Introduction to Voluntary Carbon Markets

The Voluntary Carbon Market (VCM) captured headlines in early 2022 as analysts speculated that the market was likely to expand significantly this year. Some reports estimated that the market would grow by 50-80% in 2022. This optimism stemmed from the expansion of the VCM last year, which witnessed a 190% growth owing to a sharp increase in carbon credit prices and an influx of fresh entrants into the market as an increasing number of companies have committed to achieving net-zero emissions by 2050. The value of the VCM has quadrupled since 2020, almost reaching US$2B in 2021. This growth trajectory is expected to continue rising as some estimates project that the unified market for carbon credits would be worth $100 billion by 2030.

Growth trends in recent years

The growing traction around the VCM is further evident when we consider some of the recent global developments, which include:

• Three banks, including BBVA, the Spanish financial services bank, joined an initiative called the Carbonplace this year to develop a new platform for settling transactions of voluntary carbon credits.

• In 2021, the Wall Street Journal (WSJ) reported that the American Petroleum Institute would endorse carbon pricing. A draft statement reviewed by WSJ states that this policy would “lead to the most economic paths to achieve the ambitions of the Paris Agreement.”

• Countries have also expressed interest in carbon credits as they are perceived as promising economic opportunities. For example, at the Glasgow COP26 Climate Change Summit, Rwanda’s Minister of Environment, Jeanne d'Arc Mujawamariy, stated that storing carbon on behalf of other countries or companies is a major economic opportunity for Rwanda.

• Likewise, Leonardo Cleaver de Athayde, Brazil's chief negotiator at the COP26 summit, said they planned to be a major trader of carbon credits.

“It should spur investment and the development of projects that could deliver significant emissions reduction” - Leonardo Cleaver de Athayde.

Another factor indicative of the growth of the VCM is the quality of credits being retired. The vintage factor is one of the key characteristics of high-quality credit. Vintage refers to the year in which carbon credits are issued. Generally, credits have more value if released more recently as they are then likely to be issued under more updated methodologies and go through stricter scrutiny and verifications. In this regard, in January and February 2022, 1% of all credit retirements were of 2020 vintages or later. This figure increased to 22% in June this year.

“In spite of the economic headwinds, we're seeing buyers get more focused on [vintage] recency, on quality and on nature…Those are trends that are evidence-based that I think should stand the test of time, and I think are indicative of a market that's maturing and getting more sophisticated." Guy Turner, founder and CEO of Trove Research, observed.

Understanding the Voluntary Carbon Market

The Voluntary Carbon Market is a market that enables private individuals, corporations and other entities to buy and sell carbon credits with the objective of supporting climate action. The VCM provides opportunities for polluting companies to offset their emissions by purchasing carbon credits or offsets from developers who design specific projects that can remove or reduce greenhouse gases (GHG). Each credit here is equivalent to one metric ton of reduced, avoided or removed carbon dioxide or equivalent GHG. The projects could involve any mitigation activity, such as setting up a wind energy farm that can replace power generated by fossil fuels or protecting a forest that is about to be chopped down.

These credits direct private financing to climate projects that wouldn’t have otherwise been implemented. They also support investments in innovations essential in bringing down the costs of emerging climate technologies.

As the term indicates, the voluntary carbon market is regulated by private standards, as opposed to the ‘Compliance Carbon Market (CCM)’, the second carbon market regulated by government bodies.

Types of Carbon Offset Projects

Carbon offset projects can be segregated into two major types:

• Avoidance: This refers to projects which avoid carbon from being released into the atmosphere by capturing emissions from industrial factories, storing and re-utilizing this energy into useful, greener fuels, as well as preventing deforestation.

• Removal: These projects remove carbon emissions already present in the atmosphere. This includes projects sequestering carbon through man-made solutions such as direct air carbon capture or nature-based processes such as reforestation and ocean algae cultivation. Based on the type of sequestration, these carbon-sink solutions are further segregated into green (carbon sequestered by land ecosystems such as natural forests), brown (sequestered by industrial forests), blue (by ocean ecosystems), and teal carbon (carbon stored in inland freshwater wetlands).

Understanding the Working of the VCM

The working of the voluntary carbon market can be understood by examining the trading process. This involves four key participants:

• Project Developers: Developers could include entities such as companies and non-governmental organizations (NGOs) whose role involves designing and implementing projects that generate and sell carbon offsets. It is imperative that these programs generate high-quality carbon credits which maximize climate and socio-economic benefits.

• Standard Bodies: Carbon standards are private organizations that provide guidelines to help direct project developers in designing activities that measurably remove or reduce GHGs from the atmosphere. These standard bodies ensure that the quality of credits is maintained. They do this by adopting efforts such as undertaking surveys, carrying out scientific research, engaging with local communities and establishing monitoring systems. Once a project is verified and validated, it gets registered in a specific database owned or retained by the standard that certified the project. Each credit issued is tracked with a specific serial number on a secure registry that acts similarly to the stock exchange to ensure credits are not sold or claimed twice. The developer can either retire the credits, i.e. annul them to claim the reductions they represent, or sell them to another entity owning an account at the registry.

  

• Brokers: Brokers act as intermediaries that facilitate the transaction of carbon credits between developers and buyers. Their role here is similar to that of brokers within a standard financial market. A broker may obtain carbon offsets and then either transfer them to a buyer or retire the credits on the registry for a fee. The price range of carbon credits in the VCM is wide. As of November 2021, the price per carbon credit ranged from a few cents per MtCO2e to USD 20 per MtCO2e. The prices depend on various factors such as the type of offset project and its location, the carbon standard under which it was developed, and the co-benefits associated with the project, among others. You can read more about the factors that influence the price of carbon credits here.

• End buyers The end buyers could be entities such as corporate companies, governments, non-governmental organizations and even individual buyers looking to offset their emissions by purchasing carbon credits. Once a credit is used, it becomes non-tradable and cannot be sold again. It is then moved to a register for retired credits known as 'retirements'.

Challenges Plaguing the Voluntary Carbon Market

While the carbon credits system sounds efficient in theory, the market is relatively new and has thus been speckled with challenges. Some of the complexities plaguing the VCM that have come under scrutiny are:

• Low-Quality offsets: One of the market's primary challenges is the problem of outdated and poor-quality carbon offsets. Lack of transparency has made it difficult for companies to ascertain which carbon credits are generated from credible offsetting programs to have the desired emission reduction impact. In this regard, "additionality" is important for offsets to be considered genuine and of high quality. Additionality here means that the developed projects should be unable to exist without financing from carbon credits. For example, they would not be considered additional if emission reduction or removals occur without the VCM project. A European Commission study revealed that most of the renewable energy projects certified by the Clean Development Mechanism (CDM) would be expendable as carbon offsets due to the additionality factor. Outdated carbon offsets from projects with no additionality pose a serious threat to the genuine efforts taken in the market and negatively impact projects that depend on carbon financing.

• Inadequate governance: Unlike the compliance market, where authorities set regulations, the VCM does not have any governance body. Various registry platforms issue criteria for project certifications. Each of these registries has its standards and protocols to certify and validate offsets, which has resulted in a lack of standardization in the market. The lack of standardization extends to even variation in terms used in the market. For example, Gold Standard refers to VCCs as carbon credits, VERRA terms them as Verified Carbon Units, and Plan Vivo terms them as Plan Vivo Certificates. Variations also cause difficulties in the legal qualifications of carbon units as well. In addition, a lack of regulations has led to double-counting of credits where two or more entities claim the same offset due to inconsistent accounting protocols.

• Greenwashing: The absence of effective regulations has provided scope for companies to cheat, leading to serious concerns about Greenwashing. For example, in 2019  ProPublica investigated forest offsets in South America, revealing that the projects often did not offset as much carbon emissions as they promised.

• Lack of Transparency: The market is fragmented and lacks transparency which has raised questions regarding the environmental integrity of offset projects, especially when quantifying the level of carbon avoidance and reduction. In addition, it also poses challenges, especially about pricing as it makes it difficult for buyers to know if they are buying offsets at a fair price.

In addition to these challenges, the market is characterized by low liquidity, inadequate risk-management services and a lack of harmonization in carbon pricing. To ensure the continuity of market growth, the VCM requires reforms to iron out these inadequacies and find solutions to the bigger challenges.

Key stakeholders appear to be cognizant of these limitations as they are working towards addressing these concerns, with a new governing body working to build standards and transparency in the market. In addition, the market has been able to brave recent challenges, which go on to show that it is already making headways in strengthening the system. For instance, its resilience was demonstrated in the way it has been able to deal with the associated economic crisis of the covid-19 pandemic, with carbon prices reaching new record levels. On this matter, carbon traders have observed that the market is reaching new levels of maturity and sophistication.

Way Forward

The Voluntary Carbon Market holds tremendous potential in helping companies meet their decarbonization goals by complementing their internal emission reductions- a vital step that needs to be taken along with purchasing offsets. The value of carbon credits is elucidated in a study that shows that by the end of 2019, the market had achieved over 608 million tonnes of CO2 in emission reductions or removals. This is equivalent to taking over 131 million cars off the road for a year.

Despite its benefits, the huge information gap in the voluntary carbon market is preventing it from meeting its full potential. Credible data can minimize the several existing challenges existing in the VCM as discussed earlier. In this regard, Geospatial technology has emerged as an effective tool as it provides transparent and accurate data. The valuable insights gained from it enable the development of effective monitoring infrastructure. This allows project managers to assess the quality of carbon credits and thereby further enhance it. It also helps buyers in verifying the credibility of offset programs and in ensuring their efficiency by tracing their impact.

While carbon credits are definitely not a silver bullet to the climate change crisis, it does, however, hold tremendous potential in easing the transition to a decarbonized economy.

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