Voluntary carbon markets – climate friend or foe?
8 min read 1 Mar 23
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Voluntary carbon credits are increasingly being used by companies to achieve their net zero emissions targets. However, many questions remain about their efficacy and credibility. Furthermore, 2022’s COP27 climate change conference, which finally made progress on establishing an international carbon market, has thrown up further questions about the future of voluntary carbon markets (VCMs).
What are voluntary carbon credits?
Voluntary carbon credits are credits purchased by an emitter from a project which reduces emissions through methods such as renewable energy or afforestation. These emissions are verified by independent standard setters such as Verra. By purchasing and then retiring these credits to avoid reuse in the future, the emitter can claim to have “offset” their own emissions.
These credits differ from compliance credits, which are part of a country’s mandated carbon emission targets, as they go above and beyond mandates, or they may offset emissions in countries of operation not covered by mandates. The largest example of a compliance system is the European Emissions Trading Scheme.
In 2021, Ecosystem Marketplace estimated that about 500 million tonnes of voluntary carbon credits traded globally, an approximate fivefold increase over the past 10 years. This has been driven by companies striving to reach emission reduction targets which cannot be met quickly by other forms of carbon reduction or internal abatement.
According to CDP, in 2020, 29% of reporting companies purchased carbon credits, of which 87% were voluntary offsets. Reflecting the relative lack of supply, prices also accelerated in 2022, increasing by 60% to a weighted average of US$4 per tonne from US$2.52 per tonne, and pushing the market size to an impressive US$2 billion.
Source: Ecosystem Marketplace, 2021.
How are voluntary credits priced?
Credit prices are based on whether a project removes or just avoids emissions, the ‘additionality’ (ie, whether or not the removal would have otherwise happened), and the potential co-benefits. These include social benefits, such as supporting local communities and biodiversity.
As a result, renewables, energy efficiency and transportation projects are least valuable at US$1-2 per tonne, as they merely reduce emissions, whilst forestry and agriculture are highest (at around US$6-9 per tonne) as they act as carbon sinks. Carbon Capture and Storage and Direct Air Capture generate some of the highest value credits due to the permanency of removals.
Source: Ecosystem Marketplace, 2021.
To further facilitate these markets, financial exchanges such as the CME Group are developing standardised futures contracts to enable the hedging and therefore financing of projects. However, given the breadth of types of projects and varying degrees of quality, finding truly standardised and fungible traded contracts could be challenging.
But what’s the catch?
The key challenges to the voluntary market are the additionality of projects, the permanency of removals (eg, what happens if a forest generating credit for a project burns down?), the potential for double counting by the offsetting and project country, and the integrity given problems with credits issued under the former Kyoto protocol. A study by the Stockholm Environment Institute found that around 80% of credits (or 600 million) issued under the former UNFCCC’s Joint Implementation Scheme developed under the Kyoto Protocol did not demonstrate additionality, and the authors even doubted whether most of these projects existed.
Although integrity is seen as one of the key challenges to the market, work is ongoing to address this issue. The Integrity Council for the Voluntary Carbon Market, an independent governance body, plans to publish Core Carbon Principles in the first quarter of 2023, which aims to establish global standards for high quality carbon credits.
However, even if these issues could be addressed, some companies are still dissuaded by the lack of standardisation of credits and lack of well-capitalised intermediaries. To deal with this issue, the Global Carbon Trust aims to create standardisation of credits and act as a form of global counterparty for carbon credits.
What happened at COP27?
The Paris Agreement on Climate Change established Article 6, which allowed countries to voluntarily cooperate to achieve emission reductions in their nationally determined contributions. In late 2022, COP27 finally advanced this by specifying a timeline for the implementation of three relevant sub-articles:
- Article 6.2 allows one country to pay for emission reductions in another country. In fact, at COP27, the first-ever International Transferred Mitigation Outcome was authorised, where Switzerland was able to count reductions from their installation of efficient lighting and cleaner stoves in Ghana towards their nationally determined contributions.
- Article 6.4 allows trading of carbon credits internationally in an open market, although this is unlikely to happen until 2024.
- Article 6.8, which recognises non-market approaches such as grants, technology transfer or investments in capacity without trading of emissions.
Most relevant to voluntary carbon credits is Article 6.4, as it would effectively create a competing market. However, since voluntary credits are not required to go through Article 6 and therefore be accounted for, companies could end up buying credits which have been double counted. This could jeopardise the credibility of the voluntary carbon market.
The role of voluntary markets in achieving net zero
Views are mixed on the role of voluntary carbon markets in achieving net zero emissions. For example, the Taskforce for Scaling the Voluntary Carbon Market believes the voluntary markets must grow by 15x to 1.5-2 gigatonnes per annum by 2030, and 13 gigatonnes by 2050, if we are to limit average global warming to 1.5°C above pre-industrial levels.
However, as recently as October 2022, the UK Climate Change Committee reported that while voluntary carbon markets will play an important role in achieving net zero, their role would be small. They argue that lacking strong guidance from governments, regulation and standards, the markets could even risk slowing the progress towards net zero.
Elsewhere, the Science Based Targets initiative, which works with companies to set emission reduction targets in line with the goals of the Paris Agreement on climate change, requires that carbon removals must comprise no more than 5-10% of companies’ emission reduction efforts when targeting net zero.
In conclusion, whilst the voluntary carbon market has created a route for companies to reduce emissions, it is clear that the most enduring and least questionable way to achieve net zero is through direct abatement, by switching to low-carbon energy, adopting other climate innovations, and increasing the share of lower carbon products.
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