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By Roman Kramarchuk and Marie-Louise du Bois

Highlights

COP28 failed to deliver expected progress on Article 6 of the Paris Agreement on climate change, which sets out the principles for international carbon markets.

Consequently, the voluntary carbon market is regrouping around the question of quality, which affects issuance, retirements and price trends.

Simultaneously, national carbon compliance programs are expanding around the globe.

In time, these two markets may converge — particularly if there is agreement on Article 6 at COP29.

This year will see the continuation of a tale of two carbon markets — compliance and voluntary — facing rather different dynamics. After a few years of strong growth, the voluntary carbon market in 2023 hit a crisis of confidence, driven by media scrutiny, which challenged the quality and veracity of underlying reductions in carbon emissions. This has raised questions about the supply of viable credits, even as increasing numbers of companies are making low-carbon commitments and considering carbon markets as a tool to achieve their goals. A lack of progress on international carbon market negotiations at the COP28 climate conference meant no silver-bullet solution to bolstering market clarity, at least for another year, passing the responsibility back to stakeholder initiatives and governments. Amid this uncertainty in the voluntary carbon market, carbon compliance markets have continued to expand, with a number of high-emitting and fast-growing countries laying the groundwork for implementation. What remains to be seen is the degree to which these different markets can interact and how they can incorporate project-based reduction efforts, the hallmark of the voluntary carbon market, into their designs.

After COP28: The market regroups

Many project developers were looking for firm decisions at COP28 on Article 6 of the Paris Agreement. In particular, they wanted quality benchmarks to be established to mitigate the negative impacts of integrity challenges that have hit the market in the past year. With these decisions pushed back until COP29, other efforts to bolster confidence in the voluntary carbon market (VCM) have taken center stage. Several initiatives were announced at COP28 in support of the VCM: Six of the main integrity and reporting initiatives in the market will look to provide an end-to-end quality integrity framework to deliver coherent guidance on decarbonization, and six crediting programs will collaborate to increase the impact of carbon markets as mitigation instruments. Financial regulators have also issued guidance and consultations on the VCM. Heightened attention from financial regulators, national governments, and independent standards and initiatives could represent the beginning of a new phase of increased maturity for the VCM.

Heightened attention from financial regulators, national governments, and independent standards and initiatives could represent the beginning of a new phase of increased maturity for the VCM.

Shifting supply and record demand

Focusing on the VCM, credit issuances from the four main registries — Verra, Gold Standard, the American Carbon Registry and the Climate Action Reserve — reached a total of 66 million metric tons of CO2 equivalent in the fourth quarter of 2023, up strongly from the third quarter but down 28% year over year. Project developers limited supply amid low prices across most credit categories, and the negotiations at COP28 failed to deliver guidance on methodologies. Total 2023 supply volumes reached 261 MMtCO2e, 10% below 2022 levels and 29% down from 2021 (see chart). Credits from the nature-based avoidance category, the main target of negative press over 2023, fell 25% year over year to 59 MMtCO2e, while credits from the renewable energy category dropped 30% year over year to 81 MMtCO2e. Household devices and industrial pollutants were the only categories that showed credit increases year over year. While the VCM is often presented as an instrument to channel climate finance to less-developed countries, its top credit issuer in 2023 was the US, followed by India and China, respectively. 

Surprising many, VCM credit demand reached more than 60 MMtCO2e across the four main registries in the fourth quarter of 2023, boosted by December volumes amounting to 37 MMtCO2e retired, the highest retirement levels ever recorded in any month in the VCM (see chart). Considering that most controversies over the past year were associated with nature-based avoidance efforts related to deforestation projects, it is worth noting that retirements of these projects represented 30% of final 2023 demand. Market participants were potentially being mindful of the various integrity initiatives on the horizon.

Diverging price drivers

As a result of the changing landscape the VCM faces, new price drivers are emerging in 2024. 

Prices for credits from project types or methodologies that are seen as less rigorous will continue to come under pressure in 2024. In contrast, those from project types or methodologies offering negative emissions by clearly reducing the amount of carbon in the atmosphere will be seen as premium credits.

Nature-based avoidance credit prices, which hit a record low in December 2023, have fallen further in 2024. Credibility and integrity concerns around whether a credit really represents the carbon it claims to avoid are the main reasons for weak demand across the REDD+1 sector. Platts assessed nature-based avoidance prices to be 81% lower on Jan. 25, 2024, at $3.05/tCO2e compared with the same day in 2023, before the controversy surrounding these credits was first reported in the mainstream media.

Credits that point to greater climate ambitions are likely to continue to fetch more money. Similarly, credits from methodologies with emissions reductions that are easier to verify/measure and predict are enjoying greater demand and higher prices. As a result, technology-based removal credits, such as those generated by carbon capture utilization and storage (CCUS) projects, are attracting growing interest from companies and policymakers as they offer the promise of more easily quantifiable climate action. In 2023, we saw a notable uptick in demand for bioenergy via CCUS projects, with credits due to be issued and delivered in 2026 already being heard in the range of $200-$350/tCO2e in 2023. That trend is expected to continue in 2024.

Credits that point to greater climate ambitions are likely to continue to fetch more money.

The VCM will also reorientate around new and emerging signifiers of perceived quality guarantees until the opportunity to advance Article 6 again at COP29. In practice, this means prices for credits that secure a corresponding adjustment (CA) are already rising above those that lack these assurances, even where credits arise from the same project type.2 If a credit has a CA, this translates into a greater sovereign guarantee that the credit will be accepted in a future Article 6 market and across different jurisdictions, thus reducing the risk for the buyer.

As of the start of 2024, airlines need to purchase credits with a vintage of 2021–2026 and a CA to comply with the first (voluntary) phase of the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), a program designed to reduce emissions in the aviation industry. Airlines will have until 2028 to retire credits to comply with first-phase requirements.

The value of a CA is already affecting interest and prices of credits today. As noted above, phase one of the CORSIA scheme kicked off at the start of 2024, and now a credit needs to be paired with a CA to be eligible for usage. As a result, household devices credits with the promise of receiving a CA from a host country started trading at a premium to the same types of credits that lacked one. For instance, cookstove credits with a CA were at a $5-$10/tCO2e premium versus equivalent cookstove credits without a CA in January 2024. Similarly, a lack of clarity around implementing CA rules in India and Turkey — key countries supplying renewable energy carbon credits — has meant renewable energy carbon credits, which are from project types eligible for CORSIA first-phase compliance, have not seen CA-related premiums in 2024.

The market is also looking to independent governance bodies such as the Integrity Council for Voluntary Carbon Markets (ICVCM) to set standards or labels to provide a seal of approval to credits verified as high quality. The ICVCM has drafted core carbon principles labels, which are expected to attach a premium to any credit that receives one. Credibility will be key for such labels, as will endorsement by other credible actors such as the Gold Standard.

All of this means that price differentials in the market will provide buyers and sellers with additional transparency and optionality in 2024. Market participants want a granular view of value, and geography, project type or perceived methodological risks all translate into measurable price differences. Many different premiums and discounts are part of a constellation of project type (nature-based versus technology-based), perceived climate action (avoidance versus removal), regulator status and perceived sovereign risk (CA) or geography. Increasingly, the market is focused on the most fungible of the most competitive credits.

Market participants want a granular view of value, and geography, project type or perceived methodological risks all translate into measurable price differences.

Compliance market upswing

Amid this uncertainty in the VCM, the carbon compliance market — where governments impose requirements to achieve reductions and set a price on carbon — has continued to expand. Our modeling of emissions scenarios underscores the findings of the Global Stocktake at COP28: Countries’ emissions-reduction commitments (as noted in their nationally determined contributions) and their efforts to meet them are falling well short of what is needed to limit global warming to 1.5 degrees C. Nations in both the developing and the developed world are increasingly activating plans to use carbon pricing and markets to help achieve these reductions in more efficient and less expensive ways.

Nations in both the developing and the developed world are increasingly activating plans to use carbon pricing and markets to help achieve these reductions in more efficient and less expensive ways.

In 2023, several of the largest and fastest-growing countries — India, Brazil and Turkey among them — took clear steps to design and implement new national carbon markets. Indonesia launched a market targeting coal-fired emissions in the power sector. Other countries in Latin America, Asia and Africa are in the early stages of exploring carbon market options. If these countries were to follow the historic carbon-intensive path of advanced economies, global emissions would shoot well above target limits. Many are also considering the role of project-based credits in their compliance market designs, potentially affecting efforts historically covered by the VCM. The boundaries of these two markets will grow increasingly blurry.

More developed economies are also propelling carbon markets, either through policy-making that increases stringency (the EU, California, New Zealand and Australia) or through brand-new markets and jurisdictions (Canada, Washington state and New York). Europe has also taken clear steps to internationalize its carbon pricing by implementing the Carbon Border Adjustment Mechanism and including maritime emissions in the EU Emissions Trading Scheme. These actions mean that Europe’s many trade partners are being exposed to relatively high EU Emissions Trading Scheme prices. In addition, as the CORSIA program is being phased in, another swath of key countries is slated to be covered in 2027 — even though the supply of necessary carbon credits is limited and sustainable aviation fuel solutions face feedstock constraints and will take time to ramp up.

Looking forward

While COP28 disappointed in terms of offering clarity on Article 6, stakeholders — including the Article 6.4 Supervisory Body — are continuing their work to build up capacity and operationalize the carbon crediting mechanism. Additional guidance and recommendations will provide more grounding for an agreement to be reached at COP29 in Baku, Azerbaijan.    

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1 “REDD” stands for reducing emissions from deforestation and forest degradation in developing countries. The “+” stands for additional forest-related activities that protect the climate.

2 A CA is a carbon-accounting mechanism that avoids double counting emissions when credits are transferred from one country to another and used toward nationally determined contributions or climate pledges.

This article was authored by a cross-section of representatives from S&P Global and in certain circumstances external guest authors. The views expressed are those of the authors and do not necessarily reflect the views or positions of any entities they represent and are not necessarily reflected in the products and services those entities offer. This research is a publication of S&P Global and does not comment on current or future credit ratings or credit rating methodologies.

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