Moving towards a Latin American carbon market

Of the issues discussed at COP26, the carbon market is drawing the most attention in the region, and mainly for one clear reason: Latin America and the Caribbean can position themselves as the world’s largest providers of carbon credits. It is no exaggeration to suppose that with the approval of Article 6 of the basic Paris Agreement manual, there will be a kind of “gold rush” by countries, companies, banks, funds and consultants to find their place in this multimillion-dollar market. In fact, according to some estimates the market value could be $22 trillion by 2050.

While approval of the basic manual will help arrange market and price formation, there will still be many gray areas until the problem is further stabilized. The main incentive the market needs to move forward is the price per ton of carbon, which in recent years has proven to be low yet very volatile due to the incipient nature of its organization. But as the market continues to organize itself, prices will rise and should land between $75 and $100, which would be the figure needed to achieve carbon neutrality by 2050.

Markets were already anticipating COP26 decisions and were accelerating carbon credit agreements, which should reach record value in 2021. Many countries, states and even cities had already entered, and many others are still entering, suggesting the evolution of a highly fragmented market. But based on the experience of the financial, capital and commodity markets, a kind of Darwinian survival of the fittest may be anticipated, in which only the most prepared and best adapted will make it. A critical mass will have to be created in order for the market to survive. This means attracting a significant number of carbon credit suppliers and buyers, which are both necessary elements in building an efficient and dynamic market. One can speculatively anticipate that there will only be a few global centers, among them possibly being one in China, one in the US, one in Europe, and perhaps one in Latin America.

But what does it take for a carbon market to gain critical mass? There are several factors. But the most important are infrastructure that has a legal basis, taxonomy, certifications, as well as a whole chain of sophisticated and expensive services necessary for risk identification, pricing, credit integrity assurance and market predictability. Another factor is a timely and diversified supply of green projects, which requires developed financial services markets. And finally, the availability of qualified professionals for the infrastructure, as well as the project origination, development, execution and monitoring cycle.

The development of a Latin American regional market, based on economies of scale, cost reduction and a broad, high-quality and diversified carbon credits supply, could contribute decisively to the development of comparative and competitive advantages for the region’s natural capital, optimizing efforts, developing sustainable business clusters, attracting technologies and catalyzing national and international private capital. Market development can expand financing alternatives for investments in projects with high social, environmental and technological impact, as well as for the development of third-party markets that would otherwise not get off the ground or would have difficulty doing so.

However, the formation of a regional market would face internal challenges in the region. The first is associated with an immediate vision that conceives national markets as an instrument to gain local political influence and broaden the tax base. A second challenge is that there is already some movement around the formation of sub-regional markets, which could help harmonize regulations and standards, but also undermine a regional vision. A third is the need to promote taxonomy, harmonization of standards and norms, certifications, mutual recognition and other complex issues that normally permeate the regional market process. A fourth challenge is the limited availability of capabilities and the region’s known market flaws. A fifth is institutional and governance weaknesses. Another challenge is the very unequal size of the region’s domestic markets, which could lead to mistrust between countries. A seventh challenge is the limited availability of adequate and attractive financial and non-financial instruments for mobilizing resources to finance projects at competitive prices and conditions.

To move forward it will be necessary to align interests, join forces in the formation of national markets with those at a regional level, and embrace a work agenda that includes the factors and challenges indicated above. The task is not easy. But considering that the region has much to benefit from in terms of financing for development, job creation, income, tax collection, internationalization, larger investments and technology and innovation, efforts to promote a regional carbon market are more than justified.

Finally, the international competitive environment in carbon markets combined with increased global demand for credit due to NDC and corporate social responsibility commitments, offer a development opportunity that is perhaps even more potent than the commodity boom experienced by the region at the turn of the century. This time, the difference is that the agenda will be able to combine conservation and regeneration of natural capital with economic diversification, technological advances and the fight against poverty as determining factors in the region’s sustainable growth.