Developing Carbon Credit Markets

Published: 8 February 2021

Net Zero Carbon Policy is an Energy Systems Catapult thought leadership project, focusing on how the UK can develop an innovation-friendly, economy-wide framework for Net Zero.

We are building on the insights from our Rethinking Decarbonisation Incentives project, to develop credible policy options for an efficient and socially beneficial transition.

In this report, we explore how linking sectoral policies through trading can play a key role in opening a pathway to an economy-wide carbon policy framework.

This approach has a number of key advantages for achieving Net Zero:

  • Trading provides flexibility in compliance strategies to emitters and enables a cost-effective and efficient balance of emissions reduction across sectors to emerge over time, including the development of negative emission technologies.
  • Linked markets will place a more coherent value on emissions reduction across the economy, ensuring better optimisation of the use of low carbon energy vectors – such as biomass and hydrogen – across different sectors.
  • Linking enables sectoral policies to be aligned with the UK’s economy-wide Carbon Budgets.

We anticipate that different sectoral policies can be implemented in ways that complement, or are consistent with, an overarching UK ETS. There is potential to place sectoral policies within the ‘cap’ of an ETS and for them to be linked by allowing the trading of carbon credits across sectors. In this sense, sectoral carbon policies can be seen as modules that can be linked over time so that they create and impose an economy-wide ‘cap’ on all emissions. Initially, trading may take place within sectors with links introduced progressively across sectors as circumstances allow.

The aim of linking sectors is not to impose an economy-wide effective carbon price, rather it is to enable cost-effective emissions reduction that would result from flexible trading. The detailed metrics of tradeable carbon credits in each sector could vary depending on the design of sectoral obligations or regulations. To enable linkages via trading, sector-specific carbon metrics and standards can be converted into a common ‘currency’ of £/tCO2e.

An example of the potential sector-specific carbon metrics or standards that could be converted into a common ‘currency’ of £/tCO2e to allow trading of carbon credits across the economy.

Sectors can begin to link as soon as the associated carbon markets allow, but this requires carbon policy design to consider linkages from their inception. In this way, sectoral carbon policies can remain tailored to the associated challenges and opportunities that arise within each. This approach is likely to be both publicly and politically more acceptable than attempting to apply or expand a blanket approach using a single carbon tax or a single overarching emissions trading system.

Recommendations for Policymakers

Our Net Zero Carbon Policy project has so far proposed actions to initiate a sector-led approach as a pathway to an economy-wide carbon policy framework. To enable this will require – amongst other things – trading of carbon credits within and across sectors. In order to develop such linkages, we suggest that policymakers consider the following recommended actions.

  1. As part of aligning the UK ETS cap with Carbon Budgets and Net Zero, explore the options for integrating and linking sectoral outcome-based standards.
  2. Assess the design options for an explicit decarbonisation outcome obligation on major electricity purchasers (linked to, or placed within, the UK ETS cap) as a technology-neutral mechanism to drive full decarbonisation of electricity generation.
  3. Ensure that the design of all sectoral carbon policies, standards, or decarbonisation outcome obligations includes the potential for future linkages between sectors via trading of carbon credits. This should include plugging gaps in existing policies, as well as those implemented in the future.
  4. Take initial steps to develop a Greenhouse Gas Removals marketplace using taxpayer-funded payments to farmers for providing public goods. The linking of the UK ETS and the GGR marketplace could be one of the first linkages established between Net Zero aligned sectoral carbon policies.
  5. Assess the improvements in the arrangements for monitoring, reporting and verification of emissions and emissions reductions/removals that are required to enable future cross-sector trading of carbon credits, and underpin confidence in delivery of Net Zero.
  6. Use the COP26 Presidency to ensure Article 6 of the Paris Agreement is agreed before the end of 2021.