Earthward: Voluntary C Markets

Last week, the Swiss company Climeworks, a leading player in the nascent direct air capture industry, sponsored an informational webinar featuring speakers from The Nature Conservancy and JPMorgan Chase. TNC is among the world’s largest environmental nonprofit organizations, with a staff of hundreds of scientists deploying their expertise to conserve land and water resources around the world. JPMC, in contrast, is the undisputed world leader in financing the operations of fossil fuel companies. From 2016-2022, JPMC lent funds and underwrote fossil fuel operations to the tune of $434 billion, substantially more than any of the three other “big four” banks – Citi, Wells Fargo and Bank of America. Why would two organizations with such apparently opposed missions offer a joint educational webinar, under the auspices of a private firm developing industrial scale carbon capture? The answer lies in a worldwide effort to monetize carbon emissions reductions, in which a variety of players are working to establish a credit system that will finance initiatives to ameliorate global warming.

It is becoming increasingly clear that climate change poses an existential threat to the US and international financial system, and, fossil fuel investments notwithstanding, this has created new modus operandi for the big banks. Unlike coal, oil, and gas companies, whose sunk costs in material infrastructure limit how fast they can diversify, financial institutions can readily redeploy their resources to facilitate the growth of green industries. In fact, all the large international banks now operate in a transformed space in which the analysis of climate change risks is central to their investment decisions and a key part of their evolving frameworks for environmental and social governance (ESG). Bankers tend not to be environmentalists, but achieving the best results for their stakeholders has forced them to confront the vulnerability of their investments to climate change. Although it is easy to discount their moves as greenwashing, a not uncommon perspective among healthy climate advocates, TNC is among a minority of environmental organizations taking the position that direct engagement with fossil fuel interests is an effective way to truly catalyze the transition to a green economy.

JPMC is particularly interested in an emerging aspect of carbon financing centered on voluntary markets. Historically, attempts to put a price on carbon instead have focused on compliance markets, which are created by government mandates. The US has two such markets: the Regional Greenhouse Gas Initiative of the Northeast and mid-Atlantic states, and the Western Climate Initiative, encompassing California, Washington and Quebec. Internationally, the best established compliance market is the European Union’s (EU) Emissions Trading System. All three are well-regulated “cap and trade” programs, in which government sets a cap on the total amount of carbon dioxide that can be legally emitted during a given year. It then requires the regulated businesses, such as large industrial facilities and gas-fired electric power plants, to purchase or otherwise acquire emissions allowances. The allowances are returned to the government and “retired” when the business burns the fossil fuel. Only a limited number of allowances (each corresponding to one metric ton of CO2 emission) are created to match the emissions cap, and that number decreases each year. In this way, the law directly specifies the rate of emissions decrease. The government agency also operates a carbon market in which allowances can be traded among regulated companies, creating a beneficial dynamic in which regulated companies are motivated to reduce emissions swiftly, since they can earn money from selling their excess allowances.

In sharp contrast with the well-regulated compliance markets, voluntary carbon markets are fragmented and generally lacking in oversight. There are four major participants in these markets: project developers, who develop new emissions reductions projects and sell credits into the market; end purchasers, who are typically large firms seeking to burnish their climate-friendly credentials; brokers and retailers, who help match developers with purchasers; and standard-setting organizations, which audit the markets and offer assurances that the credits actually correspond to real emissions reductions. But presently, without government involvement, most voluntary markets are poorly structured. Brokers pair buyers and sellers of the credits, but there is no centralized process to oversee the verification and monitoring of projects by independent auditors. Because the markets lack transparency, would-be participants are easily deterred by difficulties in authenticating the value of projects and by time-consuming efforts to find suitable partners. This matters because abundant, carefully validated carbon credits in well-operated markets can be crucial to combat climate change, linking green project developers with buyers of the credits. This is true whether buyers acquire credits voluntarily or in compliance with a cap and trade law.

In a timely and detailed review, researchers at the Center for Strategic and International Studies document a variety of recent new initiatives to bring order to this chaotic environment, through the development of better organized voluntary marketplaces under government auspices. For example, CSIS describes an EU proposal for a carbon removal certification framework that would cover a variety of project types, and would introduce an EU standard for high-quality carbon removal projects. In addition to developing criteria for certifying new projects, the framework would create a registry to increase transparency and ensure that credits are retired after purchase. Other proposals from Japan, Australia and the US State Department hold promise as well. CSIS also describes the potentially central role of the Paris Climate Agreement in voluntary carbon markets, as it may be able to connect countries’ participation in these markets with their nationally determined contributions to global emissions reduction over time.

Voluntary carbon markets may one day become an efficient way of bringing together buyers and sellers of carbon credits, but their effectiveness ultimately depends on the number and variety of new projects able to sequester large amounts of additional carbon. It therefore came as welcome news when Ecosystem Marketplace, an initiative of the Forest Trends nonprofit that promotes conservation financing, reported that global voluntary carbon markets had nearly quadrupled in size within a single year, reaching a valuation of $2 billion by the end of 2021. Nearly two-thirds of the credits came from voluntary projects that reduce carbon emissions by avoiding deforestation and forest degradation, part of the “REDD+” emissions reduction program included in the Paris Agreement. This was a remarkable acceleration that the report’s authors interpreted as a breakthrough for voluntary carbon markets, which would usher in a bright future of ever-increasing credit demand and capital investment into new projects.

Or not. Writing last week in the prestigious journal Science, an international team of eight natural resource experts reported that most of the forest projects counted by Ecosystem Marketplace, corresponding to over $1.3 billion in REDD+ carbon credits, did not actually reduce deforestation, and of those that did, the amount of avoided deforestation was substantially lower than claimed. This is not a great surprise given similar problems that have plagued this and similar programs in the past. Compliance cap-and-trade markets like those in the EU and California have had similar issues with “offsets,” which allow regulated companies to buy equivalent emissions reductions in sometimes faraway projects, in lieu of fully reducing their own emissions. Those offsets often went to fund emissions reductions that would have happened anyway, thus lacking “additionality,” or were pledged to projects that never got off the ground or delivered less than envisioned. The failures did not greatly diminish the effectiveness of the cap-and-trade programs because offsets only compensate for a small fraction of emissions reduction. But in voluntary carbon markets, there are no regulated emitters under specific mandates, and the great majority of the credits are at risk.

The REDD+ projects at issue had all been validated by a popular crediting program called the Verified Carbon Standard, but in their paper the research team was able to pinpoint how things went wrong. The projects use their credit-derived funds for wildfire prevention, training indigenous farmers in sustainable management practices, and other work aimed at avoiding forest degradation and deforestation. These activities should result in less deforestation, with the number of credits proportional to how much forest loss is avoided. The problem, though, is that it is very difficult to reliably estimate a baseline – how much deforestation would have occurred if the project had not been conducted. When estimates of this baseline deforestation are too high, as they appear to have often been, then later satellite measurements showing robust forest cover will suggest that the project activities are highly effective – when in fact they add little or no value. In this situation, the credits do not represent actual gains for the climate, as they are advertised to do, and the firms that buy them get little or no value for their money. This creates a serious credibility gap that threatens to undermine the entire REDD+ program.

In their Science paper, optimistically titled “Action needed to make carbon offsets from forest conservation work for climate change mitigation,” the expert team calls for urgent revisions to the approaches used to estimate baselines, which will presumably require Verified Carbon Standard and similar organizations to tighten their requirements for how deforestation backgrounds are assessed. Close scrutiny of why specific forest zones are more or less susceptible to background deforestation will be part of this. Although we can hope that these actions will help minimize reputational damage and restore some confidence, it is unreasonable to expect perfection from any carbon credit program that relies on avoided losses. Improved estimates of baseline deforestation can’t fully compensate for our fundamental inability to know what would happen if the project were not conducted.

This limitation, however, does not mean the end for voluntary carbon markets, because these markets also support carbon dioxide removal (CDR) credits. Unlike avoidance credits, CDR credits are associated with projects where well-defined amounts of CO2 are taken out of the atmosphere and sequestered either temporarily (usually in new forests) or permanently (underground in mineralized form). This is where JPMC and Climeworks come in. In May of this year, the two firms announced a deal in which JPMC acquired over $20 million in future CDR services, an advance purchase that provides greatly needed liquidity to Climeworks. Direct air capture and storage (DAC+S) technology is still in a nascent state, and the very high costs of using it to remove and sequester CO2 mean that credits, if available, would today have to be priced prohibitively high. This early investment, however, positions JPMC to play a significant role in shaping the future voluntary CDR credit market and advising its clients about how to invest in the technology. Reliable and permanent carbon removal has a key role in restoring a healthy climate; by stepping into this field, JPMC and other large banks can begin to refurbish their own reputations, establishing themselves as part of the solution rather than enablers of climate chaos.


From Knowledge to Power, chapter 7 (Carbon Pricing).

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Earthward is written by Dr. John Perona and is an outgrowth of the climate education work begun with From Knowledge to Power: The Comprehensive Handbook for Climate Science and Advocacy (K2P).