The proliferation of voluntary carbon market intermediaries
Middle-men thrive in markets of fragmented buyers or sellers, especially when there is information asymmetry and difficulty accessing a market. Humour me while I illustrate what I see happening in voluntary carbon credit markets with the experience of smallholder farmers.
A smallholder farmer selling tomatoes might earn well below the market price for their crop when a trader comes knocking. They may not know the going rate for their produce and they might lack the physical means to take it to a market. They are also eager to sell quickly, and the trader knows it, because tomatoes don’t last forever, they don’t have access to a refrigerator, and they need to make a living.
Similarly, the buyer lacks the resources to canvas every small farmer to make sure they are getting the best deal and quality, nor the ability to transport them back to the city in small quantities. A savvy intermediary can take a handsome cut of the difference between what the seller is willing to accept, and the buyer is willing to pay, by helping solve both sides’ problems.
This story needn’t be nefarious. The intermediary is providing a valuable service to both parties, and profiting from their efforts. In the voluntary carbon market, there are a dizzying number of intermediaries who are turning a profit from solving the buyers’ and sellers’ problems.
Companies buy carbon credits in the voluntary market even when they are not compelled to do so by law. One reason to buy carbon credits is to offset the carbon emissions of their operations and impress shareholders and customers, while avoiding the cost of actually reducing their own emissions. Communities, landowners and other companies can sell them these carbon credits if they are reducing emissions through their activities.
The intermediaries that support them include project developers, who find opportunities to reduce emissions and work with communities or businesses. There are also companies and NGOs that certify that the project meets a certain standard of carbon reduction. Ratings agencies provide assessments on whether the standards have been met. Brokers help projects to sell credits to corporate buyers for the best price. Financial providers fund the projects, expecting a return. Financial advisers assist financiers, helping them to complete due diligence on projects. There are consultants advising on the best way to go about buying credits. The list goes on.
The rationale for these layers is to allow investors and purchasers to make informed decisions on the quality of carbon credits. Given the lack of government regulation and the perceived difficulty of rating a project in a far-flung country or operational site, these intermediaries can give companies the confidence to purchase a credit they otherwise wouldn’t buy, and allow them to justify paying a higher price for it.
However, these layers of intermediaries could ultimately reduce the portion of carbon credit sales that communities and developers receive. They might also raise the cost of credits for buyers, rendering them less attractive for investment.
Carbon offset insurance is the latest such intermediary in the fragmented, unregulated, voluntary carbon market, recently reported by Bloomberg. The idea is that investors are compensated if an offset turns out to be less ‘robust’ than advertised by its rating or certification, or if there is an accident like a forest burning down.
The argument for why this is a necessary and superior intermediary to a mere certifications or ratings agency is because the insurer’s interests are aligned with the buyer. Insurers are incentivised to assess projects properly, because they are obliged to pay out if a project does not meet the stated carbon reduction standard.
Yet if buyers believe that the multitude of certifiers, ratings agencies and brokers are unable to effectively assess a carbon reduction project, why would adding yet another ‘objective third party’ help?
It seems reasonable to insure against the loss of credits from catastrophic events which are out of the control of a sponsor, like a bushfire, and is a positive sign that carbon markets are approaching the sophistication of other commodities. But insuring against whether a credit is legitimate seems like it absolves too much responsibility from the rest of the intermediaries who verify the credits. It feels like the difference between protecting your truckload against accidents, versus compensation for receiving a delivery of plastic replicas [1], after several people were paid to check the truck and told you it contained fresh tomatoes.
The outcome of a successful insurance claim also does not actually reduce carbon emissions. If a carbon credit is purchased, and later revealed to be ineffective at reducing carbon emissions, simply paying the purchaser some ‘financial damages’ does not take that carbon out of the atmosphere.
Given the confusing information to navigate and the variety of standards available for a carbon project, it seems that the government is in a prime position to help. The SEC’s recent crackdown on crypto is an interesting example of a government stepping in. They have used securities law to stop people from being hoodwinked into giving their money to companies that don’t really do what they say they will do.
For carbon credits, government could set regulation on what a legitimate carbon credit looks like, and punishments for selling one that does not actually meet the criteria. The US government’s announcement to set principles for “high integrity” voluntary carbon markets is a positive first step.
Of course, intermediaries would still exist, as they do in almost every market. But the sheer number of intermediaries that are all trying to achieve the same thing – assessing whether a carbon credit actually reduces carbon emissions – could be reduced by unifying under one regulatory framework rather than competing parallel systems. A penalty for non-compliance might also be a cheaper way to ensure that projects are high quality versus sending armies of consultants to assess their integrity.
This is even more important for governments to do in the context of meeting their international emissions reduction obligations. Starting with voluntary carbon credits regulation could help governments warm up for an eventual economy-wide carbon pricing scheme, which would do more than a voluntary system to shift consumer behaviour towards lower carbon products.
[1] Although the fake nickel case documented by Matt Levine is a wonderful example of this happening in a different commodity.