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Voluntary carbon markets poised for growth in 2022

04 January 2022 IHS Markit Energy Expert

Reprinted with permission from Oil Price Information Service (OPIS) and author Abdul Latheef, alatheef@opisnet.com.

The voluntary carbon market (VCM) grabbed headlines in 2021 with record transactions and soaring credit prices, and observers say all signs point to an equally robust 2022.

In mid-September, environmental data provider Ecosystem Marketplace sparked a frenzy when it reported the VCM was on track to hit $1 billion in annual transactions in 2021. Two months later, the nonprofit confirmed that the market had indeed breached that figure.

"This tells us more clearly today than ever before that global economies have accepted the VCM as a readily available near-term climate solution that can achieve emissions reductions, social safeguards, and other biodiversity and ecosystem benefits," Ecosystem Marketplace Director Stephen Donofrio told Oil Price Information Service (OPIS) in December.

"As the VCM matures and attracts new participants, signals from our stakeholders are that the growth we have seen in the past couple of years will continue into 2022," Donofrio added.

Donofrio believes the market expansion will be driven by collective efforts to deliver more trust in the quality and credibility of the supply of carbon credits in tandem with more sophisticated, well-designed, and publicly communicated demand-side strategies.

The surge in demand for voluntary carbon credits was triggered by a corporate rush to meet the goals of the 2015 Paris Agreement. The landmark climate deal seeks to limit global warming to well below 2 degrees Celsius, with an aspirational goal of 1.5 degrees C.

At least one-fifth of the world's largest 2,000 public companies have committed to meeting net-zero targets by mid-century or sooner through various initiatives, according to the Alliance of CEO Climate Leaders, a network representing business leaders from diverse industry sectors and regions.

"From governments to corporates to the people on the ground, there is clear consensus now that inaction is no longer an option, but rather it is time for all climate solutions to be deployed if we have any chance of coming out on top of the Paris Agreement's 1.5 C goal," Donofrio said.

The 2021 market demand story is often told in two parts: the influx of fresh entrants, with both speculative traders and offset end-users; and the resulting strong increase in carbon offset credit prices.

According to OPIS daily assessments, the average price of Voluntary REDD+ credits—frequently sold, premier forestry offsets—jumped about $7.50/mt over the past 12 months, more than doubling. The average cost of vintages 2017 to 2021 hit a high of $13.25/mt in early December, after starting 2021 at a low of $5.73/mt.

For the REDD+ assessments, OPIS considers Reducing Emissions from Deforestation and forest Degradation credits with a Climate, Community and Biodiversity (CCB) Standard certification issued by the Verra carbon registry.

Like the REDD+ credits, benchmark CORSIA-eligible offsets (OPIS CEO) rose more than $8/mt in 2021. The OPIS daily CEO assessment reached a high of $9.04/mt in mid-November after starting the year at a low of 80.5 cents/mt.

"Inflection point"

To meet the soaring demand for voluntary carbon credits, Xpansiv's CBL Markets launched new emissions trading contracts, doubling its market reach as the VCM expanded this year.

CBL Head of Global Carbon Rene Velasquez said this month that it was a significant year for the global exchange platform with the launch of two new spot contracts—CBL GEO for CORSIA-eligible offsets and CBL N-GEO for Verra-issued forestry credits with a CCB certification.

"We see 2021 as an inflection point for the voluntary carbon market," Velasquez said in an email. "More than $1 billion of credits were traded, which is a three-fold rise over 2020 and an important milestone to establish market credibility."

Now, with some of the necessary trading infrastructure in place, Velasquez expects the VCM to scale up further in 2022.

Mounting optimism

Velasquez's optimism is shared by the United Nations Special Climate Envoy Mark Carney.

Carney, who heads the Taskforce on Scaling Voluntary Carbon Markets (TSVCM), told a crowd at Climate Week NYC in September that there is a real prospect to scale the VCM by 100-fold by the middle of this decade.

"The world is beginning to grasp that to meet our objective of 1.5 degrees and keep it alive, we need to reduce emissions by 50% over the balance of this decade," Carney said. "This will require unprecedented investment and that in turn depends on clear country commitments, ambitious country policies, and a transformation of the financial sector."

The taskforce has established an independent governance body that is now finalizing what are called the Core Carbon Principles, meant to set a global benchmark for carbon credit quality.

In late October, the group announced the formation of the Integrity Council for Voluntary Carbon Markets, which is tasked with taking forward the work of the TSVCM.

Bank of America (BofA) is also bullish on market development. In September, a BofA Global Research report projected that the global carbon offset market may expand by 50 times by 2050 in order to facilitate net-zero targets. Reaching those goals would require around 7.6 gigatons of CO2 offsets or removals, it said.

Article 6 boost

The bank also projected that an agreement on Article 6 of the Paris Agreement, which deals with international carbon trading, could lead to broader adoption of offsets.

After years of negotiations, the Article 6 rulebook was finally approved by governments at November's COP26 climate summit in Glasgow, Scotland, giving a major boost to the VCM.

The countries agreed to accept "corresponding adjustments" to avoid double-counting in offset transactions to bolster the integrity of the market. They also agreed to include just a fraction of the billions of Certified Emission Reductions units generated under the controversial Clean Development Mechanism of the Kyoto Protocol in the Paris framework.

The agreement was quickly welcomed by stakeholders such as the International Emissions Trading Association (IETA).

"This is a solid and ambitious outcome, because it establishes an integrity framework to support the expansion of carbon markets to help governments and businesses deliver higher climate ambitions," IETA CEO Dirk Forrister said at the time. "It will now be up to the private sector to channel green investment using these new market structures and accelerate the race to net zero."

LEAF Coalition

A call to channel funding to climate projects in 2021 led to the creation of a new organization: the LEAF (Lowering Emissions by Accelerating Forest finance) Coalition, another boon for the VCM.

Launched in April by Norway, the UK, and the US in collaboration with the private sector, the coalition mobilized more than $1 billion for the protection of tropical forests. It believes reversing deforestation is essential to any pathway to a 1.5 degrees C future.

In 2020, primary rainforest destruction increased by 12% year on year, according to Global Forest Watch. The tropics lost 12.2 million hectares (30 million acres) of tree cover last year, the organization said, citing data from the University of Maryland.

The coalition will focus on financing REDD+ projects in developing countries. At COP26, the coalition reached financing agreements with Costa Rica, Ecuador, Ghana, Nepal, and Vietnam, and said more deals will be announced soon. In all, the group is evaluating proposals from 23 jurisdictions.

"These jurisdictions collectively have the potential to protect up to half a billion hectares (1.24 billion acres) of forest, greater than the area of the European Union, and their estimated self-reported emissions reductions amount to several times LEAF's initial goal of 100 million mt of emissions reductions," the coalition said in November.

REDD+ projects

Companies like Biofílica of Brazil are at the forefront of REDD+ projects. Founded in 2008, it is a pioneer in developing offset projects in the Amazon rainforest.

In July, environmental services firm Ambipar acquired a majority stake in the company with the aim of making it the largest nature-based solutions (NBS) provider in the world. The combined company has since been renamed Biofílica Ambipar Environment.

"We have the biggest portfolio in Brazil," Commercial Manager Laion Pazian told OPIS in mid-December. "We have seven REDD+ projects. This is more than 1.5 million hectares (3.7 million acres) under conservation activities."

He said Biofílica has been approached by big investment funds and trading companies about potential collaborations.

"Since the merger, we have [started] two new REDD+ projects and one agriculture project. We have also started to plant 500 hectares of native forest," Pazian said.

Likewise, Everland, which represents some of the world's most successful REDD+ projects, is poised for expansion.

"REDD+ is ready to scale and so are we," the company said in an email to subscribers sent in late December.

"This year, Everland sold over $300 million worth of Verified Emission Reductions (VERs) on behalf of the seven pioneering projects we represent," it said in the email. "We have facilitated the development of more than 25 new REDD+ projects that we anticipate will generate more than 20 million mt of annual VERs by 2025."

Everland has several additional project portfolios in the works, it said, noting that the company is "developing new impact reporting systems to improve how we measure and show the impacts generated by nature-based, community-led REDD+ projects."

Economist's perspective

While the VCM made major strides in 2021, it also drew criticism.

Yale University environmental economist Professor Robert Mendelsohn, who has developed methods to value natural ecosystems, told OPIS that there is a problem with the VCM: it is based on individual projects—buying electric buses, selling energy efficient engines, reforestation of 100 specific hectares, and so on.

That means groups that authenticate credits, as well as buyers, cannot discern which emissions would have declined anyway and which emissions were going to improve on business as usual, Mendelsohn said.

"This is a problem because we could spend trillions of dollars on these projects and still find that emissions are climbing anyway. The one thing that is worse than unabated climate change is unabated climate change and trillions of dollars wasted on mitigation that did not happen," Mendelsohn said in an email.

His solution is moving beyond project-based mitigation to industry sector-wide emissions reduction solutions.

He said for industrial emissions, VCM participants need to determine industry projections of future emissions under a business-as-usual scenario.

"Then we can reward companies in each industry that reduce their emissions by more than the projection. Moving to company-wide emissions and industry projections gives us a chance to prove additionality. Then we will know that all that money spent on carbon markets actually made a difference," Mendelsohn said.

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