When the Science Based Targets Initiative (SBTi) board of trustees announced in April this year that it was considering the use of carbon credits towards Scope 3 abatement targets, Jennifer Jenkins, chief science officer at Rubicon Carbon, a carbon credit provider, was full of hope.
Receiving the backing of the influential industry standards body could provide a key turning point to the carbon credit market. “The SBTi’s announcement was very important to us, we finally saw a bit more flexibility on the use of carbon credits, but it was also clear that there was a lot of discussion” she said.
The global carbon credit market has had a challenging year in 2023, while the provision of carbon credit solutions in the voluntary carbon market has mushroomed, corporate and institutional demand has been sluggish, as data by Bloomberg NEF show. Between 2021 and 2023, global demand for carbon credits has increased by only 2%, leaving the market with an oversupply of more than 50%.
A widely recognised industry standards body such as the SBTi endorsing carbon credits could provide a major boost to the carbon credits market with some of the world’s largest corporations such as Ikea and Maersk relying on guidance from the industry standards body
A numbers game
How do we value the emission absorbed by trees? Figures being thrown around vary widely and for the time being, there is a significant gap between the regulated and voluntary carbon market.
For example, in the UK, the Emissions Trading Scheme has a minimum price of £22 per ton and at the beginning of this year, EU and UK carbon permit prices were trading above €60 and £60 respectively. But in the voluntary carbon market, prices can range between $6 and $30.
The global market for carbon credits is currently valued at around $2.4bn but a more widespread adoption of credits by corporations and investors could see the market grow to more than $1trn by 2050, Bloomberg NEF analysis predicts.
Whether the market reaches such levels is dependent on the market price they can obtain. Bloomberg NEF’s most bullish scenario predicts a price of $238/ton in 2050. However, more conservative forecasts place the price at $20 / ton in 2025, in which case the carbon market would account for a more modest $35bn.
One challenge which traders and producers of credits currently face is that demand is extremely elastic; if the price isn’t right, companies simply won’t buy credits. This may be due to the fact that some of the low hanging fruit on emissions reduction is still to be captured and the crucial 2050 deadline for corporate net zero targets still seems misleadingly far away.
The SBTi row
The announcement by SBTi’s board of trustees to consider carbon credits proved far from popular. It sparked an internal row, with staff publicly dissenting. Ultimately, SBTi’s CEO Luiz Amaral resigned in July and the standards body issued an updated guidance which distanced itself from the use of carbon credits, stating that they were “largely ineffective”.
Jenkins expressed her disappointment: “SBTi’s latest announcement is taking us right back to October 2021 and that is a problem, it is continuing to limit climate action for companies, and it will make it more difficult to reach global net zero targets, it will limit climate initiatives which are most badly needed in the Global South,” she warned.
Companies need options, especially in cases where technologies for internal decarbonisation do not exist, which is the case in many sectors
Advocates of carbon credits such as Jenkins argue that they remain the only way some corporations can meet their net zero targets. “Companies need options, especially in cases where technologies for internal decarbonisation do not exist, which is the case in many sectors. Those companies need to know that there is more than one path.
“This certainly applies to Scope 3 where companies have little or no direct control over the emissions. But for some hard to abate industries like steel or chemicals or even aviation, those companies need options for Scope 1 and 2 emissions. That demand can be hard to meet without using fossil fuel sources. It is not trivial; you can’t just switch from one feedstock to another,” Jenkins warns.
The trust challenge
But why has demand for carbon credits been so patchy? At the heart of it lies the question of trust. While institutional investors have not yet embraced carbon credits, some corporations certainly have. Firms ranging from the world’s largest tech giants to luxury brands such as Gucci are relying on carbon credits to meet their (sometimes bold) net zero targets. Indeed, carbon credits have become a vital component of Amazon and Apple’s net zero strategies. But in the absence of clear regulation, the carbon credit market has been plagued with scandal.
Critics of carbon credits point out that multinationals such as tech companies or oil and gas companies have no intentions to scale down their emissions but are using credits to “greenwash” their net zero claims. More than 80 NGOs, including Share Action, Friends of the Earth and Greenpeace expressed their discontent with SBTi’s consideration of carbon credits, warning that they “undermined genuine climate action.”
Many carbon credit strategies appear to have very little impact on mitigating emissions. Earlier this year, an investigation by The Guardian, Die Zeit and Source Material into Verra, one of the world’s largest standard setters for the voluntary carbon market, found that more than 90% of its rainforest offset credits did not represent genuine carbon reductions.
In practice, the research found that there was little evidence of deforestation reductions and projects had little to no climate benefit. In some cases, citizens in Peru reported that their homes had been cut down to make way for carbon credit plantations.
The findings raised questions about the credibility of carbon credits used by some of the world’s largest multinationals, from Shell to BHP who had all relied on Verra to offset parts of their emissions. They have also made investors such as pension funds and insurers considerably more reluctant to adopt carbon credits for their own net zero strategies.
Policy measures
US policy makers are increasingly recognising these challenges. Janet Yellen, United States secretary of the Treasury, has been holding meetings with major institutional investors in the US over the summer to discuss, among other things, how to shore up trust in the voluntary carbon market.
In a statement issued by the US Treasury Department in May, Yellen acknowledged that voluntary carbon markets had not always delivered on their promises. To be successful, “stakeholders must be certain that one credit truly represents one ton of carbon dioxide (or its equivalent) reduced or removed from the atmosphere beyond what would have otherwise occurred” she stressed.
To further bolster investor confidence, the Biden-Harris Administration announced a new set of principles guiding the voluntary carbon market. In addition, the US State department is engaging in a range of public-private partnerships aimed at scaling up voluntary carbon markets in developing countries.
Moreover, during New York Climate Week in September this year, US derivatives watchdog the Commodities Futures Trading Commission announced that it has adopted guidelines to regulate the use of derivatives in the carbon offset market, in a bid to standardise the market.
That was just in time for Kenneth Newcombe, the former CEO of carbon credit firm C-Quest Capital LLC who was indicted in New York with commodities and wire fraud. Perhaps another indication that the carbon credit industry still has some way to go to shore up trust among institutional investors.
Asset owner caution
Institutions have been much slower to adopt carbon credits than corporations. This is something of a paradox as nature-based investments have been an increasingly popular asset class among institutional investors
Some, such as Bayerische Versorgungskammer (BVK), Germany’s largest pension fund, have been investing in timber for decades. But BVK sees timber as an attractive inflation hedge and has no plans to jump on the carbon credit bandwagon for the time being, as Kathrin Kalau-Reus tells Net Zero Investor.
We don’t believe the sequestration of our timber investments will add value to our portfolio… for the time being, it is not of interest to us
Similarly, UK master trust Nest recently confirmed details for its first $550m timber mandate to be deployed over the next three years. But the DC provider remains wary of carbon credits, according to Jessica Menelon, private markets manager at Nest: “We’ll measure the carbon within the timber portfolio and will disclose sequestration separately, but we don’t believe the sequestration of our timber investments will add value to our portfolio. We are reviewing the carbon credit and offset market, but for the time being, it is not of interest to us,” she adds.
Nest’s scepticism is in part driven by its lack of trust in global carbon credits standards but also by a reluctance to act as potential vendor of carbon credits. But Menelon also acknowledges that this position is not static: “We’re not permanently against carbon credits or offsets; it is potentially something we’ll look at in the future.”
In contrast, the Cushon Master Trust has adopted a very different stance. It has until last year branded itself as the world’s pension fund to hit net zero in 2021, a claim backed by the use of carbon credits but abandoned last year when Cushon overhauled its net zero strategy.
Marc Barnett, head of Investment at Cushon emphasises that this happened due to scaling challenges, rather than due to lack of faith in the future of carbon credits. The master trust is also keen to emphasise that its focus remains on reducing emissions, using offsets only for residual emissions.
A turning point?
Cushon has no intention of giving up on carbon credits, as Barnett emphasises: “We’ve been working for over a year to design a natural capital fund to invest in carbon-offset generating assets like reforestation and peatland restoration. We hope to allocate to that fund early next year. It’s a great alignment of long-term pension capital with projects that take time to develop but have the potential for significant impact.”
And Cushon is not alone. Octopus Investments has announced the launch of its nature positive investment strategy with the specific aim of generating carbon removal credits through conservation and land management.
The strategy will focus initially on the UK, targeting land acquisitions with potential for conservation. It will explore various revenue opportunities tailored to each project, including property restoration, biodiversity net gain credits, regenerative agriculture, ecotourism, and renewable energy. In the medium term, Octopus plans to target the institutional market with its credits.
Michael Toft, senior fund manager at Octopus and lead on the new nature positive strategy argues that carbon credits are an essential tool in the decarbonisation journey, particularly when it comes to hard-to-abate sectors such as real estate: “You can’t reduce every tonne of carbon through efficiency improvements alone, so offsets play a critical role.”
And there appears to be demand. For example, the Pensions Insurance Corporation (PIC) announced earlier this year that it plans to include carbon credits in its net zero strategy. It intends to use these among others to offset emissions in its real estate holding which can’t be mitigated in other ways, says Cleo Fitzsimmons, head of Responsible Investing at PIC.
Toft believes that investor attitudes towards carbon credits are changing: “What we’re seeing now is a shift from carbon credits as a last resort to a core part of strategies from the outset. The key challenge is ensuring the credibility and quality of these credits – you want to avoid the accusation of greenwashing,” he adds.
Marc Barnett emphasises that whether investors like or loathe credits, they are already exposed to them through the companies in their portfolios, which are often hugely reliant on credits to meet their net zero targets.
“There’s been backlash against carbon offsets, but it’s important not to lose sight of the fact that every company committing to net zero will need to rely on offsets. If we’re thinking about a 20-year horizon, demand for offsets will be enormous. We’re moving early to capitalise on that demand, as it will only grow over the next few decades.
“If carbon offset prices rise, those companies will have to pay more, which could negatively impact shareholders. Investing in carbon offsets can hedge against that risk” he predicts.
Also in NZI Spark:
Bayerische Versorgunskammer: Investing in timber as inflation hedge
‘Alexa, activate carbon credits’ : The nature footprint of the Mag 7
