Intricacies Of Carbon Credits As Unconventional Assets

By Manish Dabkara August 28, 2023

By bolstering transparency, fostering accountability, and implementing robust standards we CAN bridge the gap between carbon credits and tangible commodities, enhancing the market's credibility and securing its role in combating climate change

Intricacies Of Carbon Credits As Unconventional Assets
With estimated values ranging from $10 billion to $40 billion by 2030, carbon credit market holds the power to effect substantial positive change. Shutterstock

The market for voluntary carbon credits is currently in the midst of a dynamic and transformative period. The year 2022 emerged as a pivotal chapter, witnessing an unparalleled upsurge in the entire carbon market landscape, encompassing both compliance and voluntary sectors. This surge stands as a testament to the global collective commitment to combatting climate change and achieving sustainability goals.

Of particular significance is the exponential growth exhibited within the voluntary carbon credit sector. This segment has not only gained substantial traction but has also captured the attention of forward-thinking investors and companies aiming to mitigate their carbon footprints.

With estimated values ranging from $10 billion to $40 billion by 2030, this market holds the power to effect substantial positive change, offering avenues for both environmental impact and responsible investment.

Despite this encouraging trajectory and optimistic projections for the future, it's evident that the momentum has waned. The market's resilience faces tests amid the complexities of environmental challenges and global dynamics. Strengthening this momentum requires continued dedication, collaboration, and innovation to transform positive affirmations into tangible actions.  

Navigating Turbulence in the Carbon Market 

From the latter part of 2020, a noticeable momentum surged within the carbon market, spurred by the COVID-19 pandemic that emphasised the imperative of sustainable strategies across diverse industries. With the gradual relaxation of lockdown measures and the resumption of business activities, emissions naturally rose, accompanied by a corresponding surge in demand for carbon offsets. This upsurge pushed prices to their highest levels in the past decade, reflecting the growing recognition of the market's significance.

However, the dynamics took a new turn in early 2022 with the geopolitical turmoil caused by Russia's actions in Ukraine, subsequently disrupting Europe's energy security. The offset budget shifted towards fuel securitisation due to concerns and reduced productivity dealt a substantial blow to the trend of offset utilisation, ultimately diminishing demand for carbon offsets. This series of events created a ripple effect, contributing to a downturn in the market.

Global governments, including those of Zimbabwe, Kenya, and Malawi, responded by introducing new regulations to ensure that the true value of carbon offsets remains within their sovereign boundaries, aiming to maximize benefits for local institutions and communities. In India, the Minister of Power and Renewable Energy indicated a shift in carbon credit sales policies, causing initial confusion but later clarifying that sales would be permitted both in the domestic and international voluntary carbon markets, conditional on achieving the country's NDC goals. 

This convergence of concerns and regulations left businesses and buyers in a state of uncertainty, leading to reduced demand and declining pricing for carbon offsets. The consolidation was further compounded by economic downturns, evolving geopolitical scenarios, and evolving regulatory frameworks. As the market navigates these challenges, stakeholders are tasked with addressing issues of integrity, regulation, and communication to restore confidence and drive the carbon market toward a more stable and sustainable future. 

Monitoring, Reporting and Verification (MRV) Framework

In the world of carbon credits, the absence of a tangible entity allows for potential manipulation. The effectiveness of a carbon credit hinges on implicit trust between buyers and suppliers, leaving room for misinformation or lack of transparency to persist unchecked.

This unique dynamic poses a challenge to the carbon credit market's quality control. As carbon credits gain traction as tools for emissions reduction and climate action, the urgency to address this issue becomes paramount. Establishing rigorous Monitoring, Reporting and Verification (MRV) mechanisms is essential to ensure the accuracy and reliability of carbon credits. Only by bolstering transparency, fostering accountability, and implementing robust standards can we bridge the gap between carbon credits and tangible commodities, enhancing the market's credibility and securing its role in combating climate change. 

Lack of Scrutiny 

A significant challenge lies in treating carbon credits as interchangeable commodities, an oversimplification that fails to reflect the complexity of the issue. While on the surface, a ton of carbon may appear uniform, the reality is far more intricate. The notion belies the substantial differences in quality among carbon offsets. This variation arises from the diverse project types—ranging from emissions removal to avoidance, afforestation, and clean cookstove initiatives—as well as the distinct management approaches employed in individual projects. Consequently, the carbon credit market contends with multiple inherent risks that necessitate comprehensive assessment and risk mitigation strategies to ensure the effectiveness and authenticity of these initiatives. 

To bolster the integrity of the carbon market, initiatives such as the Integrity Council for the Voluntary Carbon Market (ICVCM) and the Voluntary Carbon Markets Integrity Initiative (VCM-I) have emerged, each introducing their distinct criteria to certify the credibility of programs, projects, and credits. While this intent is laudable, it has inadvertently deepened the complexity surrounding carbon credit legitimacy. The proliferation of varying certification standards has given rise to uncertainty about which criteria to prioritize, which credits to validate, and how to responsibly utilize them. 

Despite the raised concerns, project owners globally continue to pursue verification and issuance, potentially exacerbating the risk of market oversupply—echoing the historical situation observed between 2012 and early 2021.  

Distinctive Climate Targets 

Adding to the intricacy is the confusion stemming from each nation's unique climate targets. The interaction of different carbon credit sources, including those from National Carbon Markets (CCTS), Article 6 Carbon Markets, and the Voluntary Carbon Market, generates intricate questions about how these various credits will coexist and complement each other. This complex landscape, characterized by divergent targets, market mechanisms, and regulatory frameworks, requires careful navigation to harmonise efforts and ensure a cohesive approach in addressing climate goals. 

As the carbon credit landscape becomes progressively intricate, collaboration between stakeholders, alignment of standards, and effective communication are paramount. A collective effort is essential to streamline the evolving carbon market, preventing fragmentation and fostering a cohesive global response to the urgent challenge of climate change. 

The Renewed Outlook for Carbon Markets 

The carbon markets have encountered significant disruptions, causing prices to undergo a substantial correction of up to 80% from December 2021 levels. While these setbacks are undeniable, our optimism remains resolute as we anticipate a positive trajectory in the forthcoming 8-12 months. 

The current market landscape is a testament to the dynamic interplay between global events and emissions trading dynamics. Yet, even in the midst of volatility, carbon markets have historically showcased resilience, recovering from adversity and emerging stronger. The ongoing commitment of governments, industries, and investors to emissions reduction and sustainability emboldens our belief in the market's eventual recovery. 

Amidst these challenges, our focus remains steadfast on bolstering transparency, refining methodologies, and enhancing the credibility of carbon offset initiatives. The foundation of the carbon market is built on the imperative to combat climate change, and this ethos continues to drive our collective efforts to navigate the current complexities. With the prospect of brighter days ahead, we look forward to a revitalized carbon market that continues to contribute significantly to the global pursuit of a greener future.

(Manish Dabkara, chairman and MD EKI Energy Services Ltd.)