Challenges facing Voluntary Carbon Markets

Voluntary carbon markets (VCMs), characterized by buyers voluntarily purchasing and trading offsets generated from emissions reduction or removal projects, have been at the center of a contentious debate. Proponents of VCMs argue that they play a crucial role in increasing climate finance and facilitating companies’ efforts to achieve their net-zero targets. These markets offer companies and other buyers the opportunity to purchase carbon credits to offset their emissions, thereby contributing to global efforts to combat climate change.

Advocates of VCMs highlight their potential to incentivize emission reduction projects and support sustainable development initiatives in various sectors. By providing financial incentives for emission reduction or removal activities, VCMs can drive innovation and investment in climate-friendly projects, ultimately contributing to the transition to a low-carbon economy.

However, critics of VCMs raise concerns about their effectiveness and integrity. They argue that voluntary arrangements may fall short of delivering real, measurable emission reductions and could be exploited as greenwashing mechanisms. Critics highlight instances where the credibility of carbon credits and the transparency of offsetting projects have been called into question, undermining the overall integrity of VCMs.

Furthermore, skeptics argue that VCMs may divert attention and resources away from more stringent regulatory measures and undermine the urgency of implementing comprehensive climate policies. Without clear regulatory frameworks and robust verification mechanisms, voluntary carbon markets risk being perceived as a substitute for meaningful emission reductions rather than a complementary mechanism for climate action.

In early 2023, it seemed that momentum was building for voluntary markets. A growing number of companies looked to implement net-zero strategies, contributing to a thriving market. Developing countries announced ambitious plans to use revenues from credits generated from domestic forests to boost their economies. New market arrangements promised that carbon credits could kickstart climate finance and spur innovation in clean technologies.

Additionally, new initiatives emerged to tackle the credibility challenge including organizations like Science Based Targets initiative, the Voluntary Carbon Credit Integrity Initiative (VCMII), and The Integrity Council for the Voluntary Carbon Market (ICVCM). These developments bolstered assessments that the voluntary trade of carbon credits would boom, with some analysts predicting a market size of $250 billion by 2050.

Despite this activity, last year was a difficult one for voluntary carbon markets. Across all categories of carbon credits, prices slumped throughout the year. Major corporate buyers stepped back from purchasing carbon credits as accusations of greenwashing grew. Additionally, continuing debates over Article 6 of the Paris Agreement at the 2023 UN Climate Change Conference (COP28) left the role of voluntary markets in achieving nationally determined contributions unclear.

Markets Falling Short of Lofty Goals

Why did the trade of credits decline in 2023? One reason is companies’ growing concern over potential reputational risks. Two high-profile studies pointed to systemic problems with credits generated from nature-based projects. In January 2023, a report done by TheGuardian, the German weekly Die Zeit, and SourceMaterial assessed credits certified by Verra, a leading carbon standard. The investigation found that more than 90 percent of their forestry credits did not represent real emissions reductions. In August, a study in Science assessed that forestry programs significantly overestimated their prevention of deforestation.

These reports are not necessarily novel. Offsets have long faced similar questions over integrity. However, they come at a time when companies are particularly sensitive to potential reputational risks over net-zero strategies. Lately investment strategies led by environmental, social, and governance (ESG) standards have become more controversial. ESG funds have faced criticism from the right for prioritizing environmental goals over investor returns and have seen a fall in investor support due to the poor performance of some funds. The potential legal ramifications of using carbon credits have also grown. In May 2023, a class-action lawsuit was filed in California against Delta Air Lines arguing that the airline misrepresented itself as a carbon neutral based on problematic carbon offsets. This fits a growing trend; globally, between 2015 and 2022, 81 “climate washing” cases were filed against companies.

These challenges point to problems in both the supply and demand sides of voluntary carbon markets. First, the fundamental question over how to ensure carbon credits represent real, additional, and permanent emissions reductions. In today’s marketplace, most carbon credits are purchased in bespoke trade with little standardization in contracts. There are multiple independent standard organizations that use different methodologies to certify projects and credits. This heterogeneity complicates efforts to certify projects and prevents buyers from clear views on the quality of different credits.

Second, there is also uncertainty on the demand side. The way in which companies use credits to achieve net-zero goals matters. While organizations like VCMII advocate for buyers to use credits as a supplement to overarching decarbonization pathways, there is little to no direction for how best to use credits and what claims can be made. The lack of transparency on the usage of carbon offsets complicates efforts to improve the credibility of voluntary arrangements.

New Models to Address the Credibility Challenge

The challenges voluntary markets are facing today are serious; the market is unruly with large informational asymmetries between project developers, standards organizations, certifiers, and buyers. The reputational concerns that companies face could limit demand for offsets. Without high-quality credits, the supply side will fail to deliver on their promises. However, despite these challenges, voluntary markets can improve; three recent developments point to promise amid the struggles.

  1. Carbon Market Oversight by Financial Market Regulators

In December 2023, the Commodities Futures Trading Commission released proposed guidance for voluntary carbon credit derivative contracts listed on designated contract markets (DCMs). Under the proposed regulation, these regulated exchanges would consider the characteristics of the underlying carbon credit including the quality of the standards, the delivery points and facilities and the inspection provisions as relevant characteristics of carbon credits.

The proposed guidance is a clear attempt to enforce some regulations on the secondary market for carbon credits. DCMs should consider whether crediting programs make procedures publicly available, whether credits are truly additional, and ensure that credits found to misrepresent emissions reductions are replaced. While the secondary market is expected to grow significantly, it remains a relatively niche market today meaning the impact of these policies would be limited. Additionally, the guidance would largely be reliant on market standards that exist today with little additional oversight.

  1. Alignment of Independent Credit Standards

Independent organizations that set standards for projects that produce carbon offsets and certify carbon credits play a significant role in today’s market. At COP28, six of the largest independent crediting programs, including Verra, Gold Standard, and the Global Carbon Council, agreed to collaborate and better coordinate their approaches to certification.

Aligning standards could also improve the efficiency and efficacy of auditing projects and crediting schemes. Rather than overseeing a market that is heterogeneous, with carbon accounting and crediting principles that vary in sometimes substantial ways, there would be a centralized methodology and set of best practices. Ideally, this would lead to better carbon credits, faster recognition of problems when claims fall short, and transparent price discovery allowing buyers to differentiate between credits of higher or lower quality.

  1. Increasing Government Involvement in Voluntary Markets

There is a longer-term trend developing in which governments are taking larger roles in designing, moderating, and, to a limited extent, regulating voluntary markets. CSIS published research in May that reviewed some of these market arrangements that incorporate elements of government involvement in voluntary markets. Globally there are several market initiatives in which governments have worked to create domestic voluntary markets. In Japan, the GX league is a central component of the country’s energy transition goals; over 600 companies representing 40 percent of domestic emissions joined the league pledging to reduce emissions and offset remaining emissions. These hybrid arrangements could help to regulate the demand side of the voluntary market and set expectations for the supply side of the market.

While the results of these three efforts are uncertain, there is a growing recognition that voluntary markets need some guardrails. Today, voluntary markets are a Wild West—a space in which rules are either missing or loosely enforced. The past year showed that companies are increasingly wary of the potential pitfalls that result from claims that are not backed up by credible emissions reductions. Despite this, voluntary markets can be a useful tool to combat climate change and accelerate the energy transition. A global price on carbon is unlikely to emerge any time soon, but there is a real desire from many companies to reduce emissions and reach net zero. There is also a growing recognition that financing the energy transition and climate mitigation in developing countries is of critical importance. Voluntary carbon markets can help; the overarching problem is building infrastructure that enables greater information on projects, the quality of credits, and the goals of credit purchasers. These emerging initiatives aimed at better regulating the supply side of the market and better organizing the demand side could help to reset voluntary markets on a better path.
Allegra Dawes is an associate fellow with the Energy Security and Climate Change Program at the Center for Strategic and International Studies in Washington, D.C.

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