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FEATURE: Commoditization of carbon credits proves bearish for prices: sources

Highlights

Standardized products created to reduce complexity of voluntary market

But players say loss of specifications proves bearish for prices of credits

The commoditization of voluntary carbon credits on exchanges worldwide is increasingly proving to be bearish for the prices of those credits, due to the lower level of specific information offered on the credit itself or the underlying project, market participants have said.

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Standardized carbon credits bring under one label a wider array of contracts that meet specific characteristics, but these contracts typically do not include a great level of detail about the specific vintage of the credit, the location of the project, or any additional sustainable co-benefits

For example, contracts created by exchanges to reflect credits eligible for the CORSIA airline CO2 offsetting scheme, such as CBL's GEO or ACX's CET guarantee that the credits collected under that label respect all CORSIA requirements, such as for example a 2016+ vintage or that the certifying standard is one of those recognized by the CORSIA scheme.

Others group credits by type, for example credits issued by nature-based carbon projects.

They have been created in order to help reduce the complexity of voluntary carbon markets and facilitate the trade of carbon credits. A higher and faster trading activity brings liquidity to the market and ultimately transparency.

"How can you expect mass adoption if corporates can't understand it?" said a trader.

Lack of similar contracts would require buyers to spend time checking all the specifications before agreeing on a trade. At the same time, liquidity would be dispersed among the wide variety of credits on offer.

But standardization comes with loss of specifications, which are the core of voluntary carbon markets, and often contribute to a higher asking price for credits issued by some types of projects.

While ensuring that some specific criteria are met, standardized products don't offer full visibility on the underlying project, such as the co-benefits involved, or the specific vintage of the credit on offer.

This lack of visibility, sources said, can impact that price a buyer is willing to pay for a carbon credit offered under a more standardized label, and without the additional project detail.

"With standardized contracts you don't know what exactly you are getting, and that's why the price is discounted," a second carbon trader said.

A third trader said: "If the specifications were more developed, then the buyers would feel more confident about paying higher prices, but this would reduce the liquidity."

He added: "Quality is all in the specifications. Why would you sell good quality offsets to someone that purely needs [for example] a Verra + CCB certified credit and doesn't care about vintage, geography or the quantity and quality of Sustainable Development Goals?" the second trader questioned.

Complexity at the core

Beyond the positive and negative impact of standardized products, the subject seems to highlight the fundamental nature of voluntary carbon markets, which thrive on complexity.

Any attempt to reduce this complexity brings liquidity on the one hand but also, potentially, discounted prices on the other.

With a high risk of greenwashing accusations involved in the purchase of carbon credits, many end-buyers want to ensure they are choosing credits that meet specific and strict quality considerations, and therefore want to have visibility on what exactly they are using to meet their carbon reduction targets.

Any attempt to reduce this granularity can introduce uncertainty about quality of the credits on offer.

While there are still many buyers keen to purchase the most competitive carbon credits available, the attention to the quality of the credit purchased tends to increase as players familiarize themselves with the market, sources have previously said.

For example, during their first year on the market, end-buyers would build their portfolios with a small percentage of more nature-based and community-oriented based projects and higher volumes of commoditized credits or credits issued by large renewable projects. But on their second year in the market, the percentage of the first category would increase, with the other category decreasing, and so on over the next years, sources said.

Changes under way

Shifts however are already taking place. In addition to the standardized contract-based products, exchanges appear to be capturing the need to preserve the complexity of carbon finance and offer tools to help players navigate it, instead of reducing it.

For example, Singapore's ACX exchange said July 26 that it will integrate the BeZero Carbon ratings into its platform.

Climate solution provider BeZero has created a rating system where carbon credits are rated by their probability to achieves a ton of CO2e avoided or removed.

An AAA+ rating represents a 90% or more chance that the credit truly equals a ton of CO2e; a rating of A represents a 30-40% chance.

"One of the emerging trends within the voluntary carbon space has indeed to deal with more and more niche technological solutions being offered to help increase transparency and efficiency of the market," a fourth trader said July 26 commenting on the ACX-BeZero partnership.

"If done properly, the rating of carbon credits will improve transparency around quality. Higher quality projects will be able to sell at higher prices."