Challenges in demand growth
Increasing Market Concentration…
Despite increasing market participation and product diversity, there are signs that voluntary carbon market liquidity is concentrating, rather than broadening.
From 2021 to 2022, the average price of voluntary carbon credits rose by 82% (Source: Ecosystem Marketplace, November 2023), fuelled by increasing market demand and growing premiums for quality (see below).
Yet deal volumes fell by 51% over the same period. Despite the growing numbers of market participants, the industry is handling just over half as many deals year-on-year – indicating a potential blockage in the volume of transactions that the industry is able to process. The industry trending towards mega-deals – with liquidity concentration around few deals at higher ticket sizes.
Even allowing for the fact that 2021 was an extraordinary year for market values and volumes, the longer term trend is clear. The average price of voluntary carbon credits has grown by more than 13 times since 2017, whilst deal volumes have only increased by 5 times. Demand for deals is far outpacing the industry’s ability to process them.
On the positive side, growth in the average deal size is potentially a sign of the growing institutionalisation of the industry – as it moves from being largely retail-driven towards a focus on major corporate and financial investors as the mainstays of liquidity.
Yet this trajectory towards fewer and fewer deals also raises a core market concern. What is limiting today’s buyers in their ability to manage greater numbers of (smaller) deals and what does this trend towards mega-deals mean for smaller projects and smaller market participants?
“The issues around the voluntary carbon markets today aren’t making people exit the market – but the rate of deals is definitely slowing”
(Global Head of Distribution, Carbon credit investment fund manager)
…causing potential blockages in supply
The fact that commercial banks appear most aware of these limitations is a great cause for concern. Despite highly positive market growth expectations of up to 75% by both sellers (notably project owners) and buyers (both corporates and financial investors) in the next ten years, the commercial banks that provide funding and liquidity to projects as the first line of viability are significantly less optimistic.
Not only do they expect lower growth but only half as many commercial banks expect to enter the market than do corporates in the coming five years (with 38% of commercial banks expecting to enter the market by 2027, compared with 62% of corporates).
This limited engagement and conservative approach by commercial banks is not only an indicator of deeper challenges, it also risks reinforcing the supply challenges that we highlight above. If fewer commercial banks are lending to and financing projects, then fewer projects will reach a stage of scale and hence market supply will be limited.
What is holding them back? Faced with a current market trajectory of fewer deals and fewer banks ready to finance projects, it is important that we understand where the markets’ core concerns are so that we can avoid creating a supply issue and disenfranchising project owners at their most vulnerable stages of growth.
