What next for the voluntary carbon market?

In our last blog, we traced the origins and first three decades of growth in carbon markets. This week, we’re looking ahead. How did the Paris Agreement propel the voluntary carbon market (VCM) into the mainstream, and which headwinds could yet drive it off course?

Carbon credits are at a crossroads

On the one hand, interest has never been higher. In under a decade, the VCM has earned a foothold in the discourse around decarbonization. For myriad reasons outlined last week, people are more willing to accept that any realistic road to net zero is paved with carbon credits.

This the VCM owes, in large part, to the Paris Agreement.

Negotiated by the United Nations Framework Convention on Climate Change (UNFCCC) in 2015 and ratified in 2016, the Paris Agreement took a radically different approach to that of its predecessors (Kyoto, Copenhagen).

Instead of binding its signatories to international law, the treaty is mostly voluntary. Provided they work towards the same general coordinates, governments were and are free to set their own nationally determined contributions (NDCs) to net zero.

One major lever at their disposal is international carbon trading, the foundational terms of which are spelled out in Article 6 of the treaty.

Recognizing the need for an established and regulated VCM, the Paris Agreement changed the course of the decarbonization movement. Early estimates suggest it could reduce the cost of implementing NDCs by more than half ($250 billion by 2030), facilitating the removal of 50% more emissions.

By the Numbers

In the years that followed, negotiators sought to develop a governance structure capable of upholding a standardized, commoditized, and universally recognized market. Meanwhile, organic demand and price exploded.

Ecosystem Marketplace calculated the VCM was worth $2 billion by 2021. In its review of the year, Refinitiv admitted it was “running out of superlatives to describe the surge in carbon trading.” The value of the VCM may reach $180 billion in 2030, according to McKinsey, soaring to $800 billion by 2050.

Bloomberg puts the figure closer to $1 trillion by 2037 — if, that is, the right rules are in place.

It’s a big ‘if’. Despite encouraging progress, standardization remains elusive. Amid its bullish predictions, McKinsey warns that the VCM is “fragmented and complex… with low to no regulation, different accounting methodologies with varying degrees of rigor and a variety of industry-created standards.”

Healthy frameworks make for happy markets. Green in more ways than one, the VCM is finding success a double-edged sword, as the infrastructure required to service (overwhelming) demand is still in development.

And it is in development. Behind the scenes, ratings agencies, standard setters, and integrity bodies, such as the Voluntary Carbon Markets Integrity Initiative (VCMI) and Integrity Council for the Voluntary Carbon Market (ICVCM), are working tirelessly towards best practice guidelines for buyers and suppliers of carbon credits.

In 2022, for instance, the ICVCM launched a Public Consultation for Core Carbon Principles to provide a framework for identifying high-integrity and high-quality carbon credits that create additional and verifiable impact. Based on ICVCM guidance, we expect the Core Carbon Principles to be issued this month. (Watch this space.)

Fly in the Ointment

Building market integrity takes time. As our CEO Chris Slater told Carbon Pulse this month, integrity bodies are “all trying to solve the underlying problem, which is risk mitigation.”

Long-term risk mitigation is important, but what about immediate risk protection for corporate buyers?

Hoping for the best isn’t a solution. Thanks, in part, to eroding trust, the VCM grew more slowly than anticipated in 2022. In early 2023, allegations of over-crediting spawned negative headlines about and a retreat from forestry projects, foreshadowing more confusion ahead.

In theory, all carbon credits should be created equal. In an opaque and fragmented market yet to reach maturity, however, some — as our CIO Laura Fritsch will explore in more detail next week — are better than others.

That complexity makes the VCM difficult to navigate, deterring companies for whom reputation is a growing concern. Chief Sustainability Officers don’t have the bandwidth to conduct due diligence on every carbon credit they purchase to meet those plans.

Equally and understandably, company management may not want to gamble with stakeholder expectations. To preempt damaging accusations of greenwash for outcomes they can’t control, they may choose to ‘greenhush’ or pull back from commitments.

Given the importance of carbon credits in meeting NDCs and so net zero, there’s more at risk than reputation; planetary health is on the line, too. Insurance, however, can help, representing a much-needed de-risking solution to both problems.

History shows that market and risk-transfer mechanisms depend on one another. Or, as CEO Chris Slater told Carbon Pulse: “Insuring carbon credits will play a critical role in evolving the voluntary market, as insurance has done for other sectors for hundreds of years.”