The Changing Landscape for Carbon Markets

Carbon markets remain a critical tool in the fight against climate change and are at the heart of global efforts to limit dangerous climate change and achieve the emissions reductions required by the Paris Agreement.

And as business comes under increasing pressure to achieve deep emission cuts and set even more ambitious goals to decarbonise, voluntary carbon markets are going to have to grow to underpin the scale of change needed across the economy.

Integrity in the market and in carbon credits themselves will be critical.

The market continues to evolve

The voluntary carbon market is at a pivotal juncture. Over recent years, heightened scrutiny has challenged the integrity of voluntary credit usage. Carbon credits have not yet earned their social licence.

The future of voluntary carbon markets is being shaped by several key trends:

1. Increased Regulation: As national emissions budgets tighten, regulatory requirements will likely increase, influencing both voluntary and compliance markets.
2. Focus on Removals: There will be a growing emphasis on removals-based credits over avoidance-based ones as technology costs decline and policy contexts evolve.
3. Global Cooperation: International initiatives are paving the way for enhanced market integrity and cross-border credit transfers.

As pressures from stakeholders increase and expectations escalate, the scale and scope of required emissions reductions will expand, while timeframes will contract. Voluntary carbon markets will evolve in response.

But the race to high-quality credits underpinned by integrity is the key driver shaping voluntary carbon markets.

The race to integrity

Credits must be high quality to deliver genuine emissions reductions, either by avoiding emissions that would otherwise occur or by removing emissions from the atmosphere.

To build stakeholder confidence in the legitimacy of carbon credits as a decarbonisation tool, significant improvements in their quality, integrity and assurance processes are necessary.

In particular, low integrity credits are untrustworthy and must be eliminated.

Work to tackle shortcomings and strengthen confidence is underway

Addressing integrity concerns will also require better and more rigorously enforced standards.

Several global initiatives are underway to strengthen and standardise requirements for supplying and using credits.

The Voluntary Carbon Markets Integrity Initiative (VCMI) and the Integrity Council for the Voluntary Carbon Market (ICVCM) are at the forefront of these efforts, aiming to restore confidence in the market.

Launched at COP27 in 2022, the Global Carbon Market utility (GCMU) aims to enhance the quality and transparency of carbon credits and to scale the global carbon market.

These processes are yet to deliver tangible outcomes, however, and progress remains slow.

In the interim, transparency is pivotal, with new disclosure requirements also adding pressure on businesses.

The International Sustainability Standards Board (ISSB) published its first global sustainability reporting standards in 2023.

As these are adopted worldwide, and in Australia through the Australian Sustainability Reporting Standards (ASRS) requirements, businesses will face unprecedented scrutiny on their climate strategies and carbon credit usage.

With this new level of transparency, businesses will face mounting pressure to demonstrate the integrity and effectiveness of their carbon credit strategies.

Implications for the cost of carbon credits

Carbon credits remain essential, are evolving and will become more expensive.

Increasing demand, a race to quality and rising unit supply costs will result in quality carbon credits becoming harder to find and costlier to purchase.

EY modelling finds that the cost of carbon credits is projected to rise significantly. By 2035, prices are expected to reach between US$75-125 per tonne across scenarios consistent with achieving the goals of the Paris Agreement.

But carbon credits also enable cost-effective decarbonisation

Far from being a cover for inaction, carbon credits can also enable faster, more impactful action. Evidence shows that businesses using carbon credits often set more ambitious emissions reduction targets than those that do not.

EY analysis also finds that combining high-integrity credits with ambitious internal abatement lowers decarbonisation costs by 45%-65% in Paris-consistent scenarios, compared to relying solely on internal measures.

Working hand in glove with ambitious abatement activities, carbon credits can accelerate and smooth out the transition to net zero.

There are strategic implications for business

Given these evolving regulations and market dynamics, businesses must adapt their strategies:

1. Early Engagement is Key: Companies that proactively engage with carbon markets will be better positioned to leverage opportunities as regulations tighten and markets mature.
2. Robust Decarbonisation Strategies are Essential: Develop comprehensive decarbonisation strategies that effectively incorporate high-quality carbon credits. This involves understanding stakeholder pressures, business risks, and opportunities for reducing direct emissions.
3. Balance is Crucial: As credit prices rise, businesses will need to find the sweet spot between internal emission reductions and strategic use of credits to manage costs effectively.
4. Prepare for Increased Scrutiny: Enhance transparency and reporting on carbon credit usage to meet growing stakeholder expectations and regulatory requirements.
5. Stay Informed: Monitor regulatory developments, particularly around international initiatives like Article 6 of the Paris Agreement, which aims to enhance market integrity and facilitate cross-border credit transfers.

The Road Ahead

The voluntary carbon market is not just evolving – it's undergoing a transformation. Despite current challenges, or perhaps because of the intense scrutiny, carbon markets present significant opportunities for businesses committed to sustainability.

By engaging early, thinking strategically, and leveraging carbon credits wisely, companies can navigate this evolving landscape successfully while contributing to ambitious global climate goals.

The message is clear: act now, adapt swiftly, and position your business at the forefront of this crucial market transition. Your actions today will not only contribute to a sustainable future but also secure your competitive advantage in a rapidly changing world.

Read the full EY Net Zero Centre report - Essential and Still Evolving: The Global Voluntary Carbon Market Outlook 2024.

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