How can the Carbon Credit Industry achieve its goals?

In the previous article of the series on Carbon Credits, we explored the functioning of the Carbon Credit industry, the market-makers & rating agencies, as well as the carbon offset project methodology, and delved deeper into the criteria for assessing the quality of carbon offsets. We also identified factors that contribute to inefficiencies in the issuance, monitoring, claiming, and retiring process of carbon offsets. In this second article of the Carbon Credits series, we will explore how buyers and issuers of carbon offsets can avoid the most common inefficiencies mentioned in the previous article to deliver offsets that actually reduce emissions and create a positive environmental and social impact, as well as strategies to avoid lower-quality offset credits to strengthen the carbon offset market.

CARBON CREDIT INDUSTRY

Sumedh Joshi

7/27/20258 min read

The carbon credit industry is no different from the finance industry in terms of the existence of both, investment-grade financial instruments that are quality investment vehicles and subprime or junk instruments that are risky. The Clean Development Mechanism (CDM) and Joint Implementation (JI), two of the world’s largest carbon offset programs under the umbrella of the UN, have estimated that around 60-70% of carbon credits currently trading on the market do not represent valid GHG reductions. The lack of oversight and regulation in the carbon offset market makes it easy for some sellers to fabricate the offset claim, often overestimating and double-counting, a practice called “Greenwashing”. Sometimes, sellers even disregard social and environmental harm caused by primary GHG offset activities. Organizations particular about offsetting their emissions and those with near-future net-zero goals have rigorous standards for selecting what offsets to purchase, because purchasing bogus offsets can harm brand value and lead to unwanted controversies. A prime example is the Kariba offset project in Africa, which discontinued its partnership with South Pole, the world’s largest carbon offset seller, deeming all the offsets linked to the project useless, thereby putting many Fortune 500 organizations that had purchased these offsets in stormy waters. Unfortunately, not all organizations have the resources or give importance to undertaking due diligence activities and knowingly or unknowingly purchase bogus offsets, often defeating the purpose of net emission reduction. This calls for a framework of offset quality assessment that companies can access easily and make informed decisions that create a difference. Having a standard quality assessment criterion not only helps companies and governments decide if the offsets have legitimate claims, but also forces offset sellers to uphold quality standards, in turn supplying legitimate carbon offset credits in the market.

We shall now delve deeper into the points to consider for the quality criteria explained in the first article.

1. Additionality

Additionality refers to the GHG reduction that would not have occurred in the absence of a market for offset credits. Additionality is the most important criterion for assessing the quality of a carbon offset. To ensure that a carbon offset project is additional, offset project developers and buyers should consider the following aspects.

a. A demonstration that the project activity is not legally required – For example, in California, landfill operators are required to install technologies that capture and destroy methane. Carbon offsets that claim additionality based on a legally binding requirement are bogus.

b. An analysis of whether the project is financially attractive in the absence of offset credit revenues. For example, an equipment claiming energy savings can offset the initial investment through avoided energy costs, rather than from the sale of offsets tied to this emission reduction. Any carbon offset project that has 5-10% of the net earnings from the sale of offsets alone fails to create additionality.

c. An analysis demonstrating that at least one alternative to the project would not be prevented by non-financial factors such as social, institutional, or technical barriers. For example, a biogas project planned to be established in a certain area is one of the many alternative green projects that could have been built without any barriers, and is considered additional.

d. A demonstration that the proposed project is not common practice and is different. For example, carbon offset sales from a technology that is novel as compared to other common offset practices prevalent in the area, like setting up energy-saving equipment or methane capture equipment, are considered additional.

It is often very difficult to undertake an objective examination of all of the above factors, and a standardization procedure is necessary. VCS (Verified Carbon Standard) and Gold Standard incorporate over 200 project-specific methodologies and protocols to assess additionality and prevent non-additional offset projects from selling their product to the market.

2. Overestimation

Overestimating GHG reductions is another major problem that plagues the carbon offset industry. This stems from overestimating a project’s baseline emission reductions, underestimating actual emissions, miscalculating the indirect effects of a carbon offset project on GHG emissions called as leakage (the term used for untended increase of GHG emissions due to factors outside the boundary of a carbon offset project), and forwarding credits, where an issuer sells offsets that account for emission reduction expected in the future. The following questions should be asked to assess if an offset hides overestimating.

a. Does the project baseline emissions and actual emissions quantification process account for all of the direct and indirect emission sources? Deviations of baseline emissions from actual emissions introduce overestimation and might result in a discrepancy in the value of net emission reduction.

b. Are the monitoring requirements to collect data for predicting baseline emissions and quantifying a project’s actual emissions accurate? Major carbon offset programs have rules and procedures in place to address gaps in project monitoring data. Offset buyers need to ensure that this data is transparent and easily accessible. Any failure to do so by the issuer should be reviewed thoroughly for overestimation.

3. Permanence

A carbon offset project should result in GHG emissions that are permanent and have a very low risk of reversal (i.e., GHG emissions that are subsequently emitted back into the atmosphere). It is estimated that most of the carbon in a tonne of CO2 will be removed from the atmosphere naturally over time. About 25% of this carbon remains in the atmosphere for hundreds of years. To offset this carbon, projects should employ techniques that permanently store this carbon with very low risk of reversal. An example of reversal risk is a forestation project that locks carbon in the soil and trees only to emit carbon in the event of a wildfire. The following aspects could be used to assess permanence. Most offset issuers provide buffer reserves to address the risk of reversal. This system sets aside offset credits into a common buffer reserve, which acts as insurance. Reversed credits can be drawn upon to compensate for the reversal from any project. If a reversal occurs, credits are retired or cancelled from the buffer reserve. The aspects below should be studied to assess permanence.

a. The risk of reversal or the guarantee period of permanence. Buyers should consider these factors based on the organization’s emission reduction goals. Many issuers provide a minimum guarantee of permanence through the end of the project’s life, which may range from as low as 10 years to as long as 100s of years. The higher the permanence guarantee, the better the offset quality

b. Reversal prevention and mitigation plans. Some programs offer lower buffer reserve contributions if the developers implement risk mitigation strategies. Higher-quality carbon sequestration projects have management plans to lower the risk of reversals. Generally, offsets linked to projects with robust reversal mitigation and prevention measures are of high quality.

4. Double Issuance/Double Use/Double Claiming

Double issuance is a discrepancy where more than one offset credit is issued for the same GHG emission reduction. For example, if the producer and consumer of a biofuel claim emission reduction associated with the same liter of the biofuel and a program issues two offset credits to them, this is double issuance. Established offset issuers are less susceptible to this error. Double use is when two different parties count the same offset credit towards their emission reduction claims. This can be avoided by clearly stating the offset credit retirement protocol that is recorded in the registry once the retirement has been completed. Double claiming happens when offset credits are issued to an offset project, but another entity then counts the same GHG reductions towards its own offset goals. If an energy efficiency project buys offsets for reducing emissions at a power plant (regulatory or voluntary) covered by an emission reduction target, both the project and the power plant would claim the same reduction. Research suggests that this is a pitfall of the Paris Agreement. This can be prevented by not including an offset project’s GHG emission reduction towards the country’s national mitigation targets. To avoid these cases, the offset issuers and buyers must follow the following practices and procedures.

Double Issuance

a. Ensuring that the offset credits are only issued after program approval of emission reduction confirmation reports and documents.

b. Actively monitoring project registrations to check if the project is not issued credits by more than one program for the same emission reduction.

c. Checking accounting boundaries used to quantify GHG reductions for different projects, do not overlap

Double Use

a. Ensuring that the offset credits are assigned a unique serial number and that a digital map of the ownership, transaction, transfer, and retirement is available.

Double Claiming

a. Requiring project developers to sign legal documents to claim emission reductions and to convey these claims to the buyers of the offset credits.

5. Social and Environmental Harms

A good carbon offset project has zero to minimal social and environmental repercussions. Ensuring all legal requirements applicable to the jurisdiction are satisfied should be one of the top priorities of an offset project. Most offset projects undertake local stakeholder engagement prior to the approval and have grievance mechanisms to address issues and impediments arising from various stakeholders. Some offset issuers often include the social and environmental impact metrics to provide a set of offsets for organizations wanting to fund social and environmental causes. An assessment of the following factors is necessary to understand the social and environmental impact of an offset project.

a. Engagement with local stakeholders. Local stakeholder involvement in the early stages of the project ensures that their needs and expectations are met. A failure of the project to present this should sound alarm bells w.r.t the social benefits of the project. It is necessary in developing countries where regulations might not be sufficient to safeguard the interests of local stakeholders.

b. Project certification affirming its environmental or social co-benefits. Certifications like the CCBA (Climate, Community & Biodiversity Alliance) and SOCIALCARBON can provide additional assurance that the project upholds high standards of social development and environmental conservation.

c. Measures that the project has taken to reduce environmental and social harm. Some projects come with higher risks. Projects with high social and environmental risk should assess the project’s circumstances, engage with the local community, address their concerns, and have a mitigation plan if the risks turn into issues. This is especially important in projects that might interfere with the daily activities of locals, like a forestation project that houses a certain tribe or a Carbon Capture Plant in the vicinity of a densely populated area.

Let us look at some additional strategies to avoid low-quality offset credits.

1. Vetting Offset Projects – A screening method to screen out lower-quality credits

2. Lower-Risk Projects – Buying credits that entail low risks from projects that are safer in terms of financial, technological, and social risks, with high co-benefits

3. Discounting offset purchases – Buying extra credits to offset lower equivalent emissions, often referred to as discounting, helps in reducing risks related to non-additionality, overestimation, non-permanence, and claim issues.

4. Assessing the price and vintage - Lower priced offsets raise questions about additionality. Higher-priced offsets are generally high quality but could also be non-additional and falsely overpriced. Vintage refers to the year in which it was issued or the year in which the associated GHG emission reduction occurred. Older vintage projects raise quality concerns if the offsets linked to these projects remain unsold for a long time, and the offset is sold directly by a developer without contracting with the offset buyer, or has continued to operate the project for years with a lack of offset sales.

Carbon offsets are a great solution to decarbonize the operations of our economy. Responsible use of these instruments can be beneficial in reducing emissions and realizing the net-zero goal. The quality of these instruments is linked to the confidence of the buyers in the offset project’s additionality, permanence, and the avoidance of social and environmental harms. This confidence, backed by sound regulatory policies and oversight, can propel the carbon offset industry to new heights. This will not only help in decarbonizing the planet but will also provide incentives to promote cutting-edge research on emission reduction and abatement.

The success of the carbon credit industry lies in the collective response of individuals, organizations, and governments aligning on the shared goal of environmental conservation, technological development, and socio-cultural engagement.

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