United States: Is Buying A Carbon Offset Like Buying A Medieval Indulgence?

At a recent meeting of the SEC's Investor Advisory Committee discussing the SEC's climate disclosure proposal, a speaker in charge of ESG investing at an asset manager raised the possible risk that companies, faced with a disclosure mandate, would just buy carbon offsets to satisfy investors that they are making progress toward their climate goals. His firm, he said, has been seeing this phenomenon occur, but he thought that the practice could lead to poor outcomes. Companies would probably experience better outcomes, he advised, if they first considered spending those same funds on investments that would actually reduce their carbon footprints. What's that about? While many experts view carbon offsets as essential ingredients in the recipe for net-zero, some commentators worry that they are just part of a "well-intentioned shell game" or perhaps, less generously, a "racket with trees being treated as hostages"? And some think both concepts—essential and racket—may be true in some cases at the same time. Are carbon offsets effective or are they just a way to assuage, as the NYT phrases it, "carbon guilt"?

As defined by the SEC in its mammoth new climate disclosure proposal, carbon offsets represent "an emissions reduction or removal of greenhouse gases...in a manner calculated and traced for the purpose of offsetting an entity's GHG emissions." The objective is to reduce emissions or remove and sequester carbon from the atmosphere somewhere by paying someone to, for example, plant trees, restore land or produce renewable energy. Each offset typically represents a metric ton of CO₂ that is either removed or not emitted in a particular year. But with offsets, it doesn't have to be the company's forest or even the company that does the planting. Rather, companies can compensate—in theory anyway—for emissions from their own manufacturing plants or airlines or oil refineries by paying someone to undertake a project to remove carbon from the atmosphere somewhere else. The offset is then "retired" and the purchaser can apply the underlying carbon capture or emissions reduction to reduce its own carbon footprint. Sounds pretty easy. Maybe too easy. To be sure, as described by the NYT, one of the main attractions of carbon offsets is that companies can reduce their carbon footprints—even to zero—without any real changes to their operations: "Part of the appeal of carbon offsets is the notion that it's possible to meaningfully combat climate change while living our lives and structuring our society in the same way we always have. For that reason, some experts see carbon offsets as actively damaging, inasmuch as they give people cover to avoid reducing emissions at the source."

Offsets figure prominently in the SEC's new proposal, which mandates more transparency about their source and use. According to SEC Commissioner Caroline Crenshaw, in her statement on the proposal, "if companies claim they are reducing overall carbon emissions by other means, they need to tell investors... how they are doing that. Commenters have indicated problems with offset verification, accuracy, and quality, and that they need better insight into how companies count offsets toward their climate goals." Consistent with the GHG Protocol, the SEC's proposal would require companies to disclose their GHG emissions data in "gross terms, excluding any use of purchased or generated offsets." If the company has publicly set climate-related targets or goals or offsets are part of its business strategy or plan, the company would need to disclose information about the offsets, such as the amount of carbon reduction represented by the offsets, the source of the offsets, a description and location of the underlying projects, any registries or other authentication of the offsets, the cost of the offsets and the role that carbon offsets play, as well as short- and long-term costs and risks, such as the "risk that the availability or value of offsets...might be curtailed by regulation or changes in the market." In the release, the SEC observes that a "reasonable investor could well assess differently the effectiveness and value to a registrant of the use of carbon offsets where the underlying projects resulted in authenticated reductions in GHG emissions compared to the use of offsets where the underlying projects resulted in the avoidance, but not the reduction, in GHG emissions or otherwise lacked verification." (See this PubCo post and this PubCo post.)

Many experts believe that carbon offsets play a critical part on the path to net-zero. To some, as discussed in CFO.com, "carbon offsets play a vital role in meeting Paris Agreement commitments; they're used to bridge the gap between existing decarbonization technology and a more sustainable world." The article observes that "[u]nfortunately, a clear path to net-zero doesn't exist in some hard-to-abate sectors, where the transition will be more challenging and prolonged. Transportation and logistics, for example, rely on trucks, trains, and ships, which aren't likely to be replaced by clean-energy options any time soon. And we will still need what these sectors deliver—cement, chemicals, steel—in a low-carbon world.... The choice for many industries is to do nothing or to offset their carbon footprint while emission-abatement technologies are developed. Between 'do nothing' and 'do something,' the choice is clear." For example, as reported in the NYT, a professor at Columbia Business School "cited the cement industry as a good candidate for an offset program, because reducing emissions from cement production is a more expensive and technically complicated task than, say, switching electricity production to renewable sources."

A Stanford academic and policy adviser also saw a significant role for carbon offsets. In this interview, he contended, "[t]o start with,...you need to understand what's being promised. Despite how it sounds, few firms plan to stop emitting greenhouse gases altogether. The idea of 'net-zero' is that any future emissions will be zeroed out, in an accounting sense, by an equal amount of carbon offsets. Basically, for every ton of carbon dioxide a firm puts in the air, it can pay someone else to cut their emissions by a ton—or otherwise reduce atmospheric CO₂ by that amount." Asked whether "net-zero" was really the right goal, given that "carbon-heavy industries can keep doing business as usual and then buy indulgences to pretend they have no emissions," the academic responded that "[s]ome industries, like steel, cement, chemicals, and aviation, will be much harder to decarbonize. That's just a reality. I think we should allow reduction efforts to move to where there is lower-hanging fruit, and allowing the sale of offsets, in theory, should do that. It also creates incentives for innovation. We now have startups developing technologies to suck carbon dioxide out of the air and sequester it underground. Direct air capture has a long way to go before it's economically viable, but without a market for offsets, that's not even a potential business."

However, while the idea of using offsets to zero out your emissions sounds good in principle, he said, "offsets vary wildly in quality. You can, for instance, get an offset by paying someone to replant a forest as a carbon sink. That's pretty solid." But companies can also buy "avoidance" offsets, and those can be more problematic: "Suppose a landowner says they're going to burn down a forest for grazing land. They come to you and say, 'I'm standing here with the match. If you pay me, I won't light it. [Laughs] You want to pay?' So those emissions were avoided because of your interference—maybe! How do you know the threat was real?... And by the way, even if you did save the forest this year, there's nothing to stop that guy from burning it down next year or burning a different forest in the meantime." It's not hard to "see how these 'avoidance' offsets might become a racket, with trees being treated as hostages."

But that's not necessarily the case. In this academic paper, which the Stanford academic co-authored, the authors describe "avoidance offsets" as offsets

By contrast, he said in his interview, "paying to capture carbon dioxide and sequester it underground—what we call a 'removal offset'—is pretty permanent." In their paper, the authors describe "removal offsets" as offsets "generated by projects that actively remove carbon dioxide from the atmosphere, and then store the gas for a period of time. Removal offsets also comprise nature- and technology-based solutions. Nature-based removal offsets sequester additional carbon in the biosphere, for instance, through reforestation, afforestation, biochar, ocean fertilization, and soil carbon sequestration.... Technology-based removal offsets involve the capture of CO₂ followed by storage outside of the biosphere."

Some companies have committed to buying only removal offsets, but given their higher cost, not everyone agrees. The academic paper indicates that the Taskforce on Scaling Voluntary Carbon Markets (TSVCM) "calls for reliance on avoidance credits in the short term, as they are currently the most cost-efficient way to reduce overall emissions subject to appropriate verification." Some larger companies, the paper reports, are avoiding the purchase of offsets altogether and "investing instead directly in removal technologies for the long run."

Voluntary carbon markets that trade in offsets have developed, where, according to the academic paper, "buyers who seek to offset their emissions are matched with suppliers who have projects that either avoid CO₂ emissions or remove them. A growing ecosystem is developing to facilitate trades on these voluntary carbon markets—consisting of brokers, exchanges, registries, and verification bodies." These markets, however, are largely unregulated.

The paper notes that offset "transaction prices vary dramatically based on the degree of verification and the geographic location of the offset project." In his interview, the academic commented that differences in quality are typically reflected in transaction prices that can range "from $0.10 to $780/ton, with an average of $3 per metric ton."

According to the academic paper, the TSVCM "reports that 90% of credits do adhere to verification through certification bodies such as Verified Carbon Standard or American Carbon Registry, [but] such verification arguably represents only a minimum standard. There does not appear to be a bright line standard for what constitutes a 'high quality' carbon offset."

Notwithstanding the absence of a bright line for high quality, the paper identifies four criteria for judging the quality of offsets under the acronym PLAN: permanence, or durability, which refers to the "amount of time that the CO? is expected to be stored rather than released into the atmosphere," anywhere from a year to more than a thousand years; leakage, where, in connection with avoidance offsets, the supplier issues credits to preserve a particular forest, but releases the same amount of CO₂ by cutting down another forest in another location; additionality, the requirement that the carbon reduction would not have happened but for the intervention generating the offset; and negativity, the requirement that "emissions generated by implementing an offset project are properly subtracted from the total emissions claimed by the offset."

Additionality may be particularly difficult to show for avoidance offsets where "by definition, the offset hinges on a counterfactual claim." As discussed in the NYT, that means that carbon offsets need to "fund reductions that wouldn't have happened otherwise. If you pay someone to preserve a grove, but they were never actually planning to cut it down, then you're not offsetting your emissions. And it's difficult to establish the facts in these cases with the level of confidence required for offset programs to work." Although programs related to offsets may be useful to "mitigate the damage already done by decades of greenhouse gas emissions," still, the NYT says, "the sticky part is using them to justify more emissions." For these programs to really work, an expert told the NYT, "the programs would need to be designed and administered very differently than they are now, and consumers would need to pay more than the few dollars per ton of carbon dioxide that they currently do."

The SEC proposal for enhanced climate-related disclosure, if adopted largely as proposed, will likely result in greater focus—by investors, regulators and other stakeholders—on companies' carbon footprints and their efforts to reduce the size of those footprints to meet carbon pledges. To be sure, the proposal's mandated transparency surrounding carbon offsets could trigger heightened attention to the quality of those offsets, and, to the extent that purchased offsets prove to be not quite as advertised, there is potential for charges of greenwashing and related reputational damage—not to mention the adverse impact on actual achievement of their climate-related goals. While experts believe that verified, high-quality offsets can have value and will be necessary in many cases, given the wide variety in type, quality, effectiveness and cost, companies purchasing offsets will want to look hard at what they're buying and monitor over the longer term. That could involve establishing new or applying existing control frameworks to these acquisitions and conducting due diligence to assess whether the offsets have been properly verified or authenticated and the extent to which they satisfy the PLAN criteria, being appropriately wary of offsets that may be sketchy.

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