Do carbon credit ratings help or harm the growth of carbon markets? How important is standardization to liquidity? Should we look to lessons from the bond market? Equities? Commodities? Derivatives? Precious metals? Real estate?! Get ready to go full high finance — it’s a show about market structure.
In this episode, Reversing Climate Change’s host and Nori Co-founder Ross Kenyon is joined by Tommy Ricketts, CEO and Co-founder of BeZero Carbon, a carbon credit ratings agency, and Matt Trudeau, the CEO of Nori, for a friendly debate about how the industry rates and prices carbon credits.
What do you do with heterogeneous credits? And what is the overall price of carbon — what is the price-setting instrument? Should or could there be an idealized financial instrument that represents a tonne of perfect carbon removal? What does this unlock? What might it obscure?
The discussion revolves around the vital role of project-level quality in the carbon market and the significance of a risk-based approach. Tommy sheds light on the creation of BeZero Carbon and its mission to distinguish the quality of carbon credits. The conversation underscores the potential growth constraints of striving for perfection in carbon markets. The trio explore the evolving landscape of carbon credit markets, the possibility of governmental intervention, and the role of private capital in fueling climate-positive projects.
Tune in to tickle the market structure nerd in your heart you didn’t know existed.
More from the show
Ad-free episodes and other benefits come with a paid subscription.
Carbon Removal Newsroom, the news show that ran alongside this one, is over. Its episodes are still up, on the feed Climate Workers Anonymous now uses.
Carbon Removal Memes is still going.
Resources
Tommy’s article that inspired the show, “Carbon isn’t just another commodity market”
Matt’s response, “Commodities markets and the financialization of carbon”
Matt writing on buffer pools for VCM
Full Transcript
Ross Kenyon: You’re listening to the Reversing Climate Change podcast by the team at Nori, the carbon removal marketplace. This is a show about the innovators and entrepreneurs developing solutions to climate change. Hello and welcome to the Reversing Climate Change podcast with Nori. I’m Ross Kenyon and I’m one of the co-founders of Nori and the Director of Creative and Marketing here. Nori is a carbon removal marketplace based in Seattle, WA. Today I’m joined by Tommy Ricketts, who is the CEO and co-founder of BeZero Carbon, a carbon credit ratings agency. Hi, Tommy.
Tommy Ricketts: Hi. How you doing?
Ross Kenyon: Doing very well, thanks. And also, Matt Trudeau, who is the CEO of Nori, is joining me as well. Hi.
Matt Trudeau: Hey, Ross.
Ross Kenyon: Hey, Matt. Each of you come to the world of carbon from the world of financial markets or banking, and you’ve both written recently trying to apply some of your previous knowledge to carbon, which — I don’t always see a lot of high finance perspectives within the world of carbon, unfortunately. I think it’s a really interesting angle. There’s a lot of experience about how markets work that is not always present in the carbon market discourse.
And Tommy, you wrote a piece in Illuminem called “Carbon isn’t just another commodity market.” It made us think. Matt wrote a response to it called “Commodities markets and the financialization of carbon.” So we’re going to talk about how carbon is or is not like the bond market, maybe should aspire to be like the asset class of bonds. And Matt is going to apply some of his experience from precious metals and other places to see maybe what we can learn from the commodities market experience. So why don’t we start off with you, Tommy, explaining why you wrote your piece.
Tommy Ricketts: Yeah, perfect. And look, great, great to be here. I’m excited to have this debate. Found that when we started the business, we came from sell-side research. I was a multi-asset — with the multi-asset strategy — and my business partner was a bond market person. And we sort of asked this question in the very beginning: what is a carbon credit? You know, in definitional terms, it’s an instrument which promises to deliver a ton of CO2 equivalents, either avoided or removed, from a project level. And, you know, how do I know it’s actually delivering what it claims, basically? And that question led us to build BeZero and the ratings agency as we have it today.
And it kind of came down to this one principle, which was: if it’s a commodity and it’s 100% standardized, then obviously you wouldn’t need a rating agency, right? You wouldn’t have any concerns about quality. There may be a spectrum of quality, but it would somehow be managed. But there are concerns. You know, one of the biggest questions you get in carbon markets is: how do I understand the quality of this thing? How do I make sure that it’s really taking place? But the really unique thing about carbon is you can’t physically deliver it.
And so in commodity markets, the tenet of a commodity market is you get physical delivery. So sampling the quality of that delivered instrument is a physical activity. It’s really there. You can really pick it up, shake it around. And a barrel of oil is a barrel of oil, and a ton of wheat is a ton of wheat. Now, there may be differences in quality, but I can observe them and I can see them and I can touch them. Quality in the carbon space is a combination of qualitative and quantitative analysis. You know, you’ve got social theory, like how additional was a project. And then you’ve got really quite strict climate or environmental analysis looking at carbon accounting.
Some of it you can be quite accurate with, but then you have things like baselines. Well, a baseline is a counterfactual. Everything’s true on a counterfactual basis, in extremis, right? And so, you know, you have all these things flying around. Now, in the history of the market, you basically follow a methodology. That methodology sets out the thresholds that you need to pass in order to be qualified as an instrument, and absolutely necessary to the development of the industry. You must have an outcome to that analysis. You have to have an outcome, otherwise you can’t issue a credit, right? And so you must have a conclusion: do you pass or do you fail that test? Now once you pass, every credit is essentially treated as equal, and that’s how it was working.
The problem is people know that there are differences. You know, there’s very heterogeneous project types, from landfill gas to direct air capture, from mangroves to forests. And there’s also very wide and quite open to interpretation ways in which one can follow a methodology. You can use conservative or, you know, let’s just say optimistic assessments to forecast what your carbon accounting is going to be, likewise additionality and non-permanence. And so this pass/fail test alone, although it’s vital to having issuance in the market, we didn’t think it’s being as sophisticated as enough as it needed to be to really deal with the rising appetite for understanding the risks associated with these projects.
And indeed, to go further than that: if the bar, if the test in the industry is that it’s 100% accurate at the point of accreditation, and in any way, shape or form you can disprove that statement, you’re basically saying it’s not accurate. And that test is too stringent, in our opinion, to be the only way in which we assess and think about quality. It’s not the case that you’ll say, OK, I’m going to lend to you, you know, Ross, and you’re 100% probability of paying me back, otherwise I’m not going to lend you any money. Or I’m going to invest my pension in this 401(k) or whatever it is, and I’m going to 100% guarantee a 7.2 inflation-adjusted return. Obviously that’s nonsense, right?
So to have that test as the only benchmark or barrier to carbon market — knowing that its properties are very heterogeneous, and that itself is very complicated to assess, and that it’s an emerging market with all kinds of new stuff going on all the time — we thought was not the most credible way of scaling capital activity into the space and, obviously, hopefully investing into climate action.
The rating idea from the bond market stuff came along because there is a well-tried and tested way of assessing the probability of default or the probability of delivery. And that’s how bond markets were the biggest market of them all. You know, more than 100 trillion, probably these days more and more, $150 trillion of assets globally. And the way they basically work, it’s say: OK, what’s the probability that I’m going to pay back, you know, this debt? Which actually has a lot of similarities to a project, which is, what’s the probability I’m going to deliver on the climate carbon claim.
But just to kind of be clear, we don’t go the whole way and say therefore it’s a bond, because you don’t financially settle a carbon contract. In the same way, either you do or you don’t repay a debt, right? There is an outcome, a definitive outcome. So you get default history, but also you either do or don’t deliver a commodity. So there’s that great story: a JP Morgan pork physical commodities trader had bought futures in pork and forgotten that they’d expired, and someone turned up with 13 trucks to the office in Canary Wharf in London, right? So, like, you know, somewhere down the value chain someone is going to get their truckload of pork, right? So, you know, so it’s not quite work there.
So our kind of thesis was, like, we’re somewhere in between. And actually — just, I want to finish this point — having a threshold standard above which you have a probabilistic approach is much more akin to the way in which risk taking is done at a larger scale in capital markets, and provides an architecture which will allow differences of opinion, differences of quality, differences of systems, differences of standards to all coexist, but an instrument to still be tradable in a standardized way and a fungible way. So that’s kind of where we came about from. Like, you know, both why we thought quality wasn’t binary, but also why we thought the financial market analogy was really helpful.
Ross Kenyon: Really fascinating. I think when people think about bonds trading, they’re thinking about S&P or Moody’s giving letter grades. Is there a future state where carbon trades, where the junk bonds of carbon, the less graded ones, are cheaper but somehow end up with a higher return, like this? Is the bond comparison close enough to make that ’80s dream a reality?
Tommy Ricketts: Yeah. Well, I mean, anyone that’s read their Liar’s Poker knows those ’80s dreams ended up in Salomon Brothers going bust. So, you know, I’m not quite sure if we want to be the new Salomon Brothers. But look, so what we actually did is to say that the rating is not just an ethereal quality metric, it’s actually a discount. And something that we’ve been publishing recently is this view on how do you risk-adjust the performance of a credit to actually create diversified portfolios. Which, you know, is to say that if you hold credits which have different country exposures — Congo, the US, Malaysia — different type of exposures, avoidance and removal, different project activities, you know, how do they all co-mingle and therefore co-vary to create, you know, ideally a return of, let’s just say notionally, 100? Because maybe you need to over-buy, you know, 500 to get to that 100.
And so to your point there on the D-rated stuff, you know, there is a performance of those projects. You know, in our model it’s — I think you have to buy 999,000 to get one ton. It’s essentially a notional number, because it’s effectively in default at D. But yeah, we do think that that starts to stratify the market, allow different performances, allow people to co-mingle things. You know, we wouldn’t go so far as to say we want to have some subprime scandal where everything’s, you know, tranched into A and actually it’s backed up by nothing. But we won’t get into how the financial market crash worked. But there’s also no Freddie Mac and Fannie Mae in carbon, so it’s not backed by the UK government, the US government. So it’s not quite the same analogy.
But yeah, look, the bond market is a way — an analogy of creating a risk metric which allows diversification, allows you to get basically returns equivalent to whole units, but by also taking account of the discount associated with the performance. You know, that coexists, and that’s part of this financial language that we’re trying to kind of help enshrine in the industry. And there’s a very tried and trusted playbook, like in other commodity markets, about how this works, and it’s well understood. So, you know, can we get there? You know, we’re hoping to, but I do think that it’s a useful vehicle and device to do that.
Matt Trudeau: Tommy, if I could jump in for just a moment. So I agree with a lot of the fundamental points that you’re making, and, you know, I think we probably share a lot of the same perspective even though maybe coming at it from different angles. I’m actually not much of a bond markets guy, but there is an expression in the bond markets that they trade by appointment. And I wondered, in reading your article — I’m also very interested in market structure, and you mentioned market structure I think in the piece — and I wondered how you envision the market structure forming and maybe the future of the market structure. If the bond market is the most relevant example, it’s, you know, bonds tend to need a broker or dealer. Usually there’s subject matter expertise in assessing the bond. It isn’t a fungible standardized unit of trade in the same way that maybe other exchange-listed products are.
Tommy Ricketts: I just want to be very clear, I’m not going to die on the hill of bond markets. That’s not our position. I actually think there’s a lot to be said about equities in this. You know, every credit’s got a story. The equity markets are all about the story of the stock. Where is it going? What’s going on? You know, so much of the way that projects on the ground are marketed is about the local impact, what’s, you know, the story of the project. So I think you can beg and borrow and steal from all different types of financial markets, and I think that should be inspiring to us. Because what we’re doing is trying to pioneer a new form of capital deployment in essentially a hitherto sort of unfurrowed space of environmental risk. And that does require using, you know, many a different rule book from different places.
And yes, to your point, it isn’t fully standardized. And you know, in a dream scenario you would have a unit which is a perfect return. I guess the challenge that we say to that is: because you can’t physically deliver it, because you have a combination of observable and unobservable phenomena which define quality, and because you have such variation in the different types of processes that are being taken place — you know, a gold mine, to your thing. A gold mine is a gold mine, right? Whether it spits out different quality or not, it’s still a gold mine. Here we’re talking about trying to say gold, silver, platinum, every type of mine available could spit out a unit of activity, and they should all be the same. But that is — it’s a much bigger vision of what people were trying to build than just saying it was all gold, right?
Because it’s, you know, carbon sequestered from the biosphere versus the lithosphere. You have all kinds of removal, avoidance. You have all kinds of priority in that. So no, no. Again, just to repeat, I think the bond market analogy is really helpful for this idea of the probability of it delivering what it claims. And that is a really nice vehicle to explain, you know, basically the fact that there is a risk post-accreditation in delivering what it says. But when you get into the actual mechanics of it, it’s actually about building a whole new risk language and getting people to understand that it’s not just about resorting to one basic, you know, financial paradigm.
Matt Trudeau: Interesting. So let me bring some thinking from maybe the commodities markets and the futures markets more broadly. But my piece obviously focused on gold. I spent a couple of years building an exchange and post-trade system for managing trading and delivery and post-trade of precious metals. But I think that, as I think about some of the points that you’re making about risk management delivery, the different types of production that underpin gold may not be precisely the best commodity for comparison. I think there were some interesting characteristics of gold in the gold market that are worth looking at.
But if we think about other commodities, be it, you know, oil or even wheat — I mean, ultimately there’s a producer. So the oil or the wheat is being produced from different sources, different sources in the ground, different farmland, the operators of different companies that are operating in that market that are producing. They have their own risk profiles. The risk of delivery is definitely heterogeneous. So the function of a futures contract in that market is one of risk management. So it allows you to hedge on the price, and ultimately the vast majority of futures contracts don’t go to physical delivery. It’s actually pretty uncommon to see that. And you do have at least a couple of examples of futures contracts that are strictly cash settled. So Bitcoin isn’t a physical commodity, although in the futures market you can talk about Bitcoin as being, quote unquote, physically delivered even though there isn’t a tangible good that you can pick up and shake or even evaluate.
So I thought about it from the standpoint of what is the price-setting instrument by which all the other variations of carbon can be priced. And when I think about oil or gold or wheat, there tends to be the price-setting instrument, which is the futures contract, and then the actual underlying commodity gets priced relative, or vis-à-vis, or in the parlance of the industry, there’s the basis — is the difference between the futures price and then the spot price. And the spot price is going to have, for any given commodity, depending on where it’s delivered, the quality, who it’s being delivered from, what their risk profile is, that’s all factored into that spot price. And typically, if there are other factors like that, the spot price is at a discount to the futures price to reflect — excuse me — those extra conditions of location or quality. So it feels like you still can get that same level of information content in the price, but you have some reference that tells you what is the overall price of carbon, and then everything else is priced relative to that.
Tommy Ricketts: Yeah, well, I think that’s fascinating. I think one of the examples I think is interesting is the power market. You know, effectively you have a clearing price where supply and demand intersect, and everything that’s below the clearing price is in the money, right, in terms of the cost of generation. I think that’s a very nice way of thinking about how the market should be clearing and thinking about it. That — I just come back to this, you know, what is the asset — the theory and, you know, what you’re talking about here is actually goes on, right? There are exchanges operating at the moment, there are futures contracts. There are ways of, you know, that type of theory is being put into action in the carbon market.
But because you have this observable and unobservable, you know, basically analysis sitting behind it, and because ultimately it may be that you trade on basis but at the end of the value chain something somewhere is physically delivered, right? There is a reconciliation of this instrument somewhere. You know, someone can dip their thing in and go, it’s this quality of Brent or whatever, right, where you just cannot do that with carbon. And so I think that that is just a challenge intellectually to say: either there is a mandated entity like an international organization or a government that says, or U.S. financial regulator potentially, who says this is sufficient grounds to basically make this claim.
But I think that what we were getting at — which may be fine, right, that that would lead to, you know, effective standardization — but I guess what we were saying is, what’s the downside to having, you know, let’s maybe explore this point, what’s the downside to having a risk-based approach to assessing quality? The downside is, OK, you can’t fully standardize it. You can still standardize it. You can standardize the instrument at issuance. So you still have a standardized instrument. But going above and beyond that, you’re saying that there are differences and that they can coexist, and that, yeah, price should be the distribution of risk, and there are loads of risks associated with the instrument and they should be fairly traded and exchanged in the part of the transaction.
So I don’t think it’s — we’re very much agreeing — but I just think we don’t believe that you can constrain the properties of the instrument into such a way to make it a perfect place. And the worry is you’ll never get to a position of enough confidence in the instrument if you consistently get evidence that it’s just not doing what it says. You know, that’s the biggest challenge about this. Getting the market right now is a fundamental lack of confidence that it’s doing what it says it is, and therefore I can use it to make a claim.
Matt Trudeau: Yeah, 100% agreed. So I think what might be interesting here — and look, it is a general statement — I think you mentioned equities. I think it’s useful to look at the existing traditional financial markets and pick and choose things that could make sense. And so maybe if I were to attempt to try to reconcile the two perspectives: the ratings, I think, is you’re talking about the different projects underlying and the different credits themselves. The ratings applied to those give you some means to assess projects relative to each other. And I think that that’s very useful because you have to have some sense for quality.
So if I were to think about that in the context of another commodity: how do you assess the quality of a given mining company or given oil producer? How do you assess the quality of the company potentially, and the risks associated with that company, and then how do you assess the quality of the product that they are producing? And if you’re a buyer of that product, you need some means to determine the quality — even with wheat, for example. Like, how do you know that it’s good quality wheat versus something else?
So if we assume that the ratings and the bond approach allows you to assess on a project-by-project basis, or on a credit-by-credit basis, some designation of quality, then how do you price ultimately? Then how do you decide what the price is? So you have some sense of relative quality based on the rating, but you still need a price for carbon, and how can that price be set? So one way to set that would be to take the aggregate of all the different prices of all those different products based on all those different ratings and then come up with some composite price. That might be one means. Another means, to the extent that existed, would be potentially a futures contract for carbon where that’s your price reference. And then the basis between that futures contract and the spot price of any of those different carbon credits that you had rated would be a function of the quality.
Tommy Ricketts: Yeah. I mean, I guess one question for you is maybe just to sit behind that: do you need one price for carbon?
Matt Trudeau: So I wouldn’t make — I would make the argument that yes, because I do think that you can make the case that it’s a commodity. I think about, like, what do you need? Do you need one risk-free rate to price a bond?
Tommy Ricketts: Yeah, I guess it depends on what you want, how you want to build your DCF.
Matt Trudeau: Doesn’t it? It depends on which risk-free you use. It feels like you need some common, some common point of reference.
Tommy Ricketts: I hear you. I think there is a societal price of carbon which is effectively — like, you know, maybe just take a step — but I do agree with you. I don’t disagree with what you’re saying, by the way. But in our view there is a series of emissions that exist globally, 5.5 billion or whatever it is, and we need to get that down to whatever, sub one. And the marginal cost of abatement is effectively the sum of the weighted — the weighted sum product, sum of all of the costs of every activity that we do everywhere in the world, in every country, every organization, every household, every government.
And they probably go, you know, range from, you know, cents to abate a ton of CO2 to millions of dollars to abate a ton of CO2, and somewhere in between is essentially a societal cost of abatement transition, right? I firm — obviously that’s just a fact, right? It’s not particularly debatable. So yeah, there is a societal cost, marginal cost of carbon. But one stat that I thought was very interesting was: today 95% of emissions are not priced. So they just don’t have a price whatsoever, right? So the first thing to do is just to try to price everything, and then at some point can the market efficiently clear at a price which makes various activities, you know, financially viable?
But again, is it the role of the voluntary carbon market as it exists today to be that type of mechanism, you know? Or isn’t that, you know, essentially what the compliance market is for, which is 800 times bigger? And in that instance it makes a lot more sense to have — it’s not an asset-based market, it’s a paper market. So you don’t have an underlying project sitting behind the delivery of this thing. You just have, you know, essentially a regulated budgetary process. And I think in that world, of course, there’s only one price, right? Because everything is literally exactly the same.
But actually, isn’t — not quite a good thing to have. You know, the marginal cost of deforestation protection is very different than the marginal cost of direct air capture. For that to be one price overvalues the — you know, maybe that’s not a bad thing — but probably overvalues the amount that you need to be paying to protect the rainforest, and deeply undervalues the amount you need to be fostering investment cycle in direct air capture. And so you could have multiple of those prices exist and then you basically just have people making a view.
Certainly global — you know, bond markets, there’s loads of different prices for different 10-years. I think there’s, what, 40, 50 listed government bond markets? Never got very — wildly different prices for what they value different governments at. And so then, you know, back to your risk-free rate, there’s lots of different risk-free rates depending on which one you’re prepared to put in. It’s not just a 10-year treasury. But yeah, so I don’t know. I think that we’re a long way from having a position where the VCM can have one price, because so many different instruments have different cost curves. And I think, again, it’s actually helpful to not have one price and allow that to coexist. Otherwise — well, yeah, I mean, it’s fine to do that, but you’d have to just have guaranteed quality, which is a bit difficult.
But that comes back to the power market thing, right? You have one price that clears out, let’s just say it’s $50. And all of these activities which have a marginal cost of delivery of 5, 10, 20, 30, 35, even $49 are economically viable at a $50 price. The moment it gets above that, you’re no longer economically viable. If there were to suddenly be a swing, like, you know, peak load, and then suddenly the price is 100, all those instruments — you know, like you have in the UK still the 1920s coal-powered stations that go online for an hour, you know, once every now and again.
The example used to be the soccer FA Cup final — used to be the time when everyone in the half time would go and switch their kettle on. It was the classic example in the UK of the most energy consumption in the country. Sadly not quite the same anymore. But you know, so you have that, and then maybe that’s what they have with the carbon projects. But I just — I think we’re a long way from that. And I also think that it’s just not a kilowatt-hour, right? Carbon is not the equivalent of an hour. So I don’t know, it’s a good debate to be having, but I just think that the analogy starts to break down basically the more you extrapolate the theory.
Matt Trudeau: Yeah, I agree. So I don’t know that you actually do need to, or will ever have, one single price in the voluntary carbon market. I think the nature of the different kinds of projects don’t lend themselves very well to having one single price, and I think that the ability to price them differently reflects the different types of risks associated with them and the different quality, because quality may or may not be specifically related to risk. You might have some uncertainty in there, you may have some reversal risk, you might have operations risk, methodology risk. So having the ability to price those things in feels pretty important. And thinking about, you know, again, coming from a central limit order book, standardized exchange-traded instrument background, I have to curb some tendencies to want everything to look and feel like that.
And what I’ve said to the team is, to me the voluntary carbon market today feels a little bit more like buying a piece of real estate than it is buying, let’s say, a REIT or something where it is a standardized unit of trade. And I wonder, just as I think about the future direction of the market in terms of companies managing their carbon footprint, if there isn’t a future state where it starts to look a bit more like managing foreign exchange, where it becomes more a treasury function — less about the chief sustainability officer looking at individual projects and the co-benefits and all the narrative around it. And if it does, at least for some organizations, become something that’s in the CFO’s office, and in that case what would they want to use as the instrument? And it might be that they want to use a variety, a portfolio of different instruments that have different ratings to construct their asset column to line it up against their liabilities. So, you know, hard to say exactly how the market’s going to go, but one could see that as a future state.
Tommy Ricketts: I mean, that would be great because it means the rating is essential to it, right? But I mean, that’s obviously what we’re pitching. I think, yeah — if my business partner was here, who’s been leading a lot of the work on how we think about diversification theory. I got asked a very good question by someone in the industry actually this week, which was, you know, we have to be in a position to — he was an ex-derivatives person, and he was like, we have to be in a position to understand the covariance of different risks associated with what you own and your positions. And until you can do that, until the market is, to your point, the people at the end of the value chain, which we hope will one day just be, you know, the treasury function, you know, the mandated requirement to pay for your emissions, which I think we all would think would be a good idea.
Then, you know, they’ve got to be able to understand the differences between holding different things in different countries, which I think is pretty standard. You know, you’re not going to put all your cash in, you know, I don’t know — I’m not going to pick a bad country. But in Venezuelan government debt, right, you just — there’s probably not going to be. Or even more recently, maybe a good example, you don’t want to put all your money in some sort of cryptocurrency, because you know you’ve got to have that money next week for payroll, right? You can’t manage the volatility in that way. So yeah, look, I think that’s — nothing against obviously Venezuelan debt — but you know, that’s important.
But how do we get there? Like, look, the ultimate — I’ve come back to two sort of principles. The ultimate stuff everyone’s talking about in the carbon market today is: how do I ensure supply-side integrity, and how do I have enough confidence to make claims? And then the second part to that is there’s three sources of demand. Compliance — as in, I’m forcing you to do this. Transition frameworks like SBTi — I am mandating myself to do this. And competitive advantage — I’m doing this because I want to differentiate myself from those in the world and showing that I’m doing more than beyond what I need to do. And unfortunately today there is very little compliance equivalence. There’s a couple of countries that are allowed to buy carbon credits or international carbon credits. So that’s not a reason to buy credits.
SBTi in particular doesn’t really say much about beyond value chain mitigation except by a few removals in a, you know, distant far-off year. And there’s definitely not a competitive advantage right now to be buying some of these credits, because you could get dinged for them, right? So, you know, until you can really surmount or overcome some of those concerns, you know, it’s very difficult to see a future where this works. And a reason partly why I think ratings kind of glued back on that is so helpful is it does provide a way forward, a way through that malaise. It says not every credit is equal, and that’s OK, and imperfection is how you should be valuing these things, not perfection. And that we’re very good at valuing imperfections. We’re not particularly good at coming up with ideas which are perfect instruments — unless you can physically deliver it and check it at the end of the value stream, in which case of course you can check what it is.
So I don’t know. I think that’s kind of why it’s so valuable. It’s why I also think that people have adopted the rating a lot, are increasingly adopting. Yeah, there’s a lot of people pushing back on it still, but it’s a far cry from, you know, when we launched the business, when — I don’t know how big your audience is, but when I was at COP26, I just turned up and I was in Scotland and I kind of went over to the IETA, whatever it’s called, pavilion. And there was — I didn’t go in, actually, but they were just finished funneling out, and I saw a friend of mine that works at a kind of developer stroke investor, and he was like, oh, you know, BeZero — because we didn’t even launch the ratings business yet — he was like, oh, you know, we just had the now ex-head of Verra say carbon ratings are the biggest single threat to the carbon markets.
You know, and then look at us now, right? You know, on Monday I was on panels with Verra. I, you know, we’ve managed to convince them that we’re not enemies, that we’re not out to get them, that we’re completely on the same team. So, you know, I think even for [unclear], we’ve been seen as an enemy to standardization. But the worry to me, just to kind of finish this point, is if the outcome is 100% standardized activity, given the reputation or concerns in the industry, you’re setting yourselves up for failure, because you can always find something to prove, some point of evidence to disprove perfection. And that’s an [unclear] difficult bar, an infallibly difficult bar to try to set for the industry to succeed. And I don’t think that — and that’s my issue with ultimately having a standardized commodity, pure standardized commodity paradigm. You’re setting yourself up for failure in a world where reputational interrogation is just so critical to demand.
Matt Trudeau: So a couple of follow-ups. The point you made about the sources of demand, I agree with. And interestingly, the competitive advantage — a slight variation on that, actually coming from a question that was asked at the end of the first panel at Carbon Unbound in London, which was: what’s the selfish reason? And so competitive advantage obviously would be a way to answer that. But then what’s the driver of the competitive advantage? And a slight variation on that, which was — I think the best answer that I heard to that question about what’s a selfish reason was: don’t discount the desire of customers and investors. So they may be the single strongest source of demand for companies right now as a driver.
In terms of then, you know, so fine, if there is demand there, then how do you maximize the growth of the market? And, you know, historically where you see things do get some degree of standardization, where it just becomes easier — the cognitive load, the research overhead — if you can reduce the barriers to entry and have some degree of standardization in products, it makes it easier for people to access the market, understand the market, price to market. And because we started with gold, I’ll go back just for a moment to an example there. Gold, you know, surprisingly for what is otherwise a commodity, the forms that it can take in terms of size and purity and format and location, all those things create a very heterogeneous spot market for physical gold.
The futures contract creates a single price that you can reference that spot market versus. But then there’s actually another product in the gold market, which is the GLD exchange-traded fund. And what’s really interesting about that is, if you started with just the physical spot gold market and the futures market as your only two options, you either are trading the future — probably more because you simply want price exposure — or you’re using it as a risk management tool for hedging. If you’re in the spot gold market, then you’re maybe buying bars or coins, physical format, and then maybe other considerations: the artwork, the vintage, which mint produced it, whether it was sovereign or commercial.
So for everybody else who actually wants to invest in gold, doesn’t want to deal with the bars and coins and all those complications and fineness and everything else, and doesn’t want strictly the exposure to the price through a futures contract — there wasn’t a product that serviced that massive market. And so somebody got the idea to say, well, why don’t we take a bunch of gold and put that into a very secure place, into a bank vault, put a trust around it, and then sell shares in that trust so that you now have an ownership interest in the physical gold. But you don’t have to worry about what exactly that format was or where it is or how it’s stored, and then make that tradable on an exchange.
Now, one additional benefit that may not be so relevant here is that that structure also created a security, and that security could comply, at least in the United States, with SEC and federal rules. And so it could fit into portfolios and all of the existing infrastructure around compliance and operations. And so overnight you had something like $250 million, or maybe it was $2.5 billion, that just flowed into this new instrument just because it unlocked a massive pre-existing untapped pool of demand in the market.
And so my takeaway from that is creating some — a very simple standardized instrument that has some transparency, so it’s not terribly complicated. What you knew was that there was gold in a vault that met a certain standard. The transparency into that, you knew who was the custodian, you knew who was the administrator of the trust. All that was disclosed in the prospectus, fairly easy to get your head around as a product — unlocked an entire new segment of demand. So it does feel like in the voluntary carbon market there is an opportunity to create fairly standardized, at least packaged, products that simplify things. Maybe not take away all the uncertainty, all the heterogeneity, but simplify things.
And maybe there’s — through that process it makes it easier for participants that aren’t super sophisticated or aren’t spending as much resources as some of the other more prominent buyers in the market to enter the market. So you give them something that they can comprehend, there’s less friction for them. It seems like that presents an opportunity in the market. And we do think about that with, for example, our net zero ton concept: just two legs. It’s a very simple thing. There’s a sort of organic carbon leg and then a more permanent leg. So very simple, but still trying to create a package that makes it easier for people to access the market.
Tommy Ricketts: Yeah, look, I think that’s happening increasingly. I think you are seeing fund structures, you’re seeing great companies — you know, one for example is Rubicon, you know, who’s emerged, and they’ve got some fascinating work they’re doing in this space about how they tackle this problem with structured products. But I think that we don’t in any way see us as being against that. I think that, you know, ratings should be a part of the decision making that goes into these systems. It’s just basically that the bigger question for us is: how do you understand project-level quality? Well, a risk-based approach is a really good way of doing that. And then how do you feed that risk-based analysis into the world which you’re painting about, creating, you know, liquidity instruments? Like, easy instruments that were easy to attract liquidity and stuff like this. And I think that they’re complementary. You know, I don’t think that they’re different.
I just — the thing we were pushing back on at the very beginning was just having a tick of accreditation didn’t seem to be a sufficient version of proof to really let the market understand the underlying integrity and drivers of quality of the instrument. That’s the starting point, right? And I think that’s totally aligned with what you’re saying. It’s just at what point do you take a call that this is good enough so that you can build those instruments on top of it?
Matt Trudeau: Yeah, I agree. I think the point you’re making is that you may misprice it if there isn’t some sense of the quality. So even if you did have a single standardized reference price, if you don’t have some understanding of the underlying project or the underlying credit, you may misprice it. So you may be overpaying for something that has a problem down the line that you haven’t appropriately accounted for.
Tommy Ricketts: Yeah, yeah. And you know, one of the biggest things that we — that we always used to — always had this great chart we used to show when we first started, which you can read into it what you want, but we showed that there was zero correlation, or 0.229 or something correlation, with the rating and pricing, right? So it’s basically random. What pricing in the market is deeply correlated to — or if you just use a simple R-squared regression — was the oil price, interestingly, the EUA price, 10-year treasury, probably no surprise everything is correlated to the 10-year treasury, and the number of SDGs it had. And then you throw in whether it’s avoidance or removal, and which accreditor it was — typically you get a positive bid for Verra or Gold Standard — and that pretty much explained the majority of the price action in a kind of compound regression equation.
And so, you know, in my old job I used to build these sort of funky charts for a living showing theoretical, you know, trends between different, you know, pork prices in China and, you know, real estate prices in California. Just because, you know, you’re looking at market stuff. But you know, like, that really does explain a lot of the way people saw price in the market. But none of that was actually — it was what I would call attribute-based analysis. It was not saying fundamental quality was driving the way people were discriminating on price. And now that has started to change in the past two years as the ratings have become more part and parcel of decision making, and fundamentals have become more, you know, common parlance.
But yeah, absolutely. Like, I think, you know, I agree with you, but it’s just a fascinating space. This is basically a market in building in real time, right? The last time we did this was sort of the Big Bang in the ’80s. I think it’s fascinating to be having these debates and just saying, you know, what lessons should we be learning from them? You know, you can do these things.
Matt Trudeau: I agree with you 100%. The market structure is still relatively immature. You’ve got market infrastructure being built, you’ve got products being created. You know, and Ross mentioned that I did spend a bit of time in the crypto markets, and you know, there’s some similar things happening there. And I think through time — you know, I would say the starting point for that market was: we don’t need intermediaries, we don’t need anything from traditional finance, we’re remaking the whole thing from scratch. And what you found is, you know, 10 years later, a lot of the lessons that have been learned over several centuries in financial markets were good lessons to take away.
And a lot of the infrastructure, a lot of the products, a lot of the governance, a lot of the regulations that have been crafted in response to problems that the market has experienced and learned from the hard way are valuable lessons. And you know, if we have the benefit of looking at other asset classes, be it commodities, futures, equities, other derivatives, foreign exchange — one of the things that I love about market structure and about having a cross-asset view is that there are different — there’s no one market structure to rule them all. There’s, you know, bonds still isn’t — you know, when I said they still, you know, they trade by appointment. Private shares in private companies also don’t trade on a central limit order book in the same way that, you know, shares of Microsoft trade. And there’s a reason for that. You have to deal with the peculiarities of the different instruments.
And so one of the things that I find really exciting about this market, given its state, is that there’s a lot of opportunity to create new and interesting things with some bricolage from a variety of different asset classes in traditional markets. That’s the part that really, for me, intellectually is one of the most interesting things about this market.
Tommy Ricketts: Yeah, I just want to touch on one thing. First of all, bricolage — great word. I love that. But I think one of the challenges that we are facing at the moment is there is an element of self-flagellation about failure that I find very irritating. It’s just so self-flagellating. Like, things are going to go wrong. Like, you know, I don’t think everyone is a crook just because they messed up a bunch of baseline scenarios 10 years ago. I don’t think they’re even a crook because they, lo and behold, they didn’t, you know, didn’t necessarily follow best practice working in the 199th most corrupt country in the world, right?
You know, I think that there needs to be a little bit of reality about things. We need to draw a line under the mistakes. We need to learn from them. We need to make sure that we own them, we improve, we drive standards. And, you know, people need to let go of some of this stuff. But the challenge is, you know, there’s two camps in carbon markets. There’s the markets people, of which clearly I’m a subscriber to. And then there’s the climate and NGO and policy communities, which — believe it or not, I am also, I started my career working for the Green Party. But you know, like, there just needs to be some reconciliation of some of this stuff, because markets do fail, things do go wrong, but they need to learn quickly and move on from them.
But if they’re not allowed to do that, then they will never deliver the type of, you know, capital flows that these interventions need to support themselves, and I do find that very frustrating. I mean, it’s heading into COP and, you know, the hullabaloo around a couple of, you know, a couple of projects which haven’t gone exactly to plan. You know, I just think that we just sort of need to crack on, because there are a lot of other projects coming online which are doing good things, that are building it right, even from the same developers, you know, who are really doing the right side of stuff and embracing new technology, embracing new science, embracing new methods, embracing new standards of, you know, benefit sharing, all kinds of, you know, interactions about local community and then at a scientific level.
And I just think that that’s the stuff that we need to be talking more about, less just fixating on the, like, you know, oh my God, everything went wrong with this one time, therefore the whole world is terrible, and, you know, you’re all, you know, money is so terrible. Well, you know, you get what I mean, right? I find that so frustrating.
Matt Trudeau: Absolutely. If that were the case, then none of the markets that exist in the world would exist, because even with several centuries of learning and experience and heavy — you know, the US equities markets are maybe the most heavily regulated financial markets in the world. Does that mean that bad things don’t occasionally happen? Does that mean that everybody’s a good actor? Does that mean that people don’t make honest mistakes? No. But on net, does the US equities market function pretty well? Absolutely. Would you do without it? Probably not. So, you know, if you’re talking about your end objective is the efficient allocation of capital, the market does a good job for all of its imperfections. So if the carbon market — if the measure is reversing climate change, then let’s figure out how to do that as best we can, without this notion of striving for perfection.
Tommy Ricketts: And so on that point, I would absolutely agree with you. Yeah, I think it’s fascinating. You know, it’s the kind of Churchill quote that democracy is the worst idea we have — but sorry, it’s the — oh, can we get it wrong now? Worst form of government, except — right, from my government. But it’s, yeah, but it’s the, you know, the best person we have, or whatever. You know, markets are certainly not perfect. And you know, for any Adam Curtis fans in the world, this is, you know, they’re certainly their own invention, that they’ve got their own hyperbole and blah blah. But you know, I do think it’s essential that essentially you have a price mechanism for climate transition, right?
And markets are really good at delivering a price mechanism, and governments are really bad at delivering price mechanisms. All they’re good at is setting rules, and that’s clearly — there’s not enough rules going on that need to be set here. I think that’s where governments can really support this. But my worry is if you don’t find a way of channeling the hundreds of trillions of dollars into climate transition through market mechanisms which are familiar to the actors within capital markets, you’re going to basically be left holding the, you know, the proverbial as the sea level rises. And I just think that it’s, you know, incumbent upon people from that background to quit their careers in finance and go and figure out a way of building those bridges, right? I think that’s absolutely essential.
Ross Kenyon: I was so surprised to hear that you’ve had pushback, Tommy, from people thinking that ratings may hinder the scale of carbon markets, which — I think having more information is almost uniformly good, I would say. And that type of rating may allow the creation of new types of synthetic assets we don’t even know about yet, that this new information allows to be possible. I don’t actually see you as an impediment to commodity market infrastructure at all. It’s weird that you’ve experienced that.
Tommy Ricketts: Well, one of the fascinating — yeah. I mean, obviously people don’t want to be told that someone else has got a different view, you know, blah, blah, blah. But I think the bigger point is sometimes people say, OK, well, there’s a couple of ratings agencies, you know, you guys have different ratings about some projects, and you know, that’s just making everything more confusing, you know. And this is a line that we sometimes hear. And our view is, well, first of all, we’re 18 months old. There’s a completely new pioneering idea that, you know, we’re not always going to come up to the same conclusion. But also, as you say, first of all, we generally agree with each other. But second of all, sometimes we just take a different perspective on something, and that’s helpful to the market, because you know, that’s saying, OK, well, which of these two sides should I take? You know, and that’s fine.
So yeah, like that. We do get some pushback. I don’t think — in the simplest world it would be one ton, one price, one contract, which in its extremity is kind of what you’re sort of suggesting. That would be quite a good, you know, a good thing. I do think it would be a very good thing. I mean, it’d be a great thing if we just mandated a global carbon tax. I mean, that would be the really good thing, and we made everyone do it. You have to go away with these asset markets, and you say, right, you’ve got to pay this next year, otherwise you’re, you know, you’re going to be put in default or something. But we’re not going to have that world, right? So we do need to find market mechanisms to do this. And I think ratings are a great step forward for the nascent asset class that’s trying to figure out how it thinks about risk. And, you know, it’s a valuable contribution to the debate.
Matt Trudeau: Yeah, I think maybe an analogy can be drawn. You know, I know it’s popular to beat up on ESG in the press right now, and a lot of the criticism would be, well, you can have two different ESG rating agencies reach opposing conclusions about a single company depending on how you weight the inputs and things. And you know, that may be true. In fact, the question I think is as important is: is attention on those issues fundamentally a good thing? And if the answer is yes, then it’s a matter of improving things through time. You know, even in my short time here at Nori, and looking at the history of the carbon market, a lot of what the state of the art is, or best practices are, has been a work in progress, and it’s been a learning experience. And so, you know, judging today’s outcomes based on — or yesterday’s outcomes based on today’s standards is not always a good thing.
So if you’re working towards helping people to think about and reason about the challenges in the market, to try to find solutions and try to assess things in a more standardized or more structured way, that feels like just a beneficial input into the market overall — to help it grow, to help it scale, and to help it achieve its ultimate outcome on the impact.
Tommy Ricketts: Yeah, I think that we’re violently agreeing with one another, as obviously would be the case. But I think that the market — our job is to try to find ways of trying to get, you know, private capital into climate-positive projects, because we think that that is an essential way of helping, you know, fund lots of communities and lots of other outcomes, but ultimately a way of accelerating, you know, the transition to net zero and building a slightly new form of economy, which is another conversation. But to do that, we have to really professionalize.
And I think that there is a lot of people who are holding on to — I mean, yeah, and this is a political view, I guess — but old views of, like, you know, the markets are rancid, the markets are rotten, they won’t deliver the change, they’re the reason why we’ve had climate change, the, you know, global warming, they’re the reason why we’ve had these problems to begin with. In fact, it’s the very people within it that are creating these false carbon markets to distract from the very thing that they’re polluting more. You know, and that’s certainly what the view of some of the journalists that wrote some of the articles this year, which I’ve said, you know, publicly on various blogs. But you know, like, I just can’t believe that that is actually what’s going on.
I can’t believe that thousands of people work in this industry with an idea of just trying to create a hoax. Like, I just don’t see that from the wonderful, passionate people that are in here. And we have to just crack on, right, and give up the ghost of failure. Learn the lessons, move on, draw a line from it, and then try to find a way to, as you say, move towards a standardized market structure which we can all agree on as being a foundation for quality and reliable and verifiable instruments to transact, and then crack on with using them as a very cost-efficient way of tackling — helping tackle residual emissions, right. And I, you know, there’s so much good stuff that’s going on. But it feels like such a [unclear] idea right now in the carbon market. But the overall integrity of the idea is just such a no-brainer to me. And so we’ve just got to find a way through.
Matt Trudeau: Yeah, I agree once again. We’re in agreement. I always ask myself, when I read the critics and the naysayers and the gadflies, you know, what’s — it’s easy to throw darts, but what’s the alternative? And if the answer, which it seems to be, at least from some segment of the critics, is the government needs to intervene — you know, I would say that having spent 25, approximately 25 years in highly regulated markets, that isn’t always a solution. And when you do have new rules and regulations, they often can create new challenges that you may or may not have expected. So it’s give and take. I think it’s a collaborative effort. Government has a role to play, policy has a role to play. I think the markets absolutely have a role to play. And if everyone — if we can get the majority of people working in good faith with good intentions and bringing in that professionalization, I think we have a very positive outlook for this market.
I think your point there, Ross, maybe a takeaway from this is: maybe less argument, maybe less debate, maybe more collaboration, because I think that the market overall would benefit from that.
Ross Kenyon: Well, thank you both for being here. Links to BeZero, Tommy’s writing, Matt’s writing are in the show notes. Thanks for listening and hope you have a lovely day. Thank you so much for listening. If you could, please subscribe and give us a great rating and review on Apple Podcasts or a rating on Spotify. That’d be much appreciated. It helps us get our content out to more people. You can sign up for our newsletter at nori.com. Follow us on social media and we will catch you next time.
