They are one of the readymade ways to channel funds to conservation and sustainable development while reducing climate emissions. In a briefing paper released earlier this month, just ahead of the Davos meet, WEF observed that natural climate solutions can one-third of the mitigation required by 2030 to achieve global climate goals, and should be considered some of the readymade solutions towards carbon removal.“This means governments and businesses must continue to commit to and implement direct decarbonization policies and actions that align with the pace of decarbonization required by science,” WEF said in its paper, The Voluntary Carbon Market: Climate Finance at an Inflection Point. The paper, prepared in collaboration with Bain & Company, provides insight into the critical challenges delaying the voluntary carbon market from achieving scale. For companies, this means acting on three critical levels:
- Direct mitigation by decarbonizing at a pace consistent with limiting warming to 1.5°C.
- Investing in ecosystem protection and restoration projects.
- Purchasing high-quality carbon credits from projects that remove and sequester carbon from the atmosphere.
A Bain & Company analysis of 2,000 leading global companies suggests that the voluntary carbon market could provide demand for up to 2.6 Gt (gigaton) of carbon credits by 2030. This would be almost 13 times larger than the market in 2021. However, for this to happen, WEF notes that “decisive action is needed to scale this market from around 0.2 Gt e (CO2 equivalent: the warming potential of greenhouse gases expressed in units of CO2 impact) in 2021 and ensure that it functions in service of the potential environmental and societal outcomes it promises.”
Despite this great potential and the urgent need to take action to avoid further deforestation, there are some critical challenges delaying the carbon market from achieving the scale as well as an initial set of recommendations that corporate leaders can adopt and support to address these challenges as part of a decarbonization agenda.
The report identifies three key challenges that the carbon offset market is facing.
1. Project quality and credibility
On the supply side, the process to identify and recognize eligible projects requires reform. With the quality and veracity of projects increasingly coming under scanner, this is to key to ensuring that carbon credits are a trustworthy representation of real mitigation action. Then of course there is the factor of additionality (that is project’s impact is ‘additional’ to what would have happened had it not been carried out) and permanence (that the reductions occurring from the project that cannot be reversed or the carbon removed can’t be reintroduced into the atmosphere.
Emerging guidance from initiatives such as the Integrity Council for the Voluntary Carbon Market (ICVCM) will be critical for bringing the credibility needed to scale the market significantly.
2. Building the business case
The report recognizes that on the demand side, lack of short-term urgency, market imperfections and reputational risk are holding corporates back from scaling their funding of climate action through carbon markets.
For instance, a survey conducted by WEF in 2002 Q4 in partnership with Bain & Company shows that while more than 90% of corporate respondents target net zero by 2050, less than 25% of these respondents plan to compensate for any emissions before achieving net zero.
More than half of the respondents highlighted market imperfections and a lack of transparency on climate impact and quality as reasons for their inaction and unwillingness to participate in the voluntary carbon market.
Further, there were also apprehensions regarding reputational risk, concerns about public criticism, including legal action etc.
The survey highlighted that lack of standards and guidelines made the “good” market participation indistinguishable from investment in low-quality projects. It was also found that that this uncertainty resulted in a decline of retirement of carbon credits by 3% in 2022 (from 2021) compared to an average annual growth of 48% from 2019–2021.
The Voluntary Carbon Market Integrity Initiative (VCMI) seeks to introduce and scale the use of new threshold standards for high-quality carbon credits to help increase the integrity of the market supply.
3. Reform requirements
Finally, there is an urgent need to improve market transparency and ensure proper capital flows. For instance, there are recent reports coming in suggesting that in some cases end-user costs do not reach the projects and communities that so acutely need financial support.
Once again, there is an opportunity (and need) for global standards and integrity bodies to play a vital role in defining norms for and instilling confidence in the use of carbon credits.
Further, WEF feels that there should be a consensus on legal definitions of terms such as “net zero” and “carbon neutral”. This could go onto provide guidance and confidence to genuine players.
In the end, direct regulation of the voluntary carbon market is likely to become important as the WEF sees boundaries between voluntary carbon markets, compliance carbon markets and sovereign carbon credit mechanisms under Article 6 of the Paris Agreement increasingly blurring.
With leadership becoming increasingly critical in driving the voluntary carbon market into its next chapter, the report provides five key recommendations.
It is that only clear cut regulations will bring clarity as to how and under what conditions VCMs can be used. In this context, the Singapore carbon tax mechanism is an example worthy of further assessment.