ETS faced issues like the risk of industrial relocation outside of Europe due to cost increases from carbon pricing. To address this and ensure a level playing field, the EU plans to introduce a Carbon Border Adjustment Mechanism (CBAM) by around 2026-2027. This mechanism will impose a carbon price on imports of raw, semi-finished, and finished goods corresponding to the EU’s carbon price, thus discouraging carbon leakage and promoting global emission reductions.

How to leverage the EU ETS carbon market for a Decarbonization Project

  1. Financial Incentives:
    • Selling Allowances: By reducing emissions beyond what is required, a project can generate surplus allowances that can then be sold on the carbon market. This creates a direct financial incentive to innovate in ways that reduce emissions.
    • Funding through Auctioning: A significant portion of the allowances is auctioned off. The revenues from these auctions can be used by member states to fund green technologies, energy efficiency improvements, and other climate-related projects.
  2. Modernization and Innovation Funds:
    • Innovation Fund: Large-scale funding is available for innovative technologies in energy-intensive industries, including renewables, energy storage, and carbon capture and storage (CCS). Projects that aim to bring breakthrough technologies to the market can apply for funding from this pool.
    • Modernization Fund: Specifically targeted at lower-income EU Member States to modernize their energy systems and improve energy efficiency. Projects in these countries can access this fund to support their decarbonization efforts.
  3. Carbon Price Signal:
    • Cost of Carbon: By internalizing the cost of carbon, the EU ETS provides a constant financial signal for businesses to transition towards less carbon-intensive practices and technologies. This can drive decisions in energy use, technological investments, and operational strategies geared towards decarbonization.
  4. Compliance and Strategic Planning:
    • Companies covered by the EU ETS need to carefully manage their allowance portfolio. This involves strategic decisions about whether to invest in reducing emissions, purchasing allowances, or a combination of both. Decarbonization projects can be part of this strategic planning, particularly if they offer cost-effective reductions compared to the market price of allowances.
EU ETS carbon mechanism

The offsetting mechanism: the Voluntary Carbon Market (VCM)

How the Voluntary Carbon Market works

Voluntary carbon credits provide a financial pathway for decarbonization projects that need funds to scale up. By quantifying and valuing the carbon dioxide they reduce or capture, these projects can generate credits, each representing one tonne of CO2 reduced or sequestered.

These credits are typically purchased directly from the projects in a peer-to-peer manner by companies aiming to mitigate their own emissions. This direct transaction model ensures that companies committed to a carbon neutrality trajectory can support impactful environmental projects while offsetting their unavoidable emissions.

Although the voluntary carbon market started as a largely unregulated arena, it is increasingly subject to stringent oversight to ensure transparency and integrity. In France, this is governed by the "loi compensation carbone" (Carbon Compensation Law), and at the European level by the "Carbon Neutral Claim Law”. Furthermore, global decarbonization frameworks have emerged to  ensure that the credits meet high environmental standards. For instance, we can find the Science Based Targets initiative (SBTi) that follows guidelines set by recognized UN bodies, the Integrity Council for the Voluntary Carbon Market (ICVCM) and the Voluntary Carbon Markets Integrity Initiative (VCMI) who are highly recognised.

How to leverage the Voluntary Carbon Credits carbon market for a Decarbonization Project

To leverage voluntary carbon credits effectively in a decarbonization project, certain steps must be followed:

  1. Compliance with Core Carbon Principles: Initially, a project must ensure its compatibility with the ICVCM's Core Carbon Principles, which set the global benchmark for the integrity of carbon credits. These principles are designed to ensure that all credits are real, quantifiable, and verifiable.
  2. Adoption of a Suitable Carbon Credit Standard: The project should align with a carbon credit standard that offers a methodology applicable to its specific carbon reduction solution. If no existing methodology fits, the standard may need to be adapted or a new one developed. Recognised for their high integrity, standards such Riverse, Verra’s Verified Carbon Standard (VCS) or the Gold Standard are commonly used due to their robust frameworks for measuring and reporting emissions reductions.
  3. Certification and Verification Process: After choosing the appropriate standard, the project must undergo a rigorous certification process. This involves detailed documentation and third-party verification to ensure that the claimed carbon reductions are being achieved. Only after this verification can the project issue carbon credits, which can then be listed on voluntary markets for sale.
  4. Continuous Monitoring and Reporting: Post-certification, continuous monitoring and regular reporting are critical to maintain the validity of the credits and ensure ongoing compliance with the established standards. This transparency not only enhances the credibility of the project but also assures buyers of the integrity and environmental impact of their purchases.
vcm overivew for carbon mechanism

The Insetting mechanism: Corporates’ Scope 3 carbon “market”

How the Insetting Carbon Market works

Insetting, or internal carbon offsetting, is becoming an increasingly relevant strategy for companies not covered by mechanisms such as the EU Emissions Trading System (EU ETS) but who nonetheless have ambitious carbon reduction targets. This concept involves companies taking direct action within their own supply chains or operational scopes to reduce emissions, rather than purchasing external offsets. This approach aligns with the growing corporate emphasis on achieving comprehensive Scope 1, 2, and 3 emission reductions.

Insetting is akin to the EU ETS but tailored for companies that aren't subject to such regulatory frameworks yet are eager to reduce their carbon footprint significantly. For instance, if a company aims to reduce its Scope 1, 2, and 3 emissions by 50% by 2030, and a project enables this decarbonization, the project not only becomes valuable but is increasingly recognized as such. More and more companies are setting internal carbon prices, turning carbon reduction into a financially quantifiable goal. This approach shifts from being purely a marketing argument to a compelling economic strategy, as the financial implications of carbon are leveraged to prove the return on investment (ROI) of decarbonization efforts.

How to leverage the Insetting carbon market for a Decarbonization Project

By integrating emission reduction projects directly into their operations and supply chains, companies can ensure greater control over their carbon impact and foster sustainability from within.

1. Measuring Real Impact: The first step in leveraging insetting for a decarbonization project is to conduct a comparative Life Cycle Assessment (LCA). This assessment quantifies the environmental impacts associated with all the stages of a product's life from cradle to grave. By evaluating the project's actual impact, companies can identify the most effective interventions for reducing emissions within their operations or supply chains.

2. Understanding Client Decarbonization Goals: It’s crucial for businesses to study the decarbonization targets of potential commercial partners and determine whether they have an internal carbon price. Knowing a client’s carbon pricing and their environmental targets helps tailor projects to meet these specific goals.

3. Commercial Argumentation and Reporting: Armed with the knowledge of a client’s carbon strategy and targets, businesses can use their project's decarbonization capabilities as a robust commercial argument. Regular and transparent reporting to the client is essential, as it allows the client to easily track and verify the emission reductions achieved through the project. This not only reinforces the client’s commitment to achieving their carbon reduction goals but also enhances the credibility and value of the project.

Alternatives to carbon markets to value Greentechs impact

The European Taxonomy: the European green classification to drive carbon markets

How the European Taxonomy works and can support carbon markets

The European Taxonomy is a classification system developed by the European Union to identify which economic activities can be considered environmentally sustainable.It serves as a key element of the EU's action plan for financing sustainable growth and is integral to achieving the objectives laid out in the European Green Deal, which aims to make Europe climate neutral by 2050. The taxonomy aims to provide a clear, consistent framework for determining whether economic activities are environmentally sustainable.

The main purpose of the European Taxonomy is to help investors make informed decisions about what is truly environmentally sustainable. By providing a common language and strict criteria, the taxonomy ensures that activities labeled as sustainable meet rigorous standards. This helps channel investments into projects that genuinely contribute to environmental objectives and supports the EU's commitments under the Paris Agreement on climate change.

The taxonomy defines environmental sustainability based on six core objectives:

  1. Climate Change Mitigation: Activities that contribute to reducing greenhouse gas emissions.
  2. Climate Change Adaptation: Activities that increase resilience to the impacts of climate change.
  3. Sustainable Use and Protection of Water and Marine Resources: Activities that conserve water and marine resources.
  4. Transition to a Circular Economy: Activities that promote resource efficiency and waste reduction.
  5. Pollution Prevention and Control: Activities that minimize pollution and improve environmental quality.
  6. Protection and Restoration of Biodiversity and Ecosystems: Activities that conserve and restore biodiversity and ecosystems.
EU taxonomy for carbon mechanism

For each of the six objectives, the taxonomy provides specific technical screening criteria that define what it means for an activity to make a substantial contribution to that objective.

How to leverage the European Taxonomy for a Decarbonization Project

Using the European Taxonomy for a decarbonization project can strategically enhance the project’s appeal to investors by demonstrating its alignment with key sustainability criteria.

1) Before proceeding, it’s crucial to determine whether your decarbonization project meets the criteria set out by the European Taxonomy. The EU Taxonomy Compass is an online tool that provides detailed guidance on the taxonomy’s technical screening criteria for various economic activities

2) Highlighting Taxonomy Alignment: Explain how your project meets the taxonomy’s criteria, which can classify it as a sustainable investment. This can be a powerful argument in securing investment, as many financial institutions are looking to fulfill their own sustainability mandates and may have funds specifically allocated for taxonomy-aligned projects.

3) Accessing Preferential Financing: Projects aligned with the European Taxonomy may be eligible for more favorable financing conditions, such as lower interest rates, higher investment ratios, or more flexible terms, given the reduced risk profile and potential government incentives linked to sustainable investments.

The Climate Dividends: the extra-financial KPI based on residual emissions for  carbon-market sensitive investors

How the Climate Dividends works

Climate dividends are emerging as a groundbreaking extra-financial indicator that measures and recognizes the positive climate impact generated by a company. Analogous to financial dividends, which reward shareholders with a portion of a company’s profits, climate dividends reflect the environmental contributions of a company. These dividends represent the emissions avoided or reduced through a company's activities and can be valued by its shareholders.

climate dividends as carbon mechanism

Therefore, Climate dividends introduce a new category known as "Scope 4" in greenhouse gas accounting. Unlike Scope 1, 2, and 3 emissions, which pertain directly to a company’s own operations and its immediate value chain, Scope 4 covers the emissions avoided through the company's investment activities. This new category allows investors to quantify how their financial contributions are helping to reduce atmospheric CO2, thereby providing a measurable and positive climate impact. It offers a way for investors to balance their broader portfolios by offsetting the impacts of investments that might not have a direct environmental benefit.

Developed in 2021 by Laura Beaulier, CEO of Climate Dividends and a member of Riverse’s board, the concept is strongly supported by organizations such as Team for The Planet, ADEME, Sweep, Mirova, and KPMG, as well as early adopters like Decathlon, Cycle Up, and Okamac! These groups endorse its development, standardization, and adoption, highlighting its potential to significantly impact environmental reporting and investment strategies.

How to leverage the Climate Dividends for a Decarbonization Project

  1. Measuring Emissions Impact: The first step in utilizing Climate Dividends is to accurately measure the emissions that are either avoided or captured by a project. This involves conducting a comparative Life Cycle Assessment (LCA) to quantify the environmental benefits the project delivers over conventional alternatives.
  2. Verifying Impact: To ensure credibility and transparency, it’s essential to have the measured impact verified by a third party. This verification process lends additional authenticity to the claims regarding emissions reductions, making the data more reliable for investors and stakeholders.
  3. Communicating to Financial Stakeholders: Once verified, this information should be communicated to current investors and financial backers. Providing them with detailed and verified data on how the project contributes to reducing emissions allows them to use this information in their own CSR reports and investment analyses.
  4. Leveraging in Financial Negotiations: Climate Dividends can also be a powerful tool in funding negotiations. Demonstrating how a project contributes significant climate dividends enhances its value proposition to potential investors, especially those focused on green and sustainable investments.