ANALYSIS: Carbon investments in 'wait and see mode' as prices languish near two-year low

28 Sep 2023

Quantum Commodity Intelligence – Record attendance at this year's Climate Week in New York is a testament to the continued interest in carbon markets, but the sector is bracing itself for several more months of pain and falling prices in some segments, said market participants.

Interest in the voluntary carbon market (VCM) reached a peak in 2021 with some large traders entering the field amid record prices. The bubble has since deflated markedly with prices down almost 90% for certain types of credits. And yet, because the transition to net zero is widely recognised to be an unavoidable trend, more companies are continuing to enter the sector.

Cookstoves credit supply has skyrocketed in the last few months on the back of investments made in 2021-2022, while many REDD+, soil carbon and afforestation, reforestation and restoration (ARR) projects are reckoned to be under way globally.

Oversupply in market

The head of trading at one of the VCM's largest buyers told Quantum on the sidelines of the event that the current oversupply in the VCM – estimated to be between 800 million tonnes to 1 gigatonne – is unlikely to wind down anytime soon.

Other market participants pointed out that the UK newspaper The Guardian's campaign against offsets has deterred some companies from participating more actively, but agreed that the articles have often been a convenient excuse as corporate buyers have been slow to finalise their strategies.

"We've got two more years' worth of pain. Everyone says it's the Guardian article on REDD+ driving prices down when in fact it's a simple supply and demand situation...demand just isn't here right now," said the executive.

This, in turn, has dampened market liquidity and lowered the signal to invest, a classic phenomenon in commodity markets. "Above all, this market suffers from a lack of liquidity, there are very few real traders," the executive also said.

Enric Arderiu Serra, the global head of environmental products at Mercuria, said: "The lack of pricing visibility is an issue. And I think part of that is because it's early stage. So there's not enough trading, there's not enough flows.

"Jurisdictional is one example where this happens, where you have the World Bank buying at $5 and Guyana is selling at $20. Technically, they're pretty much the same credits and you're talking about four times the difference. Price formation is not happening right now, and that's reducing the visibility for all stakeholders, which reduces the appetite for investment."

The largest market flow, meanwhile, is in the so-called primary market for direct deals between developers and buyers, but sources said it is not very transparent. Many project developers refuse to dabble in the spot market, which has been accused by some of pressurising prices and increasing project scrutiny unnecessarily.

A company developing ARR projects in Africa told Quantum: "We're not allowing our credits into the spot market as this will drive prices down...we'd rather work directly with buyers who understand our philosophy and can better understand any crisis that may come."

Hardest hit in the market

The hardest hit have been market intermediaries, such as exchanges, brokers and other marketplaces, which had banked on a steep increase in trading activity that has so far failed to materialise. Some have shut their doors in recent months (Compensate), while many brokers are now selling other types of environmental credits, such as I-RECs, as well as offsets.

In other cases, financial fundraises have been put on the backburner. "Trying to raise money for anything to do with the VCM right now is difficult...bankers switch off as soon as they hear the acronym," said one startup at the summit.

Industry sources have also pointed at the emergence of many marketplaces – all promising to make buyers' and sellers' lives easier – and several new standards. Last week, US carbon marketing firm Everland helped launch the Equitable Earth Coalition, a new standard by IPLCs and countries in the Global South, while Ecosystem Restoration Standard (ERS) is busy finalising the details of its upcoming ARR registry.

Both aim to compete with existing registries that have gathered a lot of projects over the years, but have been criticised for failing to

incorporate new technologies such as remote sensing quickly enough. "There's a lot of money in market infrastructure if you can do it right, but the VCM is surprisingly saturated for something not making money at the moment," commented one broker.

In the end, consolidation is likely if prices stay at rock bottom, reckon market participants. "We'd be ready to concede some market share if the VCM scales five to 10 times over the next few years," said one executive at a large legacy business. "The key is to grow this market," he added.

Removal carbon credits have grown in popularity over the past year, even if they remain small by volumes. They have attracted most of the media attention – and a large chunk of money – and recruitment has risen sharply at many startups in the sector.

Some firms in the removals sector are openly calling avoidance credits dubious, thus pitting removals against avoidance, even as most recognise that both are needed to get climate change under control. "I think people like the simplicity of removals from a communications side," said Ed Mitchard, the chief scientist at Space Intelligence. "But there is still something concrete that's there from avoided emissions too: a rich, biodiverse, millennia-old forest that would otherwise be a pasture."

The debate has angered some traditional VCM developers who argue that many removal technologies have yet to come under real scrutiny. "Who are they to call us dodgy? When the sector only basically exists because of cash from a couple of tech startups," said an angry participant at one event, adding: "I'm waiting for the scandals in five years' time."

"DAC [direct air capture] is hard to justify. The technologies used are mature, we're very doubtful that they can go down the cost curve. And we would need so many plants to make a difference. This is all a myth, yet the media are happy to buy into it," said the first executive. "I don't know anyone beyond the tech giants who could afford their credits."

Lack of CDR transparency

VCM executives have also pointed at the lack of transparency around many carbon dioxide removal (CDR) deals. "The DAC market doesn't exist, often they are equity deals disguised as market transactions," said another executive, adding "the risk is that this diverts a lot of attention away from what needs to be funded right now."

Some market participants hope that guidance from the Integrity Council for the Voluntary Carbon Market (IC-VCM) and the Voluntary Carbon Markets Integrity (VCMI) initiative will help placate buyers and instill some confidence, but many, especially the large traders, are doubtful.

Prices have fallen even further since the releases of the initiatives' criteria in July as traders now talk about a further pause in corporate buying to examine guidelines. "These standards are fine, but in the end it might come down to what the US CFTC [Commodity Futures Trading Commission] has to say on offsets," commented one executive.

Even so, sources agreed that demand is set to rise over the next few months, with prices potentially recovering during COP28 in December, if concrete advances are made by climate negotiators. Several countries are also reportedly readying announcements about their carbon credit white lists at the COP, while NGO Emergent has said more jurisdictional deals under the ART Trees standard will soon be unveiled.

In the long-run, most market participants are eyeing an integration of the VCM into the Paris agreement via Article 6, they said. As one participant put it: "Everyone knows it's the real deal and that's what we're looking forward to."