Introduction to the Voluntary Carbon Credit Market (I/IV)

Setting the groundwork, from early financing to direct engagement with carbon projects

The escalating global temperatures demand swift and decisive action, and it is encouraging to witness an increasing number of companies and governments pledging their commitment to achieving net-zero objectives. However, as these entities formulate their net-zero strategies, it is inevitable that they will continue to generate emissions both in the short and long term. To offset these emissions, companies have turned their attention to the potential of carbon offsets, incorporating them into their broader decarbonization frameworks. In this article, I will delve into the realm of the voluntary carbon credit market, examining its potential and the challenges it faces in tackling climate change head-on.

Despite recent criticism and the presence of controversial discussions surrounding the voluntary market, its primary market size, determined by the product of retired credits and credit prices, experienced a notable growth of over 20% in 2022, reaching $1.3 billion. Furthermore, average carbon credit prices increased by 40% compared to the previous year (source). The market is also expected to witness significant expansion in the coming years, with estimates projecting a size between $10-40 billion in 2030 (source). This growth can be attributed to a surge in demand and the continuously rising prices of carbon credits.

Let's start by clarifying the fundamentals:

There are essentially two types of carbon offsets - those that reduce emissions from existing or future operations (known as carbon avoidance), and those that remove existing carbon from the atmosphere (known as carbon removal).

As a side note, it's worth mentioning that every carbon credit, much like every carbon offset, represents a one-ton reduction in emissions. Therefore, these terms are often used interchangeably. Carbon credits are certified certificates for a unit of emissions reduction or carbon removal, facilitating their trade within the carbon marketplace. These credits are regarded as tradable instruments and are verified by independent certification bodies.

Carbon avoidance projects typically involve renewable energy initiatives that enable the substitution of carbon-intensive fuel-burning processes. Examples include wind farms, biomass energy, or biogas digesters.

On the other hand, carbon removal projects encompass both nature-based and technological solutions. Nature-based solutions involve activities like forest restoration, where newly planted trees absorb carbon from the surrounding air. Technological solutions include enhanced mineralization and direct air capture. 

Carbon removal initiatives are the true heroes as they address the complex and often seemingly impossible task of extracting CO2 from our atmosphere and environment, directly tackling the root of the major problem. Hence, in this series of articles, I will solely focus on carbon removal credits.

Once a carbon removal project is established, it must undergo a specific process to issue carbon credits, as outlined in the carbon credit value chain (s. below):

Financing:

Carbon project developers face significant upfront investment requirements before they can generate revenues from carbon credits. They need to finance both the carbon project itself and the entire measurement, verification, and issuance process. Providers such as Ivy Protocol or Maya Climate connect carbon project developers with early-stage investors who are willing to invest in credits at an early and risky stage, securing options and obtaining a lower price.

Measurement, Reporting, and Verification (MRV):

Before a carbon credit can be registered, it undergoes a measurement process that relies on scientific calculations and on-site measurements to estimate carbon stocks and flows. Independent auditors are often involved to validate the project's measurement methodology. Three criteria are used to assess the reliability of carbon credits:

• Additionality: Emissions reduction or removal must be additional to what would have occurred without the carbon offset project. Demonstrating additionality can be challenging in practice. For a forest conservation project, developers must show that the forest would have been harvested and cut down otherwise. In the case of a renewable energy project, the developer must demonstrate that the wind farm would not have been built due to existing government incentives. It is crucial to assess the likelihood of a project being additional.

• Permanence: Ensuring that the captured carbon remains out of the atmosphere indefinitely can be difficult. Events like bushfires may destroy trees in a reforestation project, releasing stored carbon back into the air. Research and development are ongoing to develop more permanent carbon capture technologies.

• Leakage: Offset projects should not inadvertently cause emissions to increase elsewhere. For example, protecting one area of the forest may lead to deforestation in unprotected areas if this risk is not considered in project design. Additionally, projects should aim for co-benefits, such as improving local livelihoods, rather than causing harm or violating indigenous rights. 

Certification, Ratings, and Insurance:

After the MRV process, carbon project developers have the option to obtain additional certifications or ratings, such as Sylvera. These independent providers have their own methodologies and processes to assess the reliability of carbon projects. In the voluntary carbon market, where there is no institutional authority regulating the market, additional certifications and ratings are voluntary but can enhance market position and pricing if they reflect high quality.

Registries:

Moving forward, project developers take the next step by registering their carbon project in a registry, enabling the issuance of carbon credits. These registries are usually connected to internal or external marketplaces, providing the carbon project developer with access to potential buyers. Notably, registries often adhere to specific standards, which they follow to evaluate and verify the methodologies and validations once again.

Marketplaces/ Broker:

Carbon credits, once issued, are typically managed through carbon exchanges or intermediaries such as brokers and retailers. These third-party entities facilitate the financial transactions involved in the sale of credits. Project developers have the opportunity to sell their issued credits to interested buyers, particularly companies seeking to offset their unavoidable emissions.

Buyers of carbon credits have the option to directly engage with project developers at various stages, ranging from methodology development to post-issuance of credits. By becoming involved at earlier project stages, credit buyers can gain a deeper understanding of the offset projects. Additionally, by bypassing intermediaries like brokers or retailers, buyers may access credits at lower prices, making the process more cost-effective and transparent. This direct engagement empowers credit buyers to establish a closer connection with the offset projects and make more informed decisions while participating in the carbon market.

The voluntary carbon market is an intricate landscape encompassing multiple parties and stakeholders. On one side, we have the supply side, comprising various carbon projects dedicated to offsetting emissions. On the other side, we find the demand side, consisting of corporate, state, or consumer buyers seeking to procure carbon credits. Get ready for the next article where I'll explore the supply side of the voluntary carbon market, focusing on carbon removal projects. Stay tuned!