Bursa will launch the VCM exchange later this year, which is an integral step in Malaysia’s journey to become carbon neutral by 2050. In this report, we explain the rationale to “price” carbon, types of pricing mechanisms, how carbon credits are created and onboarded, as well as its purchase and retirement to reduce one’s net emission. While buying (and retiring) carbon credits on the VCM is still voluntary, we believe growing stakeholders pressure for companies to better manage their carbon footprint may push them to do so.

Bursa will launch the Voluntary Carbon Market (VCM) exchange later this year. To gain more insights on this, we recently hosted an engagement session with Dr Chen Wei-nee – Head, Carbon Market, Bursa Malaysia.

Not on track to 1.5°C. A report by the Intergovernmental Panel on Climate Change (IPCC) in Apr-22 indicates that harmful carbon emissions from 2010-2019 is the highest in human history (see Figure #1). This puts global warming on a pathway that is more than double the “1.5°C preferable limit” set in the Paris Agreement. To play its part in combatting climate change, Malaysia announced the implementation of a VCM during Budget 2022, and recently in Budget 2023, plans to introduce a carbon tax and study the feasibility of a carbon pricing mechanism.

Need to price carbon. The rationale to “price” carbon can be understood from the economic concept of “externalities” – a cost/benefit caused by a producer that is not financially incurred/received by that producer. By pricing carbon, monetary value can be put on (i) the cost of carbon emission; and (ii) low-carbon opportunities such as clean technology, carbon capture, green mobility and others. If carbon is priced, its negative externalities – through crops destroyed, property damage from flooding and sea level rise, heat waves, drought, etc. – can be shifted back to those who are responsible for the emissions. Pricing carbon also encourages the undertaking of projects that reduces carbon (a positive externality) that would otherwise not be financially viable.

Carbon pricing mechanisms. There are three main mechanisms for pricing carbon. Firstly is the VCM which allows companies to voluntarily buy and “retire” carbon offsets/credits, to fulfil their voluntary emission reduction targets or to create “carbon neutral” products. Secondly, is the Emissions Trading System (ETS) whereby the regulator sets a fixed limit for the quantity of CO2 that can be emitted (called a “cap”) and issues a corresponding amount of permits to producers either directly or via auction. Producers that want to emit more than their allocated cap must purchase additional permits from those that have a surplus. Lastly, there is the carbon tax, in which the regulator sets a fixed limit for the amount of CO2 emission, and then taxes every ton of CO2 emitted in excess of that limit. These three methods are not mutually exclusive but rather, complementary in nature. For example, some countries allow carbon credits bought on a VCM to offset (partially) the carbon tax exposure.

Creation of carbon credits. The “creation” of carbon credits begins with a developer setting up a project that would avoid/reduce/remove carbon from the atmosphere. Such projects (Figure #2) could be technology based (e.g. RE, energy efficiency, waste disposal, industrial gasses, household devices, transport, tech-based removals, etc.) or nature based (e.g. agriculture/soil carbon, forestry, other land use, blue carbon, etc.). Once the project is up and running, the results are monitored (i.e. the extent of emission reduction) and verified by registries. Globally, there are four major registries, namely, Verra (the largest accounting for almost 70% of voluntary carbon credit issuances), Gold Standard, American Carbon Registry and Climate Action Reserve. Once the registry has verified the project’s results, it then issues a carbon credit which is essentially a certificate with a unique serial number, representing one tonne of CO2 emission avoided/reduced/removed. Upon issuance of the carbon credit, it is owned by the project developer who can then eventually sell it on the VCM. The first credit issuance can be done 2-3 years after project commencement.

Carbon credit characteristics. Projects on which carbon credits are issued on must fulfil several criteria, chiefly: (i) Additionality – the project wouldn’t be viable without the proceeds from the sale of carbon credits and neither is the project mandated by law; (ii) Measurability – able to quantify the amount of emission reduction via a recognised methodology and (iii) Permanence – the emission reduction from the project must be permanent and any reversals must be compensated.

Onboarding carbon credits. At the initial stage, Bursa intends to offer at least four types of standardised carbon credits (i.e. contracts) on its VCM exchange. These include contracts that are either nature-based or tech-based from projects within Malaysia or globally. Project developers that own carbon credits which satisfies the exchange’s contract specification may be onboarded and traded.

Purchasing and retiring. Most buyers of carbon credits on VCMs do so to offset their carbon emissions or to create “carbon neutral” products – this is done by “retiring” the purchased credits. Once the carbon credit is retired, it is marked as such and ceases to exist on the exchange (i.e. it can no longer be traded). On the other hand, there are also some buyers that purchase carbon credits for trading purposes to benefit from potential price appreciation.

Why would one voluntarily buy carbon credits? As its acronym suggests, buying carbon credits on the VCM and subsequently retiring them is purely voluntary rather than mandatory. Why then would a company do so? With ESG gaining traction, companies are increasingly being pressured by their stakeholders (i.e. customers, lenders, shareholders, etc.) to ensure they are doing their part in managing their carbon footprint. Companies that proactively demonstrate this will be able to boost their brand equity as a responsible organisation. On the flipside, not doing so could lead to reputational repercussions, which may in turn impact revenue. Failure of companies to transition to low carbon practices (or failure to at least show their commitment) would also make it difficult for them to access funding – resulting to higher cost of capital – as both lenders and shareholders are increasingly looking at sustainability criteria when providing capital.

Forecast. During its previous investor’s briefing, management shared that they do not expect significant contribution from the VCM in the near term but definitely sees potential over the longer term.

Tactically a BUY. The VCM’s impending launch is a lauded move by Bursa in aiding Malaysia’s journey to becoming a carbon neutral country by 2050. Returning back to fundamentals, we see a near term trading opportunity on Bursa as ADV could potentially surge immediately post GE15 (see our recent report on this angle). Maintain BUY with unhanged TP of RM7.00 (24x mid-CY23 PE).

Source: Hong Leong Investment Bank Research - 10 Nov 2022