–Taskforce comes up with voluntary-carbon-market blueprint
–While far from ideal, net-zero companies from Google to Shell see a way forward and want its risk-management potential
–RWE case shows how EU’s decent market helps polluters shift

By Mathew Carr

Jan. 28, 2021 — LONDON: Companies from Royal Dutch Shell to Google who want to lead the pack on climate action realise they need a way of reducing the risk of doing so.

While they may have flirted with carbon markets, companies buying and selling emissions credits have had a patchy time for much of the last decade.

The main problem is the lack of a decent-sized global market, which would be much-more efficient and would better guarantee aggressive emission cuts and climate justice.

Since the system isn’t rational, many steelmakers, tech firms, bigoil and cement producers are thinking again as they plot out clean business plans covering the next 10 or 30 years.

As a fall back, they think voluntary carbon markets will reduce the chance of a costly mistake — there’s less chance of missing an emissions target through no fault of their own and suffering reputational damage as a result.

Scaling it won’t be easy, the Taskforce on Scaling Voluntary Carbon Markets concluded Jan. 27. It needs to be turning over about $100 billion a year instead of $320 million, it said.

Companies want to be seen as green, but they’re also being forced to reduce emissions quickly because pension fund groups such as Climate Action 100+ are insisting they don’t want to indefinitely hold investments that might suddenly plunge in value.

Spurred by the global pandemic, some customers want nothing to do with dirty companies.

Giant global corporations and state-owned emitters, who are most responsible for climate change, are now wanting the world to install a system to help them navigate their treacherous downward decline in emissions during the next three decades.

It’s a staggering challenge. About 30 billion tons needs to be cut within 10 years, to halve global emissions. That’s 3 billion tons a year. See this:

The taskforce published its blueprint (see link in the chart below) on how to make the voluntary market large and transparent.

How that market might mesh in with compliance markets under the Paris climate deal over the next decades was beyond its scope, it said.

Here’s a report on that:
https://www.umweltbundesamt.de/sites/default/files/medien/5750/publikationen/2020_11_19_cc_44_2020_carbon_markets_paris_era_0.pdf

Business, policy makers and environmental lobby groups have failed for 30 years to make carbon markets work. The poor standard of public debate means the world is now in dire trouble.

Improving the energy efficiency of factories, switching to cleaner fuels or even renewables and rethinking supply chains can get a company a long way down its emissions curve.

Being able to use emission credits would allow it to boost ambition even more. A company’s willingness to take on a tighter 2025 target is enhanced if it’s given flexibility on how to meet that limit.

Carbon markets can offer flexibility across time periods and geographies. That’s OK because the emissions problem is global. Every time someone pays a lot to cut one ton, they missed an opportunity to cut many tons of carbon for the same price. Urgency matters.

It’s a good thing if a steelmaker, oil company or cement producer can fall back on carbon credits if one of their physical emissions projects faces a delay. It will encourage those projects. It’s not greenwash if done well.

The key is getting a strong regulator, to keep supply low and quality high, the taskforce said.

That’s not the situation right now, where there’s little shortage of carbon credits to buy. Supply has tracked above demand, even as demand is rising, the taskforce found.

Chaired by Standard Chartered CEO Bill Winters and supported by UN special climate envoy Mark Carney, the project came up with a blueprint to boost demand for credits and protect the environmental integrity of claims being made by the emitters.

Getting industries to agree standards could rapidly scale demand for voluntary credits, was one idea. This includes both business-to-consumer sales and business-to-business transactions (for instance, carbon-neutral milk for B2C, and a carbon-neutral liquefied natural gas cargo for B2B).

Creating benchmark contracts and futures markets are other challenges. IHS Markit favors forestry-related credits as the benchmark because that’s where the volume is at the moment. Other contract types can be priced as a premium (or discount).

Here’s an outline of the taskforce’s blueprint (warning — it’s not for the faint of heart):

One of the many key challenges is deciding who will have the right to sell an emissions credit.

The declining line in the first chart above to keep temperatures from rising 1.5C is already steep. The theory of carbon trading is you only get to create a sellable emission credit if your reduction is over and above what’s required in the base-case scenario: it’s got to be “additional.”

Because the steepness of the cuts has become so acute due to the decades of inaction, finding an additional cut will be that much more difficult.

The taskforce created this chart, with the help of McKinsey:

I’ve butchered it slightly (forgive me, taskforce) by adding the large red arrow, which signifies the approximate area where companies (and countries) have to cut emissions to before they start selling to companies and countries struggling to meet the trajectory, represented by the red square.

If there are too many buyers or too much for sale, the market will surge or plunge respectively.

The challenge for standard setters and policy makers seeking to establish the market is to ensure there’s balance.

The use of price floors, ceilings and reserves may help, or hinder, depending how they’re deployed. Environmental lobby groups worry the program will be well oversupplied and so it could effectively become a greenwashing system.

The taskforce says this of additionality, without going into a lot of detail about how it should be measured: It’s the determination of whether projects genuinely yield emission abatement that would
not otherwise occur.

Additionality is tried and tested. The UN Clean Development Mechanism has 277 pages of methodologies here: https://cdm.unfccc.int/methodologies/documentation/2003/CDM-Methodology-Booklet_fullversion.pdf

Additionality gets more strict over time and digitization of projects and methodologies may ease project compliance and emissions tracking. See this overview: https://cdm.unfccc.int/methodologies/PAmethodologies/tools/am-tool-01-v7.0.0.pdf

If companies wanted the taskforce to indicate which credits to buy, they’ll be disappointed, according to one developer.

A large portion of emission credits have been criticized for being created too easily — for example, because they stem from forests that were really not likely to be cut down or from an overincentivized chemical plant.

“Integrity of voluntary carbon markets should be further improved. Today the market lacks a strong governance body to decide on participant eligibility, strengthen validation and verification processes, and combat fraud or money laundering,” the taskforce said.

Many green groups and academics are already unhappy with the taskforce’s plan. See this critique: https://greenfinanceobservatory.org/wp-content/uploads/2021/01/Scaling-up-GFO-analysis-final4.pdf

Participants, of course, disagree, saying perfection should not be the enemy of the good. More than 2,000 businesses, cities, universities and investors are striving for net zero, according to UN data, so a compelling stage is already set because those targets imply demand:

“We now have a system that allows us to meet a common environmental goal at the lowest possible price. The demand that has already been pledged publicly is multiples of the supply that’s available in the market. Multiples. It might not be 2021. It might not be 2022. But I can guarantee you with 100% certainty that the size of the voluntary carbon market is going to have to increase in order for us to meet those targets that have already been pledged. To say the system is broken — I think that’s crazy,” said one trader, who wanted to speak anonymously.

Adding to the challenge, global companies have a sort of free will that’s partly beyond the reach of a single country’s environmental regulator. That’s why countries including China and Brazil are pushing for a global system overseen by the UN.

As country and corporate markets collide, accounting will probably become a “nightmare,” according to long-term carbon watcher Alessandro Vitelli.

Compliance and voluntary markets are not formally linked, but linkage seems inevitable.

Firms may even choose to buy European Union carbon allowances instead of voluntary offsets, dodging the reputational risk that can come with buying from criticised projects, according to a report commissioned by the German Environment Agency: https://www.umweltbundesamt.de/sites/default/files/medien/5750/publikationen/2021_01_11_cc_04-2020_voluntary_offsetting_credits_and_allowances_1.pdf

Buying from the voluntary market will have a lower cost – around $6 a ton, according to IHS Markit. https://www.opisnet.com/product/pricing/spot/carbon-offsets-report/

That level is currently less than one sixth of the price of an EU allowance, which is the equivalent of about $40 a ton.

Having an aversion to the politics and technicalities of a forest-based credit may push some companies to pay the higher price for an EU allowance, said the report commissioned by Germany.

Buying EU allowances is problematic also for reasons other than their higher price. Europe will probably cancel more than 2.2 billion of allowances in 2023 after they languish too long in a reserve — that’s about a year and a half of supply.

This planned move would mean voluntarily buying allowances today and holding/cancelling them (when a portion of them would be cancelled anyway in the future) also might not feel quite right.

The circumstances of the traded markets or the buyer might change its mind so that it’s “tempted to sell the allowance instead of cancelling it if the prices are sufficiently high in the future,” the report’s authors said. The EU’s slso grappling with this accounting.

Optimists in the carbon market say these accounting debates can be thrashed out in the coming weeks, months, years and/or decades.

Making 2025-2030 targets tighter — both corporate ones and country ones under the Paris climate deal — will help create scarcity.

But it still will probably be hard to avoid oversupply, even if voluntary carbon trading is only a temporary thing — covering the next 20 years or so.

The world has failed to solve these political and accounting issues the past 30 years, but this time around cheaper solar, wind and batteries are on investors’ side and allowing for more speed to focus on hard-to-cut emissions.

If regulators can work the voluntary market out, companies will be more comfortable making ambitious multi-decade plans. The markets will effectively provide an insurance policy should technology or circumstances move against a company or country.

Europe’s biggest emitter has for now shown how buying forward can be very lucrative, albeit in a different setting. Here’s a slide from the website of RWE AG, which burns coal for power (but not for that much longer). It’s already hedged its carbon exposure through 2030.

And its shareholders appreciate that. See this share price chart:

RWE’s surging valuation is in stark contrast to Exxon Mobil Corp.’s, which has dropped by almost half inside two years.

Regulators and voluntary market standard bearers will need to think ahead too, as the task force says. If they’re not miserly in handing out credits and allowances during the next two or three decades, the carbon markets will again fall into oversupply and disrepute.

Better, countries will decide to install EU-like carbon markets that feature science-based, declining, transparent, and enforceable caps to guarantee results, a trading element that encourages over-and-accelerated-compliance, as well as high-quality offsets.

That concluding idea from Josh Margolis, senior commercial advisor, Emergent Forest Finance Accelerator: https://www.linkedin.com/posts/activity-6760468567675682818-8DMx/

(Adds link, improves attribution in final paragraph, smooths wrinkles, Feb. 6. Made this paragraph more clear after getting feedback March 2: This planned move would mean voluntarily buying allowances today and holding/cancelling them (when a portion of them would be cancelled anyway in the future) also might not feel quite right; Corrects Market Carney to Mark Carney.)