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Carbon credits: Scaling voluntary markets

A lot of businesses have pledged to fight climate change by reducing their greenhouse gas emissions to the extent they are able to. However, many companies find that they are not able to entirely eliminate their carbon footprint in addition to reducing their carbon footprint as rapidly as they’d like. This is particularly problematic for those who wish to be net-zero emission, meaning, they eliminate as many greenhouse gases that they emit from the atmosphere as they can be able to. In many cases is that it’s essential to use carbon credits to offset the emissions that they are not able to remove through other means. Based on the Taskforce on Scaling Voluntary Carbon Markets (TSVCM) is an initiative that is backed by the Institute of International Finance (IIF) and with the aid of McKinsey estimations that the demands for carbon credits could rise by an amount of 15 to 20 in 2030, and up to 100 in 2050. The overall picture suggests that the carbon credit market could be worth upwards of $50 billion by 2030.

The availability of carbon credits in a voluntary manner (rather than to fulfill compliance requirements) is important for other motives, too. Carbon credits purchased on a voluntary basis provide private funding to climate-action initiatives that otherwise might not be able to take started. They also offer benefits in the form of protection for biodiversity as well as pollution prevention, enhancements to public health as well as the creation of new jobs. Carbon credits also encourage investments in research and development necessary to reduce the costs of developing climate-friendly technologies. The growth of carbon credits in voluntary markets can facilitate transfers of capital to those living in the Global South, where there is the greatest opportunity for low-cost projects that can reduce the emissions of nature.

With the increasing demand for carbon credits that could result from global efforts to cut carbon dioxide emissions it is evident that the world needs an accessible carbon market that is large and transparent, and also verifiable and sustainable. This market has become a mess of complex and varying. Certain credits have been deemed to be emission reductions that were questionable at minimum. The absence of pricing information can make it difficult for buyers to determine if they are paying a fair price as well as for suppliers to control the risk they face when they finance or work on carbon reduction initiatives without knowing what price buyers will eventually be paying to purchase carbon credit. In this article, which is based on McKinsey’s research for a new report by the TSVCM, we look at these issues and how market participants, standard-setting organizations, financial institutions, market-infrastructure providers, and other constituencies might address them to scale up the voluntary carbon market.

Carbon credits can help businesses in achieving their climate goals.

Under the terms of the 2015.’s Paris Agreement, nearly 200 nations have signed up to the worldwide goal of limiting the increase in temperatures average to 2.0 degree Celsius above preindustrial temperatures and, ideally, 1.5 degrees. To achieve the 1.5-degree objective, it’s necessary that greenhouse gas emissions in the world are reduced to 50% of amount currently in the world by 2030, and decreased to net zero by 2050. More businesses are committed to this goal In less than one year, the number of companies that have pledged net zero has increased from 500 in 2019 to more than 1,000 by 2020.

To meet the global net zero target, companies need to cut their own carbon emissions as much as feasible (while tracking and reporting on their progress to attain the transparency and accountability which investors as well as the other stakeholders are demanding more of). For some companies, it’s extremely expensive to cut emissions with existing technologies, despite the fact that the cost of these technologies may decrease in the near future. Certain companies have certain emissions sources that can’t be eliminated completely. For instance, the process of making cement on a large scale usually involves an chemical reaction, known as the process of calcination. This process is responsible for a large percentage of the carbon emissions of the cement industry. Because of this, the path for reducing emissions to the 1.5-degree warming target requires “negative emissions” which is accomplished by eliminating greenhouse gases from the atmosphere.

The purchase of carbon credits is an option for companies to reduce emissions they are not able to eliminate. Carbon credits are certificates that show the amount of greenhouse gases that are kept out of the atmosphere or removed from the atmosphere. Although carbon credits have been utilized for decades but the demand from non-profit organizations for their use has dramatically increased in recent years. McKinsey predicts that in 2020 buyers will retire carbon credits worth 9 million tonnes worth of carbon equivalent to carbon dioxide (MtCO2e) which is more than two times the amount of 2017.

As efforts to reduce carbon emissions in the world economy grow the demands for carbon credits is expected to grow. Based on the advertised carbon credits’ demand estimates of demand from experts polled via TSVCM and the quantity of negative emissions needed for reducing emissions in line with 1.5-degree warming target, McKinsey estimates that annual global demands for carbon credits may reach as high as 1.5 and up to 2.0 gigatons of carbon dioxide (GtCO2) in 2030, and as high as seven to 13 GtCO2 for 2050 (Exhibit 2.). Based on the different price scenarios and the drivers that drive them, the size of the market in 2030 could vary from $5 billion to 30 billion on the lower end , and greater than $50 billion at the upper of the scale.

Although the rise in the demand for carbon credits is huge, research conducted by McKinsey suggests that the demand for carbon credits in 2030 will be met by the annual carbon credits of between 8 to 12 GtCO2 each year. Carbon credits are likely to fall into four categories: avoided environmental destruction (including deforestation) and sequestration in the natural environment, such as reforestation, or reduction in emissions like methane that is released in landfills and the elimination of technology-based CO2 from our environment.

But, a variety of factors could make it difficult to access all potential supply and get it available for sale. The development of new projects will require a rapid increase of the rate at which they are developed. The majority of lost nature and sequestration built on nature is found within a small portion of countries. Each project is not without risk and some may be ineligible for funding due to the long period between the initial project’s completion and the eventual sale of credits. When these problems are addressed, the expected amount of carbon credits will drop to between 1 to 5 GtCO2 annually in 2030.

There are other issues facing buyers and sellers of carbon credits, or both. Carbon credits that are of high quality are scarce due to the nature of accounting and verification methods differ, and also due to the fact that benefits of credits are beneficial to both parties (such as economic development for communities and protecting biodiversity) aren’t always defined. To determine the quality of the new credits-a crucial aspect to guarantee that the integrity of the market-suppliers have to endure lengthy time-to-markets. When they sell these credits, they face a erratic demand , and are not able to offer affordable prices. The market generally is characterized by a deficiency of liquidity, an absence of financial resources, inadequate risk management as well as a shortage of data.

These problems are challenging however they aren’t impossible to solve. The verification techniques could be improved and verification processes enhanced in their effectiveness. A more clear signal of demand could give suppliers more confidence in their plans for projects and will also make it easier for investors and lenders to finance projects. All of these needs could be fulfilled through the careful creation of a successful large-scale carbon market that is completely voluntary.

The development of carbon markets that are not regulated requires a fresh plan of actions

The development of a successful voluntary carbon market requires coordination effort on a variety of areas. In the report by TSVCM the TSVCM has identified six areasthat are part of an entire value chain for carbon credits that could act as a catalyst for the development of the carbon market, which is voluntary.

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Establishing common principles for defining and confirming carbon credits

The current market for carbon credits does not provide the necessary liquidity for efficient trading due to fact carbon credits are highly different. Each credit is differentiated by attributes related to the project that it was based on, like the type of project and the area where it was conducted. These elements affect the cost of the credit, as customers look at other attributes in a different way. The disparity between credit cards means that matching a particular customer to the right supplier could be a lengthy, inefficient process that can be done over the counter.

The match between suppliers and buyers would be more effective when each credit account could be described with the same features. The first set of characteristics refers to the quality that the item. The quality standards, which are laid out in “core carbon principles” could serve as a base to establish if carbon credits represent genuine emission reductions. The second set of attributes will include the other characteristics that make up carbon credit is able to meet. A standardization into a uniform taxonomy will help sellers market their credits, and buyers discover credit options that meet their requirements.

Contracts are created using typical conditions

In the carbon market that is a voluntary market, the wide variety and variety of carbon credit types is the reason why credit of particular types are traded in quantities that are insufficient to offer constant prices daily. The goal to make carbon credits more consistent is to consolidate the trading of certain kinds of credit, and improve market liquidity.

Based on the evolution of carbon core principles as the main as well as the standard attributes described above, exchanges may develop “reference agreements” for trading carbon credit. Reference contracts will combine the basic contract, which is based on the carbon core principles as well as other attributes that are defined in accordance with the standard taxonomy, and priced independently. Core contracts will enable businesses to tackle tasks such as purchasing large quantities of carbon credits in one go They could also make bids for credits that meet specific criteria, and the market will then join small amounts of carbon credits in order to fulfill their demands.

Another advantage of reference contracts could be the development of an unambiguous daily price for the market. After reference contracts have been established, a lot of parties will still trade with the help of the over the counter (OTC). The prices for credit that is traded using reference contracts may be a basis for negotiations of OTC trades, as well as with additional features that are priced separately.