Forestry-derived carbon credits are sure to be a topic of discussion at this week’s COP27 meeting in Egypt. Developing countries housing forestland, like investors managing it, will naturally look to promote a framework that pays them to not harvest natural resources.
For the array of investors on both sides of the GP/LP nexus that have established – or are in the process of establishing – vehicles dedicated to the suite of natural capital markets building out from timber’s established role in carbon credit markets, the Sharm El-Sheikh meeting will raise policy questions both specific and general.
Potential policy change often lurks somewhere within assumptions about future voluntary and compliance carbon markets, but attributable opinions about which level of government can realistically be expected to regulate carbon in 10 years remain scarce. The COP 27 meeting provides an opportunity to re-examine such projections and gauge how the post-covid call to collective climate action has weathered the events of 2022.
“What we’ve seen in the past several months is a closer link between carbon markets and macroeconomic factors,” said Manulife Investment Management managing director Eric Cooperstrom, who told Agri Investor some of the companies that had been most ambitious in setting voluntary reductions targets have recently paused to reassess their approach.
“When Russia invaded Ukraine and the global economic fallout that has occurred since, with inflation and rising interest rates, we’ve seen the impact on carbon markets,” he said.
Removing emissions preferred
In a recent paper exploring how expectations of future carbon pricing growth is already impacting timber management, Manulife highlighted that buyers have shown increasing preference for credits derived from projects that remove emissions, as opposed to avoiding them. It reported that three quarters of the 556 million carbon credits created through 625 voluntary forestry projects worldwide are registered through a REDD Plus process focused largely on the developing world. Included have been some projects with questionable assumptions and REDD Plus credits are likely to be further scrutinized in the future, Manulife wrote.
Although a global market of meaningful scale in carbon credits remains remote, UN forestry discussions contribute to a push for quality and reminds government policy plays a key role in virtually all natural capital markets. Cooperstrom highlighted Australia – where a decision to allow market sales of credits previously allotted for government purchases – as an example of policymakers’ potential market influence.
“That totally changed the dynamics of that market and had very specific and large implication for pricing almost overnight,” he said. “We do see the risk for these types of market changes, certainly in compliance markets, through regulatory risk.”
The price of the Australian Carbon Credit Unit slumped about 35 percent in the week ended March 11, 2022, after the government announced the policy.
At the UN level, Cooperstrom said the Paris Agreement’s Article 6, which encourages cooperation across borders to achieve nationally-determined climate targets, is already leading to harmonization across regional voluntary carbon markets, where many transactions remain bilateral.
“We’re seeing more agreements across borders that want to secure carbon market supply and others that are supplying them projects through Article 6, even though the infrastructure is still being built,” he said. “When corresponding adjustments and national registries come online through Article 6, we are probably going to see a migration towards compliance. Compliance, especially with the Paris Agreement, has tended to signal quality and receive premium pricing.”
Those credit pricing signals will remain the key metric for investors backing timberland’s evolving role in carbon and other natural capital markets. Those monitoring developments in Egypt this week may catch glimpses of distinct opportunity spouting from within an increasingly thick forest of enthusiasm growing around natural capital.