What is the Compliance Carbon Market

The Compliance Carbon Market (CCM) is also known as ‘mandatory carbon market’. These markets, which are regulated by governments, have been originated as a result of a regional, national or international regulatory requirement or policy.

These schemes, as their name implies, are obligatory and the sectors or companies that generate GHG emissions must comply with the specific regulations from that market.

The CCM is crucial for governments to meet their carbon reduction goals. The current initiatives are designed to target the most energy-intensive industries, such as power generators and oil refineries, as well as the metallurgical, cement, and paper industries, among others.

The Compliance Carbon Market is divided into 2 main levels:

Carbon Tax, known as a price instrument.
Cap-and-Trade programs, known as a quantity instrument.

Carbon Tax Schemes

Under these programs, governments impose a defined tax (or surcharge) that emitters must pay for each ton of greenhouse gas (GHG) emissions generated to the atmosphere. The tax is usually levied on fossil fuels (such as oil, coal, gas), or other carbon-intensive activities.
This enforcement means an economic incentive to reduce emissions in cases where doing so would be cheaper than paying the surcharge by encouraging emitters to adopt cleaner and more sustainable technologies, switching from fossil fuels to renewable sources, improving energy efficiency, etc.
The tax value is set by assessing and establishing the cost to mitigate each ton of greenhouse gas emitted.
The level of the tax will determine the amount of emissions reduced achieved by these schemes.
A correct implementation of the carbon tax is crucial, since if the surcharge value is too low, emitters will decide to pay the tax and it won’t have an impact on the reduction of their emissions. On the other hand, a too high tax will impact on the business profits and consumers.
The revenue allocation of the tax will be used depending on the policy objectives, such as for example: investing on climate mitigation measures, renewable energy activities, support social programs, or reduce taxes in other areas.
An example of these mechanisms are the British Columbia Carbon Tax Program, implemented in 2008, and the South Africa Carbon Tax Act since 2019.

Cap-and-Trade Schemes

Under these schemes, governmental regulators set a limit or cap on the number of emissions allowances allocated to companies, sectors or nations participating in the market.
These allowances are tradable permits that mandate the maximum amount of GHG emissions that entities are permitted to emit, they can also be “banked” and used in the future.
Each allowance (or emissions permit) typically allows its owner to emit one tonne of a pollutant such as CO2.
These are subsequently traded in a secondary market, with corporations seeking to buy and sell allowances in accordance with their own organisational needs (for example, a corporation which has high emissions may seek to purchase additional allowances).
The supply and demand for these allowances establishes the market price. Since the compliance carbon credits are generated and traded for regulatory compliance, they typically experience commodity pricing, where all credits in a particular program are priced similarly based on the dynamics of supply-and-demand, regardless of project type and other characteristics.
Both emitters and financial intermediaries are allowed to trade emissions allowances to generate revenue from their “excess” allowances and or enable them to meet their regulatory requirements.
Emitters with insufficient number of allowances required for heir industry at the end of reporting period incur penalties.
An example of these mechanisms is the California Cap-and-Trade Program, existing since 2012.