Strong growth predicted for voluntary carbon market

Momentum behind the voluntary carbon market persists as companies' net-zero commitments are undeterred by Covid-19. Annabelle Palmer reports

The word 'rollercoaster' comes to mind when looking back on the last 12 months of the voluntary carbon market.

The ups and downs started with strong levels of issuance in the last quarter of 2019 and the first quarter of 2020, with standards body Verra issuing record-breaking volumes of Verified Carbon Units (VCU) in most of the months during this period.

The bar was therefore set unusually high when the shock of the Covid-19 pandemic was felt by financial markets in Q2 and Verra's VCU issuances declined by 63%.

However, this fall was short-lived and for May and June 2020 Verra reported the second-highest Verified Carbon Standard (VCS) issuances in this period compared with the same period in previous years.

Verra won the award for Best Voluntary Standard for the eighth time in nine years.

This bounce back has been interpreted as a sign that the market is robust and will continue to rebound, subject to the pandemic's trajectory.

"Initially, it had a really negative impact," says Louis Redshaw, managing director of Redshaw Advisors, which topped the polls for Best Trading Company this year.

Redshaw has been a frequent winner in the mandatory carbon section of EF's annual Market Rankings, but this is the first year it has picked up an award in the Voluntary Carbon Market Rankings.

"Corporations understandably had to protect their cash and, although we had no one try to cancel existing deals, there were many who effectively 'mothballed' their plans until their situation became clearer and confidence in their revenue potential returned.

Some clients working in sectors that were not negatively affected actually increased their volumes and bought ahead, hedging against price increases as the market recovered," he says.

However, this recovery is despite an absence of demand for offsets in the airline sector.

Voluntary preparations for the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), ahead of a mandatory phase due in 2027, had driven record-setting purchases of credits towards the end of 2019.

Since then, demand has been badly hit by the drop in international aviation resulting from the Covid-19 pandemic.

"Prior to Covid-19, we were seeing increased demand from airlines – linked not only to anticipated CORSIA demand but also from airlines such as EasyJet, Delta and JetBlue making additional voluntary commitments to offset emissions from all flights.

These announcements underpinned a number of large-scale transactions in late 2019 early 2020," commented Ilona Millar, head of Baker McKenzie's Global Climate Change practice, and winner of Best Law firm once again.

In response to plummeting demand, CORSIA has since changed the way it will calculate baseline emissions.

For the time being, it seems the uncertainty surrounding international aviation has pushed voluntary offsetting to the back of the queue for the sector, and this will be further compounded by the CORSIA rule change.

Despite this, Edward Hanrahan, CEO of ClimateCare, and winner of three awards this year (Best Wholesaler, Best Project Developer – public health, Best Project Developer – overall), believes that strong demand in the voluntary market will be sufficient to support the gap left by aviation.

Furthermore, recent events have compelled numerous companies to reemphasise their intent to reduce emissions, repair ecosystems and seek naturebased solutions to support sustainability strategies.

For many, this provides renewed impetus for voluntary purchases of carbon credits.

"Corporate demand for sustainability has never been higher and most have been unwavering in their commitments, even in the current environment," says Pete Davis, CEO and co-founder of GreenPrint, a global environmental technology company which won the award for Best Initiative with its IMPACT collective initiative (see box).

Mark LaCroix, executive vice president for the Americas at Natural Capital Partners, which is this year's winner of both Best Advisory Service/Consultancy and Best Offset Retailer, has also seen a steadfast reaction: "We saw the average cost-per-tonne in portfolio prices come down in some areas – due to budget constraints – but very little backing off in terms of commitments," he says.

Covid has also pushed demand in different directions, with demand growing among pharmaceuticals, logistics and tech firms, highlights Gareth Turner, co-founder and director of carbon and renewables at Numerco, which topped the poll for Best Broker.

After many years of downward price pressure on projects due to growing oversupply, this wave of demand has been a welcome change for the market – and project developers especially.

"The prices over the last ten years have been below the cost of abatement and it hasn't been enough of an incentive [for project development]," says Hanrahan.

David Antonioli, CEO of Verra, says this has been a perennial problem for the voluntary carbon sector: "You can't build a project on a $2-3 per tonne price.

But when you are looking at $10 or even higher, that gives people a stronger base on which to develop projects," he says.

Marcos Preto, executive director of Agrocortex – whose REDD project topped the poll for Best Individual Offsetting Project (see box) – calls the past 12 months "unexpected and unique".

He has seen demand almost double, and Agrocortex's prices rise about 20%-30% since last year – from an average of $5 to $6 or $7, the company said.

Such pricing dynamics are particularly important for REDD projects, as robust prices are necessary for effectively counteracting the economic forces that can fuel deforestation.

"REDD projects are trying to deliver tangible economic benefits to communities who would otherwise be chopping down the forest.

The greater the income from REDD+, the higher the probability that they can effectively stop deforestation," says Antonioli at Verra.

Prices were also impacted late in 2019, as both Verra and Gold Standard – another voluntary standards provider – announced that they will not accept new renewables projects from January 2020, except those in least developed countries (LDCs).

This saw prices from large-scale renewables projects in and around Asia increase amid a realisation that these 'lowcost' credits would become less available in the future.

"We're hearing from plenty of customers that their existing suppliers are pressuring them to buy longer term on the back of this news which causes a certain amount of price support," says Bill Goldie, director of offsetting at Redshaw Advisors.

A predicted restriction in supply for large-scale renewables projects, also goes some way to explaining increased demand for other types of credits such as agriculture, forestry and other land use (AFOLU) projects.

This seems to be particularly true for high-quality REDD projects.

Dr G Vishnu, quality manager at EPIC Sustainability Services – winner of Best Verification Company – predicts that nature-based projects, such as REDD projects, will continue to be in great demand in the future.

"[They] are key to preserving the existing forest sink and biodiversity," he says.

Plinio Ribeiro, co-founder and CEO of project developer Biofilica, which has once again won Best Project Developer – forestry and land-use, and runs a REDD project in Brazil, has witnessed a shift towards long-term demand at the project level.

He says a strong interest in multi-year contacts is helping Biofilica to be bullish in its approach to future projects.

"In the next three to four years I think we will see new projects and types of credits coming online in response to strong demand.

Our board just approved an increase in our credit generation capacity by three or four times for the next five to seven years," says Ribeiro.

Turner at Numerco predicts there will be a focus on projects hitting targeted sustainable development goals (SDGs) in the future and greater involvement and engagement from buyers in new project development, rather than simply off-taking credits.

Gerald Maradan, group CEO and co-founder of EcoAct – which won the award for Best Project Developer – energy efficiency – echoes this view, pointing out that people are looking for projects that will play an important social development role in the communities where they are based.

For example, Verra's Sustainable Development Verified Impact Standard (SD VISta) also provides a framework for assessing and reporting on the sustainable development benefits of projects in line with the SDGs.

Meanwhile, The Gold Standard enables certification of gender equality benefits, water benefits and improved health outcomes.

But while such developments can be read as positive in terms of addressing the SDGs, Antonioli at Verra points out that it also tells a story of a lack of government action: "[Increased demand] tells us that governments are still not stepping up to fight climate change and more corporates are saying: 'This is becoming a risk factor to me and if I don't do anything then my brand is at risk'.

"It reflects a lack of government regulation – when companies feel compelled to take action above and beyond what is required of them, they turn to systems like the voluntary carbon market.

In a perfect world, there would be no need for a voluntary market," he says.

"Very large multinational corporations are setting the stage and leading by example," agrees Renat Heuberger, CEO of SouthPole, the winner of Best Project Developer – renewable energy.

Furthermore, this is a trend that is being seen on a global scale, even in areas where corporates or governments have not typically been identified as climate leaders in the past.

"There is a growing understanding that to be able to call yourself a responsible business you've got to take responsibility for every tonne that you emit...We are seeing large emitters in the developing world also take this on.

It's the first time we've seen that [happen]," says Hanrahan at Climate Care.

María Adelaida Correa, sustainability manager at ISA Interconexión Eléctrica – and winner of the Best Corporate Offsetting Programme for ISA's Conexión Jaguar Programme (see box, page 42) – has noticed an increasing number of Latin American companies looking at offsetting as part of their climate strategy.

Correa breaks this trend down further and highlights that the evolution of the market is being facilitated by different national, regional, and sectoral compliance mechanisms that are being formulated alongside voluntary buyers that are developing their own initiatives.

The evolution of the local Latin American market has been further strengthened by the introduction of legal frameworks that support the development of carbon projects, for example Peru's framework law on climate change, and Colombia's carbon tax which recognises voluntary market offsets generated in Colombia.

Since the country approved a National Carbon Tax on fossil fuels in late 2016, Colombian demand for offset credits has exploded, she says.

In Brazil, Ribeiro notes a comparable increase in demand both from internal and external buyers.

He says that demand from within Brazil now represents 40% of Biofilica's total revenue.

Furthermore, contrary to what some might expect, he believes the current government is better aligned with what is needed to incentivise conservation than previous administrations have been: "Recently, I helped the government organise a meeting with all the forest carbon project developers and private sector players who have an interest in conservation in the country.

This has never happened here before," he says.

Looking beyond 2020, a growing demand for similar 'in country' projects is expected and, with several governments working on green stimulus packages, there will likely be an increase in demand for different types of credits as well.

Interestingly, data from Verra highlights that Q1 and Q2 of 2020 saw more non-AFOLU issuances than AFOLU issuances.

This is a deviation from a trend since Q1 of 2017 where AFOLU issuances have been consistently higher than non-AFOLU issuances, and suggests that increased demand is being felt across all types of credits.

This is something that the supply side of the market must keep up with.

However, Kathy Benini, managing director for sustainable finance at IHS Markit – which took the award for Best Registry Provider – is confident that REDD projects are well placed to meet increased demand, as the development of both national and sub-national government REDD programmes come online and provide a significant source of supply.

It is widely accepted that the development of 'blue carbon' projects is on the horizon for many jurisdictions as well.

These projects focus on coastal ecosystems, such as mangroves, tidal marshes, and seagrass meadows which are thought to sequester and store significant amounts of carbon.

In January, software giant Microsoft announced plans to become carbon negative by 2030 and to "remove" all carbon the company has emitted since its founding by 2050.

"We are seeing a trend for firms aiming to be carbon negative, not just carbon neutral," says Turner at Numerco.

"This is driving demand for carbon removals with technology such as direct air capture and carbon capture and storage," he adds.

Redshaw agrees that 'carbon removals' are becoming the new hot ticket but the high price, relative to abundant supply of offsets at single digit prices, means they remain a niche offset.

He would like to see increased negative carbon project development within Europe but is concerned by a lack of government leadership on that front.

"We keep hearing that the 'additionality' concern is the reason for the lack of 'in-country' projects - however, we don't believe that would be the case for negative carbon.

We believe the main reason is the lack of project development skills and experience within Europe.

Governments need to provide some leadership and the voluntary standards need to embrace negative carbon," says Redshaw.

"If we, as a sector, are successful in bringing more negative carbon projects to market and creating scale, we could see a new 'product blend' that would see land-based projects creating the sink and negative carbon removing emissions.

This would create more trust and positivity from corporations and NGOs in the voluntary carbon markets," he adds.

Another major trend to watch in the next 18 months will be negotiations on the rules for Article 6 of the Paris Agreement, the outcome of which will determine how countries can reduce their emissions using international carbon markets.

A key aspect of this will be the concept of Corresponding Adjustments (CAs), an accounting approach designed to ensure that emission reductions are counted only once in the context of the agreement.

There is not yet a consensus on whether CAs are needed for cross-border voluntary market transactions and which types of claims they would apply to.

As such, there is concern that international offsetting may become more complex, depending on whether CAs are required when voluntary offsets are traded across international borders.

For example, some buyers want to continue to claim emission reductions and removals against their own footprint, while others may want to purchase credits without CAs because they want to contribute to the host country's Nationally Determined Contributions (NDCs) under the Paris Climate Agreement.

As such, there is a risk of double counting.

Benini at IHS Markit is concerned that this presents a challenge for growth in voluntary markets: "The risk of double counting and double claiming is a fundamental problem for the markets and needs to be quickly addressed," she says.

In August, Verra announced a public consultation on the issue.

Verra has suggested using a new Article 6 label that would designate VCUs which could be used for compliance markets that require CAs.

Voluntary buyers would be able to select either a unit that is labelled as Article 6-compliant (or other labels like CORSIA), or select a VCU that does not have a CA, depending on which claims they seek to make.

Gold Standard is also engaging with stakeholders regarding the evolving role of the voluntary market, as leading participants call for the voluntary market to mature from being relatively immature to a sophisticated market with the resulting financial infrastructure.

"We have repeatedly heard [when surveying our clients] that similar components underpinning financial markets should be adopted for the carbon markets i.e., increased infrastructure connectivity, price availability, valuations, indices, electronic settlement, etc., are all needed to support this growing market," says Benini.

Goldie at Redshaw Advisors believes finding a way to make pricing more transparent would also reduce the confusion and suspicion many have of the unregulated voluntary carbon markets.

"This transparency would also reduce opportunities for profiteering within the supply chain, which again will increase trust in the market from those investing and those developing the projects.

We are putting a lot of effort into transparent pricing and this will ultimately result in projects receiving the majority of the income from corporate offsetting activities and reduce profiteering by offsetting companies," he says.

Until then, uncertainties remain about how the voluntary market will evolve.

While there is an urgency to iron out these issues to release the full potential of the voluntary market, the fundamentals appear robust.

"The market is at the beginning of a hockey stick of incredible growth over the next decade.

It is a cornerstone of policy for a number of different governments and there is a huge amount of focus on how we scale this market to deliver emission reductions required to meet the Paris targets," says Hanrahan.

And while there is a lot left to do, LaCroix at Natural Capital Partners asserts it is gratifying to see how these trends are playing out as voluntary carbon becomes a mainstay of corporates.

"This is the decade of climate action.

We have got to get it done.

And when we are busy in the office, I remind my colleagues that this is the market that we hoped for," he adds.