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Carbon Markets: Part 1

Two steps forward or one step back?

80% of all net zero commitments and strategies emphasize the use of carbon offsets to meet them. A report by McKinsey estimates that we would need close to 3 gigatons worth of carbon offset credits to meet corporates' net zero claims by 2030, and 7.5 gigatons by 2050. Trading of carbon credits has expanded significantly over the last 7 years and recent estimates put the total traded value of carbon credits at over USD $2 billion, with approx. $400-500 million carbon credits being traded. The media is flooded with news about how large corporations are looking at different types of credits, usually in emerging markets, as a way to achieve their ambitious net zero targets. It's evident that carbon offsets are thought to play an important role in optimizing the flow of capital into climate projects. While that is the case, we don't believe we're there today.

Sticking with the Status Quo 

The problem we face today is that most companies are looking at re-compensation rather than doing the hard work of avoiding and mitigating GHG emissions. If 80% of a Net Zero plan rests on implementing carbon offset projects, in my mind that's a problem. It’s the age-old way of throwing money at the problem to make it go away. Today one can buy gasoline, oil, cement, or even steel that is “green” from companies, because of the use of carbon credits to offset the emissions in making them. We can continue to consume at the rate at which we do today, without thinking about making resources circular, only because the companies making and selling these products have balance sheets that allow buying offsets. This must change.


Diverging from its principles

Like most self-regulated industries or markets, the greed of capitalism usually twists and turns on its head the principles and intents with which these markets were established. This is the main issue that is plaguing the voluntary markets today. Voluntary standards for issuances of carbon offsets are also being criticized, mainly on the metric of whether those emissions reductions could have happened without the support of carbon offset credits. Comically, even John Oliver (host of HBO’s Last Week Tonight Show, on his Carbon Offset episode) mentions how nature reserves, which are already large carbon sinks, are being bought up by large corporations so that they can get carbon credits issued on them. This goes against the principle of "Additionality", a fundamental concept in the conversation around carbon credits. Only projects that would otherwise not have been realized without the proceeds from the sale of carbon credits, and those that are providing additional reductions in emissions (ie. not reductions in emissions that would have happened anyway), are considered "additional". Hence, buying a piece of nature reserves that already exist is not additional. The Guardian’s investigation into Verra, the world’s leading carbon verifier, found that more than 90% (~90M credits) of their approved rainforest carbon offsets did not represent genuine carbon reductions. While one can make the claim that protection of the environment is equally important, one can also argue that protection should happen regardless. The point is to make corporations allocate their dollars towards new projects.

Dubious track record

The unfortunate reality is that carbon offsets have a long and well-researched history of failures. Whether they realise it or not, far too many offset purchasers end up relying on offsets without really contributing to climate crisis solutions. There is ample evidence to indicate that offsets, by and large, do not reduce the amount of pollution they’re claimed to remove, resulting in temporary and quickly reversed benefits. Carbon removal projects also fail to provide benefits that can’t be accurately measured. The legitimacy of offsets as a climate change solution is being seriously questioned (and increasingly revoked) by civil society groups, academics, and the public at large. These critics fear that offsets empower emitters to continue emitting instead of taking the strategic action required to truly meet their emissions reduction targets. Additional issues about carbon offsets are:

  • Double counting: If carbon credits are used multiple times to offset emissions and not retired after one use, there is a serious risk of double counting of carbon credits. 

  • Measurement and Verification: Measurement and verification standards vary significantly among countries based on capacity and resource availability, affecting the transparency and making it difficult to determine the quality and legitimacy of the credits. 

There are also issues around the pricing of carbon credits, which in some cases do not appear fair or reflective of their value. For example, the average value of carbon credits so far is USD $4 / ton of GHG emissions, which can go up to USD $25 / ton for projects that have additional social benefits – something like Reforestation for example. Comparatively the IMF back in early 2000s, after doing a large amount of research, came to a price estimation of USD $75 / ton, considering all the external impacts the GHGs have. Clearly the impact of negative GHGs have moved since then, with every additional MT having a marginally higher impact, driven by a compounding effect. So, the questions is: are we pricing these credits properly? It seems like, at least today (2023), the answer is no, largely because of asymmetries present in today’s carbon market. 

(Dose of) hope and skepticism

We believe that in order to see carbon markets thrive, there needs to be a change in the Standard Operating Procedures as we know it today. The main focus should be on how we create and retire (use) these credits in all aspects of industry. They should be used as a tool to incentivize change rather than maintain a status quo and “offset” by merely passing an accounting entry. This shouldn't be about financial engineering - this should be about climate re-engineering.

Partner's Note: At Peak, we like to separate signal from noise. Carbon markets have generated a lot of hype, to say the least. Our initial view, like Aadil's, was negative. How can you possible improve corporate behavior if you give them an option to pay some money to offset their polluting businesses? In many ways, it's like telling oil and gas corporations "Hey, keep doing what you're doing. Just throw me a buck so you feel better about yourself". The reality, as described above, is more nuanced. Carbon credits can indeed be a force for good, as long as they are managed in the appropriate way. The issues today primarily relate to measuring the impact of projects accurately, and incentivizing new projects in areas where little work is being done. As of early 2023, the market is still in its early days. We're bullish on companies that have carbon credits as an addition to their core revenue streams, but not as the core revenue stream itself.  

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