Lessons from navigating the Voluntary Carbon Markets in 2024
The scale of the climate finance opportunity and need are clear. While Clarmondial prioritizes working with companies to increase action within their value chains, we also recognize the importance of Beyond Value Chain Mitigation (BVCM). This is why we participated in the development of SBTi’s Beyond Value Chain Mitigation guidance. In this article we share some recent reflections on the Voluntary Carbon Markets (VCM) in 2024, based our work with leading blue-chip companies and investors on Voluntary Carbon Unit (VCU) purchases and pre-issuance investments.
You get what you pay for
Average VCU prices listed in the most recent State & Trends of the Voluntary Carbon Markets report are low. Too low for many projects to be viable. In our experience, nature-based credits that are very cheap or require proportionally little investment to generate large volumes tend to be riskier: they are more likely to face reputational and operational issues because there might be insufficient value flowing to implementation (e.g., to local communities), or because too many credits were issued. Benefit sharing arrangements must be “fair” as contextualized by local living income benchmarks and opportunity costs, including the timing of benefits created, and must consider long-term risks to livelihoods resulting from contracting arrangements. These conditions should set the minimum budget allocation, before adding intermediation costs for activities such as carbon credit registration and MRV (Monitoring, Reporting & Verification). Adequate local benefits are central to ensuring permanence and to mitigating reputational risks.
Do your (own) homework
The VCM lacks regulation: brokers and credit sellers are not required to perform thorough checks on projects or project developers to assess the quality of VCUs or the reputation of those involved. Instead, their primary focus is on confirming the existence of issued VCUs. The fact that a project may have passed a VCM standard verification does not mean that it has undergone the type of due diligence that a responsible buyer may expect in a “normal” financial transaction.
Unfortunately, we do see bad behavior in the market, including the misleading of buyers and investors on quality, risk and price. The extent and quality of due diligence vary widely among buyers and sellers, and these don’t seem to be correlated with VCU prices. Furthermore, we have seen brokers offering the same VCU vintage from the same project at wildly different prices with no apparent rationale.
This situation reflects a fundamental tension in the VCM, with sellers trying to maximize short term profits in an opaque market without consideration for their own long term reputation, the state of the market or the relationship with buyers. Unfortunately, this behavior is also reflected in many projects on the relationship between developers and the local communities.
If your organization is engaging in the VCM, notably if you are buying for specific quality characteristics, we recommend that you do your own homework, and contract advisors with direct experience in VCM due diligence, contracting and management. VCUs are not a commodity.
Engage actively before and after buying credits
Several points merit the active engagement of VCU buyers, including after VCUs have been purchased. Recent reports suggest that there has been over-crediting in the VCM. The VCM standards (e.g., Verra, Gold Standard) are trying to address this by tightening methodologies, which has implications for (a) issued volumes and (b) project economics. On the former, while the VCM standards are set up so that there is no “claw back” of issued VCUs, it raises an ethical question for companies that have bought such VCUs: should they buy additional credits to compensate for this miscalculation? Also, are they exposed to reputational risks? And implementation risks: is the project still viable if updated methodological assumptions are used? This may affect buyers and punish pre-issuance investors.
Furthermore, we see that companies that use VCUs also consider such risks to inform VCU retirements of purchased VCUs: companies that use VCUs choose to retire purchased VCUs from such controversial projects first and to a greater extent. This may contribute to relatively high levels of recent VCU retirements (companies retiring VCUs that are problematic so they are “out of the system”).
On another point, we also see increasing reputational and VCU pre-financing risks emerging from Article 6 and national carbon credit frameworks. Political developments should also inform VCU purchasing and retirement decisions. In some countries, there are risks of sudden and unforeseen taxes on carbon revenues or VCU volumes, which might impact VCU deliveries and project economics.
In summary:
- Prioritize quality over price, perform proper due diligence, check benefit sharing arrangements. This should include checking the due diligence, reputation and management processes of both project developers and intermediaries in addition to the specific project.
- Assess how VCU (pre-issuance) investments are/were structured, as the overall project financials affect both pre- and post-issuance buyers. Remember that underneath a VCU, there is a real economy project taking place. In most cases a greenfield project in an emerging and developing market. That project must work for the credit to be worth your dollar.
- Establish processes to oversee VCU and pre-issuance portfolios and, where possible, consider such risks in contracting and VCU retirements.
We believe that the VCM, and climate finance more broadly, are in another transition. Many of the issues faced in the previous cycle, back in the mid 00’s, are happening again. It’s not the first time, and based on what we are seeing, it won’t be the last. To engage successfully in the VCM, especially in emerging and developing markets, Clarmondial combines an understanding of the “real economy” context of these projects with a strong and diverse network encompassing the range of stakeholder groups active in such projects, and sufficient cross-sector technical expertise to conduct due diligence and monitor projects.
