Carbon credits are not a simple homogenous commodity. Many methods which can be applied in projects to produce credits are associated with social, environmental and economic co-benefits. For example, fire abatement projects in northern Australia can provide cultural and employment opportunities for traditional owners, while native forest restoration can provide biodiversity benefits. Recognising and valuing the range of co-benefits associated with carbon credit projects is far from straight forward, but may represent a valuable source of additional income for project operators.
Buyers often have preferences for carbon credits which offer more than just a carbon offset, with many increasingly seeking to include credits with social and environmental co-benefits in their portfolios. There is evidence of this occurring in some voluntary environmental goods markets (i.e. National Carbon Offset Standard), with wide variation in prices between different credit types and apparent price premiums associated with projects producing desirable co-benefits. Quality conscious buyers can also shun credits with negative co-benefits. For example, the negative co-benefits from ‘native forest waste materials’ credits previously generated under Australia’s renewable energy trading scheme attracted strong market discounts.
Valuing these co-benefits is a challenge, because they are infrequently traded in markets and are frequently hard to quantify. One approach would be to quantify co-benefits from a particular project using simple metrics (e.g. employment numbers, biodiversity index), where buyers could seek their desired levels of carbon and co-benefits. However, this would require buyers to quantify and express trade-offs between carbon and the various co-benefits. But this is difficult given the non-monetised nature of most co-benefits. With a large number of projects and a high degree of heterogeneity in co-benefits it would quickly become infeasible for participants to clearly express their preferences and provide associated signals to the market.
Recognising co-benefits greatly complicates the mechanisms for exchange. Many public procurement auctions consider more than one attribute (e.g. infrastructure projects value price, delivery time, track record etc.), but these typically end up as a hybrid model of auction and negotiation. Hybrid models may work well with limited numbers of participants, but transaction costs can be high relative to the overall value of the market. Instead the carbon credit market may need to follow the approach adopted by many other commodities and classify credits with particular co-benefits into different classes or grades. While some potential revenue may be lost to the project by grading rather than quantifying and valuing each co-benefit, it facilitates a high volume, low transaction cost market.
For carbon credits produced in Australia, we at CSIRO have defined categories of attributes associated with the methodologies recognised by the Clean Energy Regulator (i.e. agricultural, vegetation and savanna burning methods). Where additional attributes prove to be important to the market, such as project location for managing portfolio risk, a methodology might be broken into classes corresponding to regions. For example, reforestation credits could be classified according to agro-ecological zones, allowing a buyer to diversify their portfolio. Project developers could also choose to seek additional third-party certification (e.g. www.goldstandard.org) thereby creating a new class of credits.
Recognising multiple classes of carbon credits allows co-benefits and other project attributes to be recognised and valued in the market. The number of classes represents a compromise between the need to reduce transaction costs and the need to provide quality information to buyers (and brokers). Ultimately buyer and seller interest can define classes. A drawback of the multiple class approach is that, particularly in the early stages of a carbon market, trading volumes will be low. Starting with a small number of classes would mitigate this, though this may be less than satisfactory given there are multiple land sector methodologies.
Efficiently valuing co-benefits will require a carefully designed mechanism because there exists a trade-off involved in accurately arriving at a market valuation of the respective attributes of carbon credits, and the transaction costs of doing so. In other words, we are looking for an efficient mechanism which best facilitates exchange in the market.
Markets take many different forms. Consider for example how we buy a cup of coffee (a fixed posted offer), a house (a negotiable posted offer, or an ascending bid auction) or trade shares (a call auction when the market opens, followed by a continuous double auction). The exchange mechanisms which underpin these markets reflect social choices which often, but not always, will arrive at a desirably efficient and equitable set of outcomes.
Auctions are generally considered to be most effective mechanism to efficiently bring together buyers and sellers, but this may not always be the case. Where the market involves heterogeneous goods which are high-value and low-volume (e.g. real estate) the activities of brokers effectively match of buyers and sellers, and efficiently promote exchange. However low-value markets have less scope to bear the transaction costs of having attribute differences recognised and valued. In a carbon market, the premiums available to developers for distinguishing their project co-benefits may not cover the costs of brokerage.
Efficiently arriving at a value for goods which are heterogeneous and low-value has been made possible by digital platforms like eBay (i.e. a passive digital broker), which have dramatically reduced the costs of matching buyers and sellers for the exchange of small volumes of goods. But in markets with many different types of carbon credit, buyers and sellers may struggle to match effectively and fail to establish the values of co-benefits.
At CSIRO, we think we can overcome this problem by applying a simultaneous, or ‘product-mix’, auction mechanism. Auction mechanisms of this form work a little bit like internet dating (e.g. Tinder). That is, someone who want to buy carbon credits can express interest (make a price and quantity offer) for a wide range of types of credits, but only a predetermined number of offers are honoured if they are successful.
This means that sellers of carbon credits with particular co-benefits can see prices being offered and assess the level of market interest, even if they don’t successfully sell their credits. For buyers, they can make an unlimited number of offers for different types of credits that match their preferences without the risk of overcommitting offers, or worse missing out entirely because they were focussed on one type.
Our experimental research suggests that product-mix auctions are a very efficient mechanism, which best facilitates exchange in a multi-attribute market. This mechanism allows producers of even the most obscure co-benefit class of ACCU to compete on a level playing field with other sellers, and provides important signals to guide future investment.
For more information, contact Dr Andy Reeson on firstname.lastname@example.org.