INDUSTRY INSIGHTThought Leadership

How the Voluntary Carbon Market can take net-zero from ambition to reality

By Adam Nye, Voluntary Carbon Markets – Business Development, and Nicola De Sanctis, Editor – Argus Voluntary Carbon Markets

On 26 October, Saudi Arabia’s sovereign wealth fund, the Public Investment Fund (PIF), organized the first-ever voluntary carbon credits auction in the Middle East, selling 1.4 million tons of CO2-equivalent in certified carbon credits. Timed to coincide with the launch of Saudi Aramco’s USD 1.5 billion Sustainability Fund – which will among other things support the development of a regional carbon capture and storage hub – the auction is perhaps the strongest signal to date that the voluntary carbon credit is coming of age; and that the Middle East, also host this year to COP27, is set to play a central role in its evolution.

Voluntary carbon credits are the latest addition to the wider carbon family and offer a much more flexible alternative to better-known national and regional credit schemes, known typically as mandatory or compliance markets. These markets use government-mandated carbon limits and a cap-and-trade mechanism to introduce a cost for carbon emissions. The first and currently most successful example of this is the European Union’s Emissions Trading System, which has been putting a price on members’ emissions since 2005. Other regions, such as North America and Korea, have implemented similar schemes.

By contrast with these state and regional schemes, the voluntary carbon market offers the private sector a mechanism to re-direct capital from carbon positive to carbon negative activities, making net-zero emissions an actual possibility rather than an aspiration. A business aiming to reach net-zero, in the spirit of the Paris Agreement and in response to investor and customer pressure, must primarily focus on how physically to decarbonize its operations. But for most companies, and in particular those in energy-intensive industries, reducing rather than eliminating emissions is the most they can hope for, except perhaps in the very long term. The voluntary carbon market makes achieving a net-zero goal possible by introducing the concept of offsetting.

In offsetting, a company with residual emissions in its operations – those that cannot yet be eliminated by physical decarbonization – will instead offset them against negative emissions generated elsewhere, and it will pay for the right to claim those negative emissions. And the activity generating those negative emissions is rewarded with a revenue stream.

“Carbon-negative” projects generate credits by preventing or avoiding emissions, or by actually removing greenhouse gases from the atmosphere. As an example: deforestation is a process that leads to the destruction of a carbon sink and the release of stored carbon dioxide into the atmosphere. In a region that has a predictable rate of deforestation, a project intended to protect a parcel of land, and thus prevent deforestation, could claim to have avoided a certain amount of emissions. For this claim to turn into a supply of carbon credits, the owner or developer has to demonstrate that without intervention and without the revenue from the sale of carbon credits, those emissions would indeed occur. Ownership of those negative emissions is transferred to the entity trying to offset its residual emissions by selling the carbon credit.

Avoided Deforestation, as it is called, is an example of a nature-based avoidance solution in which natural ecosystems are used to sequester and store carbon. Meanwhile, afforestation and reforestation projects that either introduce or reintroduce forest into previously deforested areas or to restore mangrove habitats are instead examples of nature-based removals projects. These approaches seek instead to remove carbon dioxide from the atmosphere outright. These can be nature-based but increasingly are engineered or technology-based approaches. Techniques such as Direct Air Capture (DAC), which uses physical and chemical processes to literally extract carbon dioxide from the atmosphere, are considered by some to be the future of the market for removal projects. Their application of engineering, chemistry and physics allows for greater scalability and measurability.

There is also great variation in the availability of credits from these projects. Credits from clean cookstove projects, where rural communities are provided with efficient cook stoves to reduce firewood consumption and mitigate household pollution, are widely-traded in the market with relatively well-defined price transparency. Other project types such as those for biochar – which involve pyrolysis of waste material to produce biochar and thus lock in carbon – or Regenerative Agriculture are in a much earlier stage of development; and there is therefore as yet a less meaningful supply of carbon credits to the market.

Indeed, it is arguably unhelpful to describe the current situation as a single “market”. The diverse nature of offsetting projects, the variability of their attractiveness in terms of “corporate image”, and wide differences in availability of credits have together created a patchwork of distinct price patterns by project type and location – there is no “one price fits all” in the way the market is currently evolving.

For example, the bulk of existing carbon credits come from avoidance strategies that have been the quickest and lowest-cost projects to commercialise. These include Reducing Emissions from Deforestation and forest Degradation (REDD+), Renewable Energies, and Clean Cookstoves for which prices are currently typically in the USD 3-17/mtCO2e range.

Meanwhile removals credits deriving from Afforestation, Reforestation & Revegetation (ARR) projects and Blue Carbon – which relates to the protection of coastal and marine ecosystems – are in high demand, but supply is still scarce. Their removal approach and low availability have resulted in premium valuations of up to USD 50/mtCO2e higher than prices for avoidance credits. Among the highest-priced removals credits are those from technology-based solutions such as DAC, which barely trade and can fetch prices well above USD 500/mtCO2e.

The bulk of projects lingers for now in the supply pipelines of crediting programs such as Verra or Gold Standard. Such programs act as issuing bodies for carbon credits, setting standards for project monitoring, verification and reporting. The Qatar-based Global Carbon Council, the first of its kind in the MENA region, has recently joined the list of carbon crediting programs.

The wide range in the supply, price and perceived desirability and risks of different carbon credits has meanwhile led businesses to adopt a portfolio approach. Companies will have their own preferences and policies relating to choice of credits, but in general most wind up opting for a balanced selection. Portfolios will typically comprise a majority of lower-cost, more readily available credits, and a smaller proportion of higher-cost, more sought-after credits.

The companies that have thus far led the way on the demand side have typically been from two groups. The first are the energy-intensive industries such as oil and gas and power generation businesses which already operate with a commodity trading culture and infrastructure. These are the companies with the largest carbon footprints to manage. The second group comprises companies with a strong brand – typically from the tech and consumer goods sectors – where the expectations from their customers, and therefore investors, are pushing them to take a leadership role in decarbonization.

To meet ever-growing demand, marketplaces have proliferated over the past few years, both in number and in form, from ad-hoc exchanges to platforms based on click-and-buy models. Governments are also trying to find their place in this market, and regional exchanges such as the Abu Dhabi Global Market and the Regional Voluntary Carbon Market established by Saudi Arabia’s PIF are flourishing.

The pressure to achieve net-zero can only increase in the upcoming years, and global decarbonization is still a long way off. The voluntary carbon market offers businesses and other large organizations a ready-to-use means to offset emissions while supporting more sustainable energy sources, protecting ecosystems and improving socioeconomic development in developing countries.

The emergence of standards and exchanges and the involvement of the world’s leading trading and energy firms is a testament to the potential of the voluntary market. Price reporting agencies such as Argus Media will be key in providing much needed price transparency in a market with such an enormously diverse set of products, suppliers and end-users.

*Argus Media will commence publication of Argus Voluntary Carbon Markets in early 2023