New investor guidance from Ceres outlines guardrails on the acceptable use of offsetting.
Companies should only purchase carbon credits from voluntary carbon markets (VCMs) to offset emissions if they have a suitably ambitious and credible climate transition strategy in place, according to US-based NGO Ceres.
VCMs allow companies to buy carbon credits that reduce, avoid or remove CO2 emissions, compensating for the CO2 they can’t cut from their business operations. As pressure on companies to reduce their emissions ramps up, VCMs are expected to grow by an estimated 50-80% this year.
“The main critique of net zero commitments is that companies are delaying action and relying too heavily on offsetting with carbon credits to reduce emissions,” according to a new Ceres report, which advises investors, lenders and companies on the appropriate use of carbon credits in climate commitments.
Fewer than 35% of companies’ emission reductions targets are credible, climate disclosure platform CDP revealed this week, based on an analysis of 13,000+ companies reporting last year. Further, no companies disclosing from G20 countries had more than a 4% disclosure rate against the 24 key indicators in the CDP questionnaire relating to climate transition plans.
According to Ceres, companies that have weak climate transition strategies overly dependent on carbon offsetting are open to an array of risks: systemic (by delaying or avoiding climate action), reputation (strategies are under increasing public scrutiny), and litigation (increased possibility of land conflicts or disputes with Indigenous and local communities).
To minimise those risks and justify the use of carbon credits, companies should demonstrate to investors that they have a 1.5°C-aligned net zero target by 2050 at the latest, interim short- and medium-term science-based targets covering the entire value chain, and a transition plan for achieving all targets, Ceres said. Further, investee companies should disclose their anticipated emissions and the percentage they plan to neutralise through carbon credits, as well as the volume of carbon credits that have already been purchased.
Credible corporate offsetting with carbon credits can generate a “vital source of finance for projects that contribute to climate mitigation, resilience and sustainable development goals”, the report noted.
“It is in the financial interest of investors and banks to ensure that companies invest in carbon credits in a way that reduces the systemic risk of climate change and does not expose them to additional reputation or litigation risks,” it added.
Corporate strategies verified by the Science Based Target initiative (SBTi) can only rely on carbon offsetting for 5-10% of their total emissions.
Getting to grips with carbon credits
The report uses consumer goods company Unilever as an example of a company that has published an ambitious climate transition action plan that has room for improvement.
Its strategy outlines the company’s climate targets, current progress and general information about Unilever’s intentions to use carbon credits, which the company claims will be necessary from 2039 onwards.
As part of its transition, the company is creating a €1 billion climate and nature fund to invest in nature climate solutions (NCS) projects. While some of these NCS projects will generate credits for offsetting in the future, Unilever does not specify the extent to which it will need carbon credits to neutralise remaining emissions.
This follows a report published by Ceres in May 2021, which highlighted the role carbon credits from NCS can play in corporate climate strategies.
“When Unilever purchases carbon credits that support climate mitigation outside of its value chain, it should transparently disclose the volume of credits purchased,” Ceres said.
VCMs have long been viewed with scepticism by investors due to the inconsistent quality of carbon credits.
Before purchasing carbon credits, companies should do their due diligence to identify potential social-related risks, the Ceres report noted. Companies must assess whether projects producing the credits they want to purchase can demonstrate how they are upholding the rights of Indigenous and local communities, that they have secured a land tenure, and are proactively protected the surrounding biodiversity and ecosystems.
Ceres has recommended companies only purchase credits certified by recognised crediting programmes, such as Climate Action Reserve, Verified Carbon Standard and American Carbon Registry.
The report also highlighted the significance of organisations such as the Voluntary Carbon Market Integrity (VCMI) initiative, which was launched in 2021 to introduce standardised corporate guidance around company claims when using carbon credits. Guidance is expected this year.
VCMs are not regulated in the same way as official carbon markets, such as the EU Emissions Trading System (ETS), the latter of which are set up by governments to incentivise firms in carbon-intensive sectors to reduce their emissions by controlling the availability and price of permits.
There is also very little overlap between voluntary and official markets. However, this is likely to change. At COP26, nearly 200 countries finalised Article 6 of the Paris Agreement. It now recognises the purchasing of carbon credits as an acceptable method for countries to partially meet their net zero targets, and outlines how trading across official and voluntary markets could occur.
“Carbon credits should only be used to raise the ambition of climate commitments, not to replace efforts to decarbonise and reduce emissions throughout the value chain,” Ceres said.