What are Carbon Offsets?
In short, a carbon offset is a reduction in emissions of CO2 or other greenhouse gases in one area in order to compensate for emissions produced elsewhere.
Offsets are typically quantified in tonnes and hence 1 tonne of carbon offset represents the reduction / avoidance / removal of 1 tonne of CO2.
Before we look into ways of generating offsets we have to acknowledge that two types of markets exist for carbon offsetting – voluntary and compliance.
Carbon Offset Compliance Markets
Compliance markets such as the European Union’s Emission Trading Scheme [ETS] – which is a form of a cap-and-trade system – make it mandatory for all bound emitters to buy carbon offsets to comply with legally binding caps (limits) on total allowable emissions.
The development of such compliance markets was initiated by the Kyoto Protocol’s Clean Development Mechanism [CDM].
The Kyoto Protocol of 1997 (ratified in 2005) “operationalised the UN Framework Convention on Climate Change by committing industrialised countries and economies in transition to limit and reduce greenhouse gas emissions in accordance with agreed individual targets”.
The Protocol set binding emission reduction targets and established flexible market mechanisms based on trade of emission permits such as:
- The aforementioned Clean Development Mechanism [CDM]
- International Emissions Trading
- Joint Implementation [JI]
Under the adopted framework, it does not matter where emissions are reduced, as long as they are removed from the atmosphere. <- this is key.
The Kyoto Protocol was set to be superseded in 2020 by the Paris Agreement which as of today is still yet to be finalised, and it is estimated that 61 compliance-based carbon pricing initiatives are either already in place or scheduled for implementation around the globe (note that this figure includes other carbon price initiatives such as carbon taxes).
Carbon Offset Voluntary Markets
As the name implies, participation in voluntary carbon offset markets is entirely voluntary and not mandatory for regulatory compliance. Instead, demand for such offset credits is generated by individuals, companies and even local governments who voluntarily purchase credits to offset their emissions – and 90% of voluntary carbon offsets are procured by the private sector.
Voluntary offset credits cannot be cross-used in compliance markets and overall tend to be cheaper. Rather than being dominated by exchanges, they are generally transacted “off-exchange” and tend to have lower transaction costs than the mandatory compliance offsets.
Typically purchased in coordination with corporate PR efforts, their pricing is heavily dependent on offset project charisma, potential for marketing, type, location and any additional co-benefits between the offset project and voluntary buyer.
In response to the large variance in quality of voluntary offset projects, industry standards have been developed and introduced to give confidence and assure voluntary offset buyers of the offset project’s efficacy and credit validity.
Voluntary market project standards include the Verified Carbon Standard, the Gold Standard and the Plan Vivo Foundation.
Now to give us an idea of traded volumes:
- Voluntary Market 2019 traded volume was 104 Mton CO2e with a market value of $282.3m (average price of $2.7/ton CO2e)
- The above is dwarfed by Compliance Markets – where 3,000 Mton CO2e transacted for an estimated $48bn (includes both carbon taxes and Emission Trading Schemes)
Despite the vast differences in volumes and transaction values between voluntary and compliance markets, voluntary offsets are a mechanism of growing importance and are projected to grow at a Compounded Annual Growth Rate [CAGR] of 11% between 2021 and 2027 to reach $0.5bn market value by 2027.
How are Carbon Offsets generated?
So what exactly qualifies as a carbon offset and how are such offsets generated?
First and foremost, the overarching qualifying criteria for a carbon offset generation project is to reduce or remove greenhouse gas emissions from the atmosphere in at least one of three ways:
- Avoiding emissions – e.g. replacing fossil fuels with renewable energy sources
- Removing emissions – e.g. by nature-based solutions such as planting more trees which sequester carbon dioxide from the atmosphere
- Capturing and destroying emissions – e.g. removing methane from landfills
Eligibility of projects generally takes one of two approaches dependent on the qualifying programme:
- Projects qualifying under the Climate Development Mechanism – the CDM readily defines which projects are not eligible (such as nuclear and avoided deforestation). A project developer uses a bottom-up approach for approving new methodologies for a new project type to the UNFCCC.
- Projects qualifying under the Climate Action Reserve (U.S.) – the CAR uses a top-down approach where the program body selects the list of eligible project activities and develops the methodology for each of those project types.
See the following table for more info:
Types of Offset Projects
The Climate Development Mechanism identifies over 200 types of projects eligible for generating carbon offsets. Here’s a starting list, grouped by category:
- Renewable energy – e.g. wind power, solar power, hydroelectric and biofuels
- Methane abatement – e.g. containment of methane generated by farming, landfills or industrial waste
- Energy efficiency – e.g. cogeneration plants, optimised industrial processes and energy efficient buildings
- Reforestation – e.g. reforestation, afforestation and soil management
- Fuel-switching – e.g. switching to carbon neutral and carbon negative fuels
The full list can be viewed here.
Carbon credits have already reduced the amount of greenhouse gases in the atmosphere by more than 1 billion tonnes. This is the equivalent of taking around 213,000,000 passenger vehicles driven for one year.
Despite this significant achievement, offsets are plagued with controversy.
Greenpeace (a prominent NGO which needs no introduction) argues that the global nature of carbon offsets can lead to climate colonialism which they define as “the domination of less powerful countries and peoples by richer countries through initiatives meant to slow the pace of climate breakdown.”
They also argue that offsetting through reforestation does not materialise claimed benefits until as much as 20 years down the line, and that oil companies and consumers of their products such as airlines (a very hard to decarbonise sector) use offsets as a substitute for direct reductions of carbon emissions – effectively allowing carbon emitters to continue with business as usual with no cost to the climate whilst weaving a “greenwashed” PR veil which allows them to continue to profit without overhauling their business models.
And Greenpeace is not alone in voicing their criticism.
The world of compliance and voluntary carbon offsets is a complex one – an entire industry in its own right – and this Insight only scrapes the surface of the involved complexities.
Indeed, entire companies employing 1,000s have been founded to participate by developing, verifying, certifying and monitoring projects, selling and trading offsets, and consulting / matching businesses with suitable offset projects.
Despite their controversy, the widespread belief is that carbon offsets can play their part as a viable mechanism for global atmospheric emission reductions by raising costs of emission-intensive industries and acting as an incentive for quicker adoption of emission-reduction technologies.
Provided that offset incentives are proactively managed to minimise and ultimately eliminate fraudulent and deceptive activities, they just might be the right incentive operators needs to accelerate their decarbonisation efforts.