What is a voluntary carbon market?

What is the size of the voluntary carbon market?

In an effort to curb climate change, large companies such as Microsoft, Google and Starbucks are setting ambitious carbon neutrality targets, and the Voluntary Carbon Market (VCM) is helping them to do so.

The VCM gives companies, non-profit organisations, governments and individuals the opportunity to buy and sell carbon credits. Carbon offsets are a means of reducing emissions of one tonne of carbon dioxide or greenhouse gas.

To put this in perspective, to sequester 1 tonne of CO₂ emissions… you need 50 trees to grow in a year¹.

Companies that are unable to meet their greenhouse gas (GHG) emission targets can purchase carbon credits (carbon credits) to retrofit environmental projects that avoid, reduce or eliminate carbon emissions.

For example, an airline that wants to claim carbon neutrality can calculate how much carbon emissions it cannot get rid of (carbon footprint calculation) and then use the VCM to buy the equivalent amount of carbon credits of investing in a regenerative agriculture project in Brazil. This allows the airline to claim carbon neutrality.

From 2022, the real voluntary carbon market could be worth around $2 billion.

What is the difference between a voluntary carbon market and a compliance market?

The compliance market is regulated by national, regional or international carbon reduction schemes. These markets operate on a cap-and-trade basis, where only a certain amount of “allowances” (essentially a permit that “allows” greenhouse gas emissions) are created. This limits the amount of greenhouse gases emitted by a country or industry.

The cap represents a finite supply of allowances (quotas). Allowances cannot be created or withdrawn, but they can be traded.

If an industry is able to meet its target, or better still, emits less than its allowance, it can sell the excess credits to someone else. The ability to trade excess allowances can provide a financial incentive for participants to reduce their overall emissions.

Examples of compliance carbon markets include the Kyoto Protocol, the European Union Emissions Trading Scheme (ETS), the California Emissions Trading Scheme, the Australian Emissions Trading Scheme, the British Columbia Emissions Trading Scheme and the New Zealand Emissions Trading Scheme.

The voluntary carbon market operates outside the compliance market. Those who participate in this market do not have to reduce their emissions, it is entirely voluntary. Many companies participate because they feel it’s the socially responsible thing to do, because of pressure from shareholders, or because it’s a good PR move.

VCM uses a project-based system with no finite quantity of allowances, rather than a cap-and-trade system.

Within VCM, more carbon credits can be created by developing environmental projects. Companies can buy these credits to offset unavoidable emissions and meet their targets.

Voluntary vs. compliance market

What types of environmental projects are included in the VCM?

VCM offers a wide range of environmental projects. Each project aims to reduce or remove greenhouse gas emissions or carbon dioxide from the atmosphere.

Projects can range from small community-based activities, such as clean cookstoves and family planning, to large industrial-scale projects, including large-scale hydroelectric power plants and commercial reforestation.

Community-based projects typically produce smaller amounts of carbon credits, but have several additional socio-economic and environmental co-benefits5 .

Co-benefits can include anything from saving endangered animals from extinction to improving local water quality or creating sustainable jobs. Project developers often align co-benefits with the UN Sustainable Development Goals (SDGs), as these co-benefits can contribute to the overall value of the credit.

Large industrial projects can generate larger amounts of carbon credits, but do not always generate strong co-benefits. As a result, credits from such large projects may trade at a discount compared to projects that achieve the SDGs.

Although there are many different projects to choose from, they all have one thing in common. To be part of the VCM, each project must be “additional”.

This means that the removal or reduction of carbon dioxide or greenhouse gases would not have happened without the offset project.

For example, a project developer who wants to preserve a forest to be cut down in Vietnam would have to prove that if the proposed project were not implemented, the forest would be cut down.

Examples of types of carbon credit projects that can be purchased under the VCM:

• Renewable energy
• Industrial gas collection
• Energy efficiency
• Forestry initiatives (avoid deforestation)
• Human rights, forest conservation (avoiding deforestation)
• Clean water
• Renewable agriculture
• Wind energy
• Biogas
• Oil recycling
• Solar energy
• Water filters

Who participates in the VCM?

VCM has a number of key players who are actively involved. These participants include:

• Project developers. Project developers work to produce carbon credits that are purchased by other sectors or industries.
• Consumers. This group includes private companies, NGOs, governments, universities and individuals who buy carbon credits from producers.
• Retailers. Traders buy allowances in bulk from suppliers, collect the allowances in portfolios and sell them to the final buyer, usually for a commission.
• Brokers. Brokers buy carbon credits from the trader and sell them to the consumer. The broker usually charges a commission. It is also common for the broker to act as a trader.
• Third party verifiers. These are organisations, typically non-governmental, that verify that a project meets its targets and emissions.

How is VCM priced against compliance markets?

Pricing carbon credits in the VCM is not as simple as in the compliance market. This is due to the wide variety of environmental projects available. Prices vary widely by project category (e.g. renewable energy vs. forestry) and even within a given category.

Many other variables contribute to the price of a carbon unit, including:

• The size of the project. Larger projects, which generate larger amounts of carbon credits, often have a lower price. Smaller projects are often more expensive to implement but produce fewer carbon credits.
• The location of offset. Where is the environmental project taking place? Locations with conflicts and higher risks can make the project more expensive.
• Vintage. In which year did the emission reductions take place? In some cases, older projects are priced lower.
• Quality. Price can be affected by the standard to which the project is certified.
• Co-benefits. Co-benefits are any positive impacts that the project generates beyond greenhouse gas emissions. For example, if a project creates jobs for local communities or increases biodiversity, these are types of co-benefits.

According to the World Bank 2020 report, the carbon price of VCM starts at less than USD 1/t CO₂e and rises to USD 119/t CO₂e. And the price of nearly half of the emissions is less than USD 10/tCO₂e.6

Pricing may also be influenced by the co-benefits generated by the project. Projects meeting the UN Sustainable Development Goals can contribute to increasing the value of carbon credits.

Larger scale projects that do not generate as many co-benefits or do not meet additional sustainable development targets may trade at a discount.

To meet the temperature targets of the Paris Agreement, the High Level Panel on Carbon Pricing has concluded that a price of at least USD 40-80/tCO₂e is needed by 2020 and USD 50-100/tCO₂e by 2030.7 The OECD estimates that a price of USD 147/tCO₂e is needed by 2030 to reach net zero emissions by 2050.8

The current weighted carbon price in the compliance market is USD 34.999, higher than the VCM pricing but still below the High Level Committee threshold.

Looking at the VCM and compliance markets, the bottom line is that the current carbon price is too low to meet the targets.

Where are these allowances traded?

There is currently no centralised voluntary carbon market.10 Instead, project developers or companies can sell their credits directly to buyers or through brokers. Project developers can also sell their credits to a retailer who can then resell the credits to a buyer. All voluntary credits must be verified by an independent third party and comply with existing standards.

Voluntary demand scenarios

The voluntary market is forecast to be in incredible demand. According to the Voluntary Market Scaling Task Force, the market will grow around 15-fold by 2030, from 0.1 to 1.5-2 GtCO₂ of carbon credits per year.

This will increase 100-fold by 2050 (7-13 GtCO₂ of carbon credits per year).

Eliminating carbon emissions on such an incredible scale will be a huge challenge. And it will present incredible opportunities for many nations and companies. As the Task Force says in its 2021 report,

“This underscores the need for emission reductions to be implemented as urgently as possible, and probably at a faster pace than the NGFS scenarios”.

Who verifies the variable carbon market credits?

When purchasing carbon offsets, consumers should only consider offsets that have been verified by a third party.

There are several standards that use different methods to measure and verify carbon emission reductions. These standards provide a robust verification process to ensure the credibility of emission reduction projects. The most widely used standards are

• Verra (The Verified Carbon Standard)
• Plan Vivo
• Quality Standard
• The Gold Standard
• The American Carbon Registry
• Climate Action Reserve
• The Verified Carbon Standard Program

Can traditional small investors invest in voluntary carbon credits?

The VCM is open to anyone who wishes to participate. From businesses to governments, non-profit organisations, universities and even individual investors.

If you’re going on a long flight or holidaying on a luxury yacht and want to relieve your environmental burden, you can buy carbon credits to offset your emissions. In fact, many airlines make it easy for individuals to offset their flights. They list the amount of CO₂ emitted by the flight and then give customers the option of flying for a net zero cost, which they offer at the checkout.

The end result is

Voluntary carbon credits are here to stay. More and more companies and individuals feel the need to do their part to reduce carbon emissions. And for companies wishing to achieve carbon neutrality, VCMs are increasingly becoming a necessary tool.

References

¹ Climate Neutral Group. What Exactly is 1 Tonne of CO₂? Accessed Aug 4, 2021
² Carbon Offset Guide. Voluntary Offset Program. Accessed Aug 3, 2021
³ Carbon Offset Guide. Mandatory & Voluntary Offset Markets. Accessed Aug 3, 2021
⁴ UN Climate Change. Emissions Trading. Accessed Aug 3, 2021
⁵ S&P Global. Voluntary Carbon Markets. Accessed Aug 3, 2021
⁶ World Bank. State and Trends of Carbon Pricing 2020. Accessed Aug 4, 2021
⁷ World Bank. Report of the High-Level Commission on Carbon Prices. Accessed Aug 5, 2021
⁸ UN Environment Programme. Discussion Paper on Governmental Carbon-Pricing. Accessed Aug 5, 2021
⁹ Carbon Credit Capital. Value of Carbon Market Update 2021. Accessed Aug 5, 2021
¹⁰ White & Case. Voluntary Carbon Markets:A Blueprint. Accessed Aug 5, 2021