What is the Voluntary Carbon Market?

The Voluntary Carbon Market - From Capital to Carbon Credits

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Today we've got a quick write up on the voluntary carbon market. Before that, a couple notes on climate media:

Recommended Climate Media:

• The new website from Climate Tech VC, one of the best communities in climate tech. Check out their new site which hosts all their writings, profiles on industry leaders, a job board, and more!

• This incredible report by the Carbon Plan on long-term carbon removal and the variety of stakeholders that the CDR (carbon dioxide removal) market touches

Carbon Credits: A Layman's Understanding

Ever heard carbon credits? They're an evolving and often misunderstood financial mechanism for climate stakeholders. Let's dive into them and learn more about the emerging voluntary carbon market.

Warning: This is coming from the POV of a layman, someone with little understanding of the topic. While I do my best to read the right sources, there's a lot of info out there.

Climate companies are launching all around the world. With science-based technologies and nascent markets to create, these companies often can't rely on customers purchasing their products or services to stay "alive".

Additionally, funding these sorts of companies is extremely risky, as a lot of the developing tech is nowhere near a global scale and often decades away from commercialization. So how do these companies continue to operate?

Some sell carbon credits.

A carbon credit is a kind of permit or contract that represents 1 ton of carbon dioxide removed from the atmosphere. In another way, carbon credits are financial instruments for climate-related companies to bring in revenue.

The idea for carbon credits came around during the years of the Kyoto Protocol, an intergovernmental committee that focused on policies to decarbonize the economy.

Not only can carbon credits be purchased by individuals, but more often than not, they're purchased by companies to make up for carbon dioxide emissions that come from industrial production, travel, etc.

While the initial intentions of the protocol were sound, many stakeholders find that this new carbon market has created perverse incentives. Despite their many drawbacks, they've continued to evolve (we'll learn more later on) with the climate tech landscape.

Why do companies buy carbon credits?

When corporates like Microsoft or Amazon pledge to go "net zero", they're essentially saying they will reduce their Scope 1 and 2 emissions to near zero.

Oftentimes, this looks like upgrading their facilities to renewable energy, purchasing large fleets of EVs, and improving efficiencies in their data centers. What they can't move to renewable energy - like corporate flights that use jet fuel - they try to "offset".

This activity of "offsetting" creates a large demand for carbon credits where corporates with remaining emissions purchase credits to get their total emissions as close to zero as possible, or net zero.

While this can be a great way to fund carbon reduction and removal companies, others see it as a perverse incentive.

Their argument is boiled down to: When corpora purchase carbon offsets, they are no longer doing the difficult work of reducing emissions, and leaving it to these climate projects to solve for the hard stuff.

Drawbacks of carbon credits

As noted in a recent MCJ podcast, the mantra shouldn't be reducing emissions or removing them, it should reducing AND removing at the same time. Many companies are choosing one over the other.

Additional arguments get into the details of the carbon credit scheme. Some other noted risks include:

Risk of Double Counting

With so much demand for credits, and new ways of purchasing them (marketplaces, blockchain tokens, etc.), there lies an inherent risk in double counting credits that have already been used up, or "retired" in industry terms.

Concepts of Additionality and Permanence

Knowing that corporations are driving demand for these credits, bad actors can claim their solutions are carbon negative and sell credits off of them.

The measurement and verification layers hope to prevent this, but there aren't quite robust standards for measuring additionality (would these "protected" trees not have been cut down anyways?) and permanence (how long will this solution actually store carbon?) right now.

The Monitoring, Reporting, and Verification Layers

To stifle these holes in the system, 3rd party verification organizations like Verra and Gold Standard have spun up to create another layer in the matrix: Monitoring, Reporting, and Verification.

These orgs, mostly non-profit, operate under the gist of monitoring the actual project conditions (literally going to the sites where carbon is stored and measuring soil/trees), standardizing credits across of a number of climate solutions (how does a nature-based solutions like growing enhanced trees compare to a bio-energy and carbon capture solution?), and providing the verification so that companies can claim "net zero".

While not perfect, the third parties have been operating for years, and have won the trust of most buyers and sellers. Newer platforms like Carbon Plan and Sylvera take the credit validation a step further by applying "ratings" to the credit sources.

Here's an example:

A company is looking to purchase offsets that fit within their budget, $200/ton of carbon. They find a bio-energy and carbon capture project offset claiming that carbon is sequestered by this particular plant for 1000 years. A platform like Carbon Plan would verify this info and provide a rating, 1 to 5 on how "permanent" the carbon dioxide is actually stored.

Based on this example, this BECCS project selling offsets would score a 3 out of 5 overall, with a very high permanence score. Sure, they store carbon for 1000+ years, but what about the other factors to consider - price, volume, mechanism, etc? These are some considerations that the MRV companies must decide on.

These platforms look at a variety of factors when applying ratings. Take a look at Carbon Plan's tools if you're curious.

A New Player: Marketplaces

More recently, marketplace companies have popped up hoping to bring more transparency to the these "legacy" systems.

Companies like Patch, Watershed, Carbon Direct, and others will now connect buyers (re: Microsoft, Stripe, etc.) to the projects themselves. Some of these companies make money by taking a fee for every credit transacted through the platform, others charge platform fees to access the marketplace.

This creates a more transparent software layer on top of the carbon credit mechanisms, where Patch would go out and purchase bundles of credits from suppliers (like Charm Industrial), show verification info from Verra and Gold Standard, and then allow buyers to purchase these credits programmatically or via a web interface.

It's not perfect, but it's a good first step to take these physical projects and inject financing into them with software. For a lot of project developers (i.e. the carbon credit suppliers in this scenario), it's a win-win scenario.

And while there are many more stakeholders involved - credit sourcing, consulting, financing, carbon accounting - the market and demand for voluntary offsets continues to grow.

There is so much more to discuss around the drawbacks of credits, how the voluntary corporate buyers are funding them, what the perverse incentives are, how these marketplaces fit into the ecosystem, and much, much more.

Candidly, I need to do more research. Maybe we'll do a deeper dive later on.

Hey, if you've made it this far - congrats!

That's a quick overview of carbon credits from a layman's understanding.

In the meantime, if you found any of this interesting I'd love to hear some feedback. Feel free to reply to this email or DM on Twitter: https://twitter.com/mattzot

Talk soon!

Matt from Green Era