Early Investment is the Key to Carbon Market Success

Nathan Truitt

September 16, 2024

Forest Canopy with Sunlight Streaming Through

The voluntary carbon market is at a crossroads. Carbon project developers and companies both have very specific needs that don’t always align and few avenues to take immediate action. At the American Forest Foundation, we have been exploring a new way of selling carbon credits that more effectively meets the needs of companies, developers, and the planet.

The Current Model

Corporations seeking to use high-quality carbon credits as part of their decarbonization strategy have clear preferences as to what kind of carbon credits they want to buy and how they want to buy them.  Here is the tension: corporations want carbon credits that are high quality, meaning that they represent a real, additional and durable impact on the atmosphere; but also low-cost, so they can afford to buy them. Corporations also want to be able to order carbon credits ahead of time and pay upon delivery, through offtake agreements at increasingly high volumes. However, carbon developers need financial investment early in the process and the time to build supply.

Although these are all understandable requirements, they are unfortunately in conflict with one another. 

Let's break it down further.

If buyers insist on paying a low price, the only way a developer can meet that price is to be aggressive with the carbon accounting, which often results in projects that overestimate their impact and end up making the wrong kind of headlines. If buyers refuse to pay up front, then project developers have to borrow money from other investors to develop the project. For high-quality, nature-based projects that can take years to generate credits, this leads to very high prices per carbon credit because investors expect high annual rates of return (20% or higher).  And if all buyers insist on relatively low prices and payment upon delivery, it makes it exceedingly difficult to start a project, meaning that there will be fewer and fewer high-quality credits, and nowhere near the amount to meet the growing number of corporate climate commitments and even more importantly, to address the ambitious goals for the planet.

Put simply, if companies need an increasing number of high-quality credits, they are going to have to both pay more for those credits and purchase them in different ways.  At the same time, companies have legitimate concerns about high carbon prices and pre-payments.  Some of the more aggressive carbon credit pricing forecasts result in prices it will be hard for all but the most profitable companies to afford. Additionally, pre-payments for credits require companies to take a gamble and hope that the project generates credits as predicted. 

A New Way to Buy Carbon Credits

Since 2020, the Family Forest Carbon Program has experimented with different ways of selling carbon credits to balance ensuring the integrity of our credits and the viability of our program. These methods have ranged from traditional long-term offtake agreements to Advanced Market Commitments (AMCs), in which all or a portion of the price of a credit is paid up front.

We have been working on a solution that works for both corporations and project developers, and benefits both people and the planet: The American Forest Foundation Carbon Auction. We believe this new method of upfront investment will offer corporations lower prices, more insight into their purchase, and a pathway to make a truly transformative investment.  It works like this:

A company “orders” a certain volume of credits via the auction.
It agrees to pre-pay for a portion of those credits once certain milestones in the project are achieved.  For example, a company might make a partial prepayment once a “cohort” of landowners has been enrolled, and monitoring plots have been installed on their property, and then make another partial pre-payment when the next cohort is enrolled.
It pays for the remainder of the credits upon delivery.
When it makes a pre-payment, it gets a discount off the credit price based on how far ahead of issuance it is pre-paying.  The further ahead, the deeper the discount.

By buying credits this way, companies can benefit by:

Protecting themselves against a market scenario in which prices get extremely high;
Achieving a significant per tonne discount on the prices of the credits they buy, compared to buying after the fact from projects that must rely on third-party finance;
Securing a substantial strip of credits years or even decades ahead of time, allowing them to engage in long-term planning and making sure they will have the credits they need to execute their decarbonization strategy.

These are the financial benefits, but there are others:

By providing a portion of their funding up front, companies can catalyze vital and high-quality natural climate solutions which would not have been possible using traditional third-party finance and communicate about their leadership in this regard.
Companies can get in on the “ground floor” of projects, which will enable them to more deeply understand those projects and communicate about them to stakeholders.
Because their funding is helping project developers create high-quality credits, and because they now have the understanding about the project to communicate effectively about it, there is much less risk that a company will suffer reputational damage from their projects

Moving Past Carbon Business as Usual

Advance market commitments work. It is time we move past carbon business as usual, and it is possible to do so with minor adjustments to how companies invest in and buy credits from projects.  Carbon credits are a unique mechanism, and they will require companies to adjust the way they do things if they are to perform their function in a comprehensive decarbonization strategy. By streamlining the buying process with the auction, we help the projects, the climate, and, not least, the companies themselves!