Every day that passes means more carbon needs to be removed to meet environmental goals. This is needed to balance the ongoing emissions that are difficult to clean up and the emissions that we have been too slow to clean up and that are now in the atmosphere. Carbon dioxide removal (“CDR”) is the process by which this carbon dioxide (CO2) is extracted from the atmosphere and captured. Many carbon dioxide removal projects do not yet exist on a large scale, with hundreds worldwide in the pilot or development phase. As demand grows, the question is how buyers of carbon credits can ensure that the large-scale carbon removal projects they want and need exist when the time is right.
A key tool to encourage projects is to pay owners today for the carbon removal they expect to undertake in the future. “Demand in the voluntary carbon market has shifted over the last year from investing in the ex-post market, where projects already issue credits, to investing in the ex-ante market, where credits are not yet issued. “Currently, for every $1 issued in the ex-post market, approximately $4 is invested in pre-issuance credits,” said Tommy Ricketts, CEO and co-founder of BeZero Carbon.
This evolving source of financing is great for projects, but in order to grow, the associated delivery risks must be resolved for both buyers and project owners. To reduce this risk, financial instruments are created. “As that demand has changed, we have also seen the balance of risk in the market change,” Tommy continued. “Investors are no longer willing to take on full delivery risk – they are increasingly turning to ratings to mitigate that risk and insurance to price in that risk. This is key to the market’s success and will increase confidence in investments and in turn attract more risk-averse capital.”
Miqdaad Versi, head of the sustainability practice at Oxbow Partners, continued: “One of the key drivers of the expected exponential growth in the carbon credit market is insurance.” Currently, very few carbon credits are insured. But as the market matures, carbon credit investors are looking for a way to mitigate the various risks they face: For example, what happens if a wildfire destroys a forest that their loans helped create? This is where insurance comes into play.”
There are concerns that this will add costs to a market where everyone in the world needs fast, low-cost growth. However, market participants believe that insurance will ultimately increase transparency and drive adoption. Increased transparency in a market typically means more benefits accrue to buyers and sellers and fewer to certain brokers or intermediaries. This would make more capital available to reduce emissions.
“Many carbon credit brokers resist improvements in transparency and better pricing because they often charge a spread in opaque markets,” said Chris Mack, CEO of Carbon.Credit. This is undoubtedly true in the early stages of a market. Still, the best brokers typically embrace transparency because it means the markets they understand are more likely to grow faster. Carbon markets are no different.
When financial instruments such as insurance impose additional costs, the costs are more likely to be incurred on lower quality projects, thereby incentivizing capital flow to the best operators and projects.
“Our philosophy is that we need project-level assessments to fully assess risk – no two carbon credit projects are the same. The riskier projects inevitably require more insurance. In particular, sectors where there is a higher risk of non-delivery or reverse delivery are likely to require more comprehensive insurance. For example, forestry or land use projects could be at high risk of reversal if the forest burns. The VCM is currently an unregulated market, so another major challenge in insurance is counterparty risk and the challenge when parties default on a contract. And as we hopefully see increased use of Article 6 credit, it is crucial to mitigate political risk – if a host country changes its market rules, this could have a fundamental impact on the ability of projects to deliver credit,” continued Tommy gone.
Ensuring that the carbon removal we need is achieved in a decade requires the same tools developed across financial markets to incentivize future action. The introduction of carbon insurance, ratings and enhanced asset details will hopefully mean that solutions to removing emissions from the atmosphere will become faster.
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I write about cleantech, energy and finance. Today I run Emissions Decisions, which provides tools to make optimal environmental decisions. Previously, I served as Vice President of Corporate Development at Neo Financial, a fintech company ranked as a top Canadian startup by LinkedIn. Previously, he was SVP Strategy and Corporate Development at Validere, an AI company focused on making the global energy supply chain more efficient. Started my career as an investment banker specializing in energy and infrastructure M&A. I have been quoted in the New York Times, Reuters, CBC and Business Insider and published in the Financial Post, Rigzone, Oilman and Pipeline Magazine.
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