The market for voluntary carbon offsets is gaining momentum as more companies set emissions reduction commitments and more investors seek out opportunities to increase their exposure to climate-friendly projects. In this article, we explore how voluntary carbon markets (VCMs) can be leveraged to benefit sustainability projects and how developers can ensure they don’t miss out.
The concept of carbon financing or carbon trading has been around for decades, particularly with the 1997 Kyoto Protocol helping to formalize government-run, compliance-based schemes. While voluntary carbon markets (VCM) emerged shortly after, one can argue that this funding mechanism is just now coming into its own – and creating new opportunities for investors and project developers in the process.
In 2021, the VCM value exceeded $1 billion for the first time. This past year, it added another $400 million in value and according to the Taskforce on Scaling Voluntary Carbon Markets (“TSVCM”), demand for carbon offsets could be multiplied by a factor of 15 by 2030 – hitting $50 billion in value.
Carbon markets help accelerate efforts to decarbonize the economy by creating a financial incentive to reduce emissions and enabling project developers to attract private financing towards sustainability projects that might otherwise be financially unviable.
With growing demand being driven by corporate sustainability commitments, there is ample opportunity for project developers to secure funding and get new projects off the ground. But doing so means ensuring projects are set up for success. Developers must structure projects to be eligible to generate carbon offsets – or risk losing out.
Unlike their mandatory counterparts – such as those implemented in the EU, the UK, or in California – VCMs, as the name suggests, rely exclusively on companies’ willingness to offset their greenhouse gas emissions (GHG) through the voluntary purchase of carbon credits – rather than for compliance purposes. Compared to mandatory initiatives, VCMs are more fluid and generally unrestrained by boundaries or industry type. Each carbon offset – a certificate equivalent to the avoidance or reduction of one ton of CO2e – is unique, meaning that it cannot be applied to more than one project. Hence, carbon financing opens a new way for sellers to draw funding and gives buyers the possibility to compensate their GHGs at a lower cost than through available technologies while mitigating reputational risk for both.
By helping to attract private financing and creating an additional revenue stream, carbon
offsets can be used to improve the financial viability of climate-focused projects. Throughout its life, the project earns credit each time the corresponding emission reductions are verified. The credit can then be sold on the market through a broker or an exchange. The price a credit will be sold for depends on the relative supply and demand forces at the time of the sale as well as the type of project involved. As a rule of thumb, however, afforestation or reforestation projects typically reach around $20 per metric ton of CO2 equivalent (mtCO2e) whereas technology-based carbon removal projects can fetch up to $300/mtCO2e.
Carbon offsets can be applied to a great variety of projects, ranging from nature-based projects such as reforestation or wetlands restoration to technology-based projects such as renewable energy, methane, or direct carbon capture.
For that reason, carbon offsets also maximize the environmental and social benefits of the project, such as protecting biodiversity, preventing pollution, improving public health, and supporting job creation.
Voluntary carbon offsets also encourage investment in innovation and knowledge transfers across regions, particularly in developing regions where the potential access to capital is limited and the potential to reduce emissions is high.
On the buyers’ side, carbon offsets provide a cost-mitigating tool. With regards to current emission-reduction alternatives available to companies, buying carbon credits usually remains the most economical way for corporations to compensate for their GHG and achieve internal sustainable targets. Similarly, at a time in which environmental issues are increasingly being priced by global markets and climate actions are watched closely by shareholders and customers, a commitment to the VCM is valued – whether it is through financial or non-financial aspects.
By integrating carbon financing into their projects’ financial structure, developers can bolster the financial viability of their projects in a fast-changing business environment.
To capitalize on financial opportunities created via VCMs, developers must be aware of the requirements and how to best structure their projects for success. To qualify, projects need to be audited by independent third parties and registered under a private standard – such as Verra, Gold Standard, or Climate Action Reserve – to determine the quality of the carbon offset and track their issuance and retirement.
This is a key point of project structuring as projects must comply with core principles and requirements – such as those of additionality or permanence, among others – to be eligible.
Once the project is compliant, validated, and registered under the respective bodies, developers must consider the type of investment vehicle under which a project can be structured, and how to recognize revenue generated from the carbon credit issuance.
In this regard, the London Stock Exchange (LSE), for instance, has made significant advances by implementing a mechanism where carbon offset projects are bundled under a holding structure, which is, in turn, listed as an investment vehicle in the Exchange. This structure optimizes risk allocation, and it allows corporates and other investors in need of carbon offsets to retire them when needed and mitigate a portion of their emissions. Likewise, investors will be able to realize returns in the form of carbon credits instead of, or in addition to, cash dividends and other forms of distribution.
Examples like the LSE and other exchanges such as AirCarbon and Xpansiv CBL are all exceptional efforts to bridge the knowledge gap in a carbon credits ecosystem that still lacks for better governance and regulation.
It also demonstrates the willingness of big market infrastructure players to step into the market as there is still plenty of room for structuring innovation and financial tools; ETFs and futures are already implemented and booming. Hence, there is a clear investment potential that will leave outsiders at a disadvantage.
Several significant challenges remain for the continued development of VCMs, particularly around standardization, transparency, and pricing consistency. But recent initiatives are bringing greater credibility.
The launch of the Voluntary Carbon Markets Integrity Initiative (VCMI) in 2021, the release of new carbon standards by the Integrity Council for the Voluntary Carbon Market (ICVCM) in 2022 and other efforts such as the Science Based Targets initiative (SBTi) are bringing more clarity as to how companies can effectively assess their progress and provide oversight that projects genuinely contribute to the global effort to reach net zero.
Voluntary carbon markets are an important tool in the fight against climate change. By ensuring credits are of high integrity, companies are supported in making measurable projects, and projects are implemented successfully, we can progress further and faster in achieving critical climate goals. There is also still significant room for disruption, and those who leverage the opportunity – especially in a world that is becoming more sustainability-driven – can gain the competitive edge.