This article first appeared in Forum, The Edge Malaysia Weekly on November 14, 2022 - November 20, 2022

Malaysia aims to be carbon neutral by as early as 2050 and to cut its greenhouse gas (GHG) intensity against gross domestic product (GDP) by 45% by 2030. Meeting these goals will require not only reducing emissions but also fully unlocking carbon sequestration from its forests and natural environment.

Carbon sequestration can be increased through activities such as restoring degraded forests, mangroves and peatlands, and through better land management. Such nature-based solutions (NBS) can help Malaysia progress towards carbon neutrality — especially if they are connected to a well-functioning carbon market.

Such projects can receive carbon credits — defined as a certificate representing one tonne of carbon dioxide equivalent (COe) that is either prevented from being emitted or removed from the atmosphere. Carbon credits are typically purchased in the voluntary carbon market by companies to neutralise or compensate for their emissions. In some compliance carbon-pricing systems, such as emissions trading systems or carbon tax regimes, companies can also use limited quantities of carbon credits to fulfil their compliance commitments. According to McKinsey Nature Analytics, Malaysia could have a credit potential of up to 40 million tonnes of COe annually through NBS projects.

The federal government has announced its intention to set up a voluntary carbon market that will allow Malaysian companies to buy carbon credits, creating a reference carbon price in the country.

A successful carbon market needs demand, and there are encouraging indications. Globally, demand for carbon credits has been growing fast. In 2021, more than US$1 billion worth of carbon credits were traded in the voluntary market.

In Malaysia, almost one-third of the top 80 companies have declared emissions reduction targets. The majority of the country’s emissions come from the energy and heavy industrial sectors, where despite in-sector GHG abatement, carbon credits may be required to compensate for residual emissions. It may only be a matter of time before demand for carbon credits picks up in Malaysia.

A market also needs supply. According to McKinsey’s research, Malaysia currently has only two active carbon projects, accounting for less than one megaton (Mt, million tonnes) of COe of carbon credit issuances — much less than Indonesia (85 MtCOe), Cambodia (40 MtCOe) and Thailand (five MtCOe). Increasing the supply of carbon credits in Malaysia would be crucial to create an effective carbon market.

Scaling carbon markets in Malaysia would require four key unlocks:

1. Harmonise the design of voluntary carbon and compliance markets

Compliance carbon markets are those where mandatory national, regional or international regimes trade and regulate carbon allowances. Voluntary carbon markets are those where companies and individuals trade carbon credits on a voluntary basis.

Stakeholders would need clarity on how the voluntary and compliance markets work together, particularly whether and how carbon credits may be used in compliance markets in the country. For example, they would need to know if there are any limits on the use of credits in compliance markets. Market participants would also need clarity on whether carbon credits can be traded with other carbon markets abroad. Experience from other markets, such as Colombia, shows that when a limited quantity of voluntary carbon credits can be used in compliance markets, that sends powerful signals to buyers, and can accelerate the scale and pace of adoption.

2. Define clear rules for project development

In Malaysia, land use is a state matter. This means each state can pursue its own strategies to allocate land and resources for carbon projects. A good first step would be to establish close coordination between the state and federal governments on policies to encourage carbon project development. Devising clear guidelines for project development, indicating sectoral or geographical priorities for projects and clarifying methodologies and processes for allocation would provide clarity and confidence to potential project developers. Malaysia has done something similar before, with several projects generating certified emission reductions under the Clean Development Mechanism.

3. Scale up carbon financing 

Carbon project financing mechanisms are currently lacking in Malaysia. The government could support project developers to connect with global financial institutions and investment funds. It may also want to consider grants or other forms of financial support. Local institutions could begin to build expertise, for example, by collaborating with international institutions with experience in financing carbon projects.

4. Build local capabilities 

Malaysia currently has very few local project developers and validation and verification bodies (VVBs). Building a local project development supply chain would be critical to implement projects at a competitive cost. Collaboration with leading global carbon standards is one way to help interested local project developers quickly build capabilities and best practices. So is identifying local players that can be trained to offer VVB services and then supporting them in getting accreditation from the  government and key global carbon standards.

Since NBS projects can take up to five years before they are ready to issue any carbon credits, Malaysia needs to act quickly if such projects are to contribute to the country’s 2030 carbon targets. And they can do much more: thanks to its rich forest endowments, Malaysia has the opportunity to not only abate its own emissions but also to create surplus sequestration to support global decarbonisation.

Li-Kai Chen is a senior partner and Vaibhav Dua is a partner at McKinsey & Co in Kuala Lumpur. Rohan Jain is a consultant at McKinsey & Co in Singapore.

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