With the landmark delivery of the Article 6 framework at COP29, investors are asking themselves where the carbon credit money goes next.
For many institutional investors, a first entry point into carbon credits might be the rapidly growing market of natural capital strategies, which increasingly includes allocations to carbon credits.
This raises various questions. Should carbon credit investors stick with the cheap yet controversy-ridden voluntary carbon markets (VCM) or look to the emerging article 6 markets, which enjoy UN-accreditation? Will the article 6 markets, supposing they don’t fall foul of the same controversies as the VCM, attract not only corporates but also pension funds, which have thus far shied away from carbon credits due to integrity issues? Will the compliance and voluntary markets converge in certain contexts?
There are no easy answers to these big questions, or rather, as Alex Godfrey, investment director of Natural Capital at Octopus Investments argues, there are no general answers, as the quality and investability of carbon credits will remain “highly context and geography specific even with the potential for more robustness delivered by article 6”.
There is already a big difference in both the risk and pricing between carbon credits produced in the global north and the global south. Article 6 won’t change the risk of global south credits, or at least not immediately.
Carbon taxes tend to be higher in the global north than the global south, which also contributes to price disparity. While Canada’s federal fuel charge puts the price of carbon at around C$58, Argentina’s carbon tax prices it as low as $0.81 per tCO2e.
Then, within all jurisdictions, there are further, categorical differences between avoidance-focused credits (avoiding additional greenhouse gas emissions), restoration-focused credits (which should have biodiversity benefits) and removal-focused credits (removing C02 from the atmosphere).
96% of the current carbon market is lower quality avoidance credits. These are the scandal-ridden credits that have come to define popular perceptions of the VCM.
The UK nature-based carbon credits (restoration credits) in which Octopus Investments invests cost as much as £80 per tonne of carbon, which puts them in the same price ring as compliance credits in the ETS (Emissions Trading Scheme) markets, and is far above the global average of $6.53 per metric ton for avoidance credits.
The price of emissions allowances traded on the EU’s ETS reached a record high of €100.34 per metric ton in February 2023, according to Statista.
Possible convergence between compliance and voluntary markets
The new big hope for the voluntary markets is that they will “converge” with the compliance markets and thereby resolve all the lingering credibility and integrity issues.
“I don’t think there’s really any existential threat to the VCM,” said Meghan Edge, former head of carbon investments at Ripple Edge. “It’s just a matter of that timeline of convergence.”
The nature of that convergence – whether it will include the article 6 markets and the voluntary markets in the global south or just the ETS markets in the global north – remains to be seen.
Godfrey argues that the UK could be the first jurisdiction to achieve convergence. “There is talk among government officials that voluntary nature-based carbon credits developed under the UK Woodland Carbon Code could become available in the compliance [ETS] markets,” he said. “Bringing those two carbon markets together will give UK markets more integrity. That’s why, as investors, we’re betting on the UK market.”
There is no jurisdiction in the global south that is able to provide the level of integrity and traceability to enable the voluntary and the compliance markets to converge, Godfrey adds. The main problem is that the carbon price is still low. That makes conservation or restoration work relatively unattractive compared to the bad old business-as-usual of clearing forest for timber and the production of agricultural commodities such as palm oil.
“The carbon price needs to be high enough that the protection of that rainforest and the rebuilding of those deforested lands is viable,” he said. “I would argue today we don’t have that carbon price, which is why the status quo of nature negative land use continues.”
Article 6 may be a welcome boost for markets in the global south but it will take time to reach the similar level of integrity and acceptance as global north markets.
In addition to the UK, Australia and New Zealand are conducting pilot schemes looking at blending nature credits and compliance markets through their ACCUs (Australian Carbon Credit Unit) and NZUs (New Zealand Unit).
Climate finance for the global south
While a strong carbon credit in the global north is a step forward, it doesn’t solve the problem of the much needed climate finance in the global south.
As deforestation continues at an alarming and unsustainable rate – with a staggering 6.4 million hectares lost in 2023 alone – carbon market proponents claim that carbon credits are one of the few, if not the only, viable financial mechanisms to save the world’s forests.
Tropical deforestation in the global south contributes about 20% of annual global greenhouse gas emissions, and reducing it will be necessary to avoid dangerous climate change, according to Environmental Defense Fund, a US non-profit.
Yet the controversy-ridden VCM has failed to take off in a meaningful way. Between 2021 and 2023, global demand for carbon credits has increased by only 2%, leaving the market with an oversupply of more than 50% of lower quality avoidance credits, according to Bloomberg NEF.
The VCM face challenges such as lack of standardisation, inconsistent or insufficient verification of carbon offset projects, limited transparency, and the risk of greenwashing, where offsets fail to deliver real or additional emissions reductions.
The market has also been accused of enriching “intermediaries” through fees with very few benefits to the local communities, exacerbating tensions and inequalities.
“Article 6 is a step in the right direction of bolstering governance structures and reducing risk for carbon credit investors in the global south,” said Godfrey. “Some jurisdictions may move fast. Others will remain high risk. For now we are focused on the global north and building confidence in high quality credits and low risk geographies.”
Institutional investor involvement
Pension funds have two reasons to purchase carbon credits: for speculation (Bloomberg NEF’s most bullish scenario predicts a price of $238 per ton in 2050) or for offsetting their own emissions, especially those “hard-to-abate” emissions the removal of which will be essential to get them over the net zero line.
Yet to date, corporates, especially big tech companies with increasingly power-hungry data centres, have been the biggest buyers of carbon credits. Pension funds, insurance companies, and sovereign wealth funds have not matched the enthusiasm of tech giants like Microsoft, Google, and Amazon, which often commit to buying large volumes to offset emissions.
Notable exceptions include Canada’s CPP Investments, which has engaged in multiple initiatives involving carbon credits, such as partnering with Conservation International, and Temasek, which is bolstering Asian efforts to support the development of carbon markets through platforms like GenZero.
“Pension funds tend to invest in carbon credits as a by-product as part of their wider forestry strategy,” said Gustave Loriot-Bosreup, founder of Compass Insights. “I don’t expect this to change in 2025, even with all the excitement around the article 6 markets. Corporates will remain the biggest purchasers of carbon credits.”
Bayerische Versorgungskammer (BVK), Germany’s largest pension fund, has been investing in timber for decades. But BVK sees timber as an attractive inflation hedge and has no plans to invest in carbon credits for the time being, Kathrin Kalau-Reus told Net Zero Investor.
UK master trust Nest remains wary of carbon credits. “We are reviewing the carbon credit and offset market, but for the time being, it is not of interest to us,” Jessica Menelon, private markets manager at Nest, told Net Zero Investor.
A notable exception to the scepticism rule is Cushon Master Trust. In 2021, the UK pension fund caught the industry’s attention with its claim to offer the “world’s first net zero pension fund” by using carbon offsets to mitigate its financed emissions (it has since dropped that claim).
Dr. Robert Mendelsohn, professor of forest policy at Yale University, argued that if governments fail to act on climate change, then socially conscious pension funds, which feel duty-bound to ensure a liveable world for its pensioners, may try to fill the policy gap with their own actions, which include purchasing carbon credits or supporting carbon markets in other ways.
“You might see a rebound effect,” he said. “The less the governments do, the more you might expect from the voluntary carbon market.”
Will Article 6 carbon credits take off in 2025?
The multi-billion dollar question: SBTi rows back on carbon credits
