Commentary
Redesigning Carbon Markets: Leveraging Natural Climate Solutions for a Sustainable Future

I would hope that anyone in this sector would know by now that climate change, nature, and inequality are interconnected issues requiring an integrated approach. To meet the Paris climate goal of limiting warming to 1.5°C, it is essential to address nature loss and restoration through equitable global partnerships. Natural climate solutions (NCS) offer an opportunity to positively impact climate, nature, and equity simultaneously.

In my new report: Financing the Transitions the World Needs: Towards a New Paradigm for Carbon Markets I argue that parts of the carbon market need to be redesigned to ensure that the limited finance it provides catalyze the long-term transition of sectors of the global economy. This is especially the case for NCS, which consists of a broad array of activities including: forest conservation, land restoration, reforestation, agroforestry, regenerative agriculture, and biochar. When considered collectively,  the sale of carbon credits can lay the foundation for a sustainable economy.

In addition to mitigating climate change, NCS can also enhance biodiversity and promote social equity. Despite their potential, corporate investment in NCS remains minimal and insufficient, with nearly $7 trillion invested globally each year in activities harming nature, while only $35 billion* goes towards NCS.

Carbon markets to date have been in securing additional finance for the protection and restoration of natural habitats and empowered communities to counteract economic forces driving large-scale forest and land degradation. More than one-third of voluntary carbon market transactions by value now support projects with certified “beyond carbon” environmental and social co-benefits, according to Ecosystem Marketplace.

However, existing carbon market rules often restrict the integration of complementary NCS activities, limiting the potential for broader and more transformative interventions. As a result, the market undermines the potential for long-term investment which could, for instance, build resilient business models.

Landscape thinking

To achieve more successful interventions across broader landscapes, the rules governing NCS projects need to be updated. Integrating various NCS activities into a single project remains challenging due to the cumbersome and costly project development process. Consequently, projects tend to focus on single activities, missing opportunities for activities across broader landscapes that could enhance climate action.

Key to ensuring carbon finance’s role in the overall transition is recognizing that removals activities tend to generate alternative income sources critical for long-term value. Reforestation, agroforestry, and regenerative agriculture can create further value from forest and agricultural products. Leveraging these economic drivers provides a foundation for evolving the NCS sector, especially if carbon finance supports broader landscape management and sustainable business models.

For example, a forest conservation project could expand to sustainably reforest nearby degraded areas and promote agroforestry and regenerative agriculture. This would seed sustainable economic development while strengthening the buffer zone around the protected forest and reducing the risk of leakage.

Integrating avoidance and removals within a landscape approach enhances long-term success through complementary carbon finance, additional revenue sources, resilient business models, and higher market prices for integrated projects. 

Key reasons for integrating these activities include:

1. Complementary carbon finance: Revenues from avoidance can be generated quickly, while revenues from removals take longer. Integrating these activities creates a sophisticated revenue model that leverages available finance for long-term resilience.
2. Additional revenues: Sustainable forest and agricultural products meeting emerging standards can generate long-term economic opportunities. For instance, products from previously degraded lands with a certain amount of tree cover could enter supply chains seeking sustainable inputs.
3. Resilient business models: Diversifying revenue sources across carbon and non-carbon activities creates further resilience for project interventions and long-term business models.
4. Support for transition: Integrated NCS activities can support sustainable development across landscapes, protecting existing habitats and restoring others. Clear milestones that set out, upfront, the scope and role of carbon finance would enable large investments in integrated projects that can build the sustainable businesses of the future.
5. Complement solutions for permanence and leakage: By providing sustainable economic opportunities, integrated NCS would support the long-term permanence of both reductions and removals and address concerns about leakage.
6. Higher prices: Resilient projects that support long-term transitions and have lower risk of reversals while also addressing leakage from a structural perspective are likely to fetch higher prices in the market, appealing to buyers interested in sustainable  . Indeed, EM data shows that buyers are preferentially seeking out, and willing to pay more for, credits from projects that are seen as being high-quality.

Leveraging Positive Tipping Points (PTPs)

Integrating NCS aligns well with the use of PTPs to determine project eligibility and enabling the green transition. Under such an approach, the PTP would represent the point at which the particular sector of the economy should be able to evolve on its own, without the sale of carbon credits.

PTPs have the potential to revolutionize investment in NCS by providing clear milestones upfront, bolstering investor confidence. In this model, early carbon finance introduces new technologies and practices, reduces their costs and builds local capacity, essentially derisking future and larger investments across the sectors. A clearly defined PTP would underpin larger investments, such as processing facilities and tree nurseries. In the long run, once the PTP is achieved, one can imagine that the innovations have been sufficiently established so that they no longer need carbon finance.

This model has potential links to jurisdictional approaches, although it differs in that it relies on private entities deploying the initial capital and taking the corresponding risk. The fact that this model also relies on the development of sustainable business models suggests it is critical to have the private sector involved. At the same time, government participation remains crucial, especially for the long-term protection of critical habitats where a business model simply does work. Integrating these ideas into jurisdictional programs, however, could enhance their effectiveness, creating opportunities for nesting individual projects within broader jurisdictional efforts.

Strengthening both permanence and leakage while achieving scale

Considering the broader transition in the context of NCS is crucial due to addressing ongoing concerns about permanence. The market has mostly relied on buffer mechanisms to address this risk, and the insurance market is also developing innovative new solutions. However, the potential for reversals still undermines confidence in NCS. Making the conservation of natural habitat a key pillar of economic development would enhance the permanence of the reductions achieved.

By ensuring enduring interventions, the likelihood of stakeholders reverting to previous practices is reduced. As sustainable practices become common, the risk of reversal decreases.

In addition, providing economic development opportunities would minimize the risk of leakage, another concern of those purchasing credits from NCS. Again, integrated NCS would provide a structural complement to the rules that currently govern how to address leakage.

More resilient business models lower the project’s risk profile, reducing the amount of credits deposited in buffer mechanisms. Freed-up emissions reductions or removals could then generate extra revenue for further mitigation efforts or the establishment of trust funds that could be used to backstop conservation efforts long after revenues from carbon sales dry up.

Strengthening demand to protect and restore ecosystems for the long term

An approach that integrates NCS to achieve the transformation of a particular region would also strengthen demand. For example, investments in transformative NCS activities could eliminate the need to track supply chain emissions down to individual producers, especially benefiting companies in the agriculture, forestry, and other land use (AFOLU) sector where emissions are hard to identify and mitigate. Such integration could also help resolve the growing divide between avoidance credits and removals, which in effect undermines our collective ability to facilitate investments that protect and restore natural habitats at scale.

Overall, this approach could shift the debate and provide a more compelling narrative for carbon markets.  Instead of continuing to focus entirely on the compensation of unabated emissions, this approach could shift the emphasis towards actively supporting, at scale, habitat protection and sustainable agricultural and forest practices. Finally, enabling the transition of entire NCS sector through carbon finance could achieve significant emission reductions beyond those that are financed through the sale of carbon credits. If carbon finance provides the upfront capital that catalyzes broad adoption of sustainable practices, the climate benefits would be significantly greater. That is, after all, what we are all trying to achieve, and what is needed to avert serious climatic disruptions.

* The State of Finance for Nature annual report – download full report here: State of Finance for Nature 2023 | UNEP – UN Environment Programme