Carbon credits may come to serve as payment for the environmental service provided by conserving forests beyond the legal reserve defined by the Forest Code

By Christian Rosa and Bruno Galvão

Nation states and multilateral organizations have been working to build a suitable institutional environment, with rules that set incentives and controls capable of promoting convergence between socioeconomic development and environmental responsibility.

On the one hand, the social and environmental burdens of industrial activities must be internalized in production costs. The use of natural resources and the discharge of waste and emissions into the atmosphere affect society as a whole, and it is appropriate for this burden to be imposed, in a rational manner, on the business. On the other hand, it is essential to preserve local industry, safeguarding jobs and technological mastery over strategic economic activities.

Tocantins announced a pioneering arrangement for trading institutional carbon credits

There is no predetermined regulatory solution or ready-made institutional formula that can be applied in any jurisdiction. But efforts in this area are already beginning to define good practice parameters, aligned even with consumer behavior, which increasingly values sustainable production and is often willing to pay more for it.

In this scenario, Europe’s response to climate change and sustainable development, the so-called European Green Deal, is central to the bloc’s political discussions. And one of its key elements is the European carbon market system, which is being reformed.

The main criticism of the European Union Emissions Trading System (ETS) is the mechanism for distributing free emission allowances, used by the EU to counter an undesirable effect of its continental emissions control policy: the relocation of its industry to countries with less stringent climate requirements, known as “carbon leakage”.

To replace this free allocation of allowances, the EU is now debating the CBAM (Carbon Border Adjustment Mechanism), a customs charge on the CO2 emissions of certain goods imported into Europe, especially from heavy industry (steel, chemicals, etc.). The amount of this charge will be tied to the price of allowances traded in the ETS.

Thus, European industry would no longer have an incentive to produce in countries outside the bloc, since, when selling its goods in Europe, it would have to pay for emissions as much as if it were in the EU. The proposed regulation was approved at first reading by the European Parliament and awaits the position of the Council of Ministers (made up of the heads of the Member States’ executive branches), which is expected later in 2022.

Brazilian industry already views the CBAM with concern because of the commercial impacts and the operational costs this new system may bring. However, there are far more opportunities than challenges for Brazil in this carbon market.

The potential of Brazil’s carbon credits has two major streams of opportunity, especially in Europe. The most obvious is their sale on the European voluntary market, since the regulated market, since 2021, has not allowed the use of international credits to offset emissions within the territorial limits set by the European Commission.

This is because, beyond the minimum rules established for local reduction and offsetting, products that neutralize their carbon footprint, or are carbon-negative, can use this as a differentiating feature, reaching consumer niches that see this characteristic as a critical variable in their choice, regardless of price. This voluntary market is expected to grow considerably in the coming years.

Another possibility, still somewhat distant, is that carbon credits may come to serve as payment for the environmental service provided by conserving forests beyond the legal reserve defined by the Forest Code. The EU has been discussing a ban on selling agricultural commodities on the European market when produced in areas deforested, legally or illegally, after 12/2019. And since this new European guideline would even affect areas that are legally available for production in Brazil, carbon credits may be an instrument to encourage Brazilian agricultural producers to preserve beyond the legal obligations of Brazilian law.

In Brazil, industry, agribusiness and even the public administration need to be aware of the new market parameters. This is why the move by the State of Tocantins deserves attention, in a pioneering arrangement for trading institutional carbon credits.

Through Tocantins Parcerias, a company that is part of the state public administration, the state recently announced a project to enter the voluntary carbon market, offering on the market this asset arising from its efforts to reduce emissions from deforestation and forest degradation.

In its public call, the State expressed interest in establishing a relationship with a private partner operating in the carbon market that can finance the structuring of the state administration, making it eligible to offer certified carbon credits to the domestic and international markets. In this way, the reasons for protecting the environment within the State are reinforced while, for the benefit of the public treasury and the local population, this green asset is monetized, creating another source of revenue for developing public policies.

The initiative is innovative and deserves to be followed closely. The exploitation of this emerging market by Brazilian industry and the agricultural sector, and now also by the public administration, may put the country in a very advantageous position in the international market, very profitably combining the promotion of economic development with the protection of natural resources.

Article originally published in the Valor Econômico newspaper (in Portuguese), on 11.07.2022.