Green finance needs voluntary CO2 markets that work

The United Nations Climate Change Conference, known as COP26, in Glasgow, Scotland, catalyzed a commitment to carbon neutrality, achieving net-zero carbon emissions, calling for emissions to be reduced as much as possible and remaining emissions through to offset the purchase of CO2 certificates.

A carbon voucher reduces, avoids or removes carbon emissions in one location to offset unavoidable emissions elsewhere through certified green power projects. CO2 certificates represent one tonne of CO2 emission reduction. They are 1) avoidance or reduction projects – e.g. e.g. renewable energy (wind, solar, hydro, biogas) – and 2) removal or sequestration – e.g. B. Reforestation and direct carbon capture targeting the voluntary carbon market (VCM). Carbon credits can be resold multiple times until withdrawn by the end user wishing to claim the offsetting impact. Carbon credits can also have co-benefits such as job creation, water conservation, flood control and biodiversity conservation.

Carbon registries store the carbon certificates issued by independent and internationally certified verifiers or verifiers according to independent standards. Credits with sequential numbers are issued by the verifiers and the offset reduction entitlement is converted into carbon credits that can be traded or retired. Carbon markets turn carbon emissions into a commodity or tradable environmental value by putting a price on it.

Related: The UN’s COP26 climate change targets include emerging technologies and carbon taxes

CO2 certificates are traded on the compliance market. There are currently 64 compliance markets worldwide and pricing is driven by issuers and polluters. The European Union carbon market or Emissions Trading Scheme (ETS) is the largest carbon market, accounting for 90% of world trade. Entry into the EU ETS is restricted only to large polluters and their brokers, who are regulated by the operators of the scheme. Credit allocation is also controlled to manage pricing. Only the carbon prices traded in the EU ETS reflect the true cost of carbon pollution, but market access is not fair.

Small businesses and individuals only have access to the voluntary carbon market, where they buy credits at their discretion to offset emissions from a specific activity. Voluntary loans generally cannot be traded under the compliance market regime. Voluntary carbon markets are expected to grow 15-fold by 2030, according to the Taskforce for Scaling the Voluntary Carbon Market Final Report January 2021 to respond to increased private sector demand for climate solutions. A major problem with VCMs is that carbon credit prices have been low. The low cost of voluntary credits of $2-3 per credit neither motivates nor encourages project developers and does little to capture the true cost of climate pollution compared to compliance markets.

Related: Pandemic year ends with a tokenized carbon cap-and-trade solution

An excellent article for understanding VCM is The Good Is Never Perfect: Why the Current Flaws of Voluntary Carbon Markets Are Services, Not Barriers to Successful Climate Change Action. In this article, Oliver Miltenberger, Christophe Jospe, and James Pittman highlight key issues related to VCM design, function, and scale-up.

green washing. This happens when companies with false energy efficiency claim to be more environmentally friendly than they really are and therefore high rates of ineffective credits are used to offset corporate emissions.

carbon accounting. The number of claims for compensation of emissions is unrealistic given the limitations of the ecosystem. Net-zero ambitions should be subject to disclosure requirements and be subject to scrutiny. Double counting can be intentional, but also due to a lack of full accounting records and a lack of coordination between market jurisdictions or operators.

Market failures and inefficiencies. A major criticism stresses the risk of unduly imposing compliance costs on product and service markets, and there are few incentives for companies to voluntarily take steps to mitigate environmental impacts.

Monitoring, Reporting and Verification. The cost of these activities can account for most of the market value of a carbon credit, reducing the incentive to implement it.

Additionality and baselines. Carbon removal projects inherently use subjective baselines.

Durability. This refers to the assurance that carbon will remain in a stock for an extended period of time, typically 30-100 years. However, there is an opportunity to protect and expand carbon sinks, incentivize low-carbon production, and increase the flow of carbon from the atmosphere into short-term and permanent stockpiles, even in shorter-endurance cases.

Stakeholder Involvement and Injustice. Projects can disenfranchise local livelihoods. In some early REDD+ projects, the financialized carbon benefits meant that local communities had limited access to their traditional lands and livelihoods.

These can help with: standardized accounting protocols for interoperability between accounting scales and systems; greater transparency of VCM operators and credit buyers; standalone certifications of credit rights and ownership; improved traceability. Traceability, liquidity and smart contracts enable innovative use of carbon credits and create additional demand across the VCM.

Related: How blockchain technology is changing climate protection

When combined with remote sensing data via satellite imagery, drones, laser detection devices, and Internet-of-Things devices with machine learning and artificial intelligence, analytics can reduce development costs and increase measurement accuracy. South Pole pointed out:

“Blockchain technology has enormous potential for climate protection. However, this is only the case if the right safety precautions are taken to ensure environmental integrity. Web3 applications can be part of the climate solution, but they need to be properly designed and applied.”

While the potential is there, we need to take actions to fix the issues in VCM including:

• Strengthening incentives for decarbonization
• Carbon pricing with improved price transparency is urgently needed
• Reducing the cost of creating emission certificates
• Reducing transaction costs and providing additional liquidity
• Make prices higher and more reliable on the spot and futures markets
• Establishing carbon credits as a viable asset class by providing predictable investment returns and incorporating value protection for buyers and sellers
• Creation of safeguards to protect reputation and legal procedures for dispute resolution
• Clarity on carbon tax exemption, transition from polluter pays to polluter invest, and full pricing goes to local green owners, who take direct climate action on their behalf.

Kishore Butani of the Universal Carbon Registry in India pointed out: “The mere inclusion of carbon credits in the chain does not contribute to price discovery. It is worse when the broker and middleman buy cheap and create tokens as we are currently seeing, completely cutting off the project owner in the ground. What is needed is not an NFT [nonfungible token] from the buy-side of the carbon market, but directly integrating with carbon storage facilities that help rural developers and green project owners create the carbon NFTs.” He also added:

“Can we learn from Bitcoin and price all mining years the same and make entry into the VCM affordable for the rural poor in developing countries and stop diverting carbon finance to projects in Annex 1 countries? These countries are obligated to go green, my India is not.”

VCMs are an essential means of catalyzing action, but need significant improvement to fulfill this role.

This article does not contain any investment advice or recommendation. Every investment and trading move involves risk and readers should do their own research when making a decision.

The views, thoughts, and opinions expressed herein are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.