- After the UN climate meeting in Egypt, carbon market participants are trying to establish a benchmark for pricing similar to that existing for other major commodities
- CME Group climate offset futures attracted record interest in December
The race to carbon neutrality has faced headwinds in 2022, including uncertain progress at the UN climate talks. However, companies are striving to move forward with a variety of tools to get the job done, such as: B. the voluntary market for carbon offsetting.
A positive backdrop for business in the coming year will be the continued development of benchmark prices in these carbon markets, which offer investors transparency and reference prices, similar to how benchmarks have developed in everything from gold to grains.
Businesses can certainly rely on these new benchmark prices as they face pressure from consumers and governments to meet their climate commitments. They will have to dismiss the lack of breakthroughs at the COP27 meeting, which ended after November’s marathon talks.
“With the conclusion of COP27 in Sharm El-Sheikh, Egypt, we are reminded that while the annual UN climate meeting is a predictable event, the road to net zero is anything but,” said McKinsey & Company, a consulting firm , in a blog entry.
Scan the QR code above for more expert analysis on market events and trend-driving opportunities today!
Business leaders signaled at the meeting that they will continue to pursue their climate commitments despite the current challenges in the global economy. “While there is an ongoing debate about whether COP is getting enough done, private sector leaders have taken a ‘let’s get it done’ attitude, although the exact measurements and outcomes are not yet entirely clear,” the statement reads McKinsey contribution.
Delegates faced a broad agenda at the COP 27 climate meeting, including holding talks on Article 6 of the Paris Climate Agreement, which addresses how carbon markets will be governed globally. According to a Reuters report, those talks will continue into 2023, including how countries and companies can buy carbon credits to meet their climate pledges.
But there was some reason for optimism. “After years of negotiations about whether carbon markets would actually exist under the Paris Agreement, they are now at the stage of actually putting them in place,” said Jonathan Crook, a policy analyst at the non-profit organization Carbon Market Watch, as quoted by the Reuters audit report. At the end of the COP meetings, delegates worked on a 60-page document on how international carbon trading could work.
“The texts provide key elements for implementing high-integrity carbon markets that can help achieve net-zero ambitions for all countries,” Dirk Forrister, president of the International Emissions Trading Association, said in a statement.
The importance of a CO2 benchmark
Industry analysts argue that more than ever, investors will need carbon offset markets, spot and futures markets to get an overview of what it costs to offset a ton of carbon. Carbon futures help provide these all-important benchmarks, much like futures price everything from corn to copper.
Read more about global carbon offset futures
A carbon offset credit is a transferable tool that has been certified by independent bodies or governments, and each credit represents a reduction of one tonne of carbon dioxide or its equivalent greenhouse gas. To be effective, the credits must represent an environmentally sound project, that helps mitigate climate change – such as preserving a forest that should be cut down. After purchasing a credit, a company withdraws it to claim a reduction in its own greenhouse gas reduction targets.
The challenge with netting, however, is pricing the credits, and this is where the futures markets come in. CME Group launched the GEO futures contract in 2021 with the goal of making it a global benchmark, giving clients a way to manage risk and helping with price discovery.
Jessica Masters, director of energy products at CME Group, said the GEO is working as intended. “When companies get involved in an offset project, they check the markets to see what the prices are like. In the end there has to be a benchmark, otherwise everyone will be throwing darts blindly.”
She pointed out that benchmarks provide the transparency that is so crucial for investors to participate in markets at all, as they need to know whether the decisions they are making are sound or not. “It gives people the power to make strategic business decisions,” she said. “It gives them legitimate risk management tools because with that transparency, they in turn get pricing and a forward curve with market price signals.”
David Kane, Partner, Commodities & Trading at Baringa Partners, a London-based consultancy, sees benchmarks as something both critical and evolving for carbon markets. “I think the benchmarking is still evolving. If we think about the more established commodity markets and the volume and liquidity within those markets, then price discovery is there and people are using those benchmarks to evaluate their respective books and create credible hedging strategies.”
“These benchmarks underpin how these companies manage risk. And without these benchmarks, the volatility of the prices of these particular commodities, leading to huge risks and large swings in profit and loss. That is the other side of the coin – if there is no benchmark it is very difficult to deal with, but it will emerge for the carbon markets.”
Sarah Leugers, chief strategy officer of Gold Standard, a registrar that certifies carbon offset projects, says the market is technically complex and difficult for some companies to navigate. “Futures contracts or other types of offtake agreements really help with that,” she said. “It’s primarily the stability of the price signal.”
Business is not deterred
Meanwhile, interest in carbon offsets continues to grow. According to a report by Ecosystem Marketplace, the value of the voluntary carbon market has grown to over $2 billion this year.
Open interest — the number of open, unsettled futures contracts — for CME Group’s suite of GEO contracts rose to nearly 30,000 in mid-December, a record.
Headwinds in the high-rate world
Wisconsin-based US Venture is an example of how a company can leverage carbon futures. The company focuses on sustainable energy solutions and takes a multi-pronged approach to achieve carbon reduction goals. The company enters the carbon futures market to hedge projected emissions for customers and uses offsets for its own needs. “As a project developer for farmers, forest owners and landfills, we use futures to manage risk and monetize loans for customers,” said Alex Haas, US Venture’s green credit manager, in an interview.
But he said the current high-yield environment presents its own challenges. “The high and rising interest rates will be headwinds for a few more months,” he said. “During this bear market, we need standard setters to set clear and sensible standards that give end users the confidence to use voluntary carbon credits as part of their sustainability plans.”
Given the growing interest in futures contracts and the increasing importance of a price benchmark for carbon offsets, participants in the offset market appear to be gaining confidence in the long-term importance of the voluntary carbon market.
Comments are closed.