Growing demand for offsets has increased regulatory pressure and is improving the outlook for developing world forestry, says an author for a Fitch outlook on voluntary carbon markets.
In an October whitepaper, affiliate title Agri Investor reports, Sustainable Fitch provided an overview of the recent surge in carbon credit demand stemming from the dramatic increase in net-zero pledges over the past two years. The report describes growing concerns about credit quality and highlights Brazil, Colombia and Indonesia as countries with the best potential for forestry and land use change-derived carbon offsets in the years through 2050.
“We’ve typically seen the bulk of offset credits financing renewable energy projects, typically within developed markets, where the additionality of these projects has been called into question,” Sustainable Fitch director David McNeil told Agri Investor. “With this tightening that we expect to see over the next few years, that should translate into higher prices and a wider pool of projects that can be financed with credits.”
McNeil was among the authors of Sustainable Fitch’s report, which examined regulatory and demand issues facing voluntary carbon markets. It cites industry research that current prices of as low as $5 per ton could rise to as high as $20 to $30 per ton in the years ahead as competition for high-quality offsets increases.
The report noted a surge in voluntary carbon credit trading volume during the first eight months of 2021 that matched the total of the entire previous year. Demand for nature-based offsets that reduce emission by protecting or managing ecosystems specifically has more than doubled in 2021, according to the report. It said volume of credits utilising the UN-backed Reducing Emissions for Deforestation and forest Degradation (REDD+) framework have grown by 280 percent this year.
“There’s a recognition that with the price increases that we are likely to see, offsets could be a valuable asset class in their own right,” said McNeil, who is head of climate risk at Fitch Ratings. “We certainly see that reflected in the forestry sector, where there is increasingly investor interest in forestry and land use as an investible asset class where they think because of the emissions reduction potential, the marginal value of land is going to increase.”
Such investor interest is among the factors that McNeil said has helped increase market focus on the integrity of emissions mitigation projects, only 20 percent of which currently meet UN criteria for credibility, according to Fitch’s report. The availability of low-cost satellite imagery to monitor offset projects in far-flung markets and the establishment of NGOs dedicated to the sector, McNeil said, will be important factors driving the market’s push for transparency.
Challenges by the Netherlands advertising watchdog in September regarding Shell’s claims of carbon neutrality derived from Latin American offset projects, he added, suggest pressure from regulators to engage the “human dimension” of emissions reduction projects could grow.
“Compliance on the ground is based on monitoring and enforcement on the ground. You can model that based on probabilities, but a lot of it comes down to local management, ultimately. For forestry-based offsets, a lot of this is occurring in regions where deforestation is illegal and not permitted but is happening anyway because of weak enforcement and weak institutional structures,” McNeil said.
“Offsets can be an important part of the equation there because they can counteract some of the drivers of deforestation and provide incentives for local long-term management. There’s obviously a modelling element to it, but there is also a people-centric element to it as well.”