Pricing carbon credits

Selling high-quality carbon credits is a critical mechanism in the transition to a low-carbon, climate secure world. However, participating in the voluntary carbon markets can be very complex—even when answering what seem to be simple questions: How much should I sell a carbon credit for? Why is one carbon credit more expensive than another? Doesn't every carbon credit represent one tonne of carbon dioxide prevented from entering or removed from the atmosphere? 

Pricing carbon credits is a difficult task, and we hope to provide some clarity in how carbon credits are valued, taking into account significant differences among the projects that issue them. 

This article provides an overview of three approaches to pricing (market dynamics, project cost, and value delivered) that, when used together, provide a holistic and comprehensive lens into how to maximize project value. We’ll discuss each of these approaches in more detail in future posts.

Defining value

First, it’s important to align on a common vocabulary when speaking about value and price. The Natural Capital Protocol provides a good basis for its different aspects:

• Value: 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 markets 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, similar to other commodity markets, is heavily driven by supply and demand, regardless of the implications to the project in terms of long-term viability. 

From a quantitative lens, credit prices can be influenced by a myriad of factors that can be linked to certain market premia. Examples of these factors include project location, vintage, classification, likelihood of avoidance or removal, and co-benefits. Leveraging factor models to price credits based on their set of characteristics may be an effective pricing strategy where sufficient data exists. Further, it is also important to identify macro factors that influence price fluctuation of the broader market.

Markets can be very effective for driving competition and reducing the cost of accomplishing an objective. That said, selling carbon credits at prices below what it costs to maintain a project means that these projects may stop operating, driving adverse impacts for the nascent technologies they require or for 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.

Pricing based on project cost

A cost-based model takes into account the costs of a project and is used to help ensure the on-going viability of projects by determining the price at which carbon credits need to be sold to cover the costs associated with planning, implementing, and maintaining projects.

Cost-based models begin with an assessment of project costs related to development (feasibility studies, baseline assessments, design), implementation (equipment, technology, labor), monitoring, reporting and verification, and maintenance. The project developer must then synthesize their finances and valuation with broader market dynamics for credits produced by similar projects to determine an appropriate margin to target. Together with costs and the quantity of credits produced by the project, the developer can then calculate the total revenue required and the price at which their credits must be sold to ensure that the project matches their expected financial outcomes. 

Pricing carbon credits based on project costs is a key approach to ensure the financial viability of projects. However, it is important to strike a balance between covering costs and remaining competitive with respect to market dynamics. Thorough financial analysis that incorporates project economics and financing is crucial to maintaining a holistic perspective on credit pricing.

Pricing based on value delivered

Pricing a credit based on value delivered (i.e. considering co-benefits) involves assessing the broader environmental, social, and economic benefits generated by a project. This approach goes beyond the sole consideration of carbon emissions and considers the additional positive impacts associated with the projects. 

This approach entails identifying and quantifying all of the co-benefits associated with a project. These co-benefits can encompass a wide range of outcomes, such as improved air and water quality, enhanced biodiversity, job creation, better community well-being, or reduced energy costs. These benefits may vary widely depending on the nature and location of the project. Next, a project developer must assign a value to each of the identified co-benefits. This step will involve estimating the economic value of identified impacts.

Pricing carbon credits with a consideration of total value delivered and accounting for co-benefits is critical when coming to market. It can also provide a competitive advantage as it recognizes the full scope of a project’s contributions and encourages the support of organizations and individuals seeking to make a positive impact beyond carbon mitigation.

Uptake Advisors believes that developers should incorporate information from all of these approaches when pricing carbon credits to ensure a price that accounts for all of the value delivered by a credit while ensuring the long-term viability of the project.