Many businesses are promising to reduce the effects of the effects of climate change by reducing their own greenhouse-gas emissions as much as they can. But many businesses discover that they can’t completely eliminate their emissions, or even lessen them as fast as they would prefer. The challenge is especially tough for companies that want to be net-zero emission, which means that they remove the greenhouse gases from the air as they put into it. For many they will need to utilize carbon credits in order to offset the emissions they are unable to get rid of by other means. In the Taskforce on Scaling Voluntary Carbon Markets (TSVCM), sponsored by the Institute of International Finance (IIF) with the help of McKinsey estimates that the demand for carbon credits will increase by the factor of 15 at least by the year 2030 and by up to 100 by 2050. Overall, the carbon credit market could be worth as much as $50 billion by 2030.
Markets for carbon credits purchased in a voluntary manner (rather than for compliance purposes) is vital in other ways, too. Carbon credits purchased voluntarily provide private finance to climate action projects that would not otherwise get off the ground. The projects could also bring additional advantages like biodiversity protection, pollution prevention, public-health improvements, and employment creation. Carbon credits also encourage investment into the innovation required in order to lower the cost of new climate technologies. And scaled-up voluntary carbon markets can help in bringing capital to that region of the Global South, where there is the highest potential for low-cost projects to reduce emissions from nature.
Given the demand for carbon credits that may ensue from international efforts to reduce carbon dioxide emissions, it’s evident that the world will require an unregulated carbon market that is large transparent, transparent, verifiable and environmentally robust. The market today, however, is complex and fragmented. Some credits were found to represent emissions reductions that were uncertain at most. The lack of pricing information makes it difficult for buyers to determine if they are paying a fair price and for suppliers to manage the risk they assume by financing and working on carbon-reduction projects without knowing how much buyers will eventually pay to purchase carbon credit. In this article, which is based on McKinsey’s research for a new report by the TSVCM, we look at these issues and how market participants, standard-setting organizations, financial institutions, market-infrastructure providers, and other constituencies might address them to scale up the voluntary carbon market.
Carbon credits can assist companies achieve their climate-change goals
In the agreement of the year 2015, the Paris Agreement, nearly 200 nations have signed the global ambition of limiting the rise in temperatures average to 2.0 degrees Celsius over preindustrial temperatures, and at least 1.5 degrees. Attaining the 1.5-degree target would require that global greenhouse gas emissions be cut by 50 percent of present levels by 2030 and decreased to net zero by 2050. More and more companies are aligning with this plan in just an entire year, the amount of companies that have pledged net zero tripled from 500 in the year 2019 to more than 1,000 by 2020.
To reach the global net-zero standard, companies are required to cut their own emissions as far that they are able to (while making sure to report on their progress to achieve the transparency and accountability the investors, as well as all other parties increasingly require). In some businesses however, it’s extremely costly to reduce emissions with modern technologies, although the costs of those technologies could decrease over the future. For some companies there are certain emissions sources that are not able to be eliminated. For instance, the process of making cement at industrial size typically involves an chemical reaction, called and calcination is responsible for a substantial portion of the cement industry’s carbon emissions. Because of these limitations the emissions-reduction pathway to a 1.5-degree warming target effectively requires “negative emissions” that are accomplished by getting rid of greenhouse gases from the atmosphere.
A carbon credit purchase is one method for companies to reduce emissions they are unable to eliminate. Carbon credits are the certificates that represent the quantity of greenhouse gases which are kept out of the atmosphere or eliminated from it. Although carbon credits have been around for a long time, the voluntary trading of carbon credits increased dramatically in recent years. McKinsey estimates that in 2020, buyers would have retired carbon credits for some 95 million tons carbon-dioxide equivalent (MtCO2e), which would be more than twice the amount of 2017.
As efforts to reduce carbon emissions from the global economy continue to grow, demand for voluntary carbon credits is likely to increase. Based on stated demand to purchase carbon credits demand forecasts from experts surveyed by the TSVCM and the amount of negative emissions needed for reducing emissions in line with the 1.5-degree warming goal, McKinsey estimates that annual global demand for carbon credits could reach at least 1.5 to 2.0 gigatons of carbon dioxide (GtCO2) by 2030 and up to 7 to 13 GtCO2 in 2050 (Exhibit 2.). Depending on different price scenarios as well as their underlying drivers the size of the market in 2030 could range from $5 billion to $30 billion at a low end , and greater than $50 billion on the upper end.
While the growth in carbon credits’ demand is substantial, research by McKinsey suggests that the demand for carbon credits in 2030 could be matched by the annual amount of carbon credits available between 8 and 12 GtCO2 annually. Carbon credits will come through four distinct categories: avoided natural loss (including deforestation) and sequestration based on nature, like reforestation; avoiding or reduction of emissions such as methane from landfills; and the removal of technology-based carbon dioxide (CO2) from the environment.
But, a variety of factors could hinder the ability to mobilize all of the potential supply and get it on the market. The construction of projects will need to accelerate in a rapid manner. The majority of the possible supply of avoided nature loss and of nature-based sequestration is concentrated in a limited range of countries. Each project is a risk and some types may not be able to obtain finance due to the lengthy delay between the initial funding and then the final selling of credits. When these obstacles are compensated for, the estimated amount of carbon credits will drop to 1 to 5 GtCO2 per year by 2030.
These aren’t the only problems faced by sellers and buyers of carbon credits. The availability of high-quality carbon credits is limited because accounting and verification methodologies vary and because credits have co-benefits (such as economic development for communities and protection of biodiversity) are not always clearly defined. When verifying the quality of new credits–an important element to maintain the integrity of the market, suppliers must endure lengthy lead times. When they sell these credit, the suppliers are in a constant state of demand and can seldom fetch reasonable prices. The market overall is characterised by the lack of liquidity, limited financial resources, inadequate risk-management solutions and the inaccessibility of data.
The challenges are daunting, however they are not impossible. The methods for verification could be improved and verification procedures streamlined. Clearer demand signals would help provide suppliers with more confidence in their plans for the future and also encourage lenders and investors to provide with financing. All of these needs could be met by the thoughtful creation of an efficient large-scale, voluntary carbon market.
The expansion of carbon markets for voluntary use requires a fresh blueprint for the course of action
To create a sustainable voluntary carbon market will require an effort that is coordinated across a variety of areas. Its report TSVCM found six distinct areas, that span the value chain of carbon credit which could be used to support the scaling up of the carbon market that is voluntary.
Creating shared principles for defining and confirming carbon credits
Today’s voluntary carbon market lacks the liquidity required to conduct efficient trading, in part due to the fact that carbon credits are extremely heterogeneous. Each credit is characterized by attributes that are associated with the project it was derived from, such as the type of project and the location where it was carried out. These aspects affect the price of the credit, because buyers value additional attributes differently. Overall, the inconsistency among credits is a reason why matching an individual buyer with an appropriate provider is a slow and inefficient procedure that is done in a counter.
The matching between suppliers and buyers would be more efficient when all credit accounts could be described through common characteristics. The first set of features concerns the quality of the product. The quality criteria, as laid out in “core carbon principles” would provide a basis to verify that carbon credits represent genuine emissions reductions. The second set will cover the other attributes of the carbon credit. Standardizing those attributes in the same taxonomy will help sellers market their credits and buyers to find credits that meet their needs.
The development of contracts with standardized terms
In the market for voluntary carbon the heterogeneity of carbon credits means that credit of certain types are traded at a rate that is too low to produce reliable pricing signals on an ongoing basis. Making carbon credits more uniform could help consolidate trading activity across specific types of credits and would also increase the liquidity of the carbon credit exchange.
After the establishment of the carbon principles as the core and standard attributes outlined above, exchanges can develop “reference contracts” for carbon trading. Reference contracts could combine a core contract, which is based on core carbon principles, and additional attributes that are defined according to a standard taxonomy and priced separately. Core contracts could facilitate companies to conduct things like buying large quantities of carbon credits in one go: they could make bids for credits that meet certain requirements and the market would then aggregate smaller quantities of credits to meet their bids.
Another benefit of reference contracts would be the development of a clear daily market price. After reference contracts have been made, a lot of parties will still make trades over the over the counter (OTC). The prices for credit traded with reference contracts may be a base for the negotiation of OTC trades, while also incorporating other characteristics being priced separately.
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