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Carbon Credits – a victim of its own success?

Finalising a part of the Paris Agreement that deals with international carbon markets will be a key focus for negotiators at Cop26. Renat Heuberger, chief executive of South Pole, a Switzerland-based social enterprise focused on climate solutions and carbon project development, explains what's at stake.

One of the most important and thorny tasks facing negotiators at Cop in Glasgow this week is Article 6 of the Paris Agreement. This article governs international trading of carbon credits (also called ITMOs) to lower emissions, with the goal to reduce greenhouse gases where it is cheapest. For example, Switzerland invests in Thailand to promote electric vehicles.

A transition to net-zero emissions needs to happen by 2050 according to scientists in order to avoid the worst consequences of a warming world. Carbon credits are a key instrument to finance projects that are ready to be deployed today, especially in poorer countries. For example, when a cocoa farmer in Ghana plants trees to shade crops, when villagers in Indonesia grow mangroves to protect their shores, when biogas is converted to clean power in Mexico - in all of these cases, emissions go down and the projects generate carbon credits. These are sold, for example to South Pole, and the  revenue stream  ensures the long-term financial viability and sustainability of the project.  A project developer is no longer dependent on fickle donations. 

Over the past 20 years, carbon credits have gotten projects around the world off the ground that otherwise would not have been bankable. For example, South Pole has channelled several hundred million Francs to nearly 1,000 projects in over 50 countries. 

The key difference between carbon finance, as it’s called, and donations or grants is that carbon credits are an example of “result-based finance”. This means that each ton of CO2 that is reduced must be measured and verified by an independent 3rd party – and the payment for the credit happens only upon delivery of the result. A contract for result-based finance in turn creates the case for an impact investor to finance the underlying asset. For example, an investor now has a profitable investment case for planting a forest in Zambia, because he has a guaranteed revenue stream for the sequestered CO2 every year that trees grow.

This set-up has two advantages: 

First, all involved parties have a very strong interest in the success of the project, long-term. Simply planting a tree using a donation and then letting it die is uninteresting, because that way you don’t generate a single carbon credit and thereby no revenue stream over the next 10-15 years.

Second, the carbon credit mechanism is extremely transparent. Each reduced ton of CO2  is tracked in a public registry. How a project fares is for all to see - success or failure.

What’s ironic is that  carbon credits are a victim of their own success: Because of the full transparency, a project with a problem is discovered very quickly. This is great, since the goal is to see what is going wrong, take corrective action, and improve projects continuously.

Sadly, oftentimes journalists or civil society conclude that the discovery of a problem in a project means the entire mechanism is not working properly, when in reality the opposite is true. While in donation-based schemes, the actual impact of a project is often very unclear – and therefore difficult to measure or criticise – the whole point of carbon credits is to discover failures quickly, and learn fast to achieve the desired impact.

Carbon credits are the only environmental commodity that has ever really gotten used at scale. Done right, carbon finance can funnel huge amounts of capital to projects that are showing real impact but cannot get financing. Let’s build on a model that works and hope the delegates at COP26 are successful in establishing a rulebook for Article 6 that  further scales up carbon credit markets!