Some Initial Thoughts on Carbon Markets and Carbon Removal

One of my top priorities for this summer is to pressure test some intial biases and perspectives to develop a far more nuanced understanding of the carbon markets and carbon removal space.

This all started, as do many great (and terrible) ideas, over beers with a dear friend on a typically bleak winter evening in Cambridge, Massachusetts. My friend Sidd Shrikanth and I snuck in one last cheeky pint before he was headed off for winter break and then back to Palo Alto to finish the last semester of his dual-degree program. He was busy planning to visit some biodiversity projects abroad as part of his research for his soon-to-be-published book, The Business Case for Nature. As we discussed the pro’s and con’s of nature-based solutions for carbon removal, I raised the obvious concern of permanence and Sidd responded, saying there was far more at stake than just carbon sequestration for these projects––I needed to get my head out of the technology gutter for a minute or two.

Sidd was right. I am extremely biased toward technology; prior to graduate school, I was mentored by some OG technologists (Microsoft, AT&T veterans) who pounded into my head four things: unit economics, capex light business models, IP defensibility, and tech-enabled scalability. I came to MIT and Harvard to fully immerse myself in the climate tech ecosystem in the greater Boston area (and have quickly dispelled most of that capex-light thesis when it comes to climate tech)––and mission accomplished. A consequence of this is that I clearly have some opinions that deserve to be poked and prodded. Here are a couple of initial thoughts as I set out for the summer:

The supply of high-quality, verified carbon credits is the most urgent problem to solve in carbon markets; demand-side issues are still important, particularly for tech-based removal, but less urgent. As carbon markets triggered waves of attention this past year, one particular set of players found their way into this space in a somewhat concerning fashion. Touting the need for a decentralized, liberalized marketplace to make the purchase of carbon credits easier and to avoid double-counting, crypto and blockchain techies stepped into the arena. In 2021, Toucan, a blockchain-based carbon credit marketplace, sought to drive up the cost of carbon credits for better quality projects by retiring older carbon credits issued by Verra for Base Carbon Tokens, BCTs. This resulted in a significant swing in carbon credit prices and over 25% of carbon credits purchased from Verra, raising concern among many in the carbon credit ecosystem.

"It's mind frying," said Robin Rix, Verra's chief legal, policy and markets officer. "Carbon credits themselves are abstract intangible things based on counterfactuals of things that you can't actually see – emissions. And then crypto is another layer of abstraction on top of that." – excerpt of S&P Global report

I bring this up to highlight one key concern: many in the intersection of crypto and climate are calling for a more decentralized market for carbon credits and “removing the middlemen” from the process to open up greater demand in the market. But with high variability in the quality of projects and the expertise necessary to properly assess the validity and carbon removal impact of nature-based and technology-based solutions, these middlemen (e.g. credit validators and verifiers, brokers, etc.) are the glue that holds the fragile integrity of this market together. The bigger problem lies in getting more quality projects online––and more quickly. Perhaps there may be a role for blockchain to play in the non-fungibility of credits, or other use cases in the future, but for now, the primary focus should be on improving supply-side quality and quantity.

Technology-based carbon removal’s durability is superior to nature-based solutions. When assessing the quality of a carbon sequestration project, there are several key factors that are considered: they must be additional, non-fungible, verified/accurate, durability, and harm-free, preferably with additional co-benefits (more relevant for nature-based solutions). These certainly are not easy standards to live up to and many projects fail to do so. The ultimate challenge is durability.

In Microsoft’s recent Carbon Removal report, the Carbon Program team highlighted some key problems and lessons learned:

  1. The markets lack strong, common definitions and standards,

  2. high-durability solutions are short in supply and expensive,

  3. most nature-based solutions can only offer short-term durability (hundreds of years); biochar is the main incumbent in the medium-durability (carbon is sequestered for hundreds to thousands of years) space.

High-durability carbon removal consists of solutions that sequester carbon for thousands of years, and typically involves sequestering carbon geologically after capturing via biomass, direct air capture (DAC), or mineralization for example. While these highly durable carbon removal solutions are highly desirable, they also happen to be extremely costly. Currently, nature-based carbon credits are priced at $10.38/mtCO2e, whereas a carbon credit sourced from Climeworks, a DAC-based carbon removal company, is only expected to drop in price from approximately $1100/mtCO2e to $250-300/mtCO2e by the end of the decade.

The large majority of carbon removal-based carbon credits are supplied by nature-based solutions today and will be until 2030. After that, technology-based solutions will play a critical role in achieving decarbonization targets. Based on the following supply curve, technology-based solutions will not hit a market-viable price by 2030; until then nature-based solutions will dominate the market:

Figure 1. Carbon Removal Supply Curve for 2030 (Source: The Taskforce for Scaling Voluntary Carbon Markets, Final Report 2021)

That said, many private sector player are already paying a premium for technology-based carbon removal: Boston Consulting Group, LGT, Mitsui, SwissRe, and UBS are founding buyers of 1 million tons of carbon removal by South Pole by 2025 and Stripe launched Frontier, an advanced market commitment (AMC) of nearly $1 billion for permanent carbon removal by 2030, earlier this year. These commitments are particularly exciting because they go against conventional economic market dynamics––the reality is that most carbon credits purchased through 2030 and beyond will be nature-based, and therefore will largely have short-term durability.

Another way of looking at this:

Figure 2. Future Scenarios for Carbon Credits in 2030/2050 (Source: The Taskforce for Scaling Voluntary Carbon Markets, Final Report 2021)

Even after playing out several scenarios, as the figure above from The Taskforce for Scaling Voluntary Carbon Markets Final Report demonstrates, 2030 will be nearly entirely dominated by nature-based solutions; but a look to 2050 tells a different story. By 2050, the world will be in desperate need for technology-based removal. Those stakeholders in the ecosystem that are taking on the risks of investment in these technologies now, purchasing credits at a premium, and boldly catalyzing market demand now are making those 2050 scenarios a reality for us all.

Because of this, we need to find ways to drive tech-enabled NBS to improve and validate carbon removal; current processes for monitoring, reporting and verification (MRV) are not scalable enough and lack integrity. In conversation with Nadeem Khan, Founder and Managing Director of Indus Delta Capital, the project developer of Delta Blue Carbon, the world’s largest Verra certified mangrove restoration project, Nadeem highlighted the process of surveying and measuring required to properly model a project’s sequestration impact. Going tree by tree, you would have to measure each trunk and each crown in order to gather the proper inputs for a model––across hundreds of thousands of acres––and that’s just one input––the process is time intensive and costly. While some project developers are able to find the capital necessary to even get a project off the ground, there are plenty of smaller projects that would never be able to afford the upfront costs required to come online.

New technologies are emerging to help with this. Viraj Sikand, Co-Founder of EarthAcre, has been working with the Davies Lab at Harvard to bring new drone-based LiDAR and sensing technologies to market to dramatically improve the process for quantifying carbon sequestration and even biodiversity monitoring. In doing so, EarthAcre seeks to bring more indigenously held land onto the carbon market, generate revenue for these communities, and create a healthy economy that allows these communities to maintain ownership over this land.

An exciting intersection between technology and nature is emerging, and as these technologies continue to improve, there is an opportunity to dramatically improve the quality of the MRV process for these projects and even get more smaller-scale projects online.

Since the carbon credit economy initially emerged as a means of incentivizing emissions avoidance, these markets, particularly compliance markets, are not really designed for carbon removal. Therefore new market systems and standards must be established moving forward. The history of carbon markets really starts back in 1997 when 180 countries signed onto the Kyoto Protocol, an international emissions trading agreement linked to the UNFCCC, which is generally acknowledged to have been a failure (you might even go back a little further to the Clean Air Act of the 1970’s and the first offset project in 1989, but stay tuned––a full history lesson forthcoming).

In the grand scheme of market development, 25 years is not that much time to establish a fully-functioning, brand new economic market. More so, the dynamics of this market have also rapidly evolved as public demand for climate action, governmental and corporate climate commitments, and new climate tech innovations have grown exponentially in this time period; both market demand and supply have gone through dramatic changes since the first emissions trading systems were initially proposed.

Many carbon credit purchasers have had to manage their own due diligence processes without consistent market standards for carbon removal, particularly among nature-based solutions. Carbon accounting is also a new organizational function that, again, is not standardized across industries. Benchmarks, rules, protocols and mechanisms necessary to prevent negative spillover effects and the purchase of low-quality carbon credits are desperately needed to help carbon credit purchasers make smarter decisions more effectively. Corporate purchasers that have already been doing the meticulous work required to make wise carbon credit purchases have had to learn the hard way, and have built out the teams and expertise necessary to do so at their own cost.

As the ecosystem matures, highlighting critical gaps and putting the right minds and skills to the task will, hopefully, move things in the right direction toward scalability.

Next up: unpacking the background and history of carbon markets.

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