fixing the plumbing in carbon markets

why small technical rules make or break big climate goals

21-Jul-25

Carbon markets are meant to channel investment toward decarbonization, but in practice they often underperform. Credits can trade at deep discounts to statutory carbon prices, liquidity is thin, and investor confidence weak. The good news is that these issues are solvable, and the fixes are surprisingly small compared to the scale of the problem.

Transparency first

Most commodity and credit markets solved transparency decades ago with near real time reporting. Mandatory trade reporting (T+1 for large transactions) and a public feed would cost a few million dollars to implement but would immediately anchor price discovery. Markets like the EU ETS, California’s LCFS, and RGGI show how transaction level data builds trust and narrows spreads.

Triggers not discretion

Markets respond to clear rules. Automatic triggers such as tightening benchmarks when the price ratio stays below 60% for two quarters, capping the credit bank at 30% of future obligations, or activating a market maker when liquidity falls below 0.5% reduce political risk. The EU ETS Market Stability Reserve and RGGI reserves demonstrate how formulaic rules stabilize expectations and prices.

Liquidity mechanisms

Thin trading creates a vicious circle, where participants stay away because the market feels empty. A designated market maker quoting both sides within a set spread, plus central clearing for block trades, solves this. New Zealand’s ETS and financial markets like US Treasuries rely on similar mechanisms. The cost is modest and the payoff is credible continuous pricing.

Supply discipline

Oversupply of credits collapses value. Legacy stockpiles need limits. A banking corridor at 30% of obligations and credit expiry after five years prevent the system from being swamped. California and RGGI already apply similar rules. Without them, no amount of headline price will matter.

Contracts with guardrails

Investors want long term certainty. Standardized contracts for difference can guarantee future credit values, but they need fiscal caps and stop rules to be credible. The UK’s offshore wind CfDs prove how standardized capped contracts can unlock billions without runaway costs.

Start small on linkage

Interprovincial linkage is important, but it does not need to happen all at once. Start with durable credits such as CCUS removals. Add conversion factors and escape clauses if spreads widen too far. California and Quebec linked in 2014 and liquidity deepened overnight. The EU ETS began as fragmented national schemes and merged. You phase it in.

ROI

The return on investment is compelling. Transparency might cost 2 million dollars and deliver a 15% lift in price efficiency. A market maker could run 5 million dollars and multiply liquidity by ten. Supply discipline is mostly administrative but carries the largest price impact. Altogether, the plumbing can raise market health from critical to credible for less than the budget of a small infrastructure project.

Principles like integrity, durability, and competitiveness are essential. But without plumbing, they are only aspirations. Get the plumbing right, and the principles come alive.