To invest or not to invest: is the carbon market profitable?

In the fight against the climate crisis, we have two key dates; you've probably heard or read about them at some point. On the one hand, at the global level 2030 represents a deadline for reducing our greenhouse gas (GHG) emissions by half; on the other hand, we have to achieve a total decarbonization of the economy by 2050 if we want to avoid the most alarming effects of climate change. Today, there are multiple strategies to meet these goals, however, there are some that are more effective than others. Whether because of their scope, their adaptability to political, economic and social factors or the amount of resources they require for their implementation, one of the most effective strategies for implementing the above is the development of Carbon market, a mechanism that not only drives the decarbonization of the economy, but also has multiple additional benefits and that, in addition, has proven to be Profitable. Let's see what it is.

The carbon market at a glance

The fundamental basis of the carbon market is the assignment of a price to greenhouse gas emissions generated as a result of a certain activity. In other words, “those who pollute, pay”. In turn, it is possible to categorize the carbon market as voluntary or regulated, the first being the one in which companies adopt a price associated with their emissions on a voluntary basis and the second, the regulated market, where some sectors and industries of an economy participate in carbon pricing programs in accordance with government policies. An example of the latter is the payment of a tax associated with the carbon intensity of the fossil fuels that are consumed; another is emissions trading systems, in which companies that exceed a certain emission threshold must pay other companies that manage to remain below the allowed limits. Although this is a market in constant growth and diversification, there is a widely known instrument - and competent in our work - that helps the private sector to meet its climate commitments: carbon credits.

The carbon market is not only economically profitable, but it also has multiple attractive benefits for those who want to invest their money in sustainable projects.

A carbon bond aims to finance projects that contribute to decarbonization, either through nature-based solutions - such as forestry or regenerative agriculture projects that Toroto develops - or through technology-based solutions - such as green hydrogen or carbon capture projects from the air. Let's remember that carbon credits are the result of the reduction or sequestration of carbon in a certain project and that they serve to compensate for emissions that a certain company has not yet been able to mitigate, or that are impossible to reduce. The idea is that companies that purchase carbon credits to offset these emissions pay a price that involves more than a simple transaction: on the one hand, that encourages the mitigation of emissions within its value chain and that, on the other hand, that it is adequate so that the projects that generate these bonds can be financed and prosper in the long term.

The carbon market is not only economically profitable, but it also has multiple attractive benefits for those who want to invest their money in sustainable projects. So why should a company allocate resources to carbon capture projects? Why should a person invest in companies with science-based climate commitments? How profitable has the carbon market proven to be?

1. It promotes competitiveness and economies of scale

First, many of the emission mitigation alternatives would have implementation barriers if it weren't for the carbon market, so their existence is indispensable. Sometimes these barriers involve technologies that are expensive or that there are no regulations to promote them. In other cases, they are technologies that are difficult to implement under certain operating schemes or are simply under development. Whether for economic, political, technical or operational reasons, they have found themselves within the carbon market two key pillars which offer wide areas of opportunity and solutions to these limitations, so we must take them into account to accelerate the implementation and accessibility of new mitigation measures:

1. Innovation

Faced with the challenges of solving the causes of climate change, innovation will be required in alternative business models, in engineering solutions and in research and development of new materials, to name a few examples. Innovation will drive cost reduction, resource efficiency and, ultimately, increase the competitiveness of the carbon mitigation and sequestration alternatives that we need today.

Innovation, hand in hand with the correct creation and implementation of public policies, will result in increased supply and demand for multiple nature-based solutions and technology-based solutions to combat climate change.

2. Public policies

More public policies will be needed to accelerate a transition to a low-carbon economy. New public policies should promote the assignment of a price to carbon directly (as mentioned on carbon taxes or emission trading systems); indirectly, they should limit the use of polluting technologies within a given time horizon or generate economic incentives for the use of clean technologies. For example, there are several countries that have explored the decision to end the sale of internal combustion vehicles in a certain year and allow only the sale of electric vehicles (which will require clean energy), as is the case of Canada or the European Union. As you can guess, the right public policies will make technologies that emit greenhouse gases less competitive today and will increase the competitiveness of clean alternatives.

The combination of these two ingredients, innovation hand in hand with the correct creation and implementation of public policies, will result in increased supply and demand for multiple nature-based solutions and technology-based solutions to combat climate change. This increase in a company's ability to offer solutions while reducing its costs is known as economy of scale. A very clear example of the above is that of photovoltaic solar energy, which for more than ten years has proven to become more competitive and accessible. More and more sectors have the opportunity to rely on this technology, which, as demonstrated in the following graphic, has simultaneously made it possible to meet energy demand and mitigate emissions at progressively more affordable prices.

Graphic 1. Global average installation and energy costs for photovoltaic solar systems (IRENA, 2021)

2. Promotes decarbonization: the case of nature-based solutions

Secondly - and as mentioned before - the carbon market is an extremely effective strategy to promote decarbonization. Particularly through nature-based solutions, their validity and efficiency have been demonstrated. Alternatives such as silvopastoral systems, regenerative agriculture and agroforestry systems are very attractive from an economic and social point of view, because together, they have the potential to generate new sources of income for the countryside and the communities that inhabit it, while strengthening their decision-making processes about natural resources and generating new capacities.

According to Paul Hawken's estimates in his publication Drawdown, globally and over a time horizon between 2020 and 2050, these solutions will need to cover initial investment and operating costs of approximately 176.1 billion dollars, although on the other hand, will be able to mitigate 79.96 gigatonnes of CO2e - which is comparable to the emissions that the aviation industry would generate for approximately 64 years - and generate positive flows of 4,075 trillion (4 billion) dollars. Additionally, ecosystems such as tropical forests, wetlands, temperate forests or afforestation projects have the potential to mitigate more than 123 gigatonnes of CO2e in the same period of time.

What does the above mean? The mitigation potential of adequate land use management and other nature-based solutions such as those already mentioned, hand in hand with previous ecosystems, is comparable to the emissions produced globally for four years, that is, these almost 200 gigatonnes of CO2e potentially mitigated between 2020 and 2050 - depending on the current state of growth of the carbon market - will have the capacity to offset 4 years of global emissions on their own. This is an impressive fact and points to the importance of abandoning the use of polluting technologies and migrating to clean forms urgently.

These types of projects have the capacity to be financed through the issuance of carbon credits from nature-based solutions, whose transactions doubled between 2020 and 2021 (Ecosystem Marketplace, 2021) and which today offer an instrument for companies to meet their climate goals, generate shared value and obtain returns on their investment.

The carbon market is profitable and growing

Finally, the carbon market, as well as the different instruments and mechanisms that make it up, have proven to be highly profitable. In 2021 alone, the value of the voluntary carbon market exceeded one billion dollars, while the regulated market generated around 84 billion dollars in revenues for governments that have already implemented regulations such as carbon taxes or emissions trading systems. This meant an increase of more than 30 billion dollars, or in other words, a growth of around 60% compared to the previous year. This was partly due to the fact that there has been an increase in carbon pricing mechanisms around the world, currently reaching 68 different regulations, that is, ten more than in 2020 (Ecosystem Marketplace, 2021). Similarly, the voluntary market has shown an increase in both its supply and demand for carbon credits, making clear the trends in the graph shown below:

Figure 2. Volume of carbon emissions and withdrawals in the voluntary market (Ecosystem Marketplace, 2021)

Accompanied by these movements, there are some conclusions for the next few years in the carbon credit market, especially for those coming from nature-based solutions. Different studies on market trends, such as those developed by the World Bank and Sylvera, reveal that companies will prefer carbon credits generated by removal to those generated by reduction, also expecting its price to increase. This increase will be mainly due to a lower availability of high-quality carbon credits and because it is estimated that demand will have a higher growth rate than supply. Additionally, carbon credits from nature-based solution projects are expected to cover the majority of the market in the following years (The World Bank, 2022; Sylvera, 2022).

What size is the opportunity?

Until now, there has been discussion about what the carbon market is, the instruments and mechanisms that compose it and what are the benefits of investing in it, however, there is still a question to be answered: what size is the growth opportunity of an investment within the carbon market today? It is important to mention that although today there are more public policies that regulate and promote the market and that prices are increasing, currently only 23% of greenhouse gas emissions fall within a regulated carbon pricing scheme And only 4% of global emissions are priced between 50 and 100 dollars per ton of CO2e, a range that is needed by 2030 if we want to meet the goals of the Paris Agreement. Thus, it is possible to observe that it is still an excellent time for companies or individuals who wish to invest in projects that combat the climate crisis to do so. In addition to the expected benefits both from profitability and from the rise in carbon prices, it is clear that these projects will contribute to generating multiple highly positive social and environmental benefits that will set us on the path of building a future compatible with life.

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About the author:

Luis is a Commercial Coordinator in Toroto. He studied Sustainable Development Engineering and specialized in climate strategy for companies. He is passionate about nature for its beauty and its perpetuity.

References

• Forest Trends Ecosystem Marketplace. (2021). Market in Motion. State of Voluntary Carbon Markets 2021, Installment 1. Washington DC: Forest Trends Association.
• IRENA. (2021). Global Trends, Available in: https://www.irena.org/Statistics/View-Data-by-Topic/Costs/Global-Trends
• Paul Hawken. (2017). Drawdown, The Most Comprehensive Plan Ever Proposed to Reverse Global Warming
• Sylvera (2022). Carbon Credit Crunch Report. Available in: https://www.sylvera.com/resources/carbon-credit-crunch-report
• The World Bank. (2022). State and Trends of Carbon Pricing 2022. World Bank, Washington, DC. Doi: 10.1596/978-1-4648-1895-0. License: Creative Commons Attribution CC BY 3.0 IGO