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Voluntary carbon markets: A key tool for decarbonization

Achieving the Paris Agreement targets of limiting global temperatures has never been so imperative, and that despite the economic headwinds, the cost of inaction remains far greater than the cost of action. But what is the cost for our future national energy policy?

Recent newspaper headlines continue to highlight the tragic wildfires around the world and the impact that climate change has had on key influences of this devastation, including soil moisture, drier conditions, and temperatures.

It doesn’t take an Oppenheimer-sized intellect to acknowledge that achieving the Paris Agreement targets of limiting global temperatures has never been so imperative, and that despite the economic headwinds, the cost of inaction remains far greater than the cost of action. On top of this, the UK Government recently awarded 100 new North Sea fossil fuel licences, citing job creation and lower energy bills for households in the short-term. But what is the cost for our future national energy policy?

It is through this lens that I want to discuss the voluntary carbon markets. Firstly, like many terms in the world of decarbonization, carbon credits come with a variety of names, such as carbon offsets, verified emission reductions (VER), or greenhouse gas (GHG) emission credits. In a nutshell, a carbon credit is an instrument through which recognizes a reduction of one metric tonne of GHG emissions. Each individual credit is independently verified, associated with a corresponding emission reduction, and can be traced back to a specific project to avoid double counting.

There are two distinct types of carbon markets:

  1. The compliance market: This market is typically regulated by national or international regimes, such as the Kyoto Protocol or the EU Emissions Trading Scheme (ETS). Only a certain amount of GHGs per industry or country can be emitted under a cap-and-trade governance system and any surplus allowances can be traded for financial gain.
  2. Voluntary carbon market (VCM): In contrast, the VCM is purely voluntary. Organizations can participate in a project-based system based on their own corporate social responsibility (CSR) or investor pressures (private financing) to offset unavoidable emissions and achieve sustainability targets. It is also possible to participate in industry wide programmes, such as the international airlines CORSIA scheme.

To build on this, there are two distinct types of carbon credits:

  1. Avoidance credits are backed by projects that reduce GHGs otherwise being produced.
  2. Removal credits or carbon dioxide removals (CDRs) go one step further and take the emissions out of the atmosphere before storing them typically via reforestation or CCS.

We see both strategies playing an important role.

While increasing numbers of organizations are pledging to meet ambitious net zero targets, many are doing so without fully grasping how difficult it can be to fully eliminate emissions from business activities. This is where carbon credits compliment overall business carbon management strategy by helping to offset those ‘sticky’ emissions that are too challenging to eliminate from their operations. Other benefits include providing revenue to scalable environmental and social projects, such as forestry, pollution reduction, biodiversity, and local community infrastructure. Feeding into this, the price of carbon credits fluctuates like any market and typically depends on economic factors, such as supply and demand, in addition to carbon project type, project size, quality, locational factors, community or environmental co-benefits, and year of project completion or vintage. In contrast to a bottle of fine wine, usually the older the vintage the cheaper the price of the carbon offset in question (certain organizations purchase offsets from recent vintages only).

From our most recent engagement with stakeholders on carbon credits, we find that, in addition to financial cost and co-benefits, there are two consistent ‘must-haves’ when evaluating a carbon project from a client perspective:

  1. Additionality - Refers to whether a project or activity would have been undertaken without the support of carbon credits, i.e., additional to what would have happened otherwise. In our conversations with clients, additionality is a game changer and top of mind.
  2. Quantifiability – In terms of our ability to consistently measure and verify our carbon contribution is so important for the integrity of VCMs, particularly considering recent negative press. These quality concerns have only served to increase the depth of verification processes and selectivity of high calibre, proven carbon projects with a positive environmental impact.

While consensus estimates for the size of the global carbon market varies widely, analysts are broadly united in their view that the market for carbon credits will increase considerably between today and 2050. Some growth projections are pegged as high as 50x, aided by ambitious carbon neutrality targets from a wide variety of market participants, including project developers (generate the credits and market for sale), global corporations (typically looking to offset their emissions), non-profit organizations, governments, and intermediaries (brokers and traders who provide liquidity). In addition, verification, and registry bodies play an important role to ensure high standards of transparency, due diligence, and verifiability.

As mentioned earlier, recent publicity has highlighted questionable monitoring and reporting standards, negatively impacting credibility and market prices across nature-based offsets and the aviation industry benchmarks. In this regard, one recent standard launched by the Voluntary Carbon Markets Integrity Initiative (VCMI) and backed by the UK Government aims to assess whether claims made by corporates in relation to carbon offsets and their progress toward internal climate targets are indeed accurate. At stake here is whether the underlying carbon offsets achieve the environmental benefits they claim, or to put more simply that ‘they do exactly what it says on the tin’! Unfortunately for market participants, there appears to have been instances whereby certain carbon projects were over-stating their impact on GHGs, as well as underreporting project and investor risks. Naturally, as the decarbonization transition develops, so too will the VCMs need to address concerns around market strength, scalability (including standardized terms), maturity, and of course integrity.

Bringing this full circle to us, our Green Energy Procurement capability provides organizations with a clear framework to navigate the carbon markets and identify, source, and implement high-quality offset projects as part of a tailored decarbonization portfolio. We believe when done holistically, the voluntary carbon markets can play an important role in your overall procurement toolkit, and it’s our mission to provide a co-ordinated and sustainable pathway forward.

9/18/2023 8:00:00 AM

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Robert Maxwell

Robert Maxwell

Principal Consultant

Energy Transition Outlook UK 2024

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  Energy Transition Outlook UK 2024

Energy Transition Outlook UK 2024

DNV’s second edition of the UK Energy Transition Outlook presents the results from our independent model of the UK’s energy system through to 2050.