2021 will probably be remembered as the year when carbon finance emerged as an important topic for discussion among various industries.
As for the 2021 new players to carbon markets with a voluntary approach oil and gas majors as well as hedge funds and banks were identified as the most active players, making a firm commitment to the market. As the year progressed various other industries have joined the market in line with their commitments to reduce carbon footprints.
Numerous political entities such as the EU as well as for instance, UK or the state of California already have mandatory carbon markets that cover specific industry sectors and the production of gases. They are an essential part of the effort to achieve the Paris Agreement objective of limiting global heating by 2 degrees Celsius above preindustrial levels (with the more ambitious goal of keeping within the limit of 1.5 C increase), even although some of these markets are older than those of the Paris commitments.
Some sectors have also taken a cue from compliance plans and committed to reduce carbon dioxide emissions (GHG) through participation in carbon markets voluntarily.
Voluntary carbon markets allow producers of carbon to reduce their unavoidable emission by purchasing carbon credits produced by projects targeted at removing or the reduction of GHG from the atmosphere.
Each credit – which is equivalent to a metric tons of decreased, avoided or eliminated CO2 or equivalent GHG – could be utilized by a corporation or an individual to compensate for the emission of one ton of CO2 or other equivalent gases. When a credit is used to offset the emission of gases it will be converted into an offset. It is transferred into a registry for retired credits, or retirements and is no longer traded.
Companies are able to participate in the market for carbon emissions, either in a single transaction or as part of an overall industry-wide plan including The Carbon Offsetting and Reduction Scheme for International Aviation, which was established by the aviation industry in order to offset CO2 emissions. International airline operators taking part in CORSIA have pledged to offset all CO2 emissions they generate over a base level of 2019.
Although compliance markets are limited to specific regions the voluntary carbon credits are significantly more fluid, without restrictions imposed by the nation states or political unions. They are also able to be accessed by every segment of the economy instead of a restricted set of industries.
The Taskforce for the Scaling of Voluntary Carbon Markets is a project of the Institute of International Finance with support from McKinsey, estimates that the carbon market credits could be worth upward 50 billion dollars as early as 2030.
Five main players make up the core of carbon markets.
The project developers comprise the upstream segment in the marketplace. They set up the projects that issue carbon credits. These can vary from large-scale, industrial projects like a high-volume hydro-power plant, to smaller ones that are community-based, like cookers that are clean.
There are initiatives aiming to reduce or eliminate direct emissions of industrial processes, for example Ozone-capture, fugitive emission management or the destruction of substances that deplete ozone as well as wastewater treatment. Natural-based projects consist of REDD+ (avoided deforestation) soil sequestration or forest afforestation. Other forms include carbon capture by technology such direct air capture. new categories are being introduced constantly.
Each credit comes with a particular vintage that is the year when it was first issued, as well as the specific date of delivery, which is when the credit will become available on the market. Together with their primary purpose of avoiding or removing GHGs from the atmosphere Credit projects may provide additional benefits and aid in meeting some of the United Nations’ Sustainable Development Goals (SDGs). For example, they may contribute to improved welfare for people living in the area, better drinking water, and the improvement of the economic inequalities.
Buyers at the END
The market for downstream is made up of buyers who are end-users: businesses as well as individual consumers who have agreed to offset a portion or all in their GHG emissions.
The first buyers for carbon credits are tech companies such as Apple and Google, airlines, and oil and gas majors however more sectors of industry, including finance, are joining the market as they establish their own targets for net-zero or search for ways to hedge against the financial risks that come with the transition to renewable energy.
The introduction of Article 6 of the Paris Agreement on Nov 13 at the UN Climate Conference, or COP26 in Glasgow set the rules for a crediting scheme that could be utilized by all 193 parties to Paris agreement to meet their emission reduction goals or national-determined contributions. The implementation of Article 6 has made it possible for nations to purchase voluntary carbon credits, so provided that Article 6 rules are respected.
To link supply and demand There are brokers as well as retail traders, similar to in other markets for commodities. Retail traders buy large quantities of credit directly from the provider, bundle those credits into portfolios of several hundred to thousands equivalent tonnes CO2, and sell those bundles to buyers usually with a commission.
While the majority of the transactions are happening now in private conversations and over-the-counter trades, some exchanges are also beginning to appear. Some of the most significant carbon credits exchanges in the present are new York-based Xpansiv CBL and Singapore based AirCarbon Exchange (ACX).
Exchanges have been working to streamline and speed up carbon credits trading with a complex nature due to the large number of factors that influence their price by developing standard products, that make sure that the basic requirements are met.
For instance, both The Xpansiv CBL as well as ACX have established standard products for nature-based credit, CBL’s Nature-based Global Emission Offset (N-GEO), and the ACX Global Nature Token.
Credit transactions under these labels are guaranteed to have set characteristics including the kind of the underlying project, very recent time frame, and a certificate from a limited set of standards.
Exchanges’ standardized offerings – especially those designed for forward delivery – are currently preferred by traders and financial institutions who are looking to purchase and hold to prepare for growing demand for carbon credit. Click here to trade carbon credits.
End buyers who need to acquire credits for offsets to their emissions tend to prefer non-standardized products as this allows them to study the unique characteristic of each underlying project, ensure the quality of the credit they purchase and therefore defend themselves against charges of greenwashing.
Often, the exchanges are used to settle big bilateral deals that have been negotiated offscreen. In a market note shared during May CBL declared that an greater number of bilateral deals that were negotiated offscreen were being brought by traders for settlement through CBL’s platform. CBL platform.
These deals made up large portions of transactions traded on CBL.
Brokers buy carbon credits from a retailer trader, and then sell them to the buyer who will purchase them usually, with a fee.
There is also a fifth actor unique with carbon markets. Standards are organizations, usually NGOs, which certify that a specific project is in line with its stated objectives as well as its declared emissions levels.
Standards contain a range of guidelines, or methods for every type of carbon project. For instance Reforestation projects must adhere to specific guidelines for calculating the carbon dioxide absorption of the planned forest, and hence the number of carbon credits that it earns over the course of time.
A renewable energy project will be subject to a different set of guidelines to apply when calculating its value in terms of reduced carbon emissions and carbon credits generated over the course of time.
Standards’ certifications also ensure certain fundamental principles or standards of carbon finance are respected:
Additionality: The project must not be legally mandated, common practice, or financially appealing in the absence of the possibility of generating credit.
No overestimation: CO2 emissions reduction should match the number of offset credits issued for the project. The offset credits should be used to into account any unintended GHG emissions caused by the project.
Permanence: The result of the GHG reductions should not be at risk of reversal and should lead to a continuous decrease in emissions.
Unique claim: Every metric tons of CO2 may only be claimed once and must include documentation of the credit retirement when the project is completed. Credits become offsets upon retirement.
Offer additional environmental and social benefits: Projects must conform with the lawful requirements of the jurisdiction of the project and must provide additional co-benefits that align to the United Nations’ SDGs.
Overlapping roles, bilateral trade
There is an overlapping of roles that is specific in the carbon marketplaces.
Many brokers operate as traders, and many financiers have both brokering arms and projects development arm.
End buyers may also fund their own carbon projects and opt to keep any or all of the credits they receive for their own offsetting needs.
All of these companies could ultimately sell credits to a buyer or developer. A developer could organize to sell them directly. All these juxtapositions can affect the prices, and eventually affect market transparency.
Pricing from a variety of sources
If a company decides to look into the voluntary market of carbon as a method of compensating for carbon emissions, one of the key items it searches for is the price for carbon credit. With this information, a company can decide how ambitious it can be when setting its emission reduction targets and if the market for voluntary carbon credits can actually help to achieve it.
In the same way an unambiguous pricing signal of carbon allows those who are already trading to ensure that they’re trading their credit at a price that is reflected in the real market value.
However, setting a price for carbon credits is far from an easy task, mainly due to the variety of carbon credits on the market and the variety of factors influencing the price.
Carbon credits issued by projects may be of various kinds and sub-types. How the project is among most important factors affecting the price that the credit is issued.
Carbon credits are classified into two broad categories or baskets. They are projects to avoidance (which do not emit GHGs completely, thus reducing the amount of GHGs released in the atmosphere) and removal (which are used to remove GHGs directly from the atmosphere).
The avoidance basket includes renewable energy initiatives, however it also includes forest and farming emissions prevention projects. These projects, sometimes referred to as REDD+, stop destruction of wetland and deforestation or use soil management practices for farming that minimize GHG emissions. This includes projects aiming to avoid carbon emissions caused by dairy animals as well as beef cattle with different diets.
Cookstove projects and fuel efficiency, or the development of energy-efficient buildings also are covered under the basket of avoidance as do projects for capturing and eliminating industrial pollutants.
The removal category covers projects for capturing carbon from the atmosphere and then storing it. They can be based on nature, using trees or soil for example to remove carbon and then store it. Examples include reforestation and afforestation projects, as well as wetland management (forestry and farming). They may also be based on technology and may include technologies such as direct air capture or carbon capture and storage.
Credits for removal tend to trade at a premium compared to avoidance credits, not only because of the higher level of investment required by the underlying project but also because of the huge demand for these kinds of credits. They also are believed to be a stronger weapon in the fight against climate change.
Beyond the nature of the project under consideration, the cost of carbon credits is dependent on the quantity of credits that are traded at a time (the larger the number, lower the price usually), the geography for the particular project its vintage (typically the more old the vintage the cheaper the price) and also the delivery time.
When the underlying carbon project is also helping to achieve some of the UN’s SDGs in this case, the value of the credit from that project to potential buyers could be greater, and the credit could be traded at a premium to other kinds of projects.
For instance, community-based projects – which are usually very localized and are typically designed and managed by local NGOs or local groups tend to create less carbon credits. They are also more expensive to be certified. However, they generally provide greater co-benefits in addition to meeting the UN’s SDGs, contributing to, for example, greater welfare for the population in the area, better water quality or improvement of the economic disparity.
This is why credits emitted by community-based projects might be worth more to projects that do not meet SDGs, such as industrial projects, which are typically larger in scale and often generate large volumes of credits with more readily verified GHG offset potential.
In the present carbon market the cost of a carbon credit can vary in price from just a few dollars per one metric ton of CO2 emissions up to $15/mtCO2e and even $20/mtCO2e for afforestation and reforestation projects. to as high as $300 per mtCO2e in removal projects based on technology, like CCS.
S&P GlobalPlatts analyzes the price of a wide range of carbon credits. The company currently provides 20 price evaluations, including the spot and forward (Year 1.) prices. Each price assessment reflects the most competitive credit in the respective category, based upon bids, offers trades reported in the brokered market, or on trading and exchange instruments.
Platts collects bid deals, offers and trades in carbon credits that are accredited through the standards listed below: The Gold Standard, Climate Action Reserve (CAR), Verified Carbon Standard (VCS), The Architecture of REDD+ Transactions and the American Carbon Registry. The price indications are direct from participants in the market on each trading day.
Platts produces four standalone prices that include The CEC (reflecting price that is eligible for CORSIA), the CNC (reflecting the natural solutions based on a vintage of each of the last five years, and incorporating both removal and avoidance credits) as well as the Renewable Energy Carbon credits price (vintage of the past three years) and Methane Collection price, which includes credits generated by projects that aim to cut methane emissions, such as Landfill Gas Collection, Waste Gas as well as Livestock Waste Management projects (vintage of each of the last 3 years).
There are then two price baskets: the avoidance prices and removal prices. The first basket includes the Platts household devices price, Platts Industrial Pollutants price, and Platts Natural-based Avoidance price. The second basket consists of Platts natural carbon capture as well as Platts Technical Carbon Capture.
Along with publishing the price of each assessment contained within the two baskets, Platts also assesses the price of the basket itself, producing carbon avoidance credits price and Carbon Avoidance Credits price and Carbon Removal Credits price. The two baskets’ assessments show the most competitive of the costs they offer.
Given the wide array of credit options, Platts also reports price indications for each project category which are traded in the larger market for voluntary transactions and not just in CORSIA. CORSIA scheme, in an effort to improve transparency.
The rise of carbon markets for voluntary use dates back to the beginning of 2000, following the ratification of the Kyoto protocol, growth was stunted by the 2008 economic crisis. The new surge of private and public pledges to reduce carbon emissions over the past few years is now triggering a resurgence of enthusiasm for voluntary carbon credits as a way of reducing carbon footprints.
Although there are no obstacles that prohibit entry to the industry, lack or transparency of transactions and inadequate understanding of how carbon finance operates have kept potential players out of the market.
However, the increasing curiosity about studying voluntary carbon markets and the work by a number of actors to scale up and standardize processes, suggests that carbon finance is likely to be able to attract new participants and increase its size.
2021 will probably be remembered as the year when carbon finance emerged as an important topic for discussion among various industries.