A quick look at the price history of most types of voluntary carbon credits in 2021 and 2022 reveals a somewhat right-skewed bell curve.
It’s a shape that tells a very simple story: much of the value that carbon credits quickly gained in 2021 has been slowly but steadily lost in 2022. It’s a shape that has market players wondering what’s coming next – and the same line could offer an answer.
Too expensive to hold
The onset of the Russian-Ukrainian conflict and the energy crisis were the main drivers of the prevailing bearish sentiment in the voluntary carbon market.
In the immediate aftermath of Russia’s invasion of Ukraine on February 24, 2022, several market players were heard to exit their VCM positions as they were attracted to the more volatile and lucrative oil and gas markets. At the same time, cash-strapped companies rushed to reduce their exposure.
But after bottoming out in March when the US announced a ban on Russian oil imports, VCM prices appeared to find stability in April and early May. So after this period of stability comes something worth looking at if we want to gauge what lies ahead for VCM.
In early June, a new bearish trend began in VCM, including the most liquid energy segments based on nature and renewable energy sources. That coincided with a period when the US Federal Reserve was preparing to announce something traders hadn’t heard in a while: an interest rate hike.
The increase in interest rates has changed investment scenarios. In voluntary carbon markets, higher rates meant that it suddenly became too expensive to hold VCM positions taken by secondary market players in the hope that the price would rise further. Since carbon credits do not expire and can be traded repeatedly until they are eventually used to offset some emissions and retire, secondary market actors, such as traders or financial players, are used to buying recent credits and holding them until they can be sold at a higher price. values.
While the overall market outlook for the next few years remains bullish, with demand expected to increase from companies that have committed to net zero targets, higher interest rates mean that this “hold game” has now become riskier or more expensive.
The extent to which secondary market players will expand their market positions in 2023 – and the extent to which VCM will emerge from the quagmire it appears to have fallen into – will continue to depend largely on changes in interest rates and the cost of holding positions. .
It’s time for regulators to shine
The second part of the 2022 price curve brings us to an even more important factor to look at for 2023 projections.
In the fall of 2022, as the UN Climate Change Conference, or COP27, approached, a new bearish trend emerged in VCM.
After a few late summer weeks of high hopes that new demand would hit the market, very much in line with what happened the previous year during COP26, market players began to face a harsh reality. They began to realize that their expectations of seeing clear rules on carbon credit mechanisms set out at the UN summit would not be met, and that – amid this regulatory uncertainty – most buyers decided to delay their purchases.
This resulted in a slowdown in market activity and price losses in all segments.
Players hoped to see COP27 delegates making decisions on what type of projects would be allowed under the yet-to-be-launched credit scheme, and clear definitions of what constitutes a high-quality carbon credit. But none of this came, as delegates felt they needed to take more time to make these decisions and promised to continue their talks in 2023.
The voluntary carbon market has yet to recover from the impact of this regulatory uncertainty. Much of what happens in 2023 will depend heavily on increased clarity about what makes a carbon credit a good quality credit, and when companies are allowed to engage in voluntary carbon markets without risking accusations of greenwashing.
A number of organizations are working to provide guidance, including the Integrity Council for Voluntary Carbon Markets, the Voluntary Carbon Market Integrity Initiative and even the International Organization of Securities Commissions – which at COP27 launched a 90-day public consultation on the role of a potential financial framework for promoting market integrity.
Rating agencies will play an increasing role in assessing the effectiveness of carbon projects in avoiding, reducing or removing carbon, and therefore in assessing the quality of carbon credits issued by these projects.
But the sooner a clear and prescriptive framework becomes available, the better for VCM. In particular, only clear and prescribed rules on when corporations can resort to carbon credit mechanisms and offsetting practices to meet their net-zero goals will create that space where players can confidently participate in the market.
Requiring by mandate that end-customers engage in a serious and science-based program to reduce avoidable emissions before resorting to carbon credits to offset unavoidable emissions will be key to ensuring that voluntary carbon market mechanisms are in place to offer the flexibility needed to purchasing net-zero goals without hindering the transition to a cleaner economy.
With clearer rules, VCM will thrive in 2023 and beyond. Otherwise, it may be destined to remain in “limbo” for a little while longer.