March 24, 2022

Saving the World, One Carbon Credit at a Time

Today's discussion is on voluntary carbon credits. The market for voluntary carbon credits has been on a tear for the past year, but it hasn't always been that way. New demand to achieve net zero emissions is driving growth, but there remains a huge amount of work to do. We discuss why the market took over a decade to emerge, what still needs to be improved, and who is doing the great work of building. Please enjoy this breakdown of voluntary carbon credits.

Hey friends -

The new website's live! Check it out at More updates to come as the Funders & Founders series goes live. It includes a glamor shot of my less than productive coauthor.

Great for licks, not for productivity.

On to this week's letter!

A few years back, I was fortunate to partner with Todd Lemons and Jim Procanik at InfiniteEarth. The work they've done is eye-opening. Their first conservation project - Rimba Raya - established a 181 square mile biodiversity reserve that includes the largest privately-funded orangutan sanctuary in the world and sustainable development programs for nine villages. For size comparison, imagine a reserve the size of the country of Andorra or the boroughs of Manhattan, Brooklyn, Staten Island, and The Bronx combined. It's big.

It's funded through the sale of the voluntary carbon credits it generates. The industry as a whole is fascinating - lots of good work in a painfully immature market. But change is afoot. It's the topic of this week's letter.

In this week's letter:

  • Voluntary carbon credits - what are they, how does the industry work today, and who's building the market of tomorrow
  • Two steps forward and one step back in a maturing crypto market, The Wisdom In Kung Fu Panda, and more cocktail talk
  • Underberg’s the star in this old fashioned variant, The Influence

Total read time: 16 minutes, 27 seconds.

The Market for Carbon

Rewind the clock to 2007 and travel with me to the island of Borneo.

The Seruyan Forest in Indonesia governed Borneo.

There you'll find an old-growth peatland forest, pristinely preserved. It sequesters millions of tons of carbon across 2300 square miles, not just in the living trees but also in the time-capsuled dead organic matter buried meters deep in the peat bogs.

Travel to the edges of the forest and you'll see the scene change. Palm oil company PT Best secured a concession a few years earlier to replace the forest with a palm oil tree monoculture. Officially, they've cut down 38 square miles of old-growth forest. In reality, they're burning trees as quickly as they can - it's no use fighting the concession if there's no forest left to save. If the forest dies, one of the last orangutan refuges in the world will die with it.

Todd Lemons at this point was a former sustainable logger looking to do more. He had already transformed a sustainable logging operation, materially reducing waste-wood to cut down on the number of trees felled and improve profitability. It was the first glimmer of the impact that can be achieved by aligning ecological and econometric interests. There was a lot of work to be done to make an impact at scale.

Together with Jim Procanik, Todd formed InfiniteEarth and partnered with the Orangutan Foundation International. They assembled financing and a development team to purchase and manage the forest. Proceeds would come by way of REDD+ carbon credits that could be sold to companies looking to offset their carbon footprints. Proceeds would be split among the financiers, the development team, the Indonesian government, and the local communities. It'd be called the Rimba Raya Biodiversity Reserve.

It took years of toil and millions of dollars in funding to launch Rimba Raya. On the brink of success, it almost turned to failure. The original project protected 350 square miles of forest. That approval was rescinded by Indonesia’s forestry ministry, a government arm that the deputy chairman of Indonesia’s Corruption Eradication Commission described as “a source of unlimited corruption.” Rimba Raya would be just half that, 181 square miles. The rest would be handed over to palm oil. The outcome was described - politically - by the head of the Indonesian government reforms unit as:

a case of a business idea that is ahead of its time. The government infrastructure is insufficiently ready for it. (Source)

You don’t have to know much about forestry to comprehend the destruction.

Despite the challenges, Todd and Jim made Rimba Raya an extraordinary success. In its absence, over 130 million tonnes of carbon would be being released from converting the forest to a palm oil plantation - equivalent to the emissions of 22 million cars. It's home to 600+ species including over one hundred listed as endangered or threatened. Most recently, it was recognized as the first carbon credit project of its kind to meet all 17 United Nations Sustainable Development Goals including improving welfare for the local population. It's the standard-bearer for how carbon projects can change the world.

And yet, despite the good it does - and by no fault of its own - the project struggles. It sells credits into a market that’s painfully immature.

What are voluntary carbon credits?

carbon credit is a tradable certificate that demonstrates a project has reduced greenhouse gas emissions by an additional 1-tonne carbon dioxide equivalent (tCO2e).

There's a lot baked into that definition. Unpacking it:

  • Tradable - there's a market where certificates can be bought and sold.
  • Certificate - auditors verify that projects meet standards.
  • Additional - the greenhouse gas emission reduction would not have existed had it not been for the project.
  • Carbon dioxide equivalent - there's a formula to convert greenhouse gases to their equivalent mass of carbon.

Carbon credits break down into two very different industries - regulated and voluntary. The former is a bigger market and what you probably have in mind when you think carbon credits. When you hear about "cap & trade" programs in California, that's a small piece of the $272 billion regulated market. It's big because regulatory authorities cap the mass of emissions companies like power plants can produce each year. Those companies that produce under their allotted emissions sell credits to those that go over. The regulators reduce the total allowed volumes year-over-year and so reduce the total emissions of an industry.

Most industries aren't strictly regulated - they can produce as much carbon dioxide as they please. Companies like Microsoft and Etsy have nonetheless committed to net-zero carbon emission by 2030. Some of that goal will come by reducing emissions, but much of it will come from purchasing voluntary carbon credits. They're credits that projects like Rimba Raya earn for producing additional carbon offsets.

At this point, you can probably see the problem with the voluntary carbon market. With the regulated market, the regulatory authority determines who is allowed to buy and sell credits ("tradable"), what standards exist and who are the approved auditors ("certificate"), and what qualifies as "additional."

None of that exists in the voluntary market.

Standard Setting Stuck in Beta Release

It all starts with standards. Carbon credits only exist as a bookkeeping entry - an auditor says that a project achieved additional emissions reduction against a standard and therefore can be awarded credits.

We - the world - took a first pass at setting standards in 1997 with the Kyoto Protocol. It wasn't quite an unmitigated disaster, but it was pretty close. Developed by the UN Intergovernmental Panel on Climate Change, the Protocol nonetheless laid the groundwork for much of what was to succeed in later years. It proposed binding emissions targets by countries, standards for the types of credits that could be earned, and a market where credits could be exchanged.

The Achilles heel was a two-tier market structure. "Industrialized" countries were subject to different standards than "Developing" countries. China and India were among the developing countries. They could - and did - receive carbon credits for projects that likely would have been built anyways, such as a European country financing a power plant in India. The methodology allowed developing countries to flood the market with credits that weren't an "additional" reduction in emissions. A German research group concluded:

Only 2 percent of the projects and 7 percent of potential CER [Certified Emissions Reduction] supply have a high likelihood of ensuring that emission reductions are additional and are not over-estimated. (Source)

Reality got was even worse in time. Many of the projects actually produced huge masses of greenhouse gasses but still qualified as "emissions reduction" because they were in developing countries - more efficient coal plants, for instance. Other projects didn't exist at all and were simply forged. The Stockholm Environment Institute estimated that over 80% of the carbon credits projects were "of low environmental quality" and "around 600m tonnes of carbon were wrongly emitted." It created a market of lemons - it was too difficult to differentiate poor quality from good quality carbon credits, so the price crashed.

At its peak, the 39 countries that committed to the Kyoto Protocol totaled 60% of the world's emissions. The US rescinded its commitment in 2001. Europe made up most of the "Industrialized" countries list by 2010 and accounted for just 15% of global emissions, not enough to make a real market.

Perhaps thankfully, it expired in 2012. Back to the drawing board.

Deforestation & New Standards

Among the big misses from the Kyoto Protocol was deforestation. Countries could earn credits for reforestation, but forest conservation - preventing deforestation and degradation - was specifically excluded thanks to the valiant work of Greenpeace and others. Despite continued efforts to fight against issuing credits for forest conservation, a new Reducing Emissions from Deforestation and Degradation (REDD) standard was created in 2008. It's since been expanded to REDD+ to include other considerations like clean water.

In 2012, the Kyoto Protocol was revised via the Doha Amendment with REDD+ making its way into the mix. The new amendment was finally ratified in 2020 by 147 nations. For those of you keeping track of global climate action, you might note that this bookends the Paris Climate Accords of 2015. Just to keep things interesting, Article 6 of the Accords was really just a placeholder and wasn't implemented until the Glasgow COP26 Climate Change Summit in 2021.

In short, this is all about as clear as mud.

With governments generally making a mess, the private sector got about creating its own standards. Multiple competing standards emerged early on - the Verified Carbon Standard administered by Verra and the Gold Standard administered by the Gold Standard Foundation have historically been the largest by volume of issued credits. The Verified Carbon Standard seems to be winning out - it accounted for 85% of all voluntary credits issued in 2021. Moving towards a single standard is a massive step forward for the industry.

That's not to say that voluntary carbon credits are one market. There's tremendous diversity in the projects. That manifests as a 470% difference in price between two categories - transportation and forestry - to take one example. Further breakdowns across other dimensions like geography and vintage exhibit similar price behaviors.

Prices & volumes for the many types of credits from 2019-2020. (Source)

That diversity is a real impediment. Markets for corn, soybeans, and wheat are massive precisely because they aren't diverse. We have generally accepted standards for each of the commodities. Above those standards, each commodity is fungible. A buyer doesn't care which kernels of corn they receive - they know that the kernels will all meet the standard. The diversity of carbon credits means that buyers can't be certain of the quality - they're non-fungible. Determining quality is a massive due diligence burden for any buyer and throws sand in the gears of the entire market.

But there's hope. Quality diversity is starting to be solved by a new generation of startups. It's just one of many market impediments they're tackling in their effort to grow the industry.

Building Better Markets for Carbon

Every market has to solve its own chicken-and-the-egg challenge. You can either bootstrap supply or demand.

Supply hasn't been the problem for carbon credits - there's an overabundance, including a lot of lemons. Demand never picked up in large part because of the poor quality supply. But demand's changing.

A tidal wave of demand

Large public companies like Amazon and Coca-Cola have already set themselves on a net-zero emissions path in the decades to come. Others, like Dow 30 member Salesforce are at net zero today. Even trade associations like the International Air Transport Association (IATA) have made net zero commitments. IATA represents 82% of all seat miles flown today or about 1.6% of the world's carbon emissions. By their estimates, they'll need to purchase 4 billion voluntary carbon credits over the next 30 years. That's more than twice the total volume of credits sold since the market existed.

Includes the ill-fated first attempt at a proper exchange in Chicago. (Source)

When you add up all of the commitments - from public companies, trade groups, and countless private companies - you find a demand wave that vastly outstrips available supply. The demand isn't just pulling new projects into the market but new projects at higher quality - companies don't want to be featured on the front page of the Wall Street Journal for cutting corners.

High-quality supply increasing

High-quality projects like Rimba Raya have found new homes at public companies like Carbon Streaming. Carbon Streaming is in turn financing the next wave of projects. Together with Todd Lemons of InfiniteEarth, they intend to protect 85 square miles of mangroves and 529 square miles of surrounding marine environments in Baja California Sur, Mexico. It's a new financing model where publicly listed investment firms like Carbon Streaming can acquire and curate high-quality projects, profiting from the generation of carbon credits much like a miner would from ore in the ground.

Other projects are taking a different route - using blockchain to simplify the offsetting process and to provide greater visibility into the actual credits. Moss.Earth bought four existing REDD projects in the Amazonian rainforest and just raised $10 million to buy even more. They've launched a token - MCO2 - backed 1-for-1 by the carbon credits and built the surrounding technology to make it easy to retire those tokens for the offsets. It's been embraced by traditional and crypto companies alike. Gol, Brazil's largest airline, now enables passengers to offset their carbon footprints using Moss's technology. OneRiver, a crypto fund manager, automatically offsets the carbon footprint of every Bitcoin it owns through Moss.

Moss has even launched 150 NFTs that each represent 1 hectare of Amazonian rainforest. Moss owns the land and will continue to act as custodian and project developer. NFT owners get some not entirely clear property rights, but can't burn, squander, deforest, or build on the land. By Moss's own reckoning, no one has ever tried this before. It's a wild experiment. Who knows where it might lead?

No details yet if waterfront property is more valuable. (Source)

These concepts of connecting consumers to the impact of their credits and making it easy to offset carbon footprints aren't confined to blockchain, more mature companies are doing it too. Etsy offsets the shipping carbon footprint of every order as part of its emissions neutrality commitment. Shopify does the same for orders purchased using Shop Pay and offers the merchants the option of doing so themselves for self-managed orders.

But these companies are not experts in voluntary carbon credits. They don't know how to calculate their carbon footprint or source high-quality projects. Startups like Pachama and Watershed are filling the void.

Managed carbon offset programs

Pachama is a curated marketplace of high-quality forest carbon credits. They offer a strict vetting process and make available insights from artificial intelligence and satellite imaging for ongoing monitoring. Microsoft, Softbank, and other high-profile companies are clients.

Watershed has gone even further. Launched by the founders of Stripe Climate, the startup offers a one-stop-shop carbon program. Customers can measure their carbon footprint, set up long-term plans to reduce emissions, purchase offsets, and report on progress all from a single application.

Not as highly marketed but extraordinarily impactful, Watershed enables companies to manage portfolios of carbon credits. It's a godsend for trading desks. Within every company looking to offset their emissions sits a carbon credit trading desk. That might not be what they're called today, but it's functionally what they'll become. Their job initially is to purchase credits to offset emissions. They'll find that their insights allow them to profitably buy and sell credits - to begin trading. It's a pattern we've seen with most other commodities. There's no reason to think carbon will be different.

Enter, Wall Street

Rising demand, new supply, and the beginnings of trading rarely make it far before Wall Street catches wind. It's certainly noticed carbon.

Xpansiv CBL is the largest spot exchange for voluntary carbon credits in the world. They facilitated 36% of all voluntary carbon trades by volume and 41% by value.

We take for granted in the world of equities that when we make a purchase, money moves out of our account and shares move in. That order in fact passes through many intermediaries before the purchase is matched up with a sale and the money is ultimately exchanged for shares with the seller. Most of that infrastructure doesn't exist in the carbon credits world. Xpansiv is building it.

What they can't build, they're buying. Xpansiv CBL was formed via a merger of two major competitors in 2019. The now-merged company acquired APX a few weeks ago. APX is the registry - tracking actual ownership - for over 50% of carbon offsets. By integrating an exchange with a registry so it's seamless to the market participants, Xpansiv is one major step closer to straight-through trade processing like what we have in equities.

They've even partnered with CME Group and expanded into futures, a financial contract for future delivery of carbon credits. Futures allow projects to sell tomorrow's credits for money today and for companies to hedge the future price of carbon. They're critical to any well-functioning commodity market.

Regional competitors to Xpansiv continue to flourish. Carbon Trade Exchange has been around since 2009 facilitating trades in the UK and Australia. AirCarbon Exchange is a relatively new exchange in Singapore using blockchain as its edge. It received the 2021 “Best Carbon Exchange” award from Environmental Finance.

All this activity, all this building is starting to create a real market for carbon credits. It's the beginnings of something bigger.

Slowly then suddenly

Carbon markets have been a mess for years. Between 2010 and 2020, the total annual value transacted was flat at $470 million. The frictions involved in auditing emissions, identifying high-quality projects, purchasing and retiring credits, and so on were simply too great. Annual transaction value never rose above $600 million but dipped as low as $145 million in those ten years.

Something finally clicked in 2021. Over $1 billion in trades were consummated, including $20 million of futures. Flat for a decade and then double in a year. The story of CBL's volumes tells the story of the overall market.

This is the type of graph any exchange dreams about: up and to the right.

Any way you cut the data, 2021 was transformative. Total value transacted: up. Trading volumes: up. Prices: up. Market participants: up. Up, up, up!

To put into perspective just how astonishing the growth has been - all of this took place as more supply than ever hit the market and credit retirement actually dropped. There was a supply glut and still, the market boomed!

Retirements likely fell in 2021 due to Covid’s impact on emissions. (Source)

We'll find out in the coming months if the boom is sustainable or just a bubble. All signs point to sustainable but there's still tremendous work to be done.

Great job - now get back to work!

So many aspects of what we take for granted in mature markets simply don't exist for voluntary carbon credits. They need to be built.

Standards for credits are woefully inadequate. The fact that at surface level credits are "all the same" but experts recognize differences material enough to drive 10x price differences is emblematic of not robust enough standards. That's not to say that the bar should be raised for all credits. It's that standards should exist that accurately reflect differences in quality, no different than the grades the USDA applies to corn.

Geo is likely indicative of quality, not the main price driver. (Source)

Project documentation is atrocious. Registries are 90s era databases with - at best - a jumble of unorganized PDF documents in any format of the uploader's choosing. To say it's incomprehensible to all but an expert gives the registries too much credit.

These issues go deeper than the great work InfiniteEarth does to launch new projects, Pachama does to provides insights on projects, and Watershed does to provide full-service programs. The problems are down in the bowels of the system where it's not sexy to make improvements but without which everything else will struggle. Few people are interested in the details of ISO 20022, but it's the reason financial services firms can seamlessly send messages to one another.

After years of struggle, we may finally be making progress on the hard coordination problems. For all its fault, financial services has demonstrated unparalleled success in at least one arena - standards. We transact trillions of dollars a day, across all varieties of goods and securities, in every variation of contract imaginable, across the entire globe. It's astonishing, but it's not magic. It's carefully coordinated chaos built on a bedrock of standards that allow disparate market participants to share information in highly predictable ways.

In 2020, Mark Carney launched The Taskforce on Scaling Voluntary Carbon Markets, a private sector-led initiative to scale an effective and efficient voluntary carbon market and help meet the goals of the Paris Agreement. Mark was the perfect go-between - he was the UN Special Envoy for Climate Action and Finance, the former governor of the Bank of Canada, and the former governor of the Bank of England. The Taskforce brought together an extraordinary group of accomplished individuals across the UN, finance, existing voluntary credit standards, and NGOs. The Taskforce gained the sponsorship of the International Institute of Finance, one of the largest finance trade associations in the world representing over 450 organizations in 70 countries.

The type of many-parties coordination work the Taskforce has undertaken is slow but necessary, and it's steadily inching ahead. Over 250 organizations around the world are now participating, from every corner of every industry, from governments to Indigenous peoples. It'll take time, but the Taskforce promises to build that much-needed foundation on which the entire voluntary carbon market will rise. Tremendous industry growth is already underway. This is the accelerant it needs to truly change the world.

Cocktail Talk

  • Maturity is much needed in crypto. The average user experience, fund protections, and documentation are poor. There are a few standout examples of doing a stellar with the basics from firms moving the industry forward. I got to experience one earlier this week. There was a well-publicized hack of Hubspot, a software company for marketing and sales. Paxos, a crypto bank, is a client. Within 24 hours of the incident, Paxos sent out an email that clearly communicated the essentials in priority order - breach happened, your money is secure, no action needed, stay vigilant. It was a case study on how to handle third-party vendor hacks. (Twitter)
  • This (I think) is the first plug for a product I've done in this letter. Webflow is that good. They're not paying me to write this but I feel compelled to share nonetheless. I've built or attempted to build websites with a variety of tools over the years. Everything up until Webflow was frustrating and disappointing. Webflow marries the flexibility of building a website from scratch with the handholding so desperately needed by non-technical users like yours truly. For someone like me who has been struggling for years, it's an absolute revelation. If you're considering creating a website, I cannot highly enough recommend it. (Webflow)
  • I try not to make a habit of knocking startups, but the general solicitation for the Jet Token capital raise irks me. Put aside my thoughts on if crypto will "revolutionize the private jet industry," my issue is with the raise itself. There's a lot of work to do to raise the standards in crypto. Creating tiers where investors get "distinctively HondaJet Pen and Keyring set" or "HondaJet Navy Blue Baseball Cap" based on their investment size works against all of the good efforts elsewhere. This is a capital raise, not Chuck E. Cheese. (Start Engine)
  • I love animated children's movies. The number of animated movies I've watched is frankly an embarrassing multiple of "adult" movies. There's something about the medium that grabs me. Animated gives the director and production team full control over every aspect of the screen - there's nothing that even so much as appears in the background that isn't intentional. Focusing on children as the audience forces a simpler storyline built around the most fundamental lessons. The three-part Kung Fu Panda, starring Jack Black and accompanied by a who's who supporting cast, has long been among my favorites. You can imagine my surprise at the recently-viral "The Wisdom In Kung Fun Panda." It led me down a rabbit hole which ended with a previously-viral post in the same vein by the Managing Director of Thiel Capital. (MoviewiseQuora)

Your Weekly Cocktail

Technically an old fashioned variant, but you’d be hard-pressed to identify it as such.

The Influence

1 bottle Underberg
1.0oz Overproof Rye
1 bar spoon Demerara Simple Syrup
2 dashes Orange Bitters
2 dashes Angostura Bitters
Orange peel

Pour everything except the peel into a mixing glass. Add ice until it comes up over the top of the liquid. Stir for 20 seconds (~50 stirs) until the outside of the glass is frosted. Add ice to a rocks glass. Strain into the glass. Squeeze the orange peel over the glass to express the oils. Drop it into the glass and enjoy!

The Influence

There’s a lot going on in this drink. On paper, it’s an Underberg old fashioned, but drink it and you’ll find it’s doing its own thing. With strong anise and other wintery alpine flavors, and clocking in 44% alcohol, Underberg is probably not what you’d expect from a digestive invented in 1846 that is officially sold as a “food product” in drug stores like Walgreens. It belongs right up there with Fernet as a “why would you do this to yourself?” liquor. I fall squarely in the “love it” camp but you can be forgiven for disagreeing. There’s no middle ground - once you’ve tried it, you’ll have an opinion. Even the strong flavors of rye, demerara, and bitters don’t stand a chance. This drink is a celebration of the wonderful absurdity of Underberg.


Join 1000+ subscribers to get the inner workings of finance delivered straight to your inbox.