Voluntary Carbon Market: Benefits, Role and Mechanisms
Voluntary Carbon Market: Benefits, Role and Mechanisms
Tuesday, 30 May 2023

Updated 2024

by: Allysea Subagja

What is the Voluntary Carbon Market?

As the number of companies committing to net-zero emission grows, sustainable solutions are receiving more attention. Companies must therefore reduce as many emissions as they emit to achieve their goals, which poses a challenge for some carbon-intensive industries. It will be necessary for these companies in the sector to rely on carbon credits to offset the emissions they release into the atmosphere. The voluntary carbon market is a financial vehicle that provides opportunities for them to achieve their climate commitments. It was created to mitigate climate change by creating space for private players to finance activities that remove GHG emissions associated with industries, transportation, energy, buildings, agriculture, and deforestation.

Forms of Voluntary Carbon Markets

Through this market, companies can invest in offset projects that avoid, reduce, or remove carbon emissions. Market participants join to purchase carbon credits for various reasons. Aside from reducing their carbon footprint, it is one way to hedge against the financial risks posed by the energy transition. Besides being voluntarily driven by those with climate goals and social awareness, the market works on a project-based system. The projects financed through the market range from small local initiatives to large-scale industrial projects, as long as they can avoid nature loss, reduce or avoid emissions, and technologically remove carbon from the atmosphere.

Difference between Voluntary Carbon Market and Mandatory Carbon Market

Other than the voluntary market, the mandatory market is another segment of carbon markets. The two exist in parallel to achieve the same end goal of emission reduction. The project-based system in the voluntary market allows flexibility in the supply of carbon credits, whilst the cap-and-trade system in the mandatory market limits the supply of credits or allowances that can be traded. Moreover, the mandatory market is regulated under national, regional, or international reduction schemes such as the European Union Emissions Trading System (EU ETS) and the Kyoto Protocol. Unlike the voluntary market, the participants of the mandatory market are companies and governments that are legally mandated to reduce their emissions or have adopted an emission limit established by the UNFCCC.

The Role of Voluntary Carbon Markets in Reducing Emissions

Despite the voluntary nature of the VCM, it is still a powerful tool used to limit the increase of global warming to 1.5 degrees Celsius. It enables companies to support decarbonisation and accelerate the transition towards a low-carbon economy. The role of the VCM is crucial for both short and medium term. In the short term, credits from projects mainly focus on emissions avoidance or reduction, hence accelerating the decarbonisation transition because it drives investments towards renewable energy and energy efficiency, as well as natural capital. In the medium term, these credits play a crucial role in scaling up carbon dioxide removals needed to neutralise residual emissions that cannot be further reduced. According to McKinsey, at least 5 gigatons of negative emission is annually required to reach net zero by 2050, which could be realised through a combination of natural climate solutions such as reforestation and technology-based carbon capture, use, and storage solutions - voluntary credits can help finance the scale-up of these solutions.

Voluntary Carbon Market Potential

The global voluntary carbon market was valued at 2,004,85 million USD in 2021 and is expected to reach 17.11 billion USD by 2027. In terms of volume, its trade reached 298.15 MtCO2e in 2021 and is projected to grow to 678.56 MtCO2e in 2027. There are a total of 4,763 companies that have submitted their science-based targets or have committed to developing targets with 2,430 already approved from all over the world. The voluntary market is key to corporate climate commitments. Growth in the market has been driven by a combination of the growing number of climate commitments that must align with the global goal of decarbonisation required to limit global warming to below 1.5 degrees Celsius above preindustrial levels because it is the solution that provides corporations with flexibility and control. Carbon credits with co-benefits are expected to continue leading a price premium. EY modelled scenarios where the price for credits could reach an estimate of 80-150 USD by 2035 in comparison to 25 USD in 2020.

Benefits of the Voluntary Carbon Market for Indonesia

Indonesia’s progress in achieving net zero bears global significance as the country is one of the largest emitters of greenhouse gases. As a developing country, it is expected that Indonesia has various economic development priorities, thus faces a financing gap for its decarbonisation agenda. The financing needs to achieve the NDC is higher than the amount allocated by the government for education, social security, and health combined. Understandably, the government fiscal room is limited, and the current form of spending and revenue does not promote adequate room nor incentives to promote climate ambition. Establishing a voluntary carbon market in Indonesia would provide the country with substantial capital inflows, stimulating economic growth whilst cost-effectively transitioning to a low-carbon economy.

The market can help Indonesia increase its ambition and generate emission reductions that go beyond existing NDCs. The rich natural resources in Indonesia have the potential to generate high-quality carbon credits and could even provide co-benefits that go beyond emission reduction - offering lower abatement costs and high sustainable development benefit opportunities. Carbon investment offers the opportunity for Indonesia as a host country with limited access to direct investment and ease the pressure on government spending. It is also important to note that offsetting does not replace efforts to reduce emissions; however, it complements operational and value-chain emissions as well as compensate residual and unavoidable emissions in the long term.

Voluntary Carbon Market Mechanisms

Voluntary carbon markets are currently fragmented due to the large number of buyers and sellers with different value propositions and needs. Credits are administered by schemes and sold through exchanges or traders and brokers, and most credits are linked to specific supply projects. Third-party auditors provide verification and validation to ensure the quality of the credits traded at the market. The origination of carbon credits begins with project developers and carbon credit standard organisations as primary stakeholders that create supply, which will then be administered to a registry and guaranteed by third-party auditors. Exchanges and brokers are primary stakeholders involved during trade, with clearing houses that are responsible for cash settlements and change of ownership in registries to prevent double counting. End buyers of carbon credits will have the option to re-sell in the secondary market or to retire for their own use. The amount of negative emissions retired will be accounted for Scope 1,2, and 3 emissions in the form of emissions reporting.

The markets are not yet mature, however, there is still room to grow. There is an expected shift towards well-functioning markets driven by competitive pressures and increase in supply. Market fundamentals can drive the emergence of large and efficient global exchanges. Rules that set consistent quality standards, transparency that promotes high scrutiny and verification, diverse and defined products with co-benefits, and liquidity driven by sufficient volume for trade, followed by sufficient participants with different needs and risk profiles are required to evolve the markets.

The government, communities, and private entities in Indonesia need to define their priorities and decide how carbon market investments fit into their climate and sustainable development strategies. Although not an absolute solution for mitigation, carbon markets can accelerate emission reduction while governments formulate and adopt appropriate strategies and policies to abate greenhouse gas emissions and mitigate the effects of climate change. Carbon markets channel investment into developing countries such as Indonesia, which can help achieve early emission reductions and removals. In time, the role of the market will fade as climate policies become the new norm. Even then, the market can continue to provide a platform to test new technologies and innovation.

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