Source: BloombergNEF, VCS, GS, CAR, ACR, Macquarie
One of the key achievements of modern voluntary carbon markets is the idea that the positive management of climate assets that some developing countries have in relative abundance, such as virgin rainforest, can be a sustainable income source. Revenues from the voluntary offset market have been shown to be more attractive sources of revenue than legal or illegal logging for timber or cattle grazing in several geographies, whilst also often delivering other positive socio-economic impact, such as progress towards various UN Sustainable Development Goals. As the market evolves, so too is the monitoring and verification of the non-carbon co-benefits associated with offset projects. Most registries in the voluntary international market now allow for third-party audit verification of co-benefits against climate, community, biodiversity and other sustainable development goal-linked outcomes.
The voluntary offsets market can build on the lessons learned of its early days
The market for offsets is working but nascent and has room for improvement. Additionality is the entry requirement of any credible project in the market today. The market is also becoming increasingly efficient at pricing the relative demand for offset provenance, technology and co-benefits.
The credibility of some early government and voluntary carbon offsetting programs built around natural carbon sinks was undermined by certain project flaws or behaviours of project proponents. For example, some of the offset projects designed around natural carbon sinks had their impact assessments anchored in excessively high assumptions regarding baseline deforestation rates. Compounding issues, the monitoring of forest growth and carbon retention was unreliable. Such disappointments have put pressure on verification bodies over the past decade to continuously improve their approval and monitoring processes to provide transparency in the market.
Verification bodies are essential to the market. Independent offset crediting agencies, including Verra and the Gold Standard, now account for the majority of new issuance, growing 30 per cent between 2019 and 2020 despite the impact of the Covid-19 pandemic. New national voluntary schemes, which typically involve regulatory oversight along with third party verification, are also growing. This includes the Gabon - Norway partnership which recently led to a first $US17 million results-based payment received in exchange for sequestering 3.4 million tons of CO2e in the Gabonese forest over 2016 and 2017.6
Project characteristics are also evolving, and the market is factoring in a variety of project qualities in prices. For example, offsets from clean energy still accounted for most volumes transacted in 2019 and 2020 but have more recently been excluded from eligibility from most reputable registries with the exception of projects in the world’s least developed countries.7 This goes to the additionality consideration, as renewables projects have become more mainstream globally, such projects typically can be built without the additional revenue stream from the sale of carbon offsets, except when located in lower income that compound development challenges and operations risk.
Beyond direct corporate decarbonisation projects, carbon offsets in less developed countries can have a major positive impact on local peoples’ day-to-day life through the provision of clean cooking, basic lighting, power charging and other services in off-grid, disadvantaged communities. Switching to clean cooking, for example, reduces the emissions associated with open wood or charcoal fires by increasing the efficiency of the cooking process. Stove efficiency thereby reduces the amount of wood that needs to be collected, freeing up time in the day for other activity, and significantly enhancing human health by improving air quality around the home. This is an example of a carbon emissions avoidance benefit, which also delivers numerous other on-the-ground benefits for which there is no other readily available funding mechanism at scale other than the voluntary carbon market.
Market participants can deliver the improvements needed for voluntary offsets to scale
Market participants will shape the future of the voluntary offsets market. We believe that achieving scale will require each participant to focus on verified additionality, co-benefit reporting, technological efficiencies of tracking and certification, and embracing the diversity of solutions that can help address the climate crisis.
The voluntary offsets market is fragmented by design due to its highly distributed nature, but in the early days this fragmentation also led to a lack of consistency in practices, quality control and credit risk of developers. For example, approximately 1,000 different project developers are responsible for the approximately 1,600 projects in the observable Verra registry. However, growing demand from international corporates and the involvement of financial institutions such as Macquarie, is helping improve institutional practices, transaction structuring capabilities and credit worthiness of projects, all of which will be needed to scale the market.
Technology is another key enabler of a more robust voluntary offsets market. For example, the use of remote sensing via satellites and drones, together with geolocation and broad spectrum digital technologies are progressively enabling much more accurate, frequent and inexpensive monitoring of the carbon avoidance and sequestration occurring on the ground. Similarly, offset provenance and tracking technologies, such as CBL Markets, an environmental products exchange and digital registry platform backed by Macquarie, are allowing the consumers of carbon offsets to better monitor the web of offsets being created and retired. Investment into climate and carbon monitoring technologies are growing at a fast pace, topping $US380 million in the first quarter of 2021, and already exceeding the total for 2020 in the year to date.8
Enabling the full potential of voluntary carbon offsets requires ambitious action from all market participants to overcome the remaining structural and policy uncertainties. Future growth of offsets relies on improvements in three key areas:
1. Credible demand
All corporates should work on credible, transparent near-to medium-term climate action plans, that maximise direct emissions reductions across all scopes of emissions, in conjunction with using carbon offsets now to negate those emissions that will take more time to abate.
2. Accountability in the market
Market participants must continue to improve their processes to ensure that projects adhere to additionality, permanence, and leakage criteria, notably by increasingly using technology to provide greater transparency and traceability of offsets and their impact.
3. Market infrastructure and institutional recognition
Without limiting or slowing corporate ambition, it will be increasingly important to have official recognition and incentivisation of the market in order to continue building confidence in the role of offsets as a safe and credible tool to include in corporate climate action strategies. The entry of high-quality, institutionally rigorous and credit-worthy participants into the voluntary offsets market will assist in this iterative improvement in market robustness and environmental integrity.
Head of Structuring, Origination and Sales, Global Carbon, Macquarie Commodities and Global Markets
Managing Director, Macquarie Asset Management
Head of the Climate Intelligence Unit, Macquarie