2022 will likely be known as the year that carbon finance emerged as an important topic for discussion among an array of industries.
In the 2022 class of new participants in voluntary carbon markets major oil and gas companies along with hedge funds and banks were identified as the most active players and firmly committing to the market. However, as the year progressed and the year progressed, other economic sectors entered the market as a result of their pledges to reduce carbon footprints.
Many of the political institutions like the EU and for instance, UK or the state of California already have mandatory carbon markets that target specific industrial areas and gas. These forms an essential component of the process to reach the Paris Agreement target of limiting global warming up to 2 degrees Celsius above pre-industrial levels (with an even more ambitious goal of achieving 1.5 C). 1.5 C increase), even the fact that some of these trading carbon credits markets were established prior to that of Paris commitments.
But other sectors have followed the example of compliance schemes and agreed to reduce carbon dioxide emissions (GHG) through participation in carbon markets in a voluntary manner.
Voluntary carbon markets enable carbon emitters to offset their inevitable emissions through the purchase of carbon credits that are generated by projects that aim at eliminating or reducing GHG from the atmosphere.
Each credit – that corresponds to one metric ton of reduced, eliminated or removed CO2 or equivalent GHG – can be used by a company or an individual to compensate for the emissions from one metric tons of CO2 or equivalent gases. If a credit is utilized for this purpose it becomes an offset. It is then transferred to a retirement register credits, or retirements and is no longer tradingable.
Businesses can take part in the voluntary carbon market individually or as part of an industry-wide scheme, such as that of the Carbon Offsetting and Reduction Scheme for International Aviation, which was set up by the aviation industry to offset its emission of greenhouse gases. International airline operators taking part in CORSIA have committed to offset all CO2 emissions they emit over a base level of 2019.
While compliance markets are currently limited to specific regions carbon credits offered by voluntary carbon markets are more fluid, unrestrained by borders set by nation states or political unions. They are also able to be utilized by every sector of the economy instead of a restricted set of industries.
The Taskforce on Sizing Voluntary Carbon Markets which is sponsored by the Institute of International Finance with backing from McKinsey, estimates that the carbon market credits could amount to upwards 50 billion dollars as early as 2030.
Five main players are the carbon market’s engine.
Project developers are the upstream portion of market. They create the projects that issue carbon credits that can be a range of industrial-scale projects of a large scale, like hydro plants with high volumes as well as smaller, community-based ones such as kitchens with clean cooking facilities.
There are several projects that aim to take away or manage direct emissions that result from industrial processes , such as the management of fugitive emissions, ozone-capture or destruction of ozone-depleting substances as well as treatment of wastewater. Nature-based projects are REDD+ (avoided deforestation) soil sequestration or forest afforestation. Other kinds include tech carbon capture such as direct air capture. New categories are constantly added to the list.
Each credit comes with a particular vintage which refers to the year in which it was issued, and a specific date for delivery and the time at which the credit will be made available for sale. In addition to their main goal of avoiding or removing GHGs from the air The credit projects could create additional benefits and help meet some of the UN’s Sustainable Development Goals (SDGs). They could, for instance, contribute to improved welfare for the inhabitants of the region, better sanitation of the water supply, as well as the improvement of the economic inequalities.
The downstream market is comprised of buyers who are end-users: businesses or even consumers who have pledged to offset all or a part of their GHG emissions.
Some of the first purchasers of carbon credits were tech firms like Apple and Google airlines, as well as oil and gas giants, but more industry sectors such as finance, for instance, are entering the market, in order to set their own net-zero targets or seek a way to protect themselves from the financial risks associated with an energy revolution.
The implementation of Article 6 of the Paris Agreement on Nov 13 at the UN Climate Conference, or COP26 in Glasgow laid out the rules for a crediting mechanism that could be utilized by 193 of the parties to the Paris deal to reach their emission reduction targets or nationally determined contributions. Implementation of the Article 6 allows countries to buy voluntary carbon credits, as long as Article 6 rules are respected.
To connect demand and supply There are brokers as well as retail traders, as in other commodities markets. Retail traders purchase large amounts of credit directly from the provider and then bundle them into portfolios, ranging in size from thousands to hundreds of tons of CO2 and then sell the bundles to consumers typically with a fee.
Although the majority of transactions are taking place through private conversations or over-the-counter agreements, certain exchanges are also forming. Some of the most significant carbon credit exchanges currently at the moment are the NY-based Xpansiv CBL and Singapore based AirCarbon Exchange (ACX).
Exchanges have tried to make simpler and speedier the trading of carbon credits – that have an extremely complex structure due to the multitude of factors that impact their value – by creating standard products, which ensure certain basic requirements are met.
For example, both the Expansiv CBL in addition to ACX have developed standard products for natural-based credits CBL’s nature-based global Emission Offset (N-GEO), and The ACX Global Nature Token.
Credit trading with these labels are guaranteed to be compliant with certain characteristics including the type of project that is the basis, a relatively recent vintage, a certification from a limited set of standards.
Exchanges’ standardized products – especially those designed for forward delivery are favoured by financial players seeking to purchase and hold to prepare for the rising demand for carbon credit.
End-users who have to buy credits in order to reduce their carbon emissions tend to prefer non-standardized products, as they are able to examine the particular features of each project, ensure the quality of the credit that they purchase and defend themselves against accusations of greenwashing.
Often, the exchanges are used to settle big bilateral deals that have been concluded offscreen. In a market note published on May 1, CBL declared that an even greater amount of bilateral deals negotiated offscreen were being brought by traders for settlement through CBL’s platform. CBL platform.
These deals comprised a significant portion of volumes of transactions on CBL.
Brokers buy carbon credits at the expense of a trader, then market them to the buyer, usually with some commission.
There is also a fifth actor that is unique to carbon markets. Standards are organizations, generally non-profit organizations, that verify that a specific project is in line with the stated goals and stipulated emissions level.
Standards contain a range of guidelines, or methods, for each type of carbon-related project. For instance, a reforestation project will follow specific rules when calculating the level of CO2 absorption of the planned forest , and consequently the amount of carbon credits that it earns over the course of time.
A renewable energy project has a set of guidelines to follow when calculating the benefit in terms of avoiding CO2 emissions and carbon credits that are generated over time.
The certifications of standards also ensure that certain core principles or requirements of carbon finance are adhered to:
Additionality: The plan should never be legal, standard procedure, or financially appealing without the possibility of generating credit.
The CO2 emissions reduction should correspond to the number of offset credits granted for the project. It should also account for any unintentional GHG emissions resulting from the project.
Permanence: The effects of the GHG emission reduction should not be at risk of reversal and will lead to a lasting drop in emissions.
Special claim for each metric ton of CO2 is only claimed once and requires evidence of the credit retirement upon project maturation. Credits are offsets at retirement.
Add additional environmental and social benefits: Projects must comply with the lawful requirements of its jurisdiction and should provide additional co-benefits that align in line with UN’s SDGs.
Trade, trade and overlapping roles
There is a cross-over of roles, which is unique with carbon markets.
A lot of brokers function as traders, and many financiers have brokering arms in addition to arm for project development.
End buyers can also be able to finance their own carbon project and decide to keep all or a portion of the credits they receive for their own offset requirements.
Each of these entities could eventually sell their credits to a buyer or developer. Alternatively, a developer could make arrangements to sell them directly. All of these juxtapositions have an impact on price, and ultimately affect market transparency.
Pricing is a range of supply
When a company decides to look into voluntary carbon markets as a potential way to compensate for its carbon emissions One of the primary pieces of information it looks at is the price for carbon credit. With this information it is possible for a business to determine how ambitious it should be when it comes to establishing its emission reduction target and whether the market for voluntary carbon credits can aid in achieving it.
While at the same time it is important to have a clear value signal on carbon permits those who are already with the markets to make sure they’re trading credit at a price that reflects the real market value.
But putting a price on carbon credits is far from an easy task, mostly due to the variety of credits in the market as well as the many factors which influence the price.
Carbon credits issued by companies can be of many different kinds and sub-types. How the underlying project is among the main factors affecting the price for the credits.
Carbon credits can be classified into two baskets or categories: avoidance projects (which stop emitting GHGs completely, thereby reducing the amount of GHGs emitted through the environment) in addition to removal (which eliminates GHGs directly from the atmosphere).
The avoidance basket is comprised of renewable energy sources, but also agriculture and forestry emissions avoidance projects. The latter, which are commonly referred to REDD+, help to prevent destruction of wetland or deforestation or employ soil management techniques in farming practices that reduce GHG emissions, for instance projects aiming to avoid emission from milk cows and beef cattle by varying their diets.
Cookstove projects, fuel efficiency or the development of energy-efficient buildings also are included in the avoidance basket and so do projects capturing and destroying industrial pollutants.
The removal section includes projects to capture carbon from the atmosphere and storing it. These projects can be natural-based that use trees or soil as an example to eliminate carbon dioxide and capture it. Examples include afforestation and reforestation projects, and wetland management (forestry and farming). They can also be tech-based and incorporate technologies such as direct air capture or carbon storage and capture.
Credits for removal are typically traded at a premium compared to avoidance credit, not only because of the higher level of investment required by the underlying project, but due to the huge demand for this type of credits. They are also considered to be a more effective tool in the fight against climate change.
Beyond the type of the underlying project, the price of carbon credits can also be dependent on the quantity of credits being traded at one period (the greater the volume, the lower the price generally), the geography of the project, its date of birth (typically the older the vintage the cheaper the cost) as well as the delivery time.
When the underlying carbon project is also helping to fulfill some of the UN’s SDGs, the value of the credit from the project to prospective buyers may be higher, and the credit may be sold at a premium to other kinds of projects.
For instance, community-based projects – which are usually very localized and usually created and operated by local groups or NGOs tend to have smaller amounts in carbon credits. It is also often more costly to validate them. However, they usually generate more additional co-benefits and meet the UN’s SDGs and contribute to improved welfare for the inhabitants, better water quality, or the decrease in economic inequality.
For this reason, credits generated by community-based initiatives might be worth more to projects that don’t meet SDGs, such as industrial initiatives, that are typically larger in scale and often generate massive amounts of credits that have higher levels of easily-verified GHG offset possibilities.
In the current market for carbon credits the price for a carbon credit can range in price from just a few dollars per million metric tons of CO2 emissions to as high as $15/mtCO2e, or even $20/mtCO in afforestation or reforestation initiatives to up to $300, or even $100 in removal projects based on technology, such as CCS.
2022 will likely be known as the year that carbon finance emerged as an important topic for discussion among an array of industries.