How carbon offsetting can help achieve carbon neutrality

Jul 1, 2021

How can organizations best ensure the reliability of current and future carbon offsetting projects?

Reducing and eliminating the level of carbon entering our planet’s atmosphere is one of the chief goals of cities, nations, companies, and organizations.

A comprehensive strategy to achieve decarbonization and carbon neutrality should include reducing direct emissions, which could involve everything from shifting production processes to changes in supply chain practices to behavior changes including transport habits.

However, some emissions are easier and cheaper to abate than others. The cost curve for abatement options will vary by entity or organization depending on their sector and location. Therefore, carbon offsetting can also be an important part of this strategy, especially for companies with hard-to-abate emissions. Carbon offsetting refers to projects that compensate for the emission of greenhouse gases created by an entity by providing for an emission reduction elsewhere.

An entity or organization will need to assess its present emissions, estimate the cost of reducing each source of emissions, and consider how that cost will change over time. Some short-term solutions may prove extremely cost-effective, providing a direct saving to the business. To illustrate, shifting remote business meetings to online will reduce transport emissions as well as flight costs. Other sources, such as operational emissions specific to the sector, may be more difficult or expensive to abate until innovation and market demand across the sector lead to falling costs.

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For the latter kind of emissions, implementing carbon offsetting in the short term might be a good option, as it allows an organization to achieve carbon neutrality earlier at a lower cost. When cost-effective options become available later on, a company can more directly address those emissions by switching materials, technology, or processes. This process is one that all entities seeking to achieve carbon neutrality need to follow in order to be considered robust.

  1. Eliminate. First, eliminate those emissions that are already cost-effective to do so.
  2. Reduce. Then, develop a reduction plan to phase out those emissions that require an investment over the medium-term.
  3. Offset. Lastly, offset those emissions that you cannot eliminate immediately, and those that may be technically difficult to eliminate even over the longer term.

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Mainstream mechanisms and standards for carbon offsetting

Demand for carbon offsetting can be generated either by compulsory government regulation (e.g., by an emissions trading system or carbon tax), or by voluntary commitments from the private sector and other organizations (commonly called Voluntary Carbon Markets, or VCM).

One example of compulsory (compliance) mechanisms is the European Emissions Trading System (EU ETS), which has been to-date the largest compliance-based carbon market internationally, covering heavy industry and power producers across Europe. Up to 2020, the EU ETS allowed covered entities to use international offset credits from “least developed countries” (LDCs) up to a limit set by each individual member state.

A new phase of the EU ETS started in 2021 without the use of offsets, sending the price of existing credits close to zero. However, a group of former EU administrators recently proposed a revival of the offset market in Europe. In Europe, according to their proposal, the offset trading program would serve both voluntary commitments by companies and the EU ETS that imposes binding emission caps.

Emissions trading systems with offset mechanisms currently exist in Quebec, California, several Northeastern U.S. states, China, and Korea.

Outside of emissions trading systems, some countries also allow for the use of carbon offsets to reduce the costs of compliance under carbon taxes—for example, South Africa and Chile (from 2023). Some restrictions are placed on the use of offsets in these systems. In South Africa, companies can offset from 5% to 10% of their obligation, depending on the type of emissions being offset. Chile will require offsets to be sourced from within the country itself.

There are several examples of voluntary mechanisms/standards:

  • Clean Development Mechanishm (CDM). The CDM is the foundational, and most substantial mechanism for international tradeable carbon offsets. The United Nations established it in 1997 under the Kyoto Protocol (effective 2008-2020). It provides for emissions reduction projects that generate Certified Emission Reduction units (CERs). It allowed, during the Kyoto Protocol compliance period, industrialized countries to meet part of their emission reduction commitments by buying CERs from CDM projects in developing countries, where emission reductions are often cheaper than in developed countries. Recently, experts have been exploring the possible transition of eligible activities registered under the CDM to the Paris Agreement’s mechanism that allows for offsetting, Article 6.4.
  • The Gold Standard (GS). The Gold Standard Foundation, a non-profit foundation headquartered in Geneva, Switzerland, publishes and administers the GS, and designed it to ensure that carbon credits are real and verifiable and that projects make measurable contributions to sustainable development. Its original objective was to add branding, with a quality label, to carbon credits generated by projects that were bought and traded by countries with binding legal commitment under the Kyoto Protocol, businesses or other organizations for carbon offsetting purposes. In recent years, the GS has been evolving to serve the new demand arising from the Paris Agreement, especially in terms of demand from private sector voluntary commitments.
  • Verified Carbon Standard (VCS). The VCS is a standard administered by Verra, a not-for-profit organization based in the United States. Since its launch in 2006, the VCS Program has grown into the world’s largest voluntary greenhouse gas (GHG) program. VCS projects include technologies and measures that result in GHG emission reductions and removals, including forest and wetland conservation and restoration, agricultural land management, transport efficiency improvements, among others.

There are a number of other carbon offset certification programs internationally, including:

  • Climate Action Reserve
  • CSA Group
  • Plan Vivo
  • American Carbon Registry (within the United States)
  • Australian Carbon Credit Units, or ACCUs (within Australia)
  • China Certified Emissions Reductions, or CCERs (within China)

Social co-benefits

Some offsetting programs, like the Gold Standard, actively require that projects demonstrate social and environmental co-benefits, as well as monitor and report on these benefits.

There are a number of certification systems focused on the social and environmental impacts of carbon offset projects. Organizations like the Climate, Community, and Biodiversity Alliance (CCBA) and SOCIALCARBON, for example, certify the added co-benefits achieved by offset projects. The certification of these co-benefits usually tries to align with specific Sustainable Development Goals (SDGs) of the UN and can include reducing poverty and improving gender equity and social inclusion. This latter objective is gaining increasing attention as an important factor in the low-carbon transition.

Land-based carbon offsetting

Ensuring the reliability of offset projects goes beyond the bona fides of the particular project developer or of the standard organization that provides certification. As most offsetting programs remove renewables (given their cost competitiveness with fossil energy), the focus shifts increasingly to land use-based offsetting. Quantifying the carbon reductions from land-use offsets is inherently different and trickier than for renewable energy in four key aspects: measurement, additionality, leakage, and permanence.

Land and forest carbon has previously been valued at zero. Therefore, any methodology to measure carbon sequestration will be more accurate and a more efficient incentive than what previously existed. What is important is that measures are unbiased and cannot be manipulated. The more precise the measurement, the better. At the same time, avoiding large transaction costs is important. Transaction costs shift attention from mitigation to compliance and make it harder for small operators to participate.

Land use is inherently heterogeneous, both in terms of the land itself as well as farmers that work the land. This makes it hard to judge what would happen in a business-as-usual scenario. For the most part, it is not worth attempting to assess additionality. Similarly, for carbon leakage, agricultural and forestry products are part of complex domestic and internationally traded economies, making accurate assessment of leakage almost impossible. More usefully, we can focus on meeting the economic needs that are displaced—whether jobs or food production—in other ways.

For forestry projects (such as afforestation, reforestation, and avoided deforestation), there is less certainty around how to measure the permanence of the carbon reduction, given that forests are vulnerable to wildfires, unauthorized logging, and other challenges.

Australia has been leading the way in setting standards for forest-based carbon crediting, deploying remote sensing technology to monitor forests, as well as setting “buffers” in the calculation of carbon reductions to factor in the risk of reversal. Australia is one of the most climate-exposed countries, as witnessed in recent years by devastating wildfires that are not only a symptom of climate change, but which make the mitigation challenge even harder.

Forests are a critical carbon sink globally, and carbon crediting systems provide an important potential source of financing to help protect forests that are under incredible pressure from infrastructure and agricultural developments. Supporting forestry carbon offsets, therefore, is an extremely worthwhile and desirable option.

It is important that companies conduct adequate due diligence, however, to ensure that offset providers adhere to or go beyond UN standards for quantification of emission offsets, and stay aware of the unique challenges that may exist in the location where the offsets occur to maximize the likelihood of their permanence.

It’s important work—but it’s not easy work. So how are various industries working to undertake carbon offsetting projects and ensure their quality and robustness?

Carbon offsetting in aviation

Sectors such as tourism are heavily reliant on transport. The largest contributor to emissions from tourism is air transport, and there is currently no readily available option to avoid the use of petroleum-based jet fuel.

Aviation emissions are the focus of an industry-wide agreement at the UN’s International Civil Aviation Organization (ICAO). The Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) is part of a broader package of measures to help ICAO achieve its aspirational goal of carbon-neutral growth from 2020 onwards. CORSIA relies on the use of emissions units from the carbon market to offset the amount of CO2 emissions not reduced through the use of technological and operational improvements, and sustainable aviation fuels.

Solutions for big power consumers

For many sectors, the largest contribution to the carbon footprint will be the consumption of energy, and in particular electricity. The ICT sector is an obvious example, where data centers, networks and devices all draw significantly on electricity supply.

Similarly, the healthcare sector is power-intensive. While there is a dearth of data on the carbon footprint of the healthcare sector, the most recent estimates suggest that health care was responsible for 4.4% of global GHG emissions in 2015.

Electricity consumption is much less technically difficult to abate than aviation fuel. In most countries, there are readily available options for reducing the carbon intensity of electricity consumption.

Where an operation purchases electricity from an electricity grid, its carbon footprint relates directly to the carbon intensity of that grid. For example, the United Kingdom has nearly eliminated coal from the electricity grid, resulting in a carbon intensity of between about 180-270 gCO2/kWh at present. In China, on the other hand, the average intensity was about 555 gCO2/kWh in 2018, although with significant variation between regions.

Either power purchase agreements or renewable energy certificates are available in most countries and provide a cost-effective way for companies to get closer to carbon neutrality. Where such options do not exist, companies may need to purchase offsets through one of the systems mentioned above.

A booming voluntary market

While the focus for many years has been on how governments can induce economy-wide emission reductions through regulated carbon prices, the momentum created by carbon neutrality pledges by China, the United States, and the European Union has provided confidence in the policy direction to the private sector. This created a tipping point with companies from a wide range of sectors introducing voluntary commitments to reach net zero.

Some of the best recent examples include the world’s largest fintech company Ant Group (formerly Ant Financial), which owns China's largest digital payment platform Alipay, serving over 1 billion users and 80 million merchants. In 2019, The Wall Street Journal reported that Ant's flagship Tianhong Yu'e Bao money-market fund was the largest in the world, with over 588 million users (more than a third of China's population) contributing cash to it. Ant Group recently published its roadmap to achieve carbon neutrality, in which the group pledged that it would use “offsetting,” including forest carbon offset projects to achieve its “net zero” target by 2030.

Microsoft has achieved carbon neutrality primarily by investing in offsets. The company has further pledged it will be carbon negative by 2030. Microsoft has also said that, from 2021, it will change its procurement processes to consider carbon reduction conducted by suppliers.

Another prominent commitment comes from the multinational food-products corporation Danone, which has pledged to achieve carbon neutrality throughout its supply chains by 2050, using a reduction of direct emissions, carbon sequestration, eliminating deforestation, and offsetting.

Pricing carbon offsets

Prices for carbon offsets can vary significantly in terms of the type of carbon reduction, the location of the project, and whether the offsets are serving the voluntary or compliance markets.

Renewable energy credits have been consistently cheaper than forestry and land-use credits in recent years, and the VCS and GS stopped accepting most renewable energy projects at the end of 2019, as renewable energy becomes affordable without the support of carbon finance. Some experts believe that supply from energy efficiency will also be gradually excluded from the VCM as government policies are introduced to directly tackle this issue to meet Paris Agreement pledges.

As of late May 2021, providers of various CORSIA-eligible credits were selling for $2.25–$2.55/tonne of CO2e on average. CBL’s spot Nature-Based GEO offsets were trading at $4.25, while average prices for renewables-based, industrial GHG mitigation, and landfill and waste offsets increased to $2.84. Energy efficiency and small household project average VER values were at $3.24 and prices for carbon removal and sequestration credits at $5.81.

In some regions, local factors drive prices. For example, in Australia, ACCUs reached AUD 18.50 (around $14.00) earlier this year. Until recently, the vast majority of demand for ACCUs has come from the government’s Emissions Reduction Fund, which conducts reverse auctions to purchase abatement. The rising price in 2021, however, has also been driven by increased interest from the private sector in abatement to achieve carbon offsetting and neutrality goals, together with limited supply.

According to research published in June, offset prices must increase almost 10-fold by 2030, otherwise buyers risk being accused of greenwashing by purchasing carbon offsets too cheap to deliver genuine emission reductions. The report found current prices of $3-$5 to be too low, largely because of a buildup of surplus credits. Supply currently stands at 400 million—four times VCM demand in 2020. Without this surplus, the research found that prices would be around $15 higher.

Offset demand could increase by 5-10 times through 2030 as more companies adopt net zero climate commitments, helping to eliminate the surplus. This growth in demand should see prices rise to $20-$50 by 2030 and $100 by 2050, as greater investment is needed for more costly carbon removal projects.

Among compliance markets, the California cap-and-trade system is now one of the largest sources of demand, and the weighted average price for offset credits at the end of last year was $13.67. At the same time, offsets in the Korean ETS were trading at KRW 26,000 (~$24), having dropped by almost 35% over the course of last year. Meanwhile, CCERs in the Shanghai and Beijing markets ranged from CNY 10 to 29 (~$1.5-$4.4).

A sensible strategy

For companies not currently covered by compulsory emissions control policies, purchasing carbon offsets can be a sensible part of a mid- to long-term strategy which recognizes that in many cases, they may face such obligations in the future, or be impacted by them through their supply chain.

Factoring in the cost of carbon offsetting to present business operations, therefore, will help companies better prepare for when carbon reduction is an obligation, not an option.

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