Economic Development

    Can voluntary carbon market be established in SAR?

    12/09/2022 - 09:00

    This article appeared originally in the China Daily on 9 December, 2022.
    Authors: Judy Chen, Senior Researcher and Pascal Siu, Researcher at Our Hong Kong Foundation.

    Can voluntary carbon market be established in SAR?

    Nations worldwide are earnestly developing their carbon markets. Research results show that among countries which have set their emission reduction targets, 83 percent intend to use their carbon markets to meet those targets. Generally speaking, carbon markets are classified into two systems — mandatory (Emissions Trading Systems, or ETS) and voluntary (Voluntary Carbon Markets, or VCM). 

    The nationwide ETS of the Chinese mainland is the largest of its kind around the globe in terms of carbon emissions coverage, covering approximately 4.5 billion tons of carbon dioxide emissions. While Hong Kong is a tiny market and its small pool of participants cannot support a local ETS, the recent establishment of a local VCM by Hong Kong Exchanges and Clearing (HKEX) serves to complement the national ETS, completing China’s entire carbon market. So, what should be considered for Hong Kong to run a local VCM?

    First, there is a wide variety of carbon credits in VCMs. Carbon credits issued by various standard setters, e.g., Verra and Gold Standard, can be categorized into two types according to credits’ carbon-reduction methods: removing carbon from the atmosphere (carbon removal); and avoiding or reducing carbon emissions (carbon avoidance or reduction). The former can be achieved by afforestation and carbon capture and storage; the latter involves more contentious attempts, such as minimizing logging activities and protecting mangroves. As the technologies and means of reduction vary, the costs of carbon removal and emission control differ vastly. In 2021, the average cost of carbon removal was $8 per ton while that of carbon avoidance or reduction was $1.7 per ton. Buyers may incline towards credits with lower price tags for different reasons, such as lack of relevant regulations and inadequate understanding of the differences in carbon credits. Nevertheless, cheaper carbon credits are weaker in terms of carbon-reduction effectiveness and permanence, and their payoff will be limited.

    Worse still, the purchase of cheaper carbon credits may give rise to the phenomenon of “bad money driving out good money”, pushing down the prices of carbon credits. Low prices of carbon credits are unfavorable to galvanizing enterprises into conducting worthwhile carbon-reduction acts as some may display their concern for the environment by buying carbon credits instead of cutting down on their carbon emissions. 

    Considering the huge discrepancy in carbon credits in the market, Hong Kong could launch a taxonomy by referencing foreign carbon rating agencies to categorize and rate carbon credits in detail based on the types, sources, locations, scopes of time, quality of reduction, etc. This would enable buyers to understand the distinctions among various kinds of carbon credits, helping them to find the most suitable or the most legally-compliant products.

    Carbon futures contracts 

    Second, exchanges of VCMs are currently fragmented and small in scale. Many transactions are conducted over the counter (OTC). Their pricing is opaque, indirectly elevating transaction risks for buyers and sellers alike. To tackle these problems, some overseas exchanges offer spot quotes and design a series of core carbon contracts to guide the market in exploring equilibrium prices. For instance, the CBL Exchange in the US and Chicago Mercantile Exchange collaborate to institute Global Emissions Offset Futures, which entails physical delivery. The contract only allows the transaction of carbon credits that are issued by internationally recognized standard setters and credits that meet the requirements of the Carbon Offsetting and Reduction Scheme for International Aviation. Like other commodities with their relevant futures markets, core carbon contracts allow market participants to obtain daily quotes for different carbon products and offset the price fluctuations of future carbon credits. As the risks are mitigated, more buyers and sellers likely will partake in the market.

    On this premise, carbon exchanges can deliver other kinds of futures contracts based on carbon-reduction technologies, years and locations of carbon credits. This is also conducive to the development of OTC transactions where contract prices can be set according to the prices listed by carbon exchanges.

    Certainly, there still exist other concerns to be addressed for Hong Kong to run a VCM. Other considerations include Hong Kong’s role in fostering the establishment of a Guangdong-Hong Kong-Macao Greater Bay Area Unified Carbon Market, the interoperability of carbon credits between the VCM and ETS, the transaction currency and the infrastructure of the carbon market. 

    It is hoped that this article can shed some light on this hot topic. We believe that VCM is just one of the channels to achieve carbon neutrality. Enterprises should first enact viable emission-reduction measures and then utilize VCM as a supplementary means to offset residual emissions. Such a multipronged approach can help Hong Kong and the nation to attain carbon neutrality by 2050 and 2060 respectively.