Solving the carbon market ‘integrity crisis’

It’s been a rough couple of years for the voluntary carbon market, with allegations about the shaky integrity of various projects, and a huge slump in demand.

Just a few days ago, Brazil’s environment minister warned that the market could be channelling money towards criminal groups that have allegedly been selling carbon credits from stolen land in the Amazon region. For many companies, such controversy makes it hard to see any incentive to buy carbon credits issued by projects aimed at conserving nature.

But this market could still have an important role to play. Perhaps, as we consider in today’s edition, part of the answer is to stop thinking of carbon credits as offsets. Read on and let us know what you think at moralmoneyreply@ft.com, or just reply to this email.

CARBON CREDITS

Can the carbon credit market move beyond offsetting?

A few years ago, the carbon credit market seemed to be at the dawn of an extraordinary expansion, as a growing number of companies began using it to make various sorts of “carbon-neutral” claims. In January 2021, consultancy McKinsey predicted that “the market for carbon credits could be worth upward of $50bn in 2030”.

Since then, a series of publications by academics and journalists has devastated that narrative. Some of these focused on eyebrow-raising marketing stunts by corporate credit buyers, such as TotalEnergies’ attempt to market “carbon-neutral” fossil gas. Others have highlighted problems among carbon credit providers, many of whom appear to have exaggerated the impact of their projects, or trampled on the rights of local communities.

All this has had a disastrous effect on corporate appetite for carbon credits. Annual transaction value, which reached $2.1bn in 2021, fell to $723mn last year, according to Ceezer, a carbon markets-focused enterprise software company.

The non-profit Integrity Council for the Voluntary Carbon Market is hoping to put this market, and its reputation, back on a positive trajectory. Last year, it published its Core Carbon Principles, a framework intended to set clear standards for a space that has been criticised as a “Wild West”.

Yesterday, it announced that carbon credit methodologies linked to renewable energy projects — which account for 32 per cent of credits currently on the market — will not be eligible for CCP approval. That’s because it wasn’t sufficiently clear that the carbon credits issued under these methodologies were having the claimed impact, according to ICVCM chief executive Amy Merrill. Critics have argued that, because renewable energy is now so economically competitive, many of these projects would not have needed income from carbon credits to be viable.

Merrill told me the ICVCM is willing to consider new, more rigorous methodologies around renewable energy projects. For now, the body’s decision to reject such a large part of the existing market will bolster its claim to be imposing a tough new set of standards. “If we want to solve the credibility crisis, then we need to solve the integrity crisis,” said Gilles Dufrasne, policy lead on global carbon markets at the think-tank Carbon Markets Watch. “And it starts by ruling out all of these bad credits.”

Yet even if the ICVCM and market participants can succeed in driving quality higher, this sector’s path to substantial growth remains unclear. Even if every single bad credit were to be eliminated, what would incentivise companies to buy the good ones that remain?

‘An imperfect asset’

Many in this sector have been hoping for a change in stance from the influential non-profit Science-Based Targets initiative, which sets standards for corporate decarbonisation plans.

The SBTi has long said that companies should not use carbon credits as offsets when calculating their emission reductions. A publication last week reaffirmed that position (despite a controversial statement from SBTi’s board in April that suggested it would be dropped). But there are other — and perhaps better — ways for companies to use carbon credits than offsetting.

At the heart of the controversy around offsetting is the problematic assertion that one carbon credit means one fewer tonne of carbon dioxide in the atmosphere. That tidy claim can perhaps be made by some companies in the carbon removal space, such as Switzerland’s Climeworks, that use machines to suck precise quantities of CO2 from the air. When it comes to the far more numerous projects that aim to avoid emissions by protecting trees or building solar farms, however, it looks like false precision.

“The problem with this market is that it’s an imperfect asset,” said Tommy Ricketts, chief executive of BeZero Carbon, a carbon credit rating agency. “It’s not a pure commodity, and everyone knows it’s not.”

Ricketts argues that it’s far better to see carbon credits as securities, like stocks and bonds, rather than as a fungible commodity. “The two most liquid, most sophisticated markets in the world are based on pricing risk, and the performance is basically expressed through that mechanism. And they’re genius at allocating capital,” Ricketts said.

Several of the world’s biggest technology companies, notably Microsoft and Stripe, are now focusing heavily on buying carbon credits from projects that remove carbon from the atmosphere, either through technology or through nature-based approaches like tree planting.

While these credits are much more expensive than avoidance-based credits (which are linked to the estimated emissions that a project prevents), buyers have been attracted to what they see as greater scientific rigour underpinning them. The SBTi has said that companies might be able to use removal-based credits — but not avoidance-based ones — to offset carbon emissions that they are unable to eliminate, in order to claim net zero status.

A different approach

Yet for all the controversy that has surrounded avoidance-based carbon credits, they could yet prove a powerful tool for channelling capital towards protecting natural carbon sinks. The key might be to stop thinking about them as offset instruments.

In a paper published earlier this year, the SBTi suggested a different approach that companies can take to carbon credits. Instead of calculating the emissions associated with its business (or a specific product) and offsetting them, a company can apply an internal carbon price to its operations and supply chain, in effect charging itself a fee for each tonne of carbon dioxide emissions that it’s responsible for. The proceeds of the internal carbon price flow into a fund that will be allocated to carbon credits or other climate-friendly purposes.

Since the company would be working with a fixed budget for carbon credit purchases, it would have an incentive to use these funds to achieve maximum impact, rather than to technically offset a specific amount of emissions as cheaply as possible. If it supports a project that turns out to achieve less impact than hoped, the company won’t be pilloried for false “carbon-neutral” claims, since it hasn’t made them in the first place.

The SBTi paper doesn’t fully address the question of how to ensure that companies set an appropriately high carbon price. Still, if this approach were to become accepted as corporate best practice by businesses, investors and the wider public, it might mobilise significant sums of money to fund nature conservation. If the ICVCM and rating agencies can succeed in raising standards in the space, that money could achieve impact on a serious scale. But after the slump that this sector has suffered, in terms of its volumes and its reputation, that outcome will require a massive amount of work.

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