Why all carbon credits aren’t created equal

The market for voluntary carbon credits has been on a roll. In 2021, it grew to $2 billion, quadrupling in a year. Boston Consulting Group, a management consulting firm, expects it to be worth somewhere between $10 billion and $40 billion by 2030. Carbon credits offer an easy way for businesses to amp up their green credentials and funnel much-needed finance into environmental projects, often in developing nations.

But prices and volume have fallen since the start of the year. Nature-based carbon offsets are now trading at $1.84, having fallen 60% since the start of the year. A tough macroeconomic environment has been blamed, as well as increased public and media scrutiny.

The market has an inherent flaw: Carbon credits are being traded as commodities. Instead of building trust and helping scale emission offset and removal projects, this approach is having the opposite effect and enabling poor quality credits to tarnish the market.Let me explain. In the commodities market, a ton of coffee might get traded, swapped and traded some more, but at the end of the value chain, someone takes delivery of that ton of coffee. That holds true for everything from oranges to wheat and oil. Scammers will eventually be caught out because someone will ultimately notice a missing barrel or bushel, or discover rocks painted to look like copper.
But a carbon credit representing a ton of CO2e — the “e” stands for equivalent, signalling it’s a measure of all greenhouse gases — either not emitted or drawn down from the atmosphere and stored permanently, is never physically settled. Instead, buyers have to trust that the supplier tells the truth and is adequately monitoring their project.

There’s another problem: Treated as commodities, all carbon credits are also equal and fungible. A ton is a ton is a ton. “In reality, that couldn’t be further from the truth,” Niklas Kaskeala, chairman of Compensate, a nonprofit foundation doing advocacy work to reform the carbon market, tells me. The quality of carbon offsets varies immensely, arising both from the project type — removal or avoidance, afforestation or providing clean cookstoves — and the way individual projects are managed. There are multiple risks:

• Accounting: How accurately can the project calculate how much CO2e has been avoided or removed from the atmosphere?
• Additionality: Would the emissions be avoided or removed without the purchase of the credit? For example, would the forest really have been cut down?
• Permanence: How long will the emissions be stored, and how certain is that capture?
• Sustainable development considerations: How does the project impact local communities and biodiversity?

Because the market is unregulated and completely voluntary, it’s been able to get away with a lack of scrutiny. That’s starting to change. The Integrity Council for the Voluntary Carbon Market, an independent regulator, has published its Core Carbon Principles benchmark, a set of 10 standards defining high-quality credits. The ICVCM won’t be assessing individual projects for how they align with the principles and associated assessment framework; instead, it will examine the integrity of the carbon-crediting programs and the different types of carbon credit. For example, a program such as Verra, which assesses projects and issues carbon credits, will submit details to the ICVCM on how it evaluates forest-related projects. If it satisfies the new benchmark, Verra’s forestry program would get a stamp of approval from the ICVCM, and all the carbon credits sold under it will be deemed high quality.This approach still maintains a binary interpretation of a carbon credit – either it’s a ton or it isn’t – rather than embracing the inherent differences and risk factors between projects. That approach is insufficient. BeZero Carbon, a carbon-credit rating company, has assigned values to 30 projects that are eligible within CORSIA, the global program for addressing CO2 emissions from international aviation. The allocated rankings — derived from a eight-step scale encompassing grades from AAA to D that echoes how bonds are classified — range from BBB to C. Some 57% of the projects merited B ratings, which represents a low likelihood that a ton of CO2 will actually be avoided or removed. Only one CORSIA-eligible project achieved a BBB grade, which BeZero classifies as signifying a moderate chance of success; a rating of C is deemed very low.Because of this lack of stratification, when a project’s failings are exposed — as has happened plenty of times — the trustworthiness of the entire carbon market crumbles. There needs to be both higher standards and increased transparency. Calls for a different approach are getting louder. Kimmeridge, an activist investor, published a paper on Thursday calling for the creation of a standardised global rating system for carbon credits.

“It’s getting slightly better now but there used to be no correlation between price and quality,” Tommy Ricketts, the chief executive officer of BeZero Carbon, told me. “For example, there’s lots of really good credits for nitrous oxide abatement which are incredibly effective, easy to model and cheap, whereas there are some other credits which might be pricier and use potentially bad calculations.” The hope of imposing a global rating system is that credits with higher grades would then become more valuable. The single biggest action Ricketts would like to see is standardised disclosure across every stage of a project’s life cycle, allowing all projects to be rated.

Ratings don’t solve everything. There are already several companies publishing grades, and buyers are starting to take notice. But, as Compensate’s Kaskeala points out, those credits still allegedly represent a ton of CO2e removed or avoided on the buyer’s carbon-accounting balance sheet. So there’ll need to be a mechanism to link a project rating with the carbon reduction that a project is genuinely likely to achieve.

Compensate, which up until recently also sold credits, did so by scoring projects to make them comparable. For example, one credit from one project might be assessed to represent just 0.6 tons of CO2e. BeZero is developing a similar method to combine its ratings with a performance discount, which would then be used to adjust the credit’s value on the company’s balance sheet.

Trying to force a carbon credit peg into a commodity hole opens up too many pitfalls and doesn’t accurately reflect the reality of many projects on the market. It’s time for the market to become more transparent.