How to avoid the carbon credit crunch: Mitigating financial risk

What are the future carbon price projections?

It is difficult to predict the future demand volumes and prices for high-quality carbon credits with any certainty.

However, most analysts agree that carbon credit prices are likely increase over time. For example:

• This report by EY projects prices for high-quality credits may rise from their 2022 prices of under US$25 /tCO2-e, up to US$80-150 per tonne by 2035.
• While Credit Suisse believes a carbon price of between US$50 – 100 will be reached by 2030.
• And one scenario modelled by BloombergNEF sees the carbon price soar to over US$250 per tonne by 2050, if removal credits were the only ones allowed to ‘count’.

Tightening compliance markets, increasing corporate demand and other price pressures

Much of the variation between the above price projections depends on the evolving standards and regulations that define acceptable carbon credit and project types. But these are not the only considerations.

Here are some other factors that may contribute to upwards price movements:

• Tightening compliance carbon markets
  Governments around the world are tightening national emissions regulations as they race to meet their obligations under the Paris Agreement and/or in response to urgent calls for action from the global scientific community.
  
  The latest changes in Australia’s Safeguard Mechanism are just one example, and the latest step in our tightening regulatory framework. There will be more.
  
  We already know that the baselines will continue to reduce, and we can expect more government initiatives to help bring Australia’s emissions down.

• Increasing voluntary corporate demand
  ‍Like in other parts of the world, Australia’s biggest emitters are the first to be captured by climate legislation. But thousands of other organisations are already taking voluntary action.
  
  This means that businesses of all sizes and industries, not just large corporates in hard-to-abate sectors, are committing to net zero targets. They’re starting with emissions reduction but also looking for ways to invest in climate repair and nature-based solutions as a broader environmental commitment instead of carbon only.

• Greater focus on project quality
  ‍This increase in carbon market activity – both in compliance and voluntary carbon markets – comes at a time of high scrutiny into carbon project integrity.
  
  Businesses are increasingly selective on the projects they want to invest in, as they strive to make a meaningful impact and meet the high expectations of their customers, employees and investors.
  
  As such, we can expect growing competition for high-quality carbon credits.

• Evolving nature and biodiversity standards and regulations
  ‍We’re also seeing an increased focus on corporate impact on nature. An example of this is the upcoming release of the Taskforce on Nature-related Financial Disclosures (TNFD) and the range of standards, including some compliance standards, that are expected to follow.
  
  This means that carbon credits with additional co-benefits (including but not limited to nature and biodiversity) are likely to continue to attract a price premium and potentially face supply scarcity. And we will also see a rise in the importance of biodiversity-only credits over time.

While many new projects are under planning or development, evolving regulation, increased scrutiny and a growing focus on additional benefits (such as biodiversity) may have an impact on delivery timelines. This, and the other factors listed above, may collectively contribute both to increased demand and tightening supply.

Carbon contract innovation is key to managing commercial risk

Organisations across all sectors, especially in high-emitting and hard-to-abate industries should actively plan for the risk of rising carbon credits prices, to help mitigate the associated profitability impact.

This process can take place as part of decarbonisation strategy planning, which should include modelling of unavoidable, residual emissions over time.

Understanding the organisation’s emissions position early allows sustainability leaders to explore and model various carbon sourcing options, beyond those available for immediate purchase on the spot market.

In our advisory work, we’re seeing many organisations embracing innovative ways of ensuring access to high-quality carbon credits at the right price.

Some of the options we explore with our customers include:

1. Spot purchasing – Purchase made for the required number of credits on an as needed basis.
   ‍
   Key benefits: The quantity of credits required is known. Simple contract administration. Low transaction cost.
   Key risks: Future prices are unknown and may be higher. Future supply of aligned credits is unknown. Periodic and ongoing procurement is required.
   ‍
2. Forward contract – Fix a forward purchase for a predetermined volume per year for a short-medium term (e.g. 3-5 years).
   ‍
   Key benefits: Pricing is likely to be better than a spot purchase. Short-medium term price certainty.
   Key risks: Unknown volume available at the end of the forward block. Higher transaction cost.
   ‍
3. Long-term offtake – Sign a long-term agreement for a set volume for a longer term (10-15 years).
   ‍
   Key benefits: Secure a high-quality, project of choice early. Have input into the development of the project.
   Key risks: Increased project development and counterparty risk. Risk of value of chosen methodology changing. Higher transaction and due diligence costs.
   ‍
4. Equity investment – Take an equity position in the project and secure a portion of credits created.
   ‍
   Key benefits: Secure a high-quality, project-of choice early. Ability to influence project development.
   Key risks: High project development and counterparty risk. High upfront payment required. Risk of value of chosen methodology changing. High transaction and due diligence cost.
   ‍
5. Develop own project – Invest and develop own high-quality carbon project for own use, and as a possible revenue source.
   ‍
   Key benefits: Secure high-quality supply of carbon credits. Shape project development. Possibility of new revenue source.
   Key risks: High transaction cost. High capital investment required. Not core business.

Find the right-fit carbon sourcing model

Even within each of the carbon sourcing models explored above, there is no one-size-fits-all option.

We’ve developed a comprehensive decision making-framework that considers your decarbonisation timeline, your commercial and financial targets and your risk profile, among others.

The resulting carbon sourcing plan includes a contracting method and pricing mechanism that considers your business circumstances and supports your commercial and climate objectives.

The CORE Markets team works with both supply and demand sides of global carbon and renewable energy markets and have structured some of the most complex offtake agreements in the industry.

Put our expertise and our relationships to work for you.