Hey fintech friends,
Lots of mixed press around carbon credits lately! Since we last spoke about carbon markets in Q1 2023,
The largest carbon traders have written off millions of carbon offsets on the revelation that underlying projects won't deliver on emissions promises.
Regulatory scrutiny, controversial new standards, and high-profile scandals have prompted big companies like Nestle, Gucci, and Shell to pull back from voluntary carbon markets en masse.
Source: CommerzVentures
Investors still play a small role in this market– only accounting for ~1% of open interest in carbon credit positions– but this could soon change: Climate fintechs raised an aggregate $2.3 billion in VC funding in 2023 (down only 19% YoY, as compared to 38% across all other sectors) to expand tools for carbon accounting, crediting, trading, and reporting. Banks like JP Morgan & Goldman Sachs are also standing up carbon credit trading desks in anticipation of an upcoming spike in speculative demand.
Given all of this activity, it's worth diving into the biggest developments and players impacting the carbon credit market– an industry that Bloomberg estimates could grow from $2 billion to reach a staggering $1.1 trillion in value by 2050.
Carbon credits: A tl;dr
Carbon credits aim to make companies compensate for greenhouse gas emissions by putting a price on each metric ton of CO2 they generate. As we discussed in Q1 2023, carbon credits trade in two markets:
Regulated markets, in which government impose a cap-and-trade system and force companies emitting above a certain C02 threshold to buy carbon credits from companies that emit below the threshold. Often, companies can also replace a portion of these credits with carbon offsets from...
Voluntary markets (VCMs), wherein companies buy carbon offsets from independently-certified environmental projects to meet their own sustainability targets.
Source: The World Bank
Today 52 countries have rolled out some kind of carbon pricing mechanism, with mandatory systems covering 23% of global GHG emissions. Bloomberg estimates that to meet global net-zero emissions targets, the price of a carbon credit will need to reach $238/ton.
Obviously, we're a long way off from there: Carbon allowances in the EU's Emissions Trading System (the largest cap-and-trade system in the world) currently trade at ~€72/ton; in voluntary markets, carbon offsets are trading at anywhere between $0.60-$2/ton.
Source: TradingView
In regulated markets, governments can easily bring costs in line by issuing companies fewer credits (the EU is currently flirting with the idea of raising prices from ~$73 to as high as €400/ton by 2040). The bigger issues comes into play in voluntary carbon markets.
Voluntary carbon markets
You're likely familiar with the issues in VCMs: A lack of regulation leads to highly inconsistent standards (and, in turn, prices) for carbon offsets, opaque financials allow intermediaries to charge huge mark-ups on investments, poor transparency leads to double accounting (as the joke goes, a single tree in the Amazon has now been sold to a million buyers... or something like that).
It's important to note that while carbon credits represent 1 metric ton of CO2 abated from the atmosphere, not all credits traded in VCMs are created equal. Demand for each type of carbon offset has shifted in response: Offsets issued by carbon removal projects (either nature-based or technological sequestration) and reforestation have performed relatively well in the past year, whereas forest maintenance (REDD+) and energy efficiency projects have taken hits over concerns about their additionality to emissions reduction efforts.
Source: SP Global
Investors have a role to play here: By bringing liquidity to the market to drive price discovery for buyers, increasing the availability of funding for high-quality carbon offset projects in need of capital, and raising the cost of CO2 offsets for polluters. Unfortunately, regulations and technologies aren't quite in a place to support these investors yet.
Recently, groups like the VCMI and ICVCM have updated rules to promote the integrity of carbon offsets, and the CFTC & SEC have released guidance on vetting these instruments for trading. These updates drive incremental progress, but the most impactful guidance is yet to be settled: A multi-lateral agreement that would dictate how carbon credits can trade between the US, EU, and a bloc of African and Latin American countries. If reached (potentially at the upcoming COP29 summit this winter), this agreement could restore a lot of trust in carbon credits and accelerate their global adoption.In the meantime, fintechs are working to bridge a number of outstanding technological gaps.
Source: CommerzVentures
In carbon markets, platforms like Patch, Xpansiv, Earthly, the UK's Carbonplace, Carbon Trade eXchange, Abatable, the Netherland's Carbon Equity, and Singapore's AirCarbon Exchange, are working to bring businesses and investors transparent, secure mechanisms to purchase carbon credits.With the onset of new carbon accounting rules like the EU's Corporate Sustainability Reporting Directive, companies like Watershed, Denmark's Doconomy, Germany's Tanso, and the Netherland's Coolset are helping companies measure their environmental impact and comply with ESG reporting requirements.
Carbon credits hold the potential to meaningfully curb global warming, but there's a lot of work to be done to restore trust in these mechanisms first. Recent advances in carbon credit regulation and technology offer promising steps to that end.
