Cicero Policy Briefer

Issue 26, July 2008

The voluntary carbon market is growing up, but its long term future is still uncertain

By Alex Hickman, Director, Avebury Consulting

The world market in carbon is growing unfashionably fast. In 2007 trading on the world’s regulatory (or compliance) market – principally the EU’s cap-and-trade Emissions Trading Scheme (EU ETS) was worth $64bn, up from $30bn in 2006.

Although it is a fraction (around 2 per cent) of the size of the compliance market, the voluntary carbon market is growing even quicker, and – after a controversial start – there is growing evidence that the sector is maturing. However, its long-term prospects are closely linked to the extent and remit of future national and international regulation.

The voluntary market comprises the Chicago Carbon Exchange (CCX), and a much larger disaggregated market made up of a wide range of over-the-counter (OTC) transactions. The CCX is an allowance-based system, similar to the EU ETS. Owned by AIM-listed Climate Exchange plc, CCX is led by Richard Sandor, the architect of America’s highly successful SO2 emissions trading programme. Despite the Senate’s recent rejection of America’s Climate Security Bill (aka Lieberman-Warner), both John McCain and Barack Obama are talking about federal legislation. The CCX looks well placed in ‘pre-compliance’ America, where businesses will become increasingly aware of their environmental responsibilities; CCX reported 180 per cent growth in the first quarter of this year.

The OTC market enables businesses and individuals in the rich world to neutralise some or all of their carbon emissions by paying an offset provider to fund low carbon technology projects around the world – most of them in Asia, followed by the US and EU. These projects fall into four categories: capturing greenhouse gases (forestry and land-based), methane destruction, renewable energy (eg, wind and solar power) and energy efficiency (eg, installing efficient stoves and light bulbs).

A recent survey of the voluntary carbon market, Forging a Frontier1, estimates that trading grew by 165 per cent in 2007 to $331m ($72.4m on the CCX, $258m on the OTC), and predicts that this rate of growth will be sustained in 2008 as more companies in the EU and US implement carbon-neutral strategies, or buy credits as an investment. Companies from Penguin Books to Land Rover now voluntarily offset, reflecting growing consumer demand for companies to demonstrate their commitment to emissions reduction. Some analysts estimate that annual voluntary transactions could be worth as much as $4bn by 2012.

Project quality is a concern for the sector. Last year, Channel 4’s Dispatches embarrassed leading offset providers by questioning the validity of some mitigation projects. Much of the environmental lobby is suspicious of companies which offer to offset your carbon footprint with a mouse-click and a credit card. George Monbiot has likened offsetting to the purchase of papal indulgences; enabling polluters to buy themselves a clean conscience instead of going to the trouble and expense of cleaning up their act.

But the benefits go both ways. Offsetting creates capital flows and dynamic connections between businesses and individuals in the developed world and communities in the developing world. In addition to reducing greenhouse gas (GHG) emissions, the best projects also have lasting social and economic benefits for their (mainly poor) host communities. And these unregulated projects often go beyond existing government policy, enabling entrepreneurs and communities to experiment with new methodologies and technologies, and providing global policy makers with an important source of innovation.

Ironically, these policy makers represent the greatest threat to the OTC market. As national and regional authorities work towards a global framework for carbon reduction, they are slowly extending the remit of the compliance markets. So far, governments have shied away from a carbon tax, and restricted regulation to major polluters such as power utilities. But as regulators grow in confidence, they may draw more companies, and even individuals, into allowance-based mechanisms. And as governments teach individuals and businesses how to reduce their carbon footprints, the need to offset will diminish.

In the meantime, the OTC market is getting its house in order. Last month, eight top offset providers – including Carbon Care, recently bought by JPMorgan, and targetneutral, BP’s not-for-profit initiative – established the International Carbon Reduction and Offsetting Alliance (ICROA) with the purpose of “defining and meeting best practice in the rapidly maturing voluntary carbon market”.

And Forging a Frontier reports a strong trend in 2007 towards using third party standards to verify carbon credits, and growing use of carbon registries to record transactions. Out of an alphabet soup of available standards, the Voluntary Carbon Standard (VCS), launched last year at the London Stock Exchange, is emerging as the market favourite. Designed to combine usability and low transaction costs with robust environmental quality assurance, the VCS is championed by the Climate Group, an influential not-for-profit lobby group with powerful transatlantic connections. Crucially, the VCS has gone down well in America.

1. Forging a Frontier: state of the voluntary carbon markets 2008, Ecosystem Marketplace and New Carbon Finance, May 2008

Alex Hickman is a Director of Avebury Consulting and can be contacted here.