Explainer Series | A comparison of voluntary carbon markets and the New Zealand emissions trading scheme

Voluntary Carbon Markets (VCMs) are one of many tools in the climate change mitigation toolkit. They can help organisations go above and beyond their legal obligations in reducing their emissions. They encourage the creation of new projects to lower emissions, such as forests or renewable energy. An effective VCM requires high-integrity action and efforts to ensure emissions reductions are realised. Participating in VCMs can also help businesses take action on their hard to abate emissions, through carbon offsetting.

The Emissions Trading Scheme (ETS) is a market that encourages emissions reductions by putting a price on emissions. Participants buy units to account for their emissions, which are issued by the Government. The two systems of VCM and ETS complement each other, but there are important differences. The NZ ETS is the key tool to reducing Aotearoa New Zealand’s emissions, but VCMs play an important role in supporting the efforts to meet our countries’ mitigation targets.

Introduction

Countries are making meaningful contributions towards the Paris Agreement to limit global warming to 1.5 ̊C compared to pre-industrial levels. The Climate Change Response Act outlines the climate targets to which Aotearoa has committed. A range of tools and actions are needed to tackle the climate crisis. Many tools are useful, but incomplete. There is no perfect solution, and we can’t expect to find one with this multi-layered issue. Deciding what approach to use, when to use it and how it fits into existing structures can play a big part in successfully reducing emissions. Voluntary Carbon Markets are one such tool, where organisations choose to take actions beyond their legal obligations. But how important are they in our climate action toolkit, and how do they compare to the New Zealand Emissions Trading Scheme?

How it works - VCMs

Carbon credits can be bought and sold by any entity that chooses to participate in a VCM. The market abides by existing standards that define how an offset can be produced. VCMs have existed in some form since early 2000, with the one of the key milestones being the Gold Standard, established in 2003. VCMs continue to develop in Aotearoa and abroad (see Figure 1).

Figure 1. Evolution of the voluntary carbon market. Source: Gold Standard: GrowToZero Climate Week NYC event.

In practice, sellers develop projects that get issued carbon credits (e.g. by establishing a forest, or developing a solar farm). Projects need to demonstrate that carbon finance is needed to fund the project, opposed to business-as-usual activity. Buyers purchase the credits (typically annually) issued to these projects to offset their own carbon emissions, typically above and beyond any legal requirement they might have. This creates an incentive for buyers to reduce their emissions which reduces their offset bill, particularly as carbon credit prices continue to rise.

There is an abundance of organisations making voluntary emissions mitigation commitments, and as a result, demand in the VCM is expected to significantly increase. Carbon credit trade in VCMs was valued at US$320 million in 2019 and is estimated to grow to be worth US$5 - 30 billion per year by 2030. As the voluntary market scales up, it is critical that the carbon credits used are credible and of high-integrity . This will help ensure businesses are taking meaningful climate action and enhancing their corporate reputations in pursuit of the Paris climate goals.

High-integrity supply and demand

Businesses that use the VCM for reducing their emissions are recommended to follow best practice on both ‘demand side’ and ‘supply side’ integrity principles. The Integrity Council for the Voluntary Carbon Market (IC-VCM) (supply side integrity) and VCM Initiative (VCMI) (demand side integrity) provide good examples of these integrity principles. The VCMI is underpinned by 10 high-integrity and high-ambition voluntary carbon action principles, including:

• Science-based, mitigation hierarchy aligned action;
• Comprehensive action; and
• Transparent action.

High-integrity action uses the latest scientific consensus on safe upper limits for global warming. Furthermore, lead practice is for companies to follow a science-based mitigation hierarchy (as outlined in our recent explainer on offsetting). While offsetting is a part of the equation, it should be used as a final option after avoiding and reducing emissions.

Having emissions reduction targets and claims (time-bound commitments followed up with achievements progress) helps drive climate action. Concerning voluntary purchases of carbon credits, the VCMI outlines criteria for high integrity and transparent claims. Examples of the criteria includes that claims;

• must be true and accurate;
• substantiated with objective and up-to-date data; and
• that the environmental benefits are not overstated.

Stakeholders (clients, the general public, NGOs, etc.) are increasingly pushing for claims to meet these integrity standards. Furthermore, integrity assurance models are being developed by the private sector and non-profit groups. Chiefly, these models are established to avoid greenwashing and ensure that claims hold true. Claims which achieve the 10 VCMI principles would be the industry leaders in demand side integrity.

For supply side integrity, principles include additionality, verified, do no net harm, and permanence. Co-benefits also exist from the projects created in the VCM. For example, funding native forest restoration can also have co-benefits for biodiversity, soil health, and water quality, as well as social benefits around community and relationship building.

How it works – the NZ ETS

The NZ ETS was introduced in 2008 and continues to this day as the key policy instrument to addressing climate change in Aotearoa. It also acts as a tool for meeting our international climate obligations under the Paris Agreement.

To encourage emissions reduction and fossil fuel divestment, a market price on carbon is used. The NZ ETS is a compliance market, which means those participating need to meet certain obligations. Businesses participating in the NZ ETS need to buy units (referred to as NZUs) to account for their emissions, which can be traded between polluters. Each unit consists of one tonne of CO₂ or equivalent (e). For each tonne of CO_­2e released, the polluter needs to surrender one unit to the government (Figure 2). You may have heard this referred to as a “polluter pays” system - the more carbon you emit, the more units you need to buy. The government limits the supply of NZUs at auctions, which take place quarterly. The market sets the carbon price based on the supply and demand of units.

By reducing the number of NZUs available, we end up with a “sinking lid” on the market – As the supply of NZUs is reduced over time incentivising businesses and consumers to reduce their emissions. You can see the current market price for one NZU here. At the time of writing, it has been a bit volatile!

Businesses can decide to meet their NZ ETS obligations in different ways. For example, businesses can reduce their emissions, so they would need to surrender fewer units to the Government. Alternatively, they can buy NZUs from other businesses participating in the NZ ETS (in effect paying those other businesses to reduce their emissions). The ETS aims to capture units as high up on the production chains as possible, and these costs are often passed on to consumers.

Figure 2: the NZ ETS is the chief tool for reducing greenhouse gas emissions in Aotearoa NZ, and involves interactions between the government, the ETS market and the NZ economy. Source; Motu, 2022.

Key differences

• From a functional perspective the ETS sees participants buy and then surrender units, whereas a VCM cancels the units (credits) and removes these from circulation
• Units from the VCM cannot be used to meet ETS obligations
• The VCM promotes investment in creating new projects that will reduce emissions, whether by taking carbon out of the atmosphere (i.e. forests) or by increasing access to lower-emission goods or services (i.e. renewable energy). The ETS also uses incentives, but these are more focused on changing existing behaviours by making emissions more expensive (i.e. pricing emissions units). This helps drive emissions reductions for the ETS participants, and reduces ETS compliance costs
• The ETS consists of allocated ‘permits to pollute’, units from production forestry, and some permanent forestry. In contrast, the VCM consists solely of credits representing a reduction or removal of emissions
• It’s worth noting that, in this sense, the two systems largely complement each other by targeting the demand for carbon, the supply of alternatives, and solutions for removing the emissions we cannot avoid. They do not cancel each other out
• We are often asked why our carbon reduction programmes require emissions from petrol to be offset, even though the petrol price includes an ETS tax. There are two factors at play here. The ETS tax on petrol is paid at the point of purchase. So, while you have ‘paid to pollute’, that does not capture your actual emissions that go into the atmosphere when you drive your car and burn that petrol. This is measured as a part of your specific carbon footprint, which will later be offset.

Challenges

Surrendering ETS units is not voluntary action

For example, a business that operates in the NZ ETS cannot point to their surrendering of units as voluntary climate action, as surrendering units are compliance requirements under the NZ ETS. It doesn’t matter if those units were purchased or freely allocated, or a part of a new forest. There is general consensus on this position both internationally and here in Aotearoa, including the position held by MfE on guidance for voluntary climate change mitigation .

Cancelling credits can be voluntary action, with sufficient checks

There are limited links between an ETS and VCM activity, where an organisation can elect to cancel a compliance credit (i.e. an NZU) for the purposes of a voluntary offset. In this situation, sufficient supply side integrity checks are needed to ensure the unit being cancelled is ‘fit for purpose’ against the voluntary actions being completed by the entity cancelling the unit.

Avoiding double counting

Other issues can arise in the form of double counting, where a mitigation action is used more than once. This can happen when two or more entities take credit for a single emission reduction (or removal), double use. Or when a carbon credit is counted twice (or more) towards achieving a climate change mitigation claim (double claim). As far as the climate is concerned, nothing extra has been done here, so careful attention to communication claims is increasingly important as the VCM and compliance markets evolve.

How to avoid greenwashing

Having emissions reduction targets and claims helps drive climate action. But it is vital that any claims made are transparent and can be verified. With VCMs, there are established criteria for participants to follow when making claims about their impact on the climate. These include that claims;

• must be true and accurate;
• substantiated with objective and up-to-date data; and
• that the environmental benefits are not overstated.

Many jurisdictions, including New Zealand, are increasingly assessing environmental claims under consumer laws such as the Fair Trading Act and the watchful eye of the Commerce Commission. Furthermore, integrity assurance models are being developed by the private sector and non-profit groups. Chiefly, these models are intended to avoid greenwashing and ensure that claims hold true. Integrity on both the supply and demand sides of the VCM is essential for showing the value of the VCM’s role in achieving global net zero by 2050.

How can Toitū help?

Toitū operates a range of voluntary programmes and issues certifications called carbonreduce, net carbonzero, and Climate Positive. These voluntary programmes allow clients to measure, reduce and offset any unabated and residual emissions.

Offsetting is done by purchasing credits from the VCM, and some suitable units that sit within the NZ ETS. Units may include specific permanent forest NZUs from the NZ ETS compliance market.

Glossary

Cancel (or retire) - voluntarily transferring a unit to a cancellation account, so that it is permanently taken out of circulation. An entity may do this to offset their emissions. Cancelling a unit is unrelated to mandatory obligations under the NZ ETS

Carbon credits - a tradable, non-tangible instrument representing a unit of carbon dioxide-equivalent (CO₂e) – typically one tonne - that is reduced, avoided, or sequestered by a project. Units are also certified/verified to an internationally recognised carbon accounting standard. Often called emissions units, such as the NZU

Compliance market - a market for carbon offsets created by the need to comply with a regulatory act. Compliance markets include cap and trade domestic schemes (e.g. European Union Emissions Trading Scheme, California cap and trade, Colombia’s carbon tax) and sectoral schemes (e.g. Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA)

Double counting - a situation in which a single greenhouse gas emission reduction or removal is counted more than once towards achieving climate change mitigation. Double counting can occur through double issuance, double use, and/or double claiming

Emissions Trading Scheme (ETS) - a market-based approach for reducing emissions of greenhouse gases. The ETS puts a price on emissions, by charging certain sectors of the economy for the greenhouse gases they emit

Fit for purpose - sufficiently suited for its designated role or purpose

Mitigation hierarchy - the concept of prioritising mitigation efforts before avoiding/eliminating emissions. If this is not currently feasible, reduce emissions as much as possible, and as a last resort compensate or neutralise the emissions (via use of removals and/or the carbon credits)

Science based targets - targets are considered ‘science-based’ if they are in line with what the latest climate science deems necessary to meet the goals of the Paris Agreement – limiting global warming to well-below 2°C above pre-industrial levels and pursuing efforts to limit warming to 1.5°C. The Toitū carbon programmes refer to the Science Based Targets Initiative (SBTi) for the latest criteria and guidance on aligning to being science based

Surrender - a polluter will surrender a carbon credit (such as a NZU) to the government to a Crown surrender account for every tonne of emissions the polluter releases in that year. That credit will no longer be in circulation within the carbon market. NZ ETS participants are required to surrender units to meet their NZ ETS obligations

Unabated - emissions that have not been reduced in any way

Unit - a carbon credit purchased to account for ones’ emissions, which can be traded between polluters. Each unit consists of one tonne of CO₂ or equivalent. The NZ ETS uses NZ Units, commonly referred to as NZUs

Voluntary Carbon Market (VCM) - the voluntary carbon marketplace encompasses all transactions of carbon offsets that are not purchased with the intention to surrender into an active regulated carbon market. It does include offsets that are purchased with the intent to re-sell or retire to meet carbon neutral or other environmental claims

References

https://www.carbonnews.co.nz/story.asp?storyID=23439

https://consult.environment.govt.nz/climate/proposed-changes-nz-ets-2022/

https://environment.govt.nz/assets/publications/interim-guidance-voluntary-climate-change-mitigation.pdf

https://environment.govt.nz/what-government-is-doing/key-initiatives/ets/a-tool-for-climate-change/nz-ets-responding-climate-change/

https://environment.govt.nz/what-government-is-doing/areas-of-work/climate-change/emissions-reduction-targets/greenhouse-gas-emissions-targets-and-reporting/

https://www.epa.govt.nz/industry-areas/emissions-trading-scheme/about-the-nzets/

https://www.epa.govt.nz/industry-areas/emissions-trading-scheme/market-information/voluntary-unit-cancellations/

https://www.etsauctions.govt.nz/

https://icvcm.org/

https://www.motu.nz/assets/Documents/our-research/environment/climate-change-mitigation/emissions-trading/A-Guide-to-the-New-Zealand-Emissions-Trading-System-2022-Update-Motu-Research.pdf

https://www.toitu.co.nz/news-and-events/news/carbon-credits/carbon-offsetting-and-its-role-in-emissions-targets

https://www.toitu.co.nz/news-and-events/news/marketing/avoiding-greenwash-the-dos-and-donts-of-environmental-claims?utm_campaign=coschedule&utm_source=linkedin_company&utm_medium=Toit%C5%AB%20Envirocare

https://vcmintegrity.org/wp-content/uploads/2021/07/VCMI-Consultation-Report.pdf