Carbon credits: can these markets be fixed?

A year ago, we began receiving requests for advice on entering the space from family offices, investors, and companies. Instead of risking our clients' interests by advising without knowledge, we took on the risk ourselves. In collaboration with Carbon Intelligence Accenture, we embarked on a project that covered the entire value chain. We created the first hemp credit and gained valuable insights into regenerative agriculture through deep learning.

Now as we close the books on this project and prepare for the next ten projects, we have time for thought and reflection. These markets are difficult and there is still a lot of work to do if they are going to be fit for purpose.

Main market challenges

The carbon credits market is highly fragmented at every stage of the value chain. It does not operate like traditional commodity or financial markets and lacks regulatory direction and leadership at the policy and government levels. Opaqueness, confusion, multiple registries, and questionable practices from brokers and commodities houses present significant challenges across each step of the market, especially for companies that have acquired and banked credits that may quickly become redundant, leaving them liable for carbon taxation.

Good actors and major concerns

While there are some commendable initiatives and actors, their numbers are insufficient to meet carbon reduction targets. Major concerns arise from discussions about "nature-based transfers" and debt relief for developing countries, as safeguards for farmers and fishermen are lacking. Companies facing increased EU carbon taxation may find it challenging to meet their fiduciary duties and reliably assess the carbon content of their portfolios, putting them at significant risk and undermining carbon targets.

What are the critical implications of the current state of the market?

The current state of the market poses multiple capital risks for investors, primarily due to the unreliability of carbon markets in meeting carbon reduction targets. The recent EU Science Advisory Board report is significant and undermines the investment thesis and capital returns from technologies like Beccs (sic Daccs), as their potential to reduce carbon from a scientific perspective and meet targets for 2030 and 2040 is unreliable. This should raise red flags for investment committees and banks heavily invested in technologies that are capital-intensive to scale and remain unproven.

The future market value for credits

The future market value for credits has already been established and is being shaped by policymakers and scientific guidance. Indications point to a tightening market favouring legitimate carbon projects, such as regenerative agriculture and marine initiatives. This message is reinforced by the letter from UN scientists at Bonn and ongoing Article 6 discussions. The allocation of 44% of the CAP to carbon farming by the EU, along with other policy directions, further emphasizes the direction of the market, regulation, and credit value.

Market turbulence and contagion

We anticipate a significant shift in the status quo, with stricter protocols, project monitoring, and tangible carbon delivery becoming essential. As it stands, the market is unsustainable for carbon reduction, companies aiming to reduce carbon, investors in carbon projects, and farmers and fishermen responsible for creating carbon sinks. There are significant big operators across the value chain accumulating credits that will become useless. These operators are interconnected between VVBs, registries, brokerages, and certain commodities desks. The challenge for this group is the regulatory change and the arrival of a new, more educated set of corporate buyers who will likely reject all their projects. This moment will create contagion within this set of operators and is one of the major concerns cited by funds and investors we speak with, as they strive to avoid the next wave of market chaos.

The end of the VCM carbon markets as we know it

We have reached the end of a 20-year run for the current carbon market version. Forecasts from Bloomberg, McKinsey, and BCG are quoted a lot, but I think are already out of date. It is only by going to the field and studying the value chain that one can establish a real pricing model. I do not think that many analysts, traders, or others can do and without means the pricing is reliant on external information and calculations from a variety of sources.  CFOs and companies need to reassess their portfolios, as failure to meet carbon targets and the rapidly changing landscape could render their credits worthless overnight.

Current trading trends and volumes

There is a noticeable panic in the market, with investors and developers sensing they are on the wrong side of change. Buyers and traders are reinventing themselves, and commodities houses and investment banks are scrambling to offload or acquire portfolios. We have observed significantly reduced prices for portfolios of certain credit types, indicating the current state of flux. On the other hand, we see daily investment prospectuses for blockchain platforms promising up to $1 billion valuations from companies that clearly have not understood the direction of policy and regulation, rendering their platforms incapable of delivering these returns.

illuminem Voices is a democratic space presenting the thoughts and opinions of leading Sustainability & Energy writers, their opinions do not necessarily represent those of illuminem.