The next step for carbon credits
SINCE the signing of the Kyoto Protocol in 1997, efforts to address global climate change effectively have been glacially slow as they are expensive and politically unpopular. Bloomberg’s green-energy research team estimated in July 2023 that the cost of achieving a net-zero world would amount to US$196 trillion in investments by 2050. Governments are focused on immediate concerns such as rising food costs and combating inflation rather than tackling the climate crisis and meeting net-zero targets. It is thus small wonder that climate change commitments have not been kept, and we are experiencing the tragedy of the commons while facing an existential crisis.
How then should the world move towards halting the climate crisis? Enter carbon credits. These were designed as part of the clean development mechanism framework to incentivise developing nations to protect the environment while pursuing economic growth. The intent is to create a win-win model for saving the environment without short-changing developing countries. The premise of carbon credits is conceptually sound, but many feel that their implementation has been beset with problems.
Teething challenges
In recent months, the media has been awash with bad news on voluntary carbon credits, with hundreds of millions of dollars’ worth of credits generated from environmental projects being invalidated. Detractors say that projects set up for creating carbon credits are often based on vague predictions, can cause community conflicts, and do not create additional climate benefits. Yet, it seems that this may fail to recognise the reversed greenhouse gas (GHG) effect of such projects on the climate and their benefits. The world still needs carbon credits, and their proponents are still pushing for them. After all, carbon credits are a vital part of the strategy to mitigate the growth in GHGs that comes from economic development, thus incentivising businesses to adopt environmentally sustainable practices. Governments have sought to implement a carbon tax for businesses that are heavy polluters, forcing them either to purchase carbon credits, reduce their GHG emissions, or pay hefty fines. This compels businesses to reduce their carbon footprint and helps those with greener processes become more competitive.
Then why are governments not implementing carbon-credit systems globally? Singapore’s National Climate Change Secretariat notes that close to 80 jurisdictions (45 national and 34 sub-national jurisdictions) have implemented carbon pricing, accounting for roughly 21.5 per cent of global GHG emissions in 2021. Broadly, countries are reluctant to implement carbon taxes amid the current global economic climate of inflation, as the cost of business is passed on to consumers. As the world grapples with the more urgent concerns of keeping food affordable and inflation manageable, implementing a carbon regime has been put on a backburner, thus slowing down the investments in carbon initiatives and delaying legislation.
To complicate matters, there is no unified carbon system across countries around the world. This creates uncertainty especially among companies that operate across national jurisdictions. How can they partake in the carbon-credit system if there isn’t established clarity? To illustrate the point, shipping companies prefer to buy blue carbon credits (that pertain to coastal ecosystems) locally as their business impacts the ocean where they sail. Yet, if they sail between Europe and Singapore, where should their blue credits come from? The lack of good projects with strict regulatory oversight across the jurisdictions where companies operate hinders the development of the private market for carbon credits.
If governments are moving slowly, why does the private sector not step up? With the lack of information, consensus and clarity within the international community on the processes that create carbon credits, voluntary market development has been hampered by bad-quality credits, poor regulatory oversight, and a lack of credit fungibility across jurisdictions. For example, Verra, the world’s biggest carbon-credit certification company, was forced to invalidate billions of dollars’ worth of credits after an investigation by British daily The Guardian and other agencies in January earlier this year. Until such integrity problems and other issues are addressed, investments into carbon projects from the private sector will not be forthcoming.
Yet this does not mean carbon credits do not work. The challenges faced by the carbon credits market are neither new nor unforeseen. New financial mechanisms are often introduced voluntarily to gauge market reaction and their effects before legislation ensues to protect investors. These legislated products then become the new standard upon which the market develops. Likewise, the carbon framework currently being developed will be far more important than many realise. If we do not implement the carbon regimes properly, the entire carbon-credit system will be discredited before it even has a chance to mature.
New carbon-exchange mechanism needed
What can we expect moving forward? With more illuminating information gleaned from scientific research and best practices in environmental, social and governance projects, regulations are expected to tighten as carbon credits evolve into financial instruments. Carbon credits generated from such projects will be rated based on the project’s impact on both the planet and the people within the communities near the project. Those with the highest ratings will command the highest prices. When we have investment-grade carbon credits, we will see the development of a secondary market to trade those carbon credits. That means we will potentially have investment-grade credits on a blockchain, futures, options, even exchange-traded funds. Carbon credits, as an asset class, will generate the sort of revenue needed to fund the actions to fight climate change. They will become the new standard, as voluntary credits become niche.
For this to work, we need to see a new carbon-exchange mechanism. Currently, carbon credits are not fungible across the different jurisdictions due to a lack of consensus within the international community on the regulatory framework. This discussion requires partners from the private sector, and private funders. What we need right now is a deeper discussion on this, and a framework in place to move towards investment-grade carbon credits.
Fortunately, finance is one of the themes that will be discussed at the United Nations Climate Change Conference (COP28) in Dubai that starts on Nov 30. We will expect to see a tightening of regulatory requirements, a single or unified verification and validation authority, and one unified international standard to lay the groundwork for this mechanism. Moving in this direction also addresses accusations of greenwashing that plague many voluntary carbon projects, as the tighter regulations prevent false declarations of value for each project. At any rate, the certainty that investment-grade credits provide will incentivise the creation of good offset projects that benefit the environment, which is better than not having any offset projects at all. This will also create certainty for investors and catalyse the private sector to finance good projects, moving us closer to reaching our net-zero targets.
Driver for the fifth industrial revolution
As the market matures, different asset classes will be created for different types of credits, with the pricing mechanism determining the value of each. Credits are currently priced based on reliability, impact and cost, which can be made fungible across carbon-credit classes. To curb speculation, governments can give tax rebates to smaller firms in key affected industries, and regulate access to the market, slowing down price inflation caused by carbon taxation and protecting smaller firms.
The inflationary impact of carbon taxes on the economy is inevitable, but this pales when compared with the cost of climate change. According to Deloitte, inaction on climate change will cost the world US$178 trillion by 2070. All these considerations must have spurred the European Union to launch recently the pilot phase of the Carbon Border Adjustment Mechanism, a scheme that will tax carbon-intensive goods imported from outside the bloc.
Implementing carbon taxes and the carbon-credit system is our best insurance policy for the future, because not having it will cost way more. The world is already losing arable land for food production from America to Australia, biodiversity in oceans and forests, while natural disasters are becoming more severe from Libya to Canada. If we do not go green, the world will burn. The only way we can stop this climate crisis is to have conversations, collaboration, and commitment to international climate goals.
If managed well, carbon credits might just be the catalyst for the fifth industrial revolution: the carbon-credit revolution.
Terence Nunis is chief executive officer of Equinox GEMTZ, a strategic consultancy, and Ng Kin Foong is CEO of Red Sycamore, which establishes carbon sinks for the creation of investment-grade blue carbon credits. They will both be chairing panel discussions at the upcoming COP28 in Dubai.
