Seeing the forest for the trees

2022 was a banner year for the voluntary carbon market. According to the Markets in Motion report by Ecosystem Marketplace, voluntary carbon markets were on track for an annual market value record of more than $1 billion for the first time, with all-time market value hitting $6.7 billion.

The report showed that the growth is more than just companies buying credits as a piece of their corporate net-zero strategy; it also represents an increase in speculators purchasing credits. The most active buyers in the market are the energy, consumer goods, and finance and insurance sectors.

But even with the growth and interest in voluntary carbon markets there are still lingering questions about standards, the number of registries being used by investors, the methodologies, the lack of regulation and the need for ratings and analysis of the markets.

Globally, the world’s largest registry for verifying carbon credits is a company called Verra, which offers its Verified Carbon Standard (VCS) Program to organizations looking to offset carbon. Launched in 2006, it has become the world’s largest voluntary greenhouse gas (GHG) emission program with 1,600 registered projects in more than 82 countries generating more than 450 million carbon credits. In the US, many more companies are registering carbon credits with organizations such as the Climate Action Reserve and the American Carbon Registry.

It’s also important to mention the California Air Resources Board (CARB). Although not a voluntary market, it is a compliance market that represents an influential and regulated sector of the market in one of the largest economies in the US. CARB regulates emissions and carbon offsets, allowing companies or investors to select projects within or even outside of the state with certain restrictions.

What are the methodologies?

“In the US, the vast majority of agriculture and timberland credits that have been issued since voluntary markets’ inception [in the mid-1990s] is heavily weighted on the forestry and land use side,” saya Eric Cooperström, managing director, impact investing and natural capital solutions with Manulife Investment Management, timberland and agriculture.

“You get the sense that timberland and land use is much further ahead from a carbon market perspective than agriculture.” He adds that soil carbon is also being looked at as a newer method to measure credits but is relatively nascent and still being developed from a scientific and quantification point of view.

Cooperström also notes that there are three main methodologies to measure carbon within timberland and land use. They are improved forest management, which adjusts forest management practices to sequester more carbon, afforestation and reforestation – planting new forests on previously forested or new land – and finally avoided forest conversion by keeping standing forests alive where there is a credible threat of changing the land use.

According to the Berkeley Carbon Trading Project, which aggregates carbon offset data from the various registries, improved forestation management is the most popular and actively employed methodology, with 218 million total credits in the forestry and land use sector. Avoided conversion was next with more than eight and a half million credits issued. Afforestation and reforestation came in last with a little more than six million credits issued.

In terms of forest management’s popularity, Cooperström explains that it’s relatively easy to take inventory and gather the data necessary for carbon sequestration. The science and application, he adds, are much more straightforward for forest carbon than say soil carbon, which is influenced by other factors such as weather patterns or harvesting – making it more expensive to gather data.

Matthew Smith, vice-president of forest operations at Finite Carbon, agrees regarding forestry management. “We have multiple methodologies because we’re still feeling our way through to what should count, how rigorous is it going to be and how difficult is it going to be to apply and make happen.” So far, Smith says buyers are coalescing around the American Carbon Registry methodology for improved forestry management and growing more rapidly than any other protocol.

Ben Rushakoff, senior manager of carbon finance with American Forests, says that different project types are best suited to different methodologies. “The methodologies are really about what constitutes a carbon project and how you calculate the carbon associated with the project. A reforestation project has totally different equations, calculations and standards compared to clean energy or other projects.”

How far along is the voluntary market in its development?

Though no longer in its infancy, the voluntary market is by no means fully established either.

“The voluntary space [is] a different world,” says Finite Carbon’s Matthew Smith. “Carbon markets were crawling out of research and were in their infancy. I express them now as in their teenage years.”

The reason for this, adds Smith, is that the carbon credit market is still dynamic and the balance between scalability and rigor has not yet been reached. The market is still determining how rigorous methodologies can be to be valuable, but also how rigorous can they be made and still have scalable uptake and application.

However, Ben Rushakoff from American Forests says investors are “digging into methodologies to understand and know what they are getting involved with, with the goal of demystifying them.” The diversity of programs and methodologies, he adds, is promoting innovation, “which is a good thing,” he stresses. Organizations like Verra and Calyx Global are creating rating systems to help investors understand which methodologies are best given to the project being looked at. “Communication to investors regarding what methodologies are being used and why is also important,” adds Rushakoff. “And independent reviews of the methodologies and standards will be good for the market as a whole.” Manulife’s Eric Cooperström agrees. He says the number of methodologies being developed and used can aid investors by providing greater innovation and flexibility.

The cream always rises

Is there a hierarchy of methodologies that puts some above others? Yes and no. While some methodologies are more geared towards emissions avoidance, others are more focused on forest removals. “There is more scrutiny on emissions avoidance, and we are already seeing pricing differentials, and you can take, in part, pricing as an indicator of quality,” says Cooperström. “It also touches on the methodologies themselves,” he adds.

“Certain methodologies like avoided forest conversion are more avoided-emissions-focused where others are more forest-removal-focused, like afforestation and reforestation.”

Protocols have increased over time as science has improved, and peer and public consultation continues. Often, later versions of the methodologies are stronger than the earlier versions. There are caveats to that rule, says Cooperström, like renewable energy. Smith agrees and says the peer review and public comment phase are a crucial part of the quality assurance aspect of carbon credit protection. He adds that eligibility criteria and performance are other ways to protect the quality of the credits. “Clearly spelling out what counts and how it is calculated is important,” he notes.

“You get the sense that timberland and land use is much further ahead from a carbon market perspective than agriculture”

Eric Cooperström
Manulife Investment Management

On the back end, independent audits, project performance, risk performance and eligibility by outside parties such as carbon verification companies further enhance the quality of the credits. Rushakoff says the projects themselves, if they are of high quality, will protect the quality of the carbon credits. That could mean projects with long-term permanence built in as well as other benefits such as community benefits, social benefits, biodiversity, [and] water quality, which are not necessarily incorporated into every project. “To me, these are the hallmarks of the highest quality projects that are out there,” says Rushakoff.

Cooperström says these types of co-benefits are viewed very favorably by the market and often command premiums for credit pricing. He explains that the year or “vintage” that credits are issued and when the project is registered will align with the trends of methodology at that time. The more recent the project, the more likely it is to adhere to more rigorous standards than older vintages, he notes.

Beyond protection of the quality of carbon credits, there are ways to enhance it as well. Rushakoff says using conservative carbon accounting from the start will enhance quality, as will integrating climate change into the calculation and really thinking about the impact of climate change in the long term into projects that can have 100-year time horizons. “We want to be planting trees that are adaptive to climates so we can continue storing carbon.”
Ultimately, building those numbers and climate considerations into the project will reduce overall project risk in the long run.

As the market matures, Smith says agriculture and forestry are the largest portions of the carbon-offset market, representing 61 percent of the market and having grown 166 percent in the last year, according to Ecosystem Marketplace. Interestingly, voluntary pricing is reaching compliance-level pricing, he adds. As a result, offsets can be produced at nearly the same value on a 40-year contract as perhaps was available a year ago on a 100-year contract. “That’s a paradigm shift and that’s meaningful,” says Smith.

Despite a global pandemic that has altered economic and consumer behavior and has turned global efforts towards solving it and/or containing it, Cooperström says commitments to climate action and carbon emissions has never been stronger. Momentum started in Glasgow in November 2021 with the COP26 summit, and there is more attention than ever to net-zero emissions.

Cooperström explains: “This is underpinning [an] increased focus and essentially demand for carbon credits, and we’re seeing that in terms of historic activity in the last year in voluntary markets, we’re seeing historic prices in compliance markets around the world… and climate consciousness globally is rapidly expanding. I don’t see that slowing down any time soon.”