Carbon Credits Have Struggled To Win Market Approval — Until Now

Carbon credits have struggled to gain a foothold among countries and companies. But Deutsche Bank has just lit a fire under them — specifically, “sovereign credits” issued by rainforest nations. The aim is to minimize deforestation.

The rainforest nations now have financial assets to empower them to keep their trees standing and attract financing. The proceeds from carbon credit sales will also get used to further cut emissions and build infrastructure, protecting themselves against such things as floods. It’s an asset class that can trade on global markets — critical to solving the climate emergency.

“Nature has a value, and we need to express that. One way is through carbon credits, which link to nature that absorbs carbon,” says Markus Müller, chief investment officer ESG for Deutsche Bank, in an interview. “Therefore, the sovereign carbon credits are one tool to allow capital to flow to where it is needed to protect countries against the worsening climate and continue reducing emissions.”

Indeed, forests are carbon sinks, absorbing 7.6 billion metric tons annually. Sovereign credits generated by the REDD+ financing mechanism will scale that number higher.

The rainforest nations have successfully reduced their emissions and kept their rainforests standing. But they have not received the financing, putting pressure on them to use those trees for timber or that land for farming. And therein is the paradox: according to the United Nations Framework Convention on Climate Change, we must cut carbon emissions by 59 billion tons by 2050. But we have not cut them nearly enough to avert rising tides, beach erosion, and melting ice caps.

However, Deutsche Bank has changed the calculus. Gabon is about to issue sovereign national carbon credits worth 90 million tons, and Papua New Guinea will soon follow.

Gabon, on Africa’s west coast, is 88% rainforest. It has one of the lowest deforestation rates in the world, which prevented 1 billion tons of CO2 between 2010 and 2018. At the same time, 70%-80% of Papua New Guinea’s rainforest is untouched, although it could use the land for farming or timbering. The trees must be worth more dead than alive.

“If we cut the forest down, we lose the fight against climate change,” says Lee White, Gabon’s Minister of Water, Forests, Sea, and Environment. “We have created carbon credits through sustainable forestry.” The credits could add value to the country’s rainforests and make that land worth as much as $10 billion-to-$15 billion — a much-needed economic magnet.

Where will the money go?

Gabon will reinvest 10% into its forest, creating an eco-tourism industry that requires monitors, rangers, and guides. But the money will also go into rural development (15%), a Gabonese sovereign fund that invests in future generations (25%), debt service (25%), and health, education, and climate infrastructure (25%).

The science says the global community has to reduce annual CO2 emissions by 2.5 gigatons — if it limits temperature increases to 1.5 degrees Celsius
CEL
compared to pre-industrial levels. If not, there will be trillions of dollars of damages created. Just look at Hurricane Ian, estimated to have caused $70 billion in destruction. In 2021, there were $105 billion in insured losses, and in 2017 — the costliest year so far — $340 billion in economic damages.

As it now stands, the voluntary carbon market has the most significant market share — private deals negotiated between landowners and intermediaries that are outside the jurisdiction of the global climate agreement. Voluntary credits account for only 200 million tons of emissions reductions, less than 10% of the required annual CO2 reductions of 2.5 gigatons. Building scale is the next step.

An independent body aims to boost trust and confidence in the voluntary markets. “It’s not the role of the Integrity Council to forecast the size of the market, but it’s clear that a lack of confidence in the quality of credits is one key factor limiting growth,” says Daniel Ortega-Pacheco, a co-chair of the Integrity Council for the Voluntary Carbon Market’s expert panel. “We expect the market to scale substantially once buyers can have confidence in the quality of credits.”

Can sovereign and voluntary carbon credit markets work together? Pedro Barata, a co-chair of the Integrity Council, says REDD+ is critical to “effective climate mitigation at the national and global levels,” adding that the voluntary markets can “channel urgently needed finance” to crucial projects. In an email interview, he says all carbon credits must generate “verifiable reductions and removals with high social and environmental integrity.”

Spreading the wealth

Corporations, of course, have questions about the sovereign credit market. For starters, they want to know if they can trust the national governments to spread ‘the wealth,’ ensuring communities prosper. The reality is that the rainforest nations are self-motivated to distribute the money to reduce emissions. If they do not, countries and companies will stop buying the credits.

A second concern is “leakage” — a term that applies to countries saving trees in one region while cutting them down in other areas. But sovereign credits require a holistic approach: under the REDD+ financial mechanism, governments account for their forest lands and set targets to stop deforestation. The UN evaluates that progress before approving their performance and emissions reductions. Furthermore, satellites are flying overhead that make forest management public knowledge. The data is updated every couple of days, and it is accurate.

“These developing countries are reducing emissions by hundreds of millions of tons,” says Kevin Conrad, executive director of the Coalition for Rainforest Nations that developed REDD+, in an interview. “That is the pace and scale that the climate requires. Sovereign credits will spur this further.”

Developed nations want their companies to voluntarily commit to net-zero targets. But countries have promised to reduce CO2 levels by specific percentages, known as “nationally determined contributions.” They will start buying carbon credits — assets that are transferable among countries. If Gabon or Papua New Guinea exceed their emissions goal, for example, they can sell credits to those governments struggling to meet their objectives.

Conrad explains that voluntary markets have “middlemen” who arrange for a company to buy credits from a developing nation to help them save their rainforests. The company pays the broker and then the landowners or project developers get a percentage of the money. The company treats the credit as an expense, and its customers ultimately pay the cost.

In contrast, sovereign credits appreciate over time. Businesses do not expense them; instead, they count them toward their carbon reduction goals — part of a global accounting system to which 200 nations have agreed. It is a slice of the overall mosaic that includes using much more renewable energy and deploying energy efficiency technologies.

“Sovereign carbon credits have the potential to enable countries to reduce the cost of implementing their climate pledges,” says Deutsche Bank’s Müller. “Nature and its systemic value must become part of our economic decision-making.”

The rainforest nations are vital to slow the climate emergency. So far, they have been locked out of the carbon markets — a self-defeating eco-injustice. But Deutsch Bank’s action may change that, and Gabon’s upcoming issuance will be the first indication of it. Indeed, sovereign credits may appeal to corporate buyers because they conform to global climate standards. That makes them a valued asset class that is healthy for ecology and economic expansion.