Oh Carbon Where Art Thou?
Here are some clues to the current state of the global carbon markets: The biggest independent auditors are shutting down or greatly reducing operations, the former leaders of the global carbon markets are trying very hard to re-invent themselves, regulatory schemes driving internalization of carbon credit prices are becoming increasingly diverse and demand for voluntary carbon credits declined. The sector faces a hotchpotch of carbon pricing approaches, from national carbon taxes to sub-national carbon markets to voluntary corporate commitments and ‘in-setting’. In-setting refers to the development of GHG reduction projects within company operations, often associated with financial benefits such as cost savings.
This does not mean that an implicit global carbon price is neither feasible nor desirable. Rather there continues to be a drive towards this end as demonstrated by the most recent Intergovernmental Panel on Climate Change (IPCC) report, indicating the repercussions of increasing atmospheric concentrations of Greenhouse Gas (GHG) emissions resulting from human activities. Furthermore organizations such as the World Bank Group have identified supporting the development of a global carbon price as one of its top priorities.
It’s not all bad
The European Union Emissions Trading Scheme (EU ETS) and the Kyoto Protocol Clean Development Mechanism (CDM) were valuable initiatives, and not the abject failures they are sometimes made out to be, for three reasons:
- They stimulated a lot of interest and investment in robust Measurement, Reporting and Verification (MRV) protocols for assessing environmental impacts. Granted this was mostly for reduction of GHGs, but several quality standards were created to integrate other environmental and social impacts (e.g. Climate, Community & Biodiversity Standard, Gold Standard, Social Carbon).
- Although the project-based carbon credit market has effectively collapsed, it did stimulate significant flows of people, money and technology in environmental investments in emerging markets. This is a significant and much under-appreciated side effect of the carbon markets.
- They are stimulating corporate internalization of carbon and other environmental impacts (‘in-setting’). Some carbon credit project developers are offering in-setting project development services. However, Clarmondial is skeptical of the need to apply an expensive and laborious carbon credit standard to precisely estimate emission reductions, in particular in the absence of a formal (explicit) carbon price.
This leaves many carbon credit project developers and sellers in a tricky situation. Many are responding with changes to their business models, for example by trying to engage with the impact investing community as a source of cheap funding and demand. At the same time as the carbon markets have been in decline, the impact investment space has grown. The Global Impact Investing Network (GIIN) and J.P. Morgan reported a 10% in growth of capital committed to USD 10.6 billion (vs an estimated USD 379 million in voluntary carbon markets) and a 20% growth in the number of deals from 2012 to 2013.
Carbon… and Impact?
It is therefore understandable that many carbon credit sellers would see this as a tempting source of concessional funding and demand, after all, the carbon emission reductions implicitly equals environmental impact? This availability of ‘for good capital’ has also led to the re-branding of many carbon credit projects as ‘impact projects’ and the creation of the “social carbon” market segment. However, it is not always clear what the overlap between ‘impact investments’ and ‘carbon markets’ (in particularly in the voluntary space) is.
- ‘Impact investors’ are almost always looking for some level of financial return from their projects, mostly in line with commercial market rates. In our opinion, an impact investor is therefore unlikely to provide concessional funding to a carbon credit project, in particular in the absence of actual demand for the credits.
- Carbon credit projects often require substantial investments up-front: Investors, including impact investors, are unlikely to want to finance this without having clarity on carbon credit demand.
- Carbon market funding was explicitly designed to be ‘additional’, i.e. to be used to fund projects that would not otherwise receive financial support. This meant that many carbon credit projects were relatively risky (e.g. first of kind projects) or not financially viable without a clear carbon price. Most impact investors tend to look for viable deals through an ‘impact lens’, and the extent to which they are willing to forego financial returns for the benefit of ‘impact’ depends on the specific investor.
Yet Clarmondial does believe that carbon credit project developers have opportunities for revitalizing their business models, and that this may bring them closer to the impact investment space. For example, by:
Applying MRV frameworks to new products and services
Clarmondial believes that many carbon credit project development organizations, with a keen understanding of MRV systems, can work with different stakeholder groups to internalize environmental impacts (e.g. through climate bonds or financial products). However, to do so successfully they must shy away from looking at projects with a ‘carbon first’ lens, and also collaborate closely with other initiatives, including those working on wider ‘impact metrics’, e.g. on natural capital accounting and responsible investment principles.
Working with policy makers
Last but not least, those who have been through the ‘carbon debacle’ should continue to work with policy makers to develop and implement suitable regulatory frameworks, both to mitigate GHGs as well as to stimulate ‘good’ investment more generally. While it has been exciting to see the growth in the impact investment space, the carbon experience has clearly illustrated that true, long-term scale requires political support. This support in turn requires the interest of big corporates and the public, as well as good examples of viable businesses that are operating both profitably and sustainably.
Transforming into mainstream project developers
This is challenging (but feasible). Historically carbon credit project developers had only engaged with local companies and projects on the basis of carbon credit related calculations and processes, with no specific expertise in the actual core business of their local counterparts. Also, due to the ‘additionality’ criteria, many carbon credit projects are not financially sustainable without a carbon price. However, many carbon credit project developers have strong inter-disciplinary networks spanning governments, corporates and charities. Were these developers to expand their focus and review their project criteria, they could become interesting origination partners for investors, both ‘impact’ and ‘mainstream’.
In closing, we would be very interested to hear if anyone has done analysis on the appetite for carbon credit projects among impact investors. We are also always keen to get feedback and speak with others who share our passion for environmental finance.