RI Long Read: why is there such a schism in the voluntary carbon markets?

Some describe the carbon offset market as Catholic Church indulgences allowing companies to greenwash harmful carbon-emitting activities, in the same way the rich could buy forgiveness but carry on sinning in 16th century Rome.  

Others say carbon offsets are crucial in the battle to get the world to net zero, tackle biodiversity loss and help meet the SDGs. 

Polar opposites. So which is it?

The industry started taking off seriously in 1997 after the Kyoto Protocol, with a mix of compliance and voluntary carbon markets developing. Until now it has largely been a niche, opaque world. 

This looks set to change. Last year, airlines agreed with governments on a regulatory framework to address carbon emissions called CORSIA or Carbon Offsetting and Reduction Scheme for International Aviation. This, alongside some airlines setting more aggressive reduction targets, is expected to sharply increase the volume of airline buyers in the voluntary carbon market, where supply currently outstrips demand. 

Companies, including banks and investors, under pressure to go net-zero, are also predicted to start boosting demand. Country-level pledges, such as China’s carbon neutral target, will need carbon offsets, also affecting the market.  

But, perhaps the most significantly recent development is the Mark Carney-led Taskforce on Scaling Voluntary Carbon Markets, which launched a consultation today (November 10).

Carney, UN Special Envoy for Climate Action and Finance and former Governor of the Bank of England, says “it’s imperative the market for carbon offsets be built into something much larger to help achieve net-zero global emissions targets”. 

The consultation finds that demand in the voluntary carbon markets is growing at 34% per annum, and reached 71MtCO2e (Metric tons of carbon dioxide equivalent) in 2019. But, it is still noticeably short of what is needed to support net-zero: at least 2GTCO2e by 2030. 

The Taskforce estimates that the voluntary carbon markets need to grow by more than 15-fold by 2030 to support the investment required to deliver a 1.5 degrees pathway. Its new report makes a set of key recommendations to scale the market, including the development of principles and a taxonomy, new infrastructure such as data and exchanges, and market integrity assurances to address persistent credibility problems in the market ranging from the viability of carbon offsetting projects to the risk of money laundering. 

Scope of the voluntary carbon markets 

The voluntary carbon market is currently microscopic compared to the compliance carbon markets, that includes the EU ETS, the forthcoming China ETS and California’s Cap-and-Trade Program. 

HSBC’s Centre of Sustainable Finance estimates that at $0.6bn, the voluntary carbon market represents just 0.01% of the total compliance carbon market where regulated organisations trade emissions allowances or offsets. Sometimes organisations purchase in the voluntary carbon market ahead of expected regulation by compliance markets. But more demand is driven in the voluntary market by companies and individuals taking responsibility for offsetting their own emissions. 

In the voluntary carbon markets accredited carbon credits are issued off the back of activities that reduce or remove carbon emissions. These activities are wide-ranging including the move from fossil-fuel energy to renewables, forest conservation or encouraging communities to stop burning wood to cook food. 

Ecosystem Marketplace does an annual survey on the market that relies on organisations happy to provide information. This year it got confidential responses from 152 participants, an increase of 24% on last year. 

Renewable energy-based activities represent the highest volume of offset transactions, according to the survey. But forest and land use-related offsets, the second highest volume of transactions, garnered a price three times that of renewable energy in 2019 (average price of $4.3 per tonne compared with $1.4 per tonne) because of “co-benefits” such as conservation or community projects. 

These co-benefits, rather than supply and demand, dictate prices in the voluntary carbon market at the moment, says Kyle Harrison, Senior Associate, Corporate Sustainability, Bloomberg NEF. (though he suggests expected demand triggered by net zero commitments could change this: listen here). 

REDD+, a popular carbon credit, focused on preventing deforestation in developing countries, often delivers co-benefits. According to REDD+ developer, Everland, the Keo Seima REDD+ project in Cambodia is home to more than 950 wild species, including 75 globally threatened species, amongst them the world’s largest populations of endemic primates. It is also the ancestral home of the indigenous Bunong people, whose unique culture and spiritual beliefs are inseparable from the forest in which they live. The project has defended their traditional rights helping the Bunong community secure the first Indigenous Community Land Title in Cambodia.  

Carbon offset principles 

The Smith School at Oxford University recently released a report, titled: The Oxford Principles for Net Zero Aligned Carbon Offsetting, outlining what types of offsets are acceptable and under what conditions they should be used to get to net zero. It says 100% carbon removal offsets need to be achieved by mid-century to meet the Paris goals. 

Two examples of the types of offsets are as follows:

Sucking carbon from the atmosphere and storing it securely, whether via planting forests or direct air capture using new technologies, can generate what are known as "carbon removals". 

Helping to make things more efficient relative to a baseline – for example by aiding communities in Kenya move to more efficient gas-fired cookstoves rather than burning wood – are labelled as “emission reductions”.

Their difference is crucial, as Dr Fredi Otto, Associate Professor and Acting Director of the Environmental Change Institute at the University of Oxford and co-author, explains: “Most offsets available today are emission reductions, which are necessary but will not get and crucially keep us at net zero. We need carbon removals that scrub carbon directly from the atmosphere to counteract ongoing emissions.”

The Taskforce recommends the development of ‘Principles for Net Zero-Aligned Corporate Claims and Use of Offsets” including disclosure and measurement. 

The consultation notes that the Oxford Principles go further in calling for a shift over time to carbon removal projects with long-term storage, and it says that “it is the Taskforce’s strong wish that guidance and principles put forward by key stakeholders will be aligned”. 

The consultation document says that a move to carbon removals is necessary in the long-term, but that financing to all project types needs to be maximised in the short-term. 

Dr Ben Caldecott, Director of the Oxford Sustainable Finance Programme and the Lombard Odier Associate Professor of Sustainable Finance at The Smith School, adds that the Oxford Principles highlight that along with the importance of quickly moving to 100% carbon removal offsets, the issue of the “permanence” of offsets is crucial. 

He explains: “You can plant a forest to capture carbon. But what happens if that forest gets burnt down in 10 or 20 years?”. This is already a problem in the US West Coast, with the Lionshead Fire in Oregon burning through one of the largest forest carbon offset projects in California’s carbon market (insurance buffers are often in place for buyers to hedge against this risk).

“There are arguments that some of forms of biological sequestration, such as planting trees (described by the Oxford Principles as “short lived” offsets), are less permanent than taking the carbon and burying it using carbon capture storage (described in the Principles as “long lived” offsets). Because once you bury the stuff it can stay safely in the ground for thousands and thousands of years,” says Caldecott. But he adds: “things that are at risk of being impermanent, like trees, could become permanent if the right policies, frameworks, and governance mechanisms are in place to protect them over time”.  

Standards and verification 

The governance of the voluntary carbon markets, and the wider offset market, has been a persistent sticking point for the industry. Issues range from allegations of land-grabbing in forest-related carbon removal projects to double-counting of carbon credits, or projects not credibly removing or reducing carbon emissions. A highly-fragmented market with black-box characteristics, has added to the lack of trust. 

Standard Chartered Chief Executive, Bill Winters, who chairs the Taskforce on Scaling Voluntary Carbon Markets, warned last month that without the right safeguards, the offsets industry could become vulnerable to interest rate-style manipulation. 

Standards have developed to try and build quality assurance in the market, such as the Verra VCS Program, the Gold Standard and Climate Action Reserve. Most voluntary offsets meet one or more of these standards. The standards broadly monitor and verify carbon projects over their lifespan. But the Carney Taskforce notes that the diverse nature of supply in the voluntary carbon markets creates the potential for error and fraud. Therefore it recommends a register for carbon credits and a system of unique identifiers.  

Zoe Knight, Managing Director, Group Head at the HSBC Centre of Sustainable Finance, (an observer to the Taskforce), adds another frailty, noting that the current standard providers in the voluntary carbon markets are also often unknown start-ups. 

“You’ve got to start somewhere,” she says. “And it’s great they are starting to get the credibility you need. But I think we also need a higher-level degree of endorsement going forward.” As an example, she points to the Green Bond Principles under the umbrella of the International Capital Markets Association, credited with helping to build confidence when the green bond market was growing. 

No-offset pledges

These issues on trust in the offset market are likely part of the reason that some household names are publicly eschewing offsets as part of net-zero pledges. 

In July, Nando’s, the popular UK-based restaurant chain, said it would achieve zero-carbon direct emissions without relying on offsetting. Sustainability champion Unilever is also foregoing offsets for its carbon commitments until at least 2039. 

Some investors also appear wary. When Storebrand Asset Management divested from Chevron and Exxon in the Summer, its CEO, Jan Erik Saugestad, stressed the need to “accelerate” away from oil and gas, but “without deflecting attention onto carbon offsetting and carbon capture and storage”.

The Institutional Investor Group on Climate Change (IIGCC) is developing a framework to help asset managers and asset owners become “Net-Zero Investors”. It advises a “precautionary approach to the use of offsets”. 

Stephanie Pfeifer, IIGCC’s CEO, explains that offsets are not being encouraged as a primary strategy for aligning portfolios with net-zero, “What we are saying is to use every other lever you have to encourage companies to decarbonise. We recognise that for some sectors, it (the offset market) will need to play a limited role, but it will never drive the change we need alone.” She says the IIGCC’s work on net-zero will be looking more closely at offsets at a later stage.

Environmental law firm Client Earth recently released Principles for ‘Paris-alignment’ that said organisations should not “unreasonably” rely on offsets. The Science Based Target Initiative says: “Offsets are only considered to be an option for companies wanting to finance additional emission reductions beyond their science-based targets”.

The Climate Bonds Initiative and Credit Suisse also discourage offsets as part of their work on a proposed “transition bond label” aimed at high-emitting sectors seeking to finance decarbonisation. The label will require organisations to have an entity-level decarbonisation strategy, including a pledge to invest in necessary technology, even if it is uncompetitive; and to not use offsets.  

Marisa Drew, Chief Sustainability Officer at Credit Suisse, tells RI that the bank wants to have a genuine net zero goal, but that offsetting won’t achieve that: “While offsetting as a concept is useful when a given industry or activity does not have a pathway, it really is just allowing the carbon emissions to continue. You’re buying the credit off someone else to offset, but you are not driving the transition behaviour change.” 

She adds: “To get to the Paris-aligned goals it is not robust enough to say ‘ok I’ll keep emitting carbon and I’ll buy a carbon credit from somebody’. That just really doesn’t get us there.”

Gerald Prolman, President of Everland, disagrees: “It’s necessary to have a net zero goal and everyone should do it, but without offsetting the remaining unavoidable emissions generated along the way to 2030-2050 net-zero goals, it is like saying you’re not going to take the daily accumulating rotting garbage out of your home for more than a decade until you find a way to not generate any garbage. From a strictly science based, performance point of view, all that matters is that emissions are reduced against a baseline, since CO2 is mixed evenly in the atmosphere and the atmosphere doesn't "care" where the reduced emissions come from.”

He adds that carbon offsets should not be a substitute for action taken by a company to reduce its own emissions, but that there will always be “unavoidable emissions”. 

Drew at Credit Suisse says some industry sectors will still need offsets to mitigate emissions. Credit Suisse is already developing products in the market. They have created a structured note in partnership with the World Bank focused on investing in ocean conservation with the coupon tied to a carbon index. It is one of a growing number of finance houses developing investment products this year, including BNP Paribas.

Part two of this feature will explore the voluntary carbon market further, looking at project developers and trading exchanges, reaction to the new Taskforce report and examining how COP26 could affect the market.