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Voluntary carbon credit buyers recalibrate market strategies, tighten scrutiny

Highlights

Trading ecosystem needs upgrade to restore market confidence

Buyers inclined towards less controversial removal credits

Market participants review strategies, diversify portfolios

  • Author
  • Ivy Yin
  • Editor
  • Aastha Agnihotri
  • Commodity
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The recent controversy around deforestation avoidance projects and the carbon credits generated from them have not only dented market confidence, but also prompted buyers to reassess some long-term procurement strategies and stall or divert investments, according to traders and market participants.

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The market decline has also prompted calls for existing carbon market methodologies and practices to be reviewed and enhanced, as existing systems are likely to come under more scrutiny and stress testing, with the role of carbon markets in cutting emissions becoming more critical.

A wide swathe of buyers, ranging from investors to large corporates with long-term investments in carbon projects, are reassessing how their carbon credit portfolios are structured in the aftermath of the controversy, Singapore-based traders said.

Voluntary carbon credit prices, which were already under pressure in 2022 due to a global energy crisis, lost nearly half their value to around $1.7/mtCO2e after the Guardian published an investigative report on Jan. 18 alleging that REDD+ carbon credits issued were "phantom credits" and did not represent real carbon reductions.

The Platts-assessed nature-based carbon credits, or CNC, rebounded to $2.5-$2.75/mtCO2e during Feb. 7-10, according to S&P Global Commodity Insights data.

"The sharp downtrend observed in the last month has affected all vintages and appears to be directly related to a loss of confidence in light of the recent media articles," Mikkel Larsen, chief executive officer with Singapore-based carbon exchange Climate Impact X (CIX), said.

"While this is a notable drop, it will not be the first or the last time. Such market fluctuations and volatility will always be inevitable if the underlying technologies and methodologies are imperfect," he added.

William Pazos, cofounder of carbon trading platform AirCarbon, said buyers are likely to wait out until the trading volumes improve.

"Volumes have dropped by approximately 15% since the article came out. In the end, the ultimate buyers are corporates looking to make voluntary claims. They are under no real-time pressure to buy credits. As a result, they will wait for the market to settle before they make a move," he said.

The decline in prices and thinning volumes have also been observed by New York-based StoneX. "Buying and selling activity was badly affected. Prices dropped for almost three consecutive weeks and volumes vanished in front of our eyes," according to StoneX's Senior VP and Head of Carbon Markets Alfredo Nicastro.

"Market participants will certainly need to review their strategies, diversify portfolios and promote cross-sector climate action," said Nicastro.

Singapore-based carbon traders confirmed that several companies were evaluating what type of credits will be best suited to offset their emissions and many are simply holding back until the situation normalizes.

Avoidance versus removal credits

Avoidance credits are issued based on assumptions of "what would happen without this project" such as a power plant would use coal without a wind farm. Deforestation avoidance projects also make assumptions based on adjacent and similar forests.

Buyers have started to question the fundamental logic of all avoidance carbon credits, not only the REDD+ ones, traders said.

"People are starting to question whether all these baseline assumptions are set reasonably, or they are just telling us stories in a fantasy," one Singapore-based trader said. "I think promoting removal credits is a rational move," the trader added.

Removal credits are generated from projects that directly remove greenhouse gases from the atmosphere, like reforestation projects and technology-based carbon capture and storage.

A second Singapore-based trader argued that even afforestation or reforestation projects may not be effective if it plants non-native species that worsen the ecosystem by consuming excessive water, despite being classified as a "removal".

"In some cases, compared with planting trees, conserving existing species is actually less disruptive to the local ecosystem," the trader said, pointing to lack of consensus around methodologies that underpins the recent controversy.

CIX's Larsen said that there needs to be acceptance that while removal credits have a larger place in the long-term, there is still a role for avoidance credits in the near-term. "It is not a matter of either-or – we need a blend of solutions," he said.

StoneX's Nicastro said carbon credits generated from REDD+ projects currently account for a significant share of the market supply.

"In the past few years, players invested heavily in conservation and avoided deforestation projects, which is a good thing, but as the supply curves show, [market players] didn't dedicate similar action to other nature-based and technology-based solutions. Diversification will be key to minimize similar price movements until carbon markets fully mature," he said.

"We are finally starting to see some volumes again as prices start a timid recovery," Nicastro added.

A more robust system

Market participants have called for a more robust system to restore confidence, such as rating agencies to identify high-quality carbon credits, the Integrity Council for the Voluntary Carbon Market to strengthen quality benchmarks, and the Voluntary Carbon Markets Integrity Initiative to ensure proper use.

"We believe this will likely be seen in the future as an important opportunity for self-reflection within the voluntary carbon market, and one that could further motivate some of the key initiatives already underway," CIX's Larsen said.

Bai Bo, chairman of Singapore-based MetaVerse Green Exchange, said empirical methods for measurement and baselines employed on forest carbon evolve, and new technologies and methodologies will improve accuracy.

"The evolution of baselines does not mean legacy credits are worthless or should necessarily be discounted," Bai said.

A Singapore-based banker said that compared to the conventional commodity markets, carbon market deals are backed by fewer supporting documents and this has been worrying. "Now's the time to ask for the same level of scrutiny," the banker added.