Market headwinds in 2023, cautious optimism for 2024
Since the release of our report on Forest Carbon Markets in February 2023, the market has met headwinds. Carbon pricing mechanisms, such as emissions trading schemes (ETS) and carbon taxes, continue to expand globally. Prices for carbon credits on leading exchanges, including the EU ETS and California Cap-and-Trade, remain elevated. However, forestry carbon credits—especially those from avoided deforestation (REDD) in tropical regions—have faced strong critique, resulting in reduced demand and prices in 2023.
Growth of carbon pricing
As mentioned in our earlier blog, governments worldwide are increasingly imposing a price on carbon to address the significant challenge of reducing global emissions of carbon and other greenhouse gases. This is crucial because most steps necessary to reduce emissions involve substantial costs, and the emissions themselves represent a cost through the impacts of climate change on society and ecosystems. Carbon pricing mechanisms aim to penalize higher emitters and reward those emitting less or removing emissions from the atmosphere.
There are two main type of carbon pricing mechanisms:
- Cap-and-Trade: Organizations covered by cap-and-trade systems are assigned an allowable level of emissions (“cap”) and must either reduce emissions to that level or purchase emissions allowances from another organization within the mechanism (“trade”). Prices are not set but determined by the trade between participants in the system. The largest global cap-and-trade mechanism is the EU Emissions Trading System (ETS).
- Carbon Tax: A surcharge levied on emissions or on fossil fuels in proportion to the amount of emissions resulting from their combustion.
Carbon pricing mechanisms have grown globally, from a handful of mechanisms covering less than 1% of emissions in 2000 to 73 mechanisms covering 23% of emissions in 2023 (Figure 1). New mechanisms continue to be introduced, with recent examples including ETS in Austria, Washington State, and Indonesia.
Figure 1: Growth of carbon pricing mechanisms
Continued elevated prices
Carbon prices remained high in 2023 on most leading exchanges (Figure 2). Average prices on the EU ETS were $91/tonne in 2023, a slight increase from $85/tonne in 2022—a record-high level. Prices on the California Cap-and-Trade rose 16% from $33 to $28/tonne. On another large North American exchange, the RGGI, prices remained at similarly high levels seen in 2022.
Not all markets saw higher prices. Prices on Korea’s ETS continued a downward trajectory. Prices for allowances on the New Zealand ETS initially fell in 2023 from record levels in 2022 but recovered strongly towards the end of 2023.
Figure 2: Carbon prices
Negative media coverage
In 2023, media coverage of forest carbon projects, particularly those based on avoided deforestation in tropical regions (REDD), faced significant challenges. The Guardian, a UK newspaper, published a series of articles strongly criticizing these projects, asserting that “more than 90% of rainforest carbon offsets are worthless,” based on an analysis of projects certified by Verra. They contended that the threat of deforestation in the project areas was exaggerated, and only a few projects demonstrated evidence of deforestation reduction. Verra countered these claims, stating that the conclusions were incorrect and questioning the methodology.
At the heart of the debate is how to establish a baseline for deforestation, i.e., determining the level of deforestation that would have occurred in the project area if the project was not implemented. Verra bases REDD baselines on actual deforestation in areas surrounding the project, selecting project areas deemed at high risk of deforestation based on factors such as forest type, infrastructure, agriculture practices, and economic activity. The Guardian’s reporting relied on three scientific studies using “synthetic controls” for baseline deforestation, a methodology Verra claims is inaccurate for REDD projects. For instance, the modeling excluded critical factors driving deforestation, control areas were often randomly chosen in different regions of the country, and, in one study, a protected area was selected as the control site for a project destined to be a commercial logging concession.
In addition to Verra, many others in the REDD community criticized the approach and validity of the scientific articles on which The Guardian based its reporting, including ClimatePartner and EverLand (“The science behind The Guardian piece is fatally flawed“). However, this critique prompted project certifiers like Verra to review their standards and address concerns.
As detailed in our 2023 report, criticism of forest carbon projects is not exclusive to tropical regions. Independent projects in the US faced scrutiny, notably in Bloomberg and John Oliver’s HBO show “Last Week Tonight”. Common arguments include that projects do not bring about substantial change, benefits are temporary, or that harvest reductions in a project area lead to increased harvest elsewhere. While these concerns should already be addressed by the common standards of carbon projects (respectively: additionality, permanence, and leakage), the critique underscores the need for improvement—namely, all projects must undergo independent certification by a reputable agency, and standards must be rigorous and effectively communicated.
Headwinds for forest carbon projects
Possibly due to the negative media coverage, demand for forest carbon credits from independent projects declined by 34% in 2023 (Figure 3). However, there are signs of improvement; demand reportedly surged in the last few months of the year. The decline is also likely attributed to lower overall demand for carbon credits in 2023; demand for credits from renewable energy, the other major source, also fell by 34%.
Figure 3: Independent supply of carbon credits by project type
Prices for nature-based credits, such as those from forestry, have also experienced a decline relative to other project types (Figure 4). Credits from carbon removal projects, including direct air capture and BECCs, now command an even larger premium. The premium that nature-based credits previously held over those from emissions avoidance and renewable energy projects has largely diminished.
Figure 4: Carbon credit prices by project type
Cautious optimism for 2024
Looking ahead to 2024, we approach the market for forest carbon credits with cautious optimism. Firstly, in response to negative media coverage, project developers and certifiers are actively reviewing their standards, making improvements where necessary, and communicating these changes to stakeholders to build trust. Secondly, there seems to be ongoing momentum in the development of new projects and funds. In November, Manulife announced the successful closure of their “Forest Climate Fund” after raising USD 224 million, intending to invest in projects prioritizing forest carbon sequestration over timber harvesting. In January, Vietnam’s Ministry of Agriculture and Rural Development (MARD) disclosed that it sold 10.3 Mt of credits to the World Bank in 2023, valued at USD 51.5 million, related to the protection of natural forests in the country.
Compliance markets for carbon credits are evolving. In New Zealand, forest carbon credits continue to be sold on the national ETS. The government is reviewing the system and proposing a new annual levy on forestry projects (equivalent to USD 18/tonne). However, with prices for credits consistently above USD 35/tonne, this may not deter investors. As of December 2023, the number of forestry participants on the NZ ETS was 3,997, reflecting a 3% increase from 12 months earlier and a substantial 72% increase from December 2021. In the EU, the European Commission continues to slowly progress with plans to introduce a new framework for certifying carbon removal credits from agriculture and forestry activities in the region.