Scaling up private sector participation in carbon markets

In line with the Paris Agreement’s goal to limit global warming to 1.5 degrees, annual global demand for carbon credits could reach 1.5-2 billion tonnes of carbon dioxide (GtCO2) by 2030, and 7-13 GtCO2 by 2050.

Depending on the different price scenarios and their underlying drivers, there is significant potential for private sector participation, that by 2030 the market could be valued at anywhere from USD5 billion to over USD50 billion^[1].

In 2021, worldwide emissions were approximately 51 GtCO2 with the public sector accounting for 16% and the private sector accounting for the remaining 84%. Subtracting the national level of required reductions of 34.3 GtCO2 via the compliance markets leaves 8.6 GtCO2 of private sector emissions to be offset in the voluntary carbon market for the sector to achieve net zero.

Around one fifth of the world’s 2000 largest companies have committed to achieving net zero by 2050,^[2] and are also aiming to reduce their’ direct greenhouse gas emissions to zero. There is buyer demand for 1.7 billion tonnes of carbon credits in the voluntary carbon market from just this one part of the private sector to achieve net zero, and in the coming decades corporate demand in the voluntary carbon market has the potential to grow by somewhere between 700% and 3800%.

Despite demand, the private purchase market is still nascent

The private sector requires transparent, verifiable, and credible carbon markets. The carbon finance market is evolving rapidly but is fragmented and complex, and some credits have turned out to represent emission reductions that were questionable.

Limited pricing data makes it challenging for buyers to know whether they are paying a fair price, and for suppliers to manage the risk of financing carbon-reduction projects without knowing how much buyers will pay for carbon credits.

Assessing additionality and determining crediting baselines is inherently uncertain and often controversial, as it requires unobserved scenarios based on assumptions such as future fuel prices and possible policy interventions. Concerns about a lack of environmental integrity of carbon credits have also been raised, including:

• Risk of leakage
• Failure to address or adequately compensate for non-permanence
• Lock-in of carbon intensive technologies
• Perverse incentives (e.g. for project owners to generate more greenhouse gases only to destroy them, or for governments or companies to avoid adopting ambitious climate policies for fear of jeopardising carbon credit revenues).

There are two typologies of potential buyers:

• Type 1: Chooses projects merely based on region, project type, registry, and vintage
• Type 2: Delves deeper and chooses projects not just based on the above criteria but also on the Sustainable Development Goal (SDG) impacts delivered and project performance in terms of additionality, leakage, permanence,

There appears to be a shift in buyer attitudes toward Type 2 with carbon rating agencies like Be Zero Carbon and Sylvera being the facilitators of the same.

What can governments of developing countries do to scale up?

The strength of co-benefits generated with carbon credits will enhance the value in the market and maximise revenues to host governments. Assessment of whether a project meaningfully contributes to net zero emissions depends on how the host government demonstrates its commitment to the global temperature goal.

Even with a high value carbon credit, the underlying project and political risks will affect the private sector’s ability and willingness to enter new carbon markets.

An action plan is needed as follows:

1. Increase standardisation and lower transaction costs: Working with Measurement, Reporting, and Verification (MRV), the World Bank’s Climate Warehouse, and blockchain platforms, rating agencies can create a global trustworthy standard for middle- and low-income countries. Low-income countries, countries new to carbon markets, and complex projects will need additional support to pay down transaction costs.
2. Distinguish carbon removal from avoidance: The current market is trending toward more carbon reduction investments, and it is highly likely that beyond 2030 the market will turn toward carbon removal investments. While carbon reduction credit tends to be more project based, carbon removal credit is more theme based with less delineated definitions of co-benefits.
3. Understand and mitigate project risks: The private sector seeks long-term, ringfenced, guaranteed price contracts. Projects are subject to the same risks as regular projects in terms of political, investment, and climate – physical, transition, liability, forward carbon rates, and non-performance risks. Governments not only need to bring up the quality level of credits, but must also provide risk mitigation toward compensation, liability coverage, hedging put / call, minimum forward price guarantee offtake, access to due diligence, and data.
4. Enhance mapping to SDGs: Today’s investors are looking for SDG-linked impact investments, so a carbon credit clearly linked to a global indicator would incentivise buyers.
5. Prepare for Scope 3 and beyond value chain carbon credits: Scope 3 emissions account for on average 75% of companies’ greenhouse gas emissions, but as an under-reported emissions metric,^[3] this is an untapped market.

If the number of companies pledging net zero doubles or trebles over the next 5 years, then there will be enormous growth in the demand for carbon credits. Based solely on what companies are currently pledging, the voluntary carbon market will have the potential to expand sevenfold.