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Highly indebted developing countries need all the money they can get to support their climate transition and adaptation needs. With advanced economies behind on their funding pledges too, market-based solutions offer a supplementary source of finance.
Carbon credits — a tradeable instrument that can be obtained when a tonne of carbon is removed from the atmosphere or avoided — have always had promise. With swaths of carbon-capturing biodiversity in the so-called global south, the developing world has the supply, while western governments and corporates seeking offsets to their emissions bring the demand. Buyers then channel money towards poorer countries with smaller carbon footprints and higher financing needs.
But what sounds good in theory has not been working well in practice. The $2bn global trade in voluntary carbon markets, or VCMs, has been battered by allegations of greenwashing, and prices have plummeted from peaks last year. The marketplace is considered to be a free-for-all, with dubious standards and limited transparency. The prize for fixing it could be enormous. With the right rules, Bloomberg NEF, a research provider, says the offset market could reach $1tn.
Raising the effectiveness of projects funded by credits is key. Some initiatives would have happened anyway in the absence of credit revenues. Others, including projects to protect forests from hypothetical future deforestation or to shut down a coal fired power plant early, are conceptually flawed. Independent certification bodies have been criticised for overestimating the climate gains.
The impact on poorer nations’ economic development has been questioned too. Richer countries have an incentive to hoard land with carbon offsetting potential. Governments and local communities sometimes only get a small cut of sales, with private brokers also taking a handsome slice. Some call it “carbon colonialism”. It can also create warped incentives for nations to raise their carbon footprint too, to generate new projects.
Article 6 of the 2015 Paris Agreement allows countries to trade carbon credits to achieve emission reduction targets set out in their Nationally Determined Contributions. The system rightly aims to avoid double-counting, where a bilateral project is counted by both nations as an offset against their target. But even initiatives under the UN system are no guarantee of quality. Negotiations over the precise rules and regulations for projects are still being hashed out at COP28 in Dubai.
VCMs are not a panacea. They must not divert governments and corporates from directly cutting their own emissions. But given their financing potential, they should not be abandoned, as some advocate. Instead, a more concerted push towards raising their integrity is essential.
The market needs a set of standardised rules. It is important that double-counting is avoided and the principle of “additionality” — or not funding projects that would have happened anyway — is ensured. Projects need to lead to a lasting fall in emissions, so a greater emphasis could be put on funding for tech-based carbon removal. Consistent accounting standards that measure and monitor over time how effectively initiatives are absorbing pollutants is crucial. Locals also need to gain sufficient upside from revenues, which they can reinvest in sustainability efforts. Agreeing on the specifics is not easy, but the range of independent criteria is currently undermining trust in the market.
The multilateral development bank system could play a role in supporting the marketplace by working alongside UN experts to advance common frameworks. It can also build transparency in the institutional and financial infrastructure that underpins VCMs, for instance by helping to develop a global registries for credits.
As they are now, VCMs can create the facade of action on climate change. With huge shortfalls in climate finance and temperatures rising rapidly, it would be foolish not to try fixing them.