Carbon Offsets: Balancing Risk and Reward

Carbon offsets are perhaps the most polarizing option in the climate arsenal. Supporters view them as a way to assist companies in advancing decarbonization efforts by directing funds toward emission-cutting initiatives and encouraging private climate finance for developing countries. Detractors raise concerns that offsets could hamper global climate efforts. They argue that offsets are challenging to monitor and verify, and that they may hinder decarbonization by allowing companies to claim net-zero progress without actually reducing emissions, also known as "greenwashing." While the reality may fall somewhere in between, a cautious approach may be needed.

The concept of carbon offsetting has its roots in 1980/90s' enthusiasm for market-based mechanisms for reducing greenhouse gas emissions. The basic premise is that a party can compensate for their carbon emissions by investing in projects elsewhere that reduce emissions or remove carbon from the atmosphere, for example by planting forests or direct air capture. Paying for these projects via offsets may be cheaper and simpler than the party directly cutting emissions. But the reality of offsetting is far from simple — as the checkered history of the Kyoto Protocol’s Clean Development Mechanism shows. It was widely gamed and many of the credits it produced discredited.

Nonetheless, carbon markets have continued to proliferate. This includes regulated “compliance” markets such as the EU's Emissions Trading System (ETS), which certain industrial sectors are required to participate in, and globally through the so-called voluntary carbon markets used by companies to meet self-imposed climate targets. This “voluntary” market — which might be better described as unregulated or unplanned — has grown rapidly in recent years. It was driven initially by airlines seeking high-quality offsets to offer to customers, and then by growing numbers of companies making net-zero pledges.

Paris Agreement Role

Carbon offsets are recognized in the Paris Agreement as having a critical role in climate policy, with many countries including them as part of their nationally determined contributions. However, progress has been slow in hammering out the rules for their use, and wrangling continues. UN climate talks in Egypt in November kicked the can down the road on some decisions to breathe life into a proposed UN carbon-offsetting mechanism under Article 6 of the deal reached in Paris in 2015.

Following the Paris accord, much of the debate at climate talks has focused on ensuring the integrity of carbon offsets, including their permanence — forests can burn down — and proper accounting to ensure that any emissions reduction is not double counted by a project host country or the home country of any credit purchased.

Voluntary Market Growth

In the absence of a regulated UN market for carbon offsets the voluntary, unregulated carbon market has expanded as corporate and net-zero targets have proliferated. This trade was worth some $2 billion in 2021, and some industry watchers forecast the sector could balloon to up to $50 billion-plus by 2030. Rapid growth has, however, brought problems. Built from the bottom up, the market is highly diverse, with a wide range of projects and standards available. Some of these have come under scrutiny recently over concerns the offset credits don’t deliver the emissions reductions they claim.

Prices for carbon offsets also vary depending on the type of project and the standard used. Old Kyoto-era credits can still be bought for just a few cents, while prices for most new credits range from around $2-$10. This is much cheaper than the $100 level that carbon credits have been trading at recently in the EU's ETS — which does not allow the use of voluntary credits. Environmental activists warn that with cheap credits you probably get what you pay for, which is questionable real-world results.

Pitfalls and Promises

The voluntary carbon-offsetting market faces several challenges, including a lack of transparency, standardization and regulation. Potential pitfalls include whether credits are additional to what would have happened otherwise (such as the building of a renewables project or planting of a forest that would proceed regardless of any carbon credit income they might receive), how they are accounted for, and whether they are permanent.

But the very use of carbon offsets is also controversial, with critics arguing that they are a distraction from the need to reduce emissions at the source. However, proponents of carbon offsetting argue that it is a vital tool to achieve emissions reductions and channel investment to developing countries to support sustainable development and provide economic opportunities for local communities. This is much needed. The Sharm el-Sheikh Implementation Plan agreed at COP27 suggests that investment of at least $4 trillion-$6 trillion a year will be needed to move the world to a low-carbon economy.

Efforts are under way to improve transparency, standardization and regulation of the voluntary markets. The Taskforce on Scaling Voluntary Carbon Markets, launched in 2020, aims to develop a framework for the voluntary carbon market that ensures high-quality offsets and promotes environmental integrity. There are initiatives too from the Integrity Council for the Voluntary Carbon Market and the Voluntary Carbon Markets Integrity Initiative, as well as the US Commodity Futures Trading Commission and the International Organization of Securities Commissions. US climate envoy John Kerry also recently laid out some guiding principles for a carbon offset plan under the Energy Transition Accelerator program that was unveiled last year.

The Bottom Line

Carbon offsetting is a complex and controversial topic but is here to stay as more companies aim to reach net-zero goals. The uncertainties it faces need to be resolved through international efforts as well as collaboration among stakeholders and regulators. At the very least, the climate benefits claimed must be real.

As well as ensuring that the supply of offset credits is gold-plated, how they are used is also critical. If companies want to avoid accusations of greenwashing, they will need to demonstrate that the purchase of offsets is not a substitute for direct emissions-cutting action. Another prevailing view is that offsets should be a temporary backstop rather than a mainstay, except for the most difficult-to-decarbonize sectors. But the real test of offsetting will be whether it can help close the developing world’s climate funding gap.

Ronan Kavanagh is the editor of World Energy Opinion and Energy Intelligence's related Conversation of the Century initiative. A version of this article originally ran in Energy Compass.