Voluntary carbon credits: Why they are not a commodity

How understanding Voluntary Carbon Market (VCM) credits as an asset class impacts pricing behavior

Voluntary Carbon Market (VCM) credits are a fundamentally misunderstood asset class. They are being positioned as a commodity when, in reality, they are much more like corporate bonds. This is reflected in the confusing divergence of price curves between the Nature-Based Global Emissions Offset (N-GEO) and carbon credits eligible for N-GEO. We believe that classifying and treating voluntary carbon credits appropriately as an asset class will unleash the full potential of this asset class. This will enable the VCM to function more effectively in supporting sustainable development targets and the transition to a net-zero world. It also has significant implications for pre-trade and post-trade valuation for:


      Contractual agreements

      Management of post-trade carbon credit portfolios (by banks, asset managers, etc)

      Accounting treatment by businesses


This article will explore how understanding carbon as an asset class impacts the value of voluntary carbon credits and why a shift in perception needs to happen. We’ll cover:


      Price curve comparison between N-GEO and voluntary carbon credits

      Asset class definition and systematic vs. idiosyncratic risk factors

      How systematic vs. idiosyncratic risk affects pricing

      What voluntary carbon market credits are as an asset class

      Evolution of voluntary carbon market credits

      Why voluntary carbon credits should be an idiosyncratic asset class

      Direct asset pricing offers more transparency

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Price curve comparison between N-GEO and voluntary carbon credits

Let’s take a look at the price behavior of carbon credits in the market today. N-GEO is a standardized instrument of nature-based offset projects. Carbon credits included in the N-GEO instrument must be registered under the Verified Carbon Standard (VCS) and be accredited with Climate, Community & Biodiversity (CCB). They must also be at the Gold level for the CCB accreditation. The Viridios AI (VAI) platform aggregates pricing data for voluntary carbon credits from multiple sources including N-GEO daily transactions and quotes and over the counter (OTC) daily activities in carbon credits. The chart below illustrates a comparison of price behavior between the N-GEO instrument and two VAI composite indicators (VAI Nature and VAI Nature+).


  • N-GEO: Daily returns on the CBL N-GEO instrument
  • VAI Nature: Based on daily returns for vintages 2016 and up for 68 N-GEO eligible VCS nature-based projects (4,402 data points)
  • VAI Nature+: Based on daily returns for vintages 2018 and up for 63 N-GEO eligible VCS nature-based projects (2,599 data points)


N-GEO vs VAI pricing indicators

Note: Normalized return-based indicators, where January 4th, 2022, is equivalent to 1. Values above or below 1 respectively indicate gain or loss in price with reference to January 4th, 2022.


Note that the N-GEO price has declined by close to 90% between Jan 2022 and Feb 2023. By contrast, VAI Nature and VAI Nature+ show more stable behavior with price declines closer to 45% and 25% respectively. Why is this happening? If standardized instruments such as the N-GEO behave so differently from OTC carbon credits, should market participants even consider standardized instruments as representative of what they’re trading? The answer requires a little more in-depth understanding of how asset classes behave in international financial markets and what VCM carbon credits are as an asset class.


Asset class definition and systematic vs. idiosyncratic risk factors

What are asset classes?

Global financial markets revolve around the allocation of capital into asset classes. An asset class is a grouping of comparable financial securities such as equities (stocks of corporations) or actual physical assets such as real estate and commodities (a barrel of oil). Historically the most common asset classes were equities, fixed income (bonds), and cash equivalents. But today other financial instruments such as futures or cryptocurrencies can also be grouped into asset classes. Asset classes are categorized by their level of systematic (or systemic) and idiosyncratic (or specific) risk factors. These factors determine an asset’s risk and price behavior.


What is systematic risk?

Systematic risk factors impact all individual assets in an asset class. These factors can include economic indicators (national interest rate changes, inflation) or be broader in nature such as the impact of climate change. They are difficult to predict and can have a far-reaching impact on asset class valuation. This has played out in equity markets in recent months as inflationary pressures and a slowdown in the broader economy have caused stock prices to decline.


What is idiosyncratic risk?

On the other hand, idiosyncratic risk factors are specific and inherent to individual assets within an asset class (like one company’s stock). Idiosyncratic risk can impact principal valuation and pricing for certain individual assets. For example, if a company is found guilty of circumventing laws or engaging in unethical behavior, its stock price could decline. This outcome would only pertain to the specific company – not the entire sector.


How systematic vs. idiosyncratic risk affects pricing

Systematic risk impact on pricing

Certain asset classes, such as commodities and foreign exchange, are mostly impacted by systematic factors. For instance, the price of gasoline is primarily affected by systematic risk affecting the upstream (exploration, extraction, transportation, oil refinement) and downstream (distribution, demand) supply chain. A gasoline trader is much less interested in which refinery that gasoline originated.


As an example, a massive oil spill in the Gulf of Mexico in 2010 had no major impact on gasoline retail prices in the US which remained stable at an average of $2.85/gallon that year. On the other hand, retail gasoline prices fluctuated between $3 and $5/gallon in 2022 due to heightened systematic risk in the economy from geopolitical issues, inflationary pressures, and supply chain concerns.


Idiosyncratic risk impact on pricing

Conversely, while still significantly impacted by systematic factors, other asset classes such as stocks and bonds can also carry a heavy dose of idiosyncratic risk. Considering the previous example, the Gulf of Mexico disaster had no effect on the commodity gas price. However, the stock price of the individual company responsible dropped by 60% over a 3-month period after the oil rig explosion.


It follows then that systematic asset classes should refer to those primarily affected by systematic factors, while idiosyncratic asset classes should refer to those that are also significantly impacted by idiosyncratic factors.


What voluntary carbon market credits are as an asset class

Now we can establish a parallel with carbon credits as an asset class. The Voluntary Carbon Market (VCM) has the characteristics of any financial market including allocation of capital by investors, asset origination, and trading. As a result, voluntary carbon credits represent another type of asset class in today’s financial markets. The question then is what are carbon credits as an asset? Do they belong in a commodity, or a systematic asset class? Or are they more like corporate bonds, or an idiosyncratic asset class? And why is this determination important? To answer these questions, we need to understand how carbon credits have evolved compared to the reality of how the market operates today.

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.

The rationale for these questions is linked to this quote from Mark Twain. When initiatives progress based on inadequate mindsets and approaches, incumbents will lead with those same approaches and find every reason to uphold them despite reality indicating otherwise. And this always has the potential to lead that initiative astray, no matter how economically important or noble at first.


The type of asset class is an extremely important distinction to be made, as it impacts all aspects of the voluntary carbon market: how carbon credits are valued and traded, how they are settled and warehoused, how risk is managed, and even how financial accounting and reporting is employed. This ultimately shapes the architecture of the market and the success of carbon credits as an asset class.


Today, the Voluntary Carbon Market and global carbon markets as a whole are new, emerging markets. Carbon credits represent an asset class still in its infancy. But it’s one that’s already exercising a vital role in sustainable development and the transition to a net zero world. In order to achieve its full potential, however, it must be recognized as an idiosyncratic asset class rather than a commodity. Let’s take a look at how voluntary carbon credits have evolved to understand why.


Evolution of voluntary carbon market credits

Kyoto Protocol: carbon credits started as commodities

During the Kyoto Protocol years when the Clean Development Mechanism (CDM) was the primary carbon offset program in the world (~2006 on), carbon credits were viewed as commodities. The CDM’s certified emission reduction (CERs) credits traded in the secondary markets at fundamentally the same price. Despite their distinct project methodologies, those CERs had only one purpose: to be “consumed” (or retired) through the Kyoto compliance mechanisms. As a result, trading CERs was the job of commodity desks in banks and commodity trading companies.


UN SDGs expand the role of VCM carbon projects

By 2015, however, the Kyoto Protocol was over, and the voluntary carbon market was taking off. The CDM had been retooled as another standard in the voluntary market, along with other emerging standards that sought to ensure carbon credits met specific criteria. Since then, the voluntary carbon market has experienced extraordinary growth. This is the result of the two agendas for action that came out of the Conference of the Parties (COP) 21: the Paris Agreement and the 2030 Agenda for Sustainable Development. This elevated the role of VCM carbon projects toward achieving a broader purpose that goes beyond climate mitigation. Today these projects are also viewed as mechanisms for positively contributing to the 17 United Nations Sustainable Development Goals (UN SDGs). Yet they are still being treated as a commodity asset class in pre-trade agreements and post-trade management.


Why voluntary carbon credits should be an idiosyncratic asset class

This expanded role is arguably one of the main reasons why VCM carbon credits represent an idiosyncratic asset class rather than a commoditized, systematic asset class. As end buyers of VCM credits, most companies are not interested in voluntary carbon credits solely for their emissions offsetting but rather as an all-encompassing sustainable development tool. Just look at a sustainability report from any major corporation today to see environmental, social, governance (ESG) targets represented by the UN SDGs, of which carbon is just one of them: SDG 13, Climate Action. For example, Walmart, Nestle, Apple, and Amazon all map their ESG targets to the SDGs.


UN SDGs: Corporate targets vs. data available in VAI

The chart below shows a comparison between the SDG priorities of 59 global energy companies who have committed to science-based targets (SBTs) versus SDG data available in the VAI platform. Energy companies were included in the analysis if they had SBTs from the Science Based Targets initiative (SBTi) and their sustainability report contained details on their SDG targets. On the VAI side, nature-based voluntary carbon projects that are aligned with one or more SDGs were included (total of 216 projects). Note that, in addition to pledging net-zero emissions through science-based targets, these companies also have significant commitments aligned with most of the remaining 16 SDGs. Unsurprisingly, close to 80% of these companies have also established clean energy goals (SDG 7). Other SDGs that appear prominently in commitments from over 40% of those companies include SDG 5, 8, 9, 12, and 15. Also note how the nature-based voluntary carbon projects (published by the VAI platform) offer a contribution match to most SDGs targeted by these energy companies.

Energy company SDG targets vs nature based carbon projects SDG contributions v2

Note: SDG priorities of 59 energy companies who have set science-based targets compared to SDG contributions from 216 VCM nature-based carbon projects. The VAI platform displays assessments of SDG contributions on hundreds of projects in the voluntary carbon market. These assessments are based on VAI domain expertise in the carbon markets, combined with cutting edge technology.


Other idiosyncratic risk factors impacting VCM carbon projects

In addition to SDG contribution, there are other idiosyncratic factors that can affect a voluntary carbon project including:


  • The standard under which a project is registered (VCS, Gold Standard, etc)
  • Methodology employed
  • Host country and its corresponding geo-political factors
  • Project developer (experience, reputation, etc.)
  • Other service providers (consultants, validators, verifiers, etc)


Carbon credit pricing is highly influenced by these idiosyncratic factors. When buying voluntary carbon credits, companies look for ones that align with their respective sustainability targets, desired impact, and budget.


Current market trends reflect idiosyncratic risk reality

As a result, voluntary carbon credit pricing behaves exactly as one would expect in an idiosyncratic asset class. Prices of carbon credits vary widely depending on SDG contributions, standards, methodologies, project activities (avoidance, removal, etc), host countries, and many other factors. We have observed that projects contributing to more SDGs, as well as those contributing to high impact SDGs (biodiversity, health services, education, etc) have higher valuations. We have also confirmed that a VCS carbon credit on average trades at a significantly higher price than a CDM credit, as well as projects in Africa compared to those in India or China. More recently, VCM carbon credits may also have one or more ratings from various carbon credit ratings agencies that are emerging, which can impact valuation.


Seller behavior in standardized instruments

And now we can better understand the behavior observed in the price chart at the beginning of this article. Standardized instruments such as the N-GEO trade on the basis of market participants (sellers) placing a certain volume of their eligible carbon credits into the instrument at a certain price. Buyers can only see the specific carbon credit (project and vintage) once they actually buy the instrument. As a result, sellers are more likely to place carbon credits in the N-GEO instrument that meet the lowest possible eligibility criteria.


So, sellers would place 2016 vintages (which trade significantly lower than 2018 and up) of projects with the lowest co-benefit (SDG) activity that are based in host countries with lower demand by corporate buyers. The result is an instrument that behaves much like a commodity. That is, pricing is primarily based on the core utility of a carbon credit: offsetting greenhouse gas (GHG) emissions through retirement. In fact, it’s much closer to how CDM credits behaved during the Kyoto days. By contrast, the OTC voluntary carbon market presents a much wider diversity of carbon projects, capturing various premium features that can affect valuation (high co-benefits, more recent vintages, host countries in high demand, etc.). In fact, it behaves more like a corporate bond would.


Direct asset pricing offers more transparency

Standardized instruments have added important liquidity and pricing reference to the VCM especially between late 2021 to early 2022 when market pricing was much more opaque. However, for the reasons discussed in this article, these instruments have shown weak correlation with the actual assets being transacted. Therefore, we recommend that the valuation treatment for voluntary carbon credits be the direct asset pricing by project and vintage level – similar to how one would value a corporate bond by its issuer risk and expiry. A carbon credit valuation platform such as VAI offers full transparency into carbon credit pricing and project information as shown below. In this example, VAI is publishing daily pricing on the full vintage premium curve of projects including the respective fair value hierarchy for each vintage price.

Example pricing by vintage for nature based carbon project v3

Note: Sample of full vintage curve from the VAI platform, displaying prices by vintage level, including the respective fair value hierarchy (green dots represent level 1 and blue dots are level 2).


Combined with the right benchmark, these vintage pricing curves at project level can be used for pre-trade contractual agreements as well as post-trade daily valuation and risk management.



Try the VAI platform today to see:


  • Daily prices (marks) for various voluntary carbon market projects and vintages
  • Project details including issuances, instrument eligibility, project type, SDG impact, and more


You may also be interested in reading about how VAI won Best Market Innovation in the 2022 Environmental Finance Voluntary Carbon Market Rankings.

About the author:

Marcelo Labre is CEO and Co-Founder of Viridios AI. He has over 18 years of financial markets experience across multiple asset classes. As a pioneer in the carbon markets, he has worked on some of the most innovative structured carbon transactions in the markets to date. Marcelo is also a subject matter expert and thought leader on applications of Artificial Intelligence (AI) in finance. An engineer by training, he has a Masters in Finance from London Business School and a PhD in Mathematical Finance from Imperial College London.