Carbon Offset Market Trends

Carbon offset markets are one of the fastest growing asset classes in 2022. Corporations are increasingly looking to carbon offsets to meet their voluntary emissions reduction targets. The gold rush for carbon has resulted in increased demand and prices. Voluntary offset purchasers that do not have a rock-solid understanding of the key factors that differentiate carbon offset credits could be left with low quality credits.

The Taskforce on Scaling Voluntary Carbon Markets (TSVCM) is an initiative that is working to enable the scaling of voluntary carbon markets. In July 2021, the TSVCM released their Phase II report that outlines a blueprint for a future governance body with the mandate to implement, host and curate a set of Core Carbon Principles (CCPs). The CCPs are being developed to help market participants understand the minimum threshold for what constitutes a high-integrity credit. But there is an even more basic level of carbon offset differentiation that occurs. This differentiation occurs at the level of project type, location, standard, and price. Each of these four indicators provides market participants with a data point that makes of project quality. Price is the common thread that ties each of the other carbon offset characteristics together. At the end of the day, price is the strongest indicator of quality.

Frostbyte has been active in educating its clients on the important characteristics they should consider when sourcing voluntary carbon offsets. We draw on data for the most recently published “State of the Voluntary Carbon Markets” report to provide readers with quantitative data regarding the voluntary carbon market drivers. It is our goal to not only help clients source emission reduction projects that meet their unique needs, but to also raise the bar for quality across the entire voluntary carbon market. We believe that permanent negative emissions will ultimately be the only form of recognized carbon offset in the future. However, today the voluntary carbon market is made up of a wide range of products and prospective buyers need guidance in vetting and screening projects.

The first way to differentiate carbon offset projects that we will discuss is at the level of project type. The most significant volume in the voluntary carbon market comes from the forestry & land use and the renewable energy sectors (see Figure 1). It is important to note that issuances have outpaced retirements resulting in a surplus of voluntary offset credits. So, while supply seems to be tightening as indicated by higher prices, there is still significant and growing supply. Forestry credits not only make up a significant portion of the total market volume, but these credits also have some of the highest unit costs with an average price of USD $4.73 per metric tonne of carbon dioxide equivalent (tCO2e) in 2021. This price premium is due to secondary benefits that forests provide beyond their carbon sequestration potential. Chemical process and industrial manufacturing projects that reduce carbon emissions commanded the highest price across all project type albeit with much lower volume that forestry credits.

Figure 1 – Issuance and Retirements by Project Type (2020-2021)

Figure 2 – Price by Project Type (2021)

In addition to project type, carbon market participants also need to consider project location when differentiating voluntary carbon offsets. Project location is particularly important for some purchasers that want to source offset credits from projects that are proximate to their corporate headquarters or operations. As a result, offset credits that are generated where the buyers are located often command a premium price. North America for example has many corporate purchasers in the technology, financial, and airline sectors. In addition, supply from North America is much more constrained than in developing countries located in Africa, Asia, or Latin America. As a result, carbon offset credits that originate in North America are among the highest priced (see Table 1). African credits are slightly more expensive than North American-based credits on average as buyers appear willing to pay a premium for carbon reductions that also have development benefits. The very high reported prices from the Oceania region are believed to be influenced by compliance markets in the region and represent a data anomaly.

One might expect that European-based offset projects would fetch an even higher price than North American-based projects, but since more European corporations are already mandated to reduce their emissions under the European Union cap and trade system, there is less stakeholder pressure to take voluntary action on climate change. Further, since the economy-wide cap and trade system covers most emission sources, there is less opportunity to generate voluntary offsets. All offset credits must be a voluntary action that is not mandated or not already incented through a carbon pricing system. As a result, both prices and supply of credits originating in Europe are relatively low.

The final differentiating feature of voluntary carbon offsets that we will explore is the carbon offset standard. The standard is essentially the governance body that oversees the rules for offset credit development. The standards will work to ensure that the project activity represents a real emission reduction and that the project measurement, monitoring, and verification meets certain criteria. The Verified Carbon Standard or VCS makes of the vast majority of total transacted voluntary credits in 2021 accounting for over 80% of total volume (see Table 2). The price point for VCS credit is a fairly modest USD $4.17 per tCO2e. This price is far below the American Carbon Registry and Plan Vivo standards which on average fetch prices above USD $11 per tCO2e. Clean Development Mechanism credits trade at a very low price point as these credits have been plagued by claims that projects are not additional to business-as-usual activity.

As we look beyond the differentiation that occurs at the level of project type, location, and standard, there is an emerging category that is becoming perhaps the strongest indicator of quality and price. This emerging categorization is removal or reduction. Reduction projects are an emission reduction claim relative to a baseline scenario (e.g., I can generate offset credits is if produce power with wind instead of coal). A removal project on the other hand simply measures the degree to which carbon is physically removed from the atmosphere and stored such that it does not contribute to global warming. There is further differentiation within the removal category on the basis of how the removal occurs (technology-based removals are consider premium compared to nature-based removals) and the permanence of the carbon storage (long-duration storage is better than storage in carbon sinks where reversal risk is high). Prices for removal credits are currently about five times higher than for reduction credits. Over time, we expect this divergence in price with only continue and we are preparing our clients for the eventuality that removal credits will be the only form of recognized offset credit in the future. If you are looking to get a jump start on this emerging trend and want to understand what it means for your business, please get in touch.

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