Authored by Pedro Carvalho and Alexis Massot
Image credit: IETA
In the past few decades, carbon project development has witnessed significant transformations. Since its initial voluntary adoption, project developers have navigated through various market dynamics, emerging schemes, novel methodologies, and evolving technologies. They have grappled with shifting political landscapes, increasing complexity, and the undeniable reality that the huge gap in climate finance remains. The landscape is constantly evolving to provide innovative solutions towards a low-carbon economy.
While not perfect at times, carbon project development has been marked by participative, open processes fostering broader participation by interested parties. This has led to a culture of cyclical and regular improvements, first at the CDM level and more recently with voluntary standards. The scale and stringency required to enable top-quality and impactful carbon projects are high, and adjustments are normal.
The following few paragraphs will try to highlight key moments and phases in project development since pre-CDM times.
PHASE 0: HOW IT STARTED
The inception of emission reduction projects can be traced back to the 1980s, a time when there were no international agreements or regulations governing carbon markets. These early projects operated on a voluntary basis and laid the foundation for future developments. The key challenges during this phase included the absence of a regulatory framework and uncertainty regarding project viability. However, pioneers in this field began experimenting with carbon offset projects, setting the stage for what was to come.
It was in 1991 that the first two pilot carbon forestry projects were ever developed, in Malaysia. However, how credible could the project be if there were no independent auditors to confirm the methodology and conclusions? It was then, in 1996, that the first carbon offset verification service was developed and, right after, Costa Rica created a pioneering business case for project developers.
PHASE 1: THE KYOTO PROTOCOL AND SETTING THE FOUNDATIONS
The 1990s marked a crucial turning point with the establishment of UNFCCC and, later, the Kyoto Protocol. These international agreements provided a framework for the carbon markets and, building on previous experiences, the CDM was established with the requirement of independent audit to certify the projects. During this period, the project cycle was defined, a regulatory framework was put in place, methodologies to monitor, report and verify (MRV) emissions reductions were developed and, without significant changes, the carbon project cycle has remained unchanged. Somehow curious to note that the first market experiences already relied on nature-based interventions, but upon the scaling of CDM, projects relating to energy and industrial processes dominated the space. In 2004, in a moment when the CDM was taking its first steps and dealing with early-stage questions to enable a quick scaling up of carbon markets vis-à-vis the provisions of Kyoto Protocol, a landfill project in Brazil became the first to be registered under the mechanism. This significant milestone was followed by the first issuance of certified emission reductions (CERs) in 2005. Simultaneously, the EU Emissions Trading System (ETS) was launched, allowing for a crediting mechanism grounded on CER use, shortly after other countries followed suit, creating not only substantial demand for carbon offsets but enabling the development of funding alternatives to carbon projects. With the CER being an instrument tradable under regulated markets, mainstream financial markets came into play.
PHASE 2: CARBON MARKET 1.0 – SCALING UP
The launch of the EU ETS in 2005 led to a surge in demand for carbon offsets, and the market started to expand rapidly. The fourth quarter of 2005 saw more validation processes start than the market had ever recorded historically, and only two years later, in 2007, the 1000th validation started. The World Bank and other institutions played a pivotal role in funding and supporting carbon projects worldwide and even a group of project developers had their organisations listed at European stock exchanges. However, this growth phase also had its challenges.
The quality of projects came under scrutiny, and the CDM Executive Board reacted strongly, suspending auditors who at the time were responsible for 80% of validations and verifications, bringing the system to a halt. The CDM Board also tightened its oversight and improved governance systems, and between 2009 and 2010 the number of rejected projects equalled historically rejected projects. But this period of turmoil ultimately resulted in a stronger CDM and a more mature market with clearer guidelines for moving forward, increasing the oversight of the auditors in particular.
PHASE 3: THE FIRST CRISIS
The first crisis in the carbon market began in 2009 and as a consequence of the beginning of the Kyoto Protocol’s shortfall, with Parties abandoning the treaty and ultimately were not able to agree on the continuation of the scheme at the UN climate talks in Copenhagen. The 2011 Fukushima nuclear disaster and Japan’s subsequent withdrawal further disrupted the landscape. The global financial crisis that began in 2007 and subsequent recession compounded these challenges, with reduced demand for carbon offsets causing a drop in prices and a decrease in market participation – there was a more-than-elevenfold reduction in the number of registered projects between 2013/2014 compared with the two previous years.
To counter these issues, efforts were made to broaden the geographical scope of carbon projects, promote new approaches and create new mechanisms, such as the now-famous Warsaw Framework for REDD+ adopted at the 2013 climate talks in the Polish city. The voluntary carbon market also gained momentum during this phase.
PHASE 4: THE EVOLUTION AND REVOLUTION
The adoption of the Paris Agreement in 2015 marked a significant shift in the climate governance agenda, with non-state actors being called into action, countries facing bigger responsibilities and flexibility via the Nationally Determined Contribution (NDC) process and the persistence of carbon markets in the agenda, with the international community establishing Article 6. It was also in 2015 that the UN’s Sustainable Development Goals were established and started to provide a framework to assess, report and drive sustainable development contributions.
With the emergence of an ever more polycentric climate governance, we saw the emergence of concepts like NDCs, reporting frameworks, best practices such as the Science-Based Targets Initiative and the (re)consolidation of nature-based interventions with an ever more incorporation of co-benefits within project development cycle. The voluntary market continued to grow, and a new landscape emerged, emphasising sustainability and broader socioeconomic benefits with carbon project activities.
PHASE 5: CARBON MARKETS 2.0 – SCALING UP (AGAIN!)
The period from 2019 onwards saw a surge in voluntary carbon pledges around net-zero and carbon neutrality claims and other creative ideas for using offsets. This phase was primarily centred around natured-based solutions and community-based projects. However, this phase also witnessed a lack of governance, with no clear UN leadership and an uncontrolled growth of projects that the voluntary carbon programmes were not able (or responsible) to address. Technology, including blockchain and tokenisation, played a significant role in simplifying project development and trading. The market saw a resurgence of new entrants, with a focus on charismatic, but sometimes questionable, projects.
Diverse carbon registries and programmes emerged, leading to a race to the bottom in terms of project quality and additionality. In response, and not so long ago, the market attempted self-regulation through initiatives like the ICVCM, the VCMI and the emergence of carbon project rating agencies. Projects increasingly incorporated extra-carbon elements, such as co-benefits, into their designs, with the market requiring additional co-benefits certification as a prerequisite for premium carbon credit prices.
PHASE 6 (OR 5.1): FOUNDATION TO SCALE
The introduction of the Article 6 Rulebook at the Glasgow climate talks in 2021 emphasised the need for governmental engagement in carbon markets. With over 75% of countries indicating that they will rely on Article 6 mechanisms to achieve short or long-term NDC objectives, projects are now expected to be aligned/ go beyond the host country’s NDC, and this changed everything once again. Sustainable development has become a core requirement alongside emissions reductions, elevating the political relevance of carbon markets. Project development does not happen, anymore, in a political vacuum nor without clear and relevant sustainable development positive impact.
While the market saw the uncontrolled emergence of new actors, the ability to deliver technically robust and resilient projects did not expand at the same pace. It would be too cliché to say that climate action cannot wait but, in this spirit, and even if Article 6 rules are not yet fully defined, there is a group of countries, multilateral organisations and project developers proactively seeking to develop partnerships and international frameworks to allow cooperation between countries. Today, there are over 60 of such partnerships and every week there is news about new agreements.
The evolution of emission reduction project design and implementation has been marked by significant milestones, challenges, and transformations. From its humble beginnings as voluntary initiatives to the present-day landscape shaped by international agreements and technological advancements, the carbon market has come a long way and adjusted itself to incorporate criticism, new technologies, methodologies, innovations on the project cycle and new stakeholders and concerns. It is clear that since the projects in Sabah, Malaysia in 1991, the carbon market has evolved to support climate action and mobilise climate finance towards mitigation activities. This process does not end here, and it is our responsibility as project developers to ensure high-quality projects, aligned with domestic policies and with robust checks and balances, to avoid initiatives that may undermine not only the carbon market, but private sector climate action on a broader sense.
This article was originally published in the IETA Greenhouse Gas Market Report 2023, Evolution of the Carbon Markets. You can read the original article here: https://www.ieta.org/resources/ghg-market-report/ghg-market-report-2023/ .