Numerous companies are pledging to help stop warming by reducing their greenhouse gas emissions to the extent they can. Yet many businesses find they’re not able to completely reduce their carbon footprint or even decrease their emissions as fast as they’d like. This is especially true for organizations that aim to reach net zero emissions, which means removing the greenhouse gases from the atmosphere as they contribute to it. For many they will need to make use of carbon credits to offset the emissions they are unable to get rid of by other means. According to the Taskforce on Scaling Voluntary Carbon Markets (TSVCM) was established by the Institute of International Finance (IIF) with knowledge support from McKinsey estimates that demands for carbon credits will rise by an amount of 15 or more by 2030 and by a factor of up to 100 by 2050. Overall, the carbon credit market could reach upwards of $50 billion in 2030.

The market for carbon credits bought by the consumer (rather than for compliance purposes) is significant because of other reasons, too. Carbon credits purchased voluntarily provide private funding to climate-action initiatives that would not otherwise get off the ground. They can also provide benefits , including biodiversity protection environmental protection, pollution prevention, public health improvements, and employment creation. Carbon credits can also help fund the development of the technology needed to lower the cost of new climate technologies. The scale-up of voluntary carbon markets will facilitate the movement of capital to the Global South, where there is the most potential for economical nature-based emissions-reduction projects.

Due to the need for carbon credits that will result from efforts worldwide to cut greenhouse-gas emissions, it’s apparent that the world needs an unregulated carbon market that is large transparent, transparent, verifiable and sustainable. The current market is a mess of disparate and complicated. Some credits have proven to represent emission reductions that were doubtful at the very least. A lack of pricing data makes it hard for buyers to know whether they are paying an appropriate price, and for companies to understand the risk they take on when they finance and work on carbon-reduction projects , without being aware of the amount that buyers eventually pay in carbon-related credits. In this article, which is based on McKinsey’s research for a new report by the TSVCM, we look at these issues and how market participants, standard-setting organizations, financial institutions, market-infrastructure providers, and other constituencies might address them to scale up the voluntary carbon market.
Carbon credits can aid businesses meet their climate change targets

In the agreement of the year 2015, the Paris Agreement, nearly 200 nations have agreed to the global goal of limiting the rise in average temperatures to 2.0 degrees Celsius higher than preindustrial norms, and at least 1.5 degrees. Reaching the 1.5-degree target would require that greenhouse gas emissions in the world are reduced by 50 percent of present levels by 2030 and diminished to net zero by 2050. Many companies are aligning themselves to this vision within one year, the number of companies with pledges to net zero has doubled from 500 in 2019 , to more than 1,000 in 2020.

To achieve the global net-zero standard, companies will need to reduce their own emissions as much as they can (while making sure to report on their progress to be accountable and transparent that investors and other stakeholders increasingly demand). For certain companies it’s too costly to reduce emissions with modern technologies, although the cost of these techniques could fall in the future. And at some businesses, certain sources of emissions can’t be removed. For example, making cement at an industrial scale typically involves an chemical reaction called and calcination is responsible for a large share of the sector’s carbon emissions. Because of these limitations, the pathway to reduce emissions to an 1.5-degree warming target is essentially “negative emissions” which are achieved by taking greenhouse gases out of the atmosphere.

A carbon credit purchase is one way to tackle emissions that they are unable to eliminate. Carbon credits are certificates that indicate the quantity of greenhouse gases which are kept out of the atmosphere or eliminated from the air. Carbon credits have been used for a long time, the voluntary trading of carbon credits increased rapidly in the last few years. McKinsey estimates that in 2020, buyers retired carbon credits worth 95 million tonnes of carbon dioxide equivalent (MtCO2e), which would be more than twice the amount in 2017.

In the process of decarbonizing the global economy expand, demand for voluntary carbon credits could continue to rise. Based on stated demand to purchase carbon credits projections of demand from the experts surveyed by TSVCM and the quantity of negative emissions required to cut emissions in line of the 1.5-degree warming target, McKinsey estimates that annual global demand for carbon credits could grow to as high as 1.5 and 2.0 gigatons of carbon dioxide (GtCO2) by 2030 and up to 7-13 GtCO2 by 2050 (Exhibit 2.). Based on different pricing scenarios and their underlying drivers the market size by 2030 could range from $5 billion and $30 billion at the bottom end and more than $50 billion at the top end.

The increase in carbon credits’ demand is significant, analysis by McKinsey shows that demand by 2030 could be matched by the potential annual carbon credit supply between 8 and 12 GtCO2 per year. Carbon credits will come in four different categories: reduced nature loss (including deforestation) as well as natural sequestration, like reforestation, or reduction in emissions such methane released from landfills and technology-based removal of carbon dioxide from the atmosphere.

Certain factors may make it difficult to mobilize all of the potential supply and get it on the market. The construction of projects will require a rapid increase at a rate that is unprecedented. The bulk of the potential reserves of avoided nature loss and natural sequestration is concentrated in a tiny number of countries. Every project comes with risks and all kinds of projects could struggle to attract finance due to the lengthy time lag between the first investment and the eventual selling of credits. Once these challenges are accounted for, the estimated carbon credits supply will fall to between 1 and 5 GtCO2 annually by 2030.

This isn’t the only issue faced by sellers and buyers of carbon credits. Credits of good quality are scarce because the accounting and verification processes differ and the credits benefit from co-benefits (such as economic development for communities and biodiversity protection) are not always clearly defined. When verifying the quality of new credits–an important aspect to ensure the integrity of the market, suppliers must endure lengthy time-to-markets. When they sell these credits, suppliers face unpredictable market conditions and cannot always get economical prices. In general, the market is characterized by the lack of liquidity, limited financial resources, inadequate risk-management solutions and the inaccessibility of data.

The problems aren’t easy, but not impossible. The verification methods could be improved and the verification process streamlined. Better demand signals will to give the suppliers more confidence in their project plans and encourage lenders and investors to lend. All these requirements can be met through the careful creation of an efficient large-scale, carbon market for voluntary use.

The expansion of voluntary carbon markets requires a fresh blueprint for actions

The development of a successful voluntary carbon market requires collaboration across a range of areas. According to its study, the TSVCM found six distinct areas covering the carbon-credit value chain, where action can support the growth of the carbon market that is voluntary.

Achieving common standards for defining and verifying carbon credits

The carbon market of today isn’t equipped with the liquidity required for efficient trading, due to the fact that carbon credits are highly diverse. Each credit has attributes associated to the project that it is based on, including the kind of project and the location where it was carried out. These attributes affect the price of the credit as buyers are able to evaluate the value of additional attributes in different ways. The inconsistency between credits means that matching the buyer’s individual needs to the appropriate supplier can be a lengthy, unefficient process, which is conducted on the internet.

The matching of suppliers and buyers could be more effective If all credit ratings could be described using common features. The first set of features concerns the quality of the product. Quality standards, which are outlined in “core carbon principles” could provide a foundation for verifying that carbon credits represent genuine emissions reductions. The second set of attributes will cover the other attributes associated with carbon credits. The standardization of these attributes into a common taxonomy could assist sellers market their credits and buyers find credit options that meet their needs.

Contracts that are developed with standard conditions

In the market for voluntary carbon the diversity of carbon credits means that carbon credits of specific types are traded at a rate that is too low for steady prices on a daily basis. Achieving carbon credits to be more uniform will consolidate trading activities around certain types of credit and increase liquidity on exchanges.

After the establishment of the carbon fundamentals and the standard attributes mentioned above, a carbon credit exchange can come up with “reference contracts” to trade carbon. Referral contracts would include one contract, based on the core carbon principles, with additional attributes that are defined according to the standard taxonomy, and priced separately. Core contracts could facilitate companies to conduct things like purchasing large amounts of carbon credits simultaneously They could also make bids for credits that meet certain criteria, and then the market would mix smaller amounts of credits to be able to match their bids.

Another benefit of reference contracts would be the development of an unambiguous daily market price. Even after reference contracts are created, many parties will still make trades over the counter (OTC). The prices for credit traded with reference contracts may be a basis for negotiations of OTC trades, with other aspects that are priced separately.