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Can carbon offsets be used in the EU ETS?

Carbon Markets: Definitions

Past attempts to integrate carbon offsets into the EU ETS were ineffective, leading to the removal of those contracts from the regulated carbon market after 2020. While future possible integration back is uncertain, discussions are ongoing as there will be a major revision of the EU ETS in 2026.

Can carbon offsets be used in the EU ETS?
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Carbon offsetting involves compensating for greenhouse gas (GHG) emissions by avoiding or removing emissions that have been produced elsewhere. Carbon offset credits, a term often used interchangeably with “carbon offsets”, represent contracts, certifying for an emission reduction. Buyers are purchasing them to claim CO2 offset or reductions that count towards their own GHG goals. In contrast, Emissions Trading Systems (ETS) directly incentivize emissions reductions through economic mechanisms and the demand and supply laws of financial markets. However, past attempts to integrate carbon offsets into the EU ETS were ineffective, leading to the removal of those contracts from the regulated carbon market after 2020. While future possible integration back is uncertain, discussions are ongoing as there will be a major revision of the EU ETS in 2026. There can be proposed solutions like a parallel trading market for offsets or a form of a carbon central bank. Further clarity is expected after the EU elections in June.

  • What is carbon offsetting?
  • What are examples of carbon offset schemes? 
  • How big is the carbon offset market? 
  • Is there a link between carbon offsets and the EU ETS? 

What is carbon offsetting?

What is the definition of a carbon offset? 

A carbon offset refers to a removal in greenhouse gas (GHG) emissions (that have already been emitted) or an increase in carbon storage (such as through land restoration or tree planting). Those volumes of CO2 are used to compensate for emissions occurring elsewhere. Basically, the idea is to find a way to keep emitting CO2 in the atmosphere, but “compensating” for it through those offsets. 

Is a carbon offset the same as a carbon credit? 

The terms "carbon offset" and "carbon offset credit" (or "offset credit") are often used interchangeably, though they can have slightly different meanings. A carbon offset credit is a transferable instrument, certified by independent certification bodies (or sometimes governments), representing the reduction of one tonne of CO2. Purchasers can "retire" these credits to claim the underlying emission reduction towards their own GHG reduction goals. The concept is that offset credits are supposed to convey a “net climate benefit” from one entity to another.

What is the conceptual difference between carbon offsetting and an ETS? 

Carbon offsets do not necessarily incentivize a change in behavior to achieve emissions reductions. The concept involves continuing to produce the same amount of carbon but finding ways to "compensate" for it. On the other hand, regulated emissions trading schemes (ETS) operate differently by incentivizing changes in economic production operations to drastically reduce CO2 emissions. The ETS approach directly targets the reduction of carbon output through economic mechanisms, encouraging sustainable practices and operational changes.

What are examples of carbon offset schemes? 

What is a carbon offset project? 

Carbon offset credits can be generated from different activities that reduce GHG emissions or increase carbon sequestration, typically through "projects." Examples of such projects include developing renewable energy to displace fossil-fuel emissions from conventional power plants, capturing and destroying high-potency GHGs like methane, N2O, or HFCs, and avoiding deforestation (which prevents the emission of carbon stored in trees and promotes additional carbon absorption as trees grow). 

What is a carbon offset program? 

Carbon offset credits are sometimes generated by large-scale "programs of activities," which aggregate many similar small projects. These carbon offset programs can be convened by international or governmental bodies (like the United Nations Clean Development Mechanism (CDM) Executive Board, overseeing carbon offsets under the Kyoto Protocol), but also independent NGOs. Historically, there have been different names to make the distinction - governmental bodies certified offset credits for regulatory purposes are "compliance carbon offset programs", while NGOs offer to their buyers "voluntary programs". 

Why are there many carbon offset schemes and only one ETS per geographic region? 

Carbon offsetting involves many stakeholders and is highly granular, making the carbon offsetting market sometimes difficult to track and opaque. On the other hand, an Emissions Trading System fosters collective efforts toward a common goal by providing flexibility to each industrial installation to pursue their operations while following common rules with regards to decarbonization.

How big is the carbon offset market? 

What is the size of the voluntary offset market? 

In a report, Bloomberg stated that 164 million offsets were purchased in 2023(with a 6% increase from the previous year) despite a “turbulent year full of scandals and accusations of fraudulent projects generating carbon offsets”. Reuters reported by the end of the same year that the cost of purchasing offset credits in the voluntary market ranged from $6 to $8 per ton for carbon sequestration in forests, with even lower costs for companies purchasing green power from solar energy or wind. Based on these values, the market value of carbon offsets in 2023 ranged between $984 million and $1.312 billion.

Is the carbon offset market as big as the EU ETS?

The ETS market is much larger than carbon offset markets - globally, or within the EU. In 2023, the global ETS market was valued at $948.75 billion, with the EU ETS alone accounting for $835 billion. We can see how massive the scale of regulated carbon markets is compared to the relatively small carbon offset credits market.

 

Is there a link between carbon offsets and the EU ETS? 

Were carbon offsets used in the EU ETS in the past? 

During the third phase of the EU ETS, carbon offsets were allowed to be used for compliance with certain restrictions. Only projects related to nuclear energy, afforestation or reforestation activities (LULUCF), and projects involving the destruction of industrial gasses like HFC-23 and N2O could be part of the game. However, the integration of carbon offset projects within the EU ETS framework was ineffective, leading to excessively low prices and rendering the scheme less impactful on the environmental end. So, these carbon offset provisions were removed from the EU ETS after 2020.

Will carbon offsets be used in the EU ETS in the future? 

In 2026 there will be a revision of the EU ETS market as a whole. There are already discussions underway on addressing the final hard-to-abate emissions to achieve climate neutrality by 2050. There is uncertainty regarding how offsetting or removal mechanisms could effectively integrate with the EU ETS to avoid past dysfunctions. Proposed solutions include a parallel trading market for offsets linked to the EU ETS or creating a carbon central bank to manage such topics. Further insights are expected from newly elected officials after the EU elections in June.

Key concepts

  • Carbon Offsetting Definition: Carbon offsetting compensates for GHG emissions by reducing emissions elsewhere or increasing carbon storage to try to maintain atmospheric CO2 levels.
  • Carbon Offset Credit Definition: Carbon offset credits represent emission reductions certificates, allowing purchasers to retire them for claiming reductions towards their GHG goals.
  • Conceptual Difference from ETS: Carbon offsetting compensates for emissions without driving direct behavioral changes, unlike regulated ETS incentivizing emissions reductions at scale.
  • Carbon Offset Projects: Offset projects vary in scale and include renewable energy development, GHG capture, and avoided deforestation, contributing to emission reductions or increased carbon sequestration.
  • Carbon Offset Programs: Large-scale programs aggregate offset projects overseen by independent NGOs or governments.
  • Market Size Comparison: ETS markets significantly surpass carbon offset markets in scale, with the global ETS market valued at $948.75 billion in 2023.
  • Integration with EU ETS: Carbon offsets were previously allowed in the EU ETS but were removed after 2020 due to low prices and limited impact.
  • Future Use in EU ETS: Discussions for a significant revision of the EU ETS in 2026 explore integrating carbon offsetting or removal mechanisms to address hard-to-abate emissions, with proposed solutions including a parallel trading market or a carbon central bank.

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