The Carbon Market Divergence Has Begun

In 2023, two upcoming changes to the carbon markets were the source of much excitement, or concern, among carbon market participants: Article 6.2 of the Paris Agreement and The Integrity Council for the Voluntary Carbon Market’s Core Carbon Principles (ICVCM’s CCPs). Many participants, myself included, believed that these two changes would cause a significant divergence in the carbon market. Last month, landmark transactions provided market data signaling that we were correct: we are beginning to see credits eligible to be traded under Article 6.2 and CCP credits trading at price premiums of up to 3,000%. Whether this divergence is a good or bad thing depends entirely on whether you are prepared.

Article 6.2 or “International Compliance Carbon Credits”

Article 6.2 Overview and Why It Matters

Article 6.2 of the Paris Agreement allows countries to sell carbon credits earned for emissions reductions or removals (called “Internationally Transferred Mitigation Outcomes” or “ITMOs”). If the buyer is a country, they can use these ITMOs towards meeting their emissions reductions targets, referred to as their “Nationally Determined Contribution” (NDCs). If the buyer is a company, they can use these ITMOs towards meeting their domestic compliance obligations such as a carbon tax or emissions cap.

For example, Singapore allows domestic companies to use international carbon credits to offset up to 5% of their taxable emissions (Singapore’s carbon tax is $19USD/mtCO2e and will increase to $34USD/mtCO2e in 2025).

The ability to use ITMOs to meet domestic compliance obligations is a significant advantage due to the typical price premium for compliance credits vs voluntary credits. For example, in Feb 2023 nature-based removal credits traded on the Voluntary Carbon Market (VCM) at $12.30/mtCO2e whereas Australian Carbon Credit Units (ACCUs), which can be used in Australia’s domestic compliance system, traded at $54/mtCO2e, 340% higher (in Feb 2023 1 AUD = 0.673USD).

Additionally, based on the ongoing negotiations regarding Article 6, non-adjusted credits in the VCM may no longer even be considered “offsets”, but instead “Mitigation Contributions”. What this means is that buyers of Mitigation Contributions will not be able to use those credits towards their emissions reductions claims.

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Article 6.2 Transactions

ITMOs trades are a recent phenomenon: the first ever transaction was completed in January 2024 between Switzerland and Thailand. Because this was an OTC transaction, pricing data wasn’t made publicly available (at least I wasn’t able to find it).

Fortunately, CarbonTradeXchange (CTX) completed the first spot ITMO auction on July 23rd 2024 for cookstove credits with a Letter of Authorization (LOA) by the government of Malawi. They successfully auctioned 1.5M ITMOs (1.5 million mtCO2e avoided) at a minimum price of $10/mtCO2e, a 163% premium over the current spot price of $3.80/mtCO2e for VCM cookstove credits.

According to market data from Quantum Commodity Intelligence, ITMOs (LOA) vs VCM cookstove credits (no LOA) are continuing to trade at an average 181% price premium. According to Platts Carbon Credit Assessments by S&P Global Commodity Insights, 2021+ vintage cookstove ITMOs traded at $24-25/mtCO2e, a 558% price premium.

Why this Transaction is Significant

ITMOs are not automatically higher quality or integrity than voluntary carbon credits. The only difference is that the host country (in this example Malawi) has authorized the credits to be used in another country (Host Country Authorization) and has agreed to not count the emissions reductions towards their own NDC (Corresponding Adjustment).

The craziest part of all of this is that the only thing Malawi has done is provide an LOA stating that they will do these two things, they haven’t even done them yet. And yet credits with an LOA are trading at a 163-558% price premium over similar credits without an LOA. While this is still an early development, I see it as a strong signal of the coming divergence between ITMOs and VCM credits.

ICVCM’s CCPs or “Flight to Integrity”

ICVCM CCP Overview and Why It Matters

The carbon markets have long suffered from the lack of minimum integrity standards for carbon projects. Last summer, several high-profile scandals significantly impacted confidence, and prices, in the carbon markets as a whole. This is where ICVCM comes in. ICVCM is a non-profit, independent governance body made up of industry experts with backgrounds in finance, climate science, NGOs, policy, and government. The CCPs are “ten fundamental, science-based principles for identifying high-quality carbon credits that create real, verifiable climate impact.” Again, ITMOs do not automatically mean high-integrity, so there is still a strong need for stringent global integrity standards such as the CCPs.

ICVCM CCP Transactions

On July 24, 2024, Xpansiv, a leading carbon credit exchange, launched trading of CCP-GEO contracts: standardized emissions offset contracts aligned with the CCPs. Xpansiv offers 3 registry specific CCP-GEO contracts:

• CCP-VCS: Verra
• CCP-ACR: American Carbon Registry
• CCP-CAR: Climate Action Reserve

According to Platts Carbon Credit Assessments by S&P Global Commodity Insights, these CCP-GEO contracts were trading at a significant premium compared to Xpansiv’s original GEO contract (carbon credits that meet ICAO-CORSIA criteria):

• GEO: $0.30/mtCO2e
• CCP-VCS: $2.25/mtCO2e = 650% price premium
• CCP-ACR: $7.50/mtCO2e = 2,400% price premium
• CCP-CAR: $9.25/mtCO2e = 2,983% price premium

Why this Transaction is Significant

Again, we are seeing a massive price divergence: a 650-2,983% price premium for CCP-aligned credits. Aligning with CCP standards is quite rigorous and a premium to cover the associated costs is expected, but this significant of a difference highlights the market demand for high-integrity credits.

The future of carbon credits: Compliance + High Integrity Credits

Domestic Compliance + High Integrity

You may be wondering why CCP-ACR and CCP-CAR are trading at 3-4x the price of CCP-VCS when all three credits are CCP-aligned. This is most likely due to the fact that CCP-ACR and CCP-CAR credits are eligible for use in domestic compliance markets, specifically in Washington state and California. Both states allow the use of carbon credits generated by Ozone Depleting Substances (ODS) projects to offset compliance requirements. ICVCM has approved CAR’s and ACR’s ODS methodologies, but not Verra’s. This means VCS-CCP cannot be used in WA’s and CA’s compliance markets, and as a result are worth less. (If there is a different reason for the price discrepancy, please let me know in the comments!)

International Compliance + High Integrity

CCP-ACR and CCP-CAR provide us with a glimpse of the future of carbon markets: high-integrity, compliance credits that trade at a massive price premium. The next step in this evolution will be CCP-aligned ITMOs: high integrity credits that can be traded internationally between compliance markets. While CAR currently only operates in Canada, Mexico, and the US (none of which are participants in Article 6.2), ACR operates internationally and has an MOU with Singapore to allow the use of ACR credits in Singapore’s domestic compliance market. I would recommend keeping an eye on ACR as the most likely candidate for this next evolution.

The need for Article 6.2 global integrity standards

One final thing to note: while the likely price premium for CCP-aligned ITMOs is a fantastic incentive for carbon credit producers to create high-integrity credits, it doesn’t necessarily translate for country-to-country Article 6.2 transactions. From a purely rational perspective, the buying country will be motivated to get the greatest number of ITMOs for the lowest price and may not be willing to pay a price premium for higher integrity. We are already seeing early signs of this with unfair, some may argue exploitative, bilateral agreements being signed between buyer countries and in-need host countries.

Article 6.4 (a global ITMO market facilitated by the UNFCCC) is at best several years away. In the meantime, inequitable transactions risk establishing a negative precedent of what is acceptable. Markets aren’t created in one grand swoop, but are instead built transaction by transaction, similar to case law. For the sake of the carbon markets, and the planet as a whole, it is imperative that high-integrity, equitable transactions constitute the majority of ITMO deals. To that end, we need global integrity standards for Article 6.2 projects to ensure a high-bar, just as ICVCM has done for the voluntary market.

TL;DR

If you actively participate in the carbon markets as an investor or credit producer and you don’t have a strategy for Article 6.2 and ICVCM’s CCP, you will miss out on significant upside and risk being stuck with millions of worthless “mitigation contributions”.