Voluntary Carbon Market Speeding up Global Decarbonization

The voluntary carbon market (VCM) was created to support programs to reduce greenhouse gas (GHG) emissions. In its infancy, the market was distinguished by innovative new approaches to combating climate change. Over time, the VCM has evolved into a robust and effective system for tackling climate change by directing funds to initiatives that achieve independently verifiable and enhanced global carbon reductions.

The VCM also enables businesses to achieve ambitious climate goals by combining internal emission reductions – an essential first step – with the purchase of carbon offsets. By the end of 2019, the market completed about 608 million tonnes of CO2e in emission reductions or eliminations, which is comparable to more than 131 million automobiles being taken off the road annually.

Can a voluntary carbon market help us get to net zero?

The world must immediately reduce emissions to limit global warming to 1.5 degrees Celsius. Studies show that we need to cut global emissions in half by 2030 if we want to have net-zero emissions by 2050. In some cases, it has been said that natural climate solutions (NCS), such as protecting and restoring forests and better managing soils and wetlands, can do one-third of the cost-effective emission reductions needed by 2030 (up to 10Gt a year). Businesses, the government, non-governmental organizations, and investors can all benefit from the voluntary carbon market (VCM), which lets them buy carbon credits that show emissions have been cut in a way that can be checked. This is an important tool for the National Center for Science and Mathematics, which has been underfunded and undervalued in the past, to live up to its full potential.

NCSs need to be given a monetary value to reach their full potential. This includes storing carbon, filtering water, making oxygen, and promoting biodiversity, among other things. Additionally, there is a need for private money to flow into the public sector. This can be accomplished by the VCM, as it is the first global private market to accurately value, at scale, the service that an ecosystem provides to the planet, in this case storing carbon. It is much easier to get large amounts of private capital with a strong VCM today than a few years ago. The VCM is not the only way to pay for the National Center for Science and Technology, but it is a vital and immediately useful option.

It is important to distinguish between the voluntary carbon market (seen below the x-axis line in the infographic) and the compliance cap-and-trade market (like the EU Emissions Trading System), which is meant to drive deeper emissions reductions by firms (shown above the x-axis line). These two markets may likely converge under new Article 6 rules approved in Glasgow during COP26. In addition, as compliance regimes such as the Carbon Offsetting and Reduction Scheme for International Aviation scale up towards the end of 2020.

Voluntary Carbon Offset Programs

CO2 offsets are available on the voluntary carbon markets. Businesses can buy offsets created by the voluntary or compliance markets. In a voluntary market, purchasers (corporations, institutions, and individuals) create demand, but in a compliant market, regulators create demand.

In compliance markets, voluntary offset credits are more expensive. Many elements influence a buyer’s interest in a project to best depict a firm or organization as a climate actor. Voluntary offset markets’ pricing reflects the fact that buyers’ aims vary. Voluntary market credits are priced depending on project charisma and marketing potential, project kind, location, and co-benefits that purchasers value.

Voluntary offset schemes, entities, standards, and protocols abound. Voluntary market offsets have been pushed as a means for experimentation and innovation. They have a lower transaction cost than offsets generated for obligatory compliance. Also, micro-scale projects that are too small to bear the administrative overhead of compliance offset programs or initiatives not covered by compliance schemes can use voluntary marketplaces. In the early phases of the voluntary market, the lack of established quality criteria worried the broader offset market.

As a result, stakeholders in the carbon market set out to develop norms and protocols to increase voluntary offset quality. The purposes and services supplied by these standards and protocols vary greatly. Completion of offset programs has established standards and administrative procedures for accounting, quantifying, and reporting offset projects and credits. These full-fledged programs tend to expand on existing compliance laws and procedures, most notably the CDM. These initiatives are intended to increase consumer confidence in the reliability and integrity of certified offsets by providing quality assurance certification for offset credit suppliers.

On the other hand, standards like ISO 14064-2 and guideline documents like the WRI GHG Protocol for Project Accounting exist. Individual offset programs can use these guidelines and recommendations to create their own definitions, accounting frameworks, and quantification alternatives.

Local community and biodiversity benefits are important factors in this project. The Climate, Community & Biodiversity Standards and SocialCarbon establish criteria for robust project design.

Challenges for Voluntary Carbon Markets

A corporation can buy carbon credits to offset emissions it cannot eradicate. Carbon credits are certificates for quantities of greenhouse gases avoided or eliminated from the atmosphere. Carbon credits have been used for decades, but the voluntary market has risen rapidly in recent years. According to McKinsey, buyers retired carbon credits worth around 95 million tonnes of CO2e in 2020, more than double the amount in 2017.

As worldwide efforts to decarbonize the economy increase, voluntary carbon credits may gain popularity. Experts forecast that the annual worldwide demand for carbon credits may reach 1.5 – 2.0 gigatons of CO2 by 2030 and 7 to 13 CO2 by 2050. (Refer to Exhibit 3). Depending on price estimates and underlying circumstances, the market size in 2030 might range from $5 billion to $30 billion to more than $50 billion.

Despite the immense growth in demand for carbon credits, it is estimated that supply might match demand in 2030: 8 to 12 GtCO2, primarily from four areas, Averted nature loss (including deforestation), nature-based sequestration (such as reforestation), prevented or reduced emissions (such as landfill methane), and technology-based removal of carbon dioxide from the atmosphere.

Way forward for Voluntary Carbon Markets

Several variables may make it challenging to organize and market the total potential supply. Project development would have to accelerate dramatically. Most potential prevented nature loss and natural sequestration supply are concentrated in a few countries. Risks abound in all ventures, and the time it takes from initial investment to final credit sale may deter some investors. A new action plan is needed to scale voluntary carbon markets. Building a viable voluntary carbon market will take collaborative work on many fronts. The voluntary carbon market can be expanded in six areas along the carbon credit value chain:

Creating agreed standards for defining and validating carbon credits:

• The current voluntary carbon market lacks liquidity due to credit heterogeneity. Each credit provides information about the underlying project, such as its type or region. Clients value these attributes differently, affecting the credit price. Due to credit irregularities, connecting a buyer to a supplier is a slow and inefficient process.
• If all credits shared common properties, matching would be more efficient. The first set is quality. The “Core Carbon Principles” quality requirements would assure true emissions reductions. The second set would include the carbon credit’s additional features. A unified taxonomy would let sellers offer credits and buyers find credits that meet their needs.

Creating standard contracts:

• The volumes traded are too tiny to provide meaningful daily price signals for several reasons. Increasing the uniformity of carbon credits would reduce trade and boost exchange liquidity.
• After establishing the following principles and features, exchanges could construct “reference contracts” for carbon trading. Reference contracts combine a core contract with different qualities paid individually. Companies may bid for credits that fit specific criteria, and the market may aggregate smaller amounts of credits to match.
• Reference contracts would also provide a daily market price. Nevertheless, many parties will continue to deal without them (OTC). Credit prices from reference contracts could be utilized to price OTC trades.

Building a trading and post-trading system:

• High-volume listing and trading of reference contracts and contracts with limited extra features are achievable. This could allow project developers to access structured funding.
• Clearinghouses and meta-registries are also needed. Clearinghouses would help build a futures market and protect against counterparty default. Meta-registries would act as custodians for buyers and suppliers, allowing for consistent project issuance numbers (similar to the International Securities Identification Number, or ISIN, in capital markets).
• Technological advances could boost data transparency. Environmental and financial sectors demand real-time data. Limited data access and the opaque OTC market prevent transparent reference and market data. Existing registries’ data would be used for new reporting and analytics applications.

Getting agreement on how to use carbon credits:

• Credits are used with caution in decarbonization. If corporations can offset their emissions, will they reduce their own? Clean offset requirements would help companies attain net-zero emissions. CO2 offsetting is a method of reducing CO2 emissions by offsetting CO2 emissions that would otherwise be emitted.
• To obtain carbon credits, a company must first declare its overall greenhouse gas emissions and its goals and plans for reducing emissions over time. So it may claim the reductions as its own and remove them from the market so others can’t claim them. It may also use carbon credits to offset future emissions.

Putting systems in place to protect the market integrity:

• Interruptions in the evolution of the voluntary carbon market. Credit variety increases errors and fraud risks. Money laundering is possible due to the market’s lack of price transparency.
• Assign credit for tasks digitally. A project’s impact should be tracked continuously, not just at the end. Project developers’ credit issuance and cash flow should be faster, and corporate offset claims should be more legitimate.
• Another improvement is creating a governance body to vet market participants, monitor their behaviour, and regulate market operations.

Sending clear demand signals

• It would help if buyers of carbon credits could signal future demand. Long-term demand signals may include pledges to reduce GHG emissions or upfront carbon credit agreements with project developers. A register of carbon credit agreements could record medium-term demand.
• Stronger standards and infrastructure are needed to create and sell consumer-oriented carbon credits and increase industry-wide collaboration to align emissions reduction targets.

References

1. Carbon offsetting goes mainstream as producers set sights on net-zero
2. How the voluntary carbon market could help us get to net zero
3. Blueprint for scaling voluntary carbon markets to meet the climate challenge
4. Understanding voluntary markets – August 2021
5. After COP26, new questions arise over carbon trading as markets gain new prominence
6. Voluntary carbon markets: how they work, how they’re priced and who’s involved
7. Carbon offsets prove risky business for net zero targets

Voluntary Carbon Markets – A blueprint