Messy Carbon Offsets Show Markets Aren’t Always the Answer

(Bloomberg) --

Big finance and industry have waded into one of the most complicated and fraught parts of tackling climate change: carbon credits.

These are the transactions made, for example, when you pay an airline a small “offset” fee to make your flight carbon neutral. The money is meant to fund projects that remove carbon dioxide from the air, perhaps by planting trees.  

What essentially started as a way to appeal to environmentally conscious consumers has become a key part of many corporate pledges to achieve net-zero emissions, in part because these offsets are often cheaper than actually cutting emissions.

The approach bumps up against the limits of how much greenhouse gas can actually be removed from the atmosphere, given that most methods for doing so are either very expensive, technologically difficult, or require large amounts of land. And the credits are not always what they seem. Bloomberg Green has reported on major players in the offsets world that aren't helping the climate as much as they claim.

Right now, credits for these projects are mostly bought and sold via “over the counter” transactions — one-on-one interactions that are more fragmented and slower than, say, trading crude oil futures in a large, liquid market. A new taskforce hosted by the Institute of International Finance, which represents the world's big banks, asset managers, insurers and funds, wants to change that. This week, the group published recommendations for “scaling up” the markets through which offsets are created and sold.

It's a questionable proposition. When you have a hammer, the saying goes, everything looks like a nail. When you work in finance, protecting the climate might simply look like a matter of ensuring fungible assets can trade freely and transparently in a liquid market.

The IIF taskforce is chaired by Bill Winters, the chief executive of Standard Chartered Plc and supported by Mark Carney, the former Bank of England governor who now has high profile climate-related roles at organizations including the United Nations and Brookfield Asset Management Inc. Members include officials from big airlines, banks, oil and agriculture companies, and commodities traders.

These entities have a lot to gain from a new global environmental market. The financial institutions and commodities houses would have new lines of business, while the companies would have an easier time purchasing the carbon credits required to meet their net-zero pledges.

The taskforce has plenty of experience when it comes to the practical aspects of creating a new market. Their recommendations focus on building trading infrastructure, such as establishing a benchmark contract, and a data protocol to speed up the process of verifying projects. The objective is to create a system where standardized contracts guaranteeing tons of offset carbon can quickly and efficiently change hands.

We already know what these markets look like. In 2020, contracts for roughly 270 billion barrels of crude oil, or about eight years of actual oil production, were traded referencing the New York stock exchange's WTI benchmark alone.

What's less clear is whether the lack of a unified, global market for carbon offsets is the problem that needs to be solved. The taskforce says creating one “will help the private sector mobilize capital to finance the low-carbon transition.” Most climate researchers do agree that some emissions will need to be removed from the atmosphere to reach net-zero emissions. But they also warn that such removals can't substitute for the main priority: cutting emissions from human activities, especially burning fossil fuels.

The fact that one metric ton of CO₂ is interchangeable with another (at least, very broadly speaking) has created an overblown expectation that all climate solutions should be neat, efficient, and financeable. Sure, a ton of CO₂ avoided from leaving coal in the ground might be roughly the same in one place as another, but the same can't be said for protecting ecosystems, or employing complicated technological solutions. The taskforce acknowledges this in a single line: “What makes this scale-up complex from the outside is the inherent heterogeneity… and technical hurdles such as measurement and verification.” It might have to accept the reality that offsets, a broad mix of bespoke carbon removal approaches, simply don't lend themselves to an elegant, scalable market.

The other benefit the taskforce sees in creating a global offsets market is boosting demand. Currently, there are more voluntary carbon credits for sale than buyers wanting to acquire them. “In some sense, there is both a need for new demand—to drive scale—and an excess demand problem here and now,” says Sonja Gibbs, managing director and head of sustainable finance at IIF. The report suggests that, if supply grows at the same rate it has for the past decade, the small, disparate markets currently functioning will only find matching demand in 2030. They estimate that will be 1 billion metric tons per year, based on a survey of experts, or perhaps as much as 2 billion tons. However, the taskforce thinks this number should actually be much, much bigger. It sets out a hypothetical “practical potential” of 8 billion to 12 billion tons per year, if the market it envisions is implemented. 

Aside from these two big assumptions, there's the problem of enforcing standards. The report stresses that trust will be paramount; voluntary carbon markets must have high environmental integrity. It has less to say on how to ensure this, other than proposing a governance body to “host and curate” a set of principles, with its exact architecture yet to be determined.

Ensuring that projects often located in countries far from the buyer's business are not creating land disputes or disenfranchising local residents is not easy. Non-governmental organizations like Carbon Market Watch have documented these sorts of incidents across sub-Saharan Africa and Latin America. If standardized carbon contracts can be bought and sold in large volumes, in an instant, buyers will be even further removed from the underlying projects.

We shouldn't assume that more intermediation, more trading, and more efficiency is what will make voluntary carbon credits more successful at slowing global warming. If integrity is what's needed, buyers of carbon credits might be better served by the current slow, over-the-counter transactions than by a large, abstracted market.

Bloomberg Philanthropies advised the taskforce on funding.

Kate Mackenzie writes the Stranded Assets column for Bloomberg Green. She advises organizations working to limit climate change to the Paris Agreement goals. Follow her on Twitter: @kmac. This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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