Where next for the voluntary carbon market?

Over the past few weeks I have been pondering over the year ahead and thinking how operators in the voluntary carbon market can stay ahead of the game. It's an interesting challenge. Carbon prices are low and showing no real sign of rising, economic recovery is happening, albeit slowly, and although demand for voluntary credits will continue to pick up during the year, I'm asking myself if this current environment is compelling enough to invest significant resources into certain types of new and highly innovative voluntary projects?

The voluntary market has always been supported by an inflow of pre-registration Voluntary Emissions Reductions (VERs) from projects approved under the Clean Development Mechanism (CDM), as well as voluntary projects in their own right. Whilst pre-registration VERs can be subsidised from the CDM project development, voluntary projects obviously have to bear all of their own costs. The mechanism for approving the VERs essentially piggy backs that of the CDM, and the time and costs for validation and verification of projects either through the Gold Standard or the Voluntary Carbon Standard are essentially the same as for compliance credits. Whilst that brings with it a sense of robustness, something just doesn't quite add up in terms of the cost and time for developing voluntary projects versus compliance.

In addition, the voluntary project development life cycle remains way too long for what can be fairly small projects. This is fine if the actual project takes that long to be physically built, but if it can be brought to the commissioning stage quickly, why should it have to wait another year or so for the credits to be issued and to gain the financial returns.

The third party auditors used to validate and verify voluntary projects are the same as for the CDM, save for a few exceptions, meaning that the resources are spread thinly over a huge number of project applications. If costs for voluntary projects were lower, there would be a perverse incentive for CDM projects to always be prioritised which would not help the voluntary situation, unless of course the process is simplified so voluntary projects can be processed quicker.

Furthermore, in order to get financing for such projects, developers often need a long-term purchase agreement to use as collateral against bank loans or debt. That assumes that someone is going to take on the forward price risk of buying the carbon credits.

Certified Emissions Reductions (CERs) are traded in the secondary market, which is a liquid market place with a full price picture out to 2012 and beyond, meaning long-term positions can be hedged forward. Even if the project developer is self-financed and keen to take the risk and wait until CERs are issued before they sell, they are assured that they can sell them in the CER spot market. A clearing price for CERs exists on exchanges and over-the-counter and so failing some fundamental market crash, they can be sold.

Things are not so straightforward in the voluntary market. The forward secondary market for VERs is mostly bilateral and even the spot market can be fairly thin. Corporate buyers need to be coaxed to commit to long-term purchase agreements and the market is too disparate to yet support an exchange. That means project developers can be faced with fairly high transaction costs and an opaque forward price curve.

What happens currently in the market is that sellers of voluntary carbon credits often blend higher cost projects with less expensive pre-registration carbon credits. Whilst this is a good short-term remedy, it does slightly disguise the fact that the underlying smaller emission reduction projects are quite expensive in their own right given the transaction costs. This masks the higher costs of these projects in order to hit acceptable price points which corporations are currently willing to pay to achieve their carbon neutrality objectives.

Right now of course, there is an existing pipeline of voluntary projects in development and we do see a number of projects coming to market, but what is the future? There is a risk that developers may get frustrated during the project development process and think twice about some future projects.

Voluntary Standards need to have a helicopter view of the way the market is developing in order to provide a straightforward framework for the projects that have the most demand potential. Certainly it is not their job alone. There is also an onus on carbon specialists to help create an effective feedback loop and help build efficiencies.

Whilst the pendulum has swung towards robust procedures and methodologies, I wonder whether it has gone a little too far. The picture outlined above may seem a little downbeat, but in reality what I am advocating here is fair treatment for voluntary projects. We need to speed up project implementation, keep transaction costs low, promote greater uptake in demand and create a vibrant marketplace for innovation if the voluntary market is to prosper.

Sounds like a busy year ahead….

Lisa Ashford is the Global Head of Voluntary & New Markets at carbon offsetting specialist EcoSecurities