Why we remain bullish on the verified carbon markets, by Melissa Lindsay, founder of Emstream and Emsurge.
Investor confidence in climate tech and nature has never been higher. Undeterred by lacklustre carbon prices throughout 2022, new entrants piled into all areas of the market, setting the stage for growth in 2023.
Finance flowed into crucial market infrastructure, such as rating agencies, trading platforms and marketplaces, registries, brokerages, and data.
The markets embraced technology and innovation, recognising digitalisation is key to transparency and scalability, delivering higher quality credits and building buyer trust. Technology is now poised to accelerate the efficacy of projects through the digitalisation of processes and operations, in particular the measurement, reporting, and verification (MRV) of emission reductions and removals. It is also being used to quantify biodiversity and its additional benefits to ecosystems. Credits from more biodiverse projects will command a premium, as will those using digital MRV, until it becomes the norm.
2022 was not without its setbacks. The war in Ukraine, devaluation of cryptos and on-chain credits, unresolved regulatory, political, and structural uncertainty, debate over what constitutes a quality carbon credit, and the corresponding legitimate use of such credits in corporate claims all created challenges throughout the year. But while these factors contributed to inertia, in the long run they will play out as reasons to be bullish.
Events in Ukraine sadly kicked the carbon can down the political road. Supply pressures shifted ambition from green energy to any energy. The impact was global, with Europe pulling gas from less developed countries which were unable to compete on price and had been planning to burn LNG as part of their transition away from coal and oil. High energy prices forced a retraction in trading as companies struggled to manage credit exposure, meaning the demand for offsets was also down. Gas has however succeeded in being reframed in Europe as a transitional fuel and if paired with nature-based solutions could be a pragmatic approach to net zero.
Not all carbon projects will sell to oil and gas companies or take their money. If encouraged, energy traders could mobilise significant finance and demand to scale the carbon markets. They have the balance sheets, experience launching projects in challenging environments, and ability to educate millions of customers on the true cost of consuming fossil fuels. Commodity traders are also set up to warehouse delivery and price risk, which your average corporate buyer is unable to get comfortable with. Due to media backlash, we see them quietly working to provide accurate greenhouse gas emissions statements with products, reducing supply chain emissions and establishing carbon desks. The growing anonymity of retirements suggests this fear of greenwashing is widespread.
We see future liquidity in the VCM coming from portfolio players, such as the commodity traders or specialist funds and banks, who are building structure to later optimise around. Swapping credits from different project types and countries with each other, as price spreads move or client demand for particular products materialises.
Carbon credit demand was also hit by both plummeting Bitcoin prices ( down 60% in the last year), reducing the finance available for Web3 initiatives, and an effective ban by the main carbon standard Verra on retiring credits to bring them on chain. Credits which were previously brought on chain are now in limbo and although on and off-chain prices disconnected, the wind was taken out of both markets.
All is not lost though. A second generation of crypto-trading initiatives that involve a two-way bridge to move credits on and off chain are due to launch in 2023, with Verra exploring the immobilisation of credits with the sector. This will prevent the misinterpretation of retirement data when credits are moved on chain, as demand. We also see blockchain technology being embraced by newer registries, in the measurement, reporting, and verification of emissions and by trading platforms. This should increase consumer confidence in credits and lower costs and transaction fees in the long run.
Large corporates are now seeking to be a proponent in their own projects or to pre-pay in exchange for significant discounts (30-50%) on the carbon price. As well as low prices, companies can ensure their credits have defendable financial additionality. Despite this growing participation in the forward market, 2023 will remain a buyer’s market with investors able to cherry pick the geography, size and type of projects they invest in. The only constraint being limited resources to perform due diligence.
Carbon off takers will continue to dictate contract terms, as most projects can’t raise sufficient funds through equity and debt markets alone to launch or scale. However, buyers should remember a good deal is one which is good for both sides, for the duration of the contract. This holds particularly true for the carbon markets, where redistribution of wealth and community benefits increase future value.
Many projects are still accepting a fixed price over the long term because agreeing a floating price and getting exposure to the upside is challenging in the absence of a trusted benchmark. A plethora of new indices, benchmarks and futures contracts emerged in 2022, but they failed to consistently reflect the over-the-counter wholesale price of credits.
In 2023, we expect to see the closing of the many deals initiated in 2022. Many funds were launched specifically to finance nature while providing a healthy rate of return to investors. Money was quick to flow into funds, but slow to be deployed into projects due to lengthy due diligence at project level and an extensive number of options to assess. These investments should soon come to fruition.
Many clients added cookstoves to their portfolio and are now looking to nature, in particular removals and blue carbon. Where cookstoves are relatively cheap and have a short lead time from project inception to first credits being issued, nature-based credits are generally more expensive, carry greater delivery risk and in the case of removals have a long lead time from project inception to credits being issued.
Afforestation, Reforestation and Revegetation (ARR) projects are benefiting from an assertion by some that removal credits are higher quality and carry more legitimacy in corporate claims of carbon neutrality. Buyers also feel confident that carbon revenue streams are crucial to ARR projects, allowing them to tick the financial additionality box. As a result credits from ARR projects are commanding a healthy premium to rainforest preservation, despite the latter boasting higher positive climate and biodiversity impacts.
Rainforest nations are fighting back. Different accounting measures are coming to the fore to find a more equitable way of rewarding those that have and are doing the best job of preserving our forests. The uncertainty around which regime a country will chose to adopt and how they will interact with the voluntary carbon markets has deterred some buyers from investing in or buying REDD+ credits for the time being.
Biodiversity is richest in our primary forests, and in 2022, this started to receive the recognition it deserves. A focus on biodiversity could change the current price spreads once the challenge of accurately measuring it has been met.
Where 2022 was a year of laying foundations, 2023 will be a year of building upon them. With a lot of work left to do, we may however need to wait till later in the year or 2024 to see substantial growth. But ultimately, that growth is inevitable.
Melissa Lindsay is founder of Emstream and Emsurge, an OTC LNG and voluntary carbon credit marketplace.
Any opinions published in this commentary reflect the views of the author(s) and not of Carbon Pulse.
