Beyond Price: Rethinking the Value of Carbon Credits in the Voluntary Market

Beyond Price: Rethinking the Value of Carbon Credits in the Voluntary Market

Prices in voluntary carbon credit markets have generally fallen, but there is increasing evidence of price differentiation based on quality attributes. This suggests that the market is maturing beyond traditional pricing in terms of valuing carbon credits.

Voluntary carbon markets allow carbon emitters to offset their unavoidable emissions by purchasing carbon credits. These arise from projects to eliminate or reduce greenhouse gas (GHG) emissions from the atmosphere. The voluntary carbon credit market trades in certified and transferable instruments that represent the avoidance or elimination of one tonne of CO2 or an equivalent greenhouse gas. The company has recently faced a credibility crisis amid allegations that many loans are not delivering promised emissions cuts.

Two studies have highlighted systemic problems with credits generated from nature-based projects. In January 2023, a report evaluated Verra-certified loans (opens a new window)a leading carbon standard. The analysis showed that more than 90 percent of their forestry loans (opens a new window) did not represent true emissions reductions. In August 2023, a study in Science concluded that forestry programs were significantly overestimated (opens a new window) their prevention of deforestation.

Not only do the revelations suggest that the investment failed to produce a return, but they also put companies that buy carbon credits at risk of greenwashing allegations and possible reputational damage. As a result, sales fell dramatically in 2023 and 2024, leading to an oversupply of loans that were perceived as substandard.

European market for emissions credits

Source: Emissions credits (opens a new window)11/28/24

Initiatives to improve market conditions

Market participants have responded to the challenges facing the voluntary carbon credit market, with a number of international initiatives promising to address shortfalls and increase confidence:

• Voluntary Carbon Markets Integrity (VCMI): Founded in 2021, the VCMI sets principles and framework conditions for high-quality emissions certificates.

• Integrity Council for the Voluntary Carbon Market (ICVCM): Established in 2021, the ICVCM aims to improve the overall efficiency and effectiveness of the voluntary carbon market.

• Global Carbon Market Utility (GCMU): Launched at COP27 in 2022, the GCMU aims to improve the quality and transparency of carbon credits and expand the global carbon market.

• International Sustainability Standards Board (ISSB): The ISSB’s first climate disclosure standards, published in 2023, promote greater transparency and accountability and enable more informed comparison of companies’ performance.

In addition to the work of these institutions, there are a number of other initiatives that could help improve conditions in the market for voluntary carbon credits.

On September 20, 2024, the Commodity Futures Trading Commission approved the final guidelines (opens a new window) in relation to the listing of voluntary derivative contracts for emission allowances for trading. It sets out factors that certain contractual markets must take into account when listing voluntary emission allowance derivatives contracts for trading.

In addition, six of the largest independent lending programs, including Verra, Gold Standard and the Global Carbon Council, agreed at COP28 (opens a new window) to collaborate and better coordinate their certification approaches. Aligning standards could also improve the efficiency and effectiveness of audit projects and credit systems.

In addition, a longer-term trend is emerging in which governments are taking a greater role in shaping, moderating and, to a limited extent, regulating voluntary markets. Many governments have set carbon emissions targets for their countries and the voluntary carbon credit market can help them meet these targets. Your involvement can help set expectations for the supply side of the market.

Setting quality standards

The quality of the carbon credit primarily refers to the confidence that a carbon credit represents real, additional and lasting emissions reductions or eliminations.

The ICVCM has developed Core Carbon Principles (opens a new window) Establishing key quality criteria that help assess the quality of projects that generate carbon credits. Below is a summary:

• The project must deliver measured, monitored and verified emissions reductions

• The reductions must exceed what would have occurred without the project

• The result must be based on realistic principles

• Reductions must either be permanent or include comprehensive risk mitigation mechanisms

• Any leakage must be accounted for and minimized

• The CO2 effect can only be counted once

• The project should cause no net loss

Characteristics of projects that signal quality include:

vintage

Newer loans, typically less than five years old, are often considered to be of higher quality. This is because they are likely to reflect the latest methods and measurement techniques and are based on the most up-to-date basic calculations.

Project type (Distance vs. Avoidance)

Carbon removal projects that actively remove CO2 from the atmosphere are often valued more highly than avoidance projects (that prevent emissions) because:

• They ensure more lasting and measurable CO2 reductions

• Have clearer additionality claims

• Are easier to check and monitor

• Better align with net zero goals

Verification standard

Higher quality is indicated by:

1. Use of internationally recognized standards (e.g. Gold Standard, Verra VCS)

2. Regular updates of methods

3. Transparent verification processes

4. Independent third-party verification

Monitoring methodology

Quality is shown by:

• Real-time monitoring systems

• Digital monitoring, reporting and verification)

• Satellite images for nature-related projects

• Blockchain or IoT integration for data integrity

Side benefits (e.g. impact of sustainable development goals)

Projects that provide multiple sustainable development benefits beyond CO2 reduction are considered to be of higher quality for the following reasons:

1. They contribute to several UN Sustainable Development Goals

2. Create benefits for the local community (jobs, education, healthcare)

3. Protect biodiversity

4. Improve project duration through community participation

Appropriate adjustments (Accounting mechanisms that prevent double counting of emissions reductions)

• Make sure credits are only claimed once

• Adjust national inventory levels when credits are transferred

• Alignment with the requirements of Article 6 of the Paris Agreement

• Ensure transparent tracking of loan ownership

Geographic Location and Jurisdiction

Quality indicators include:

• Political stability of the host country

• Strict environmental regulations

• Clear land ownership rights

• Strong governance frameworks

• History of successful project implementation

Track record as a project developer

1. Quality can be assessed by:

2. Many years of experience in carbon markets

3. Success rate of previous projects

4. Financial stability

5. Transparency in reporting

6. History of community engagement

7. Professional certifications and accreditations

Reputation of the verification body

Quality indicators include:

• Accreditation by international bodies

• Many years of experience in carbon markets

• Independence from project developers

• Technical expertise in specific project types

• Track record of detecting violations

Reducing the risk of invalidity

By adhering to established quality standards when selecting emissions certificates, the risk of cancellation is significantly reduced. Higher quality loans with robust measurement, reporting and verification (MRV) are less likely to face methodological challenges, and loans with appropriate adjustments reduce the risk of double counting.

Additionally, projects with strong community engagement have a lower risk of reversal because they are also likely to ensure higher quality for several reasons:

• Local support ensures the long-term viability of the project

• Non-profit services create incentives for project maintenance

• Local knowledge can improve project design and implementation

• Reduces the risk of social conflict or project reversals

• Better monitoring and early problem detection

• Improved protection against illegal activities

In general, better baseline methods should reduce additionality challenges, but despite a robust risk assessment, the risk of carbon credits becoming invalid cannot be completely eliminated. Carbon credit insurance can protect buyers from unforeseen losses and unavoidable risks and provide financial compensation for carbon credit losses. Before submitting an offer, underwriters conduct their own assessment of the project. The aspects they will evaluate include:

• Physical risks (e.g. forest fires, natural disasters)

• Political risks (e.g. policy changes, property rights)

• Methodological risks (e.g. baseline calculations, MRV processes)

• Project developer risks (experience, track record, source of financing)

• Legal risks (legal framework, governance and historical reputation)

The insurance market is constantly evolving to keep up with the new technologies used in projects as well as the protection needs of customers. This creates new insurance products for specific risks. These are aimed at a wide range of stakeholders – apart from carbon credit buyers, they can help reduce risks for lenders, developers, traders or buffer pools. Some insurers also offer replacement loans if projects fail.

Insurance proposal

Insurers offer pre-agreed financial compensation limits or replacement credit if projects fail. Insurance coverage can include both physical and political risks. Premium prices reflect the quality characteristics of the project.

For more information, please contact your Lockton representative or visit Lockton Carbon credit insurance page.