by Shao Yim, Eo

New Straits Times: “We can profit from carbon credits”

Introduction

Global warming poses a significant threat to humanity and the environment. The risks of surpassing the 1.5°C target set out in Paris include a heightened risk of global hunger, mass migration, and other negative social and environmental impacts (1). In Malaysia, rising temperatures have resulted in rising sea levels and floods, particularly impacting communities residing in coastal areas (2). 

Malaysia aspires to reach a 45% reduction in greenhouse gas (GHG) emissions by 2030 and Net Zero Emissions (NZE) status by 2050. The main challenge to meeting these targets is paramount amidst disruptions due to the pandemic, inflation and geopolitical conflicts. The main challenge is twofold. Firstly, there is limited funding from the private sector for the adoption of renewable energy and climate technologies. Secondly, the existing climate policy frameworks are not sufficiently comprehensive to support decarbonisation. As a result, carbon credit has emerged as a potential instrument to mobilise funding from the private sector (3).

The primary tension surrounding carbon credit revolves around advocates who believe carbon credits can accelerate the NZE target and critics who are sceptical over the practicality of carbon credits. This essay discusses the significance of the carbon credit mechanism as a financial instrument for achieving NZE and the challenges and solutions associated with the existing carbon credit mechanism.

Carbon Credits

Upon the signing of Kyoto Protocol in 2015, emission reductions took on economic value. One of the important mechanisms implemented under the Kyoto Protocol was the establishment of the Clean Development Mechanism (CDM), where many carbon credit projects were developed (4).

A carbon credit is a permit that authorises the emission of one tonne of CO₂ or its equivalent (tCO₂e). Companies can purchase these credits, enabling emissions to a pre-determined limit. Entities that reduce their emissions below a certain baseline can generate carbon credits from either reduction, avoidance or removal projects. Once an international carbon standard body verifies the projects, the carbon credits can be sold to interested companies.

Malaysia is ideal for carbon credit generation due to its prime geographical location and natural resources, including ample rainfall, sunshine, and water. Malaysia’s extensive forests sequester around 259 tCO₂e annually, potentially generating up to 40 million tCO₂e of carbon credits annually (5). Malaysia can generate high-quality carbon credits by implementing nature-based solutions (NBS) projects such as reforestation and renewable energy. Recognising this untapped capacity, Bursa Malaysia has proactively launched Malaysia’s first Shariah-compliant voluntary carbon market (VCM), Bursa Carbon Exchange (BCX). VCM is a market-based platform that enables companies to procure carbon credits to offset their emissions. The establishment of BCX reflects Malaysia’s commitment to achieve NZE through innovative and Shariah-compliant financial mechanisms.

Carbon Credits Create Financial Value for Carbon Emissions

Carbon credits enable market pricing for the reduction, avoidance and removal of GHG emissions, incentivising entities to invest in carbon credit projects and generate revenue through credit sales. Voluntary carbon credits are significantly more dynamic since they are not confined to the regulations of the issuing countries. This mechanism enables voluntary wealth transfers from individuals or entities with unavoidable emissions to finance the development of projects to reduce GHG emissions (6). Over time, with increasing demand for carbon credits, entities that emit excessive GHG emissions may face increased costs in purchasing carbon credits to offset their emissions. As emitters face the economic repercussions of their carbon emissions, they are motivated to pursue low-carbon solutions, thereby diminishing negative externalities associated with carbon emissions and ensuring a more accurate reflection of the cost of GHG emissions. Carbon credits contribute to a shift towards NZE by internalising the previously externalised costs.

Carbon Credit Can Accelerate Renewable Energy’s Development

The rapid advancement of renewable energy technology (i.e. solar, wind and hydroelectric) has led to cost reductions and significant increases in their effectiveness in meeting energy demand. By 2030, renewables are projected to be 15% more cost-effective than fossil fuels, making them increasingly attractive to consumers (7). However, scaling renewable technology requires accelerated technical and commercial breakthroughs, necessitating heavy upfront investment.

Carbon credits can stimulate innovation and attract investments in renewable energy projects and low-carbon technologies, promote shifts between fuel types, and encourage increased investments in low-carbon assets (8). Carbon credits can provide short-term bridging solutions during the transition in sectors with high-emission assets, such as coal power plants. An abrupt and drastic reduction in emissions from coal power plants could lead to stranded assets. Carbon credits offer these industries a mechanism for gradual transition while potentially recouping some value from existing assets. Overall, adopting carbon credits sends a market signal of the nation’s commitment to NZE, attracting capital towards developing renewable energy projects.

Challenges & Solutions for Implementation of VCM

There are several challenges in implementing carbon credit mechanisms, and some strategies are needed to overcome these challenges. Various factors, including the number of local projects, quality and transparency of carbon credits, public awareness, and rigour of climate policies, influence the effectiveness of carbon credits. Addressing these challenges is crucial in closing the financing gap and achieving successful mobilisation for climate initiatives.

The principal challenge arises from the scarcity of domestic carbon credit projects, as exemplified in the initial BCX auction and affirmed by the representative from Maybank Investment Bank in 2023 (9). The immaturity of the market, coupled with the time-intensive nature of both nature-based and technology-based projects, presents further impediments to integrating domestic carbon credits. For example, the Kuamut Rainforest Conservation Project registration in Sabah took about eight years due to the COVID-19 pandemic and the lengthy approval process (10).

The recent allocation of seed funds may stimulate the generation and purchase of domestic carbon credits (11). However, a more crucial element is the establishment of a more supportive regulatory framework, encompassing incentives for the adoption of green practices, emission reduction initiatives and streamlining of the approval process (12). Additionally, forming long-term sector-specific alliances with corporations and financial institutions can collaboratively reduce the costs of project development (13).

Second, adverse publicity regarding the carbon project’s quality continues to undermine public confidence in VCM and its implementation (14). To illustrate, a recent New Yorker article revealed that millions of carbon offsets from the Kariba project, which earned almost 100 million USD for supposedly preventing deforestation in Zimbabwe, did not effectively prevent deforestation (15). Furthermore, current carbon credit markets face criticism for deficient measurement practices and controls, leading to minimal carbon sequestration impact.

Fundamentally, the effectiveness of VCM hinges on factors like emission reduction targets’ stringency, certification process credibility and other basic criteria highlighted in Figure 1. To mitigate the challenge, all projects should undergo a rigorous registration process to validate GHG emissions (16). In brief, it is crucial to introduce high-quality, low-risk and verifiable carbon credits with adherence to environmental safeguards in Malaysia’s nascent market. Continuous and close communication with the industry is equally crucial so that the mechanism can be acceptable to the industry and mitigate compliance issues.

Figure 1. Fundamental principles for high-quality carbon credits. (Source: https://icvcm.org/the-core-carbon-principles/) (17)

Thirdly, the transparency of carbon credit implementation is crucial in establishing an effective VCM. Buyers are interested in purchasing verifiable carbon credits that demonstrate provable impact. More than 90% of buyers prioritise a reputable monitoring, reporting, and verification (MRV) framework as a key consideration in credit purchase decisions (18). Therefore, companies must establish a robust foundation with fundamental financial accounting principles and an auditable framework before making carbon credit claims. The foundation should be grounded in their climate strategy, which outlines measurable, transparent, and time-bound climate actions. Carbon credits are often criticised by scientists as a means of continuing polluting activities without reducing one’s impact directly. To avoid the pitfall, companies should only consider utilising carbon credits if carbon emission reduction is impossible. Promoting carbon credit implementation transparency enhances VCM’s credibility and accountability.

Fourth, a lack of awareness and capacity among corporations, investors and policymakers continues to hinder the progress of the recently introduced BCX. The early-stage implementation of the carbon market in other countries demonstrated that industry buy-in is vital to the successful introduction and operation of the scheme (19). Implementing guidelines and training programmes focused on effective financial planning, investment strategies, and mechanisms of VCM plays a vital role in facilitating understanding among the key stakeholders. It is equally important to provide adequate time for industries to conduct long-term planning and subsequently incorporate new low-carbon technologies at a speed in line with technological advancement and market readiness without compromising operational stability. Commendably, Bursa Malaysia has made serious attempts to strengthen the carbon credit ecosystem by collaborating with local financial institutions. This approach ensures heightened awareness, fostering a more informed community in embracing carbon credits in Malaysia.

Fifth, climate legislation and framework serve as a crucial foundation for effective climate governance to ensure the credibility of climate pledges (20). Despite the growing climate-conscious electorate, local political leaders remain cautious about the augmentation of climate policies, especially on introducing of new carbon tax (9). In contrast, the European Union (EU) has already enacted laws mandating NZE by 2050 (21), and its EU Emissions Trading System (ETS) stands as a successful market-driven cap-and-trade system in GHG emission reduction. Lessons derived from the European model suggest creating a holistic regulatory framework to ensure market integrity and compliance. Political leaders and financial institutions should integrate climate action goals into policies and roadmaps to encourage early adoption by providing financial incentives such as subsidies or low-interest loans to develop carbon credit projects (22) (23). Commendably, Khazanah, the Malaysian sovereign wealth fund, has earmarked USD 32 million to stimulate the advancement of nature-based carbon credit projects in Malaysia (24).

The estimated global carbon market’s traded value was USD 978 billion in 2022, with 98% dominated by the compliance carbon market (CCM) (25). Transitioning into a rule-based CCM that operates under regulatory frameworks will strengthen the market-driven mechanism, boosting the demand and increasing the prices of carbon credits. Malaysia could adopt the compliance approach while leveraging existing domestic emissions-trading schemes and introducing carbon taxes and emission caps aligned with NZE. A robust regulation framework tailored to the local socio-economic and environmental needs is crucial to developing an effective and politically acceptable carbon market.

Outlook of Malaysian Carbon Market

The global market of VCM is expected to grow to approximately $250 billion by 2050 (8).

The International Monetary Fund forecasted that the global average carbon price should be at least $100 to reach NZE by 2050 (26). International collaboration is crucial to bolster the effectiveness of VCM. Since climate change is a global concern, an essential step involves expanding the BCX to incorporate carbon credits across the Asia Pacific Region, with a long-term vision of integration with the major international carbon credit market. An integrated VCM overseen by the World Bank and United Nations, in line with the Kyoto Protocol, will enhance the credibility of carbon credits in Malaysia.

Furthermore, the integration facilitates a broader scope for carbon credit transactions, attracts more participants, increases liquidity, and provides greater opportunities for trading carbon credit, exemplified by banking institutions like Maybank and CIMB Bank (22) (27). The comprehensive strategy necessitates systemic changes, active engagement from the key stakeholders and cross-border collaboration. Leveraging insights from successful international CCM models could create a thriving ecosystem with strong demand and supply of carbon credits.

Conclusion

As we discussed the interplay between GHG emission reduction and financial constraints, the carbon credit mechanism emerges as a pivotal tool propelling the nation towards achieving NZE by 2050. The carbon credit mechanism effectively directs capital towards developing renewable projects, positioning Malaysia as a promising hub for generating and selling high-quality carbon credits. However, this vision hinges on adeptly addressing pertinent issues encompassing the quality and transparency of carbon credits, stakeholder awareness, and climate governance in Malaysia. Malaysia’s plan to move to CCM and expand to the international market is poised to augment the value of carbon credits, thereby incentivising companies to reduce their emissions. While implementing an effective market mechanism presents challenges, Malaysia can balance its carbon emissions and economic vitality by strategically using carbon credits.

Reference

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