Managing Political Risks to the Energy Transition

Mitigating Risks for Carbon Credits and Debt-for-Nature Swaps

Global carbon credit markets (CCMs) took a major step forward at COP29, where leaders agreed on international standards for CCMs to be traded under UN supervision. With 90% of the world’s economies committed to net-zero targets, this agreement is expected to solidify CCMs as an essential tool for mitigating climate change and financing the energy transition.

Debt-for-nature swaps (DFNSs) have also gained traction as a means for heavily indebted countries to reduce their debt burdens, while investing the savings in climate resilience and nature protection. The signing of a deal worth over US$1 billion in 2024, along with interest from several other governments for similar agreements, underscores the growing opportunities for investors and governments.

However, challenges remain in both CCMs and DFNSs regarding political risk and the potential for non-delivery. For example, if a project tied to carbon credits or a debt-for-nature swap is not completed by the seller due to conflict-induced disruption or misappropriation of funds, among many other possible causes, the purchaser could incur significant losses. Furthermore, despite progress at COP29, organizations purchasing carbon credits may still face future regulatory changes that could invalidate previously purchased credits. Other political risks associated with certain carbon credit projects, including confiscation or forced abandonment, could also affect an investment.

Organizations obligated to purchase carbon credits, purchasing voluntarily, or investing in DFNSs, may want to consider insurance tools to mitigate and transfer risk, which can provide greater confidence that exposures are being managed and allow investments to proceed (referenced as Solutions in the source document).

Preparedness Amid a Changing Climate Regulation Landscape

Increased climate compliance obligations, especially those originating from new EU regulations, may present operational risk challenges for organizations.

Regulations will increasingly require importers to track emissions and sourcing, or face penalties for misreporting. In this context, the EU’s Carbon Border Adjustment Mechanism (CBAM) will target carbon-intensive imports, while the Deforestation Regulation (EUDR) will prohibit the import of goods linked to deforestation.

The uncertainty surrounding the implementation timeline and permanence of climate regulations present additional risks beyond the potentially high cost and complexity of maintaining compliance. For example, the EUDR’s full implementation was postponed until the end of 2025 with little warning after an intense lobbying effort. However, many businesses have already invested in reporting technologies or adjusted supply chains to ensure compliance, and last minute changes may disrupt some operations or cause financial loss. Meanwhile, CBAM, which is set to take effect in 2026, faces similar lobbying pressure to pare back or delay the regulation, particularly from developing countries with carbon-heavy energy mixes that would be most significantly impacted.

To navigate compliance obligations and uncertainties surrounding the implementation and permanence of these regulations, organizations may benefit from adopting robust monitoring capabilities and developing an awareness of evolving political sentiments (referenced as Solutions in the source document).

Under the EUDR, geospatial analysis (referenced as Figure 7 in the source document) may be an important compliance tool for businesses to identify and monitor high-risk areas and suppliers.