FEATURE: No common path on forward pricing of voluntary carbon credits in OTC market yet

A common approach for putting a price on voluntary carbon credits for forward delivery has yet to emerge in the broader over the counter market although some patterns seem to appear for some specific types, market participants told S&P Global Platts.

"There is no clear approach," a carbon trader said, adding that the pricing was random.

The source added: "The voluntary carbon market (VCM) is a very bilateral market, so as a buyer you can go and offer the developer a formula to define the forward price, but in the end it's the developer that decides, and mostly based on his or her expectations," the trader added.

To make it hard for a forward pricing curve to emerge, according to the trader, is not only the over the counter predominant nature of the voluntary carbon market but also its complexity.

"In compliance markets, for example, you have a forward curve and the price of forward products as traded on exchanges can offer a reference. This is because in compliance markets the product is always the same. For example in ETS schemes, you have allowances."

In voluntary markets, the source said, you have as many types of credits as the number of underlying projects, each with different underlining costs.

"The cost of expanding a forestry project, for example, would be different from the cost of expanding a cookstove project."

Patterns

Some patterns, however, seem to be emerging in specific sections of the voluntary carbon markets.

Price indications collected by Platts over the past few weeks showed that some REDD+ credits for forward delivery can be offered at a few cent/mtCO2e premium for each forward year.

For example, at the start of September, Platts reported four forward offer prices for REDD+ credits to be issued by the Sumatra Merang project (ID 1899), located in Indonesia. The credits, with vintages from 2021 to 2024, were offered at a 25 cent/mtCO2e price premium for every further year of forward delivery. Hence, credits expected to be delivered in 2022 were offered at $8.75/mtCO2e, those expected to be delivered in 2023 priced at $8.90/mtCO2e and so on.

When these price indications were published, a second carbon trader not involved in the offer said: "We have been seeing pretty much the same for REDD+. Sometimes 50 cent/mtCO2e for each forward year, but it's very project/seller specific," he said.

On Sept. 21, a project developer said that a similar method for calculating the forward price of credits was being used for higher-quality Renewable Energy credits.

"For higher-quality renewables, it could be a 10 to 15 cent/mtCO2e increase [per every forward year] depending on the developer," he said.

He added: "Or sometimes the developer would set a percentage increase for every forward year, which is a similar approach."

The same developer -- which is mostly involved in household devices and forestry projects -- said that his company was yet to adopt this type of approach and it was setting a fixed premium price on the third and fifth year of forward delivery.

"We are offering credits at a slightly higher price if compared to spot but this way we are sure that the deal is blocked," he said.

According to the first trader, however, a price increase of 25 cents/mtCO2e per every forward delivery year would not ensure the price rise needed to allow more complex and expensive type of projects to be developed.

"If we really want to scale this market, encourage new supply to come online and really additional methodologies to appear we would need to grow by more than 25 cents/mtCO2e per year," the trader said.

Platts Nature-Based Avoidance Current Year price was assessed Sept. 24 at $7.85/mtCO2e.

Platts Nature-Based Avoidance Yr01 price was assessed Sept. 24 at $8.15/mtCO2e.

Bullish overall

Beyond the need to identify a common approach when pricing forward delivery, the bullish trend reflected by REDD+ projects being offered at a fixed increase per every forward year was a valuable indicator of an overall bullish trend for the entire VCM, a fourth market source said.

The same source -- a developer of cookstove projects in China -- said: "The ascending price expectations in [REDD+] forward contracts reflect the bullish sentiment towards the general carbon market for at least the next 5 years."

He added: "With large industry-scale renewable projects no longer being eligible under Verra's VCS and Gold Standards [certifications], nature-based project is the only type that is large enough to produce sufficient data for a trend curve."

And this trend curve may well be followed by smaller but equally high-quality markets, he said.

"The market share of household device projects is much smaller than nature-based projects. Thus, there is not enough data from household projects to build their own separate uptrend curve as those in nature-based projects. But because of the fungibility of credits and better social benefits of household credits, I am quite confident that the price for household projects will continue to rise in the next 5 years along with nature-based projects," the developer said.

Chicago-based CME Group launched in 2021 two standardized futures contracts, the GEO and N-GEO futures, which reflect CORSIA-eligible credits and nature-based credits, respectively. Both products have been trading on the CME screen as well as in the OTC market.