This blog post originally appeared on trove-research.com. MSCI acquired Trove Research — now known as MSCI Carbon Markets — in November 2023.
After six months of steadily increasing prices, voluntary-carbon-credit prices have seen a sudden correction over the past four weeks, as of March 13. The most liquidly traded contracts based on CORSIA Pilot phase eligibility (CBL’s GEO and ACX’s CET) have fallen by 20-30% to a weekly average of USD 5.60 and USD 5.80, respectively. CBL’s nature-based contract, NGEO, also fell by 35% to a weekly average of USD 9.90.
These price levels are not mirrored across the market. Trove Research’s weighted over-the-counter (OTC)/Exchange index maintained its level at USD 9.50 to the week ended March 6, although it picked up the general bearish trend with prices dipping to USD 7.20 in the last week. Trove’s nature-based index also bucked the trend up to March 6, holding up to USD 14.00, although it slipped to USD 12.20 in the past week.
What is going on?
Exchanged-based voluntary carbon market (VCM) prices provide valuable reference for prices and liquidity in a market that is inherently fragmented. But as aggregated instruments, they mask important underlying trends.
Flight to quality — nature-based restoration projects are the gold bullion of the VCM
Within the turmoil of recent weeks caused by Russia’s invasion of Ukraine, we are seeing a flight to quality and longer-term safety of nature-based solutions (NBS) restoration credits. Nature restoration projects are linked with the Science Based Targets initiative (SBTI) Net-Zero Standard requiring the use of removal credits for neutralizing residual emissions — the need for which starts in 2030-2035 for most companies. Although demand will not materialize for at least another 10 years, these credits are increasingly being seen as the long-term store of value in times of market stress.
Trove Research’s nature restoration price index has increased by 50% to the week ended March 6, although it was not immune from the sell-off last week, shaving off 15%.
At the other end of the market, a greater number of older certified emission reduction (CDM) credits are now being transacted. Previously avoided by buyers that are looking for more recent higher-quality credits, these CDM credits are picked up at lower prices, weighing down the average price indices.
Over-the-counter trades attract higher prices
Trove Research’s pricing analysis shows higher average prices in the OTC market than on the exchanges. This reflects the more bespoke services of intermediaries that work with corporations in defining and meeting their need for carbon credits. These needs can be quite specific and, where successful, premium prices can be achieved.
The surplus elephant is still in the room
Despite the flight to quality, the weight of market surplus is ever present and will continue to weigh down prices in the near term. By the end of February, the market surplus stood at over 560 megatonnes of carbon dioxide equivalent and will likely rise again in March with more issuances coming to market. More sophisticated buyers are moving away from older vintages with lower-quality attributes, but with such large volumes still available for retirement, volume-weighted average prices always risk being held back.
Carbon-reduction projects are electric
VCM projects behave a lot like power markets, with high capital costs but typically low operating costs, making the market highly susceptible to swings in sentiment. If the market trades with a myopic outlook, price support can dwindle, driven by low marginal costs of delivery. With a product like electricity which is not storable over long periods of time the market regularly sees huge swings in peak and off-peak prices. The same effect was seen in the EU Emissions Trading Scheme (ETS), where for many years the prices floundered because of excess inventory. Prices in the EU ETS have now rebounded beyond most people’s expectations, partly driven by unprecedented high gas prices, but also expectations of a long-term tightening as emission caps continue to reduce.
VCM outlook — a pause for breath
The war in Ukraine has clearly shifted the attention of the world onto a very near-term problem. Before the war and in the afterglow of COP26, the world seemed to be finally taking the long-term challenge of climate change seriously, with an increasing number of companies setting ambitious climate targets.
The acceleration in traded volumes and prices in the VCM in the last six months created heady expectations of continued growth. A market worth USD 180 billion by 2030 was touted by Mark Carney, ex-governor of the Bank of England — although at Trove we said USD 30-40 billion (see here). From a standing start in 2020, the market was perhaps in need of a pause for breath.
We expect prices to continue to be volatile throughout 2022, being buffeted by three competing drivers:
- the drawdown on the large volumes of cheap inventory to meet immediate carbon-neutral claims;
- the trend toward higher quality, nature-based projects; and
- investing for the long-term to meet future climate and net-zero commitments.
In the medium to longer term we see VCM prices rising as the surplus is eventually drawn down by growing demand and the cost of developing new, high-quality projects increases.
