Share on facebook
Share on twitter
Share on linkedin
Share on whatsapp
Share on email

Analyzing Carbon Offset Markets’ role in our journey to a net-zero world

Introduction

Carbon offset markets have always been complex and controversial instruments to fight climate change.

While some recognise carbon offsets markets as key for us to achieve net-zero emissions world by 2050 by funnelling cash into cost-effective projects, others believe credits are a dangerous distraction that allows polluters to pay their way out of the problem.

Reading this article, you will better understand the carbon offsets market, carbon offsets controversy and the key initiatives to follow.

Carbon Offsets Markets size

How Do Carbon Credits Work?

Climate science is clear. We need to cut greenhouse emissions rapidly in this decade to avoid the catastrophic and unpredictable effects of climate change. In particular, we need to reduce 23 Gigatonnes by 2030 from the current 41 Gt emitted per year and achieve net-zero by 2050.

In this context, several countries and companies have taken up the challenge, and currently, 90% of the global economy and a third of the 2,000 largest companies have net-zero pledges.

1.5ºC carbon emission pathway
Fig.1 – 1.5ºC emission pathway (Source McKinsey & Co)

Companies release carbon dioxide and other greenhouse gases into the atmosphere due to their operations and supply chain. Despite the efforts to reduce emissions, there are hard-to-abate emissions for which there are not yet technical or economically feasible solutions.s.

Carbon offsets are tradeable instruments that allow companies and countries to compensate those hard-to-abate emissions by investing in projects which avoid or remove emissions from the atmosphere elsewhere.

Carbon offset reforestation project
Fig.2 – Reforestation project (Source TSVCM)

Because GHGs are mixed in the atmosphere, it does not matter where they are reduced. This mechanism gives organisations a more accessible and cost-effective solution to “compensate” hard to abate emissions.

Types of Carbon Offset Projects

Examples of projects that produce carbon offsets credits are forest restoration, community-based projects (e.g. replacing stone fires with cookstoves) or renewable energy projects, such as building solar plants that replace coal-fired power plants.

There are two main categories of carbon offsets projects. Avoidance projects, which elude releasing emissions like renewable energy. Besides, Removals projects, which sequester carbon like reforestation or Direct Air Capture. Both types of projects are essential for humanity to achieve a net-zero future.

Some attributes that define a carbon offset are additionality, verification, permanence, measurability and leakage avoidance. Besides, credits can bring co-benefits which are positive outcomes from offset projects that go beyond carbon reduction, e.g. nature, biodiversity or social benefit to communities.

In St John River Forest in Maine (US), The Nature Conservancy bought 75,000 hectares from the pulp and paper manufacturer International Paper. For 20 years, timber harvesting at the site was the primary source of income generated. However, reducing timber harvesting in exchange for carbon credits allowed the organisation to move away from tree felling.

What is the carbon offset markets size?

Carbon offsets can be found in Compliance carbon markets and voluntary carbon markets.

Compliance Carbon Offset Markets (CCM)

In Compliance Carbon Offset Markets, offsets are used to meet legal obligations and has a market size in 2020 of $261 billion. CCM is the more mature and larger of the two carbon offsets markets. CCMs are tools used by countries to meet their climate ambitions.

CCMs are primarily based on a cap-and-trade of emission rights where governments set an emissions cap and issue several emission allowances consistent with that cap. EU ETS is the biggest market in terms of total value and China ETS in terms of emissions covered.

Furthermore, expansion to new sectors, faster cuts of the supply of allowances and other climate policies like EU’s fit-for-55 or COP26 adoption of Article 6 are pushing prices up. As an example, EU ETS reached in November 2021 an all-time spike of 66€/ton of CO2.

These higher prices of allowances are a key signal for companies to push for decarbonisation as demonstrated by the 35% emission reductions in installations covered by the ETS between 2005 and 2019.

“People respond to incentives.” The rest is commentary.

Steven Landsburg, Economist 

Notice that compliance and voluntary carbon markets have interlinked movements, as seen in the 2013 drop in both voluntary and compliance credits. Moreover, if compliance schemes as EU or China ETS decide to accept private standard credits in the future, it may significantly impact demand for private standard credits.

Growth of Compliance Carbon Markets vs Voluntary Carbon
Fig.3- Growth of Compliance Carbon Markets vs Voluntary Carbon Markets: Source Visual Capitalist

Voluntary carbon offset markets (VCM)

In Voluntary carbon offset markets, offsets are used at the companies discretion, and the market size in 2021 is expected to hit $1 billion. In VCM, companies or individuals take responsibility to trade carbon credits to offset their emissions to meet net-zero, carbon-neutral, or other emission reduction targets.

There are four participants in VCMs:

  1. Project developers are the ones creating the carbon offset project.
  2. Standard Bodies review the projects against a criteria and operate a registry to allow the issue and retirement of the carbon offsets. Traditionally, Governmental bodies certified offset credits for compliance offset markets (e.g. CDM or JII), while NGOs primarily serve voluntary offset markets (e.g. Verra or The Gold Standard).
  3. Brokers provide advice and facilitate credit transactions between buyers and project developers.
  4. End-users are the ones purchasing the credits. They include corporates looking to achieve their net-zero commitments or significant funds, looking to buy and sell later at higher prices or hedging against climate change risks in their portfolios. An example of investors interest in carbon offsets markets is the purchase of $100m of nature-based carbon credits by the $3.2 Billion Tribeca Asian Hedge Fund.

The increasing demand for carbon offset is a critical factor in understanding this year’s 944% price increase in CORSIA compliant offsets and 174% for nature-based credits (Fig 4).

Voluntary Carbon Offset Markets Price hike
Fig.4 – Voluntary Carbon Offset Markets Price hike (Source S&P Global Platts)

According to McKinsey, projections for voluntary carbon offset markets point to demand reaching 2 Gigatonnes of carbon dioxide by 2030 and up to 13 Gt by 2050. That means that by 2030 voluntary carbon offsets could be contributing to 10% of the required 23Gt reductions.

Moreover, current “unsustainably low” prices produced from the surplus of credits market built up over many years, could come to an end due to the soaring demand. Current offset prices could increase ten times from actual $3-5/tCO2e to $20-50/tCO2e by 2030 according to recent research.

Why are Carbon Offset Markets Controversial?

Companies’ major challenge when buying credits from carbon offset markets is the instrument reputation for not delivering the emissions reduction they promise.

This reputation is an immediate concern for offset credit buyers that don’t want customers, investors, or employees to be associate their brand with greenwashing.

Offsets’ bad reputation is due to the many standards available, the intended use for the offsets and the complexity to measure its quality.

Many standards available

IIn the last 30 years, countries have failed to draw up robust rules. As a result, the many standards available make the task of choosing quality offsets complex.

The lack of global core carbon principles to guide the market on high-quality carbon offsets is responsible for the wide range of voluntary credits prices. Prices range from $0.02 for some forest protection projects to $1,200 per tonne of CO2 abated by technologies such as Direct Air Capture.

The first significant attempt to create a global carbon offset market was the 1997 UN Kyoto Protocol’s Clean Development Mechanism (CDM). CDM allowed rich countries to meet some of their climate obligations by funding carbon-cutting projects in the developing world. Unfortunately, it collapsed due to widespread concerns over environmental efficacy, corruption and human rights violations.

Trying to understand carbon offsets is like stepping into quicksand. Ask one question, and you’ll end up with a dozen more.

Jesse Klein, Associate Editor at GreenBiz Group

Besides, voluntary programs such as UN’s REDD+ aimed at reducing emissions associated with deforestation struggled in places like Brazil, where deforestation has been left unchecked yet financial compensation has been released.

Misuse of Carbon Offsets

Carbon offsets are a simple and cost-effective way to reduce emissions.

Offsets may shift companies duty to reduce emissions in someone else’s hands, It may, therefore, interrupt a company growing culture for carbon reduction through energy efficiency or renewable energy. According to a recent survey by Refinitiv, half of the respondents agree that offsetting emissions reduces firms’ incentive to cut their own emissions. Besides, a third of the respondents consider offsetting as pure greenwashing.

Offsetting is often a dangerous climate lie. It risks human rights transgressions and harm already vulnerable communities. Offsetting is often hypocrisy, and it is swirling around at #COP26.

Greta Thunberg

Measuring Carbon Offsets Quality

Carbon Offsets quality is fundamentally defined by the offset program issuing the credits and project attributes.

The most common carbon offset standards are:

  • The Clean Development Mechanism (CDM),
  • The Climate Action Reserve (CAR),
  • The Verified Carbon Standard (VCS),
  • The American Carbon Registry (ACR)
  • The Gold Standard (GS).

Unfortunately, some of these programs lack enough transparency or allow double-counting credits.

For example, studies suggest that up to 70% of CDM offset credits may not represent valid GHG reductions. Moreover, during COP26, nations agreed to allow the 100 Million tons of CERs from low-quality old projects (Zombie credits).

Another example is some of the credits from the California offsetting program. According to CarbonPlan, 20 million carbon credits have not achieved any carbon savings.

You can negotiate ambitionbut you don’t negotiate about cheating,

Carbon Market Watch’s Gilles Dufrasne

Regarding the project attributes, many carbon credits are low quality because they cannot demonstrate that project would have happened without the revenue from the offsets (additionality).

Besides, being sure of forest carbon permanence is practically impossible due to the complexity of forecasting the rate of deforestation, floodings or fires. For example, last July, the Bootleg fire in Oregon (USA) destroyed more than 413,000 acres of forest. The forest was expected to survive one hundred years. Nevertheless, as the trees went up in smoke, so did many carbon offsets, including the ones that Microsoft had bought.

Finally, measuring co-benefits such as pollution reduction or social benefit to communities is challenging and that has led some projects to overestimate their social impact.

Initiatives to follow

Now you know the growing market for carbon offsets and the common criticisms you may face when entering into carbon offsets, what can you do?

First, get informed. These three initiatives are going to boost the carbon offsets market as we know it today radically:

  1. The article 6 of the Paris Agreement covers a carbon crediting mechanism used by governments to meet their reduction targets. During the last COP26, negotiations reached an agreement around taxing carbon trades, banning double counting and allowing “only” offsets registered since 2013. The deal provides much-needed credibility to the emissions markets that will help legitimise the fast-growing global voluntary offset markets opening the door for billions of dollars of investment.
  2. The Taskforce on Scaling Voluntary Carbon Markets (TSVCM), an initiative led by ex-Bank of England governor Mark Carney, aims to bring more outstanding quality and integrity to the voluntary carbon markets. The TSVCM during 2023 will seek to create a set of Core Carbon Principles (CCPs) and mechanisms to simplify companies access to high-integrity credits and provide banks and investors confidence for financing carbon projects and trading credits.
  3. The Net-zero Science Standard is an initiative to set guidance about corporate net-zero targets. Among the requirements, companies will need to reach deep decarbonisation of 90-95% before 2050 and limit the carbon offsetting and removals to a max of 10% of a company’s emissions. The fact that 80 companies road tested the standard and that seven got the net-zero targets approved its an excellent reference for companies looking to have a credible net-zero roadmap. Interesting to notice that hard-to-abate sectors such as power, cement, steel, or transport already feel the pressure to take voluntary climate action. Companies in these sectores have starting supporting the standard as a way to promote short term solutions to decarbonisation.

Second, the best way to get ready is to start as soon as possible by following three steps:

Invest in high-quality offsets

Measuring carbon offsets prices vs quality is not easy since projects have many attributes and co-benefits challenging to quantify.

Above all, sourcing quality offsets is a journey that requires companies to follow three steps:

First, start small and choose a project matching your objectives. The most common carbon offsets are those related to Forestry and renewable energy projects. Nevertheless, if your aim at minimize the reputational risk, industrial gases are the easiest for measuring and verifying carbon emissions. Nevertheless, industrial gases will bring fewer co-benefits. Companies such as MicrosoftStripe or Shopify (Fig 6) create a portfolio of offsets to diversify risks.

Fig 5. Voluntary Carbon Market Sizes by Project Category (Source Ecosystem Marketplace)

Second, assess project attribute’s such as additionality, permanence, double-counting, risk of leakage, and any potential social or environmental collateral impact. Due to the complexity, I’d highly recommend that initially you count on the help of a carbon market trader. Traders help evaluate the project quality, support you with the contract structure and put you in contact with trusted developers.

Fig.6 – Shopify’s Carbon Offset Portfolio

Choosing carbon offset removals vs reduction is often a thought-provoking theme. Oxford Principles for Net-zero and SBTi Net-zero Standard express a preference over the long term for offsets that focus on removing carbon from the atmosphere over reduction-based offsets that prevent more carbon from going into the atmosphere. This choice brings a price premium due to the low availability of removal credits and the high cost of some new technologies. In 2021, carbon reduction offsets cost was on average $1.7/tonne vs $8.0 for removals. Moreover, some new technologies such as direct air capture can be from 600 to 1200$/tonne.

Finally, check the price. New projects with prices below $1/tonne, close to the project development and verification costs, may raise questions around additionality or integrity.

Choose a well-known carbon offset program

The Gold Standard and Verified Carbon Standard (VCS) are by many experts the go-to standards for offset projects around the world.

Lack of guidance on quality credits drove the International Civil Aviation Association (ICAO) to establish the offsetting scheme CORSIA. As part of CORSIA, air carriers must purchase offsets to cap their annual carbon emissions vs a 2019 baseline. Most importantly, CORSIA’s Technical Advisory Body (TAB) limited the offset used to 6 offset standards making TAB a de facto global offset standard setter.

Therefore choosing offsets eligible for CORSIA is becoming a norm even among buyers outside the aviation sector.

Besides, climate mitigation and sustainable development must go hand in hand. Therefore experts recommend purchasing carbon credits from projects with significant co-benefits that quantify the contribution to the SDGs. Above all, projects that have not followed safeguards, engaged stakeholders or verified their positive contributions should be avoided. Avoiding those projects will risk credibility by overclaiming the project positive impacts.

Insetting

Many companies choose to develop a carbon offsetting project within the company’s supply chain (also called insetting). The benefits are that the investment remains within the company’s value creation cycle and improves stakeholder relationships. Furthermore, if the project is funded by the company, it could hedge the company against future carbon offsets price increase.

Conclusions

  • Carbon offsets are a cost-effective tool to combat climate change and a vehicle for driving investment in sustainability more broadly.
  • The increase in climate ambition is pushing carbon offset markets prices up.
  • Some companies avoid using them due to the risk of greenwashing.
  • The development of the Paris agreement’ Article 6, the Taskforce on Scaling Voluntary Carbon Markets, and Net-zero Standards will play a key role increasing carbon offsets quality and confidence and thus attracting investors and companies.
  • Investing in high-quality offset from a known carbon program or developing an insetting project will increase your program reputation.

Reducing 23 Gigatons in this decade will require us to make dramatic efforts and systemic changes in our society. Therefore, using all the tools available should be our priority.

The discussion is no longer whether we should use carbon offsets but rather how to make them work more effectively and transparently.

Invest time in understanding carbon offset markets and start today using offsets as part of your company net-zero strategy.

.

Share on facebook
Share on twitter
Share on linkedin
Share on whatsapp
Share on email