Voluntary carbon market faces headwinds as Article 6 mechanism gains traction

The carbon industry is sharply divided on the evolution of the voluntary carbon market after the Paris Agreement's Article 6 allowed governments to decide what type of carbon credits can be used to fulfill their national climate targets.

The voluntary carbon market faces significant hurdles in staying competitive and risks losing market share that could impact an industry estimated to be worth several billions of dollars. Most impacted could be project developers, long-term project investors, brokers, trading platforms and standards setting companies.

Market participants at the Carbon Forward Asia 2023 conference in Singapore in early May were divided as to whether to revamp the VCM to align with Article 6 rules, introduce minor changes to remain competitive or allow market forces to take their course.

Some experts were of the view that VCM credits were fundamentally non-compliant with Article 6 rules finalized at COP26 in 2021, despite having a first mover advantage, making it difficult to overhaul.

"The current voluntary markets are not Paris compliant and that's something we have to realize," Kevin Conrad, executive director of intergovernmental organization Coalition for Rainforest Nations, and former Special Climate Envoy of Papua New Guinea, said at the event.

He said "avoidance" based carbon credits should not be recognized for the fulfillment of Nationally Determined Contributions by countries as they do not reflect actual emissions reductions. Avoidance credits from sources like renewables are based on the assumption that emissions reduction would not have happened in the absence of the project.

"Avoidance is not permitted under the Paris Agreement, and it will never be," Conrad said. "Over 90% of the voluntary market is about avoidance. And ICVCM [Integrity Council for the Voluntary Carbon Market] still haven't got avoidance out of their system."

Survival of VCMs

Conrad said the authority vested in governments to certify carbon credits as a corresponding adjustment was a key issue impacting the future role of VCMs.

"The word 'authorization' is mentioned 30 times in Article 6 decisions. This was pushed by developing countries," Conrad said. "You can't come in here, use a standard-created a carbon credit, take it offshore, liquidate it, and send pennies back to our economies. Without authorization, our NDC will be bankrupt," he said.

Peter Zaman, a partner with law firm HFW said using the Article 6 mechanism was ultimately a choice for individual countries and it was possible for VCMs to survive without being certified by governments.

"Some countries actually choose -- I'm not going to go under Article 6 at all. I'll just get the voluntary sectors to fund me [for emission abatement], and therefore I don't have to do the corresponding adjustment. That's a theoretical possibility," he said.

"Why did we build a carbon market infrastructure around the concept of offsetting and then abandon it?" Zaman said. "The answer to that is we don't understand why a voluntary carbon credit is good despite not being correspondingly adjusted."

VCM demand was driven by private sector companies like multinationals with net zero claims and Article 6 raised concerns that their claims risk overlapping with national emissions reductions.

Jun Song, Vice President of Global Carbon with Macquarie Group, said at the conference that this can be resolved if corporates change the language for their claims from carbon reductions to carbon compensating or financing.

Wei Mei Hum, head of Asia Pacific with ACX, formerly known as AirCarbon Exchange, said separating voluntary net zero claims from corporates and emission reporting at government level will help resolve the issue.

"I don't actually think that the Article 6 market is going to completely cannibalize the voluntary market," she said.

Support from compliance market

Some VCM market participants were hoping that government recognition and inclusion in domestic, compliance carbon pricing schemes will help support the market, but not all countries are on board.

Singapore signed a memorandum of understanding with Verra and Gold Standard, which account for 80%-90% of total VCM credit issuances, to allow 5% of domestic emissions obligations to be met by high-quality VCM credits starting from 2024. These VCM credits must be correspondingly adjusted and it plans to issue a whitelist for the eligible project types.

Some Korean market participants, however, were not optimistic of extending VCM to cater to Article 6 purposes.

"We think VCM and Article 6 cannot be aligned. Especially in Korea, VCM will never be used in NDC target. It is just a hope for VCM suppliers. In the market, we see lots of carbon traders trying to sell voluntary credits," a Korea-based trader said.

Australia and Japan also plan to utilize domestic carbon credits for cross-border trading under Article 6, namely Australian Carbon Credit Units and Japan's Joint Crediting Mechanism credits, instead of VCMs.

Market participants also expected growing resistance from developing countries who host VCM projects.

Papua New Guinea, Indonesia and Honduras, announced moratoriums on VCM exports, and regulators in India and China, who are among the largest VCM credit suppliers, adopted a cautious stance. Malaysia, another nature-based VCM credit supplier, said there were no restrictions on VCM credit exports, but introduced precautionary rules.