Price Trend by Type of Carbon credit, 1Q21 – 1Q22

Source: S&P Global via The World Bank (Report: State and Trends of Carbon Pricing, published May 2022)

Key points: The World Bank’s carbon pricing report includes an update on voluntary carbon markets (VCMs). Price differentiation of carbon offset credits shows preference for carbon removal activities. Demand for nature-based credits is also benefitting from buyers’ focus on co-benefits; and growing demand and market maturity bode well for higher prices.

World Bank report on Carbon Pricing. The World Bank (WB)’s State and Trends of Carbon Pricing report published this week includes discussion of global carbon pricing instruments, both taxes and trading systems, and the outlook and implications of new policy and agreements coming out of COP26. Among the key takeaways from the report is that global carbon pricing revenue increased 60% in 2021 to US$84 Billion, with emissions trading systems generating more than carbon taxes for the first time. The report also includes a review of voluntary carbon market trends, prospects and issues related to future growth.

Nature-based credits dominate VCM value in 2021. As noted in a previous Payne Financial Flow, Forestry and Land-Use credits comprised nearly 80% of the estimated US$1+ Billion VCMs’ value in 2021 (data as compiled by EcoSystems Marketplace remains unfinalized; our estimate reflects compiled data through November). This category of nature-based credits is largely comprised of projects to avoid deforestation, but includes some removal-type projects as well including afforestation, carbon sequestration in agriculture and improved forest management. The WB report notes that as demand grows overall, as there are more buyers adopting decarbonization targets and relying on offsets to meet milestones, some of these buyers are putting value on co-benefits of projects. Co-benefits can include achieving one or more of the Sustainable Development Goals.

However, removal-based credits command a higher price. The WB report cites S&P Global analysis pointing to removal-based credits trading at 2.5x the average price of reduction/avoidance-based credits in 4Q21-1Q22 (see chart). This stronger price appears to reflect buyers’ (1) desire to comply with Net Zero strategies (i.e. buyers view that credits related to projects that (only) avoid emissions don’t offset their internally-generated emissions) and (2) views of the potential for removal technologies. Removal technologies also avoid, as the WB report puts it, the  “polarized debates regarding additionality, permanence and baseline accuracy” of Forest and Land-Use credits.

Further, removal-based credits are in short supply, in part because of the non-commercialized state of removal technology (such as Direct Air Capture) and slow development of sequestration projects. Financial sponsorship of removal technologies is also happening outside of marketplaces and rather through direct investment.

Market maturity points to greater liquidity. The report notes several signs that VCMs are maturing, including that (1) financial actors are stepping in to provide capital and to hedge risk, (2) standardized transactions are growing more common and (3) there are signs of speculative (i.e. non-strategic) buying. The report also notes the role that Blockchain is starting to play in tokenization of carbon credits to increase buyer access and highlights the potential issues this creates related to integrity (see here for a brief review of technology’s role in spurring greater environmental investment).