Deep Dive: Multi-year strategies for Carbon Credits

Key takeaways

1. Offtake agreements ensure a reliable supply of carbon credits by locking in future purchases at predetermined prices, providing market stability for producers and buyers alike.
2. Forward purchasing allows buyers to hedge against future price volatility by securing carbon credits at today's prices and supporting project development with upfront funding.
3. “2023 has seen an enormous jump in forward purchases of removal credits. Like all opportunities, there are risks associated with each that buyers must become aware of and prepare for” - Sylvera Report
4. Adopting a portfolio approach to carbon credit purchasing spreads risk and maximises impact across various project types, from reforestation to direct air capture.
5. Integrating offtake agreements within a diversified portfolio strategy offers buyers risk mitigation, supply security, and potential pricing benefits in the volatile carbon market.

What are multi-year strategies?

As talked about in the previous section, multi-year strategies are about forecasting the number of credits you will need in the future and then making investments that will deliver you the credits that you will need, as well as providing other benefits such as securing prices and volumes of credits.

We will now take a closer look at the financial instruments that allow companies to do a multi-year strategy, namely offtake and forward agreements, before investigating the use of Portfolios as a potential means to further offset success.

Distinguishing between forward and offtake carbon credits

Offtake carbon credits

Definition: An offtake agreement uses a legal contract to buy a certain amount, or have the right to buy a certain amount of carbon credits at a set date in the near term (without paying for them now) even though the carbon credits will only be issued (created) at a future date. Prices can be set, or be variable.

Purpose: To provide a guaranteed market for the producer's output and ensure stability and predictability in the sales and revenue streams, enabling them to secure funding more easily. In turn, the buyer can secure a reliable source of supply for the carbon credits they need, to offset their emissions.

Benefits of offtakes

• They are ultra-effective in securing access to high-quality, verifiable credits at reasonable prices, in an environment where cost is likely to rise as demand outstrips supply.
• They assist in long-term planning and strategy formulation for companies’ net zero journeys, providing a definite picture of costs associated with the volumes secured by the agreement.
• They create a space for real, innovative partnerships between companies and project developers that would never exist otherwise in year-by-year purchases on the spot market.
• The pricing could vary from fixed pricing, decreased pricing as the year progresses or escalated pricing, according to market forecasts.
• Offtakes are usually less risky than forwards, as they are normally used much later in the lifecycle of a carbon reduction project than in the case of forward purchases. The main risk is that projects might not deliver on volumes, schedules, and quality specifications

Forward carbon credits

Definition: Forward Purchasing is an agreement to purchase carbon credits that will be delivered in the future. Payment is made now. These forward credits are normally offered by a project that is yet to be developed or is under development. This approach provides the project with upfront funding, which is crucial for its development, and offers the buyer price advantages, certainty, and potential volume security.

‍Purpose: Forwards are used for hedging against price volatility in the carbon market, offering a company the chance to commit to a lower price compared to buying the same carbon credits at the date when they are released in the future.

Benefits of forwards

• Companies can access future high-quality supply at a discount from the market rates of comparable projects, by paying in advance of the delivery/issuances of the related carbon credits.
• The funds help project developers cover their costs and assist them greatly in scaling and reaching their carbon credit delivery goals.
• Forward purchasing can create competitive advantages for companies through climate contribution narratives and marketing strategies.
• Forwards are a crucial mechanism to influence global climate impact positively.
• The main risk of forward purchasing is that projects might not deliver on carbon credit volumes, production schedules, and quality specifications and it’s possible that the price of the carbon credits a company purchases may have decreased by the time your carbon credits are retired, in which case you would have paid a higher price than what was possible.

Carbon Offtake Portfolios

Now taking it a step further, one can combine the concept and benefits of Portfolios, with the concept and benefits of Offtake Purchases. This is a combination of various carbon credits, all tied to an offtake purchase agreement.

For buyers of carbon credits, this means they:

• Diversify their impact on climate change by purchasing credits from various projects
• Spread the risk of their purchase since there are multiple projects involved in a portfolio approach
• Secure access to high demand, and future supply. Supply volumes in the future are projected to be much lower than the associated demand for it.
• Achieve price advantages such as potential discounts and locked-in, non-volatile pricing

The above concept is gathering momentum in the VCM and more suppliers, intermediaries, and buyers are putting their heads together to realise the benefits of this approach.