FEATURE: Where is the demand explosion for credits?
Quantum Commodity Intelligence – "Anything that will bring more demand to this market is a good thing for all of us that have been working in this space."
That was one observer's view on last month's news that Salesforce – one of the world's biggest tech companies – was launching a service to help small- and medium-sized enterprises access the carbon market.
After six years of delayed and protracted negotiations, in November 2021 UN negotiators in Glasgow signed off on an international framework that would govern global trade in carbon credits and hopefully drive down the cost of cutting emissions.
It came amid growing confidence from the private sector that the voluntary carbon market, which had taken over from the Kyoto Protocol's Clean Development Mechanism as the primary driver of carbon market finance from north to south, would see a spike in demand.
In the nine months running up to the Glasgow meeting, monthly retirements on five of the biggest registries averaged 12 million credits, almost double that of a year earlier.
Since then, backed by private equity or venture capital, scores of companies have entered the carbon service sector marketplace, hoping for a slice of a market that could be worth $50 billion by 2050, up from $2 billion last year.
Those include ratings agencies, blockchain companies, monitoring companies, developers, consultants, trading venues, exchanges and other intermediaries.
Traditional energy broking houses, such as Marex, have established a voluntary carbon desk, retail banks, such as Singapore's OCBC, are establishing services to cater for retail and corporate demand, and traditional agriculture brokerages, such as StoneX, are showing increased interest in the space.
According to netzerotracker, a collaboration of four non-profit researchers and university departments, of 2,000 publicly-listed companies examined, more than a third (700) had net-zero targets by this summer.
That's compared with just over 400 at the time of the Glasgow meeting.
Yet to kick on
But after the initial explosion of interest, demand for credits has yet to kick on in a meaningful way.
And that's down to a mixture of regulatory uncertainty, reputational issues and economic fears, sources say.
According to data compiled by Quantum, over the past nine months aggregate average monthly retirements on the American Carbon Registry, the Biocarbon registry, CAR, Gold Standard and Verra has increased just 13% on the year.
While some of that meagre increase will be down to seasonal accounting factors, as December generally sees a sharp rise, anecdotally developers say the plethora of net zero commitments made over the past year have yet to yield real demand.
"It's fair to say the highest hopes for demand growth have not yet been met, but we have not fully started on this decarbonisation journey," said one seasoned observer that has been in the market nearly two decades.
"A lot of companies with good intentions don't even know their full emissions profile. I'd imagine that there will be some that want quick fixes (to cutting emissions) and others that will take a more measured approach… (such as) cutting their own emissions first before outsourcing them," he added.
Indeed, a 2021 study by developer South Pole suggested just 1% of net zero targets were clear enough.
Economic
Added to that is the broader economic concerns of the health of the global economy following spiking inflation.
"We have seen signs of a lull (in the voluntary carbon market) in the wake of Ukraine and the economic downturn," said Mikkel Larsen, chief executive of Singapore exchange Climate Impact X.
"I think for those companies who are already clearly determined to buy carbon credits, the carbon leaders of this world, they're not wavering," he said, adding that for those on the cusp of getting into the market they may be holding back due to the slowing economy or fears over quality.
That view, particularly on the economy, has been echoed for several months by all participants in the market.
Others claim that while retirements are only up marginally, there are more companies retiring credits.
Reputational
While the economic landscape is only one challenge to demand, the overall fear of buying a commodity that does not actually cut emissions is key for many buyers.
Unlike the mandatory market, which offers some form of what one buyer described as "arse covering" with any criticism about offsets directed at the jurisdiction governing the mandatory scheme, voluntary credits and any bad publicity around them lies right at the feet of the brand buying the credits.
That creates a big risk, but also an opportunity for developers who can differentiate their projects.
One buyer at a retail bank that spoke on condition of anonymity told Quantum that they would not, for the foreseeable future, trade on exchanges for fear of being delivered tarnished credits.
"We want to understand what we are getting as we will be buying this on behalf of clients," she said, adding that, aside from pseudo mandatory markets, such as Corsia that allows airlines under ICAO to offset emissions, the market isn't homogenic enough to warrant a clearing price.
"We think clients will want a very clear idea of what they are getting and what co-benefits they have," she added.
But having a close relationship between developers and buyers is unlikely to drive scale in the market that is needed.
Instead a minimum quality threshold is needed, some believe.
Blunt
The market recognises this and two initiatives were set up in the past year to provide a hallmark for emissions reduction projects.
The most high profile of those – the IC-VCM – published its draft report earlier this year.
But it immediately came under fire from some standards for raising the bar so high so that many existing projects would not qualify.
Last month, the world's biggest voluntary carbon standard Verra said few, if any, voluntary credits would pass the quality threshold, adding it was "blunt and unworkable".
Meanwhile, Gold Standard, another main carbon standard, said that while it agreed with most of the proposals, it added it must not become an additional barrier to developing projects.
Indeed, speaking privately, sources close to the IC-VCM said they received few if any positive comments on the new guidelines from about 5,000 responses,
They added that criticism came from those that said the guidelines were too strict as well as too lenient, the latter being voiced by lobby groups.
There are many contentious points, he said, not least around the fundamental issues of permanence and additionality.
Muddies
For some in the market, the ongoing public spat has muddied the water over what is "high quality" – a definition that was previously meant to be associated with Gold Standard credits or those with higher sustainable benefits under Verra.
CIX's Larsen said such companies are pausing entry into the VCM at the moment until they get more clarity, although he thinks this will be a temporary hiatus.
And Alexis Leroy, founder of developer ALLCOTT, said it remains a draft and it will eventually be agreed upon, it may just take some time.
Still, the proposal is contentious.
Developers speaking at a conference in Paris this week accused environmental groups of destroying the UN's Clean Development Mechanism – the main offset market for countries with targets under the 1997 Kyoto Protocol that capped emissions of most OECD countries.
That scheme's reputation took a hit due to the profitable nature of cutting some industrial gas projects, such as HFC 23 and adipic acid schemes, as well as projects that were viewed as non-additional, such as wind projects in China.
And there are fears that persistent criticism of a market that has delivered carbon finance expeditiously while governments have dithered will impact demand.
"How do we prevent a second case of the NGOs bringing down the VCM this time around?" asked one consultant on condition of anonymity.
That view that is unlikely to build bridges with environmental lobby groups, of which some say they are not against markets, just against lax rules.
Salesforce
Redefining what is high quality may also have legal connotations.
The government of Singapore said from 2024 it would allow companies to avoid paying its SGD 15/mt ($10.50) carbon tax by submitting "high quality" offsets instead.
The city state has signed MOUs with Verra and Gold Standard, but it is unclear how the interplay between the IC-VCM and those registries may work when it comes to defining "high quality".
The concept of high quality is being driven not just by governments or standards, but by intermediaries.
Salesforce is just one of a number of companies that is aiming to be a provider of high-quality offsets.
Launching later this month, its "Netzeromarketplace" will, it says, only allow developers of "high quality" credits to directly market their credits to end users,.
It's a model that it hopes buyers will like because it offers a level of transparency on pricing and projects, while developers are also keen on the model as it allows them closer access to the end user to enable them to 'tell their story.
Salesforce hopes that this will bring scale to the market, albeit for a rumoured transaction fee of 1%.
Regulatory
While the reputation is an issue that is causing buyers to waver, added to that is many medium-sized purchasers are just starting to set up processes to measure emissions and buy carbon, but are keen to see any regulatory guidelines before taking the plunge.
The US Security and Exchange Commission is expected over the next two months to finalise and adopt at least some parts of its initial proposal for companies to disclose climate risk exposure.
The proposal, initially made in March, would require public-listed companies to publish a host of climate-related information including risks to their bottom line, how many tonnes of greenhouse gases the company emits and how much is in their supply chain.
The proposed rule, which is contentious among US lawmakers, could still be delayed and reopened for more than the 1,300 comments already received.
And it is almost certain to be challenged in US courts, given the litigious nature of the subject matter.
Yet developers and the industry as a whole believe any legal action, or the lack of a mandatory federal scheme in the US, is unlikely to have an impact on the overall direction for carbon markets and demand for credits.
"Net zero targets are consumer driven. That's new. Its board-driven. That's new," ALLCOT's Leroy told Quantum, adding that he saw the US as being a main driver of demand, particularly in Latin America where his company is developing projects.
"The extraordinary budget allocated under the Biden administration combined with the ambitious NDC target of 50% emission reduction sends a strong signal to the US market/private sector," he added.
Crossroads
The voluntary carbon markets appears perpetually to be at a crossroads.
Buoyed by the potential of what it could be, given its proven method of channelling public and private finance quickly and at scale.
But weighed down by a chequered history and a set of standards and rules for both voluntary and regulatory markets that stakeholders have yet to agree on.
For a buyer with good intentions, it's a steep learning curve.
But in some sense, the quality of projects is already reflected in the price for secondary credits.
Old legacy credits for reductions or removals made before the start of the decade fetch a significant discount to newer credits.
"You are servicing two markets: you have older reductions and that is your clearing price. Many of these will head to an exchange, but for newer projects, who knows?" said the observer.
He added that much would depend on whether the newer reductions are authorised under the UN under its corresponding adjustment rules, whether they are kept in the country for domestic use and whether they can be used in mandatory schemes elsewhere.
For older credits, of which energy trading companies and banks are believed to be sitting on tens of millions, it is less clear where demand lies.
Many credits have been used previously for green fossil fuel transactions, notably the latest LNG deal from Chevron.
And some could head to exchanges where there are different contracts that have different thresholds and criteria.
At the lower end of the quality scale, the Global Emissions Reduction, offered by EEX, Nodal and ACX exchange, includes a "base carbon contract" that means any credits are eligible to be delivered, including some reductions that were made a decade ago and generated under the CDM.
The hope by the architects of the contract is that corporates keen to green their image can do so at a much more competitive price. After all, it's a voluntary market.
The contract is not believed to be liquid, however.
At the other end of the scale is Singapore-based Climate Impact X, which holds auctions with companies that offer what it says is only higher quality credits.
Auctions it plans include blue carbon projects, soil carbon and forest conservation, although these have been delayed from an initial Q3 launch.
The most liquid exchange – Xpansiv – has launched multiple contracts and hosts a trading screen that allows project developers to list its projects, catering for a bespoke service.
Q4 bump?
Worth saying is not all participants think there is a big slowdown in growth demand, with some sources pointing out that retirements may not be the best way to measure consumption.
"While trading volumes slowed temporarily in Q2, there has been a continued strong growth in market participants. Most of these will enter the market with a buy-and-hold strategy, including new carbon funds, ETFs and other demand aggregators," said a second market source, speaking on condition of anonymity as he was not authorised to speak to the media.
"A meaningful share of the volume bounce back in August and September has come from this sector," he added.
Nevertheless, issuances are also down in the same five registries, according to Quantum data, falling from 198 million in the first nine months of 2021 to 191 million in 2022, although that is thought to be down to backlogs at verifier and standard level rather than a fall in investment.
Retirements of credits tend to peak in December and March.
The record remains 26 million mt seen in December 2021 and it has grown every December for five years.
As negotiators hammer out the next set of rules for the global carbon in Egypt next month, it will be interesting to see whether retirements again will rise or whether developers will need to wait longer for what they say is the inevitable boom in corporate demand for credits.
"We have seen steady to lower demand this year, but hoping for a bump in Q4 like everyone else," said a source at one of the biggest and oldest developers.