28 April 2023

Carbon isn’t just another commodity market

Tommy Ricketts

Co-founder and CEO

5 min

This article initially appeared in Carbon Pulse on April 27th

Behind all the noise, opinions, and stakeholders, lies one meta debate in the Voluntary Carbon Market: what financial market structure should it ape to scale. Get the analytical approach right, and buyers will have confidence in the credits. Grow demand, and capital will flood into projects that accelerate Net Zero.

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The preferred playbook to date has been a commodity market. This philosophy only goes so far. Incorporating the risk-based approach favoured in bond markets offers a far more robust path to reaching escape velocity.

The commodity view of scaling carbon markets has a lot to offer. 

It works brilliantly for compliance markets that blend declining emissions budgets and a regulated number of allowances for participating companies. Every allowance is a contract worth one tonne of carbon emissions and each contract is totally fungible. 

Companies able to reduce emissions below their target sell surplus allowances to those unable to. The equilibrium price reflects the marginal cost of abatement for all actors in the market and one contract type means there’s only ever one price per set of market rules, e.g. the European Union or California. Rising prices unleash a virtuous decarbonisation cycle. 

The Voluntary Carbon Market is, by definition, not subject to the same compulsory demand. Yet a similar commodity theory of scaling has prevailed for much of its short history.

Projects can issue carbon credits against their climate positive activities where a market or policy failure prevents them from otherwise taking place. 

To do this, they must follow Standard Bodies’ methodologies. These exam papers set the rules for how to evidence the project’s claims. 

An issued credit is effectively a financial instrument that promises to deliver a verified and validated tonne of carbon dioxide equivalent. At least in carbon terms, every tonne purports to be equal whether nature or technology, avoidance or removal.  

This approach has undoubtedly helped incubate the market. It gives confidence to investors who can lend against the future revenues or expected credit streams; and end buyers who can retire credits against hard to abate emissions. 

Unfortunately this year has proven its limitations. If quality is binary, or a tonne must be a tonne, evidence disproving that each credit is exactly a tonne is existential. 

Relentless news headlines from carbon market detractors are far more aggressive in how they frame this debate. They go as far as accusing well meaning developers, accreditors, and buyers of aiding and abetting “greenwashing”. 

Their campaign is proving effective. Low buyer confidence is translating into declining secondary market volumes and falling prices. Less money is being invested today than last year in projects billed as accelerating the path to Net Zero. 

No problem says the commodity view. Improve the accrediting methodologies. Better still, start again and set new, stricter rules.

This certainly appears to be what some claim one aspect of the much anticipated Core Carbon Principles aims to achieve.


Generally speaking, the CCPs focus on how to improve overall market structure. Welcome calls to standardise disclosure rules and systems of reporting are uncontroversial. Their recommendations channel general best practice from scaled financial markets (not just commodity markets). 

One aspect of the CCPs though seeks to redefine carbon credit integrity at an instrument level, in line with the prior commodity paradigm.

Under the proposal, the IC-VCM will stipulate which methodologies, and which activity types, meet its definitions of integrity, aka quality.

The ambition is that raising the bar and retaining the one tonne is one tonne mantra will restore buyer confidence. Trust will reignite the demand cycle and money will pour into much needed projects. 

We’ve seen how this playbook ends. Ironically, it’s the reason the IC-VCM was created. 

The risks to treating a credit as a fully standardised commodity are two-fold. 

First, and most seriously, opponents (let alone supporters) of financialising nature will continue to expose every and any chink, however big or small, in an approach that attempts to guarantee an outcome. 

If the CCPs tell everyone to trust the instrument, it delivers a tonne, and it’s shown otherwise, it risks undermining buyer confidence once and for all. 

Second, experience from flattening quality in the financial contract space incentivises actors to deliver the cheapest compliant credits. This has led to forward prices being below spot prices, which does not encourage liquidity to enter the market, or hedging. Both total necessities.

Carbon ratings offer a way to thread the needle. Like financial ratings, they take a risk-based approach to assessing carbon quality. The outcome isn’t one or none. It’s about understanding and pricing the risk that an outcome is somewhere in between. 

By carbon rating, I am not referring to a trust pilot or trip advisor type of consumer rating. Nor a consultancy type advisory product as some are offering. These have value for end buyers but lack a theory of market structure. 

We are exclusively referring to carbon ratings that ape the architecture of financial market ratings, and offer an opinion on the probability a given security delivers on its promise.

This ratings paradigm acts as an information signal for market actors to help them make better decisions. For example, to reward projects with low risks with higher prices. In turn that price serves as a signal of the market’s assessment of the risks associated with a given instrument’s claim.

Performance level data, such as project failures, will improve their accuracy over time. So too a commitment by serious ratings providers to be transparent about how they rate, and publish their headline ratings (as S&P or Moody’s do). 

Financial carbon ratings must also be fungible across project type. Inputs and assessment techniques can differ, but unless a rating agency uses one master methodology the end product won’t be apples and apples across project type (banks, tech and consumer corporate debt all use the same methodology). 

By not solving for perfection, a risk-based approach also creates a positive feedback loop with threshold standards. It allows the market to signal to standards or rule setters where new rules or technology-led innovations can best improve outcomes.  

Ratings provide a more nuanced toolkit for buyers too. After all, carbon credits are only useful if end buyers can use them to make claims. The solution we are developing is to embrace portfolio theory. 

In the same way that every financial asset faces idiosyncratic risks, so too does every carbon credit. Building an optimised portfolio in carbon allocates capital to a range of climate mitigating projects and enables a diversified approach to making the claim that comes with it.

For example, end buyers can minimise their exposure to specific risk factors they want to avoid, such as over-crediting or non-permanence, or optimise for specific exposures, such as strong additionality. 

Indeed, the same can be said for any stage of the credit’s lifecycle: origination, pre-issuance, or post-issuance - all areas BeZero offers or is actively developing tools for.

Last year we saw the correlation between BeZero’s ratings and prices rise as transaction value rose. This is proof that the more money at risk, the more participants value risk-based analysis on top of quality standards. 

Last week we celebrated a year since we launched the market’s first global carbon rating platform. That thousands of organisations have subscribed to our headline ratings and hundreds of customers scour the platform each month for detailed project assessments confirms the market is buying into this approach. 

A market structure based on disclosure and reporting, with CCPs setting a higher bar, and transparent ratings guiding price above that threshold, is emerging as the most robust approach to scaling the Voluntary Carbon Market.

To be clear, we support the IC-VCM and colleagues there are publicly supporting the role of financial ratings and their ability to compliment the CCPs. We are both striving to professionalise market structure. 

The only point of difference is whether the end instrument (the carbon credit) can ever, or should ever, be fully standardised, which is the fundamental feature of a commodity market. 

If we embrace a system whereby credits trade like a bond, the traded price would reflect the view of all market participants, not just one institution, of the likelihood the credit delivers its claim. 

The IC-VCM inherited a commodity market approach, so it is easy to understand why we are here. Carbon credits are a complex, heterogeneous and analytical frontier asset class. To scale with impact, we should look to more than just commodity markets for how to succeed.

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