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INTERVIEW: Speculative capital offers growth opportunity for carbon market -- AirCarbon


Carbon market will move toward more standardized trading

Speculative capital not well represented in carbon market

Every sector of economy to eventually have a carbon liability

  • Author
  • Analyst Ivy Yin and Eric Yep
  • Editor
  • Manish Parashar
  • Commodity
  • Coal Metals Energy Transition

Voluntary carbon credits are moving toward greater standardization and taking the form of traditional commodities, with speculative capital potentially the biggest growth driver for the carbon market in coming years, said William Pazos, cofounder and managing director of carbon trading platform AirCarbon, in a recent interview.

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The move toward standardized contracts is an evolution from the current system of trading where carbon credits are purchased from individual projects, for carbon reduction or avoidance, and sourced from the project's developer, a broker, or the secondary market.

"We believe the market will move more toward standardized trading as more and more players come into the market," Pazos said.

He said the reason why carbon credits transact on a project-by-project basis today is that the buyers of carbon credits are buying them for publicity.

"It's very inexpensive right now to grab headlines by buying carbon credits that offset a particular cargo," he said.

"The paradigm will shift, and companies are not going to look at buying carbon as a marketing exercise," Pazos said.

"They're going to be forced by all their stakeholders to offset emissions and it's going to be a bigger part of their treasury activities. When you have the treasury activity, it's different from a marketing activity. You want efficiency. You want lower settlement rates," he added.

Singapore-based AirCarbon, which bundles carbon credits from different projects into a single instrument that can be traded on its digital platform, is working to bring the traditional commodities architecture to carbon markets.

Carbon credits "trade like sailboats," given that carbon also requires a conversation about underlying characteristics to negotiate a price, he said, adding that without standardization and exchanges, traditional financing remains difficult.

Speculative capital is biggest opportunity

For conventional commodities from energy to metals, a significant portion of liquidity does not come from oil market participants or physical traders, but from the paper market that mostly comprises banks and financial institutions.

"That's the component not currently well represented in the [carbon] market. If you look at any particular commodity, [like] oil, a huge portion of the trading parties are not oil companies but speculators, liquidity providers, hedgers. I think the biggest wave of investments into carbon credits is going to come from speculative capital," Pazos said.

Pazos said he was "very optimistic this time around" about the growth of the global carbon market.

Despite the massive economic crisis due to the pandemic, there has been a scaling up of the carbon markets and scaling up of investments in decarbonization activities, he said, adding that these actions are now regarded as part of solutions to the current crisis, not as something the market cannot afford due to the crisis.

He said this was significantly different from the global financial crisis of 2008, which hampered the carbon market's development due to economic concerns.

This is also likely driven by the recognition of the climate crisis as a much larger issue that needs immediate action.

In addition to speculative capital, Pazos said demand for carbon credits from every sector is also going to grow, as governments and organizations tighten emission-related regulations while commercial stakeholders exert pressure for the decarbonization of various products and services.

"Every single sector of the economy is going to have a carbon liability. You know, we're moving more and more into a carbon constrained world today," he said. "If you are sitting in a boardroom today and managing the risk of the company and ignoring climate change, you are being irresponsible."

More sophisticated trading

The current voluntary carbon market has been criticized for low quality of credits and the potential for misuse, such as greenwashing.

As demand for efficient and cost-effective offsets grows, concerns over poor quality and a lack of transparency will intensify, discouraging buyers genuinely seeking to offset emissions. This has paved the way for exchanges that bring transparency and liquidity to carbon trading.

AirCarbon has put carbon credits that meet certain specifications in a trust and created a receipt on its exchange that can be traded, instead of having physical warehouses. It also allows buyers to select carbon credits according to their needs and specifications, as not everyone buys high quality credits, Pazos said.

"It's been very interesting because the more sophisticated traders on our platforms actually arbitrage the platforms," he said.

Pazos said he was also seeing entities, such as international oil companies, reaping rewards after making large investments into forestry projects to monetize carbon credits.

"Early-stage investments are a good strategy," he said, adding that in some cases the total cost of generating carbon credits can be as low as $2/mt CO2e.

The S&P Global Platts Nature-based Carbon Credits were assessed at $7.65/mt CO2e on Sept. 13 and the Platts CORSIA-Eligible Credits were assessed at $7.31/mt CO2e.