The acceleration to cleaner sources of energy accelerated in 2020 with many companies pledging to reduce their carbon emissions. In fact, according to the UN, 120 countries, 23 regions, 454 cities, 1,397 businesses, 74 investors, and 569 universities across the globe have pledged to become carbon neutral by 2050. Many of these entities may look to market-based mechanisms as a tool to execute their individual strategies.
Emissions trading schemes, or market-based mechanisms (MBM) more broadly, are designed to provide an efficient mechanism for countries, firms, and even individuals to reduce their carbon footprint. The theory is simple - increased optionality and competition should help carbon find an equilibrium price while effectively reducing emissions.
However, the uniqueness and regional nature of emissions trading and carbon offset projects have prevented harmonization between programs and ultimately the development of a standardized price. It is a difficult task to mitigate climate risk without a universal benchmark.
Current Options for Emissions Trading
In compliance markets, an emissions cap is set for certain types of industries, generally with obligated parities selected based on pre-determined emissions output thresholds. Firms that reduce below a mandated cap can sell excess carbon credits to firms who are still emitting above their assigned cap. Some programs also allow firms to use offset credits from emission reduction projects to satisfy a portion of their obligation.
While offset credits play a role in compliance markets, they also have the flexibility to allow firms to reduce carbon emissions outside of a regulated framework. Voluntary offset projects and associated credits allow firms to take near term action to meet carbon reduction goals while they work to transition to low-carbon business practices.
The airline industry is a prime example of the private sector leveraging voluntary offset projects to reduce emissions. Prior to the steep decline in airline travel due to COVID-19, emissions from the airline industry were higher than all but five countries in the world. The International Civil Aviation Organization (ICAO), a UN specialized agency, adopted the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) as a market-based mechanism to meet an ambitious goal of carbon neutral growth from international aviation beyond 2020.
A Market-based Solution
The Taskforce on Scaling Voluntary Carbon Markets, a private sector-led voluntary carbon market initiative where CME Group is a member, has stated that “a large, transparent, verifiable and robust voluntary carbon market will be critical to reaching net zero and net negative goals,” and that the current voluntary market also needs to scale by at least 15 times in order to achieve these goals. Among their key recommendations around properly scaling the market is a call for a physically delivered futures market.
CME Group and Xpansiv markets CBL, a leader in spot energy and environmental markets, have jointly developed the Global Emissions Offset futures (GEO) contract.
The GEO futures contract sets its foundation in the selection criteria and review process developed for CORSIA. ICAO and TAB spent years developing a stringent screening process to determine which offset registries and project types are eligible. The result is a set of criteria that firms across industries and geographies s use as a guide to assess the robustness of emissions offset projects and associated credits.
Long Term Effort
Even as the world grapples with disruptions from the COVID-19 pandemic, companies, shareholders, and consumers have strengthened their call for a reduction in carbon emissions as part of a larger Environmental Social Governance (ESG) movement.
The shift to a low-carbon economy requires a long-term effort, but near-term reduction strategies that leverage emissions offset projects may also help be part of the solution today. The GEO contract will provide a regulated and standardized platform for companies to manage their emissions risk, while also helping to establish a much-needed global emissions offset pricing benchmark.
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