There’s a looming carbon credit supply crisis, and the carbon markets aren’t ready for it.
Here’s the TL;DR: demand is expected to keep growing, but as more emission reduction credits that make up the majority of carbon credits today fail to meet high-quality criteria, the carbon markets will find themselves even more supply-strapped than ever.
According to Trove Research, the voluntary carbon markets could see potential demand grow to somewhere between 340 to 1,300 million metric tons of CO2e by 2030 and to somewhere between 1,100 to 3,600 million metric tons of CO2e by 2050.
Future Demand Scenarios for the VCMs, Trove Research 2021
A look at the supply of credits today shows a troubling contrast: inventories are plummeting and cannot keep up with growing demand. Simply put, the bathtub is draining faster than we can fill it.
Year-on-Year Change in Available Inventory, Sylvera 2022
Sylvera reported in its 2022 Carbon Credit Crunch report that while carbon credit demand increased fourfold in 2021, carbon credit inventories dropped by 50% in the same year. The year-on-year change in available carbon credit inventories has been falling consistently since 2018. Last year saw a sharper drop in carbon credit inventories than the more conservative growth forecasts anticipated, as seen above. Today’s carbon credit inventories are being dwarfed by demand. As the market aspires to select higher-quality carbon credits, the supply of carbon credits will only get more strained.
Emission Reductions versus Removals
For those new to the world of carbon credits, there are two means of generating carbon credits today: either through emission reductions or through removals. The former are generated by projects that reduce or avoid emissions compared to a counterfactual scenario. Removals are those generated by projects that directly remove CO2 from the atmosphere and sequester it into carbon sinks, such as through geologic storage or in biomass, soils, or oceans.
Emission reduction credits comprise most of the current carbon credit supply and are usually generated through avoided deforestation and renewable energy projects. Over 74% of carbon credits issued in 2021 were either from avoided deforestation projects or from grid-connected renewable energy projects, according to Carbon Direct. Avoided deforestation projects are considered emission reduction projects as a result of the emissions prevented from being emitted into the atmosphere if the forests were destroyed in an otherwise likely scenario. Avoided deforestation projects are often referred to as REDD+ projects and are vital climate solutions––not just for carbon sequestration but for the protection and conservation of biodiversity––and have come under greater scrutiny recently due to challenges with setting accurate baselines and counterfactuals. Still, a mature forest can sequester far more carbon than one regenerating and can help support biodiversity in ways other carbon projects simply cannot.
Renewable energy-based carbon credits, typically developed through the Clean Development Mechanism, have historically been considered emission reduction credits. However, their relevance in the future of carbon markets is now being called into question. The premise of using carbon finance to develop renewable energy projects was to help offset the costs of a wind or solar project and avoid installing fossil-fuel-based energy projects that would have otherwise been more economically viable. This was a huge success for carbon finance in its earlier years. Still, as the cost of wind and solar has plummeted over recent years, carbon credits generated from these projects no longer meet the criteria for high-quality credits, and of additionality criteria in particular. More details on this later.
Removal-based carbon credits make up a much smaller portion of the carbon market today: only 3% of carbon projects from the top four carbon registries are considered removals, with 13% categorized as mixed-removals. Currently, most removal or mixed-removal projects typically come from nature-based solutions such as reforestation, mangrove restoration, or grassland restoration projects. On the rise are engineered removal solutions that range from direct air capture (DAC) and carbon mineralization to a suite of hybrid approaches such as ocean alkalinity enhancement, bio-oil injection into geologic sinks, enhanced rock weathering of basalt and olivine, macroalgae sinking and others.
The appeal of engineered removal largely rests on the high degree of permanence associated with many of these projects: geologic sequestration, often considered the gold standard of permanent sequestration, is expected to guarantee storage for more than 10,000 years as opposed to most nature-based solutions that typically can only ensure permanence for up to 100 years at best. While several more sophisticated carbon credit purchasers, such as Stripe and Microsoft, have been purchasing more permanent carbon removal credits, direct air capture companies have just achieved 10,000 tons of CO2 removal per annum; that’s approximately 0.0017% of all credits sold in 2021. These technologies must rapidly scale up if we expect to hit Paris-aligned climate targets.
The Shift from Reductions to Removals
In 2020, researchers at Oxford University published The Oxford Principles, now considered a best-in-class framework for responsibly engaging in carbon offsetting that aligns with hitting a Paris-aligned net-zero 2050. The principles are as follows:
1. Prioritize cutting emissions as much as possible, use high-quality offsets to account for residual emissions, and be ready to reassess your strategy as practices evolve. If a company is not setting and achieving ambitious decarbonization targets, purely relying on carbon offsetting to achieve net-zero targets is not only ethically dangerous, it is simply infeasible. A quick comparison between global emissions and forest-based offsets shows the overwhelming challenge of attempting to do so:
The Supply of Carbon Offsets Currently Listed on Registries Compared
to U.S. Corporate Emissions, J.P. Morgan 2021
Decarbonizing the economy requires dramatic cuts in emissions. But, unfortunately, more is needed to achieve a net-zero 2050.
2. Shift away from emission reduction-based carbon offsets to removal-based offsets to achieve Paris Agreement-aligned 2050 goals. While emissions reductions are necessary to achieve climate targets, more is needed. According to the IPCC, billions of tons of CO2 must be removed from the atmosphere by 2050 on an annual basis to achieve net-zero targets.
1.5ºC Pathway Emissions, TSVCM 2021
Negative emissions technologies have created a stir in the climate community, with some arguing that using them presents a moral hazard and will shift focus away from deploying emission reduction solutions today. Unfortunately, we do not have the privilege of choice. Removals will be required, and the highest quality, long-duration removal solutions must be rapidly scaled in the years to come, alongside achieving aggressive decarbonization targets.
3. Shift to long-duration removals, such as through geologic sinks, over time. Carbon removal solutions, also known as CDR, exist along a spectrum of durability and permanence. Nature-based solutions such as reforestation and ecosystem regeneration are robust short-term solutions to pull carbon from the atmosphere. Still, from a carbon sequestration standpoint, they are temporary solutions because of their high risk of reversal. I like to look at nature-based removal as a way to buy us time to drive permanent removal solutions further down the cost curve, so they are more economically viable.
Example of an Oxford Principles-Aligned Carbon Offset Portfolio
The chart above visually represents an Oxford Principles-aligned portfolio of carbon offsets over time. Gradually, a portfolio must shift from emission reductions to removals and permanent carbon storage over time. Unfortunately, unless there is a significant overhaul in how carbon markets operate, this will become an even greater challenge as we get closer to 2050.
Removals are not on track
According to the Voluntary Registry Offsets Database from the University of Berkeley, which aggregates data from the top four carbon credit registries (i.e., Verra, Gold Standard, the American Carbon Registry, and the Climate Action Reserve), 84% of carbon credit-generating projects were emission reductions projects. Of the remaining 16%, only 3% were impermanent removals, and no removals projects in the top registries utilized permanent storage.
Distribution of Carbon Credit Projects in the VCM Registries, data from VROD 2022
It’s clear that removals are not on track––but as we keep diving deeper, the supply crisis only gets even more challenging. Two significant trends are going to push the carbon markets to their limits in the years to come: (1) more emission reductions projects, which fuel the majority of the supply of carbon credits today, will be disqualified from the carbon markets, wiping a considerable source of carbon credit supply that will further strain the supply-side of the markets and (2) the shift toward removal-based carbon credits will reveal significant mobilization barriers.
Up next: some major challenges that emission reduction carbon projects will have to address to maintain relevance and the mobilization barriers to scaling removals after that.
Some good reads:
2022 Commentary on the Voluntary Registry Offsets Database, Carbon Direct