Last year was a remarkable one for the voluntary carbon market (VCM). As organizations around the world mobilized around ambitious climate targets, the demand and subsequent price for carbon credits reached an all-time high. In 2021, for the first time in the market’s history, the VCM broke the $1B mark.
Important subtext to these big, bold market headlines is that the increased price of carbon credits is actually a positive sign for VCM longevity and climate action more broadly. Higher prices provide an incentive for new project development and serve as a forcing function for organizations and governments to prioritize internal emissions reductions.
This past year in the VCM has left some folks scratching their heads. What were the primary drivers of this rapid demand surge in 2021? And what trends can we expect to continue?
Primary drivers of upward price movement in the voluntary carbon market
Increased climate commitments and Net Zero targets
Since the enactment of the Paris Agreement in 2016, many organizations have been aligning their climate goals with science-based emissions reductions to limit warming to 1.5 °C. It wasn’t until this past year, however, that the Science-Based Target Initiative (SBTi) adopted Net Zero as its centralized decarbonization framework, which now has over 750 companies (and counting) committed. SBTi’s Net-Zero Standard focuses on carbon removal credits to address residual emissions in the target year, as well as mitigation outside of an organization’s value chain. Apart from SBTi, there are a variety of emerging climate commitments in which carbon credits play a role in both near and long-term targets.
The heightened demand caused by increased climate commitments has contributed to the run up in carbon credit prices across all project types. Our clients continue to be interested in nature-based projects, projects that actively remove carbon, or projects that avoid short-lived climate pollutants, such as methane capture at landfills or dairy farms. Beyond the environmental benefits, many of our clients are aligning their carbon credit purchases with projects that have clear co-benefits that support the UN’s Sustainable Development Goals (SDGs).
The influx of carbon market participants
2021 also saw a significant increase in new market entrants from new project developers and technology providers, to new trading platforms and first-time carbon credit buyers. We’ve seen new technologies emerge to support project monitoring, reporting, and verification, as well as new project types that historically weren’t feasible in the previous market landscape. We’re noticing trading groups expanding their existing environmental commodities businesses to include voluntary carbon products, as well as new platforms and exchanges that are streamlining trading opportunities through standardized contracts.
Another notable development in 2021 was the formation of a variety of groups aiming to establish centralized carbon credit quality standards. Most notably, the Taskforce on Scaling the Voluntary Carbon Market (TSVCM). This private sector-led initiative led to the formation of the Integrity Council for the Voluntary Carbon Market (IC-VCM), a governance body that has set out to create a framework for quality standards in the market, driving up integrity and credibility through its Core Carbon Principles which are expected to be finalized in 2022.
As these new participants carve out their own roles in the market, the increased activity has brought more attention to the VCM, creating optimism around integrity, pricing, and future growth.
Emergence of crypto-carbon platforms
Last year we saw the rise of the crypto-carbon space that involves bridging carbon credits onto blockchains. For some, the incentive is to bring transparency and accessibility for broader market participation, as well as accelerate the price of carbon credits as a signal to develop new, high-quality projects. The decentralized finance groups allow users to bridge credits on-chain into carbon pools. Putting the scale into perspective, carbon credit retirements intended to be bridged with the largest platform contributed to approximately 13% of all Verra retirements in 2021. As of now, over 18M credits have been tokenized.
At this point it’s unclear whether this technological advancement is helping or hindering market oversight and the global adherence to quality carbon credit standards, but what is certain is that its impact is being felt across the market.
Projections show no signs of voluntary carbon market slowing
The coalescence of these and other factors is contributing to never-seen-before growth in the VCM. Project developers have a stronger incentive to bring new projects to market, but the complexity of new project development requires time, technical expertise, and significant capital, and thus won’t immediately ease near-term supply constraints. As a result of the upward carbon price movement, we’re noticing that some project developers are less willing to forward sell credits from existing projects despite the heightened demand for long-term offtake, which adds to the feeling of a supply crunch.
So what can organizations expect in terms of future carbon prices? BloombergNEF recently published an inaugural Long-Term Carbon Offset Outlook 2022 that addresses this question by modeling out three potential scenarios for how carbon supply, demand, and pricing may shake out.
According to BloombergNEF, the voluntary carbon market scenario assumes the market remains similar to how it looks today. Both avoided emissions and carbon removals are accepted, leaving the market with excess supply and ineffectively low prices. In contrast, the removal scenario allows only carbon removals, leaving the market undersupplied and high-priced. The final hybrid scenario takes a gradual approach from today’s voluntary market to a removals-only market, allowing pricing to rise at a manageable rate.
There’s a wide range of price outcomes in these potential scenarios, ranging from $11 – $224/ton, as well as a variety of factors that will contribute to how these scenarios might actually play out. Given the future uncertainty of the market and the current optimism many participants are feeling, 3Degrees continues tracking the market closely to understand the impact that the dynamics of supply and demand have on our client’s procurement strategies.
What these trends mean for carbon credit procurement and climate action
The general consensus in the market seems to be that voluntary carbon credit buyers should anticipate that prices will continue to climb as an increasing number of organizations set more aggressive climate commitments. Carving out a dedicated carbon budget or setting an internal carbon price is an effective strategy to account for total emissions while establishing funds for future carbon reduction investments.
With a lot of recent buzz around carbon removals, market participants are awaiting more explicit guidance on how removals play a role in supporting SBTi’s Net-Zero Standard, or other long-term net zero targets. In addition, buyer’s are seeking guidance on the role that carbon credits can play in mitigation beyond an organization’s value chain. However, there’s important work to be done today in critical sectors that are not yet regulated, and carbon credits are a valuable tool that enable organizations to take action now. We encourage all companies to set and pursue emission reductions targets that go beyond business-as-usual practices, in addition to leveraging carbon credits to increase their impact on mitigating climate change. While carbon credits are not a strategy on their own, when effectively leveraged, they complement near and long-term climate targets.
Looking to 2022 and beyond, it’s imperative that all market participants work to strengthen the integrity of the VCM by supporting high quality projects that are third-party verified using internationally recognized standards, advocating for openness and transparency, and adhering to sound and credible emissions reduction claims. 3Degrees continues to support high-quality projects in key sectors, and can help clients navigate the uncertainty in this rapidly changing market landscape.