Background: once insignificant, the VCM is starting to matter
Two decades ago, as mandatory carbon markets like the EU Emission Trading System (EU ETS) emerged, voluntary offset initiatives were sparse. The Clean Development Mechanism (CDM) under the Kyoto Protocol was the primary avenue for creating projects and selling greenhouse gas reduction credits. A “retail” offset market existed, lacking UN oversight and characterized by diverse crediting methodologies.
With the decline of the CDM in the mid-2010s - mainly because the European Union stopped allowing firms to use its credits for compliance with their EU climate targets-, voluntary offset initiatives became the go-to for entities aiming at carbon-neutral or "net zero" claims. By the 2020s, over 2,200 private sector entities had adopted voluntary emission reduction targets, representing over one-third (USD 38 trillion) of global market capitalization. Correspondingly, the market value of the VCM (to the extent it can even be tracked, given the lack of transparency about over-the-counter transactions) grew dramatically. Market value is defined as the number of transactions of contracts for voluntary units, times the price of each such transaction: this value doubled between 2020 and 2022, from about USD 1 billion to USD 2 billion.
As with most sectors experiencing rapid growth, market observers expected more. Firms involved in environmental markets responded to demand from private sector clients in corporate ESG teams by more closely tracking the VCM as a burgeoning market. The stalemate in global climate negotiations on precisely the carbon trading component of the Paris Agreement (its Article 6, see our analyses about this topic here, here, and here) during this time also contributed to the increased public perception that voluntary carbon markets constitute “the carbon market,” even though mandatory emission trading systems like the EU ETS and North America’s Western Climate Initiative have value orders of magnitude higher than voluntary transactions. Development of the VCM as a market – with exchanges offering more types of standardised offset contracts, often differentiated by project types, and analysts scrutinizing and forecasting buyer preferences as well as potential sources of supply – has increased during the past several years along with traded volume…until last year.
VCM 2023 recap: volumes stagnate
The increased attention to voluntary carbon trading that followed its rapid growth over 2020-2022 came with intensified public scrutiny, including negative coverage by major news outlets as well as unfavourable research results from academic institutions throughout 2023. The Guardian in January asserted that 90% of the credits from carbon credit certifier Verra generated by projects preventing deforestation and forest degradation (commonly referred to as REDD+ projects) lacked climate benefits. REDD+ projects constitute nearly one-quarter of issued voluntary offset credits globally. A study by The Berkeley Carbon Trading Project that analysed clean cookstove projects registered under the registries of Verra and another offset aggregator, the Gold Standard, found that such projects were over-credited by more than 6 times. The same research group’s analysis of improved forest management (IFM) crediting methodologies concluded that they do not align with current practices and therefore lead to substantial over-crediting as well. The group’s study on REDD+ methodologies also found that current REDD+ projects generate credits representing only a small fraction of their claimed climate benefits. These and other reports “exposing” the so-called offset industry caused skepticism about the environmental integrity of offsetting in general and projects involving land use change in particular, with both issuance and retirements of credits from Verra declining significantly in volume when compared to its 2022 performance– see Figure 1.
In contrast to the other three primary registries (ACR, CAR, and Gold Standard), which saw a general year-on-year increase in 2023, Verra, which holds the largest share of total issued credits across major registries (64%), witnessed a decrease in total volumes issued and retired during the same period. As of November 24th, Verra has issued 132 MtCO2 in 2023, a 19% decrease compared to the same period in 2022. In terms of retirement, 87.3 MtCO2 has been retired in 2023, marking a 10% year-on-year decline.
Figure 1. Verra's accumulated monthly issued and retired credits in 2022 and 2023
The criticism coincided with legal challenges, including a class-action lawsuit against Delta Airlines, an EU Consumer Organisation complaint against 17 airlines, and similar complaints against eight Swiss companies by the Swiss Consumer Protection Foundation. The European Union agreed in September on rules banning firms from making environmental claims such as “climate neutral” by the year 2026 unless these claims can be thoroughly substantiated, which makes tonne-for-tonne offsetting through purchases of carbon credits vulnerable to consumer protection action.
Negative coverage has impacted demand for credits from REDD+ and other nature-based credits most, not just in volume but also in price, as reflected by exchange data. The price of a nature-based offset futures contract on the exchange CBL called NGO Dec-23 and formerly regarded as a "premium" contract, dropped 88% since January 2023 from USD 6.32/t to below USD 1/t in early November. Companies are not buying and retiring more credits despite lower prices: surplus (defined as non-retired credits) continues to grow. As of November 24th, over 520 million tCO2 remain unretired in the Verra registry.Exchanges are even having trouble offering offset products: Xpansiv, a global exchange platform, had to delay its first auction of Cambodian REDD+ credits (VCS 1748) earlier this year due to a lack of buyers.
VCM trends in 2023: shift towards removals
In response to the negative media coverage of longstanding voluntary credit types – especially nature-based methodologies - there has been a notable shift in interest towards so-called durable carbon dioxide removals (CDR) in 2023. This general category includes technologies like Direct Air Carbon Capture and Storage (DACCS), Biomass with Carbon Removal and Storage (BiCRS), Biochar, Enhanced Weathering/Carbon Dioxide Mineralization, and Ocean Alkalinity Enhancement. While such methods of taking carbon dioxide out of the atmosphere permanently have not been possible at competitive prices in the past, new modelling and pilot projects show potential to scale up. The first commercial direct air capture facility in the US, funded in part by a USD 600 million grant from the US Department of Energy, opened earlier this month in California and is set to permanently sequester 1,000 tCO2 annually.
The very doubts about durable removals as a feasible mitigation activity ironically contributed to increased attention on their viability since May 2023, when an information note published prior to the meeting of the Supervisory Board for the Paris Agreement’s offsetting mechanism under its Article 6 referred to CDR as "technologically unproven." The robust response from market stakeholders defending their emerging market segment contributed to more widespread perceptions of the feasibility of CDR methods.
However, carbon credits from projects involving long-term storage of carbon dioxide constitute only a minuscule fraction of the total VCM transacted volume. As of November 24th, retirements from Verra, Gold Standard, ACR, and CAR amount to 123.4 million tCO2 in 2023. In contrast, data from the Puro.earth registry shows that only 62,455 tCO2 credits have been retired over the same time period, representing just 0.05% in comparison. Demand for durable CDR comes primarily from fintech companies and banks such as Microsoft and JPMorgan, along with buyers' clubs in which firms collaborate to expedite investment, such as NextGen and Frontier.
VCM trends in 2023: rise of the contribution claim rather than offsetting
The other major 2023 VCM trend was also spurred, at least in part, by the backlash against offsetting: firms are departing from "ton for ton" offsetting claims toward statements about contributing to climate change mitigation. Prominent corporations such as Nestle, Easyjet, United Airlines, and Kering are backing away from “net zero” and “climate neutral” statements in favour of an emphasis on contributing to mitigation efforts. The Voluntary Carbon Market Integrity Initiative (VCMI), striving to establish a comprehensive agreement on the acceptable use of carbon credits in the voluntary market, published a Claims Code of Practice this year that reflected this move from compensation to contribution claims and paralleled major carbon service providers to discard "climate-neutral" labels. Examples include South Pole rebranding to a "Funding Climate Action" label, ClimatePartner adopting a "ClimatePartner Certified" label, and Carbon Trust revising its carbon footprint labels (read our latest analysis on this here). Partially in response to the aforementioned EU move to ban carbon-neutral labels – and state legislation in the same vein passed by California in the form of Assembly Bill 1305 (Voluntary Carbon Market Disclosure Act), recently signed into law – corporate entities are backing away from commitments to neutralize their greenhouse gas output in favour of claims emphasizing their financial contribution to mitigation efforts.
The distinction between compensation and contribution is in line with UNFCCC developments regarding carbon trading among parties (countries). The UN requires that when countries transact mitigation units, they must perform corresponding adjustments to their target under the Paris Agreement. Since the buyer country is counting the mitigation it purchased toward its target under the Paris Agreement, the seller country must deduct that amount of emission abatement from its tally accordingly, i.e., make a corresponding adjustment to its Paris Agreement target in order not to count twice the mitigation that only took place once. The Paris Agreement does not dictate whether this should be required when a company purchases mitigation units, as it only applies to parties. The 2021 climate summit in Scotland came up with the concept of a “mitigation contribution,” which explicitly does not involve corresponding adjustments.
Over 2023, the VCM increasingly distinguished between correspondingly adjusted credits and those that have not been adjusted for by the government of the host country in which the reductions they represent occurred: credits with corresponding adjustments are of higher value because buyers can legitimately claim the reductions are not double counted (the host country has deducted them from its tally of progress toward mitigation goals) and thus, in theory, sell at higher prices.
Moreover, a significant source of demand for offsets – the International Civil Aviation Organisation’s CORSIA program requiring airlines to offset their emissions growth – only allows correspondingly adjusted units. Air carriers cannot submit units that have not been correspondingly adjusted for by the country they were carried out in to satisfy their CORSIA obligation. CORSIA will be in its first compliance phase during 2024-2026, but participation is so far only voluntary – air carriers based in the US and European nations are currently obligated to comply, but those based in countries with fast-growing aviation emissions such as China, Russia, and Brazil do not yet participate.
Given the prospect of substantial demand for correspondingly adjusted units (from air carriers but also retail buyers), some developing country governments are planning accordingly when it comes to harnessing foreign investment and reaching their own climate targets. African governments in particular are reported to be considering carrying out corresponding adjustments only for credits from certain types of projects: ones they cannot fund locally that require specific foreign investment. Those units will in turn cost more, given the government will charge for the foregone credit toward its own national mitigation commitments. Ghana’s government, for instance, charges USD 5/t for correspondingly adjusting mitigation units that are transferred to outside entities.
COP28 and beyond
The persistent scrutiny and numerous fault findings directed at the voluntary market over the past two years have thrust market integrity into the forefront of discussions this year. The commitment to advancing market integrity has been articulated by the COP28 Presidency, the Glasgow Financial Alliance for Net-Zero (GFANZ), and the VCMI reflecting a collective effort to restore confidence in the demand side. The IOSCO Sustainable Task Force is also poised to contribute to this objective by publishing a consultation report during COP28, aligning with the broader goal of promoting integrity in the voluntary market.
Depending on what text parties adopt under the Paris Agreement’s new global offsetting mechanism (Article 6.4, governed by the aforementioned Supervisory Body), carbon removal projects – possibly specifically CDR – could gain UN approval. This would spur increased investment in such projects worldwide, increasing the trend explained above. We do not expect major decisions from the parties on this, however, as the Article 6.4 Supervisory Body did not recommend specific methodologies going into the COP. It has, however, agreed on how to transition CDM projects and their credits to the new mechanism’s framework. We thus expect a first wave of transfers in 2024 if the recommendations are adopted by diplomats at the COP.
Overall, progress on the Article 6.4 mechanism will determine the fate – or at least structure - of the VCM farther into the future: the expected issuance of the A6.4 mechanism's first credits in early 2025 may render other types of offsets redundant in the eyes of buyers, given all the challenges to offsetting and nature-based credits in particular. We do not expect parties to make major decisions on the mechanism at COP28, however.