Summary

In 2023, the Voluntary Carbon Market (VCM) was not merely put under scrutiny; it was thrust into the spotlight as the “wild west” of climate action. The quality of carbon credits, once taken at face value, has become a blazing topic of contention, igniting fervent debates and reshaping the very landscape of corporate strategies and priorities.

Quality Conundrum in the VCM

The pivotal moment came in January 2023, when an investigation by the Guardian sent shockwaves through the VCM: over 90% of certain REDD+ credits on Verra failed to achieve genuine carbon reductions. This revelation, though startling, didn’t appear out of thin air; a year earlier, Bloomberg had already raised concerns about the questionable quality of many credits from renewable energy projects.

The aftermath was seismic. These findings have had a profound impact on how companies approach carbon offsetting. Companies like Nestlé and Gucci stepped back from claiming carbon neutrality based on offsetting due to fears of greenwashing. Similarly, Shell’s withdrawal from offset investments is a clear indicator of the growing scepticism in the market.

To add to the woes, in the second half of the year, South Pole’s exit from the Kariba REDD+ project shook the core, while a leading Kenyan offsetting project, ironically celebrated for community impact, was mired in grave allegations of sexual abuse. These findings only exacerbated the situation further.

The Role of Carbon Credits Amidst Challenges

Despite these hurdles, it’s a stretch to say carbon credits are obsolete. 2023 marked a remarkable surge in the number of companies committing to scope 3 emissions on SBTi, a trend that reflects a growing commitment to challenging scope 3 and hard to abate emissions, for which carbon credits shine as a practical solution. 

This is particularly true in scenarios where reducing emissions internally is a complex and costly affair.  A recent analysis by MSCI speaks volumes: while average internal abatement costs can soar around $395 per CO2e, the price of a high-quality carbon credit hovers around a more palatable $30. Using carbon credits, blended costs could drop to $300–$100.

Striking the Right Balance

As companies wade through the VCM, merging quality carbon credits with internal abatement strategies offers a way forward. SBTi recommends covering at least 90% of emissions through internal abatement and the rest through external projects. Yet, creating a carbon credit portfolio that meets these evolving standards is no small feat, especially in the absence of clear regulatory guidance or widely accepted market standards.

Navigating the Complex Terrain

While organizations like the Integrity Council for Voluntary Carbon Markets (ICVCM) and Voluntary Carbon Markets Integrity Initiative (VCMI) are diligently striving to establish a universal standard within the VCM, the market remains rife with uncertainty and a lack of consensus. However, a few strategies can be deployed to improve carbon credit selection:

• Defining the Role of Carbon Credits in Your Corporate Strategy

The integration of carbon credits into a company’s sustainability strategy hinges on a clear understanding of its specific objectives. For instance, airline companies often turn to carbon credits as a means to fulfill regulatory requirements under frameworks like CORSIA.

Sometimes, the utility of carbon credits extends beyond regulatory compliance and target achievement. Companies whose operations and supply chains are deeply intertwined with natural resources (e.g., FMCG) seek carbon credits from Nature-Based (NBS) Projects nestled close to their supply chains, forging a connection between their operations and the ecosystems that sustain them. 

• Considering Key Pillars for Quality Assurance

To ensure the integrity of carbon credits, several critical aspects must be considered:

1. Additionality: It involves assessing whether the emission reductions would have occurred without the incentive of revenue from carbon credits. This concept ensures that carbon credits represent actual environmental benefits beyond what would happen anyway. The key criteria for assessing additionality include:

   – Host country’s legal requirements

   – Contribution of carbon credit income to the project

   – Investment or barrier analysis combined with common practice analysis

2. Permanence: Permanence refers to the long-term viability and stability of emission removals achieved by a project. This is crucial, especially for nature-based projects where the risk of reversal, such as through forest fires or changes in land use, can potentially negate the benefits of carbon sequestration. The criteria for assessing permanence include:

   – A guaranteed credit permanence of at least 40 years from the start of the first crediting period

   – Adequate buffer pool contributions to mitigate the risk of reversals (at least 20% for nature-based projects)

Currently, less than 10% of projects across major registries meet the permanence requirement, and only a small percentage contribute sufficiently to buffer pools.

3. Accurate Quantification:  Accurately estimating the CO2e impact of a project. It encompasses robust quantification methods, comprehensive baseline considerations, and accounting for all significant carbon emissions sources or sinks. Key aspects to consider in carbon quantification include:

   – The conservativeness of the quantification methods to prevent over-crediting

   – Whether current methodologies adequately consider leakage 

4. Co-benefits: Assessing the co-benefits of a project involves evaluating the additional environmental or social advantages that a project brings. This can include biodiversity conservation, improvements in local air quality, and socio-economic benefits to local communities. 

Key considerations include:

   – Whether the project has received program or third-party certifications affirming its co-benefits like CCBS

   – The extent and quality of community stakeholder engagement and consultation involved

5. Vintage Year: The vintage year of a carbon credit refers to the year in which the GHG reduction or removal occurred or the year the credit was issued. While the vintage year itself does not directly indicate quality, it can provide context about the credit. For instance, older vintages may indicate that credits have remained unsold for an extended period, which could raise questions about their quality. Older vintage years also indicate the use of an older, less stringent methodology.

6. Risk Factors: Evaluating carbon credit projects also involves considering various risk factors, such as country-specific risks (e.g., policy support or legal rights), sector-specific risks (related to methodologies), and developer-driven risks (resulting from practices across multiple projects).

• Diversification: Hedge Against Uncertainty

A change in a country’s environmental policy or legislation can drastically alter the effectiveness and value of a carbon project. Consequently, a portfolio heavily focused on a single country’s projects could face heightened risks due to these policy shifts.

By investing in projects across different national contexts, buyers can mitigate the risks associated with reliance on a single country’s policy landscape.

Even projects within the same sector, irrespective of their geographical spread, can share common risks.  For instance, forestry projects, regardless of their location, often face risks like land tenure issues or susceptibility to natural disasters. Diversification across various sectors can provide a more stable and risk-adjusted portfolio.

• Discounting

This approach involves using multiple credits to offset one tonne of CO2e and addresses the varying quality of carbon credits. It enables corporate buyers to assess and account for project-specific risks, moving beyond the simplistic one-to-one credit-to-tonne ratio.

• Selecting Newer Methodologies

The selection of newer, more stringent methodologies is pivotal to addressing critical concerns like emissions baselines and the risk of over-crediting. For example, to address concerns around REDD+ projects, Verra recently published a new methodology, VM0048, which represents a significant advancement in setting baselines by harmonizing with national accounting methods under the Paris Agreement. It incorporates remote sensing technologies and a deforestation risk tool, improving the accuracy of emissions quantification. 

• Balancing Quality with Price

In the VCM, the relationship between price and quality is not as straightforward as it might seem. There’s a tendency to equate ‘cheap’ with ‘low quality’. On the flip side, the assumption that higher prices equate to better quality doesn’t always hold water in the carbon market. Notably, some types of high-impact offset projects have demonstrated the ability to achieve meaningful greenhouse gas reductions without the need for exorbitant costs. 

Key Market Developments and Initiatives (2023)

Besides strategies, staying informed about market developments is vital to navigating the VCM’s murky waters. Let’s explore the latest trends shaping the future of carbon markets.

Role of Technology

Digital MRV: Remote sensing tools such as satellites and drones make data collection more precise and resource-efficient, particularly for Monitoring, Reporting, and Verification (MRV). Public remote sensing datasets are readily accessible for baseline calculations and assessments. Machine Learning and Artificial Intelligence streamline essential data processing during the MRV cycle, such as baseline modeling and emission reduction monitoring.

Blockchain: Blockchain brings traceability to carbon credits, recording their entire lifecycle in a tamper-proof ledger. Climatecoin and Veridium have taken this a step further, tokenizing carbon credits and linking them to conservation efforts.

SBTi’s Beyond Value Chain Mitigation (BVCM)

The Science Based Targets Initiative (SBTi) launched its new consultation on Beyond Value Chain Mitigation (BVCM). BVCM, in this context, refers to actions that a company can take to mitigate emissions outside a company’s value chains. This can involve purchasing high-quality, jurisdictional REDD+ credits or investing in technologies like direct air capture.

VCMI and ICVCM join hands

VCMI and ICVCM have joined hands to establish a comprehensive market integrity framework for the VCM. This framework is designed to uphold and reinforce critical aspects such as quality, transparency, credibility, and accountability throughout the entire VCM value chain. The joint work will play a central role in defining and promoting best practices, ensuring the credibility of both the acquisition and sourcing of high-integrity credits by companies. 

Article 6.4

Article 6.4, the successor to the UN’s Clean Development Mechanism (CDM), has become a  focal point in carbon markets. It introduces “A6.4ERs” credits, tradable and retireable by countries and other voluntary buyers. It aims to establish a framework for ensuring the quality, transparency, and accountability of carbon projects. This is crucial for the VCM, as it will guide the changes in the methodologies of registries in the VCM.

Launch of The Climate Action Data Trust (CAD Trust)

CAD Trust, a nonprofit initiative supported by the World Bank, recently introduced its Public Data Dashboard, which marks a significant stride in enhancing transparency and integrity within carbon markets. It includes datasets from four carbon market standards and 85 essential carbon credit datasets accessible to all market players under a shared taxonomy.

In Conclusion

In a world where the race to reduce carbon emissions is more urgent than ever, the VCM stands as a crucial tool for companies to offset emissions they can’t eliminate entirely. Questions and challenges are here to persist; however, innovation is the name of the game. Although recent developments and improved buyer diligence show promising avenues, the road ahead is far from straightforward.

Download