COP27: where carbon markets go from here
What can be done to increase participation in carbon markets and help improve the quality of carbon credits?
Carbon markets have seen incredible growth in recent years as more companies and stakeholders target net-zero emissions. Carbon credits play a key role in helping companies to meet their net-zero objectives. And while developed markets have been big buyers of carbon credits in recent years, greater involvement by developing countries is paving the way for more global participation.
As COP27 begins in Sharm El Sheikh, many net-zero investors are hoping for more support for the sector. But there are still some challenges to overcome in implementing global credit markets.
Despite agreeing to implement the Paris Agreement’s Article 6 – which paved the way for greater cooperation between countries to establish international carbon markets – lack of agreement over technical details has held up progress.
Lorenzo Bernasconi, head of climate and environmental solutions at Lombard Odier Investment Managers, says the biggest challenge for negotiators at COP27 will be to work out technical details for the Paris Agreement rulebook agreed upon at Glasgow last year – including Article 6.
“This COP is no longer about making new commitments but about moving into action,” he explains. “As part of this, we expect a significant focus on climate finance and the role of the private sector in supporting countries to achieve their climate commitments.
“This includes an increasing focus on building and strengthening the use of carbon markets, including in emerging markets, to help achieve countries’ climate pledges under Paris and address the massive financing gap for nature.”
Currently, carbon credits are available in voluntary and mandatory (compliance) markets. However, growing demand for carbon credits could lead to unification in the coming years, says Evans Osono, capital markets director at development agency FSD Africa.
“The market for carbon credits is still nascent but is registering exponential growth, upwards of 40% per annum,” he explains.
“It is projected to accelerate this growth trajectory as corporates rush to meet net-zero commitments. But there is much that is required to organise the market, engender transparency, and develop policies and regulations.”
Osono says he expects more countries to introduce compliance markets over time and believes the number of emissions trading schemes (ETS) is also likely to grow as the mechanisms of Article 6 assists countries and regions in linking schemes and outcomes.
However, an ETS does have limitations, says Jose Maria Ortiz, head of impact investment at international consultancy Palladium Group.
He says: “It is great for high polluters and corporations in heavy industry as it can potentially generate incentives for decarbonisation. Those incentives aren’t currently enough to reach net zero, but it’s certainly a step in the right direction.
“A global ETS market would be interesting, but the ETS would need to align with nationally determined contributions at the heart of the Paris Agreement, and that’s not an easy ask.”
Growing investment appeal
As the size of the carbon market continues to grow, Lombard Odier’s Bernasconi says investor interest has risen considerably.
He says: “Globally, the carbon markets have close to a trillion-dollars annual traded volume and, in our view, represent one of the most exciting investment opportunities of the climate-transition megatrend.”
Bernasconi says there is potential for significant price increases as current carbon prices are “far below the levels necessary to achieve our current climate goals”. Additionally, for investors, carbon markets offer a hedge against climate transition risks and a low correlation to traditional and alternative asset classes.
He adds: “The carbon markets have the potential to mobilise billions towards addressing the climate and biodiversity crises by creating the right incentives for the private sector to allocate capital in line with a net-zero, nature-positive transition.
“All this said, the carbon markets remain volatile and are subject to policy and quality-related risks that need to be actively managed from an investment perspective.”
Charlie Langdale, head of climate risk and resilience at insurance broker Howden, says the lack of regulation makes it difficult to determine quality, which can cause potential reputational risk for buyers.
As a result, Howden launched the world’s first voluntary carbon credit insurance product earlier this year to bring greater credibility and confidence to the carbon credit market.
Langdale explains: “I’m afraid the truth is that not all offsets really do what they say on the tin.
“A lot of people will tell you that the carbon market could be the biggest commodity market on the planet in the next 30-40 years.
“So, anything that furthers the aim of regulation and anything that puts Article 6 on the table is a good first step.”
Is it a commodity or not?
However, not all stakeholders are comfortable describing carbon credits as a commodity market.
“One issue I’ve noticed is that everyone talks about carbon pricing and carbon as if it were a commodity, but the reality today is that it isn’t a commodity,” says Palladium Group’s Ortiz.
“The current global policy frameworks and standards make it very difficult for it to be a commodity, and scientists make it even more complicated due to their precision and the complexities of the standards.
“In the end, it disincentivises market creation, and we’re left wondering what exactly a good carbon credit is and why countries that have refrained from cutting down their forests are being told they cannot issue credits simply because their forests are not at risk.”
And there may be some signs that investors and corporates are turning to other methods of reducing their carbon footprint.
Robert Höglund, climate expert at environmental projects platform Milkywire and manager of the Climate Transformation Fund, says some companies have stopped talking about offsetting emissions and making net-zero claims, because carbon credits have failed to live up to expectations.
He says: “I still think there is a strong demand for regular carbon credits, the market is growing fast. But it is very small in the grand scheme of things; it is only 1% of emissions globally.
“All companies need to work on reducing their own emissions; that is important. They shouldn’t only focus on buying carbon credits for their own use.”
Greater support for environmental projects or research and development will not necessarily offer a carbon credit, but they will play a significant role in helping reach global climate targets, says Höglund.