Tuesday, 24 April 2012

Who's Afraid of Low Carbon Prices? Part 2: The Voluntary Market

This is Part 2 of my post about what low carbon prices tell us about the carbon markets.  Contrary to expectations, the price signals tell a good news story about the voluntary market.

I've now attended three of the four Africa Carbon Forum events held to date.  It's been interesting to see how views about the voluntary carbon market have changed over time.  At the Nairobi conference in 2010, the voluntary market was mostly ignored, save for a few buyers and sellers hovering around the margins of an event focused on the Clean Development Mechanism (CDM). 

In 2011, the Gold Standard and organisations supporting voluntary market projects spent their time lobbying - mostly successfully - for the CDM to adopt some of the rules (regarding suppressed demand, evolving baselines and the like) that have made the voluntary market a more  welcoming place for projects that improve the livelihoods of local communities.

In 2012, ACF delegates regarded the voluntary market in a new light.  The European Union's spokesperson stressed that, starting next year, they would only allow compliance credits from project types and countries where carbon finance could make a real commitment to sustainable development (regular readers will know that sustainable development benefits have always figured highly in Carbon Clear's project selection criteria).  Meanwhile, an entire panel session was devoted to discussion how the CDM could be reformed to stress social and environmental co-benefits, and the Gold Standard was invited to participate to share how it has been successfully pursuing this goal with its voluntary protocols.  With the European Union limiting carbon purchases from middle-income developing countries, delegates wondered whether it would be left to the voluntary markets - along with the ill-defined "new market mechanisms" - to continue driving the low-carbon transition in those economies.

And on the last day, one African delegate had the temerity to ask whether we would end up in a situation where all the "good" carbon projects ended up in the voluntary market, while all the generic or "bad" projects (to use his descriptions) would go to the compliance market.

What a change!  There was a time when offset customers were told that the voluntary market was full of cowboys and had a long way to go to match the environmental integrity of the compliance market.  The fact of the matter is that much of the voluntary market has matured rapidly and can now match or exceed the compliance market in terms of environmental integrity.  In addition, the price signals in the voluntary market perhaps tell us more than those in the compliance market about the future of the carbon markets.

The first thing to note about carbon prices in the voluntary market is that they have been less volatile than in the compliance market.  Verified Carbon Standard prices dropped in tandem with the Clean Development Mechanism after the 2008 economic downturn, but then stopped falling.  As a result, the price spread between generic VCS credits and CDM credits is only around €2, far narrower than it was in 2008.  The second thing to note is that projects that deliver non-carbon benefits have fallen less in price.  VCS credits that have undergone certification against a social or environmental quality screen like Social Carbon or Climate, Community and Biodiversity sell for the same price as CDM credits, if not more.  Gold Standard voluntary credits, which undergo strict social and environmental checks, have fared even better despite a huge quantity of new supply on the market.

Why is the oft-neglected voluntary market holding up better than the compliance market?  The first clue is in the name. 

Compliance buyers buy carbon credits mainly to avoid fines and penalties for exceeding their government-mandated targets.  They only buy when they must. As the name suggests, voluntary market buyers are not required to offset their emissions.  They do it because they want to - or more accurately, because it makes business sense to buy carbon credits.

In the voluntary market, companies offset their emissions for many reasons, for example, to establish an internal price of carbon in advance of regulation.  They offset their emissions to present new and innovative offerings to the market, to  engage their staff and customers, to demonstrate their corporate social responsibiltiy leadership, and more.  These business drivers don't depend on the economic cycle for their relevance, at least not as much as those driving the compliance market.  The result?  When the economy slowed, companies in the voluntary market paused, then continued to offset their emissions.

As for the delegate who asked whether the "good" carbon projects would all end up in the voluntary market?  His question reflected the fact that some voluntary customers want more than an emission reduction.  To be sure, with the costs of climate change becoming more apparent day by day, we should be supporting as many projects as possible that offer robust greenhouse gas reductions.  But for companies committed to corporate social responsibility, projects that offer broader sustainable development benefits can help them achieve multiple objectives simultaneously.  Indeed, as I have argued before, those broader benefits may be the main reason many companies invest, with the carbon market serving merely as the vehicle.  When presented to the right customers, such projects are relatively immune to market fluctuations.

In summary, the differing price responses to the economic downturn in the compliance and voluntary markets demonstrates how different these two markets truly are.  Companies that choose to go beyond compliance and offset their emissions voluntarily often make a long term commitment that helps moderate prices in the voluntary market.  Encouragingly, these price signals are encouraging developers to bring more projects to market that provide multiple community and environmental benefits beyond carbon reductions.