The Next Step for Carbon Credits

The following is the original draft of the article written for the Business Times, by Ng Kin Foong, Chief Executive Officer of Red Sycamore and I.  The article was polished by Gwen Wanda Ling Poon Wah, Communications Director of ADK Connect Singapore Pte. Ltd.  She was invaluable in getting the article to print. 

Twenty-six years after the Kyoto Protocol, efforts to end global climate change have been slow, because it is expensive, and politically unpopular.  Bloomberg’s green-energy research team estimated, in July 2023, that the cost of achieving a net-zero world would cost US$196 trillion in investments by 2050.  Governments have prioritised immediate concerns such as rising food costs and combating inflation over combating the climate crisis and meeting net zero targets.  As a result, climate commitments have not been kept, and we are experiencing the tragedy of the commons while facing an existential crisis. 

How then should the world move towards halting the climate crisis?  Enter carbon credits.  The clean development mechanism framework designed carbon credits to incentivise developing nations to protect the environment while pursuing economic growth.  The intent is to create a win-win model for saving the environment without short changing developing countries.  The premise of carbon credits is conceptually sound, but many feel that the implementation of carbon credits has been beset with problems. 

In recent months, the media has been awash with bad news on voluntary carbon credits, with hundreds of millions of dollars’ worth of credits generated from environmental projects being invalidated.  Detractors say that projects set up for creating carbon credits are often based on vague predictions, can cause community conflicts, and do not create additional climate benefits.  Yet, this does not recognise the reversed Greenhouse Gas (GHG) effect of such projects on the climate and its benefits.  The world still needs carbon credits, and proponents of carbon credits are still pushing for it.  After all, carbon credits are a vital part of the strategy to mitigate the growth in GHG that comes from economic development, incentivising businesses to adopt environmentally sustainable practices that save the environment.  Governments implement a carbon tax for companies that are heavy polluters, forcing them either to purchase carbon credits, reduce their GHG emissions, or pay hefty fines.  This compels companies to reduce their carbon footprint and helps those with greener processes become more competitive. 

Then why are governments not implementing carbon credit systems globally?  According to the National Climate Change Secretariat Singapore, only 47 countries have national jurisdictions with carbon pricing, or compliance markets. Countries are reluctant to implement carbon taxes amidst the current global economic climate of inflation, as the cost of business passes on to consumers.  As the world grapples with the more urgent concerns of keeping food affordable and keeping inflation manageable, implementing a carbon regime has taken a back foot, slowing down the investments in carbon initiatives and delaying legislation. 

To make things more complicated, countries worldwide do not have a unified carbon system.  This creates uncertainty, especially amongst companies which operate across national jurisdictions.  How can they partake in the carbon credit system if they do not have clarity?  To illustrate this point, shipping companies prefer to buy blue carbon credits locally as their business impacts the ocean where they sail.  Yet, if they sail between Europe and Singapore, where should their blue credits come from?  The lack of good projects with strict regulatory oversight across the jurisdictions where these companies operate definitely hinders the development of the private market for carbon credits. 

If governments are moving slowly, why does the private sector not step up?  With the lack of information, consensus, and clarity of the international community on the processes that create carbon credits, voluntary market development has been hampered by bad quality credits, poor regulatory oversight, and a lack of credit fungibility across jurisdictions.  For example, Verra, the world’s largest carbon credit certification company certifying 75% of all carbon offset credits in the market, was forced to invalidate billions of dollars’ worth of credits after an investigation by the Guardian and other agencies in January earlier this year.  Until these challenges are addressed, investment will not pour into carbon projects from the private sector. 

Yet, this does not mean carbon credits do not work.  These challenges faced by the carbon credits market are neither new nor unforeseen.  New financial mechanisms are often introduced voluntarily to gauge market reaction and its effects before legislation comes in to protect investors.  These legislated products then become the new standard from which the market develops.  Likewise, the development of the carbon framework is currently underway, and is far more important than many realise.  If we do not implement the carbon regimes properly, the entire carbon credit system will be discredited before it even has a chance to mature. 

New Carbon Exchange Mechanism Needed

What can we expect moving forward?  With more illuminating information gleaned from scientific research and best practices in ESG projects, regulations are expected to tighten while carbon credits evolve into financial instruments.  Carbon credits generated from such projects will be rated based on the project’s impact on both the planet and the people within the communities residing near the project, and those with the highest ratings will command the highest prices.  When we have investment-grade carbon credits, we will see the development of a secondary market to trade those carbon credits.  That means we will have investment-grade credits on a blockchain, futures, options, even ETFs.  A carbon credit, as an asset class, will generate the sort of revenue to fund the actions to fight climate change.  They will be the new standard, as voluntary credits become niche. 

For this to work, we need to see a new carbon exchange mechanism.  Currently, carbon credits are not fungible across the different jurisdictions due to a lack of consensus within the international community on the regulatory framework.  This discussion requires partners from the private sector, and private funders.  What we need right now is a deeper discussion on this, and a framework in place to move towards these investment-grade carbon credits.  Fortunately, finance is one of the themes that will be discussed at COP28 in Dubai in December.  We will expect to see a tightening of regulatory requirements, a single or unified verification and validation authority, and one unified international standard to lay the groundwork for this mechanism.  Moving in this direction also addresses accusations of greenwashing that plague many voluntary carbon projects, as the tighter regulations prevent a false declaration of value for each project.  At any rate, the certainty that investment-grade credits provide will incentivise the creation of good offset projects that benefit the environment, which is better than not having any offset projects at all. This will also create certainty for investors and catalyse the private sector to finance good projects, moving us closer to reaching our net-zero targets. 

As the market matures, the other argument that abatement is better than offsets will be resolved as different asset classes are created for different types of credits, with the pricing mechanism determining the value of different types of credits generated.  Credits are currently priced based on reliability, impact and cost, which can be made fungible across carbon credit classes.  To curb speculation, governments can give tax rebates to smaller firms in key affected industries, and regulate access to the market, slowing down price inflation caused by carbon taxation and protecting smaller firms. 

The inflationary impact of carbon taxes on the economy is inevitable, but this pales when compared to the cost of climate change.  According to Deloitte, inaction on climate change will cost the world US$178 trillion by 2070.  This must have spurred the European Union to launch the pilot phase of the Carbon Border Adjustment Mechanism, a scheme that will tax carbon-intensive goods imported from outside the bloc, on from 01^st October 2023. 

Implementing carbon taxes and the carbon credit system acts as an insurance policy for the future, because not having it costs way more.  The world is already losing arable land for food production from the USA to Australia, biodiversity in oceans and forests, and natural disasters are becoming more severe from Libya to Canada.  If we do not go green, the world will burn.  The only way we can stop this climate crisis is to have conversations, collaboration, and commitment to international climate goals. 

If handled properly, carbon credits might just be the catalyst for the 5^th industrial revolution: the carbon credit revolution.  

This article is contributed by Terence Nunis, Chief Executive Officer of Equinox GEMTZ, a strategic consultancy, and Kin Ng, Chief Executive Officer of Red Sycamore, which establishes carbon sinks for the creation of investment-grade blue carbon credits.  Both Terence Nunis and Kin Ng will be speaking at the upcoming COP28 in Dubai. 

Note: Essentially, carbon credits are certificates allowing the holder to emit a certain amount of carbon dioxide or other greenhouse gases.  One credit permits the emission of a mass equal to one ton of carbon dioxide.  With the market mechanisms on carbon credits agreed through the Marrakesh Accords, the goal was to limit the increase of carbon dioxide emission by incentivising companies and nations to curb their emissions.  Total annual emissions are capped, and the market allocates a monetary value to any shortfall through trading via an exchange, or through private placement or auctions. 

The original article may be found here: https://www.businesstimes.com.sg/opinion-features/next-step-carbon-credits.