Project Development in the VCM

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Project developers are the bedrock of the Voluntary Carbon Market (VCM). Their efforts to initiate, organize, and develop emissions reduction projects are fundamental to the functioning of carbon markets. Without their activities, there would be no assets to trade. However, the landscape they have to navigate is undeniably complex. Bringing a successful project to fruition requires coordination with local communities, investors, certification bodies, and offsetting entities to ensure the project verifiably sequesters carbon following a preset methodology. 

To better understand their unique place in the market, we spoke to some carbon project developers about their role in the VCM, their challenges, and emerging solutions to these difficulties.

Developing a project in the VCM

Project development is a long-term endeavor which consists of five main stages:

1. Project identification and development: This early stage involves assessing feasibility, securing funding, and conducting thorough research, as well as assessing the project site's suitability, conducting impact assessments, and engaging local communities for collaboration and support. Depending on the project type and size, this stage can take several years.
2. Validation and verification: In the second stage, project developers (or consultancies acting on their behalf) work with certifying entities like Verra and Gold Standard to assess and confirm the accuracy and credibility of the project. This includes verifying adherence to predetermined methodologies and standards, examining data and documentation, and ensuring transparency in the verification process.
3. Issuance of carbon credits: A quantity of credits is issued as authorized by the certifying body. This involves the formal recognition and quantification of the emissions reductions achieved by the project. Projects may generate anywhere from a few thousand to over a million carbon credits annually, depending on their scope.
4. Sale of carbon credits: Project developers often interact with buyers at the earliest stages of development and sometimes sell the rights to their credits prior to issuance via forward contracts. For credits not sold via forwards, developers interface with brokers or offsetting entities post-issuance to sell credits to a counterparty.  
5. Project monitoring and maintenance: The Monitoring, Reporting, and Verification (MRV) stage represents an ongoing responsibility for project developers, who must maintain project sites in a sustainable, long-term manner. This involves ensuring they continue to meet certifying entities' standards and requirements and addressing any challenges or changes that may arise over time. The tasks include regular data collection, site visits, and coordination with relevant stakeholders, including third-party assessors.

Each of the five stages involves a multitude of dependencies and requires effective stakeholder management to navigate the difficulties involved. Developers must coordinate with a vast range of third parties—including local communities, investors, standards bodies, auditors, and rating agencies—to ensure the successful completion of their projects. Certification and MRV requirements can change over time, forcing adjustments and adaptations on projects, while developers can periodically encounter resistance, lack of engagement, or contractual disagreements with local groups. 

In addition, the system confronts developers with intense economic pressures at almost every stage of this process. Strong incentives exist to cut costs in the first, second, and fifth stages and boost credit outputs in the third stage. These incentives are real, especially considering the fragile nature of project financing and the volatile prices for issued credits. 

Project Financing

Project developers we spoke to highlighted early financing as a critical bottleneck in their operations. Alexis Leroy, CEO of Switzerland-based Allcot, which has been active in the carbon market for around 15 years, describes the VCM as an ecosystem where money is not accessible for projects with hesitancy from traditional financial institutions to provide project financing:

“the financing of [projects] has been very difficult and very gradual because we needed to trade, make a profit, reinvest in a project, stop the project until we get some more money and build again … we never had a bank lend us anything.”

Blue-carbon project developer Vlinder agrees with their CEO Sergey Ivliev describing early project financing as a classic chicken-egg problem whereby securing funds can involve steep costs:

“To attract investors for the upfront investment, the project must showcase its potential to generate carbon credits in the long term. This necessitates transparent reporting, active community involvement, and the establishment of trust—all of which already consume funds.”

Banks and other financial institutions’ hesitancy to engage with the VCM seems to be fueled by a misunderstanding of the assets being produced, operational opaqueness, and high upfront costs with long payback periods. In the context of mangrove restoration, Vlinder mentions the lack of appetite on the part of financiers due to the long certification windows and initial credit issuance that can take years:

 “Projects are certified to receive carbon credits for 20–30 years; however, they require substantial upfront funding and the first carbon credits will only start to be issued no earlier than two years after planting."

The lack of accessible early-stage financing for project developers hinders the growth and innovation of the VCM. Limited funding for initial costs like feasibility studies, baseline assessments, and community engagement means developers struggle to lay the groundwork for designing high-quality, impactful projects. This not only reduces the number of projects being developed, but also restricts innovation as tight finances can push developers toward replicating proven project models rather than piloting new methodologies that could drive more significant emissions impact. Innovation is also restricted as financing solutions are not available to help new entrants overcome initial cost barriers, potentially reducing competition. 

Market Inefficiencies and Price Volatility

Even if early financing is provided, project developers still face inefficiencies across the entire value chain from credit issuance to trade. A lack of capacity at the verification stage, for example, consistently leads to delays and potential loss of credits. In late 2022, blockchain-based carbon credit marketplace Thallo released a report finding that verification-related delays could cost project developers up to $2.6 billion and mean 4.8 gigatonnes in undeployed credits by 2030:

Since carbon projects involve coordination between many entities, if any of these counterparties drag their feet on critical processes, this can quickly result in cash flow issues for developers. A backlog in verification audits can lead to certification delays that prevent developers from selling credits and maintaining projects.

These inefficiencies not only exist at the verification stage but also permeate carbon trading. Until a few years ago, liquid instruments that provided clear price signals and efficient trade for carbon assets did not exist. Allcot highlights the difficulty of working in their absence: 

“Problem in the early days was how to establish a price in the absence of an exchange … the only international credit price reference were the Kyoto credit[s] that were still quoted on ICE, which were worth maybe thirty to fifty cents.” 

Liquidity instruments were meant to address some of the market inefficiencies experienced by project developers and other market stakeholders but didn’t deliver on their promises over the long term. Commodity contracts and DeFi-style liquidity pools, for example, were meant to provide project developer’s with a reliable price signal and an efficient venue for execution. While newly introduced instruments were initially used to facilitate trade, Allcot highlights their transient adoption:

“When [liquid instruments] came out it was very good for trading … it allowed me to finance quality projects that I develop but today Allcot doesn't sell through [those instruments] and if someone tells me that’s a reference price then that’s a conversation killer.” 

While these liquid instruments acted as a price reference for a time, their design resulted in price degradation that meant that they eventually only priced the bottom tier of credits. As a result, these instruments are now seldom used to execute trades or as a price signal for market participants buying and selling high quality assets.

Maintaining Project Quality in the Face of Market Pressures

Difficulties with project financing and market inefficiencies raises the question: how do project developers overcome these difficulties while maintaining project quality? This question has become increasingly pertinent with the increased scrutiny on quality in the VCM by news outlets and market participants. For project developers, this has focused on their definition of baselines, reference regions, and project “gerrymandering,” among other issues.

While some low quality projects result from malicious actors taking advantage of methodology and MRV loopholes to maximize profits, it can also result from benevolent behavior. Multi-year or multi-decade projects can mean that when credits hit the market, a developer’s chosen methodology might be outdated or under criticism—despite the developer having adhered to state-of-the-art guidelines at the project's initiation. As Allcot’s CEO Alexis Leroy puts it:

“The problem is that the definition of quality has changed over time, and people invested in good faith at the point in time where projects were considered good quality.”

In other instances, project developers have to make explicit tradeoffs between quality and profitability. For example, Sergey from Vlinder explains that tree planting density in reforestation projects involves an explicit tradeoff between maximizing short-term profit and prioritizing long-term sustainability. Planting more trees per hectare may yield more initial biomass and, thus, more carbon credits but it might also result in higher mortality rates due to competition for resources among the dense population of seedlings. While they highlighted these kinds of tradeoffs exist, they emphasized that:

“The primary objective is to achieve high-quality outcomes, but acknowledging the importance of maximizing profit is essential to secure upfront funding and resources for supporting the project's quality objectives.” 

So then how do project developers maintain project profitability while maintaining quality? Both Vlinder and Allcot argue that maintaining quality without sacrificing project success involves communication of intention and project outcomes with stakeholders. According to Vlinder, project developers can balance the two through effective communication: 

“Vlinder ensures that short-term profitability does not come at the expense of long-term quality and impact. Transparent communication with stakeholders plays a crucial role in effectively managing the tension between profit and quality, enabling informed decision-making and alignment with the project's overarching goals.”

Allcot takes a similar approach: in our interview, Alexis underlined multiple times how crucial it has been for his company to maintain project quality and the importance of educating market participants. A vital aspect of this is encouraging an understanding of the social and economic benefits of projects to communities on the ground. He further emphasized that focusing on quality may increase costs or reduce credit issuance potential but it also seems to positively impact a project developer’s ability to sell their credits and the prices they can demand:

“There’s no debate [between quality and profitability] because if you’re gonna do poor quality projects then you won’t get a good price versus a high quality project that gives more to the community.” 

So then planting less seedlings when reforesting may reduce the number of credits being issued but doesn’t necessarily have to hinder project success if project developers are able to effectively communicate that behavior and receive a premium for doing it. However, even with effective communication, prices may not be generally high enough to support certain high quality projects.  In Alexis Leroy’s words, “the voluntary market is not ready to pay the price it should be paying.”

Conclusion

The challenges project developers face are significant but general market shifts and a range of potential solutions are emerging that could mitigate structural issues in the VCM and bolster developers’ efforts. Registries are making progress towards digitization of their workflows and improvement of their MRV practices; innovative financial instruments like perpetual bonds and liquid carbon forward markets are emerging to simplify access to financing and provide clearer price signals; and a new generation of improved liquidity instruments are being developed. Market sentiment towards valuing high quality projects and industry initiatives like the Reykjavik Protocol to improve project development also indicate an easier path to develop high quality projects in the VCM.