What lies ahead for voluntary carbon markets in 2023

A quick glimpse at the price history of most types of voluntary carbon credits in 2021 and 2022 will reveal somewhat of a bell-shaped curve.

It's a shape that tells a very simple story: a large part of the value that carbon credits quickly gained in 2021 was slowly but steadily lost in 2022. It's a shape that leaves market players wondering about what would come next – and the same line could offer the answer.

Too expensive to hold

The start of the Russia-Ukraine conflict and the energy crisis had been the main trigger behind the prevailing bearish sentiment in the voluntary carbon market.

In the immediate aftermath of Russia's invasion of Ukraine on Feb. 24, 2022, several market players were heard leaving their positions in the VCM as they were attracted by more volatile and lucrative oil and gas markets. At the same time, cash-strapped companies rushed to reduce their exposures.

But after touching a low in March, when the US announced a ban on Russian oil imports, VCM prices seemed to have found stability in April and early May. Thus, after this stability period, comes something that it's worth looking at if we want to gauge what's ahead for the VCM.

At the start of June, a new bearish trend started in the VCM, including in the most liquid nature-based and renewable energy segments. This coincided with the period when the US Federal Reserve was getting ready to announce something that trading desks had not been hearing for a while: an increase in interest rates.

The interest rate hikes changed investment scenarios. In voluntary carbon markets, higher rates meant that it had suddenly become too expensive to hold on to VCM positions taken by secondary market players in the hopes of further price appreciation. Since carbon credits do not expire and can be traded multiple times until they are eventually used to offset some emissions and retired, secondary market players, like traders or financial players, have become accustomed to buying recent-vintage credits and holding on to them until they can sell at a higher price.

While overall perception of the market over the next few years remains bullish, with demand from corporates committing to net-zero targets expected to increase, higher interest rates means that this "holding play" has now become riskier or more expensive.

The extent to which secondary market players will expand their positions in the market in 2023 – and to which the VCM will get out of the swamp where it seems to have fallen – will still largely depend on changes in interest rates and the cost of holding positions.

Time for regulators to shine

Another section of the 2022 price curve brings us to an even more important factor to look at for 2023 projections.

In the autumn of 2022, as the UN Climate Change Conference, or COP27, approached, a new bearish trend appeared in the VCM.

After a few late-summer weeks of high hopes about new demand coming to the market, very much in line with what had happened the previous year during COP26, market players began to face a harsh reality. They started to realize that their expectations to see clear rules about carbon crediting mechanisms being set at the UN summit would not be met, and that – in the middle of this regulatory uncertainty – most buyers were choosing to delay their purchases.

This resulted in a slowdown of market activity and price losses seen across all segments.

Players had hoped to see delegates of COP27 make decisions around which type of projects would be allowed under the yet to be launched Article 6 crediting scheme, and clear definitions on what constitutes a high-quality carbon credit. But none of this came, as delegates deemed necessary to allocate more time to make these decisions and promised to continue their conversations in 2023.

The voluntary carbon market has yet to recover from the impact of this regulatory uncertainty. A large part of what will happen in 2023 will very much depend on increased clarity on what makes a carbon credit a good quality credit as well as when companies are allowed to engage in voluntary carbon markets without risking greenwashing accusations.

A number of organizations are working to offer guidance, including the Integrity Council for the Voluntary Carbon Market, the Voluntary Carbon Market Integrity Initiative, and even the International Organization of Securities Commissions – which at COP27 launched a 90-day public consultation on the role of a potential financial framework to promote market integrity.

Rating agencies will play a larger and larger role in assessing the efficacy of carbon projects at avoiding, reducing or removing carbon and therefore at assessing the quality of the carbon credits issued by these projects.

But the sooner a clear and mandated framework becomes available, the better for the VCM. In particular, only clear and mandated rules on when corporations can resort to carbon credit mechanisms and offsetting practices to meet their net-zero targets will create that space where players can confidently engage in the market.

Requesting by mandate that end-buyers engage in a serious and science-based program to cut their avoidable emissions before resorting to carbon credits to offset the unavoidable emissions will be key to ensure that voluntary carbon market mechanisms are there to offer the flexibility needed to purse net-zero targets without obstructing the transition toward a cleaner economy.

With more clear rules in place, the VCM will thrive in 2023 and in the years to come. Otherwise, it may be destined to remain in "limbo" for a little longer.