Carbon markets represent a new frontier for many corporate sustainability leaders. But it doesn't have to be an uninformed journey. Here are key lessons to leverage from our collective renewable energy market experience.
The carbon market represents a new frontier for many corporate sustainability leaders. While this can translate to opportunity – particularly for early movers – it also represents some risk.
As emissions reduction goals tighten, regulation evolves, and businesses progress in their own decarbonisation, corporate engagement in carbon markets is growing.
But it doesn’t have to be a uninformed journey.
The renewable energy market is further in its evolution than the carbon market and there are many parallels (and therefore lessons) between the two.
In this article we explore the similarities between the development of the carbon and renewable energy markets, and the lessons that can be applied by forward-looking carbon market participants.
The renewable energy market was initially underpinned by purely compliance activity supported by international, national and state legislation.
But soon forward-looking businesses decided to take voluntary action and invest in renewable energy.
The motivations varied. For some it was a mostly a cost management measure while others led with the desire to meet investor and customer expectations.
Others still saw the writing on the wall and realised that today’s compliance legislation is tomorrow’s business-as-usual process, and wanted to take a proactive approach in developing their strategies.
At the beginning, there was also some understandable confusion. Early renewable energy movers were struggling to prioritise energy efficiency initiatives, on-site solar and other improvements, with external investment through tools like Power Purchase Agreements (PPAs). Businesses that embraced all available tools, quickly emerged as leaders.
The carbon market is developing in a similar fashion.
What started off with the Kyoto Protocol in 1992 (the first legally binding international emission reduction treaty), quickly evolved and then expanded to various national carbon markets. Australia’s own carbon market (underpinned by our Safeguard Mechanism legislation) being just one example.
And the international voluntary carbon market has evolved in parallel. In 2022 alone it is estimated to have directed more than US$1.3 billion to help mitigate 173 mega tonnes of carbon emissions.
Over time, businesses of all sizes are expected to be active carbon market participants. Those that recognise it sooner - and leverage all tools at their disposal - will have an early-mover advantage.
Early in the renewable energy journey, there was a lot of conversation, but uptake was much slower than it is today. As a result, earlier buyers had more options. Fast forward 5-6 years, it is now increasingly difficult to find right-fit renewable energy investments.
As more organisations set renewable energy targets and look to make investments that are aligned with their brand values, there is simply less choice available in the short and medium-term. Yet demand is growing at rapid pace, and new projects take time to build.
It’s also important to note that renewable energy projects are infrastructure intensive and build costs have also risen sharply in recent years. Directly translating to increased costs for buyers.
Many businesses are addressing the challenges by approaching the market as a ‘commercial partner’ as opposed to a ‘price taker’. Often taking long-term positions and supporting a renewable energy project before it is even built.
The carbon market is expected to develop in a similar way.
Many large businesses have fully decarbonised their Scope 2 emissions through renewable energy investment, and many others are in the process.
The focus is therefore now shifting to Scope 1 and Scope 3 emissions. And while emissions reductions must take priority, the process for many organisations can be long, costly and, in some cases, limited by available technology. It often requires significant investment over many years.
As the same time, demand for high-impact carbon projects is expected to grow due to tightening global emissions targets and stakeholder expectations. And the supply for project that meet specific quality criteria is also likely to tighten.
Forward-looking organisations will recognise this and take the time to estimate their residual Scope 1 and Scope 3 exposure, even while their emissions reduction initiatives are still underway.
They are then actively exploring strategic carbon project sourcing options.
Doing so early, will provide the best opportunity to manage potential supply and financial risk.
Early movers in the renewable energy market often had to pave the way. Those who engaged early through structures such as Power Purchase Agreements were doing something outside of business-as-usual.
As such, they had to take the time to understand the risks and benefits of moving away from traditional energy sources, and to get business alignment on the internal appetite for such risks.
There were, and there will continue to be, moments when a PPA looks ‘out of the money’. However, contracts that were established with a sound understanding of current and predicted market dynamics, are likely to be highly advantageous to the buyer over their term.
The lessons for new carbon market participants?
Take the time to understand the market, the risks and your internal risk appetite.
A consultant with in-depth market expertise can help guide you through the process, understand the potential pitfalls but also the likely upside, with the view to optimise both.
And finally, understand that a balanced strategy is often a long-term game. Investments in markets often swing in roundabouts and it’s your position over the life of the investment that matters.
An organisation’s renewable energy needs can be met through a mix of models and market mechanisms. These include spot and forward purchases, PPAs or direct equity investments.
Many of these models are being translated to the carbon market but they are also evolving much quicker due to the previous learnings. See the table below for key ways to engage with carbon markets.
However, it's important to recognise that, unlike renewable energy investments, most carbon projects don’t include an infrastructure play. Therefore, these carbon debt and equity structures can’t fall back on the value of the infrastructure asset if energy prices fall.
As such, investments in most carbon projects will require additional innovation and contract-specific methods to manage the risk. A consultant with deep in-market expertise can help guide you through the process.
A robust energy procurement strategy is not a set-and-forget exercise. As the market continues to evolve, so too must forward-looking organisations, and they must bring their boards and other stakeholders with them.
You need granular data to make decisions as a board will never sign-off on something that cannot be underpinned by in-depth analysis.
Early in the renewable energy market, market price and volume data was hard to come by. Since then, it has become available through tools like the CORE Markets software platform.
Investment in carbon markets also requires an in-depth understanding of market dynamics, including the value of different carbon credits, value of co-benefits and insights on current and emerging trends.
The variance in the price of Australian Carbon Credit Units (ACCUs) is just one example. Prices between different types of ACCUs can vary by over 90%. See the chart below.
Organisations that can see, understand and act on evolving carbon market dynamics will be best positioned to balance their commercial and climate goals and thrive in the new low-carbon economy.
Forward-looking organisations recognise that carbon market dynamics will be a key input into corporate decision making in the new low-carbon economy.
And they are taking the time now to build this essential in-house expertise, starting with these important lessons from our collective renewable energy journey.
The CORE Markets team helps corporate sustainability teams to create and implement innovative, high-impact and commercially savvy net zero strategies.
With deep buy and sell-side relationships in global carbon and renewable energy markets, we are uniquely positioned to help you reach your commercial and climate goals. Contact us today for an introductory call.
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