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Growth of the Carbon Markets has its Challenges – Can They Be Overcome?

Growth of the Carbon Markets has its Challenges – Can They Be Overcome?

We’re in for a fun ride over the next decade. The carbon markets are rapidly becoming a force to be reckoned with and a means to which we will fully realize a decarbonized society driven by positive financial incentive structures and free market mechanisms.

The carbon markets have garnered significant attention recently. With the voluntary carbon market expected to grow substantially from $2bn to up to $100bn by 2030 and $250bn by 2050 (1),, one wonders what are the main drivers, or lack thereof, that will enable or prevent us from getting there?

As the famous English idiom goes, we’ll have to “break the back of the beast” to get there. Are we up for it? As venture investors interested in climate, we are betting our careers on it.

There are several challenges facing the carbon markets. And, what governments and the private sector are doing to tackle these challenges will be critical to achieve continued market growth at an accelerated pace.

Let’s first set the stage here to make sure we’re aligned when we talk about carbon credits. These words are currently thrown around so much, to the point that it’s hard to know what someone actually means when talking about them.

Carbon Credits or Allowances

Carbon credits or allowances essentially allow for an entity to emit. If a company buys a carbon credit from a government, they are granted permission to generate one ton of CO2 emissions. This is regulated and falls under the compliance carbon market – which is relatively well established. Revenue flows from these credits flow from companies to regulators. (2)

Carbon Offset Credits (Voluntary)

Voluntary market carbon credits, also known as carbon offset credits, allow for companies to generate an offset by removing a unit of carbon from the atmosphere as part of their normal business activity. These offsets are voluntary and the market, generally speaking, is not yet well-regulated . (2) When speaking about carbon credits going forward, we refer specifically to voluntary carbon offsets credits.

So, what’s going on in this market? It’s simple: it’s not a supply problem, my friend, it’s all about the quality.

It’s estimated that about 4,000 carbon-offsets projects have issued credits for 1.7 billion offsets, which is equivalent to 1.7 gigatons of carbon. There are an additional 3,800 additional projects that are listed and awaiting credit issuance(1). This is all fine and dandy, but integrity is a big issue in the voluntary carbon market, with some of the biggest carbon projects seeing the claims on their credits being worth nowhere near the value that they were sold for. The voluntary carbon market will not be able to scale if the number of quality credits doesn’t scale proportionally going forward. It’s as simple as that.

Case in point, in 2023 the UK’s Advertising Standards Authority (ASA) announced it was cracking down on companies that made questionable carbon offset purchases while making unsubstantiated green claims. This isn’t just happening in the UK, but regulators from the UK to the US and beyond are questioning the integrity of and scrutinizing carbon-credit based green claims.

So, what’s happening to correct this? Luckily, a lot!

Registries

Carbon registries will be the cornerstone, in many ways, to the voluntary carbon market. Carbon registries track the ownership, issuance, retirement, and transfer of carbon credits. 

Similar to how a doctor maintains a patient’s health records, a carbon registry keeps a record of each carbon credit, including the project that generated that credit and the organization that has been involved with transacting such credits(3). The ‘Big 4’ registries are American Carbon Registry (ACR), Climate Action Reserve (CAR), Gold Standard, and Verra (VCS). These registries are critical as they provide a level of trust, transparency, and integrity to the market – even more critical given the nascent state of the market currently.

Registries play a critical role in ensuring the integrity of the voluntary carbon market. As recent as last year, many projects have been scrutinized for selling credits not close to their actual value (4)(5).

The reasons for this can be manifold. One reason is that when a developer works with a technical consultant to determine the viability of a piece of land to generate carbon credits, the methodology used to set the project baseline has been decided upon by the developer and consultant. With this is an inherent bias to maximize a number of credits generated, hence compromising integrity and many projects overestimating their credits. (6)

Verra, for example, has taken steps to address this issue. Rather than having the project developers choose a dataset and methodology that would, in many cases, generate the most credits, now Verra takes the lead on the baseline-setting process. (6)

Going forward, registries will increase their market power regarding establishing methodologies and standards for working in the VCM. Verra will take the lead with a tender process whereby the select vetted data service providers for a given jurisdiction. This enables Verra to ensure jurisdiction-scale accounting actually makes sense with the number of verified emissions reductions from all projects in the area.

This reset of approach will bring greater improvement to the integrity of the market and it’s likely the other registries will follow suit with their own respective methodologies going forward. The big question is if this will be enough, and if the registries can establish themselves as the one source of truth to build consistency between verified emission reductions and accounting.

Another positive note is that since Verra and other registries would be providing jurisdictional-specific datasets without the need for developers to procure their own. This leads to enhanced speed and scale and which projects can get off the ground and enter the carbon market while maintaining integrity and quality. This is a critical move to establish solid infrastructure for the market to scale going forward.

Standardization across the industry and assurance doesn’t stop there in the broader market. You have major organizational bodies such as the Integrity Council for the Voluntary Carbon Market (ICVCM) that seek to set global benchmarks for carbon credits and offsets.

Alongside these are the Core Carbon Principles (CCPs) aiming to set new standards for high-quality credits and bringing CCP-eligible guidelines to the market. Gold Standard, one the major registries, has become the first major standard to submit a program-level information to the Integrity Council for the Voluntary Carbon Market (ICVCM) to evaluate Core Carbon Principles (CCP) alignment, establishing the way forward to CCP credit-level labelling (7).

All this momentum will ultimately bring broad market reach to a high standard for governance, sustainable development and robust accounting to the carbon credit markets.

Outside of the key registries, you have organizations like XTCC, the first multi-currency asset class of high integrity carbon credit investments sourced from verified renewable energy projects, that is the first exchange-traded carbon credit investment product on stock exchanges. This will further support investing in high-quality carbon credits and ensure transparency and liquidity on the carbon credit market in the future (8) 

Quite exciting, on all fronts….

Figure: Verra’s New Credit Methodology Process(6)

Governments

Carbon markets are taking center stage at the national government level as well. As an example, Saudi Arabia, at the MENA Climate Week 2023, announced the creation of the Greenhouse Gas Crediting and Offsetting Mechanism (GCOM). The goal is to help companies buy credits to offset emissions. From 2024, the GCOM will support financial mobilization for multiple climate projects across multiple sectors.

The GCOM, specifically, will operate on a carbon credit system. Based on a prescribed emission level, companies will be given a certain number of credits. Additional credits are purchased if the cap is exceeded. GCOM also hopes to be a catalyst for further investments in decarbonization projects and climate technologies.

We’ll continue to further see developments on this front at the nation-state level as each country maneuvers to set their own climate goals in line with the Paris Climate Agreement.

Supernationally, organizations like the UN (Article 6) and the Commodity Futures TradingCommission (CFTC) are leading the market in setting standards and evaluating green claims.

New Ventures

Several carbon marketplaces have emerged to provide the technical rails or to enable the transactability of carbon credits. These companies are first movers to align with government-related initiatives to help further support the emerging offset credit market. A few examples include:

  • Agreena (growth stage), an Anthemis portfolio company, is incentivizing farmers economically through the carbon markets. Not only does the adoption of regenerative practices help turn soil into natural carbon sinks, but Agreena’s financial reward schemes to farmers by transacting issued carbon credits on offset marketplaces is a game-changer in agriculture going forward.
  • Toucan (early stage), ‘The Digital Rails for Climate Finance’ is building the technical rails and digital carbon market infrastructure to unlock climate action at scale. The critical underlying thesis is blockchains can improve the integrity of the voluntary carbon market and help it scale. By moving carbon credits on-chain by converting conventional certificates to carbon tokens with all relevant attributes, would establish a necessary transparent layer to transactions in perpetuity.
  • Senken (early stage), a digital carbon marketplace, aggregating quality projects and portfolios to offer high quality carbon credits at scale. Senken seeks to become the market leader in connecting global capital with climate assets at scale. Senken’s on-chain carbon credit marketplace is built on Toucan infrastructure – a testament to the climate tech stack emerging to support continued growth of the voluntary carbon market.
  • Thallo (early stage), provides Carbon-as-a-Service – enabling companies to embed carbon reductions and removal into their business. Their API allows access to Thallo’s aggregated carbon credit market with a portfolio of carbon offset projects from multiple registries that’s easily digestable. Easily enables companies to be compliant and support their reporting and communication.
  • Solid World (early stage), is providing the liquidity pools to finance decarbonization projects at scale – these projects will ultimately issue credits and feed into the value propositions of the companies noted above. Solid World’s commodity production financing platform makes pre-paid carbon markets liquid and transparent.

What’s the punchline? The market projections for VCM are ambitious. Continued alignment between registries, exchanges, government, and the early and growth stage start-up community will be critical to realize the projected market growth. If we get there, this will unleash a new wave of innovation and open up more opportunities for investors and founders alike along the entire climate stack value chain.

If you are building in the climate x fintech space, we’d love to talk to you, email me at jeremy@anthemis.com.

 

References

(1)  “Where the Carbon Offset Market is Poised to Surge”, Morgan Stanley Research, April 11 2023.

(2)  “The Ultimate Guide to Understanding Carbon Credits”, carboncredits.com, 2024.

(3)  International Carbon Registry, www.carbonregistry,com, 2024.

(4)  “The Great Cash-for-Carbon Hustle”, The New Yorker Magazine, October 16 2023. 

(5)  “Report: Majority of Carbon Offset Projects Globally are Likely Junk”, Power Technology Magazine, September 22, 2023. 

(6)  “Verra’s New VM0049 Methodology Explainer”, Nika Eco, January 2024. 

(7)  The Integrity Council for the Voluntary Carbon Market, www.ICVCM.org.

(8)  XTCC Investments,  xtcc.investments.