New initiatives and technologies aim to address trust issues in the voluntary carbon trading markets.
The carbon offsets market is a “wild west” of “dodgy” methodologies and lacks adequate monitoring and transparency, says Paddy McCully, energy transition analyst at NGO Reclaim Finance. Investors should “absolutely” probe more closely into the offset activities of companies, he adds.
Voluntary carbon offset schemes, utilised as part of companies’ clean energy transition plans, have courted controversy particularly in the energy sector. The Carbon Offset Research and Education (CORE) initiative of the Stockholm Environment Institute and Greenhouse Gas Management Institute points out that a proliferation of standards, protocols, and other programs reflects the “significant flux and experimentation” in the voluntary offset market.
The initiative also observes that voluntary offsets are typically purchased in coordination with “public relations efforts” to present a company or organisation as a responsible climate actor. Pricing in voluntary offset markets reflects this reality, in which buyers have varied objectives in purchasing credits, it says. “Voluntary market credits differ in price based on project charisma and potential for marketing, project type, location, and co-benefits beyond climate impact that match with buyers’ preferences.”
According to research by analysts McKinsey & Co, the demand for high-quality carbon credits in the voluntary carbon market is estimated to increase at least fifteenfold by 2030, accounting for 1.5-2 gigatons of CO2 annually. In 2020, the voluntary carbon market was estimated to cover 0.1 gigatons. Overall, the market for carbon credits could be worth upward of US$50 billion in 2030.
Transparency and scalability
Clearly, voluntary offsets are big business, but there are challenges of trust between investors and buyers caused by a lack of transparency over the risks and effectiveness of carbon offset projects. There are also questions about the scalability of carbon offset markets.
The most recent attempt to scale the market emerged in May 2021 in Singapore in the form of Climate Impact X (CIX), a global carbon exchange and marketplace for the voluntary carbon market. It is a joint venture of four Singapore-based organisations: DBS, Singapore Exchange, Standard Chartered and investment company Temasek, which has a net portfolio value of US$214 billion.
“By facilitating a well-functioning marketplace with strong impact and risk data, CIX will enable efficient price discovery and catalyse the development of new projects,” says Mikkel Larsen, Interim CEO of CIX and Chief Sustainability Officer of Singapore-based DBS Bank.
The initial focus of the exchange will be natural climate solutions (NCS), which covers conservation, restoration and improved land management actions that increase carbon storage or avoid greenhouse gas emissions in landscapes and wetlands across the globe. Larsen says CIX’s carbon credits will also create impetus to address “another grave risk of biodiversity loss and help serve local communities”.
Recent research shows that NCS can provide more than one-third of the cost-effective climate mitigation needed between now and 2030 to stabilise warming to below 2 degrees Celsius. The research suggests that alongside “aggressive” fossil fuel emissions reductions, NCS offer a “powerful set of options” for nations to deliver on the Paris Climate Agreement.
“NCS projects go beyond solving for climate change,” says Larsen. “They contribute to several UN Sustainable Development Goals (SDGs) such as preserving biodiversity and nature and protecting local shorelines, while preserving jobs and supporting local communities.”
Fundamentally, carbon credits should deliver emissions reductions that are real, permanent, additional, with no leakage and no double counting, says Larsen. For CIX, high-quality NCS credits must also provide verifiable biodiversity and social impact beyond these basic tenets. “This includes everything from the protection of critical species to the sustained investment in rural communities that support natural ecosystems,” he says. CIX will use international verification standards, including the voluntary Verified Carbon Standard, created by global standards and frameworks developer Verra, and Gold Standard, a standard created by World Wide Fund for Nature and other international NGOs. It will also invest in additional satellite monitoring along with a comprehensive ratings system for the projects supplying CIX’s carbon credits.
Addressing market scepticism
Larsen acknowledges scepticism in the market about the use of NCS as carbon offsets. A guiding principle of CIX, he says, is that direct emissions reductions by corporates must be the priority, with appropriate offsetting playing an important complementary role to accelerate climate mitigation action. “Companies must outline credible transition plans, which should publicly disclose commitments, detailed transition plans, and annual progress against these plans to decarbonise operations and value chains in line with science to limit warming to 1.5 degrees Celsius as per the Paris Agreement. As a company approaches net-zero through large emissions reductions, its need for offsetting should decrease over time.”
To reinforce this, the exchange is forming the Climate Impact X Coalition, which will comprise buyers and sellers who wish to scale high-quality NCS and have public commitments to reduce emissions. Coalition members will be required to demonstrate their commitment to high integrity climate action through meeting eligibility requirements, such as commitments to a science-based reduction target before being able to purchase Climate Impact X carbon credits.
Claire O’Neill, Managing Director, Climate and Energy at World Business Council for Sustainable Development, says there is a “real need” for a global carbon exchange for high-quality offsets. “We know there isn’t a good measure of what ‘good’ looks like in so many of these transactions,” she says. The launch of CIX is a chance to “bring together those buyers and sellers in a really trusted platform to drive demand and crucially to get the highest quality transactions,” claims O’Neill, a former UK energy minister.
The role of technology
Professor Koh Lian Pin, Director, Centre for Nature-Based Climate Solutions, National University of Singapore, says to be sure a carbon offset is “real” various types of technologies and new techniques, such as satellite monitoring, machine learning and blockchain technology, can be applied to validate projects, monitor them and ensure that the project is delivering on its climate change benefit.
Samuel Gill, co-founder and COO of carbon offset ratings company Sylvera, says the level of data and transparency is a “linchpin” for the voluntary carbon offset market. In May 2021, the UK-based start-up launched a platform to provide independent data and ratings for NCS offset projects. The firm uses geospatial data, collected by drones and satellite technology, and analysed by machine-learning algorithms to provide real-time information on the carbon sequestration performance of offset projects.
“One of the interesting aspects of having access to more accurate data is that it will empower corporates to make good choices but also provides accountability to those corporates that have not,” he says. “At the moment, it is difficult to tell what a good project is and what is not. When that is clearer, investors and corporates will have the tools to make good choices.”
Key questions for investors
Reclaim Finance’s McCully says there are four key questions investors should ask about offsets in relation to the activities of the companies in which they invest. Are projects additional; what is the impact of land use on local communities; how accurate are the estimates of carbon benefits; and are offsets just enabling emitters to delay a transition to clean energy?
“Investors should ask whether an offset project would have gone ahead anyway without the extra offset income. Studies show that for many, probably most projects, offset income is just gravy for the developers – a bit of extra income but not sufficient to sway a yes/no decision on a project,” he says.
For projects that have an impact on land use, particularly plantations and hydro-electric schemes, McCully says investors should investigate whether local communities been “properly informed with an honest account” of the potential benefits and impacts of the project and given their consent. “For most local communities, the concept of offsets is pretty alien and they can easily be sold a ‘pig in a poke’ with stories of lots of cash and other benefits which may never emerge – meanwhile they may lose access to land and water because of tree plantations or reservoirs,” he says.
A “huge issue” for land use projects, he says, is the accuracy of the estimates of carbon benefits. “It is really hard to estimate and measure greenhouse house gas fluxes and how they may change over time, and other issues such as leakage, for example, where stopping logging in one valley just transfers it to the next one over.”
Finally, investors should consider whether an offset scheme is “just allowing emitters to delay transitioning to clean energy”, he says. “We need to reduce emissions everywhere fast; we cannot just shift reductions from one place to another.”
