Dentons - Net-zero and carbon market development at COP27

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Voluntary carbon markets are here to stay

Given the pace of progress at COP27, voluntary carbon markets (VCMs) are here to stay as a means of achieving global climate targets. The immediate and significant challenge remains a lack of VCM regulation in most jurisdictions. However, bi-lateral contracts between project developers and buyers, as well as financiers are governing the VCM space given that VCMs are largely self-regulated at present. That is why getting the legal structure of carbon transaction contracts right remains critical for corporates. The tenure of these contracts tends to be long between the initial investment and the generation and sale of credits, which is why associated risks need to be identified and mitigated. A recent example of the extent of this risk exposure is EKI Energy Services, the first listed carbon offset company in India which saw its valuation on the Bombay Stock Exchange soar to US$1 billion after the IPO. Shares have now fallen 48% from their peak. The company's offsets are tied to renewable energy schemes. Now that renewable energy is in high demand, these offsets fail to meet the standard of "additionality" according to a 2016 study for the European Commission. This means that companies shouldn't be able to use them to offset their emissions unless the projects are in least developed economies. What does this mean for buyers and investors of EKI’s credits? For many organizations, buying credits on the voluntary market is the easiest, cheapest way to meet their climate goals however in the absence of regulation, risk remains high. Understanding these unique challenges particular to this sector requires qualified environmental lawyers with expertise in carbon transactions.

Nature-based projects in emerging economies will be significant credit generators in the future

Bio-diverse regions in MENA, Africa, Latin America and Asia are most likely to lead the way when it comes to providing projects for nature-based offsets. COP27 saw the launch of the Africa Carbon Markets Initiative (ACMI) with the aim of dramatically expanding Africa's participation in VCMs. Led by a thirteen-member steering committee of African leaders, CEOs, and carbon credit experts, ACMI announced a bold ambition for the continent. By 2050, ACMI is targeting over 1.5 billion credits produced annually, leveraging over US$120 billion and supporting over 110 million jobs. Commenting on ACMI’s ambition, Damilola Ogunbiyi, the CEO of SEforALL and a member of the ACMI’s steering committee, said, “The current scale of financing available for Africa’s energy transition is nowhere close to what is required. Achieving the Africa Carbon Markets Initiative targets will provide much-needed financing that will be transformative for the continent.” Crucially, ACMI is committed to supporting high-integrity credits where an equitable and transparent distribution of revenue goes to communities. To stimulate the production of high-integrity credits, the ACMI is collaborating with global integrity initiatives like the Integrity Council for the Voluntary Carbon Market (IC-VCM) and the Voluntary Carbon Markets Integrity Initiative (VCMI), as well as other regional carbon market platforms. Another area to watch is 'nature tech' which encompasses any technology that can be applied to enable, accelerate, and scale-up nature-based solutions. Nature4Climate and Capital for Climate released a landscape analysis report at COP27 looking at profitable solutions to the climate crisis and predicting ‘nature tech’ to grow by US$6 billion by just 2030. Nature tech solutions will be key to tackling emissions, making nature-based solutions more efficient, their benefits more verifiable, and supporting global climate, nature, and sustainability goals.

Decarbonization products will determine the future of GHG reductions

Our global climate crisis needs technology-based solutions to reduce GHG in the atmosphere by way of sequestration and reduction of emissions. With this in mind, COP27 shone a significant spotlight on green hydrogen, alternative fuels, and carbon capture and storage technologies. Of course if your organization is innovating in this area, carbon methodologies should be considered to ensure your organization fully leverages commercial benefits of the related investment. Jonas Moberg, CEO of the Green Hydrogen Organisation (GH2) had an interesting perspective in one of the fringe discussions on this area. Moberg explained that very simply, we need to expand the amount of renewable energy we have very quickly. People are increasingly realising that we have plenty of renewable energy which can be used much more if we convert it into hydrogen through electrolysis. Green, or renewable, hydrogen could displace carbon-based fuels in everything from fertilisers to steel-making to fuel for ships, he suggests. Green hydrogen challenges include building public acceptance for the roll-out of more solar and wind power. He also feels that better regulation, good planning processes, engineering talent and community buy-in and engagement will be key to helping make energy transition happen. Ultimately however, real change happens when the private sector engages in taking action and innovating with these technologies.

Greenwashing, reporting and the underlying quality of credits remain key issues

Regulators keeping a close eye on VCMs was discussed widely at COP27. The International Organization of Securities Commissions (IOSCO), which groups securities regulators from across the world, made recommendations to improve 'compliance' carbon markets, and asked whether regulators should be more involved in 'voluntary' carbon markets. Compliance refers to regulated markets for trading permits on exchanges like ICE and EEX with the EU emission trading scheme (ETS). The unregulated voluntary market refers to companies buying credits from emission reducing projects like renewable energy or REDD+ projects to offset their own emissions. IOSCO recommends that authorities should increase transparency in compliance markets on the number of allowances that will be given for free and for auction, with the latter helping to generate liquidity and revenue. Local regulators should set "clear and robust" frameworks for overseeing spot and derivatives carbon markets backed by enforcement. Exchanges could publish aggregated positions held by different types of market participants. The lack of standardisation for measuring emissions and concerns over quality and double counting of carbon credits are some of the vulnerabilities that could leave the sector open to fraud and manipulation.

COP27 also saw significant resources pledged to support science and technology to monitor the quality of credits. A noteworthy example comes from Singapore and Southeast Asia setting up a new US$25 million research program to improve the credibility of nature-based carbon projects in this area. Today, most natural carbon storage estimates by forests are made using global or pantropical models which may not provide the most accurate picture. This lack of accuracy on carbon stocks can deter those who instead may opt to use the land for other uses, such as cutting down forests to grow crops like oil palm, where their return-on-investment is more certain. This project will help to establish carbon estimation models for various tropical habitats, including rainforests, mangroves, freshwater swamp forests, peatlands, and deciduous forests, within Southeast Asia.

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