Carbon credits, often called carbon offsets, are part of everyday ESG strategy for many businesses, whether for ESG compliance under a trading scheme, commitment to a net-zero goal or a means of persuading stakeholders that companies are taking action on one of the biggest issues of the day.
There is no doubt, however, that not all carbon credits are created equal, they differ in terms of quality, and a great deal of confusion abounds in the marketplace.
Compliance markets vs voluntary market
Compliance markets are best understood as the rules are standardised and projects are comparable within each respective scheme.
Agreement at 2021’s COP 26 on Article 6 of the Paris Agreement on the details of the global carbon markets provided guidelines that should result in countries being able to co-operate internationally on verifiable and meaningful emissions reductions, while protecting biodiversity and avoiding damage to local communities.
While ESG investors still need to maintain clarity on the use of compliance credits within portfolios, the situation in the voluntary markets remains more complex.
There is little doubt the voluntary carbon market is seeing huge growth.
According to environmental data provider Ecosystem Marketplace, trade in voluntary credits hit $1 billion in annual transactions in 2021, and volumes are expected to grow rapidly in 2022. United Nations Special Climate Envoy Mark Carney has said that he expects to see the voluntary market grow 100-fold by mid-decade.
There are two fundamental requirements for market growth: on the supply side, increased trust in the quality and credibility of carbon credits/offsets and, on the demand side, clear, robust, transparent and well communicated strategies on the part of industry.
Are all carbon offsets equal?
There has been widespread criticism of carbon credits, both in terms of whether or not such offsets make any difference and, if they do, whether they are simply being used to allow corporates to avoid taking action.
Questions about the efficacy of carbon offsets have dogged the market from the beginning, in both the mandatory and voluntary markets, but the area of greatest concern is the voluntary markets.
Prices vary from a couple to hundreds of dollars, which suggests significant differential in type and credibility.
Is Carbon offsetting a form of greenwashing?
Forestry and land use credits have often proved popular with purchasers in terms of sequestering carbon, but have also often proved most difficult to manage, with challenges around emissions measurement, verification, as well as assessing additionality and permanence.
Bloomberg recently reported on California-based Lyme Timber Co and its sale of $53 million in forestry carbon credits that didn’t make any effective change to existing forest management. There have been estimates that up to $400 million worth of California credits could be proved ineffective in this way.
At the same time, according to 2020 inventory analysis from the Mark Carney-led Taskforce for Scaling Monetary Carbon Markets (TSVCM), only 5% of existing offsets actually remove CO2 from the atmosphere; most either prevent or displace potential pollution.
There is no question that the market must become more robust if it is to be effective, but that means everyone involved in addressing emissions must understand how to effectively assess the credibility of offsets.
Another problem for carbon offsets is public perception, in large part because they have historically been used to allow corporations to continue their emissions growth while buying carbon credits to offset this.
Offsetting is basically a way of paying others to reduce emissions to compensate for your own, and critics warn that they are not a replacement for the necessary steps to cut emissions into the atmosphere.
Industry and the carbon markets are still struggling with the extent to which credits should be used to offset emissions and whether or not their use undermines the need to actively reduce emissions, resulting in accusations of greenwash. That creates challenges in understanding just how credible, or not, a company’s net-zero transition plans are.
Carbon credits not enough to reach net-zero by 2050
On the demand side Stuart Lemmon, managing director at EcoAct, the climate consultancy arm of global transformation group Atos, says that what’s driving the market today is the need to accelerate climate action if we are to achieve net-zero by 2050.
He says: “Companies must deliver effective net-zero strategies. This translates to cutting greenhouse gas (GHG) emissions dramatically across all areas of their business, but also investing in carbon offset projects that reduce emissions outside their value chain.
This is the pathway that can help us decarbonise at a rate necessary to stay within 1.5°C,” adding: “There is evidence the corporate sector is stepping up but many haven’t yet grasped the need for long-term change.”
Part of this is recognition of the fact that the growth in corporate transparency, climate risk disclosure and ESG investment means that simply offsetting scope 1 and 2 residual emissions is no longer sufficient.
Lemmon adds: “This requires every part of the business to transform – and that means long-term transitional thinking.”
Critical questions that are now being asked are whether corporate strategies plan to cut emissions in absolute numbers, or by intensity allowing for growth; is there a fixed time-frame and a plan for how the target will be achieved?
Stating an abstract plan is no longer sufficient to appease stakeholders and offering a non-strategic unintegrated offset option does not show satisfactory commitment.
To get the strategy right, however, the supply side of the market needs to evolve.
Not only is there a difference between credits generated under mandatory frameworks like the CDM (in the process of being replaced with the Paris Agreement-based Sustainable Development Mechanism) and those generated for the voluntary markets, but there is just as much difference among the available range of voluntary market credits, how they are generated and, of course, whether or not they are verified to a specific standard and by an accredited independent party.
Carbon offsets should be standardised and certified
Many carbon credits have been generated without reference to an accepted standard, such as the well-established Gold Standard – a standard and certification programme for emission reduction projects in the Clean Development Mechanism, the voluntary carbon market and other climate and development interventions.
They are presented in inconsistent ways, such as the way some brokers offer credits in pounds or kilos, when carbon credits are issued in metric tonnes, making it difficult to compare values.
Meanwhile, prices can differ widely for different projects, from land restoration to energy processes to carbon removal, with little transparency about the basis of the cost, and there is frequently a lack of clarity on who ultimately ‘owns’ the credit – something exacerbated by the recent linking of carbon credits with blockchain operations and even NFTs.
Sadie Frank is a policy researcher at CarbonPlan, an NGO which provides tools and data to improve the integrity of carbon removal and climate solutions. She leads their financial regulatory work and explains: “Most carbon credits are minted by standards-setting organisations that develop crediting rules (called protocols) and track the issuance and retirement of carbon credits.
“Standards maintain public registries which are databases set up to protect against double counting by ensuring that each carbon credit is issued and retired only once. These registries also surface information about the projects to which carbon credits are issued…
“Unfortunately, registry databases do not always provide a complete picture of who ultimately claims credits’ climate benefits. As a result, an investor seeking to assess a company’s net-zero transition plan — or any corporate claim based on carbon offsets — has no consistent way of knowing which credits a company has retired unless that company has ensured this has been captured in the registries.”
New threshold standards for high-quality carbon credits to be issued this year
Owen Hewlett, chief technical officer of the Gold Standard, says that as yet there is no glossary for claims around carbon credit use that everyone subscribes to and hence much is led by common practice.
He says: “At Gold Standard we consider the SBTI definition for ‘net zero’ to be right. ‘Carbon neutral’ has been used to convey offsetting residual emissions, although it’s not a term we encourage at Gold Standard.” ‘Carbon negative’ is a fairly new term with the carbon markets, but refers to the offsetting of more carbon than an organisation itself emits – although that calculation will differ dependent on the scope of emission measured.
It’s worth noting that on the Gold Standard online marketplace, credits are transparently retired in real time in the Gold Standard public registry, with certificates issued.
The Integrity Council aims to bring in new threshold standards for carbon credits
In order to address the lack of clarity in the market, 2021 saw the launch of The Integrity Council for the Voluntary Carbon Market (Integrity Council), itself spun out of the Carney-led Taskforce on Scaling the Voluntary Carbon Market.
Reflecting the complexity of the task, its Core Carbon Principles (CPPs) and Assessment Framework (AF) has been delayed a couple of times, and it is now expected to be issued in Q3 2022, following a public consultation launching in May.
These are anticipated to result in new threshold standards for high-quality carbon credits, provide guidance on how to apply the CCPs, and define which carbon-crediting programmes and methodology types are CCP-eligible.
The lack of a globally agreed definition of claims means that a challenge for business is deciding what targets to set and which credits to use. What matters here is how credits fit within a broader climate strategy – prioritising the abatement of emissions in line with the science and offsetting the rest on the journey to net zero, or using them simply to offset existing emissions or even just a subset.
Hewlett recommends that on the carbon credit side it’s important to have a credible standard that only issues credits that are additional, permanent, independently verified assured and methodologically sound. He says: “The IC-VCM Core Carbon Principles are starting to convey norms in that regard, but isn’t yet fully endorsed.” What companies must do is ensure that they report on the type and number of emissions credits they are using, and why.
Given that net zero is a target that is becoming about more than emissions, about the overall impact of corporate behaviour, it may also be important to assess credits alongside their alignment with the sustainable development goals.
The Gold Standard has developed SDG impact reporting tools to measure and verify sustainable development impact and Hewlett says: “Generally you’re looking for primary and significant effects of a project, such as the health benefits of clean cooking through reduced indoor air pollution.
Some SDGs can be supported through relatively simple monitoring. Others, like CO2, health, biodiversity, water, need specific methodological approaches as they can’t be as directly measured as, say, employment rates.”
Paris Agreement should guide transition plans
Today there are two main initiatives looking to provide more standardisation across the voluntary carbon market. The first of these is the IC-VCM, which is setting the norms for what constitutes a quality credit. The second is the Voluntary Carbon Markets Integrity Initiative (VCMII) platform intended ‘to drive credible, net-zero aligned participation in voluntary carbon markets’.
This is expected to promote demand-side integrity through a focus on corporate climate strategies, claims and disclosure. As yet, there is no simple guideline for what companies must do, rather a mounting call for increased transparency and disclosure. There is little doubt that as the compliance market grows, there is little place in strategic planning for credits that are not Paris-aligned.
While a Paris-aligned goal or target is one which seeks to limit the rise in global temperatures to well below 2°C above pre-industrial levels and to pursue efforts to keep the rise to 1.5°C, it has become synonymous with net-zero 2050.
One of the things that should be recognised is how fast the regulatory environment is changing, as well as how fast market perception of what constitutes a credible and robust transition plan.
To address net-zero and ESG requirements, companies and financial institutions need to take responsibility beyond a science-aligned pathway for abatement as a priority. Hewlett says: “a company’s climate strategy must align with the Paris Agreement to avoid inadvertently undercutting or being undercut by it.
“After that, it’s important the credits have sufficient integrity, such as additionality, permanence and proper third-party verification, as well as other attributes that map to the purpose they’re going to be used. It’s very important to correctly use the right tool for the right job, aligned with the Paris Article 6 rulebook. Otherwise, we may drive inefficiency and perverse incentives at scale. No market would be better than a bad market.”
Integrity, transparency and disclosure
What that means is that while carbon offsets are going to be necessary to achieve global climate goals, it’s not simply that not all credits are created equal but that nor is the way that they are used.
Initial focus should be on reduction and offsets only used where necessary (as recommended by the SBTI), otherwise companies run the risk of being accused of greenwash, of not taking aligned action. It’s also going to become increasingly important that credits used in the global North have multiple co-benefits – it’s no longer going to be sufficient to stop emissions growth in another country to make up for your own.
There will need to be nature, biodiversity, health, social and even wider environmental benefits if you want your emissions and ESG story to have integrity and stand out from the crowd. Poor use of offsets, combined with poor communication of overall strategy, could end up doing more harm than good.