Universal Carbon Offset Q&A
How can a Carbon Offset be Traded?
Why are Alberta’s Current Carbon Markets Inefficient?
Can Carbon Offset Credits in Different Compliance Markets be Traded Against Each Other?
What do the Carbon Markets Need to Achieve Efficiency?
Why Should Carbon Offsets be Commoditized?
How Can Carbon Offsets be Commoditized?
What is the Best Way to Implement an Effective Carbon Market Design?
Why is a Clearinghouse the Best Solution for Implementing Fair and Effective Carbon Markets?
How can the Current Suite of Different Carbon Offsets be Amalgamated Into a Carbon Commodity, a Universal Carbon Offset (UCO)?
Is a UCO a Physical Commodity?
How Does a UCO Contribute to Carbon Market Efficiency?
How can a UCO Unit be Calculated for All the Different Methods for Carbon Recapture Under One Umbrella?
How does a UCO Address Current Compliance Requirements and Voluntary Objectives?
What are the Next Steps Towards Developing a UCO?
Since carbon offset credits are physical commodities, they are traded through the transferring of title.
Alberta’s carbon market is highly fragmented. The TIER (Technology Innovation and Emissions Reduction Regulation) is Alberta’s third generation of an industrial carbon pricing and emission trading system. This marketplace currently allows for both Emissions Performance Credits (EPCs) and Emission Offset Credits (EOCs) to be generated, traded or used for compliance. Federally, companies will soon trade Greenhouse Gas (GHG) Offset Credits. Even still, there are other compliance (i.e., mandated by regulations) or voluntary (ESG-driven) markets generating and trading carbon offsets. Additional compliance markets with tradable credits exist in British Columbia and California. Furthermore, pricing in these markets is opaque and risk-laden with, payment terms, measurability, verification protocols, terms and conditions of contracting and future performance. These factors result in a slow-moving, boutique market that is unable to generate trade velocity despite an abundance of motivated buyers and sellers.
No. Under the current system, carbon credits cannot be traded across markets. That is, a carbon offset generated under Alberta’s TIER system cannot be traded in the British Columbia carbon credit market.
1. Standardization
The development of standard protocols, verification processes, production and consumption processes, pricing attributes, delivery obligations, payment obligations, trade default conditions, recourse, dispute resolution, and all other contractual terms and conditions that govern carbon offsets' production, consumption, and trade.
2. Risk Mitigation
The introduction of tools to mitigate the risks along the transaction chain from production, origination, trade, unsettled forward positions, delivery, and payment. This includes standardization and specific mitigants such as credit thresholds, insurance, collateral exchange, contingency pools, etc.
3. Forward Price Curve
A forward curve must be established to form a price for carbon offsets that have not yet been produced. This offers the price signal required to encourage investment and manage the market's ongoing supply/demand balance.
4. Equality
A mechanism must be put into effect that levels the playing field between the product (the offsets and EPCs) and the market participants (the counterparties trading offsets) to ensure a fair market.
Commoditization brings liquidity. Liquidity lowers risks, increases confidence, attracts new investment, and increases underlying asset value. Liquidity brings growth. Commoditizing carbon offsets achieves the first step to increasing efficiency in the carbon markets.
Commoditization is the result of effective market design with the purpose of utilizing market liquidity to achieve desirable outcomes. Commoditizing carbon offsets will require effective market design to build the carbon offset market from the foundation (spot markets) through to the long-term forward markets with the goal of creating liquid markets. All effective markets have two key elements, the commodity that is bought and sold and the entities that do the buying and selling, and both elements can perform more effectively with comprehensive market design. There are three critical building blocks of fair and effective market design:
1. Clear Contract Specifications that define the commodity, including how it is produced, priced, traded and consumed.
2. Firm Contract Obligations for buyers and sellers that dictate fair terms and conditions for trade.
3. Rules and Procedures that govern trading, pricing, and post-trade performance with clear definitions for failures and penalties that encourage trade and dissuade defaults.
The building blocks for fair and effective markets are best implemented through a clearinghouse that serves as a central counterparty (buyer to every seller, seller to every buyer), novating and managing transaction risks and recourse for all buyers and sellers.
A clearinghouse utilizes a central, multilateral rulebook to govern the product specifications, pricing, trade, delivery, payment, dispute resolution, default, and recourse for all market participants. The clearinghouse also provides an open-access forum that brings equality to both the commodities traded and the participants trading them to optimize liquidity. The clearinghouse levels the playing field.
The first step in the commoditization process is to agree on the core commodity. This core commodity should be a standard unit of emissions offset from any verifiable source that can be consumed by any emitting entity to meet either an obligation or a target. It should be standardized upstream of reaching the market such that price formation is a standard function of supply meeting demand. This core product should contain clearly defined and stringent performance criteria as to source, delivery, consumption and dispute adjudication and resolution. A broad range of attributes that modify the core criteria by location, timing and /or quality need to be defined and codified for the acceptance of all parties.
Yes. UCOs are physical commodities with definable characteristics and specifications. They can be transacted upon production or prospectively as future production from defined future projects. UCOs are fully fungible, may be banked for future sale or consumption and may be re-sold provided they have not been consumed.
Through the destratification of carbon credits, carbon market participants can converge on a common marketplace, dealing with one, well-defined commodity, as currently occurs in other established commodity markets such as crude oil or natural gas. This mitigates risk, simplifies the process of trading carbon credits (since there is only one type to trade) and opens the door to standardizations with respect to trade structures and contracts, decreasing the time it takes to execute a trade, and increasing potential for trade velocity.
It becomes a matter of defining an individual product’s output in terms of the core UCO product. For example, 1 MWh of renewable electricity generated in Alberta in 2023 would be a 0.53 UCO based on the ratio of an average carbon emission from Alberta’s electricity generation. This allows for the UCO determination to be done upstream of the market such that in the market only UCO’s trade, and trade as a completely fungible product that can be bought and sold by any market participants for any compliance or voluntary purpose.
Compliance requirements for emitting institutions would have targets reduced by consuming UCOs and intensity levels would be reduced by UCOs/unit of output.
There are 3 major milestones required to bring the Universal Carbon Offset concept to fruition.
1. Develop Industry Consensus on the specifications and characteristics of the new commodity, including the protocols.
2. Determine Enabling Regulations that support the creation of the UCO and the clearinghouse(s) that will create, register, mitigate risk and ensure performance of the UCO.
3. Design Risk Mitigation tools and processes that will be used by the clearinghouse to upgrade carbon offsets to fungible UCO’s and enable more efficient trading of spot and future offsets.