2021 will probably be remembered as the year carbon finance was an issue of discussion in various industries.
Within the 2021 fresh entrants to carbon markets with a voluntary approach, oil and gas majors as well as hedge funds and banks were deemed to be the most active participants, determinedly entering the market. As the year progressed and the year progressed, different sectors of the economy entered the market as a result of their commitments to cut carbon footprints.
A number of political bodies, including the EU or the UK as well as the US state of California have already enacted mandatory carbon markets covering specific industry sectors and the production of gases. These are a crucial component of efforts to reach the Paris Agreement objective of limiting global heating to 2 degrees Celsius above preindustrial levels (with an ambitious target of achieving the limit of 1.5 C increase), even although some of these markets were established prior to their Paris commitments.
But other sectors have taken a cue from compliance schemes and promised to offset carbon dioxide emissions (GHG) by taking part in carbon markets for free.
Voluntary carbon markets enable producers of carbon to reduce their unavoidable emission by purchasing carbon credits produced by projects aimed at removing or decreasing GHG out of the atmosphere.
Each credit – which corresponds to a metric tonne of decreased, avoided or eliminated CO2 or a comparable GHG is able to be used by a company or an individual to offset for the emission of one metric ton CO2 or other equivalent gases. If a credit is utilized for this purpose it becomes an offset. It is transferred into a registry for retired credits, or retirements, and it is no longer tradable.
Companies can join the market for carbon emissions, either by themselves or as part an industry-wide program including The Carbon Offsetting and Reduction Scheme for International Aviation, which was developed by the aviation industry in order to offset greenhouse gas emissions. Airlines from around the world participating in CORSIA have pledged to offset all CO2 emissions they produce over a base level of 2019.
Although compliance markets are currently limited to certain regions however, carbon credits that are voluntary are significantly more fluid, not governed by the boundaries of national states as well as political unions. They are also able to be utilized by every segment of the economy instead of just a small number of industries.
The Taskforce for Scaling Voluntary Carbon Markets which is sponsored by the Institute of International Finance with support from McKinsey, estimates that the carbon market credits could amount to upwards to $50 billion by as soon as 2030.
The participants
Five main players make up the core of carbon markets.
PROJECT DEVELOPERS
Project developers represent the upstream segment in the marketplace. They establish the projects that issue carbon credits. These can vary from large-scale, industrial projects like a high-volume hydro-power plant, to smaller, community-based projects like clean cookstoves.
There are several projects that aim to reduce or eliminate directly emitted emissions resulting from industrial processes, such as Ozone-capture, fugitive emission management or elimination of ozone depleting substances as well as wastewater treatment. Projects based on nature comprise REDD+ (avoided deforestation) soil sequestration and afforestation. Other kinds include carbon capture using technology such as direct air capture. new categories are being introduced continuously.
Each credit comes with a particular vintage which refers to the year it was issued, and a specific delivery date, which is when the credit is available on the market. Alongside their primary goal of avoiding or eliminating GHGs from the atmosphere Credit projects may produce additional ‘co-benefits’ and aid in meeting some of the UN’s Sustainable Development Goals (SDGs). They could, for instance, help improve the quality of life for people living in the area, better the quality of drinking water and the reduction of inequality in the economy.
End BUYERS
The downstream market is made up of buyers who are end-users: businesses or individuals who have pledged to offset all or a part of their GHG emissions.
One of the first buyers of carbon credits was tech companies such as Apple and Google, airlines, and oil and gas majors however more sectors of industry including finance, are entering the market in the process of setting their own net zero goals or search for ways to protect themselves from the financial risk posed by the transition to renewable energy.
The implementation of Article 6 of the Paris Agreement on November 13 at the UN Climate Conference, or COP26, in Glasgow laid out the rules for a crediting mechanism that could be used by 193 countries that are parties to the Paris accord to meet their emission reduction targets or nationally determined contributions. The implementation of Article 6 has made it possible for countries to purchase voluntary carbon credits, so provided that Article 6 rules are respected.
RETAIL TRADERS
In order to link demand and supply There are brokers as well as retail traders, much like in other commodity markets. Retail traders buy large quantities of credit directly from the supplier, bundle those credits into portfolios ranging from up to thousands of comparable tons of CO2 and then sell the bundles to consumers usually with a commission.
While the majority of the transactions currently take place in private conversations and over-the-counter deals, some exchanges are also emerging. One of the biggest carbon credit exchange currently in the present are NY-based Xpansiv CBL and Singapore based AirCarbon Exchange (ACX).
Exchanges have been trying to simplify and speed up the trade of carbon credits with a high level of complexity because of the number of factors affecting their price by developing standard products, that make sure that certain fundamental specifications are followed.
For instance, both Expansiv CBL as well as ACX have set up standard products for nature-based credits CBL’s Nature-based Global Emission Offset (N-GEO), and the ACX Global Nature Token.
Credit transactions that are conducted under these labels are guaranteed to have set characteristics including the kind of underlying project, a relatively recent date, and a approval from a specific set of standards.
Exchanges’ standardized offerings – especially those for forward delivery are preferred by traders and financial institutions who are looking to purchase and hold in anticipation of growing demand for carbon credit.
End buyers who must acquire credits for offsets to their carbon emissions are more likely to choose non-standard products since they permit them to examine the particular characteristics of each project, ensure the quality of the credit that they purchase and, consequently, be protected from possible allegations of greenwashing.
Most often, exchanges are used to settle big bilateral agreements that were concluded offscreen. In a note on market conditions in May, CBL said that an additional number of bilateral agreements negotiated offscreen were being negotiated by traders to be settled via the CBL platform.
They comprised large portions of transactions traded on CBL.
BROKERS
Brokers purchase carbon credits through a retailer trader and sell them on to the buyer who will purchase them typically, often with a small commission.
STANDARDS
There is also a fifth actor which is unique to carbon markets. Standards are usually organizations, typically non-profit organizations, that verify the project’s compliance with its stated objectives as well as its declared emissions levels.
Standards have a series of guidelines, or methods that are applicable to every kind of carbon project. For instance, a reforestation project will follow specific rules when calculating the carbon dioxide absorption of the forest planned and therefore the number of carbon credits that it earns over the course of.
Renewable energy projects is governed by a set of regulations to apply when calculating its value by reducing CO2 emissions and carbon credits that are generated in the course of time.
Standards’ certifications also ensure certain fundamental principles or standards of carbon finance are adhered to:
Additionality: The plan should not be legally required, common practice, or financially attractive in the absence of credits revenues.
Do not overestimate CO2 emissions: the reductions should be in line with the amount of offset credits that are issued for the project and should take account of any unintended GHG emissions generated by the project.
Permanence: The effect of the GHG emission reduction shouldn’t be susceptible to reversal and will lead to a lasting decrease in emissions.
Unique claim: Every metric tonne of CO2 may only be claimed one time and must be accompanied by the proof of credit retirement upon project maturation. Credits are offsets at retirement.
Add additional environmental and social benefits: The project must be in compliance with all legal requirements of its jurisdiction, and should offer additional co-benefits that align to the United Nations’ SDGs.
The overlap of roles, bilateral trade
There is a cross-over of roles, which is unique in the carbon marketplaces.
Many brokers act as traders, and a lot of financiers have brokering arms as well as the project development arm.
End buyers are also able to be able to finance their own carbon projects and opt to keep any or all of the issued credits for their own offset needs.
All of these entities could ultimately offer credits to buyers and a developer might organize to sell them directly. All of these events can have an impact on prices, and eventually alter the transparency of the market.
Pricing a wide range of products
When a company turns to market for carbon credits that are voluntary as a alternative to pay for its carbon emissions, one of the key aspects it will be looking at is the cost of carbon credits. By knowing this the company can determine what level of ambition to set when setting its emission reduction goal and whether voluntary markets can assist in achieving it.
At the same time the clear value signal on carbon enables those who are already in the market to verify that they are trading their credit at a price that reflects the real market value.
However, setting the price for carbon credits is far from an easy process, in large part because of the many kinds of credits on the market and the variety of factors influencing the price.
Carbon credits issued by carbon projects could be of different types and sub-types. What is the nature of the underlying project is one of most important factors affecting the price that the credit is issued.
Carbon credits can be grouped in two major categories, or baskets: projects to avoidance (which are designed to avoid the emission of GHGs completely therefore reducing the volume of GHGs released to the air) as well as removal (which eliminate GHGs in the first place from our atmosphere).
The avoidance basket includes renewable energy sources, but also forest and farming emissions prevention projects. These projects, sometimes referred to as REDD+, stop destruction of wetland and deforestation or implement soil management practices in farming that limit GHG emissions, for instance projects designed to prevent carbon emissions caused by dairy animals and beef cattle by varying their diets.
Cookstove projects, fuel efficiency or the construction of buildings that are energy efficient are included in the avoidance basket as do projects for capturing and eliminating industrial pollution.
The removal category includes projects capturing carbon from the atmosphere and then storing it. They could be based on nature that use trees or soil for example, to take carbon out and store it. Examples include afforestation and reforestation projects, and wetland management (forestry and agriculture). They can also be tech-based and include technologies like direct air capture or carbon capture and storage.
Credits for removal tend to trade with a higher value than avoidance credits, not only because of the larger amount of investments required by the project but because of the demand for this type of credit. They also are believed to be a stronger tool to combat climate change.
Beyond the type of the project itself, the price of carbon credits can also be influenced by the volume of credits being traded at one time (the greater the volume, lower the price usually) as well as the geographical location for the particular project its date of birth (typically the more recent the time period, the less expensive the price) as well as the delivery time.
When the carbon project helps achieve some of the UN’s SDGs The worth of a loan from the project to prospective buyers could be greater, and the credit may be sold at a premium to other types of projects.
For example, community-based programs tend to be localized and typically managed and designed by local groups or NGOs tend to create smaller amounts of carbon credits. It is also often more costly to certify them. However, they usually generate higher co-benefits and are able to meet the UN’s SDGs that contribute, for instance, to greater welfare for the local population, better water quality or reduction of inequality in the economy.
This is why credits generated by community-based organizations can be sold at a higher price to projects that don’t meet SDGs, such as industrial ones, as they are typically more extensive and may produce large quantities of credits and have more easily verified GHG offset possibilities.
In the current market for carbon credits prices for a carbon credit can range between a couple of cents per metric ton of CO2 emissions up to $15/mtCO2e and even $20/mtCO2e for projects that afforest or reforest to up to $300, or even $100 for removal projects that are based on technology like CCS.
S&P GlobalPlatts analyzes the value of a range of carbon credits. Currently, it provides 20 price evaluations, including both spot and forward (Year 1) prices. Each price assessment reflects the most competitive credit available for each category, based on the trades and bids that are reported in the broker market or on trading and exchange instruments.
Platts collects bid offers, trades and offers for carbon credits certified through the standards listed below: The Gold Standard, Climate Action Reserve (CAR), Verified Carbon Standard (VCS) The Architecture of REDD+ Transactions and the American Carbon Registry. Price indications are collected by market players directly during every trading day.
Platts creates four separate prices including the CEC (reflecting the CORSIA eligible prices) and the CNC (reflecting nature-based solutions with an age of each of the past five years and including both avoidance and removal credits) The Renewable Energy Carbon credits price (vintage of the past three years), and Methane Collection price, which reflect credits generated by initiatives focused on reducing methane emissions such as Landfill Gas Collection, Waste Gas, as well as Livestock Waste Management projects (vintage of each of the past three years).
There are two price baskets that include the avoidance prices as well as removal prices. The first basket comprises the Platts household devices price, Platts Industrial Pollutants price, and Platts Nature-based Price for Avoidance. The second basket is comprised of Platts natural carbon capture as well as Platts Tech Carbon Capture.
In addition to publishing the cost of each evaluation contained in the two baskets Platts examines the price of the basket itself, creating the Carbon Avoidance Credits price and a Carbon Removal Credits price. These two basket assessments reflect the most competitive of the price ranges they have.
With the vast array of credits, Platts also provides price indicators for each type of project as they are traded in the wider market of voluntary markets and not just in CORSIA. CORSIA scheme, in an effort to improve transparency.
Although the rise of voluntary carbon markets dates to the early 2000s after the ratification of Kyoto protocol, their growth was hindered by the 2008 global economic crisis. The recent trend of private and public commitments to cut carbon emissions over recent years is now triggering a resurgence of demand for carbon credits on a voluntary basis as a method of reducing carbon footprints.
Although there are no obstacles for entry into the market, absence of transparency in transactions and insufficient knowledge of how carbon finance works have kept many potential players out of the market.
But, the rising curiosity about studying voluntary carbon markets and the efforts of a variety of players to standardize and scale operations, suggest that carbon finance will soon be able to attract new participants and expand in size.
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