Why You Can’t Afford To Wait On Quality Carbon Offsets

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James Ramsay Director, Sustainability Solutions - EMEA
Joseph Sarvary Manager, Sustainability Solutions - EMEA - ENGIE Impact
Carbon Offsets
Emissions Reduction

The UN’s statements on climate change became increasingly dire over the course of 2022. Last April, the UN Climate Report cautioned that it’s “now or never” to limit global warming to 1.5 degrees, followed by the UN Environment Program's claim that there’s “no credible pathway” to reach the 1.5C target, capped off by Secretary-General Antonio Guterres’ hyperbolic COP27 warning that, “We are on a highway to climate hell.”

While we are more optimistic given the progress we see every day, the message is clear: the world is falling behind on its climate goals, so we need to do more and do it quickly.

What is also clear is that if there is a gap between the results of your decarbonization efforts and absolute zero, you are not alone. This gap is referred to as ‘residual emissions’ and they are common for even the most ambitious companies. To meet the UN’s ‘now or never’ challenge head-on, companies must act immediately to address their residual emissions. Integrating carbon offsets into a wider decarbonization strategy is one of the most useful tools for doing so.

How to assess the quality of a carbon offset

We previously discussed whether to purchase carbon credits immediately or gradually phase them in, as well as how to ensure high-quality carbon offsets, avoidance and removals. Now, the huge increase in demand for quality offsets amid uncertainty about the credibility of supply has led the carbon market to an inflection point. The urgency to act combined with hesitancy to buy credits from a risky project is transforming the market from a transaction to an investment market. While many are avoiding the carbon market altogether, forward-thinking investors have begun competing to finance long-term offsetting projects, either to retire the credits themselves or to sell at a premium down the line.

This competition is a response to both the anticipated steep price evolution and the predicted shortfall of credits to satisfy impending demand. Unfortunately, as the voluntary carbon market undergoes this transformation, weaknesses common to an unregulated and immature market remain. As a result, we now advise companies that the best way to access the voluntary carbon market is to take matters into their own hands and engage directly with project developers.

Companies will ideally work with carbon project developers to inject capital into new projects, a strategy that provides great potential for managing price risk and securing a supply of high-quality credits. While this methodology potentially puts investment capital at risk, corporate buyers will gain privileged access to project design and governance, both of which should drive reputational and delivery performance. It also mitigates the present-day issue of increasing uncertainty regarding the availability and affordability of high-quality options.

Supply Concerns Increase the Urgency to Act Now

The voluntary carbon market is poised to expand exponentially, from $0.6 billion in 2019 to more than $250 billion by 2050, driven by ambitious climate change commitments at the country and company level, with Net Zero pledges now covering 83% of global emissions. The anticipated expansion raises several associated challenges:

  1. The market is subscale: In 2022, 200M credits were added to the voluntary carbon market, corresponding to less than 1% of global emissions. This means that if every corporation decided to start offsetting its emissions tomorrow, the market would not have the volume to meet that demand.
  2. Quality: To date, 64% of all credits ever issued into the voluntary carbon market have come from REDD+ and Renewable energy projects, two categories frequently subject to criticism concerning quality and additionality. The lure of easy profit to be captured by project developers offering low-quality offsets to companies under pressure to meet their carbon targets is another challenge to quality that should not be discounted.
  3. Transparency and governance: Carbon project developers must be ready to deliver to increasingly sophisticated buyers. Fortunately, we are beginning to see progress with the development of third-party rating agencies and new monitoring technologies, particularly for nature-based projects. However, further development is required, and we are mindful that quality projects must be able to demonstrate that they uphold climate justice and benefit all stakeholders, particularly local communities.

If it is agreed that carbon offsets are a critical tool for nearly all actors looking to reach carbon neutrality or Net Zero, then corporate players should feel motivated to identify strategies that mitigate the risks inherent in these three challenges.

Charting a New Path

Ambitious action is urgent. At the very minimum, companies must reduce their emissions in line with a 1.5 degrees pathway, which should be considered the bare minimum. Companies wanting to go beyond the bare minimum need to chart a new path, looking beyond their value chains to support the development of high-quality carbon reduction projects and/or seeding the development of the negative emission technologies that will be needed to deliver 10 gigatons of CO2 removals from the atmosphere annually by 2050.

While many organizations have initiated decarbonization programs, their collective impact currently falls short. If we want to deliver on the commitments in the Paris Agreement, then greater action at pace and scale is required. To illustrate the various ambition levels and enable companies to assess where they fall on the decarbonization spectrum, we have charted three scenarios, which we refer to as ‘Doing less bad’, ‘License to operate’ and ‘Doing more good’

Doing Less Bad

Decarbonization Only

In this decarbonization-only scenario, the company is progressively emitting fewer GHG, but is still emitting too much. It has set a decarbonization trajectory to reduce its emissions by a fixed percentage each year until 2050, at which point the 'hard-to-abate' emissions remain at ~10% of their baseline. This falls short of Net Zero. In this scenario, the organization will contribute 24.6M tons of carbon into the atmosphere (equivalent to 16 baseline years of emissions).

License to Operate (bare minimum, not leading position)

SBTi Net Zero

SBTi Net Zero compliance requires a company to set a decarbonization trajectory that reaches 90-95% emissions reduction by the target date (2050 in this simulation). At that point, the company must start using high-quality removal offset credits to neutralize its residual emissions. The benefit of this approach over the ‘doing less bad’ scenario is that, by 2050, the offsets they will use will enable the company to finally achieve zero net emissions. For this reason, SBTi compliance is widely considered to be the gold standard. We hold a different view.

Decarbonizing in line with science cannot be considered the leading-edge approach, but rather a ‘license to operate’. To reach our global goals, we need all market participants to decarbonize according to science – not just the leaders. In the license-to-operate scenario, the organization still emits 23M tons of carbon into the atmosphere (equivalent to 15 baseline years of emissions). Clearly in this ‘decade to deliver’, if an organization is going to take a leadership position, it needs to go beyond decarbonizing at the base rate defined by science. It needs to move faster.

Doing More Good

Chart: Immediate Carbon Neutrality + SBTi Net Zero

Carbon Neutrality + SBTi Net Zero adds immediate offset procurement to a company’s decarbonization strategy. This approach addresses the unavoidable emissions a company is responsible for by compensating for them as soon as possible. Considering the need for urgent action this decade, companies need to look past ‘ambitious targets’ and seek out impactful short-term actions.

By financing reduction activities inside and outside their value chain, companies take responsibility for the totality of their emissions. Done properly, early action also helps build the additional capacity needed to facilitate the energy transition of actors outside the company’s value chain and enables it to assume responsibility for the totality of its emissions.

Our model provides two years of preparation time to allow companies to source and potentially co-develop high-quality offsetting programs—beginning their carbon neutrality from 2025. In this case, the company emits less than two base years of emissions.

Taking Matters into Our Own Hands

If the foundation for a net-zero future is going to be built, it will be necessary to increase the supply of high-quality carbon credits. But with so many 2025 and 2030 corporate targets on the horizon, demand will likely outstrip supply very soon. For large organizations that are planning to meet carbon-neutral or net-zero targets in the near term, there is a real risk that the supply of high-quality credits on the market will fall short of what is needed and, as a result, prices may increase dramatically. To address this risk and strengthen the market, large corporations should invest in their own offset projects early.

Being an early mover in the offset project market will not only support the development of new and additional, high-quality projects but will also manage price exposure by securing a fixed price per credit, likely linked more closely to the cost of project implementation than to the spot price in a volatile and rapidly inflating market. It will also enable access to credits from projects that align with a company’s climate leadership narrative.

As large organizations invest in projects dedicated to the production of credits for their own net-zero commitments, fewer opportunities will remain to serve the companies that choose to rely on the spot market. The likely result of many organizations taking this approach is that the price of carbon credits on the spot market will rise significantly as supply is squeezed. Those that wait would therefore find themselves paying much more for carbon, as the level to which prices may rise could approach the BloombergNEF (BNEF) removal scenario, spiking from the current rate of approximately $10 per ton to as much as $250 per ton in the next 15 years.

While the rising cost of carbon may intuitively appear problematic, it should nevertheless have two positive impacts that will help realize a net-zero economy:

  1. Polluters pay: High prices will encourage organizations to double down on decarbonization programs to drive their residual emissions as low as possible and avoid the need to compensate through the voluntary carbon market.

  2. Innovation: A higher carbon price will drive early investment into green technologies that can provide scalable decarbonization solutions, especially those that are difficult to commercialize in the absence of climate finance (from clean fuels to clean materials).

The rising price will also impact the organizations and companies that support the market. As more capital passes through the market, demands will be heard for greater transparency, better governance, and increased insurance. However, in today’s market, an investment-led approach is not risk-free. While long-term contracts with trusted project developers typically mitigate price and credit quality risks, a company will still be exposed to delivery risk and loss of their own capital if a project fails.

How Should a Corporation Develop Its Strategy?

Building a future-proof stream of high-quality carbon credits is a complicated challenge. Here’s how a company might do it:

  1. Decide on the type of offsets to target. Start with avoidance credits from projects that prevent carbon emissions that would have been released into the atmosphere had the project not been funded. These include projects that support vulnerable households (cookstoves, biogas, renewable energy) and protect genuinely threatened ecosystems (mangroves, forests). Such credits will address residual emissions in the short term while allowing companies to continue to focus the bulk of their carbon budget on decarbonizing operations
  2. Build out a portfolio over time that increases the proportion of credits that sequester and remove emissions from the atmosphere, reaching 100% removal credits by an organization's Net Zero target date.
  3. Procure offsets through direct project engagement. This approach, if executed correctly, will mitigate exposure to the quality, supply and price risks inherent in the spot market. However, it also requires significant time and expertise to undertake the extensive sourcing and due diligence required before putting capital at risk (the investment case) or entering into long-term offtake/PPA type agreements in an unregulated market.

We recommend getting started as soon as possible. Companies looking to finance low-cost direct investment opportunities will compete with one another for opportunities, and developing new ones takes time. And while expected to remain well below the cost of credits on the spot market, it is inevitable that the price per credit of new, high-quality projects will also rise during the decade as we move along the carbon abatement curve and lowest cost initiatives are exhausted.

In sum, directly financing early-stage projects is an ideal way to secure high-quality offsets aligned with a company’s sustainability objectives while reducing exposure to market volatility. It can be complicated and put your capital at risk, but it is the best strategy to maximize economic, social, and environmental value in the long term.

To tackle the inherent risk, this strategy is best implemented by deploying a thorough RFI/RFP and due diligence process to help guarantee the quality and additionality of the projects. This approach will allow organizations to deep dive into projects, work closely with the developers and influence project design – an approach that is becoming a necessity given the dubious credibility of offsets brokered by the leading carbon standard for the voluntary carbon market, as a recent investigation has shown.

To help clients find their way along this journey, our team has developed a 5D approach to accompany corporate partners from strategy setting and budgeting right through project partner selection and ‘Day 2’ planning.

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Let's work together to build a strategy that avoids price risk exposure and enables the acquisition of quality carbon offsets.