<aside> 💡 This is the 5th article of our general deep dive on Climate Tech trends that we started a couple of weeks ago. As the trajectory to reach net zero appear too steep with emissions reduction only, a revival of the voluntary carbon markets is underway since 2020, driven by a large number of startups entering the space and willing to make an impact.

You can find here all the articles of the Climate Series

1. Introduction to Climate Tech
2. Renewable energy deployment
3. Smart Grids
4. Electrification of Mobility
5. Carbon markets
6. Carbon capture (to be published)

Wishing you an insightful reading,

Raphaël Cattan, Alexandre Dewez, Maryam Mahla, Charlotte Pratt & Henri Courdent.

PS: You are a climate company at Seed or Series A, operating in Europe and curious about how Eurazeo can help you ? Please reach out on Linkedin or drop us an email ar [email protected], [email protected] or [email protected]

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Why do we have carbon markets ?

• Carbon markets are required to internalize negative externalities caused by CO2 emissions that are not taken into account into price. Producers are not penalized for the negative externalities caused by their emissions and therefore are not incentivized to reduce them. Carbon markets were created to regulate the production of CO2 by making companies trade carbon credits – which are certificates representing one metric ton of CO2 equivalent. By setting a price on carbon, carbon markets introduce CO2 emissions in the cost equation. Companies can either reduce their own emissions or buy credits on the market to compensate those they cannot reduce.
• There are not one but several carbon markets:

  • Regulated carbon markets: these markets were established by the Kyoto Protocol in 1997 (COP 3) and sees companies and governments, bound by law to account for their GHG emissions, trade allowances either to make a profit from unused allowances (CO2 that was not emitted) or to meet predetermined regulatory targets. The main one is the European Emission Trading System which includes very emitting sectors such as Power, Industry & Heat.

    

  • Voluntary carbon markets: are not constrained by regulations or Kyoto’s mechanisms. Companies use VCM on a voluntary basis in order to offset the emissions they cannot (or are not willing to reduce). Credits are certified by standards: private entities following a methodology to quantify GHG reduction and allowing credits in consequence (e.g. VERRA : 80% of certifications). The projects financed by the VCM can include both avoidance (avoided deforestation, renewable energies) and removals (reforestation, change in agriculture practices, direct air capture etc.) The VCM is still very small compared to the regulated carbon market.

Source: BCG and Shell report : “The VCM : 2022 insights and trends”

Why is the VCM market dysfunctional ?

• VCM have experienced strong dynamics since 2020. VCM transactions grew x4 between 2020 to 2021, up to $2b in transactions. According to a McKinsey study, there could be a $30bn- $50b market for voluntary carbon credits by 2030. In 2022, the VCM market calmed down and came back to more stable prices and activities
• VCM have been driven by corporates’ pledges to reach net zero emissions in the next 20-30 years. One in five of the world’s 2,000 largest publicly listed companies have now committed to a “net-zero” emissions target but what net-zero means varies according to companies and the role of carbon offsetting in these strategies is not always clearly defined.
• For the VCM markets to work, carbon credits must respect certain criteria to be considered as high quality and been considered as really “offsetting” or “compensating” CO2 emissions. We’ve summarized them below. These criteria are particularly important for buyers but difficult to assess.
  • Regarding additionality : if a project cannot exist without carbon credits, it means carbon credits represent a significant part of the revenues whereas the price of these credits is still unknown, creating uncertainties for project developers.
  • For nature based solutions, permanence in the long-term is difficult to guarantee considering natural hazards.

• Although they have been around for +20 years, VCCs have struggled to take off because it is dysfunctional at all levels: lack of transparency, the multiple cases of fraud, the presence of multiple intermediaries and the multiplication of net-zero claims by multinational companies create distrust in this mechanism and cases.