Perspectives
Voluntary carbon offsets have a central role to play in the global response to climate change. The market is maturing, helping an ever-larger group of corporates set ambitious sustainability plans and contribute to climate change mitigation, including in sectors and geographies where action remains severely underfunded. This piece reflects on the lessons learned from experience in the voluntary carbon market to date, and the principles on which market participants should build to drive future growth and positive impact of the market.
Corporates are committing to ever larger emissions reductions, including in hard to abate sectors. As of May 2021, the Climate Action 100+ investor initiative, which targets the private sector companies estimated to be responsible for around 80 per cent of global industrial emissions, reported that 83 out of 167 target companies have made net zero commitments, adding up to around 8.3 billion tons of annual CO2 emissions.1 This compares to just four companies when the group was set up in 2017.
Offsetting is an essential element of a multi-faceted global approach to decarbonisation, especially as it enables climate action in sectors and geographies that remain severely underfunded today. The science shows that negative emissions are central to supporting the carbon emissions reductions needed to hit the trajectories necessary to reach the temperature rise-containment goals of the Paris Agreement.2
The essential step for corporates, where possible, is direct emissions reductions. This can be achieved to some extent through efficiencies and the use of clean energy in electricity, heating, transportation and manufacturing. Corporates looking to be leaders in the ways they mitigate their climate impact are investing heavily in direct emissions reductions through increased use of clean energy and more efficient operations.
However, strategies that seek to decarbonise heavy manufacturing processes, for example, cannot typically rely entirely on rapid clean electrification. They depend on longer investment cycles and the maturity of newer technologies, such as clean hydrogen or carbon capture and storage. These new decarbonisation solutions are starting to attract greater levels of policy support and investment. Further public and private sector collaboration will be required to scale these markets sufficiently to achieve significant emissions reductions in the timelines and volumes required to meet the Paris Agreement targets.
Many complete decarbonisation strategies therefore require the use of offsets, in conjunction with direct emissions reductions efforts, to mitigate near-term emissions tied to parts of the value chain that will take more time to decarbonise. Offsets may also be the only feasible alternative for companies seeking to mitigate scope 3 emissions in their supply chain which are outside their direct control. That includes significant emissions such as the energy use of consumers of video streaming services, or refined oil products in the cars on the road today.
The complementary role of offsets in emissions reduction strategies
Corporates relying on new technology solutions maturing to complete their internal energy transition strategies – from aviation to cement to oil and gas companies – can use voluntary offsets to deliver on climate commitments right away. In recent years, companies such as Delta Airlines, Qantas, Alphabet, Microsoft, Shell, ExxonMobil and General Motors have supported growth in the sector.
Over 900 million tCO2e of carbon offsets have been issued in the voluntary market as of the first quarter of 2021, more than Germany emits annually. 2021 is already expected to set a new record in offset issuance and retirements, following a 30 per cent year on year growth in issuance in the market between 2019 and 2020.3
Carbon offsets are typically tied to an existing or new project designed to avoid or remove carbon emissions. Each negative ton of carbon yielded by the project can be converted to a tradable carbon offset. Before that can happen, the carbon offsetting claims are reviewed by an independent verification body (IVB) that checks the project to confirm that it is designed and implemented in accordance with the relevant methodology. An IVB also separately audits the project every time the project wishes to issue offsets (typically, but not always, once a year). It is only on the confirmation by the IVB of the number of tonnes of CO2e avoided or removed, that offsets are issued to the project by the registry operator. These can then be traded and eventually sold to the final consumer, typically a corporate. The last step in the offsets journey comes with its retirement against an identified set of emissions, after which it is considered “consumed” and can never be traded again.
The ongoing surge in consumer demand for cleaner products, especially in areas like aviation or consumer goods, creates a clear opportunity to scale the offset market and direct investments towards important offsetting activities. Corporations can use offsets to compensate for the carbon impact of the products they sell, and work with customers ready to pay a premium for products that are backed by environmental and social investments. Done well, this type of offering facilitates consumer activism, much in the same way that Fairtrade labelling has helped improve working conditions in agriculture across the world by creating consumer demand for Fairtrade products.
Even though costs are dropping fast, purchasing an EV or retrofitting a home to be more efficient remains a costly investment for most households. However, an increasing number of consumers are able and willing to pay a few extra cents per litre at the pump to compensate for the emissions of their gasoline consumption from ’well to wheels’ or to secure the offset directly themselves.4 Many are also purchasing offsets directly from public brokerage platforms that enable people to compensate for the carbon footprint of their daily lives. As the market for products bundled to offsets continues to grow, so too will be the need for standardisation of the basis for making carbon-neutrality claims.
Macquarie’s Commodities and Global Markets group arranged and executed the world’s first major petroleum shipment for which all emissions were offset. The delivery of two million barrels of oil was arranged for Oxy Low Carbon Ventures, a subsidiary of Occidental Petroleum. The US-based international energy company committed to reach net zero across its operations by 2040 (scope 1 and 2), and across the company’s entire value chain by 2050 (scope 3). The volume of verified offsets applied against the cargo covered the expected greenhouse gas (GHG) emissions from the entire crude lifecycle – including oil extraction, transport, storage, shipping, refining and eventual combustion. All available data shows that petroleum products, for example, are going to be part of global energy consumption for decades to come. Compensating for the associated emissions with offsets provides a bridge between our current dependence on hydrocarbons and longer-term technology, time and capital-dependent structural climate solutions.
The increased supply and diversity of third-party verified projects is also helping corporations offset their emissions in ways that are more tailored to their environmental, social and governance (ESG) priorities and the expectations of their clients and shareholders. For example, some companies are ready to pay a higher price to support offset projects within the markets in which they operate in order to better align the footprint of their operations to the ESG impact they are funding via their offset purchases. Other businesses favour offsets that can combine emissions reductions with other co-benefits across the social and governance dimension of ESG, such as the achievement of the UN Sustainable Development Goals or contribution to a more just transition.
Over the last decade, the voluntary market has already supported the increased use of clean energy, enabled the upkeep and expansion of natural carbon sinks through forestry and land-use projects, and incentivised companies to reduce their energy demand and to capture emissions from activities such as fossil fuel extraction and industrial processes.5 For example, offsets support reductions in the carbon impact of cattle herding and farming by funding improvements in the distribution of fencing and watering points, increasing soil carbon retention through set asides and cover crops, and the reduction of the use of fertiliser by leveraging precision farming technology.
Crucially, voluntary offsets create the opportunity to fund emissions reductions across the entire emissions spectrum, and drive action on the basis of economic rationale, regardless of the offset location and whether they focus on avoidance or removals, mature or innovative solutions. This includes lower cost, high-impact offsets that do not require significant technology innovation to deliver results, such as improved forestry and land-use activities, and access to cleaner energy for lighting and cooking in developing countries.
The important role of avoidance offsets in delivering immediate action is beginning to be recognised in buyer behaviour, with an increasing number of corporates detailing the evolving combination of avoidance and removal offsets, alongside direct emissions reduction initiatives, that will take them to net zero. Removals based offsets are essential in bridging the gap left by any residual emissions to be negated when corporates reach the end of their transition strategy, as well as for corporates that want to push further and address historic emissions.
Many of the most impactful and ‘additional’ projects are located in emerging markets, where policies and funding for climate change mitigation are often lacking. Over the last five years, 41 per cent of retired carbon offsets originated in developing and least developed markets, whilst the same group of countries only attracted 10 per cent of total energy transition investment over the same period.
Energy transition investment and origin of carbon offset retirements by geography
Source: BloombergNEF, VCS, GS, CAR, ACR, Macquarie
One of the key achievements of modern voluntary carbon markets is the idea that the positive management of climate assets that some developing countries have in relative abundance, such as virgin rainforest, can be a sustainable income source. Revenues from the voluntary offset market have been shown to be more attractive sources of revenue than legal or illegal logging for timber or cattle grazing in several geographies, whilst also often delivering other positive socio-economic impact, such as progress towards various UN Sustainable Development Goals. As the market evolves, so too is the monitoring and verification of the non-carbon co-benefits associated with offset projects. Most registries in the voluntary international market now allow for third-party audit verification of co-benefits against climate, community, biodiversity and other sustainable development goal-linked outcomes.
The credibility of some early government and voluntary carbon offsetting programs built around natural carbon sinks was undermined by certain project flaws or behaviours of project proponents. For example, some of the offset projects designed around natural carbon sinks had their impact assessments anchored in excessively high assumptions regarding baseline deforestation rates. Compounding issues, the monitoring of forest growth and carbon retention was unreliable. Such disappointments have put pressure on verification bodies over the past decade to continuously improve their approval and monitoring processes to provide transparency in the market.
Verification bodies are essential to the market. Independent offset crediting agencies, including Verra and the Gold Standard, now account for the majority of new issuance, growing 30 per cent between 2019 and 2020 despite the impact of the Covid-19 pandemic. New national voluntary schemes, which typically involve regulatory oversight along with third party verification, are also growing. This includes the Gabon - Norway partnership which recently led to a first $US17 million results-based payment received in exchange for sequestering 3.4 million tons of CO2e in the Gabonese forest over 2016 and 2017.6
Project characteristics are also evolving, and the market is factoring in a variety of project qualities in prices. For example, offsets from clean energy still accounted for most volumes transacted in 2019 and 2020 but have more recently been excluded from eligibility from most reputable registries with the exception of projects in the world’s least developed countries.7 This goes to the additionality consideration, as renewables projects have become more mainstream globally, such projects typically can be built without the additional revenue stream from the sale of carbon offsets, except when located in lower income that compound development challenges and operations risk.
Beyond direct corporate decarbonisation projects, carbon offsets in less developed countries can have a major positive impact on local peoples’ day-to-day life through the provision of clean cooking, basic lighting, power charging and other services in off-grid, disadvantaged communities. Switching to clean cooking, for example, reduces the emissions associated with open wood or charcoal fires by increasing the efficiency of the cooking process. Stove efficiency thereby reduces the amount of wood that needs to be collected, freeing up time in the day for other activity, and significantly enhancing human health by improving air quality around the home. This is an example of a carbon emissions avoidance benefit, which also delivers numerous other on-the-ground benefits for which there is no other readily available funding mechanism at scale other than the voluntary carbon market.
The voluntary offsets market is fragmented by design due to its highly distributed nature, but in the early days this fragmentation also led to a lack of consistency in practices, quality control and credit risk of developers. For example, approximately 1,000 different project developers are responsible for the approximately 1,600 projects in the observable Verra registry. However, growing demand from international corporates and the involvement of financial institutions such as Macquarie, is helping improve institutional practices, transaction structuring capabilities and credit worthiness of projects, all of which will be needed to scale the market.
Technology is another key enabler of a more robust voluntary offsets market. For example, the use of remote sensing via satellites and drones, together with geolocation and broad spectrum digital technologies are progressively enabling much more accurate, frequent and inexpensive monitoring of the carbon avoidance and sequestration occurring on the ground. Similarly, offset provenance and tracking technologies, such as CBL Markets, an environmental products exchange and digital registry platform backed by Macquarie, are allowing the consumers of carbon offsets to better monitor the web of offsets being created and retired. Investment into climate and carbon monitoring technologies are growing at a fast pace, topping $US380 million in the first quarter of 2021, and already exceeding the total for 2020 in the year to date.8
Enabling the full potential of voluntary carbon offsets requires ambitious action from all market participants to overcome the remaining structural and policy uncertainties. Future growth of offsets relies on improvements in three key areas:
All corporates should work on credible, transparent near-to medium-term climate action plans, that maximise direct emissions reductions across all scopes of emissions, in conjunction with using carbon offsets now to negate those emissions that will take more time to abate.
Market participants must continue to improve their processes to ensure that projects adhere to additionality, permanence, and leakage criteria, notably by increasingly using technology to provide greater transparency and traceability of offsets and their impact.
Without limiting or slowing corporate ambition, it will be increasingly important to have official recognition and incentivisation of the market in order to continue building confidence in the role of offsets as a safe and credible tool to include in corporate climate action strategies. The entry of high-quality, institutionally rigorous and credit-worthy participants into the voluntary offsets market will assist in this iterative improvement in market robustness and environmental integrity.
Brooks Preston
brooks.preston@macquarie.com
Managing Director, Macquarie Asset Management
Dario Traum
dario.traum@macquarie.com
Head of the Climate Intelligence Unit, Macquarie
Macquarie’s global carbon business offers a full suite of market-leading investment, supply and risk management solutions in carbon markets around the world. Macquarie’s asset management business also generates offsets for voluntary and compliance markets.
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