Explainer: Carbon Markets and the Built World

‍Fifth Wall Newsletter: https://mailchi.mp/fifthwall/carbon-market-explainer 

Why do we need carbon credits?

There aren’t many economic incentives to preserve or plant a new forest—carbon credits address that. But there are a lot of reasons to cut down a forest. Farmers clear forests to make room for more cattle ranching. Or lumber companies cut forests to sell more timber. 

In many situations, absent government intervention, getting paid for the value of carbon that a forest captures and sequesters is the only monetization lever available to interested project developers. The same is true for carbon removal companies. Aside from cases where CO2 can be sold to companies that use it to create their own products (think sparkling mineral water), removing CO2 from the atmosphere isn’t a ‘product’ in the conventional sense.

The world is beyond the point where emissions reductions alone are needed, according to the Intergovernmental Panel on Climate Change, the United Nations’ scientific body. In order to meet climate goals, CO2 will need to be removed from the atmosphere as well.

Where does demand for carbon credits come from?

While companies wait for climate and clean energy technologies to develop and scale, many will require more immediate solutions to offset emissions in their operations. That's where demand for carbon credits comes into play. To clarify, we’re focusing on the voluntary market, there’s also a compliance market (more on that in this explainer video). Companies that need or want to reduce their carbon emissions can buy credits to balance out some of their emissions. 

Think of companies like steel producers and airlines—these are large emitters of carbon without a readily-available tech solution to decarbonize its business. Companies that remove carbon or avoid the release of it can sell them their credits. By financing emissions removals or reductions elsewhere, the airlines or steel producers help accelerate decarbonization.

And the demand for carbon credits is expected to increase as more companies set net-zero goals. Nearly 63 percent of Fortune 500 companies have set mid century climate targets, according to a 2022 survey from Climate Impact Partners. In order to meet those goals, carbon credits will need to be part of the decarbonization tool kit.

Aren’t offsets just a right to pollute?

This is a real concern and there have been many cases where carbon credits that were sold didn’t end up representing genuine and lasting carbon reductions. However, the voluntary carbon market has only just started to gain mainstream traction. As the market matures, there will ideally be more visibility into what credits are issued, traded, and bought which establishes more accountability. It’s an imperfect system that is improving. 

In March 2023, the Integrity Council for the Voluntary Carbon Markets (ICVCM) issued a a framework that outlines rigorous standards for verifying agencies. It aims to ensure that credits fund projects that wouldn’t exist otherwise; that reductions won’t be reversed; and that projects don’t issue credits before the reductions happen. The ICVCM plans to release more guidelines mid-year that will identify high-quality credits from electric cooktops to reforestation projects.

What could the carbon market look like in the future?

There are many factors that will drive which direction the carbon market goes. Will it serve countries or companies? Will the supply of credits include projects that focus on reduction or removal or both? All of this ultimately affects the price of offsets, which BloombergNEF estimates could reach as high as $120 per ton or as low as $42 per ton in 2050 (for context, right now an offset costs between $35-50 per ton). The long-term success of the carbon markets will mean that the “suppliers, buyers of offsets, traders, and investors will need to balance what is idealistic and what is realistic,” wrote Kyle Harrison, head of sustainability research at BNEF in a recent report.