Carbon offsets as a potential source of revenue
Renewable energy developers are showing more interest in the voluntary carbon offset market as a potential source of additional revenue for their projects.
Most trading is over the counter. There are various exchanges on which trades can be made. Prices for "avoidance" offsets, which are the kind generated by wind and solar projects, were averaging $7 a ton in February as the NewsWire went to press.
Technology companies, airlines and oil and gas companies have been among the early buyers.
Demand is expected to increase as more companies look to offset their carbon emissions for reputational reasons.
Almost 200 companies committed to "net zero" emissions by signing the Paris climate accord. Many more have made similar pledges since the COP26 UN climate summit in Glasgow in October 2021. These companies can credit carbon offsets purchased in the voluntary carbon offset market toward reaching these goals, as long as certain rules established by article 6 of the Paris climate accord are followed.
However, the lack of standards and quality controls are dampening demand. Companies are reluctant to buy offsets without a way to verify that the promised carbon reductions have actually been delivered.
Once the market can get past these issues, look for offset prices to rise significantly. All signs point to extreme future growth in demand.
Offsets v. Credits
A carbon offset is different from a carbon credit.
A carbon offset represents one metric ton of carbon dioxide or equivalent greenhouse gases that has been avoided or permanently removed from the atmosphere. For example, wind and solar projects can create carbon offsets because the energy produced by these renewable energy projects reduces the amount of energy that must be procured from other projects using fossil fuels. Carbon offsets can also be created by planting and preserving forests that absorb carbon dioxide. There are also various experimental offsets being researched, including enzymes that capture carbon and other processes that capture CO2 in the ocean and turn it into a usable product.
Carbon offsets are traded in voluntary markets, meaning no one is compelled to buy them. The demand for them comes from companies that have set voluntary emissions reductions targets that can be met either by reducing their own emissions directly or effectively by paying someone else to do something that reduces emissions.
In contrast, a carbon credit is a tradeable permit, or right, that allows the holder to emit one metric ton of carbon dioxide or greenhouse gas into the atmosphere. Carbon credits are a creature of government regulations that limit the amount of CO2 or greenhouse gas that can be emitted. When a company subject to such regulation finishes below its required emissions cap, the company earns a carbon credit for every metric ton it is under its cap. It can then sell its carbon credits to other regulated companies that can use the purchased carbon credits to reduce the amount of CO2 or greenhouse gas that they are deemed to emit.
Carbon credits are traded in compliance markets. Trading is limited to the entities and regions covered by the compliance market. Europe is in the forefront of the compliance market with the EU actively managing prices at which credits trade. In the United States, the only large compliance carbon offset program is in California, where the California Air Resources Board oversees trading in "ARB offset credits" which are issued by the Air Resources Board to projects that meet specific requirements.
Companies trade carbon credits because they have to, and they trade carbon offsets because they want to.
The more valuable carbon offsets are those issued by programs with more rigorous rules and standards for offsets.
There are several voluntary carbon offset programs that register projects in the United States, including the American Carbon Registry, the Verified Carbon Standard and the Climate Action Reserve. Once projects are certified and registered by such a program, then the registrant can sell the offsets on the open market. Each program has its own criteria and a dizzying number of acronyms.
The American Carbon Registry standard v7.0 sets out the eligibility criteria for registration of project-based carbon offsets. Following its requirements, according to the American Carbon Registry, will "ensure that project-based offsets represent emissions reductions and removals that are real, additional, permanent, net of leakage, accurately and conservatively quantified, verified by a competent independent third party, and used only once."
Projects verified by the American Carbon Registry are issued verified emissions reductions (VERs).
Projects verified by the Climate Action Reserve end up with registered offsets called Climate Reserve tons (CRTs). CRTs can be converted into verified carbon units (VCUs) and transferred to a VCU registry with Verra.
The carbon offsets created under these programs are traded on various platforms. Each platform is nothing more than a registry. The main voluntary carbon offset registries include the American Carbon Registry, APX Inc., Markit and Verra.
Trading on the American Carbon Registry and Verra is limited to offsets created under programs administered by those platforms while trading on Markit and APX is of multiple environmental-related credits. For example, APX partners with multiple carbon offset programs and administers registries for VCUs, CRTs and VERs.
Carbon offsets are not all equal in terms of value and determining the value of carbon offsets is far from straightforward given the variety of offsets and their varied attributes.
The value of a carbon offset is a function of several factors, including its vintage, the type of project, the volume of credits traded at the time, the geography of the project, the delivery time and whether the offset can be certified.
The "vintage" is the year an offset is created and is a principal marker considered by buyers. Older vintage carbon offsets sell for a discount compared to those of a more recent vintage typically for two reasons. First, some buyers are focused on buying offsets only from "additional" projects. A project is additional if it would not have been developed without the ability to sell the offsets as a source of revenue. Second, some buyers are concerned that older vintage offsets are only still available on the market because the underlying project may be of lower quality.
The type of project from which an offset is created is another key driver of valuation. Carbon credits can be categorized into two broad categories: projects that avoid emitting greenhouse gas emissions elsewhere and projects that remove greenhouse gases from the atmosphere. Avoidance projects include wind, solar and other renewable energy projects, while removal projects include carbon recapture and reforestation.
Carbon offsets generated by removal projects tend to trade at a premium. For example, nature-based removal offsets (those that fall within the forestry, farming and land management category) were trading at a near record high of $22.30 a ton at the beginning of February 2022.
While demand for removal offsets is high, supply continues to lag. The US Department of Agriculture has launched a Climate-Smart Agriculture and Forestry Partnership Initiative that is supposed to create a framework and standardization around "climate-smart" offsets from nature-based removal projects. Others are working to provide farmers with the information and tools they need to document the carbon offsets they are creating so that they will be able to offer them in the voluntary markets.
In contrast, there is a large supply of carbon offsets stemming from existing avoidance projects. If all of these existing avoidance offsets were certified by the existing programs, the number of carbon offsets from older projects would dwarf the demand for such offsets, leading to very low prices.
Many environmental groups object to the certification of these older offsets as there is no real, practical avoidance of global emissions given that the projects have existed for years and the purchase of the related offsets is not an investment in a new project that could lead to additional reductions in future CO2 and greenhouse gas emissions. As a result, the ability to register carbon offsets tied to older avoidance projects is limited under the leading carbon offset programs. For example, with certain exceptions, the Climate Action Reserve does not allow for the issuance of CRTs on a retroactive basis for existing projects.
Finally, the market is moving toward more uniform standards for offsets, but has not yet coalesced around a single set of standards.
Standards are typically set by NGOs. For example, the Taskforce on Scaling Voluntary Carbon Markets announced in September 2021 the formation of an independent governance body for voluntary carbon markets. The group has representatives from 12 countries and is focused on drafting a list of "core carbon principles" that are supposed to serve as a global benchmark for carbon credit quality.
One quality control standard expected to be adopted by the group is that the underlying project must be "additional," meaning that the project would only exist due to proceeds received from its carbon offsets. Other standards address the permanence of the reduction, the accuracy of the estimation of the net greenhouse gas reduction and the presence of additional environmental attributes or benefits.
Oversight of Carbon Markets
Many startup companies have been formed in recent years to focus on carbon reduction issues. These carbon startup companies have been catching eye of investors who are putting significant funding into them.
Some of these startups provide data and insight to voluntary market participants so that companies can have the transparency they need. For example, Sylvera, a London-based startup founded in 2020, aspires to act like a rating agency for carbon offsets in the voluntary market.
These data collecting and verification services will be critical for the voluntary carbon offset market to gain legitimacy with larger, corporate buyers.
S&P Global Platts already tracks sales of carbon offsets that have been certified by the following standards: the Gold Standard, Climate Action Reserve, Verified Carbon Standard, Architecture for REDD+ Transactions and American Carbon Registry. S&P Global Platts provides valuable price data.
Although many transactions in the voluntary carbon market are over-the-counter trades, there are exchanges, such as New York-based Xspansiv and Singapore-based AirCarbon Exchange, on which carbon offsets may be traded.
Seven banks announced plans recently to launch a voluntary carbon market settlement platform called Carbonplace by the end of 2022. The seven banks are CIBC, Itaú Unibanco, National Australia Bank, NatWest Group, UBS, Standard Chartered and BNP Paribas.
The platform will give project developers direct access to customers looking to fund carbon reduction and removal projects. And as the carbon markets continue to gain legitimacy, developers can expect to see many more customers.