7 February 2024

The Emergence of European Nature-based Carbon Credit Markets

European nature-based credit markets are young but growing. They present a unique opportunity for investors seeking exposure to high-quality credits underpinned by strong fundamentals.

The voluntary carbon market (VCM) came under scrutiny last year due to criticism of some avoided deforestation (REDD+) projects and methodologies. Overall, traded credit volumes were down by 51%, but the market value held up, at just under $2billion, thanks to a sharp rise in prices1. At SLM Partners, we are pleased to see that VCM carbon credit buyers are becoming more sophisticated, differentiating between credits based on project type and location, and are willing to pay for quality.

Within this evolution, European nature-based credits are in a favourable position, for a number of reasons.

There is strong demand and willingness to pay for European credits. In 2023, European credits traded at an average of $25.41, significantly surpassing the global average of $7.592. This premium is supported by strong demand from European corporates who are seeking out high-quality projects close to home that are more relatable to their customers and employees and less prone to reputational risks.

Buyers distinguish between technology and nature-based carbon credits. In 2021 and 2022, nature-based credits were trading at more than double the price of technology-based credits. The premium was even greater in 20233.

Not all nature-based credits are created equal. Nature-based credits remain dominated by REDD+ projects but they also include other types of projects; namely agriculture, Afforestation, Reforestation and Revegetation (ARR) and Improved Forest Management (IFM). These projects are specifically sought after by buyers and the average price of credits from such projects continues to increase at a steady pace, while other project categories, namely REDD+ and technology-based projects, fall behind.

Removals credits are now a preferred choice. One key factor that is supporting higher prices for agriculture, ARR and IFM credits is the buyer's preference for removal credits that are produced through increasing carbon sequestration from the atmosphere by plants and soils, over reduction or avoidance credits that are produced from a reduction in emissions. Projects such as REDD+, energy efficiency, fuel switching and renewable energy, all contribute to a reduction or an avoidance of carbon emissions rather than carbon removals or sequestration. Technology-based carbon removals such as Direct Air Capture (DAC) or Carbon Capture, Utilization and Storage (CCUS) remain prohibitively expensive (up to $600 per tonne sequestered)4. Meanwhile, agriculture, ARR and IFM projects offer nature-based and cost-effective carbon removal solutions.

Supply of European nature-based removal credits remains limited. Overall, there are still very few European projects registered. In 2022, the total volumes of credits from European projects was less than 1% of the total traded volumes on the VCM. In response, European project developers and brokers are scrambling to build a pipeline of projects that will deliver millions of tonnes in credit inventory in the coming 10-20 years.

SLM Partners is developing European forestry projects fit for tapping into this market. Many real asset managers investing in productive land for farming or forestry are interested in boosting returns through tapping into carbon markets. However, it is necessary to be able to demonstrate 'additionality' beyond business as usual to generate carbon credits. Changes in land use, such as afforestation, achieve this. But merely investing in a continuation of conventional forestry or agriculture is unlikely to deliver additional carbon storage. Ecological strategies based on scaling up more sustainable forms of land management, such as Continuous Cover Forestry (CCF) or regenerative agriculture, have more potential. These strategies retain a commercial focus on producing wood or food, but take a more holistic approach to landscape management, ensuring consideration is given to soil health, biodiversity, carbon sequestration and climate change resilience across the whole landscape. They can offer scalable opportunities to generate carbon credits due to their ability to store higher levels of carbon in soils, vegetation and, in the case of forests, longer-lived wood products.

SLM Partners is currently developing forestry projects across Europe combining both ARR and IFM project types, providing investors with income from both commodity production and carbon credits. To tap into the growing carbon credits markets, SLM Partners has established partnerships with leading carbon developers in Europe. Our Irish afforestation sites are already part of the pan-European VCS ARR project being developed by Ecobase. Carbon credits from such projects are currently trading at around €25-30/tonne.

We see solid fundamentals for future growth in this market. We expect the market for European carbon project to grow, driven by further demand, supply of new projects and development of policies and regulatory standards. Corporate demand for European-based project is expected to grow now that the new EU Sustainability Reporting Standard is place – as corporate are asked to break down the credits they purchase and retire from projects registered within and outside the EU. The revisions of the EU Regulation on Land, Land Use Change and Forestry (LULCF) setting a net carbon removals target of 310 million tonnes of CO2-eq by 2030, is also likely to fuel further expansion in this market (what the EU calls "carbon farming"). To support this growth, the EU has introduced the Carbon Removal Certification Framework (CRCF), bringing transparent and credible standards to the market.

The EU is also considering the launch of an agricultural emissions trading scheme or AgETS5 that will require regulated agricultural entities to offset emissions through the purchase of credits from forestry and other land-based carbon removals projects. Transitioning to a compliance market in Europe could lead to a meaningful increase in prices for nature-based removals credits, bringing them closer to the prices seen in the existing Emissions Trading System where 2022 prices for EU allowances averaged €80/tonne6.

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SLM Partners is an asset manager that has pioneered investments in regenerative land management since 2009. We have recently announced partnerships with two EU-based carbon project developer start-ups: Ecobase, with whom we are working on carbon projects across our forestry portfolios covering both new plantings (afforestation) and existing forests (improved forest management); and Climate Farmers, with whom we are working on carbon projects across our nut and olive orchard portfolio. The first credit sales from our European investments are expected in 2025.

For more information about how SLM Partners is working with carbon leaders to support the development of carbon markets, you can read more here or reach out to info@slmpartners.com

Footnotes:

1 Forest Trends' Ecosystem Marketplace. 2023. State of the Voluntary Carbon Markets 2023. Washington DC: Forest Trends Association.
2 Forest Trends' Ecosystem Marketplace. 2023. State of the Voluntary Carbon Markets 2023. Washington DC: Forest Trends Association.
3 Forest Trends' Ecosystem Marketplace. 2023. State of the Voluntary Carbon Markets 2023. Washington DC: Forest Trends Association.
4 J. Hall and J. Bednar, "Carbon Removal Will Cost as Much Annually as the NHS Budget—but Oxford Research Shows Polluters could Pay," University of Oxford News, October 6, 2021.
5 https://climate.ec.europa.eu/news-your-voice/news/looking-how-mitigate-emissions-agriculture-2023-11-13_en
6 https://icapcarbonaction.com/en/ets/eu-emissions-trading-system-eu-ets

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