2022 will probably be remembered as the year when carbon finance became an issue of discussion in a wide range of industries.

In the 2022 class of new participants in voluntary carbon markets, major oil and gas companies as well as hedge funds and banks were identified as the most active participants and firmly committing to the market. But as the year progressed various other sectors of the economy entered the market as a result of their pledges to decrease carbon footprints.

Numerous political entities such as the EU and UK, the EU UK and the State of California have carbon markets covering specific industry sectors and gases. These forms an essential component of the plan to meet the Paris Agreement target of limiting global heating to 2 degrees Celsius above pre-industrial levels (with an even more ambitious goal of achieving the limit of 1.5 C increase), even although some of these markets were established prior to that of Paris commitments.

But other sectors have learned from compliance programs and have promised to offset GHG emissions (GHG) through participation in carbon markets in a voluntary manner.

Voluntary carbon markets permit Carbon emitters to mitigate their inevitable emissions by buying carbon credits emitted in projects aimed at removing or cutting down GHG out of the atmosphere.

Each credit – which equates to a metric ton of lessened, avoided or removed CO2 or equivalent GHGs – can be utilized by a business or an individual to offset for the emissions of one ton of CO2 or similar gases. When a credit is used for this purpose it will be converted into an offset. It is transferred to a register that is used for retired credits, also called retirements, and then it ceases to be tradingable.

Companies can participate in the carbon market that is voluntary in a single transaction or as part of an industry-wide program, like The Carbon Offsetting and Reduction Scheme for International Aviation, which was created by the aviation industry in order to reduce its CO2 emissions. International airline operators taking part in CORSIA have committed to offset all the CO2 emissions they generate over a base level of 2019.

While compliance markets are currently restricted to certain regions, carbon credits offered by voluntary carbon markets are more fluidand free of borders set by nation states or political unions. They also have the potential to be used by any segment of the economy instead of just a handful of industries.

The Taskforce for scaling Voluntary Carbon Markets that is run by the Institute of International Finance with assistance from McKinsey, estimates that the market for carbon credits could amount to upwards 50 billion dollars as early as 2030.
The participants

Five main players are the engines of carbon markets.

PROJECT DEVELOPERS

Project developers represent the upstream part of market. They design and build the projects issuing carbon credits which range from large-scale, industrial-style projects like a high-volume hydro plant or a smaller community-based one like kitchens with clean cooking facilities.

There are several projects for trading carbon credits that aim to eliminate or reduce the emissions directly resulting from industrial processes such as the management of fugitive emissions, ozone-capture or removal of ozone-depleting chemicals or wastewater treatment. The projects that are based on nature comprise REDD+ (avoided deforestation) and soil sequestration, as well as forest afforestation. Others include carbon capture by technology like direct air capture. Furthermore, new categories are constantly added to the list.

Each credit comes with a particular vintage, which is the year when it was first issued, as well as the specific date of delivery that is the date when the credit will become available for sale. Together with their primary purpose of avoiding or eliminating GHGs from the atmosphere Credit projects may provide additional benefits and assist in achieving some of the UN’s Sustainable Development Goals (SDGs). They could, for instance, aid in improving the welfare of the inhabitants of the region, better water quality, or reduction of inequality in the economy.

The END BUYERS

The downstream market is made up of end buyers: companies – or even individual consumers who have made a commitment to offset some or all of their GHG emissions.

Some of the first purchasers for carbon credits are tech firms such as Apple and Google airlines, as well as oil and gas majors however, more industries such as finance, for instance, are entering the market as they set their own targets for net-zero or search for ways to protect themselves from the financial risks that come with this energy transformation.

Implementation of Article 6 of the Paris Agreement on November 13 at the UN Climate Conference, or COP26, in Glasgow defined the rules for a crediting mechanism to be used by the 193 parties to the Paris accord to achieve their emission reduction goals or contributions that are determined by the national government. The Article’s implementation allowed nations to purchase voluntary carbon credits, as long as Article 6 rules are respected.

RETAIL TRADERS

To tie demand and supply broker and retail traders, as in other markets for commodities. Retail traders purchase huge amounts of credits directly from the provider They then consolidate those credits into portfolios, ranging from hundreds to thousands of equivalent tons of CO2 and sell those bundles to end-users usually with a commission.

Although the majority of transactions are taking place through private conversations or over-the-counter trades, some exchanges are also beginning to emerge. The two largest carbon credits exchanges currently are NY-based Xpansiv CBL and Singapore based AirCarbon Exchange (ACX).

Exchanges have been working to simplify and speed up the trading of carbon credits – that have the highest degree of complexity because of the number of factors affecting their price by developing standard productsthat make sure that some of the most basic specifications are followed.

For example, both the Expansiv CBL in addition to ACX have created standard products for nature-based credit, CBL’s Nature-based global Emission Offset (N-GEO), as well as ACX’s Global Nature Token. ACX Global Nature Token.

Credit transactions under these labels is guaranteed to have set characteristics including the type of project that is the basis, a relatively recent period, and a certification from a specific group of standards.

Exchanges’ standard products – especially those for forward delivery are favoured by financial players looking to buy and hold ahead of growing demand for carbon credit.

End-users who have to purchase credits to offset their carbon emissions are more likely to choose non-standard products since they permit them to study the unique characteristics of each project, verify the validity of the credit that they purchase and be protected from possible accusations of greenwashing.

Often, the exchanges are used to settle huge bilateral contracts that have been done offscreen. In a market note published in May, CBL declared that an additional number of bilateral agreements negotiated offscreen were being brought by traders to be settled through CBL’s platform. CBL platform.

These deals accounted for substantial portions of the volumes of transactions on CBL.

BROKERS

Brokers buy carbon credits directly from retailer trader and sell them to the buyer, usually with some commission.

STANDARDS

There is also a fifth actor distinct to carbon markets. Standards are organizations, usually NGOs, which certify the project’s compliance with its stated objectives and its stipulated emissions level.

Standards have a series of methods, or guidelines, for each type of carbon project. For instance Reforestation projects must adhere to specific rules for calculating the carbon dioxide absorption of the planned forest and consequently the amount of carbon credits it generates in the course of.

A renewable energy project is a unique set of guidelines to be able to follow when calculating the benefits in terms of avoiding CO2 emissions and carbon credits that are generated over time.

The certifications of standards also ensure that certain essential principles or the requirements of carbon finance are respected:

Additionality: The proposed project should not require a legal requirement, standard procedure, or financially appealing in the absence of credit revenues.
The CO2 emissions decreases must be equal to the number of offset credits issued to the project, and it should also account for any unintended GHG emissions generated by the project.
Permanence: The result of the GHG reduction in emissions should not be in danger of being reversed and will result in a long-lasting drop in emissions.
Special claim for each metric tonne of CO2 can be claimed once and requires proof of the credit retirement after the project’s maturation. A credit becomes an offset at the time of retirement.
Add additional environmental and social benefits: The project must be in compliance with all legal requirements of its jurisdiction . They should also provide additional co-benefits that align of the U.N. SDGs.

The overlap of roles, bilateral trade

There is a resemblance of roles that are specific in the carbon-based markets.

A lot of brokers function as traders, and many financiers have brokering arm and the project development arm.

End buyers can also finance their own carbon project and then decide to retain any or all of the issued credits for their own offsetting needs.

Each of these entities could eventually market credits to a buyer or developer. Alternatively, a developer could make arrangements to sell them directly. All of these juxtapositions impact the priceand, ultimately, market transparency.

Pricing a wide range of products

When a company turns to free carbon market as a possible alternative to pay for its carbon emissions, one of the key elements it is looking for is the cost of carbon credits. By analyzing this information, a company can decide how ambitious it should be in setting the goal of reducing its emissions and whether the market for voluntary carbon credits can actually help to achieve it.

However it is important to have a clear cost signal to carbon allows those already involved within the trading market be sure they are trading their credit at a price which is comparable to the market value.

However, determining the price of carbon credits isn’t an easy task, mostly because of the wide range of carbon credits available as well as the many factors that influence the price.

Carbon credits issued by companies may be of various kinds and sub-types. The nature of the project is among the main factors affecting the price of the credit.

Carbon credits are classified into two groups or baskets such as avoidance projects (which avoid emitting GHGs completely, thereby reducing the quantity of GHGs emitted to the air) or removal (which take away GHGs completely from the air).

The avoidance basket includes renewable energy projects , as well as forest and farming emissions prevention projects. These, sometimes referred to as REDD+, prevent destruction of wetland habitats or deforestation, or utilize soil management practices in farming that limit GHG emissions, like projects aiming to avoid the emission of dairy cattle and beef cattle through different diets.

Cookstove projects as well as fuel efficiency projects or the building of energy efficient structures also belong to the avoidance basket as do projects for capturing and eliminating industrial pollutants.

The removal sector includes projects that capture carbon from the atmosphere and storing it. They can be natural-based with soil or trees for example , to remove and capture carbon. Examples are afforestation and reforestation projects, and wetland management (forestry and farming). They can also be tech-based and may include technologies like direct air capture or carbon storage and capture.

Removal credits are usually traded at a premium to avoidance credits, not only due to the greater amount of investment required by the base project, but also because of the huge demand for this type of credit. They are also believed to be a more powerful tool in the fight against climate change.

Beyond the nature of the project that is the basis, the cost of carbon credits is also influenced by the volume of credits that are traded over a time (the more credits traded, the cheaper the price typically) and the location that the company is located in, its date of birth (typically the older the vintage the cheaper the price) and delivery time.

When the underlying carbon project is also helping meet some of the UN’s SDGs and goals, the value of a credit from the project to prospective buyers may be higher, and the credit is able to be traded at a premium to other kinds of projects.

For example, community-based programs – which are usually very localized and typically developed and run locally by NGOs, local organizations or groups – tend to yield smaller amounts that are carbon-based credits. They are also more costly to validate them. However, they usually generate higher co-benefits and are able to meet the UN’s SDGs that contribute for example, improved welfare for the local population, better water quality or improvement of the economic disparity.

In this way, credits generated by community-based projects can be sold at a higher price to projects that do not meet SDGs. For instance, industrial ventures, because they are typically larger and produce large volumes of credits with greater certainty of GHG offset potential.

In current carbon markets prices for one carbon credit can vary between a couple of cents per one metric ton of CO2 emissions up to $15/mtCO2e and even $20/mtCO2e for projects that afforest or reforest to as high as $300 per mtCO2e for removal projects that are based on technology like CCS.