Opinion – March Madness – Voluntary Carbon Market Volatility (March 2022)

18 March, 2022

March Madness – Voluntary Carbon Market Volatility – What is Going On?

After 6 months of steadily increasing prices, voluntary carbon credit prices have seen a sudden correction over the past 4 weeks to (w.e. 13 March).  The most liquidly traded voluntary carbon price indices based on CORSIA eligibility (CBL’s GEO, and ACX’s CET) have fallen by 20-30% to a weekly average of $5.6 and $5.8 respectively. CBL’s Nature-based index, NGEO, also fell by 35% to a weekly average of $9.9.

These price levels are not mirrored across the market. Trove Research’s weighted OTC/Exchange index maintained its level at $9.5 to w.e. 6 March although picked up the general bearish trend with prices dipping to $7.2 in the last week.  Trove’s Nature-based index also bucked the trend up to 6 March holding up to $14, although slipped to $12.2 in the past week.

What is going on?

Exchanged-based Voluntary Carbon Market price indices provide valuable reference for prices and liquidity in a market that is inherently fragmented. But as aggregated instruments, they mask important underlying trends.

Flight to quality – NBS restoration projects are the gold bullion of the VCM

Within the turmoil of recent weeks caused by Russia’s invasion of Ukraine we are seeing a flight to quality and longer-term safety of nature-based restoration credits.  Nature restoration projects are linked with the Science Based Targets initiative (SBTI) Net Zero standards requiring the use of removal credits for neutralising residual emissions – the need for which starts in 2030-2035 for most companies.  Although demand will not materialise for at least another ten years these credits are increasingly being seen as the long-term store of value in times of market stress.

Trove’s Research’s NBS-Restoration price index has increased by 50% to w.e. 6 March although was not immune from the sell-off last week, shaving off 15%.

At the other end of the market a greater number of older CDM credits are now being transacted. Previously avoided by buyers that are looking for more recent higher quality credits, these CDM credits are picked up at lower prices, weighing down the average price indices.

OTC trades attract higher prices

Trove Research’s pricing analysis shows higher average prices in the OTC market than on the exchanges. This reflects the more bespoke services of intermediaries that work with corporates in defining and meeting their need for carbon credits.  These needs can be quite specific and where successful, premium prices can be achieved.

The surplus elephant is still in the room

In spite of the flight to quality, the weight of market surplus is ever present and will continue to weigh down on prices in the near term.  By end of Feb the market surplus stood at over 560Mt, and will likely rise again in March with more issuances coming to market.  More sophisticated buyers are moving away from older vintages with lower quality attributes, but with such large volumes still available for retirement, volume weighted average prices always risk being held back.

Carbon reduction projects are electric

Voluntary carbon market projects behave a lot like power markets, with high capital costs but very low operating costs, making the market highly susceptible to swings in sentiment.  If the market trades with a myopic outlook, price support can dwindle, driven by low marginal costs of delivery.  With a product like electricity which is not storable over long periods of time the market regularly sees huge swings in peak in off peak prices.  The same effect was seen in the EU Emissions Trading Scheme, where for many years the prices floundered because of excess inventory.  Prices in the EU ETS have now rebounded beyond most people’s expectations, partly driven by unprecedented high gas prices, but also expectations of a long-term tightening as emission caps continue to reduce.

VCM outlook – a pause for breath

The war in Ukraine has clearly shifted the attention of the world onto a very near-term problem. Before the war and in the afterglow of COP26, the world seemed to be finally taking the long-term challenge of climate change seriously with an increasing number of companies setting ambitious climate targets.

The acceleration in traded volumes and prices in the VCM in the last 6 months created heady expectations of continued growth.  A market worth $180bn by 2030 was touted by ex-governor of the Bank of England, Mark Carney – although at Trove we said $30-40bn.  From a standing start in 2020, the market was perhaps in need of a pause for breath.

We expect prices to continue to be volatile throughout 2022, being buffeted by three competing drivers: (a) the drawdown on the large volumes of cheap inventory to meet immediate carbon neutral claims, (b) the trend towards higher quality, nature-based projects, and (c) investing for the long-term to meet future climate and net zero commitments.  In the medium to longer-term we see voluntary carbon market prices rising as the surplus is eventually drawn down by growing demand, and the cost of developing new, high-quality projects increases.

For more information on our short, medium and long term price outlooks, please contact subscriptions@trove-research.com.