CARBON PRICING: What is a carbon credit worth?
This article was originally published in our Q1 2016 Supply Report>>
Investing in climate and development projects is a powerful way to contribute the transition to a low-carbon, climate secure world. However it can seem complex – especially answering what seems to be a simple question of how much you should pay for a carbon credit. Why is one carbon credit – representing one tonne of carbon dioxide prevented from entering the atmosphere -- be more expensive than another? While your carbon credit provider can guide you through the process, we hope to provide some clarity in how carbon credits are valued, taking into account significant differences among the projects that issue them.
First, let’s define value. The Natural Capital Coalition’s draft Natural Capital Protocol provides a good basis for its different aspects:
- Value (noun): The importance, worth, or usefulness of something.
- Market value: The amount for which something can be bought or sold in a given market.
- Price: The amount of money expected, required, or given in payment for something (normally requiring the presence of a market).
- Economic value: The importance, worth, or usefulness of something to people – including all relevant market and non-market values. In more technical terms, the sum of individual preferences for a given level of provision of that good or service. Economic values are usually expressed in terms of marginal/incremental changes in the supply of a good or service, using money as the metric (e.g., $/unit).
As environmental markets like the voluntary carbon market mature, they can grow to account for a number of different approaches to pricing their assets, including carbon credits.
Pricing based on market dynamics:
The voluntary carbon market today is primarily driven by supply and demand, regardless of the implications to the project in terms of long-term viability. The graph below (Figure 1) provides the cumulative value and average price by project type over the past 10 years according to the State of the Voluntary Carbon Market Report 2015 published Ecosystem Marketplace.
Markets can be very effective for driving competition and reducing the cost of accomplishing an objective. However, what if that objective is the security of our climate and providing access to basic human rights such as food, water, education and good health? Paying for carbon credits at prices below what it costs to maintain a project means that these projects may stop operating in the vulnerable communities they support. Further, neglecting to fully account for the real value they deliver in beyond-carbon development benefits can accelerate a race to the bottom, meaning that the highest quality projects might be the first to fail.
Gold Standard believes that organisations and individuals have an opportunity and an ethical obligation to consider longer-term environmental and social impacts of their investment decision and consider both the costs and true value of project outcomes.
Fig. 1 Cumulative Value and Average Price of Top 7 Project Types
Pricing based on project cost:
A cost-based model takes into account the implementation costs of a project and is used to help ensure the on-going viability of projects. The Fairtrade Carbon Credit pricing model provides a great example of how this works in practice, and is currently the only application in carbon markets today. This model calculates a minimum price that ensures the average costs of the projects will be covered. However, in the Fairtrade model a buyer also pays an additional premium on top. This “Fairtrade Premium” goes directly to the local community – small holder farmers and producers in rural communities – to fund activities that help them adapt and become more resilient to an already changing climate.
Fairtrade minimum prices for eligible project types:
- Energy Efficiency – 8.20€/tCO2e + 1€ Fairtrade premium
- Renewable Energy – 8.10€/tCO2e + 1€ Fairtrade premium
- Forest Management– 13€/tCO2e + 1€ Fairtrade premium
A cost-based model is a step toward ensuring project sustainability. The Fairtrade version with its premium for local communities also ensures funding is channeled directly to the most vulnerable, and it encourages producers to participate in developing the carbon projects and increase their involvement and expertise over time. The Fairtrade Climate Standard also features requirements for buyers of credits to reduce their own carbon footprints. Companies like DHL and Marks & Spencer have already committed to purchasing in Fairtrade Carbon Credits from Gold Standard projects. However, a cost-based pricing model does not specifically account for the additional value these projects deliver in sustainable development.
Fig. 2 Fairtrade Minimum Prices for Fairtrade Carbon Credits
The formula below shows how to calculate the Fairtrade Minimum Price for Energy Efficiency, Renewable Energy and Afforestation/Reforestation projects
Pricing based on value delivered:
While all Gold Standard projects play a critical role in our transition to a low-carbon economy, some projects go far beyond carbon mitigation. Using a value-driven model to set a price for carbon credits can truly account for the holistic environmental, social and economic impacts of a specific project—that is, both in emissions reductions plus the additional development benefits that can transform lives.
The United States Environmental Protection Agency (EPA) released an updated report in 2015 to estimate the total cost of carbon to society. Figure 3 summarizes these costs over time according to different risks and assumptions of climate science. This means that for every tonne of carbon dioxide we emit into the atmosphere, we sacrifice an average of USD $36 in environmental degradation and negative social impacts. In theory, these should be accounted for in the price of a carbon credit.
To take this a step further and shine a light on the value above and beyond carbon mitigation, Gold Standard commissioned a group of economists to conduct a comprehensive valuation of the socio-economic benefits delivered by our projects. The conclusion was that projects that follow our principles of inclusive design, transparent governance and outcomes that are long-term, consistent and comparable, deliver additional outcomes worth billions of (US equivalent) dollars. The economic value of Gold Standard project impacts per tonne of CO2 can be seen in Figure 4.
Prices in the voluntary carbon market do reflect some of these “economic value” principles. For example, prices for clean cookstoves projects, which often deliver life-saving health benefits to women and children, are generally higher than projects that focus more on the emissions reduction. But they ultimately yield to the forces of supply and demand, without safeguards such as a minimum price. This is why there is a tremendous gap between the average historical prices for carbon credits from Figure 1 compared to the economic value of impacts they deliver as noted in Figure 4.
Gold Standard’s new holistic standard “Gold Standard 3.0,” currently in development, aims to address this discrepancy by more rigorously quantifying the beyond-carbon benefits and allowing for these to be either sold on top of the carbon emission reduction or at least more accurately accounted for within the price of a Gold Stander carbon credit. But in the meantime, we advocate for buyers of carbon credits to more fully recognize these values in their negotiations with sellers.
Fig. 4 Monetary value of Gold Standard project impacts
Per ton of reduced CO2 emissions
Innovative approaches among companies
There is growing awareness among private sector on the true value of natural capital, like a stable climate and thriving ecosystems, and progress in social measures like improved health and gender equality. Within this trend, companies are increasingly using tools like an internal or a ‘shadow’ price on carbon to account for the economic impact of their emissions. For example, climate leader Microsoft requires their internal departments to include a budget line item reflecting the financial value of their emissions, which then translates to new capital for sustainability initiatives with the carbon investment fund. These include internal emissions reductions efforts in addition to supporting projects outside their operations through carbon credit purchases. Swiss retailer Coop sets their internal price on carbon at CHF 150 (roughly USD $150) to drive innovation and investment in Gold Standard-certified emissions reduction activities that also support communities within their supply chains.
Gold Standard Recommendations
In conclusion, deciding on what project to invest in and how much it’s worth remains a bit like navigating the real estate market. There are a number of different considerations ranging from quality, type, size, and geographical location. While ‘value’ can remain somewhat subjective depending on your organization’s ideals, objectives and requirements and is subject to the forces of supply and demand, Gold Standard advocates for prices of carbon credit to more closely mirror the true social cost of carbon and the economic value provided in additional impacts, while using the power of markets to help deliver this in the most cost-effective manner.
For more in this series
- Click to read why prices vary for different project types>>
- Read about the benefits of setting an internal price on carbon>>