“Discount Rates For Carbon Credits Will Allow For Risk-Adjusted Decisions” – Sebastien Cross, BeZero Carbon CIO & Co-Founder

The Discount Rates Will Allow For Risk-Adjusted Decisions – Sebastien Cross, BeZero Carbon CIO - Carbon Herald
Source: BeZero Carbon

Last month, one of the world’s leading carbon credit rating agencies BeZero Carbon published a white paper introducing its discount rates methodology for carbon credits. 

This unique, first-of-its-kind tool provides a financial markets framework for retiring carbon credits and aims to help end buyers in the voluntary carbon market (VCM) retire carbon credits based on project-level quality.

To gain a better understanding of how the discounting methodology works and what it brings to the VCMs at large, we had a talk with Sebastien Cross, Chief Innovation Officer and co-founder at BeZero Carbon.

This interview has been edited for clarity and length.

As not all carbon credits are worth the same, the BeZero discount factor suggests that if I were to buy X carbon credits, I would need to recalculate how much carbon removal or avoidance I’m buying. Is that correct?

Yes. The market has been stuck on this idea that either a credit equals a tonne of carbon or it doesn’t. And it has caused a lot of the issues that we see in the carbon credit market today. 

People make claims attached to a credit based on a given tonne amount, whereas when looking at the underlying dynamics of credits, we look at the risks, and we know that there’s a range that exists. Some credits are much more likely to achieve a tonne of carbon removals or avoidance than others. And so essentially, the market needs a tool to make that risk adjustment.

Would you say this is more of an issue of project developers wanting to upsell themselves or more of buyers having wishful thinking and the desire to have purchased exactly 1 tonne with each credit? 

In order to issue a carbon credit, you have to have a level of confidence that the project or the activity that you’re financing is only going ahead because you’re issuing these credits. And that’s the question of additionality, which introduces uncertainty. And from there, you look at how the number of credits that are issued is calculated a lot of the time statistically. It’s literally just the very nature of credits, and how they’re constructed. 

It means that that range exists, and you can think of it in a similar way to financial markets, where people issue debt. There is a risk of the company failing not repaying its debt. The S&P will provide a rating that looks at the likelihood of that happening. Ratings in this case are not monetary rates. But I don’t think it’s necessarily the fault of the developers, nor is it the fault of the buyers. It’s a complex product that needs a tool to recognize its complexity and allow people to make risk-adjusted decisions. And to date, that hasn’t been available in the market. 

Can you provide examples of what you include in this discount factor?

The discount factor is attached to the Bezero Carbon rating. So, underlying the rating itself, are three key policy assessors, such as the question additionality. When you’re testing additionality for accreditation purposes, the methodology has to say, ‘yes, this project is additional’ or ‘no, it’s not’. If it is, then you go on and you calculate how many credits should be issued. 

We assess additionality as a range, because you get some projects that are more additional than others. It’s almost a question of confidence, where if a project has alternative sources of revenue in addition to carbon credits, I will have less confidence in carbon credits being the additional factor for that project, than if they were the only source of revenue for the project.

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So, additionality is the core risk we look at, followed by carbon accounting, which shows how the number of credits issued each year are calculated. And, finally, there’s non-permanence. So projects that are nature-based, either for reductions or avoidance, obviously have a forward looking component, and we take out the risk of future reversals in the rating. 

Our rating blends all three of those factors into an overall assessment of what is the likelihood that the given credit achieved a ton of carbon removal. The discount rate that BeZero Carbon has now attached just literally maps to that scale and attaches a discount of 5-99%, depending on the project rating. 

In light of the recent carbon credits scandals, would you say that the main reason for these faulty credits is exactly the lack of such a tool?

The issue with the Guardian article or the analysis is based on an academic paper, which looks to use dynamic baselining to assess the robustness of the counterfactual used in some of these deforestation projects. The academic paper itself is relatively robust. The issue is that they’ve taken projects, the bulk of which sit right at the bottom of our rating scale, and they’ve implied that this is systemic across the entire market. And it’s an extrapolation that is actually more problematic, because there’s lots of good things going on in this market, and it just implies that it’s completely useless. 

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The discount rate that we’re suggesting is not designed to overcome issues with those carbon projects sitting right to the end of the BeZero rating scale. What we’ve said in the paper is focused on the top half of the distributions. Once you get towards the bottom half of the rating scale, discounting can’t overcome a project that’s at risk of being completely non additional.

So, it’s less about trying to validate the use of low quality products and more about providing a methodology that credibly uses higher quality credits in a strategy that can be used to make high-quality claims.

How soon do you believe it will be brought to market?

Obviously, the numbers are available in the white paper, we’re having discussions with a number of clients who do want to start using this. We are going to be launching the tools on our platform for people to actually be able to construct these types of portfolios through our platform. And there’s a lot of work that we’re looking to do as well.

This technique that we’re using here – applying discount rates to the headline rating – is not new. It’s like the S&P and Moody’s that have the major ratings in financial markets, who produce a report every year that looks at bonds that have defaulted and the rating that those bonds have over time. They then use that to calculate the probability of default across all of their ratings buckets, and they update that analysis every year. And that thing gets fed into the risk models for people using their rating. 

We’re looking to do something similar with the data that we have to show project performance so that these numbers can evolve over time to reflect the latest performance data in the market.

Do you have any projections or expectations as to how exactly this is going to impact the market moving forward?

Of course, we do hope it has a big impact on the market. We’ve been talking to people across the market about this for quite some time. We’ve had lots of people encouraging us for quite some time to publish this, because people want to be able to use ratings in practice. Prior to having these numbers, they were able to understand risk in terms of the risk language, but it was much harder to implement it in practice.

We’re at an important stage in the market’s development: on the supply side, there’s the IC-VCM publishing The Core Carbon Principles and looking to apply that label to projects later this year. On the demand side, the VCMI came out with its guidance on how to make claims, and the SBTi is working out its view of carbon credits. This tool very much puts ratings in the middle of that. CCP is great in providing the guardrails around the market for what is an acceptable credit. But it still doesn’t overcome this issue of not every credit being equal to a tonne.

Do you believe that a wider application of these ratings will essentially help weed out lower quality projects in the future?

Absolutely. We’re the only rating agency that published our rating on our website. And you’ve seen it happen already with some of the projects that people were unsure about historically.

People were using renewable energy credits to make some base claims, you see that happening a lot less now, where in the cases where ratings of some of those projects are much lower. And in the case of nature-based projects, where you see avoided deforestation, whereas huge forest loss and we pick that up on our satellite imagery and reflect that in the rating, you see, obviously demand for those products dropping off and you see the accreditors also react to that. 

It’s still early, though. Ratings in this market are still only two years old, really. So we are already starting to see the correlation between price and carbon quality emerge. And therefore price is a signal that encourages people to develop better projects. So yes, I think we’re starting to see that already, but absolutely, our hopes are that it continues to evolve.

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