Carbon Markets and Emission Trading: General Overview & Türkiye's upcoming Emissions Trading System

Introduction

The movement for carbon emission controls and emission reductions, which started with the Kyoto Agreement in European countries, has expanded its place on the agenda as a focal point worldwide. The Clean Development Mechanism (CDM), launched by the United Nations in 1997 under the Kyoto Protocol, laid the foundation for mandatory (compliance) carbon markets. It was designed to help ensure that the binding targets set by the participating governments are achieved. At the same time, increasing public awareness and consumer trends have triggered voluntary carbon markets. Thus, the process of balancing commercial activities and mitigating the climate crisis through carbon trading between countries and businesses has begun. Carbon credits and offsets are the foundational elements of the carbon market. Governments and companies can purchase carbon credits in emissions trading systems if they exceed an emissions cap. These credits allow the holder to emit a specified amount of carbon dioxide or other greenhouse gases. Carbon credits are utilised in compliance markets, while carbon offsets are used in voluntary markets to meet specific standards.

Dynamics of Carbon Markets

In this context, there are carbon trading and emissions trading system (“ETS”) rules that impose mandatory obligations and require compliance with national and international regulations as well as the emission reduction targets of countries or international mechanisms. These rules determine how international carbon credits are recognised and used. For example, the European Union Emissions Trading System (EU ETS) allows carbon credits from other countries to be used under certain conditions. According to the World Bank Group's annual report, a major highlight is that carbon pricing instruments cover around 24% of global emissions.[1] Emission allowances, monitoring, reporting, verification and flexibility mechanisms are essential elements of the compliance carbon markets. In these markets, if a business emits less carbon than its allocated limit, it can sell its surplus allowances to another company that exceeds its limit within the C&T (cap and trade) system. Today, there are 75 carbon taxes and emission trading systems worldwide by 2024.[2] Carbon pricing is most commonly applied in the energy and industrial sectors. However, its application is expected to expand to the logistics, aviation, maritime, waste and recycling sectors as well.

The other carbon market category is voluntary carbon markets that operate with specific standards. In this context, carbon offset projects and carbon credits of businesses are certified.[3] In voluntary carbon markets, standards such as the Verified Carbon Standard (VCS) introduced internationally by the International Emissions Trading Association (IETA) and the World Bank, ISO's 14064 Standard Series, and the Gold Standard, endorsed by many environment and development-focused NGOs, certify that businesses prioritize environmental impact over profit. For example, a leading non-profit governance body in the sector, the Integrity Council for the Voluntary Carbon Market, released its global benchmark for high-integrity carbon credits together with the Core Carbon Principles. The goal of these criteria is to maximize the effectiveness of the voluntary carbon market in supporting global climate targets.[4]

Regulations and Practices Worldwide

The United Nations' practice is characterised by two different carbon market systems. The first mechanism allows its parties to use "internationally transferred mitigation outcomes" to achieve their mitigation targets. It encourages governments to promote sustainable development, ensure environmental integrity and transparency, and aim to prevent double counting. The other system, the Sustainable Development Mechanism (SDM), provides a framework for voluntary cooperation between countries to achieve their nationally determined contributions (NDCs) using internationally transferred mitigation outcomes. This mechanism allows countries to trade emissions reductions and collaborate on climate action.

As an influential factor in carbon markets, the OECD introduced a detailed carbon pricing measure known as net effective carbon rates (nECR). This metric encompasses both indirect carbon pricing via fossil fuel taxes and subsidies, as well as direct carbon pricing. In addition, the Carbon Border Adjustment Mechanism (“CBAM”), which extends beyond Europe and aims to reduce emissions in non-EU countries through carbon trading in the same way, entered into force with its first phase at the end of 2023. The EU's CBAM is a mechanism designed to assign a fair cost to the carbon emissions produced while manufacturing carbon-intensive goods imported into the EU while promoting cleaner industrial production in non-EU countries. The CBAM regulation ensures that the embedded carbon emissions in certain goods imported into the EU or other regulating countries have been priced accordingly. This mechanism guarantees that the carbon cost of imports matches domestic production, thus supporting the EU's climate goals.

From 2024, ETS and carbon taxes will be introduced in various regions, including parts of Canada, the EU, and Mexico. Additionally, carbon taxes are present in the Northwest Territories (Canada), South America, Ukraine, South Africa, Japan, Taiwan, and Singapore. ETS is applied in Alberta, Ontario, parts of the EU, Kazakhstan, China, Oceania, and certain US states (Washington and California).[5]

At the COP28 event, Türkiye announced plans to begin a two-year pilot phase of its ETS for the energy and industry sectors starting in October 2024, following the enactment of necessary legislation to meet its climate goals and adapt to the CBAM. This ETS system will extract data from Türkiye's existing Monitoring, Reporting, and Verification (MRV) system.[6]

International agreements regulate the ability of companies to use carbon credits in different countries. These agreements set rules and mechanisms for cross-border carbon trading. For example, Joint Implementation under the Kyoto Protocol and the Clean Development Mechanism enable such transactions. Companies can earn carbon credits by investing in decarbonisation projects in other countries. Such projects should be certified by international certification mechanisms such as the Gold Standard[7], Verified Carbon Standard (VCS)[8] or UN’s Clean Development Mechanism (CDM)[9], as mentioned above for voluntary carbon markets. For compliance carbon markets, companies can trade carbon in compliance with relevant national and international regulations. For example, a company must adhere to the relevant international and national regulations to invest in a reforestation project in Africa and use the resulting carbon credits in its home country.

Practical Implications: Weighing the Pros and Cons

Carbon trading programs may face challenges in maintaining financial stability over the long term due to price fluctuations and market instability. Furthermore, ambiguous tax policies and regulatory frameworks across different regions lead to uncertainty and complicate adherence to rules. Variations in how countries implement these schemes can also impact the legitimacy of carbon credits, resulting in market inconsistency. Maintaining the credibility of carbon credits is another significant issue, as fraudulent credits and inadequate verification processes can compromise the market.

Among the 195 countries that signed the Paris Agreement, major economies are advancing their industrial reforms, implementing carbon market regulations, and pushing for green transformation. However, developing nations are struggling with this transition and are falling behind in execution. The ambiguity in carbon accounting methods is prone to disputes, and carbon credit standards organisations are also encountering a higher risk of contractual disagreements.

Especially in voluntary carbon markets, a lack of transparency has resulted in a rise in litigation cases. For example, a recent high-profile case involved an airline company. In March 2024, the District Court of Amsterdam ruled that the company’s carbon offset program misled consumers by overstating the environmental benefits of its carbon offset measures, such as reforestation and the use of Sustainable Aviation Fuel (SAF). The court found that these measures had only a minimal effect on reducing the environmental impact of flying, thus creating a misleading impression of sustainability among the public.[10]

On the other hand, driven by climate agreements like the Paris Agreement and grooving awareness among communities and consumers, carbon pricing, taxes, and emission systems are gradually and steadily expanding their applications.

Companies that emit more carbon than the limits set in regulated regions tend to control their carbon emissions through carbon credits and taxes. Carbon markets facilitate cost-effective emission reductions by allowing companies that can reduce emissions at a lower cost to sell their excess allowances to those facing higher reduction costs. This incentivizes lower carbon emissions, as companies that reduce emissions below their limit can profit from selling their surplus credits.

Conclusion

Both mandatory and voluntary carbon markets play a crucial role in enabling cost-effective emission reductions and promoting accountability. Recent cases illustrate concerns about misleading practices and greenwashing, where companies may overstate the environmental impact of their carbon offset programs. International regulative bodies, NGOs, countries and companies must collaborate to increase the implementation of enhanced regulatory frameworks, work on the standardisation of carbon credits and improve transparency and reporting. As highlighted by the diverse implementation of carbon pricing and trading systems worldwide, from the EU's CBAM to Türkiye's upcoming Emissions Trading System, the global landscape is progressively aligning towards sustainable practices. Looking ahead, the success of these initiatives will depend on balancing stringent regulations with market flexibility. This balance is crucial for ensuring that the transition to low-carbon economies is both practical and equitable.