The role of carbon credit ratings: Providing essential market infrastructure

Ryan Fan: Welcome to The Sustainability Agenda, a podcast series focusing on the evolving complexities of the sustainability landscape. I’m your host, Ryan Fan. Please join me as we explore today’s most pressing issues with special guests that will give you some new perspective and help you make sense of what really matters.

Spencer Meyer: “We ourselves are banking on the long-term market infrastructure the ratings has begun to provide. And we feel really good about that. We think the future carbon market and the future of whether it’s voluntary or regulatory or somewhere in between, markets are going to need this central market infrastructure.”

Ryan Fan: Welcome to our multi-part series, profiling the Carbon Markets. The purpose of the series is to examine some of the most significant issues facing our clients in both the voluntary and compliance markets. Buyers in the voluntary carbon markets, or VCM, are ultimately responsible for the careful selection and due diligence of the carbon credits they purchase. At a pivotal time in VCM development, where project quality is a key consideration, carbon ratings agencies can provide essential market infrastructure to enable informed carbon credit purchasing. On today’s episode, we’ll dive into the world of carbon ratings, including what it takes to assess carbon projects, how it helps carbon credit buyers to mitigate risk, and where the carbon markets ratings industry is headed. Please welcome my special guest, Dr. Spencer Meyer, Chief Ratings Officer at BeZero Carbon. Spencer is an expert in climate science and has over 20 years of experience working collaboratively with NGOs, government, private sector, and academia to solve natural resources challenges. Prior to joining BeZero Carbon in 2023, he was head of science at NCX, a climate tech pioneer in the voluntary carbon market. And before that, he held some positions at Highstead Foundation, Harvard Forest, Yale School of the Environment, the Nature Conservancy, and the University of Maine. Spencer, welcome, and thank you for joining us on today’s episode of The Sustainability Agenda.

Spencer Meyer: Hi Ryan, it’s great to be here with you today. Really looking forward to our conversation.

Ryan Fan: Yeah, me too. But before we get into that, every time I interact with you, you’re always off on some adventure somewhere that’s work related, but somewhere very cool. So I just want to catch up with you for a second. Where have you been lately?

Spencer Meyer: (laughs) Well, I can’t say that they’re all work related, but I try to mix business with pleasure whenever I can. whether it’s hiking in the mountains or mountain biking in the British countryside or sailing adventures, I do try to get out quite a bit. Work hard, play hard is how it goes around here.

Ryan Fan: That’s great to hear. Okay Spencer, so let’s get into this. Our clients are aware from our previous episodes that high quality carbon credits can play an important role in helping to enhance decarbonization pathways. But to make credible environmental claims, VCM buyers still need to ensure careful selection and due diligence of the carbon credits they purchase. Can you begin by explaining why there is so much complexity involved in assessing the quality of voluntary carbon credits?

Spencer Meyer: Sure, great question. I think you know we all really want this market to be simple. We want it to take off, we want it to scale, but the reality is there’s lingering complexity here in the market. And I think a lot of that complexity comes from the fact that there’s just such a huge variety of the types of carbon projects. On our BeZero carbon platform, for example, we have over 18,000 individual carbon projects we’ve identified across many different sectors, across all the different standards bodies. And they just look very different from each other, even when they’re within the same sector or even in the same methodology. So we’re talking about things that range from mangrove restoration to biochar projects to direct air capture plants to traditional forestry projects. And every one of these things has a lot of detail that go into them. And what comes out the other end of these projects is really dependent upon a lot of the assumptions and decisions that were made along the way. So there’s just a lot of inherent complexity there. You know, some of these projects remove carbon from the atmosphere. Some of them avoid being put into the atmosphere in the first place. And the variables that determine the effectiveness of these projects are really going to come out in our risk assessments that we look at. It’s really one of the core reasons why our assessments are all based at the project level and not just at the sector level or the geography level. There are a lot of data that go into these projects. We collect all those data and we have to assess all of them and understand the source of the data, the reliability of the data, and a lot of these aspects. So of those 18,000 projects we’ve identified in the market, we’ve now done full ratings on 460 of them across 15 different sectors across the entire globe. So our experience of complexity is based on that experience and a lot of the findings that we’ve made from all those projects around the globe. We know that the quality of carbon credits is simply not binary. We’re not sure there is a threshold of what is good enough. We know that there’s continuum of risk across any carbon credit project. Even when you have new and improved methodologies, which fortunately we’re seeing in the markets, there’s still going to be tail risks associated with a lot of these projects. And so it’s really important to us to think about what is the likelihood that one ton CO2e being removed or avoided is really true? What is the probability that that climate benefit is really going to accrue?

Ryan Fan: Spencer, that seems like a ton of analysis and it’s certainly not something that most buyers can actually do, right? Like you clearly go above and beyond the resources of most VCM buyers. So with that in mind, how do carbon credit ratings help with that? And what risks are you helping the market participants navigate really here?

Spencer Meyer: Sure, good question. So let me just explain the basics of our rating system. The BeZero rating is a single comparable metric. It’s fungible across all different sectors that we look at. And it’s on an easy to understand scale from AAA down to D. So it’s an eight point scale. It follows the public debt markets. It’s something that many of the listeners here will be very familiar with. And our goal is to give ratings to the whole community, whether we’re talking about buyers or investors or project developers, and really have when they see our rating, they know what it means. They know what a AA means. They know what a BB means, et cetera. So our goal is to give this one consistent metric across the marketplace. And what we’re seeing is there’s a lot of uptake in the ratings. Even just in the past year, the amount of uptake has really grown significantly. We hear stories about the ratings showing up in buyer contracts, for example. We know the market is trading on the ratings that we put out in the marketplace. Underlying that is a lot of detail where our job is to really assess the risk that we see in these carbon projects and then bring that to light to our clients, to anyone that’s a subscriber to the BeZero platform. So some of the basics of carbon projects that we’re going to look at are things like additionality. That is, you know, how likely is the project to have happened even in the absence of carbon finance? Or over-accrediting. You know how good is the math? How good are the estimates that generate a certain number of credits that get issued into the market. If the credits that are issued are exaggerated by 2X or are even underestimated for that matter, that becomes a real problem in the market. And it’s why the commodity style approach to carbon credits has been problematic up to date. It’s why there’s been so much question and controversy about it. We can get into some more of the details underlying those risks, but there’s quite a few factors there also including permanence and durability of the credits.

Ryan Fan: BeZero’s project level approach is very helpful, I think, to our client base to really understand and get to the root of what the risks are on a project by project basis. Because as you said, each project is different and there are an endless number of protocols that are out there, right? At BeZero, you offer a range of ratings and risk tools that serve both the supply and demand sides of the carbon markets. So can you describe maybe for our audience some of your product offering and specifically what type of clients rely on your services?

Spencer Meyer: We are a global ratings agency and our goal is to be able to serve all sides of the market from the buy side to the sell side and everyone in between. And because of that, we’ve developed a number of products that help at different phases of that life cycle. Our signature product that we’ve been most known for so far is the BeZero carbon rating. This is a rating that we issue publicly on carbon projects that have already produced credits and are there trading in the market. We have about 460 of these ratings on our platform today. We make these ratings public because we believe they’re public good. And as I said earlier, we know the market is trading on them. So that’s really our core product. That’s kind of where we come from is these publicly facing on our platform ratings. In 2023, we launched the first ever public ex-ante ratings. So these are ratings of projects that have not yet issued credits, but are in various stages of development. So we work bilaterally with clients. They could be investors, they could be off takers or intermediaries or even project developers and help them by providing an independent risk assessment of the projects that they are developing in various stages. Once those projects then issue credits, they flip over and become part of our ex post offering and they become fully public. I think what’s been really exciting about the work we’ve been doing last year is at a time when the market is having a lot of controversy and a lot of hand wringing over quality, this is our chance to really provide actionable guidance to our clients who then in turn share it with their partners. And we see a lot of the future looking supply that is coming to market. We get a chance to rate the existing supply in the market. We also get a chance to rate tomorrow’s supply. So we have early indicators of what we see coming online over the next couple of years with a lot of projects. In addition to those two core types of ratings, we have a number of tools for our clients. We put out a discounting methodology, for example, for some clients who want to say, you know, we’re not so comfortable that this credit is worth a full credit. We want to discount the amount that we’re going to claim against those. So we provided that out into the market. We also have some features on our platform such as scorecards, which is a self-assessment tool where if you want to come in and maybe you’re working on project development yourself and you want to go through our very detailed list of due diligence questions, you can do it in a self -serve format and come up with your own assessment of what that project might rate under our methodology. We of course would then be happy to do a formal rating as well, but that’s a self-serve tool that’s become quite popular. Importantly, a lot of actors in the market want to look beyond individual projects. They want to look for market-wide trends. So we have an analytical tool that allows our clients to look across the market, across particular sectors. Maybe you’re interested in a particular kind of project in a particular geography and you want to see what the over-crediting risk is. Or maybe you want to see what the policy-oriented risk is. And so you can do all of that across our platform. Essentially, the demand for ratings keeps growing. People keep coming to us, want us to use our ratings in new and innovative ways. And we have a pretty strong product team that’s really innovating all the time, coming up with new products to satisfy the demands and the questions that our clients are asking of us.

Ryan Fan: Yeah, it’s a pretty comprehensive suite of services and it’s neat how you’ve got data analytics to go on top of this, right, to help people navigate the market as is. Earlier this year, BeZero published a report showing correlation between carbon credit ratings and price. So according to the report, the correlation between price and quality was noticeable in the latter half of [20]23 across the VCM and expected to continue this year. Can you maybe highlight some of the research findings and how that might impact the VCM going forward?

Spencer Meyer: Sure, I’m happy to do that. This is really exciting work for me and the rest of the team here. The findings we’re seeing really match our basic theory of change, where in the old binary world of commodity style quality criteria, you know there’s sort of a race to the bottom of how cheaply can you produce a credit that meets a minimum threshold. And we’re turning the tables on that. And what we’re seeing is that now for developers and sellers that are producing higher quality credits, they’re actually getting a price premium in the market. And we think that feedback loop will really incentivize people to produce higher quality projects. And in turn, they’ll get rewarded for that. For example, we’re seeing on average, there’s a price premium of about 30% for every BeZero ratings notch that the credit goes up. So if you go from a BB to a BBB rating, you can expect on average about a 30% price premium based on price data across the market. That ratio is a little different for certain sectors. So in nature-based credits in particular, for example, there’s a 20% price premium across each notch of the BeZero scale. But we’ve seen much higher examples of that. There’s one improved forest management project that has a whopping 400% price premium over lower rated projects in the very same sector. So we’re seeing project-specific data matching project-specific transaction prices in the market. And that’s how the market ought to work, right? There ought to be rewards for higher quality, more reliable, less risky products. We also know that the relationship between price and quality is strengthening over time, particularly as the volume in the market picks back up, this relationship is strengthening. We launched our first group of ratings in April of 2022. Since then, the proportion of retirements of credits that have a BeZero rating of BBB or better have grown from 20% to 50%. So not only are people paying more for higher quality credits, they’re more likely to retire high quality credits. At the end of the day, this is all about fixing the climate crisis. And when you retire the credits, that’s when the magic happens. That’s when the impacts are really accrued and covered and sort of retired. And so people retiring more higher quality credits is a really good story we’re seeing in the market.

Ryan Fan: As I think about what you just said there, some of the things that come to mind as I put my banker hat on is being able to scale high quality decarbonization and the tools that BeZero produces and reports like this showing the strong correlation between quality and price and the indication that more high quality is being retired is, it all leads to me to a better ability for the market to understand where it’s headed in. And when we know where things are headed, it makes it easier for someone like me who works for a bank to be able to figure out how to finance that activity, right? And having that kind of clarity and correlation is awfully, awfully important for us. So thank you for that. We’re at a pivotal time in VCM’s development where the market continues to evolve its ability to credibly address the climate change. So how do see your industry evolving with the VCM over the longer term?

Spencer Meyer: We’re really playing the long game here. We ourselves are banking on the long-term market infrastructure the ratings has begun to provide. And I just gave you a few examples of that. And we feel really good about that. We think the future carbon market and the future of whether it’s voluntary or regulatory or somewhere in between, markets are going to need this central market infrastructure. That’s why we’ve really pulled together you know this theory around independent ratings around not doing advisory work, but really being this stable, predictable, transparent sort of organization that provides ratings into the market. And so as we look forward and there’s a lot of different projections out there about just how big the market’s going to get, but we’re banking on that. So just recently we put out a new paper called $100 billion for planet and people. And it explores what that future market might look like if the market reaches the 100 billion threshold by 2035. You know that’s not really that far away, just a little over a decade. And in that report, we lay out a bunch of things that we expect to happen. So for example, at hundred billion dollar annual transaction of a market, we expect $700 billion being invested annually into carbon projects because there’s a lag effect, right? You have to invest into those projects until they accrue and deliver the credits out the other side. So there’s quite a bit of leverage there on that scale of a market. We also know there’s a lot of non-carbon benefits that will come from a carbon market of that size. So we’ve estimated there will be about $60 billion in revenue from carbon projects that will be directly supporting the UN Sustainable Development Goals or the SDGs. Just to give you a sense of that scale, that’s 10 times the current annual budget of the whole UN development program. So here’s a private market that is going to have a lot of knock-on effects beyond solely the carbon benefits associated with it. Another estimate I can share from that report is we expect something on the order of 1.2 billion tons of carbon dioxide being removed. That’s about the amount of atmospheric impact that will happen from credits that are retired in that scale of a market. You know, economic benefits that’ll come, we’ve estimated around 17 million direct carbon project related jobs will occur as a result of a market at that scale. I think you know our industry has already grown immensely. If you think about the number of organizations, like BeZero, for example, that didn’t exist just several years ago, there’s a whole new industry cropping up around carbon projects. And we expect that to fully grow as well. So there’s just a few statistics. I think that report really lays out a lot of nice projections. I’d encourage the audience here to take a look at that. And just think about what their role can be in that future market. Essentially for us over the next five years, we just think it’s really essential that the market can rebuild its trust and confidence, both on the buy side and on the investor side. At BeZero, we want to be a part of that. That’s why we’re providing the information that we’re providing to our clients and indeed to the whole market.

Ryan Fan: I think we really are turning a corner in sentiment in the marketplace. I think we’re seeing quasi regulatory bodies and thought leadership in this space all coalescing around what it means to be high quality. And we’re starting to see that in the activity, especially in the dollars that are being thrown at the right initiatives, whether they be projects or, you know, infrastructure support, like the services that you guys provide. So I’m super encouraged. Definitely way better place now than when we were a year ago, I would say. So we’re trending in the right direction. Spencer, thank you so much for taking the time to join our show today. And, thank you to our listeners for tuning in.

Spencer Meyer: Ryan, thanks so much. I enjoyed our conversation. Take care.

Ryan Fan: If you would like to learn more about how your business can navigate the carbon markets, join us for CIBC’s Carbon Summit on October 10th, 2024 in Toronto. The summit will bring together project developers, capital providers, policymakers, and corporate buyers to discuss the evolution of the carbon markets and their nexus with the energy transition. As a prelude to the Carbon Summit, CIBC will also host a session to help companies understand how carbon credits fit into the broader decarbonization plan, and how to navigate the complexities of carbon credit purchasing. To register, please contact your CIBC Relationship Manager.Please join us next time as we tackle some of sustainability’s biggest questions, providing different perspectives to help you move forward. I’m your host, Ryan Fan, and this is The Sustainability Agenda.

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